US Senate passes tax reform bill increasing tax rate on deemed repatriation of foreign profits

by Julie Martin

The US Senate early Saturday morning passed its version of tax reform in a 51-49 vote. Like the House bill, passed in November, the Senate bill’s international tax provisions would dramatically alter the US international tax system, moving the US to territorial tax system by means of a dividend exemption system.

In a late change, the Senate increased the tax rate on the deemed repatriation of currently deferred foreign profits to 14.5 percent for cash and cash-equivalent earnings and 7.5 percent for other profits, almost matching the House bill’s 14 and 7 percent rates.

The original Senate proposal had provided for a 10 percent deemed repatriation tax rate for cash and 5 percent for the balance, a tax charge considered much more palatable by multinational business.

This last minute change added $113.3 billion in revenue over ten years to the bill, helping to pay for tax reductions for pass through businesses and other changes needed to secure the deal. Taxes raised by the Senate’s deemed repatriation provision now total almost $300 billion over ten years.

BEAT tax change

Other late changes increased the base erosion anti-abuse tax’s (BEAT’s) tax rate for banks and securities dealers by 1 percentage point and also excluded certain qualified derivative payments from that tax’s definition of a base erosion payment. The two changes resulted in an additional $2.4 billion additional revenue over 10 years.

Under the final bill, a member of an affiliated group that includes a bank or securities dealer will pay the BEAT tax at an 11 percent rate, increasing to 13.5 percent by 2026. All other taxpayers are subject to the BEAT tax at a 10 percent rate and increasing to 12.5 percent by 2026.

The BEAT is an anti base erosion measure and a minimum tax, imposed only if it exceeds the regular corporate tax. The BEAT tax rate is applied to income after disallowing “base erosion payments,” which generally are deductible cross-border payments to related parties, omitting payments subject to full 30 percent US withholding tax and for cost of goods sold.

The Senate change agreed to Saturday added an exception from the definition of a base erosion payment for certain derivative payments made in the ordinary course of a trade or business. The bill imposes a new reporting requirement to qualify for this treatment.

Interest limit changes

The Senate bill also made late changes new section 163(n). Under the original Senate bill, this provision restricted interest deductions to an amount equal to 110 percent of the amount of debt that a US member of a group would hold if the US debt-to-equity ratio was proportionate to the group’s worldwide debt to equity ratio.

The changes phase those rules in more gradually so that they apply if excess indebtedness of the US group exceeds 130 percent of total indebtedness of worldwide group in 2018, 125 percent in 2019, 120 percent in 2020, 115 percent in 2021, and 110 percent in 2022 and thereafter.

The definition of “total equity” was also modified to state that it is equal to the sum of the money and all other assets reduced  (but not below one) by the total indebtedness. The change is said to have no revenue effect.

The Senate bill continues to also restrict interest deductions to 30 percent of adjusted taxable income. The greater of this interest limitation or the 163(n) limit will apply.

GILTI  changes

Modifications were also made to the global intangible low-taxed income  (GILTI) regime, altering the definition of property considered as for a foreign use for purposes of determining foreign-derived intangible income. This change also was said to have no overall revenue effect.

Conference or ping-pong

The next step for the tax bill is for both the Senate and House to work out their differences regarding the provisions.

Speaking at a Washington DC conference cosponsored by the Internal Revenue Service and George Washington University Law School just hours before the Senate bill’s passage, Michael F. Mundaca, Co-Director, National Tax, Ernst & Young LLP, Washington, DC, said this could be accomplished either by a formal House-Senate conference or, in by a quicker “ping pong” approach, whereby the House would take up the Senate bill and either pass it or make amendments to it then pass it back to the Senate for consideration.

Mundaca said that multinationals will have a very difficult time dealing with accounting and and other issues if a tax bill is signed late December. Business representatives are talking with SEC and FASB officials to see if any relief is possible, but there is no easy answer, he said. “I don’t think the SEC or FASB will say, ‘oh well, just wait a quarter,'” he said.

Danielle E. Rolfes, Co-Partner-in-Charge, Washington National Tax-International Tax, KPMG LLP, Washington, DC noted at the same conference, the 30th Annual Institute on Current Issues in International Taxation, that many revenue raisers in the tax bill bear a January 1, 2018, effective date, yet the Senate bill does not lower the corporate tax rate to 20 percent until next year.

She said Treasury will need to get ready for an onslaught of work should the law pass as there will be an immediate need for clarifying guidance.