Businesses in the United States and foreign multinationals with U.S. tax obligations should be aware that the elements of a major U.S. tax reform legislative package are already being developed within the U.S. Congress, the Obama administration, and in interest groups and think tanks in Washington, D.C. The final make-up of this tax reform package — to be debated in Congress starting this year and into 2013 — will depend significantly upon the outcome of the November 2012 U.S. elections. There is little doubt, however, given growing bipartisan interest and growing fiscal pressure, that there will be a significant tax reform package moving in the next Congress.

Late last week, the House of Representatives formally began the process by approving legislation that establishes broad parameters for the substance of tax reform and adopts an expedited process for congressional consideration of tax reform legislation.

Under the House bill, the tax reform legislation must have these key elements:

  • reduction in corporate tax rate and top individual tax rate to 25 per cent
  • repeal of the alternative minimum tax
  • repeal of current tax preferences to provide tax revenue at 18-19 per cent of “the economy” (i.e., Gross Domestic Product)
  • change from a “worldwide” to a “territorial” tax system for overseas operations

In addition, the House bill calls for the introduction of tax reform legislation by April 30 of next year that meets these parameters, with the House Ways and Means Committee to act on the tax reform measure within 20 days. After expedited House Floor consideration, the Senate Finance Committee would have to act within 15 days on the tax reform legislation. Senate Floor debate on each amendment would be time-limited. The tax reform bill could be subject to a 60-vote threshold before moving to final passage in the Senate.

On the Senate side, the Finance Committee took what some members characterized as a first step toward tax reform by culling through the lengthy list of expiring tax incentive provisions known as “tax extenders” which historically have been renewed each year as a group, dropping some 20 current law tax incentives from the renewal package.

To get to a 25 per cent corporate and individual tax rate, tax reform legislation would have to repeal or substantially curtail most current tax preferences. Thus, in assessing the impact of U.S. tax reform, it is important that businesses look beyond the siren call of a lower corporate tax rate. It is the details of elements like these “revenue offsets” and related technical aspects like transition rules that are already in development by congressional and executive branch staff and within interest groups around Washington, D.C. These elements have the potential to result in significant increases in U.S. tax liabilities for both U.S. businesses and foreign-based companies with U.S. operations. The precise impact on a particular business in many cases will depend on arcane details of legislation that is now in formative stages.

Many businesses facing proposals for repeal of their special preferences are already seeking to position themselves vis-à-vis other, “less worthy” industry sectors. In the tax reform debate, it is virtually a certainty that industries will be pitted against one another, and that splits will occur within industries because of the clash of differing business interests.

Therefore, it is critical that businesses operating in the United States become engaged in U.S. tax reform now, beginning with the task of scrutinizing the details of the emerging tax reform plans and assessing the potential impact on their businesses, including running numbers regarding tax and financial statement impacts.

Our tax policy lawyers, including several veterans of the 1986 Tax Reform Act, are already watching and closely involved in developments in this area. If you have concerns regarding how U.S. tax reform will affect your U.S. business operations, we would be happy to provide you with insights on the latest developments and discuss how we can assist you in protecting your interests.

Examples of tax proposals by the administration and Congress under consideration include:

  • repeal accelerated depreciation and replace it with slower “economic” depreciation
  • reduction in deductibility of U.S. interest expense to reduce tax bias toward debt financing
  • significant new “earnings stripping” restrictions on the deductibility of outbound interest and other payments from the U.S. affiliate to its foreign multinational parent
  • require U.S. multinationals to pay a minimum tax on overseas profits
  • defer U.S. interest expense deduction deemed attributable to U.S. multinationals’ foreign earnings until such earnings are repatriated to and taxed in United States
  • impose current taxation on “excess profits” of U.S. multinationals associated with transfers offshore of high value intellectual property to low tax countries and other “tightening” of transfer pricing rules
  • repeal energy industry tax preferences
  • impose an entity level tax on the income of large businesses operated in pass-through (e.g., partnership, LLC, S-Corp, MLP) form