February 16, 2018 / North America
An omnipresent policy objective underpinning the Tax Cuts and Jobs Act (TCJA) has been to encourage the speedy return of cash, jobs, capital expenditures (CapEx), and tax revenue back to Uncle Sam. Many critics, and even supporters, of the TCJA have questioned the rushed pace at which the Act was put together. As these new rules rollout, it seems quite possible at least some of the new provisions will ultimately “miss the mark” from a policy standpoint.
One of the core objectives, encouraging domestic CapEx, may in fact already be challenged by a competing international provision promulgated under the Global Intangible Low-Taxed Income (GILTI) regime. At first glance, one may think “What in the (tax) world do either of these two provisions, immediate expensing of CapEx and GILTI, have to do with one another?” But as our favorite cliché tax proverb goes: “the devil is in the details.”
Under the TCJA, our much-adored bonus depreciation applicable to the acquisition of certain tangible, depreciable assets has been temporarily doubled from 50 percent to 100 percent effective September 27, 2017. The immediate expensing of CapEx will begin to phase out starting in the calendar year 2023. Two key elements of “immediate deductibility” are important to remember: 1) this “advantage” is still a “timing difference” and 2) the rule phases out eventually, meaning the unfavorable timing difference could presumably occur in a higher rate environment if the Republican party loses its stronghold on Capitol Hill and the White House.
So how does the discussion above fit into a discussion of GILTI? For those not familiar with GILTI, the “simple” explanation is the generally favorable “participation exemption” system (i.e., a 100 percent dividends-received-deduction for dividends from specified 10 percent owned foreign corporations) is potentially “[T]rumped” by a new aspect of the Subpart F regime that creates a deemed repatriation when the earnings of a controlled foreign corporation (CFC) exceed a 10 percent return on the “qualified business asset investment” of the CFC. The definition of qualified business asset investment generally includes the same class of assets eligible for the 100 percent CapEx deduction.
Using a simple example, assume a CFC earns $100K and has a qualified business asset investment base of $400K in a given year. In this case, a 10 percent return on the $400K would be $40K, leaving $60K as GILTI. The GILTI amount would be currently taxable to its U.S. parent (similar to Subpart F income), but at a lower rate due to a 50 percent deduction granted to domestic corporations against GILTI income. Ignoring the applicability of foreign tax credits, it’s obvious that even a 10.5 percent rate of tax (e.g., 50 percent of the 21 percent corporate tax rate) is a tough pill to swallow as compared to a full exemption of the income. But as compared to the alternative of operating in the U.S., a 10.5 percent rate (even assuming no FTCs) is a lot less than 21 percent (plus the state rate).
There are two key elements of the new U.S. “territorial” tax system to keep in mind going forward…