International Tax Alert - February 2017

February 2017

Overview of Potential U.S. Corporate Tax Reform:  A Guide to the GOP House Blueprint


In June 2016, Ways and Means Republicans led the effort to unveil a “Better Way for Tax Reform.” This GOP House Blueprint (“the Blueprint”) identifies several problems with the United States current tax system and proposes several changes to such system as it relates to taxation of individuals, pass-through entities and corporations.  This Tax Alert focuses on some of the significant aspects of the Blueprint relating to corporations.1
 

The Global Impact of the Current Tax Code

In discussing the current tax system, the Blueprint notes that the United States has one of the highest corporate tax rates and such rates have encouraged businesses to move overseas.  The corporate tax rate represents an important factor in a company’s decision whether to invest and locate jobs in the United States or overseas. As evidence, the Blueprint highlights that, in 1960, 17 of the 20 largest global companies located their headquarters in the U.S. However, by 2015, only six of the top 20 were located in the United States.  The Blueprint states that one of the consequences of the relatively high U.S. corporate tax rate is that the number of corporate “inversions”—e.g., where a larger American company acquires a smaller foreign company, but locates the headquarters of the new company outside the United States—has accelerated dramatically in recent years. From 2003 through 2011, corporations completed only seven such transactions, or less than one per year on average. But from 2012 through 2015, corporations completed 27 inversions, a pace of almost seven per year. At the same time, an increasing number of U.S. companies are being acquired by foreign companies.

The Blueprint contrasts the U.S. tax system with those of the United States’ trading partners around the world. It notes that the United States uses a worldwide tax system, which means it generally taxes the earnings of U.S. companies overseas when those earnings are brought back to the United States and provides a credit for foreign taxes paid on those earnings. Meanwhile, virtually all of the United States’ major trading partners have adopted territorial tax systems, under which these governments generally do not tax the active business income earned overseas by companies headquartered in their countries. Currently, U.S.-based multinational companies hold more than $2 trillion in capital overseas.
 

The GOP House Blueprint’s Plan to Address Global Competitiveness

To address the recent wave of corporate inversions and make the United States more competitive, the Blueprint proposes reducing the corporate tax rate to 20 percent, switching to a territorial system, and implementing “border adjustments.” The Blueprint seeks to eliminate the existing self-imposed export penalty and import subsidy by moving to a destination-basis tax system. According to the Blueprint, under a destination-basis approach, the tax jurisdiction of income follows the location of consumption rather than the location of production. The Blueprint attempts to achieve this by providing for “border adjustments,” which effectively exempt exports from U.S. tax while taxing imports. Simply put, border adjustments mean that it does not matter where a company is incorporated; sales to U.S. customers are taxed and sales to foreign customers are exempt, regardless of whether the taxpayer is foreign or domestic. The Blueprint also ends the worldwide tax approach of the United States, replacing it with a territorial tax system that is consistent with the approach used by the United States’ major trading partners. The Blueprint states that these structural changes are an attempt to simplify and streamline the international tax rules and to encourage businesses to access “trapped cash” overseas.
 

a. Treatment of Cross-Border Sales, Services and Intangibles 

The Blueprint notes that today, all of the United States’ major trading partners raise a significant portion of their tax revenues through value-added taxes (“VATs”). These VATs include “border adjustability” as a key feature. This means that the tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country. These border adjustments reduce the costs borne by exported products and increase the costs borne by imported products. When the country is trading with another country that similarly imposes a border-adjustable VAT, the effects in both directions are offsetting and the tax costs borne by exports and imports are in relative balance. However, the Blueprint states that balance does not exist when the trading partner is the United States. The Blueprint argues that in the absence of border adjustments, exports from the United States implicitly bear the cost of the U.S. income tax while imports into the United States do not bear any U.S. income tax cost. This amounts to what the Blueprint describes as a “self-imposed unilateral penalty” on U.S. exports and “a self-imposed unilateral subsidy” for U.S. imports.
 
Because the Blueprint reflects a move toward a cash-flow tax approach for businesses, which attempts to reflect a consumption-based tax, the Blueprint argues that the United States will be able to compete on a level playing field by applying border adjustments within the context of a transformed business and corporate tax system. This cash-flow based approach that is proposed to replace the United States’ current income-based approach for taxing both corporate and non-corporate businesses will be applied on a destination basis. This means, according to the Blueprint, that products, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced. It also means that products, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced. This seeks to eliminate the incentives to move or locate operations outside the United States, while allowing U.S. products, services, and intangibles to compete on a more equal footing in both the U.S. market and the global market.
 
