US Republican tax reform plan would rewrite international tax system

US House Republicans today presented their long-awaited tax reform bill, proposing to dramatically change the US international tax system.

As expected, the Republican proposal includes a move to a territorial tax system accomplished by a foreign dividends received deduction. This is coupled with a deemed repatriation of existing earnings held offshore. The bill sets the deemed repatriation tax rate at 12 percent for accumulated earnings comprised of cash or cash equivalents and 5 percent for other earnings.

The bill includes some interesting measures designed to prevent tax base erosion.

One provision proposes to currently tax one-half of a US parent corporation’s “foreign high returns.” The tax would apply to profits of a US MNE’s foreign subsidiaries that are greater than a routine profit (defined as 7 percent plus the Federal short-term rate) times the foreign subsidiaries’ aggregate adjusted bases in depreciable tangible property, adjusted downward for interest expense.

The provision is aimed at stopping multinationals from eroding the US tax base by shifting property, such a intangible property and risks, to low tax jurisdictions.

Another provision is designed to curtail inbound earning stripping advantages of foreign-based multinational enterprises that lead to inversions and foreign acquisitions. Under this proposal, a US subsidiary of a foreign multinational must pay a 20 percent excise tax on payments, other than interest, made to related foreign affiliates that are deductible from US tax, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset. The tax can be avoided if the related foreign corporation elects to treat the payments as income effectively connected with the conduct of a US trade or business.

The provision is estimated to bring in $154.5 billion between 2018-2027.

The bill includes two anti-interest stripping provisions, one which limits the interest deduction for corporations to 30 percent of adjusted taxable income and an interest barrier rule, which limits the deduction to the extent a US corporation’s share of its group’s global net interest expense exceeds 110 percent of the US. corporation’s share of the group’s global EBITDA.

The House bill also includes a treaty shopping provision that would deny a tax treaty’s a lower withholding tax rate if the income is deductible in the US and the payment is made by an entity that is controlled by a foreign parent to another entity in a tax treaty jurisdiction that is controlled by the same foreign parent.