Near the end of 2017, the US Congress and the Trump Administration enacted the most comprehensive reforms of the US federal tax system in more than 30 years, with many of its provisions taking effect on January 1, 2018 (US Tax Reform).
Having seen US Tax Reform "in action" over the last few months, we set out some of the key issues and opportunities for Chinese companies, financial institutions and funds with operations or investments in the US.
Corporate Income Tax Rate Reduction
The corporate tax rate has been reduced from 35% to 21%.
Net Interest Expense Restriction
The deduction for net interest expense is now limited to an amount equal to 30% of:
Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA) for four years
Earnings before Interest and Taxes but after Depreciation and Amortization (EBIT), which is closer to a company's operating income, after 2021
Other key features of the net interest expense limitation are:
An unlimited carry-forward for any disallowed interest deductions
No exemption for interest on debt incurred before the legislation was enacted (i.e., the limitation applies to interest on new and old debt)
The limitation applies to interest paid to both related and unrelated creditors (although, importantly, there are additional potential limitations for corporations in the case of cross-border interest payments to foreign related parties)
EBITDA / EBIT 30""
The net interest expense limitation does not apply to:
Certain, yet-to-be fully defined, real estate businesses that may be able to elect out of the interest limitation (although, doing so will mean those business lose the temporary right to immediately expense 100% of the acquisition cost of otherwise eligible property)
Businesses with less than US$25 million in gross receipts (with related corporations being aggregated for this purpose)
The limitation applies to partnerships and corporations. In the case of partnerships, the limitation is calculated at the partnership level and partners are generally allowed to use the partnership's unused limitation. If a partnership's EBITDA/EBIT exceeds 30% of its interest expense, the "excess taxable income" is passed to partners for use in determining their limitations on other interest expense.
"TCJA" 2017927202311 100%
A commonly overlooked, yet very significant, provision of the Tax Cuts and Jobs Act (TCJA) allows a temporary right to expense immediately 100% of the acquisition cost of certain new or used tangible property (other than land and buildings) acquired after September 27, 2017, and before January 1, 2023, with the expensing percentage declining after that date.
Net Operating Losses
Net operating losses (NOLs) incurred after 2017 May:
Be carried forward indefinitely
Not be carried back to prior years
Only be used to offset 80% of taxable income in a given taxable year
The tax rate applicable depends on how the earnings have been invested:
Cash or cash equivalents = 15.5%
Other assets = 8%
Taxpayers can elect to pay the tax over a period of years. Individuals who are US shareholders of controlled foreign corporations (CFCs) are also hit with this deemed repatriation tax at somewhat higher rates.
CFC TCJA"F" CFC CFC
International Modified Territorial System
CFC rules are applicable to Chinese corporations and financial institutions with US subsidiaries.
The US "Subpart F" (i.e., CFC rules) have not been significantly modified by TCJA. As a result, some categories of income (e.g., certain types of passive income) earned by a CFC are still subject to full US taxation, in the hands of the US parent shareholder, on a current basis.
There is still some uncertainty related to how the CFC rules and the territorial system of tax will interact. As the Treasury releases more guidance on this issue, there may be planning opportunities available to maximize the benefits of participation exemption and minimize the impact of Subpart F.
International Deemed Repatriation
Prior years' earnings of most foreign corporations with 10% US shareholders (at least one of which is a US corporation) are, to the extent not previously subject to US tax, deemed to have been repatriated and will be subject to US tax immediately.
BEAT "" BEAT2018520192025 10202612.5
International Base Erosion and Antiabuse Tax
The Base Erosion and Anti-abuse Tax (BEAT) functions as a minimum tax and attempts to counter various profit-stripping strategies adopted by international companies, including Chinese companies, with US operations.
The BEAT applies by adding back (i.e., bringing back into tax by denying any deduction) certain specified "base erosion payments" made by certain US corporations. Once determined, the BEAT rate is 5% for 2018, rising to 10% for the period 2019 to 2025, before rising again to 12.5% from 2026.
Cross-border payments of interest and royalties to related entities will not be deductible where either:
There is no corresponding inclusion of income by the recipient
The recipient is also entitled to a deduction because of the hybrid nature of the instrument (or the nature of the entities involved)
" "ECI ECI
International Disposition of Partnership Interests by Non-US Person
Non-US persons that sell or exchange interests in a partnership that is engaged in a US trade or business will now clearly be required to recognize "effectively connected income" (ECI) on the sale of the interest to the extent the partner would have realized ECI had the partnership sold all of its assets. This is a direct legislative rejection of recent US case law to the contrary.
A withholding tax equal to 10% of the amount realized by the selling partner will be imposed.
Daniel F. Roules Partner, Shanghai T +86 21 6103 6309 E email@example.com
Hua Li , Partner, Beijing T + 86 10 6589 3769 E firstname.lastname@example.org
Ju (Lindsay) Zhu Partner, Shanghai T +86 21 6103 6303 E email@example.com
Mitch Thompson Partner, Cleveland T +1 216 479 8794 E firstname.lastname@example.org
The contents of this update are not intended to serve as legal advice related to individual situations or as legal opinions concerning such situations, nor should they be considered a substitute for taking legal advice. Squire Patton Boggs. All Rights Reserved 2018