The Blueprint also discusses the border adjustments mentioned above and the rules of the World Trade Organization (“WTO”).  It notes that the WTO includes longstanding provisions regarding the use of border adjustments. Under these rules, border adjustments upon exports are permitted with respect to consumption-based taxes, which are referred to as indirect taxes. However, under these rules, border adjustments upon export are not permitted with respect to income taxes, which are referred to as direct taxes. Under WTO rules, the Blueprint notes that the United States has been precluded from applying the border adjustments to U.S. exports and imports necessary to balance the treatment applied by the United States’ trading partners to their exports and imports. By moving toward a consumption-based tax approach, in the form of a cash-flow focused approach for taxing business income, the Blueprint seeks to create the opportunity for the United States to incorporate border adjustments in the new tax system consistent with the WTO rules regarding indirect taxes.2
 

b. Territorial Taxation of U.S.-Based Multinationals 

In an attempt to allow U.S.-based companies to compete in global markets on an equal footing, the Blueprint replaces the existing worldwide tax system by allowing for a 100 percent exemption for dividends from foreign subsidiaries. It also seeks to eliminate the “lock-out effect” of current law, allowing U.S.-based companies to bring home their foreign earnings to be reinvested in United States without additional tax cost.
 
As part of the move to the modern territorial approach to international taxation, the Blueprint will provide rules that will allow foreign earnings that have accumulated overseas under the old system to be brought home. Accumulated foreign earnings will be subject to tax at 8.75 percent to the extent held in cash or cash equivalents and otherwise will be subject to tax at 3.5 percent (with companies able to pay the resulting tax liability over an eight-year period). The Blueprints basically seeks to free up the more than $2 trillion in foreign earnings that have been locked out of the United States under the current tax rules and attempts to reduce the build-up of such earnings.
 

c. Simplification of the International Tax Rules 

According to the Blueprint, the destination-based, territorial approach for international taxation reflected in the Blueprint would allow the subpart F rules of the current international tax regime to be significantly streamlined and simplified.   The Blueprint argues the destination-based approach for cross-border transactions should help level the playing field and eliminate the tax incentives for moving jobs and profits offshore.  As a result, the bulk of the subpart F rules (specifically the foreign base company income rules)—which were designed to counter tax incentives to locate overseas—could be rolled back.  Only the foreign personal holding company rules, which were designed to counter the potential for truly passive income to be shifted to low-tax jurisdictions, will continue to play a role in addressing potential abuse according to the Blueprint.  In addition to these reforms, the Committee on Ways and Means will also consider the appropriate treatment of individuals living and working abroad in today’s globally integrated economy.
 

Summary of Some of the Key Aspects of Corporate/International Tax Reform in the Blueprint

  • Reduces the corporate tax rate to a flat 20 percent.
  • Repeals corporate Alternative Minimum Tax.
  • Allows Net Operating Losses (“NOLs”) to be carried forward indefinitely (no carry back) with adjustments for inflation; NOL carryforwards limited to 90 percent of net taxable income for such year.
  • Allows businesses to immediately write off the full cost of new investments (both tangible and intangible) in the first year.
  • Creates a territorial international tax system.
  • Provides for “border adjustments” as discussed above.
  • Subjects repatriations of accumulated foreign earnings to a tax of 8.75 percent (cash and equivalents) and 3.5 percent (non-cash and equivalents).
  • Limits the application of the Subpart F regime to the Foreign Personal Holding Company rules.
  • Only allows interest expense to be deducted to the extent of interest income; remaining net interest expense would be carried forward indefinitely to offset future net interest income.
  • Provides for a business credit to encourage research and development.
  • Preserves the last-in-first-out method of inventory accounting.
  • Eliminates nearly all other credits/deductions. 


BDO Insights

If the approach to corporate and international tax reform in the Blueprint moves forward in Congress, it would represent a dramatic change to our current worldwide tax system.  There have been several proposals over the last several years to move from a worldwide tax system to a territorial tax system and such a change seems to have momentum in Congress.  However, one of the more controversial items in the Blueprint relates to border adjustments.  There are questions relating to whether such adjustments, as proposed in the Blueprint, would violate the WTO rules. Additionally, it appears that such border adjustments can have a disparate impact on certain taxpayers and industries (e.g., the border adjustments appear to be beneficial for U.S. companies that are net exporters while being detrimental to U.S. companies that are net importers).  However, more details relating to these border adjustments is necessary before determining the full impact they will have. 
 

For more information, please contact one of the following practice leaders:

 
Joe Calianno
Partner and International Tax Technical Practice Leader 
         Brad Rode
Partner  

 
Robert Pedersen
Partner and International Tax Practice Leader
  William F. Roth III
Partner, National Tax Office 

 
Scott Hendon
Partner 
  Jerry Seade
Principal  

 
Annie Lee
Partner 
  Sean Dokko
Senior Manager 

 
Monika Loving
Partner 
  Ryan Thomas
Senior Manager 

 
Chip Morgan
Partner
  Kevin Ainsworth
Senior Manager 

 

1 For a full discussion of the proposals in the Blueprint (along with the proposals to reform the rules relating to individuals and pass-through entities that are not discussed in this Tax Alert), please see “A Better Way: Our Vision for a Confident America,” published June 22, 2016.   

2 Based on language in the Blueprint, it does not appear that the GOP House Republicans view the border adjustments discussed in the Blueprint as a VAT. The Blueprint states the following: “This Blueprint represents a dramatic reform of the current income tax system. This Blueprint does not include a VAT, a sales tax, or any other tax as an addition to the fundamental reforms of the current income tax system.” “A Better Way: Our Vision for a Confident America,” page 15.