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Treasury & Taxation

Tax Reform Keeps MNCs Guessing

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April 13, 2018

New “hybrid” territorial system perpetuates complexity

financial system softwareTax reform passed at the end of 2017 gives big benefits to corporations and especially multinationals (MNCs), although their tax and treasury departments face major challenges as guidance on how to apply the hastily produced law gradually arrives.

Although the idea of tax reform has been discussed for years, the Republican-led Congress produced the major legislative package—the Tax Cuts and Jobs Act—in seven weeks, and President Trump signed it into law on Dec. 22, 2017. The unprecedentedly quick process has resulted in a law creating interpretative uncertainties and potentially unintended consequences.

Robert Shapiro, head of tax, Americas, at Societe Generale, explained to The NeuGroup’s Group of Thirty (T30) treasurers at a recent meeting that only limited guidance had been released as of mid-March, mainly concerning MNCs’ repatriation tax. He added that regulations to clarify other key provisions probably will not start arriving until summer or fall, at the earliest.

“[The U.S. Treasury Department] has said it will put out some guidance before that, to clarify questions corporate taxpayers may have, especially for U.S. companies with overseas operations,” Mr. Shapiro said. “As of today, it is a challenge to compute 2018 estimated taxes given the lack of clarity in the new law.”

That’s a challenge for corporate tax departments, but treasury executives will also have plenty of decisions to make stemming from tax reform, especially if their companies have overseas operations and cash. Mr. Shapiro noted the shift from a worldwide tax system to a territorial system, which, at least in theory, only taxes a company’s home-country income. He added that more accurately the new law institutes a “hybrid” territorial system that contains provisions ensuring the IRS collects a minimum level of tax on overseas income.

The base erosion anti-abuse tax (BEAT), for example, levies a tax rate of approximately 5% in 2018 when companies make 3% of their deductible expenses related to third parties outside the U.S, and that rate increases to 10% thereafter. The tax is assessed after a complicated calculation that adds back any such “base eroding” payments and a portion of any net operation losses. While “base erosion” commonly refers to gaps in tax rules that enable MNCs to shift profits from high-tax jurisdictions to lower-tax ones, the new BEAT does far more than that by arguably acting as a new alternative minimum tax, Mr. Shapiro said.

Also aiming to ensure a minimum tax on overseas income is the new law’s Global Intangible Low-Tax Income (GILTI) provision. GILTI together with the existing Subpart F rules, which apply to certain categories of passive income, bring different parts of controlled-foreign corporation (CFC) earnings into current taxable income. Income subject to GILTI is a CFC’s gross income less income already taxed as “US effectively connected income,” Subpart F income, certain “high-tax” income, certain foreign oil and gas extraction income, and a deemed fixed 10% return on a CFC’s offshore, depreciable and tangible assets. SocGen notes that a partial tax credit on foreign taxes paid and a 50% deduction allowed for GILTI inclusions effectively bring the GILTI rate down to as low as 10.5% when the foreign effective tax rate is less than 13.125%, and they reduce residual U.S. tax to zero when the foreign effective tax rate is above 13.125%

“GILTI was primarily intended to pick up low-tax countries like Ireland, where the rate is very low, and where many companies have operations that receive royalty streams,” Mr. Shapiro said.

Long-standing US tax rules continue to subject a CFC’s Subpart F income to current U.S. taxation. While the effective U.S. tax rate on Subpart F income is the same as the corporate tax rate (21%), the rules regarding foreign tax credit carry-forwards with respect to that income are generally more favorable than with GILTI income. Thus, companies need to carefully consider the interplay between Subpart F, the GILTI rules and foreign tax credits.

“A company may end up with a lower tax rate, depending on how it manages its foreign operations,” Mr. Shapiro said.

Corporate tax departments in conjunction with treasury will have to study these new provisions carefully, to determine how they impact individual companies and what moves can be made to optimize tax exposures.

Another part of tax reform that stands to have a major impact on treasury is the deemed repatriation of cash and illiquid assets, which will be taxed at 15.5% and 8%, respectively, and those taxes can be paid through an installment plan stretching out eight years. The law doesn’t require companies to bring cash back to the US, nor does it require how that cash is to be put to work.

A recent report from Bank of America noted relatively few announcements in the first quarter of cash being repatriated, perhaps because companies were still getting their ducks in a row, and it predicted a significant pick up in the second quarter. The bank’s analysts say cash returning to the US should strengthen the US dollar.

BofA’s analysis conflicts somewhat with the expectations of T30 members. Only 10% planned on deploying repatriated cash in less than six months, or the first half of the year, while 70% anticipated deploying it in six to 12 months.

When that cash does return and companies’ C-Suites have determined how to use it, it will be up to treasury departments to carry out the plan. Mr. Shapiro said that so far SocGen has mostly heard about companies intentions to buy back shares of stock, and that gels with what T30 members reported before their meeting. Forty-three percent marked share repurchases as the primary expected use of repatriated cash, followed by debt paydown and M&A, each at 36%. Dividends came next, at 22%, and capital expenditures was far down the list, at 14%. Employees fared worse, with increasing employee compensation and benefits, and funding defined benefit plans each garnering a mere 7%.

In terms of the type of debt T30 members plan to pay down, bank debt and reducing debt across the curve each captured 33% of the polling, while reducing CP balances and targeting short-term maturities each got 17%.

So far, only 7% of T30 members reported publicly communicating specific plans to deploy repatriated cash, another 7% plan to do so on their companies’ next earnings call. Twenty-nine percent said they will publicly communicate those plans when strategies have been finalized, and for 36% the amount to be repatriated was too immaterial to matter.

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