By Kate Barton, EY Global Vice Chair-elect, Tax
The US Tax Cuts and Jobs Act (TCJA) is giving US companies greater flexibility in terms of what they do with their cash.
US-domiciled companies can repatriate much of the estimated US$2.6t of foreign earnings they hold abroad without a tax penalty through the payment of a one-time transition tax at rates of 15.5% on cash equivalents and 8% on illiquid assets.
The new tax law is designed to encourage investment in the world’s biggest economy, according to its sponsors. The reduction in the corporate income tax rate to 21% from 35% will make the US a more attractive investment location for foreign companies.
“If we have trapped cash in the global system, it means the system is operating inefficiently,” says Marna Ricker, EY Americas Vice Chair-elect, Tax. “The fact we now see a long-term solution is to be welcomed, as is the liquidity boost.”
But ascertaining the consequences and opportunities arising from a law of this complexity is no easy task. When businesses ask Jeff Michalak, EY Global International Tax Services (ITS) Leader-elect, what will change for them, his first advice is: “Model the impact.”
“This is going to be very encompassing, and companies are going to need to do a detailed assessment of the changes and all the aspects that could be relevant to them,” Michalak says.
Headquarters locations of Fortune Global 500 companies
Shift in global business landscape: businesses consider many factors when choosing their global headquarters, including taxes and regulatory policies, regional economic growth, local infrastructure and the labor force. How will the new US tax law affect companies’ decisions?
Source: Fortune Global 500; EY Worldwide Corporate Tax Guide; Organisation for Economic Co-operation and Development (OECD); EY analysis
Seeking US opportunities
Expectations are that the TCJA will boost investment in the US as the new law frees up capital.
Early actions by US businesses offer some insight into the immediate net effects. US companies announced around US$200b of share buybacks in the first quarter of 2018, according to our research. Companies are also returning cash to shareholders via dividend increases, and some have unveiled bonuses or pay increases to staff.
In addition, our recent survey of 500 C-suite level executives at businesses with more than US$500m in annual sales found that 75% of respondents said they were likely to expand their manufacturing in the US because of savings from the new tax law, while 47% plan to use their US tax reform savings to invest more in research and development, and 42% to pursue mergers and acquisitions.
“Looking beyond the headlines, it’s clear that the TCJA is giving businesses confidence to invest more heavily in manufacturing,” Ricker says. “These decisions are directly related to permanently lowering the marginal tax rate on investment.”
Nancy McLernon, President and Chief Executive Officer of the Organization for International Investment (OFII), which represents the interests of US subsidiaries of multinational enterprises, said the new tax law is also enticing foreign companies to expand in the US. “We believe that the changes that were made updated our system and made the US more competitive for foreign direct investment,” McLernon says. She believes that the manufacturing industry could be one of the main beneficiaries of new foreign direct investment (FDI) in the US.
“FDI in the US is predominantly in manufacturing,” McLernon says. First-quarter M&A activity involving US companies hit an all-time record of US$559b, according to our analysis of Dealogic data. While Ricker says technology disruption and efforts to gain or extend market access are currently fueling M&A, some businesses may use the tax savings to accelerate M&A strategies.
The TCJA also contains provisions that allow businesses to immediately expense 100% of certain capital expenditures for five years. But Greg Matlock, EY Americas Energy Tax Services Leader, notes that companies may prefer to move forward with projects already in the pipeline, as well as focusing on acquisitions. Investment, after all, is a strategic activity, and companies only launch new projects after painstaking research into future demand and prospective rates of return, Matlock adds. So the provision will likely be “a stimulus to make capital investment earlier rather than later,” he says.
In the energy sector, for example, the immediate expensing provisions may prove timely for oil, gas, and other natural resource investments and activities, which need substantial capital throughout the value chain. “The timing is great,” says Matlock.
Reviewing the rules
Businesses keen to use the TCJA as an investment springboard need first to undertake a thorough review of its impact on their US operations. “The new rules create a whole lot more complexity for capital structuring for multinationals,” says David Golden, Director of the Capital Markets Tax practice at Ernst & Young LLP.
Foreign-based multinationals are especially affected by two new rules, Golden notes. The first involves changes to Section 163(j) of the US Tax Code, which limits the deductibility of interest payments against tax. As a consequence, “A lot of non-US-based multinationals are rethinking how they provide capital to US subsidiaries, and whether to convert inter-company debt to equity,” says Golden. The provision also impacts domestic companies with significant leverage.
The second is the creation of a base erosion anti-abuse tax (BEAT), which will apply to companies that make cross-border payments to related parties that have the effect of reducing their US tax liabilities. This measure will impact firms that use transfer pricing and make royalty payments to use intellectual property (IP) registered in another market.
The transfer of funds out of the US may be a logical consequence of the company’s geography and business model. But the BEAT rules apply irrespective of the reason for the transfers. For example, many European pharmaceutical companies retain ownership of the patents for medicines they have discovered in their country of origin. US subsidiaries producing these compounds for North American patients pay royalties to a head office in, say, Denmark, France, Germany or the UK.
Will companies change their business models to avoid new taxes under the BEAT rules? Michalak says: “If you needed to build your intangibles in each country on the planet, life becomes very complicated.” From an IP management and protection perspective, he says, that would be a “cumbersome model.”
Congress listened to the concerns of FDI investors, according to McLernon of the OFII. Now, she says, it is important that companies flag any remaining concerns or issues to the US Department of the Treasury and the Internal Revenue Service as they develop their detailed guidance in the months ahead.
- Financing: review the financial structure of your US operations.
- Immediate expensing: determine how you can profit from new deductions
- BEAT: analyze the implications for intangible payments.
- Repatriation of funds: consider how you can free up overseas funds and return them to the US efficiently.
- State taxes: monitor to see how individual states may respond
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