Companies are concerned about the vague language of the bill about the applicability of the tax, and the fact that bilateral tax treaties, designed to avoid double taxation, will not function well under these circumstances.
One of the more controversial areas of the recently passed House bill (subject to reconciliation with any Senate bill), is the excise tax of 20% on payments from U.S. entities to their related foreign affiliates for services, cost of goods sold and capital assets in exceess of $ 100 mn. The tax will cut across sectors, companies with global integrated supply chains, including tech firms that may be the hardest hit.
A multinational can still choose to treat the income from a payment as “Effectively Connected Income” to a U.S. business and pay the corporate tax of 20% on the net profit. However, it captured the attention of many global companies outside of the U.S. market as many foreign companies are concerned about paying the excise tax on the commercial activity of a U.S. subsidiary while paying again corporate income tax abroad.
Companies may pull out of the US market in the long term. They may have to restructure their businesses depending on the tax rates they pay in other jurisdictions and may also have to re-think their existing transfer pricing practices.
The need to tax
The introduction of the excise tax was driven by the need for revenue to offset the cost of the bill's orporate tax cut. Proponents say the excise tax is designed to encourage "reshoring" business operations and manufacturing back to the U.S. and solve transfer-pricing inefficiencies.
Foreign conglomerates often sell products between entities in the corporate family for inflated prices in order to shift profits from the U.S. to lower-tax jurisdictions. If the tax bill passes, foreign companies in the U.S. will have the choice to pay the excise tax or pay traditional U.S. income tax. American lawmakers hope that the new system will encourage global U.S. and foreign companies to bring back manufacturing to the U.S. and create local jobs, pay the lower excise tax, and pay any remaining taxes in their home countries.
The idea is to practically impose 20% minimum tax by either getting the US entity with foreign affiliates to pay the proposed excise tax at 20% or treat the payment to the foriegn affiliate as subject to proposed US corporate income tax rate of 20% (currently at 35%).
Impact on companies
Yet, observers are concerned about the vague language of the bill with respect to the applicability of the tax, and the fact that the bilateral tax treaties, designed to avoid double taxation, will not function well under these circumstances. Clearly, long-term production and on-shoring will increase economic activity and growth in the U.S. market. Yet, many non-U.S. companies may be concerned about the applicability of the tax mid-term and will try to shift operations outside the U.S. market. CFOs and Treasurers may also need to examine the legality of the transfer-pricing practice of their companies and any potential corporate restructuring in light of the proposed legislation.
Professor Reuven Avi -Yonah, an international tax expert, author and the director of the International Tax LLM Program at the University of Michigan, warned that “The excise tax looks formidable on paper and is sure to enrage our tax treaty partners that will see it as an indirect way of imposing a withholding tax on royalties”. In addition, if the foreign company treats the payments as “Effectively Connected Income” and pays the lower U.S. income tax, it can still deduct royalties and cost of goods sold, practically avoiding the excise tax, notes Avi-Yonah.
Another way for an inverted multinational to avoid this proposed tax is by selling directly to U.S. customers or to unrelated U.S. distributors instead of an intra-company payment.
The U.S. network of bilateral tax treaties is not the only area where the new proposed tax may conflict with international legal commitments. The anti-discrimination trade legal regime is a case in point. As the U.S. administration currently negotiates or re-negotiates existing trade agreements, the ultimate text of any future treaty may not be aliened with the current negotiated new tax bill. Several trade associations, such as the Association of Global Automakers, perceive this tax as a discriminatory tax treatment against inbound companies with an integrated supply chains and investments in the U.S. markets.