23 March 2018
On February 22, the Treasury Department released President Obama’s business tax reform plan (the ‘White House Framework’), which sets out the administration’s approach to reforming a US business tax system that is ‘uncompetitive…inefficient [and] too complicated.’ The White House Framework contains five ‘elements’ of business tax reform: (i) cutting ‘loopholes’ and subsidies, broadening the corporate tax base and cutting the corporate tax rate, (ii) strengthening US manufacturing, (iii) strengthening the international tax system, (iv) simplifying taxes for US small businesses, and (v) restoring fiscal responsibility.
The cornerstone of the White House Framework is the lowering of US top corporate tax rates from 35% to 28%, while controversially maintaining the current US policy of taxing US corporations on their worldwide income and further proposing a minimum tax on foreign earnings. The Obama Administration has said that the purpose of the new minimum tax is to target companies that are trying to avoid paying their fair share of taxes by moving jobs and profits overseas to low-tax jurisdictions and balance “the need to stop rewarding tax havens” with the “goal of keeping U.S. companies on a level playing field with competitors.” However, the White House Framework does not address a number of critical issues related to this proposed new tax, including the rate of the minimum tax, when the tax will be triggered and by what non-US activities, or how it would dovetail with current systems that tax certain overseas profits on an imputed income basis and regular cash repatriations.
A second major component of the White House Framework is the reduction of the tax rate on certain qualified manufacturing activity from the current effective rate of 31.85% to 25%. The proposal also contains increased incentives for ‘clean energy.’ In the international tax arena, the White House Framework would target accounting rules or ‘aggressive’ transfer pricing that shift profits offshore, particularly in the case of intangibles such as intellectual property, and defer certain ‘tax advantages’ such as interest deductions related to debt financed offshore investments until the income was subject to US tax.
The White House Framework, in fulfilling the Obama Administration’s long-standing position to eliminate capital gain treatment for “carried interests,” would tax all income and gains earned by fund managers as ordinary income, as well as prevent corporations from debt financing certain investments in life insurance that generate tax-deferred income. Further, the White House Framework would eliminate numerous other so-called tax “loopholes”, including advantageous depreciation rules for corporate owners of non-commercial aircraft, certain oil and gas tax preferences and the ‘last-in, first-out’ method of accounting.
Lastly, the White House Framework would simplify taxes for small businesses by, among other things, allowing a greater number of small businesses to use the cash method of accounting, increasing certain start-up and expense limitations, and reforming the health insurance tax credit for small businesses.
The Administration’s proposal will no doubt face multiple hurdles making it unlikely to become law in its current form. While the White House Framework approach to closing corporate loopholes may be politically popular, it is short on details and, aside from a few examples, does not specify the particular ‘loopholes’ that would be affected. Further, its adherence to the current system of taxing US corporations on their worldwide income has already come under fire from a range of stakeholders who favor a move to a territorial system that would bring the US in line with its global competitors and encourage US corporations to keep their operations in the US.
Republican Dave Camp, the Chairman of the House Ways and Means Committee, stated that the White House Framework “fails to address the need for comprehensive reform of [the US] tax code.” Further, Republicans in Congress have insisted that any tax reform proposal involving revenue increases will be a nonstarter in the Republican-dominated House of Representatives. While the White House Framework proposes lowering corporate tax rates, overall tax revenues should increase because of the elimination of certain tax breaks in conjunction with the new minimum tax on overseas earnings. As a result, the proposal likely will be opposed by most House Republicans, particularly those who were backed by the strongly anti-tax Tea Party in the 2010 elections. Given the deadlock in Congress in recent months, it would seem unlikely that a compromise could be reached in an election year.
Although there is agreement between the two parties that change in the tax code is necessary, due to the complexity of the task and the divergent viewpoints it is hard to predict what the fate of corporate tax reform will be. In a statement delivered with the release of the White House Framework, Treasury Secretary Timothy Geithner stated that “the current code was written for a different economy in a different era.” However, Geithner acknowledged that rather than being enacted in its current form it is likely that the White House Framework will only ‘start the process of fundamental tax reform…[that will] take time…and be politically contentious.”
US businesses and multinational companies with current or anticipated US operations or investments should keep a close eye on these legislative developments that could impact their future tax exposure and discuss their impact and planning opportunities with qualified US tax counsel. We will continue to keep you informed regarding any developments in this area.