On 2 December 2017, the U.S. Senate passed its version of a bill for Donald Trump’s tax reform plans (Tax Cuts and Jobs Act; TCJA) with a vote of 51 to 49, giving the tax reform, called “historic” in the U.S. Senate’s Finance Committee’s press release, even more impetus. On 16 November 2017, the U.S. House of Representatives passed its own version of the TCJA with a 227 to 205 vote (see the House Ways and Means Committee’s press release), making it a real possibility that the TCJA could be signed by Donald Trump before this year ends – and that the new law could take effect in 2018. Now is the time for German taxpayers with economic ties to the U.S.A. to look into how the new law could affect them.
1. Legislative status and essential contents
The last major U.S. tax reform – which included decreasing the U.S. corporate tax rate from 47% to the current 35% – was in 1986 under the presidency of Ronald Reagan. Since then, there have been many discussions about overhauling the U.S. tax system, but now, with the current combination of a Republican President, a Republican majority (no matter how small) in both the Senate and the House of Representatives and the high political priority given to the issue since the presidential election campaign, the idea has gained traction for the first time – and with previously inconceivable speed – and seems more likely to come to fruition than ever before.
The basis for the current U.S. tax reform ideas can be traced back to a policy paper drafted by the U.S. House of Representatives’ Ways and Means Committee published on 24 June 2016 called the House Republican Blueprint (“Blueprint”). The steps suggested by the Blueprint for achieving the overarching goal of economic growth in the U.S.A. include:
- changing income tax rates and brackets for individuals.
- decreasing the tax burden on transparently taxed corporate profits (“pass-through business income”, e.g. for S Corporations, LLCs, other partnerships and sole proprietorships).
- decreasing the corporate tax rate from 35% to 20% to align with a change in corporate tax developments in the OECD countries.
- eliminating the “alternative minimum tax (“AMT“) for individuals and entities, the intention of which was to ensure a minimum taxation amount by applying two calculation methods and assessing the higher tax amount.
- replacing the worldwide tax approach with a territorial tax system that provides for 100% tax exemption on dividends from foreign subsidiaries. The background is that, under the current system, a significant amount of foreign-earned profit is not being repatriated to the U.S. because this would increase to the U.S. level the tax burden on these profits (“lock-out effect”). The Blueprint also provides for a kind of mandatory tax moratorium under which these foreign-earned profits must be repatriated and taxed at a rate of 8.5% (cash or cash equivalents) or 3.5% (other assets).
- introducing an interest barrier by means of which net interest expense will not be deductible but will be permitted to be carried forward indefinitely.
- permitting immediate write-off of eligible investments (not including real estate).
- introducing a border adjustment, according to which imported goods and services expenses constitute non-deductible business expenses and income derived from export sales is exempt from taxes.
Although the “big six” (six politicians in high positions) strongly denounced the border adjustment in a joint statement issued on 27 July 2017, their policy statement published on 27 September 2017 under the title “Unified Framework for Fixing our Broken Tax Code”includes two additional important items:
- introducing rules to secure the U.S. tax base.
- limiting the immediate write-off option to five years.
These items – with more or less significant changes in content – are also found in the versions of the TCJA that have now been issued by the U.S. House of Representatives and Senate, which also contain numerous other additions. The following table provides a – rough and not exhaustive – overview of selected commonalities and differences of the two bills regarding intended changes in corporate taxation:
The legislative process now calls for both versions to be merged into a version coordinated between the Senate and the House of Representatives for a new vote. On 1 December 2017, the Joint Committee on Taxation of the U.S. Congress published a comparison report showing the commonalities and differences between the various TCJA versions. It is not inconceivable that the final version can be submitted to the President even before 24 December 2017..
2. Consequences for German taxpayers with U.S. ties (“outbound investments”)
The consequences for German taxpayers with U.S. ties must be determined separately for each individual case, and the benefits or disadvantages can be significant. Thus, the following – by no means complete – list of consequences must be examined in the context of an overall viewpoint at company as well as group level regarding their effect on tax structuring, tax returns and (group) accounting:
- Depending on the period in which the TCJA is in effect and subject to profit calculation according to German principles for the U.S. corporations involved, due to the – now very probable – decrease in the U.S. federal corporate tax to 20%, a low taxation within the meaning of section 8(3) of the German Act on Taxation with Foreign Involvement (Aussensteuergesetz; AStG) could be given and, for German shareholders with U.S. subsidiaries, lead to controlled foreign corporation (CFC) rules, with all of the accompanying declaration obligations and a possibly significant tax burden. In this context, an eye should be kept on the possible reformation of CFC taxation in German law in the context of the implementation of the EU Anti-Tax Avoidance Directives I and II (ATAD I and II).
- On the other hand, especially for individuals, the privileges provided for in the TCJA (25% maximum tax rate or decrease in taxable income, see above) could make future pass-through business income advantageous and lead to tax reduction.
- The tax benefits and reductions provided for in the TCJA are to be considered in light of a (compensatory) expansion of the U.S. tax base – especially at the cost of cross-border structures. The tax burden involved (especially regarding the interest barrier, the restriction on loss deduction and the rules to protect the U.S. tax base in international groups of companies) is to be calculated based on each individual case and – depending on the current structuring of group-internal deliveries and services – can also constitute an occasion to review and adjust presently practiced business models.
In summary, there is currently a great deal of uncertainty as to what impact the implementation of the U.S. tax reform will have (possibly very soon) on tax and accounting for German taxpayers. Nevertheless, the basic principles of the draft legislation versions proposed by the Senate and House of Representatives, which are now available for review, have been set and should be taken into consideration in the tax and accounting (group) planning of German taxpayers with U.S. ties as soon as possible.