The 2017 tax reform reconciliation act (US Tax Act) is the most significant overhaul of the US tax system in decades. In addition to cuts to both company and personal tax, the reform package also contains a range of measures designed to prevent the erosion of the US tax base and boost economic growth by encouraging on-shore manufacturing, growth and investment.
The financial reporting implications of US tax reform
Given this, Australian multinational entities with operations or exposure to the US should carefully consider the impact of US tax reform on their business. Australian subsidiaries of US multinationals should also expect to be affected, particularly if restructures are implemented in light of the changes.
From a financial reporting perspective, it will be important to consider:
- impacts on the 30 June 2018 financial statements;
- forecast impacts beyond 30 June 2018 when several of the measures will take full effect; and
- impacts of any structural, operational, or funding restructures that are brought on by US tax reform.
What are the impacts?
Some of the most significant changes for Australian multinationals with US operations are:
- a reduction in the headline corporate tax rate from 35 per cent to 21 per cent
- the introduction of a Base Erosion Anti-Abuse Tax
- new limitations on interest deductibility in the US
- restrictions related to hybrid transactions and hybrid entities, and
- the ability to immediately deduct the cost of certain depreciable assets.
These are each discussed briefly below.
Reduction in the headline corporate tax rate
The US federal corporate income tax rate is reduced from the existing rate of 35 per cent to 21 per cent with effect from 1 January 2018, regardless of the entity’s tax year. Entities that do not have a 31 December reporting date will be subject initially to a prorated US federal corporate income tax rate that will apply to the first income tax year that ends after 31 December 2017. For example, a 30 June 2018 year-end company would apply a prorated US federal corporate tax rate of approximately 28 per cent, and 21 per cent rate for income years thereafter. State taxes will still apply.
Base Erosion Anti-Abuse Tax
The Base Erosion and Anti-Abuse Tax (BEAT) is a new, minimum corporate income tax. While it is designed as an anti-abuse rule to discourage US tax base erosion through excessive related-party payments to non-US entities, its operation may create challenges for many common business transactions and structures. Intragroup payments such as interest, royalties, or service payments made by the US to foreign related parties should be considered to determine whether they could be affected by the BEAT provisions (resulting in additional US tax costs).
New limitations on interest deductibility
Interest deductions claimed by US groups will be restricted to 30 per cent of “Adjusted Taxable Income” or ATI. ATI is approximately equivalent to EBITDA before 1 January 2022, and approximately equivalent to EBIT thereafter. The tightening of interest deductibility may cause multinational groups to revisit the capital structure of their US operations.
Restrictions related to hybrid transactions and hybrid entities
A new rule has also been introduced to target hybrid arrangements, which are broadly arrangements that give rise to asymmetrical tax outcomes in different jurisdictions (for example, a payment that gives rise to a deduction in one jurisdiction but no corresponding assessable income in the other). These rules can deny US interest and royalty deductions where there is no corresponding assessable income included by a foreign related party due to the existence of a hybrid instrument or entity. Intragroup arrangements should be reviewed to identify whether US deductions could be denied under these provisions. Hybrid rules similar to this are being introduced in several countries (including Australia which is in the process of introducing comprehensive hybrid rules). The interaction of these rules across jurisdictions can be complex and often lead to unanticipated outcomes.
Immediate deductions for the cost of certain depreciable assets
The rules provide for the ability to immediately deduct the cost of certain depreciable assets acquired and placed in service after 27 September 2017, and before 1 January 2023. This is an incentive to encourage investment in US operations and multinational groups should think of the opportunities arising.
Other measures relevant for US groups with foreign subsidiaries (or Australian groups which have intermediate US holding companies that hold other foreign subsidiaries)
There are several significant changes to the taxation of offshore subsidiaries of the US including:
- a one off “toll charge” on undistributed earnings of foreign subsidiaries of 15.5 per cent for cash or cash equivalents and 8 per cent for illiquid assets; and
- exemptions for foreign dividends received by the US, as well as expanded controlled foreign company (CFC) attribution rules.
These measures are intended to tax previously untaxed offshore profits, and also to encourage the repatriation of foreign cash reserves to the US. Several of the largest US corporations have already announced plans for cash repatriation under the new regulations.
Actions for directors and finance teams
- For 30 June year-end companies, the US tax reforms will generally apply from 1 July 2018 with some provisions, such as the rate change, applicable immediately. As such, companies should expect to immediately account for their effect in their group balance sheet.
- Additionally, modelling should be carefully undertaken to appropriately understand the impacts that the various changes will have, including the impacts of any restructuring that is undertaken in light of US tax reform.
- As these changes are far reaching with limited application guidance provided to date, there is likely to be some level of estimation and uncertainty in disclosing the financial reporting impacts. As the IRS provides further guidance on interpretation and implementation, positions may change. Sensitivity analysis should also be performed in relation to areas of uncertainty. Any investor communications should clearly acknowledge the uncertainty of any impact assessment and the potential for further changes. If companies do need to report based on estimates, clear disclosure should be made acknowledging this.
John Ratna, PwC partner; Ronen Vexler, PwC partner; Rohit Raghavan, PwC director
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