US Tax Reform - Coming up Trumps?
Much has been made of Donald Trump’s proposal to reduce the corporate tax rate in the US from 35% to 20%.
Whilst that measure in and of itself is hugely important, both in the US and more broadly throughout the western world, it is some of the additional measures which are likely to cause the real ruckus.
Most significantly, both the US House of Representatives and the Senate have a plan to raise additional revenue in relation to companies which are perceived to have engaged in practices which may have compromised the US tax base.
The House and Senate proposals are quite different both in content and effect – the effect of the House proposal is to raise $US 95 billion over the next decade, whereas the Senate proposal will raise a more substantial $US 140 billion over a similar period.
Whichever is adopted, the likely flow on effect to other countries, such as Australia could be substantial.
I say “could be”, because it is not entirely clear that the effects will be as onerous as may at first appear to be the case.
The House Bill is structured so as to ensure that if a US company sells goods which it has imported from a foreign company, part of the foreign company’s profits will be bought to tax in the US. For example, if an Australian company sells a product to a US company for $200, which the American company then on sells for $250, US corporate tax will apply on the $50 gain at 20%, thus giving rise to $10 of tax in the US.
At this point, somewhat perversely, the US will, under this House Bill, demand that the Australian supplier file a US tax return declaring their profits on that transaction. Thus, if the Australian company had itself purchased that product for $160, thereby delivering a profit to the Australian company of $40, that $40 gain will need to be declared in the US. That $40 gain will then be taxed in the US at 20% giving rise to an $8 liability, but a credit will then be provided for 80% of the Australian tax that was paid on those profits. Presumably, the Australian tax paid on those profits would have been $12 (i.e. 30% of $40). 80% of that $12 is $9.60. The Australian tax paid would then wipe out any further liability in the US, because $9.60 is greater than $8. On that basis no further Australian tax would be payable.
If however the Australian tax for whatever reason was only $6.00 and the US tax remained at $8 the credit would only be for $4.80 (ie 80% of $6.00) and accordingly extra US tax of $3.20 would be payable.
By comparison, the Senate Bill does not require a filing in the US by the Australian company. However, if there are payments to an overseas associate or subsidiary of amounts such as interest, royalties, or management fees, the deductibility of those payments could be effectively reversed.
There are many questions that arise as to how exactly this will play out in the real world, since the calculations both under the House and Senate plans are complex and difficult to apply in practice.
If it does lead to a further US tax imposition, there is clearly a further question to consider as to whether the US is, in introducing these measures, continuing to comply with its many double tax Treaties. There is clearly an argument to suggest that those Treaties preclude such a tax applying particularly of the kind proposed by the US House.
Introducing laws which are in direct conflict with a negotiated Treaty position is known as “unilateral treaty override”, a practice widely criticised in the international tax arena. Nonetheless, in the past, the US has shown a marked propensity to engage in the practice of unilateral treaty override where it suits them to do so and this may well be another instance where this will occur.
In this instance however the ramifications of US unilateral treaty override will be felt far and wide and the whole saga may raise the ongoing viability of the roughly 70 US Treaties which have previously been negotiated on a bona fide bilateral basis between two sovereign nations.
This may well call into question the whole current international framework of bilateral Treaties particularly if other countries take similar steps in response.
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I take this opportunity in the final TaxVine for 2017 to wish all our members and their families a happy and healthy new year. We will return with more in early 2018!
Bob Deutsch, CTA
Editors note: TaxVine will resume on Friday 19 January 2018. Thank you for tuning in to TaxVine each week. We hope you and your families have a happy and safe holiday season.