By Kate Barton, EY Global Vice Chair-elect, Tax
The US Tax Cuts and Jobs Act (TCJA) is often touted as a landmark reform for the world’s largest economy.
“Taxpayers have been looking forward to tax reform in the US for decades,” says Cathy Koch, EY Americas Tax Policy Leader. “Now that it is law, it will be evaluated in large part on how businesses respond to it. Will we see more investment and more economic activity in the US? Will other countries respond in turn?”
But the new law could also spur global change. Now other countries may be under pressure to review their own tax laws and introduce new rates or policies to remain competitive in the global economy.
US tax reform lowered the country’s corporate tax rate from 35% to 21%, in the process dropping the marginal effective tax rate from 34.6% to 18.9%, according to a paper from the School of Public Policy at the University of Calgary by Philip Bazel, Austin Thompson and Jack Mintz. (Mintz is also a National Strategic Policy Advisor at EY.)
That is lower than the G7 average of 26.9%, and slightly higher than the Organisation for Economic Co-operation and Development (OECD) average, at 18.2%. Countries may lower their headline tax rates and firm up incentives regimes ahead of what’s anticipated to be a shift in where corporations site their functions, corporate investment and intellectual property.
There is much at stake: the TCJA will affect multinational enterprises and their foreign subsidiaries which account for almost 50% of global foreign direct investment (FDI) stock, according to a February 2018 report from the United Nations Conference on Trade and Development (UNCTAD), Tax Reforms in the United States: Implications for International Investment.
“The US reform changes the international landscape,” says Chris Sanger, EY Global Head of Tax Policy. “Other countries are taking note, reviewing their systems and enhancing incentives.”
Marginal effective tax rates on capital for Canada and the United States
(previous and under the final US Tax Cuts and Jobs Act)
Digital disruption, globalization and the global financial crisis have already forced countries around the world to modernize their tax policies. One major global initiative, the Base Erosion and Profiting Shifting (BEPS) project spearheaded by the OECD, is currently being implemented by more than 110 countries around the world. The goal of this initiative is to curtail strategies that utilize gaps in tax rules to shift profits to low-or no-tax locations.
In the European Union (EU), the Competition Commission has investigated tax rulings in Member States and ordered some to collect more tax from the involved corporation. US tax reform could prompt the EU to adopt a common consolidated corporate tax base for member states, says Marlies de Ruiter, EY Global International Tax Services (ITS) Tax Policy Leader.
But while participating governments continue to cooperate on these global initiatives, they are more likely to separately introduce changes to their respective tax policies as a consequence of US tax reform.
The UK, France, Sweden, Belgium and other jurisdictions, for example, also have announced rate cuts for corporate income tax, with countries increasingly settling on a range between 20% and 22%, according to our data.
Incentives will also be a tool to attract investment going forward. While jurisdictions have agreed to review, change and even forego certain types of tax incentives in light of BEPS and other internationally coordinated tax reforms, this doesn’t signal an end to the use of tax incentives to attract investment.
With R&D investment and jobs so highly prized by many countries, tax policy may take on an outsized role in the ongoing global competition to attract this kind of investment. “Countries have already focused on things like having the right infrastructure and workforce,” says Rob Thomas, Director in our Global Tax Policy & Controversy network. “Despite the focus on aligning tax systems, how a country taxes can still be a differentiator for inward investment — albeit under the constraints of the BEPS project.”
In fact, our outlook for global tax policy in 2018 found 14 of 41 countries polled are considering new offerings to attract R&D investment. In Singapore, for example, the 2018 budget released in February 2018 featured several types of incentives. Businesses investing in R&D projects in Singapore will earn a tax deduction of 250% for employee costs and consumables between 2019 and 2025, up from 150% previously. The government also doubled the deduction on the first S$100,000 of licensing costs for intellectual property (IP) registration and in-licensing to 200% for the same time period.
Canada could be among the countries most profoundly impacted by the new US tax laws. It was for years a lower-tax option, and one that offered access to the US via the North American Free Trade Agreement (NAFTA). For new investment in particular, that has changed, with the marginal effective tax rate on investment (METR) at 20.3% in Canada, compared with a decline in the US aggregate METR to 18.9% from 34.6%, according to EY calculations.
Now could be the time for tax reform. Canadian Finance Minister Bill Morneau has pledged to be deliberative rather than impulsive in reacting to the new US tax laws, according to a CBC report in February. Tax policy debates around the world could mushroom into full-fledged tax reforms, which may include lower corporate income tax rates.
China is another country reviewing its tax policy in the wake of the US reform. The Chinese government itself has significant exposure to tax-policy changes as it is the world’s third-largest recipient of foreign investment. Under the current resident-based tax system, China taxes businesses on their worldwide income. A 1-trillion-yuan tax reform plan aims to encourage businesses to invest in China by offering lowered corporate tax rates, value-added tax reforms and tax deferrals on corporate profits reinvested in the country, according to a December 2017 report from the South China Morning Post.
Reactions to US tax reform have come at the multilateral level as well, in particular from the EU. European leaders have raised various concerns in recent months, including that the new US tax law could lead to double taxation and hurt trade, and that it may ultimately not be in line with World Trade Organization (WTO) rules. In March 2018, the EU asked the OECD’s harmful tax practices forum to review the US tax reform, according to a Bloomberg report.
- Although countries are lowering their headline corporate income tax rates, there are other taxes, incentives, exceptions and exit taxes to consider as well when comparing jurisdictions.
- Calculating marginal effective tax rates provides a more complete picture of a multinational’s potential tax exposure on the next dollar invested, as long as the measure reflects state and local taxes, as well as indirect taxes like excise and payroll taxes.
- Businesses should take a global, holistic view, including reviewing R&D incentives that are available to them.
- Business should keep on top of the myriad tax policy changes as they emerge: how countries are implementing BEPS as well as how they are pursuing their own changes affecting tax rates and incentives.
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