With the emphasis on putting America first and making America great again, President Donald Trump signed a broad tax reform legislation called Tax Cuts and Jobs Act. This comprehensive tax reform is termed as the biggest change to the tax code since 1986 and has been effective from January 2018. It aims to boost employment of Americans while discouraging shifting of jobs overseas and encouraging repatriation of offshore profits to regain domestic economic momentum.
Considering the position of the US in the world economy, such changes are bound to impact local businesses with global operations and inbound investments. So, let us look at the key implications for India-headquartered groups with a presence in the US or US groups with Indian presence or those exploring such opportunities.
Tax rates: The Federal tax rate for US corporations is reduced to 21 per cent (from 35 per cent) and alternative minimum tax has been repealed. With reduced tax outflow, more funds will be available, boosting economic activity and growth rates. In spite of the state tax rates, now the US is a more attractive country with effective tax rates lower than the G-7 nations (except the UK). It will encourage US entities to shift their overseas operations back home. Also, when tested for parameters of tax rates in taking a decision on the intermediate entity for routing further downstream investments, the US entity could be a favourable option.
Base Erosion and Anti-abuse Tax: Introduced as a defence against base erosion, this unilateral tax is applicable to US corporations where annual gross receipts (averaging over the preceding three years) are $500 million or more and related party payments (such as interest, royalty but not cost of goods sold) exceed 3 per cent of total deductions from taxable income. BEAT is calculated at excess of 10 per cent of taxable income over regular tax liability. In situations where BEAT applies, the effective tax rate of US entities could go beyond 21 per cent.
The application of BEAT may affect the goods imported or services availed by US corporations from Indian affiliates. Given the volume of business outsourced to Indian entities in IT, BPO and pharmaceutical sectors, these companies could be severely hit. As BEAT is not like withholding tax and the burden is cast upon US entities, it will be worthwhile to see if intragroup arrangements and supply chains are modified. However, this will be subject to the test of arm's length under transfer pricing guidelines.
Foreign earnings: Certain US shareholders who own stock in foreign corporations will have to pay a one-time transition tax on their share of accumulated overseas earnings (attributable to cash and cash equivalents at 15.5 per cent and attributable to other forms of assets at 8 per cent). This is a deviation from the earlier law where deferral of US taxes was possible if profits were not repatriated to the country. Amendments have also provided for full deduction of foreign-sourced dividend to US shareholders holding at least 10 per cent stake. In case of dividend declared by an Indian subsidiary of a US entity, the Indian company will remain liable for dividend distribution tax, but the dividend income in the hands of the US entity will not be taxable. This makes profit repatriation to the US parent more tax efficient than before.
Interest deduction: In line with the BEPS (base erosion and profit sharing) recommendation, the US tax law has restricted deduction of net interest expense to 30 per cent of adjusted taxable income. The balance unabsorbed interest is eligible for indefinite carry forward, unlike India, which restricts the carry forward to eight years. This limitation applies to interest on local and foreign debts and also captures existing debt arrangements. Due to this constraint, the heavily indebted and primarily debt-funded US companies of Indian groups will need to re-examine the financing structures.
Other areas: The tax reforms also introduced provisions - global intangible low taxed income and foreign derived intangible income - to discourage migration of intangibles and related income outside the US.
Understandably, the tax reform may impact the cost of doing business. In the backdrop of the changing tax landscape across the globe under BEPS initiatives, it will be worthwhile to understand how tax planning, structuring of arrangements and investments for multinational groups take shape post the new US tax code.