As the glittering Times Square Ball descended on New Year’s Eve, ushering in 2018, it not only marked the beginning of a new year but also heralded a complete overhaul of the tax system for U.S. multinationals. The shift was monumental, transforming the global tax landscape overnight.
The worldwide tax system that had long been in place was swiftly replaced with a territorial system. Capital export neutrality gave way to capital import neutrality, and the corporate tax rate plummeted from 35% to 21%. The implications of these sweeping reforms have rewritten the international tax playbook, but the true impact remains uncertain.
While the reduction in the corporate tax rate and the adoption of a territorial system bring the U.S. more in line with other OECD countries, the reforms also introduce new taxes, bringing fresh complexities to the table.
One such addition is the tax on Global Intangible Low-Taxed Income (GILTI). This tax is levied on U.S. shareholders of a Controlled Foreign Corporation (CFC) when the entity is deemed 'guilty' of generating low-taxed income. The objective of the GILTI tax is to discourage CFCs from relocating to low or no-tax jurisdictions, potentially posing challenges for CFCs engaged in the service industry or with high levels of deductible interest and low book values for depreciable assets.
Another novel tax, the Base Erosion and Anti-Abuse Tax (BEAT), is designed to target related party transactions that erode the U.S. tax base. This provision imposes an excise tax on specified amounts paid by a domestic corporation to a foreign corporation when both entities are members of the same consolidated group. Both the GILTI tax and the BEAT are set at a rate of 10%.
It's crucial to note that these new taxes are applicable to future earnings. However, the transition to a territorial tax system necessitates a one-time transition tax on previously untaxed foreign earnings. Recognizing the potential significance of this transition tax burden for many U.S. multinationals, the legislation allows the payment to be spread over an eight-year period.
The net effect of this new legislative landscape on U.S. multinationals is undeniably a mixed bag. Entities stand to benefit from the reduction in the statutory corporate tax rate and the elimination of U.S. residual taxes on repatriations from foreign subsidiaries. However, some argue that the effective tax rate of many corporations was already below 21%, with existing deferral rules enabling companies to sidestep U.S. residual taxes through strategic tax planning.
Now, as companies transition to the new system, they are required to pay a minimum tax on previously untaxed foreign earnings. Additionally, they must navigate the complexities of new taxes, such as the GILTI tax and the BEAT, introduced under the revised regime. Compounding these challenges are the repeal of the taxpayer-friendly 863(b) source rules, changes in the apportionment of interest expense, and the introduction of a new foreign tax credit basket for branches, limiting opportunities for cross-crediting.
The seismic shift in international tax policy and practices will undoubtedly necessitate thorough analysis and digestion over time. In the interim, accountants and tax attorneys find themselves welcomed into the New Year with an unprecedented workload, emerging as perhaps the most significant beneficiaries under the new legislation. As we navigate through this uncharted territory, the true ramifications of these tax reforms will gradually reveal themselves.