The newly introduced Tax Cuts and Jobs Act is a comprehensive tax reform package that touches virtually every area of the tax law. Though largely consistent with September's tax reform Framework, new details reveal the potential winners and losers in tax reform, ushering in a critical new phase of scrutiny for the effort.
On November 2, 2017, Chairman Kevin Brady of the House Ways and Means Committee introduced H.R. 1, the "Tax Cut and Jobs Act" (the House Bill), a comprehensive tax reform bill including extensive proposed changes to the corporate and international tax rules. In broad terms, the House Bill is consistent with the nine-page tax reform Framework released by the White House and Republican congressional leadership on September 27, 2017, but as expected, the first look at the details of the legislation reveals the potential winners and losers in tax reform, and thus ushers in a critical new phase of scrutiny for the effort.
The Ways and Means Committee is planning to mark up the House Bill during the week of November 6. It is likely that Chairman Brady will release a revised version of the bill (a Chairman's mark) prior to the start of mark-up, and that many amendments will be made during mark-up. If the committee can agree on an amended bill, then it would go to the House floor for a vote. Meanwhile, the Senate Finance Committee has been hard at work developing its own legislation, which also could be revealed in early November.
The House Bill is a comprehensive tax reform package that touches virtually every area of the tax law. McDermott will provide detailed summaries and analysis of various aspects of this legislation, as well as status updates as the legislation moves forward. In the meantime, this update notes several noteworthy provisions of the House Bill in the areas of corporate and international business taxation.
General Business Taxation
- Corporate income tax rate reduced to 20 percent, with no phase-in or expiration
- Pass-through tax rate (for sole proprietorships, subchapter S corporations and businesses taxes as partnerships) generally reduced to 25 percent, but with a portion of pass-through income treated as individual compensation income, as well as other restrictions intended to limit use of the pass-through rate to avoid the top individual rate
- Accelerated recovery of certain capital expenses, including full expensing for at least a five-year period
- Deductibility of net interest expense only up to 30 percent of "adjusted taxable income" (roughly similar to EBITDA)
- Elimination of the section 199 deduction for domestic production activities, but not the R&D credit or the low-income housing credit
It is noteworthy that the House Bill neither phases in nor sunsets the 20-percent corporate rate. As the various revenue-raising features of the bill come under fire from affected groups, it will be interesting to see if this resolution of the corporate rate issue will hold. The scope of, and restrictions on, the pass-through rate also will be hotly debated.
- Territorial dividend exemption for 100 percent of foreign-source dividends received from foreign subsidiaries (in which a US parent owns at least 10 percent of the stock), also applicable to section 956 inclusions (thus effectively substantially repealing section 956)
- Transition tax on currently accumulated foreign earnings under a deemed-repatriation model, employing a bifurcated rate (12 percent for earnings considered as held in the form of cash or cash equivalents, and five percent for other earnings), with fixed determination dates and an anti-abuse rule designed to prevent manipulation of earnings and cash amounts, and payable over eight years
- Imposition of a minimum tax on above-routine foreign earnings (termed "foreign high returns") on a current basis, at a 10 percent effective rate, subject to a reduced foreign tax credit
- Imposition of a new 20 percent excise tax on deductible payments (other than interest) to related foreign parties (including, for example, most service fees, royalties and payments includible in cost of goods sold or depreciable or amortizable basis), unless the related foreign party elects to treat the payment as "effectively connected income" subject to current-basis US income tax
- Preservation of most existing rules of Subpart F, including the foreign personal holding company income, foreign base company sales income, and foreign base company services income rules, as well as the CFC look-through exception of section 954(c)(6) (which would be made permanent)
- Imposition of a new excess-leverage restriction that limits a US group member's ability to deduct its net interest expense if its share of the worldwide group's net interest expense is more than 110 percent of its share of the group's EBITDA (coordinated with the general 30 percent limit noted above, such that the provision resulting in the greater disallowance amount applies)
- A treaty override, under which a deductible payment otherwise eligible for treaty-based reductions of withholding tax would not be entitled to such treaty benefits if the ultimate foreign parent of the group would not be entitled to withholding tax reductions if it had received such a payment
The international provisions of the House Bill are broadly in line with what had been expected, but with a few notable surprises. The 12 percent cash transition tax rate is significantly higher than had been expected and will prove controversial. The new 20 percent excise tax on certain payments to related foreign parties would be very burdensome to both US-based and non-US-based multinationals, disruptive to normal cross-border business models and presumably objectionable to US treaty partners. The fact that the House Bill relies heavily as a revenue matter on such controversial proposals portends an interesting road ahead.
The process is sure to be contentious, and the outcome uncertain, but the House Bill represents a very useful starting point for the inevitably very difficult work of achieving comprehensive tax reform. The McDermott Tax team is closely monitoring this activity, and is advising clients on potential impacts and planning responses. We will continue to provide general tax reform updates as circumstances warrant, as well as more detailed examinations of specific aspects of tax reform.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.