How Will Tax Reform Impact Old and New Inverters?
By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott
One of the primary goals of tax reform is to “put American companies on a level playing field with their foreign competitors” 1 in a way that reduces the “tax-driven incentive for foreign takeovers of U.S. firms” 2 and the “financial pressures for U.S. headquartered companies to re- domicile abroad,” 3 colloquially referred to as inverting or expatriating. Summarized below are the proposals in the tax bills under consideration by Congress (a compromise version of which could be released as early as December 15) that could impact past and future inverters:
|
Impacts |
Description |
Found In |
|---|---|---|
|
New inverters (those that first became a surrogate foreign corp during the 10- year period beginning on the date of enactment) |
Repatriation Discount Recapture: If 1) a U.S. corp that owned at least 10% of a foreign corp with post-1986 deferred foreign earnings was taxed on its portion of those earnings at reduced rates (in the tax year that began in 2017) as part of a transition to territorial in tax reform, and 2) that U.S. corp first becomes a 60% and above (but not 80% and above) inverter at any time during the 10-year period beginning on the date of enactment of tax reform, then the earnings that had been taxed at reduced rates will instead be taxed at 35%, with no credits allowed to reduce the liability. |
Senate Sec. 14103 |
|
Old and new inverters |
Increased Rate on Dividends: Any dividends paid in taxable years beginning after 12/31/2017 are not eligible for the qualified dividend (Section 1(h)(11)) rate (20% for high-income individuals) and are taxed instead as ordinary income if paid by a 60% and above inverter (but not 80% and above), even if the corp became a 60% and above inverter as far back as 2004. |
Senate Sec. 14224 |
|
New inverters (those that first became a surrogate foreign corp after 11/9/2017) |
Payments for COGS Included in the BEAT: For purposes of the Senate’s base erosion and anti-abuse tax (BEAT, see page 3 for more), all deductible payments that a U.S. corp makes to a foreign affiliate that is a 60% and above (but not 80% and above) inverter (or is a member of a group that contains an inverter) are included in the BEAT calculation—meaning the exceptions for payments for cost of goods sold (COGS) and payments for services without a markup do not apply. |
Senate Sec. 14401 |
|
New inverters (those that first became a surrogate foreign corp after the date of enactment) |
Increased Insider Excise Tax: Under current law Section 4985, when a U.S. corp inverts, an excise tax of 15 percent of the value of “specified stock compensation” is levied on certain officers and directors of the inverter. While the excise tax essentially reduces the net value of the insiders’ stock-based compensation, it is generally paid by way of a gross-up from the inverter. The proposal increases the excise tax to 20 percent. |
Senate Sec. 13604 |
The House bill 4 contains no provisions exclusively targeted at inverters—only the Senate. 5 But that does not mean that the House bill gives inverters a pass. There are broad provisions in both the House and the Senate bills that would have a profound impact on old and new inverters, but apply more broadly than to just formerly U.S.-parented companies. They work to limit various base erosion strategies often used by inverters to lower their U.S. tax liability. (The following summaries assume tax reform will reduce the U.S. corporate income tax rate to 21 percent.)
|
Impacts |
Description |
Found In |
|---|---|---|
|
Among others, old and new inverters that have a U.S. taxpayer (including partnerships) within their group |
Basic Interest Expense Limitation: Revised tax code Section 163(j), which applies before the BEAT in the case of the Senate bill, limits the deduction for net interest expense to 30% of earnings before interest and taxes (EBIT) but after depreciation and amortization deductions have reduced the amount; the House would limit it to 30% of EBITDA. A possible compromise that is emerging would allow for the more generous limit (30% EBITDA) for the first five years and then switch to 30% EBIT after that. Only one interest expense limit (Section 163(j) or, below, Section 163(n)) applies, whichever is most restrictive. |
Senate Sec. 13301 and House Sec. 3301 |
|
Among others, old and new inverters that have at least one U.S. corp in their groups |
Worldwide Group Leverage Limitation (Thin Cap Rule): New tax code Section 163(n) would limit the net interest expense deduction to 110% of a group’s domestic corps’ share of net interest expense calculated by reference to the group’s global debt-to-equity ratio (defined somewhat differently in the House and Senate). The House provision only applies if the group reports annual gross receipts over $100 million. The Senate version phases in the 110% cap, beginning it at 130% in 2018 and not reaching 110% until 2022. |
Senate Sec. 14221 and House Sec. 4302 |
|
Among others, old and new inverters that have at least one U.S. corp in their groups and if that U.S. corp makes certain deductible payments to a foreign affiliate |
BEAT—Tax on U.S. Corps with Sizable Base Erosion Payments to Foreign Affiliates (Senate) and Excise Tax on Payments by U.S. Corps to Foreign Affiliates and ECI Election (House): Both provisions involve a tax on deductible payments made by a U.S. corp (no matter if the parent is U.S. or foreign) to a related foreign corp. The Senate’s version is an alternative tax regime that applies if the U.S. corp has made a lot of such payments. If the BEAT applies, it adds back into taxable income the payments and taxes the whole amount at 10% (as opposed to the corp’s regular tax liability, which taxes at 21% a smaller amount of income) with no credits allowed to reduce the tax due (except for the research credit until 2025). In the Senate, payments for COGS are excluded (unless the foreign affiliate is or is related to an inverter, see above). In the House, payments for COGS are included no matter if the foreign affiliate is an inverter. The House imposes a 21% tax on all related-party, deductible payments (negating the deduction), unless the foreign affiliate treats the amount received as effectively connected income (ECI), taxed at 21% with deductions allowed for deemed expenses and some foreign tax credits. |
Senate Sec. 14401 And House Sec. 4303 |
The 29 House and Senate lawmakers assigned to the conference committee are working out now which provisions will be included in the final compromise bill, which could be voted on early next week. If approved, it will likely be signed by the President and will become law. We are hearing that the corporate rate will likely be 21 percent, instead of 20 percent, but will be effective in 2018 (whereas the Senate’s bill would have delayed the corporate income tax cut for one year). Additional details on what will be in the compromise bill should be released in the coming days.
[1] https://www.finance.senate.gov/imo/media/doc/12.6%20Policy%20Highlights.pdf
[2] https://www.budget.senate.gov/imo/media/doc/SFC%20Explanation%20of%20the%20Bill.pdf
[3] https://www.budget.senate.gov/imo/media/doc/SFC%20Explanation%20of%20the%20Bill.pdf
[4] For the version of TCJA as it was engrossed in the House November 16, see https://www.congress.gov/115/bills/hr1/BILLS-115hr1eh.pdf.
[5] For the version of H.R. 1, the Tax Cuts and Jobs Act (TCJA), as it was engrossed in the Senate December 8, see https://www.congress.gov/115/bills/hr1/BILLS-115hr1eas.pdf. The “Repatriation Discount Recapture” provision can be found beginning on page 374; the “Increased Rate on Dividends” provision can be found starting on page 423; the “Payments for COGS Included in the BEAT” provision can be found starting on page 444; and the “Increased Insider Excise Tax” provision can be found on page 275
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