Proposed consumption tax would likely streamline corporate treasury.
In short order, President Trump has sought to follow through on his campaign promises to revamp immigration policy and reduce regulation. He has waffled somewhat on how precisely to change the corporate tax code, but the options on the table so far, including a consumption-based tax, would streamline corporate treasury departments.
Republicans in the House of Representatives published “A Better Way; Our Vision for a Confident America,” often referred to as the House tax blueprint, back in June 2016. When faced with criticism President Trump has at times tried to distance himself from the proposal, but more often he has expressed support for its vision of replacing the corporate income tax with a consumption-based tax, in which goods consumed in the US are taxed but those exported are not.
Such a change would require significant systems changes initially, but longer term it could greatly simplify those systems as well a multinational corporations’ (MNCs) global treasury infrastructures.
For example, today MNCs typically have cash management systems in the US and separate treasury centers to manage cash generated overseas, since intercompany lending by US companies from overseas subsidiaries could be deemed a taxable event and trigger the 35% US repatriation tax rate.
“Companies are always careful to not have US members of the group borrow from offshore treasury centers, because that would be a distribution back to the US and subject to tax,” said Chip Harter, a principal in PricewaterhouseCooper’s national tax office in Washington, D.C.
Mr. Harter noted that proposals over the last few years by the Obama administration as well as House Ways and Means Committee Chairman Dave Camp (R-MI) both would have allowed free repatriation of offshore cash, and essentially put a minimum income tax on foreign earnings. In all three cases, Mr. Harter said, “We would no longer need to have this segregation” of cash management systems, “and that would be very significant.”
The earlier proposals are relevant because the House blueprint is likely to face major opposition from US importers as well as US trading partners, which could interpret the tax-free exports as an abrogation of World Trade Organization rules. In that instance, Mr. Harter noted, the Camp and Obama plans offer more traditional alternatives to fall back on that would also eliminate today’s segregation of cash management systems.
That’s not to say, however, that those systems will no longer be needed. Tom Deas, chairman of the National Association of Corporate Treasurers Chairman and former treasurer of FMC Corp., noted that the US’s currently punitive taxes on repatriating cash generated abroad have prompted MNCs to horde large sums of excess cash overseas. He added that MNCs would likely still make use of the treasury centers they’ve established to manage at least some of that cash, since their primary purpose is to facilitate lending between subsidiaries and so reduce bank costs.
“No matter what happens with a potential one-time repatriation tax for offshore cash and changes to tax rules that could make large stores of cash overseas less necessary, companies with a multinational group of subsidiaries will likely still want this 21st century, central-control of cash,” Mr. Deas said.
The decision today by MNCs to store often oodles of cash overseas—billions of dollars in the case of technology, pharmaceutical and other cash-rich companies—requires those companies to invest the funds. Under the House blueprint or the earlier proposals, companies would still retain cash overseas to fund operations and strategic moves, but likely not as much. So there would be less need for treasury to put that excess cash to work.
“A lot of companies would likely choose to liquidate their offshore securities portfolios and distribute the money back to the US group, putting that excess cash to more efficient use, such as buying back shares,” Mr. Harter said. “There’s a lot of cash held by US MNCs in passive investments, so much of it would end up potentially going back to shareholders.”
Eliminating the tax on cash repatriation could also reduce MNCs incentive to fund offshore operations through cash pooling structures. Mr. Deas said that the excess cash MNCs have opted to keep offshore for tax purposes has often “tipped the scale” in favor of overseas capital investments, such as plant expansions.
“With a change in the tax structure, it would tend to make periodic repatriation of cash more attractive,” Mr. Deas said, adding that companies would have less incentive to create R&D centers and other operations, often paying high salaries, outside the US.
Mr. Harter said that that the consumption-based tax would probably be simpler to administer than the current corporate income tax. He added that the House’s version is similar to a “subtraction method VAT (value-added tax),” but in addition to getting a deduction for imports, there are deductions for wages and salaries. Most countries apply VAT and income taxes, so MNCs are familiar with administering VAT-type taxes outside the US and would have to apply that knowledge in the home office.
“It would be a significant change but doable. The systems required would likely be simpler than the ones they already have to administer the corporate income tax, but companies would have to start over with some new systems that aren’t now in place domestically,” Mr. Harter said.
Mr. Deas noted that corporate taxes are essentially divided into two categories: income-based and non-income based. For the latter, US MNCs already have systems in place to track import duties and state sales-and-use taxes, which resemble a consumption tax. Nevertheless, a federal consumption tax would require systems changes, which treasury-system vendors such as SAP and Reval would implement. Those changes would require complying with the Sarbanes-Oxley Act to ensure amounts aren’t misstated on financial statements as well strict rules concerning tax payments to the government that can result in penalties if not followed properly.
“That’s where treasury gets involved,” Mr. Deas said. “Treasury has to work with the tax and procurement departments or whichever department is figuring out the exact payment, to make sure the payment gets to the right place and is paid securely.”
Mr. Deas said that treasury executives will face other considerations that may be impacted under a new tax regime, such as the method of repatriation. A foreign subsidiary can provide a dividend to its immediate parent company, which may be another foreign subsidiary of the international group located in a jurisdiction such as The Netherlands. The foreign subsidiary must have sufficient book reserves in its equity account to declare the dividend, which may be subject to withholding taxes, and often there must be an audit of the official financial statements submitted within the country.
The foreign subsidiary can also lend the funds back to the parent.
“This means eventually the funds will go back to repay the loan and may result in a foreign exchange gain or loss,” Mr. Deas said. “Loans also affect the subsidiary’s balance sheet and may give rise to capitalization issues for the local tax authorities. A loan back to the US parent will generally be considered income for US tax purposes.”