A House-Senate conference committee approved a final compromise version of the Tax Cuts and Jobs Act on December 15, 2017. Now the final bill must be approved in floor votes in both the House and the Senate, which are expected to occur during the week of December 18. As a conference agreement, the legislation cannot be amended on the floor of either chamber, so the conference version should be viewed as essentially final. Assuming the House and Senate floor votes succeed, the bill is expected to be signed into law before the end of 2017.
This article notes several important provisions of the bill in the areas of corporate and international business taxation, focusing in particular on changes made to the legislation compared with the earlier House- and Senate-passed bills.
Key Corporate Tax Provisions
- The final bill adopts a 21 percent corporate income tax rate on a permanent basis, effective beginning in 2018. The immediate effective date is a welcome change from the Senate Bill (which would have deferred the rate cut until 2019), and the slightly higher rate (21 percent rather than 20 percent in the earlier bills) is a minor and widely anticipated concession to revenue needs in the context of a very large rate reduction relative to current law. Taxpayers may wish to consider measures to accelerate deductions (e.g., for bonus accruals, welfare benefits and pension contributions) into the current year in order to obtain the benefit of those deductions against the higher 35 percent rate.
- A 20 percent deduction is provided for qualified business income of pass-through businesses (sole proprietorships, subchapter S corporations and businesses taxed as partnerships), beginning in 2018 and expiring after 2025.
- The corporate alternative minimum tax (AMT) is eliminated, avoiding a host of issues presented by the late decision to retain the tax in the earlier Senate-passed bill.
- Full expensing of capital assets is provided through 2022, with a phase-down between 2022 and 2027. The “original use” rule does not apply, so taxpayers can obtain full expensing for purchases of used property.
- Whereas the earlier bills adopted a two-pronged approach to limiting the deductibility of interest expense, employing both an “excess leverage” test and a test based on net business interest expense as a percentage of “adjusted taxable income,” the final bill relies exclusively on the latter approach, rejecting the complex excess leverage tests in the earlier bills. The final bill provides that net business interest expense is limited to 30 percent of adjusted taxable income, which is defined roughly as earnings before interest, taxes, depreciation and amortization through 2021, and as earnings before interest and taxes beginning in 2022. Disallowed interest is carried forward indefinitely.
- Net operating losses (NOLs) arising in taxable years beginning after 2017 are limited to 80 percent of taxable income, with no carrybacks and with unlimited carryforwards.
- Section 199 repeal would take effect immediately in 2018, corresponding with the immediate rate cut.
Key International Tax Provisions
- The final bill adopts a participation exemption system in line with the broadly similar proposals in the earlier House and Senate bills. Surprisingly, however, section 956 is retained, even for corporate shareholders that will be entitled to participation exemption on actual dividends. The retention of section 956 will preserve a great deal of unnecessary complexity and leave a trap for the unwary.
- The bifurcated effective tax rates for the transitional deemed repatriation of foreign earnings are higher than under the earlier bills, ending up at 15.5 percent (for cash and cash equivalents) and 8 percent (for other earnings). The final bill also repeals section 958(b)(4) retroactively beginning with the current year, thus providing for downward attribution of foreign-owned stock both generally and for purposes of applying the transition tax.
- The final bill generally adopts the Senate’s provision imposing minimum tax on above-routine foreign earnings (termed global intangible low-tax income or GILTI) on a current basis, at a full 21 percent rate, subject to a 50 percent deduction, as well as a reduced (80 percent) foreign tax credit. As a result, an overall foreign effective tax rate of at least 13.125 percent generally will prevent the imposition of residual US tax. The GILTI deduction is reduced after 2025.
- The final bill also follows the Senate Bill in providing an “innovation box” of sorts by allowing a 37.5 percent deduction for income earned directly by US taxpayers from serving foreign markets (foreign derived intangible income), but without the Senate’s proposal to reduce tax barriers to transferring intangible property from foreign affiliates to a US affiliate. The deduction will result in a 13.125 percent effective tax rate on foreign derived intangible income. The deduction is reduced after 2025.
- Unlike the earlier House and Senate bills, the final bill does not include a permanent extension of the CFC look-through rule of section 954(c)(6). Thus the look-through rule will remain a “tax extender” that will need to be renewed in order to prevent its expiration after 2019.
- The final bill does not include the House Bill’s controversial excise tax on certain payments to related foreign parties that would cause multinational groups subject to the provision to choose between the gross-basis excise tax and an election by the recipient of the payment to treat the amount as effectively connected income. Instead the final bill generally follows the Senate’s base erosion and anti-abuse tax (BEAT) approach by imposing a new alternative minimum tax at a rate of 10 percent. The BEAT is somewhat more narrowly drawn, applicable to a more limited subset of multinational groups and, in most cases, not applicable to cross-border purchases of inventory includible in cost of goods sold. The final bill does, however, slightly reduce the threshold amount of “base erosion” required before a group is subject to the BEAT compared to the earlier Senate Bill.
- The final bill includes the Senate Bill’s anti-hybrid rule denying deductions for interest and royalties paid to related foreign persons, where the payments either are not includible or are deductible in the hands of the recipient in its residence country. The bill also includes the denial of a dividends received deduction for hybrid dividends received from a CFC, and treats hybrid dividends as Subpart F income if received by a CFC.
- The final bill also includes the Senate Bill’s changes to the definition of intangible property and expansions of the Internal Revenue Service’s ability to apply aggregation and “realistic alternatives” theories in connection with taxing the transfer of intangible property by a domestic corporation to a foreign corporation. The final bill also adopts the Senate Bill’s repeal of the active trade or business exception for the outbound transfer of other assets to a foreign corporation.
Barring any last-minute surprises on the House or Senate floors, the stage appears to be set for the bill to be signed into law before the end of 2017. Final passage of the legislation by the end of the year will mean a major year-end sprint for taxpayers and for the Internal Revenue Service. Perhaps the most challenging part of this sprint for multinationals involves the application of the transition tax. The transition tax in the final bill would apply to the last taxable year ending before January 1, 2018, meaning that taxpayers (and their financial auditors) will need to quickly assess the potential impact of the tax. The Treasury Department and the Internal Revenue Service are already hard at work developing much needed guidance on some of these issues.
Looking forward to next year, in light of the vast scope and unprecedented speed of this legislation, countless unanticipated effects undoubtedly will come to light, both favorable and unfavorable for taxpayers. The tax-writing staffs presumably will do what they can to address some of these issues in a “Bluebook” to be prepared by the staff of the Joint Committee on Taxation sometime in 2018. In addition, the staffs will begin compiling a list of “technical corrections” to be enacted through subsequent legislation. The technical corrections process typically relies on a consensus model, but that model has proven challenging in recent years due to the increasingly polarized political environment. Ultimately, a great deal of weight will be placed on Treasury and the Internal Revenue Service to issue a massive volume of guidance, as well as on taxpayers and their advisors to make reasoned judgments in the face of many new complex and uncertain provisions.