After 31 years, Congress has passed major tax reform legislation and sent it to the President for his signature. The bill is the most significant tax reform in a generation and is intended to provide an additional catalyst to grow the economy and stimulate job growth and higher wages. For industrial products organizations in the manufacturing, aerospace and defense, chemical, and automotive sectors, the new provisions are significant and will likely impact their businesses for years to come.
Overall, the sector should benefit from the new tax bill. Lower corporate tax rates, easier access to foreign cash, and a more favorable framework for deducting interest expense than what was proposed in earlier House and Senate versions of the bill, for instance, are designed to attract additional private sector investment dollars that will provide a fiscal policy boost to the US economy. Conversely, there are new rules in the international area that will tax low-tax foreign earnings and certain outbound payments that could prove costly to companies in the sector. In most cases, however, companies in the sector will benefit – some significantly so.
At PwC, we’ve been working to assess the impact of the new rules on go-forward effective tax rates, year-end accounting if the President signs the bill by year-end, and longer-term business implications. Here are some of the bill’s most significant components:
- A 21% corporate tax rate. A new, permanent corporate rate of 21% is effective for tax years beginning after December 31, 2017, allowing companies to realize the tax reform benefits immediately.
- 100% territorial provisions. A 100-percent dividends received deduction for certain qualified foreign source dividends received by US corporations for distributions made after December 31, 2017.
- Mandatory repatriation toll tax. The tax on certain historic foreign earnings deemed repatriated to the US under the bill is higher than previous proposals at 15.5% for cash and cash equivalents and 8% on illiquid assets. Companies should be aware of complex technical definitions and interpretive issues with the new toll tax regime that can lead to more earnings taxed at the cash rate than might be expected.
- The interest deduction limitation. The deduction for net business interest is limited to 30% of ’adjusted taxable income’ with interest that is limited subject to an unlimited carryforward. To assist with transitioning into the new rules, companies will be able to add back depreciation and amortization to adjusted taxable income for taxable years beginning after December 31, 2017, and before January 1, 2022.
- The elimination of one of the two provisions limiting interest expense for US multinationals. Section 163(n) rules contained in both the House and Senate bills would have denied a deduction for certain interest expense of US shareholders that are members of an affiliated group with excess indebtedness. These were controversial as they would have had significant negative impact on a company’s ability to deduct interest. Elimination of Section 163(n) is welcome throughout the industrial products sector.
- Companies can immediately expense the cost of qualified property (including used property) placed in service after September 27, 2017, and before January 1, 2023, with provisions that provide for a phase down of expensing for property placed in service through December 31, 2026. For a sector that both manufactures ‘qualified property’ and invests in it as it digitizes its manufacturing facilities and supply chains, the cost recovery provisions are viewed by many as providing a meaningful investment catalyst for the sector.
- The R&D credit has been retained. A significant rate benefit for many companies in the sector.
- Domestic production deduction and net operating losses (NOLs). The bill eliminates the domestic production deduction and limits NOLs to 80% of taxable income for losses arising after 2017.
- ‘Foreign derived intangible income’ (FDII). Provides a further US tax benefit to companies that export goods and services generated by a trade of business in the United States. While beneficial for many companies in the sector, the FDII provisions have been identified by trading partners in Europe as violative of WTO rules and likely will face legal challenges.
- ‘Global intangible low-taxed income’ (GILTI). Designed to tax low-taxed foreign income that under current law is not taxed until repatriated to the US. For many companies in the sector, the tax cost of the GILTI rules will be an unexpected cost and a drag on future effective tax rates.
- ‘Base erosion and anti-avoidance tax’ (BEAT). A significant new cost for many non-US companies with operations in the United States, the BEAT also will be a cost for many US-headquartered companies, given the evolution of many companies’ global operations and customer base. The BEAT targets certain related-party deductible payments (and, notably, not cost of goods sold) that shift income outside the United States and is imposed if the taxpayer’s modified taxable income (i.e., without the deductible payments) exceeds the taxpayer’s regular taxable income after certain allowable credits.
As companies work through the impact of accounting for the new law in the quarter it is signed by the President, they are also having to work through many challenging interpretative issues. That challenge is significant. There is also a possibility that the SEC could step in before year-end to provide some form of relief to companies facing these late-stage demands, but the form of the relief and whether it will come to pass is still uncertain.
The new tax bill is indeed a pivotal moment for tax practitioners and the companies they assist. The law will change in dramatic ways a company’s tax profile and how they manage their businesses over the long term. The current focus of practitioners to interpret the new guidance and deal with year-end issues is resulting in the busiest December anyone can remember.
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