November 2, 2017 / North America
Today, the House Ways and Means Committee released the statutory language and detailed explanation of its long-awaited, 429-page tax reform bill, the Tax Cuts and Jobs Act. This bill is the culmination of more than a year of anticipation and speculation about competing plans, from the 2016 House Blueprint, to candidate Trump’s plan, to President Trump’s April one-pager and most recently to the September Framework proposal. We are feverishly reviewing the package for our clients; watch for coming editions of Tax Advisor Weekly where we will share our planning insights.
Throughout the tax reform process, taxpayers have been confused and frustrated by the lack of details as to any of the proposed changes, and it is important to keep in mind that today’s release is only the beginning of the legislative process (discussed in more detail below). Nonetheless, this Ways and Means Committee release provides our first window into that place where the devil reportedly resides (i.e., in the details). The details will allow taxpayers to assess how the proposed legislation (if enacted) would really affect them. There will be a great deal to digest over the coming days, but for now, we touch on some of the highpoints of the major elements of the Ways and Means proposal.
While we expected some surprises in today’s bill, a few provisions are nothing short of bombshells.
Interest deductions were always expected to be a target. And indeed, the Ways and Means proposal puts a limit on interest deductions of 30% of adjusted taxable income (a proxy for EBITDA). But unlike the current interest limitation rules, which generally apply only to inbound companies with related-party debt, the bill targets any company (foreign or domestic), regardless of form, and applies to both related and third-party debts. However, this limitation would only apply to companies with gross receipts of at least $25 million.
The bill also includes surprise implications for multinational companies, going well beyond a purported shift to a territorial system. The House had been advertising its efforts to “level the playing field” between U.S. and non-U.S. companies, and we now know what that actually means.
The House bill includes a new 20% excise tax on payments by U.S. companies to related foreign parties, unless the foreign party elects to treat the payment as effectively connected income. This excise tax would not apply to interest or to payments made at cost (i.e., without markup) and would not be effective until 2019. While the so-called “border adjustment” tax was thought to be dead weeks ago, this provision appears strangely similar, albeit with a smaller scope.
Further, the House offered up a substantially more complicated “minimum tax on foreign earnings” than anyone had anticipated. Rather than a single minimum rate on earnings, foreign subsidiary income would be measured against a Treasury-determined rate of return, effectively creating a new category of Subpart F income. If the foreign return on tangible assets exceeds 7% plus the federal short-term rate, those earnings would be considered “foreign high returns.” U.S. shareholders (including individuals, not just U.S. parent companies) would be required to recognize 50% of those foreign high returns in their taxable income, with a partial foreign tax credit available.
The bill proposes limiting foreign persons’ ability to reduce withholding rates on payments from related U.S. persons on fixed, determinable, annual or periodical (FDAP) income. Under the proposal, the 30% withholding rate on payments of FDAP income would not be reduced under an applicable treaty if the payor and the payee have a common parent who would, itself, not qualify for reduced rates under the treaty. This will most certainly raise objections from some of our treaty partners.
Perhaps the biggest bombshell is a somewhat hidden one. The combination of the new Subpart F category for “foreign high returns” coupled with the retention of many of the existing Subpart F provisions would serve to make the new corporate tax system a more pure form of a worldwide system — not a territorial system as touted by the Framework and before that the Blueprint. Under the current system, taxpayers at least had the possibility of “deferral.” The proposed new system would appear to impose significant taxes on the foreign income of U.S. corporations with no possibility of deferral.
In short, any hopes for a simplified tax code (at least with respect to multinationals) can be forgotten — the House bill adds substantial new complexities that we will be digging further into over the coming days.
Additional Details from the House Bill
While the House has kept things exciting with a few surprises, the rest of the bill offered details that have been foreshadowed for the past few weeks:
Tax Rates for Corporations
– Rate would be cut from 35% to 20%.
Tax Rates for Non-Corporate Businesses
– Rate on income generated through pass-through entities (e.g., partnerships, S‑corporations, etc.) would be reduced to 25%, with limitations and exceptions for professional services firms and owners actively involved in the business.
Expensing of Capital Investments
– Immediate deductions for capital expenditures would be available for the next five years, with exceptions for real property businesses.
Other Business Deductions and Credits
– The domestic production activities deduction (i.e., Section 199) would be repealed.
– The research & development credit would be preserved.
Provisions to Enhance Global Competitiveness
– Dividends received by U.S. corporations from their foreign subsidiaries would not be subject to U.S. taxation.
– A one-time toll charge would apply on previously unrepatriated earnings and profits of foreign subsidiaries: 12% rate of tax on cash and 5% rate on non-cash earnings and profits, payable over eight years with a partial foreign tax credit offset available.
Taxation of Individuals and Families
– Brackets reduced from seven to four, of 12%, 25%, 35% and 39.6%: top rate would stay the same, but lowest rate would increase from 10% to 12%.
– Increase in standard deductions and elimination of exemptions: $12,200 standard deduction for individuals and $24,400 for married couples filing jointly, up from $6,350 and $12,700, respectively, for 2017.
– Elimination of SALT deduction.
– Inclusion of itemized deduction for property taxes, up to $10,000.
– Existing 401(k) rules are largely kept intact.