On 2 December 2017, the US Senate passed its version of tax reform legislation ("Senate Bill") by 51 votes to 49, while the House passed its own version ("House Bill") on 16 November 2017. The next step is for the House and Senate to reconcile the differences between their respective bills.
Should the reconciliation go fast enough, US tax reform is likely to be enacted by the end of 2017. On top of decreasing the US corporate tax rate from 35% to 20%,1 both the House Bill and the Senate Bill also affect multinationals investing in or from the US. This would be the first major tax reform in the US since 1986.
The Senate Bill also aims to implement the OECD's BEPS action 2 on hybrid mismatches, so contrasts with the House Bill and the country's past policy in this respect.
The purpose of this post is not to provide exhaustive highlights of the bills, but rather to focus on some specific measures that are likely to affect both US inbound and outbound investments, also in the light of a Luxembourg context. For more detailed information on the US tax reform, please refer to KPMG US newsletters.
Although US tax rules are very complex and no final conclusion can be drawn at this stage of the legislative process, it seems that this reform could affect multinationals investing in or from the US as follows:
- US outbound: a shift
from worldwide taxation with a tax deferral system, to current year
taxation of certain foreign income (at reduced rates)2 with
participation exemption upon repatriation.
As a transition to the new regime, mandatory deemed repatriation of previously untaxed "old earnings" (i.e. post-1986 deferred foreign income)3 would apply.
Such provisions may affect the European financing hubs/treasury centres of US taxable multinationals, the income of which could potentially—depending on their nature and other tax factors pertaining to the foreign subsidiaries of the group—be subject to final US current year taxation (at the above-mentioned reduced rates), with no incremental US tax upon distribution/repatriation to their US corporate shareholder;4 this would therefore contrast with the current tax deferral system.
- US inbound:
anti-base erosion provisions would be introduced, including but not
limited to interest deduction limitations and anti-hybrid measures.
The Senate Bill's anti-hybrid rules, which would apply to
taxable years beginning after 31 December 2017, target hybrid loans
directly granted to US affiliated companies by denying interest
deduction in the US if (for example) there is no inclusion of such
interest at the level of the foreign affiliated lender. However,
these anti-hybrid rules also put the funding of the foreign
affiliated lender under potential scrutiny, for example by allowing
further guidance by the Treasury on conduit arrangements involving
hybrid transactions (or so-called "imported mismatch"
rules) as illustrated below.
Whether or when—and with or without retroactive effects—such guidance is issued remains uncertain at this stage.
The proposed US tax reform definitely confirms the general tax trends of implementing anti-base erosion rules and of reducing corporate tax rates, which aligns with objectives evident in various measures and directives at European Union level. Nevertheless, this does not mean that the US and the EU are fully convergent in this area: EU finance ministers, who met on 5 December 2017 (Ecofin meeting), have raised concerns about the potential conflicts of the US tax reform with double tax treaties and the World Trade Organization rules, and have asked the EU Commission to monitor this issue.
If the US tax reform is enacted in 2017, and given that no grandfathering is expected on the above-described measures, both US and non-US multinationals will be hit with immediate effect, forcing them to assess the impact of the reform and revisit, where necessary, how they structure and manage their cross-border operations and investments.
It is thus needless to say that adequate substance and proper governance tools are, more than ever, key to success.
1 20% rate applicable as from 2018 under the House Bill and 2019 under the Senate Bill
2 10% under the House Bill, and 10% from 2019 until 2025 and 12.5% thereafter under the Senate Bill
3 Under the Senate Bill, for corporate shareholders, a 14.5% rate would apply to cash and cash equivalents and a 7.5% rate would apply to illiquid assets (respectively 14% and 7% as per the House Bill).
4 The dividend exemption would nevertheless not apply to hybrid dividends, which are deductible in the source country and can therefore not be tax-exempt in the US.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.