One of the biggest tax stories of recent months has been the sweeping changes being made to the US tax system. It's clear that when the world's biggest economy makes significant tax changes, it's a big deal worldwide, the effects are far-reaching and could affect all of us. What are the implications for policy makers, and what should businesses be aware of? Barry Murphy, Partner at PwC explores in conversation with Tom Pattern, a US Tax Partner in PwC and Will Morris, our Deputy Global Tax Policy Leader at PwC.
Hello, I’m Barry Murphy, a Tax Partner at PwC.
Welcome to Talking Tax Podcast discussions on some of the big and thorny tax issues, creating headlines, bringing together views from PwC and beyond.
Arguably, the biggest tax story of recent months has been the sweeping changes being made to the US tax system. They are triggering many big companies to adjust to their profit forecasts, some for the betters, other for the worst.
Policymakers worldwide are discussing the repercussions, and in recent days the head of the IMF said, ‘the reforms could lead to a rapid rise in interest rates and inflationary pressure.’
What’s clear is that when the world's biggest economy makes significant tax changes, it's a big deal worldwide, the effects are far-reaching and could affect all of us.
So, what are the main changes, what should we be aware of, and what could the impact be?
To discuss this, I’m joined today by Tom Patten, a US Tax Partner in PwC, based here in London; and Will Morris our Deputy Global Tax Policy Leader at PwC.
So, Tom, Will, if we start with the context, maybe Tom, reforms suggest improvement.
What actually was driving all of this?
Well, if you look at the way the system worked before these changes came in, we had a very high rate, 35% headline rate, much higher than the rest of the world if you look at the average corporate tax rates. The effect of that is it encouraged some behaviours that congress felt were getting in the way of growth in the economy, and made the US less competitive as compared to other jurisdictions.
You look at outbound investment from the US, and arguably the old system incentivised US companies to maximise their offshore income, and not bring the money back, because that could mean a direct saving to their effective tax rate.
If you look at non-US based multinationals that would encourage them and put them arguably in a better position than US-based multinationals in terms of their ability to manage taxes on the domestic base of profits in the US.
Okay, and what are the main provisions then. So, if that was the context, what has actually landed, what are the headline provisions?
Well there are probably 2 or 3 key areas to focus on, I think, in terms of the changes and how they interact with those objectives.
So, first of all, there is a reduction to the headline rate of 35% down to 21%. So, that’s clearly more in line with, you know, the OECD average that’s out there.
There are incentives to domestic investment. So, accelerated write-offs of spend on US assets, and then there is a fundamental overhaul in terms of the international tax system, both in terms of how foreign profits are taxed in the US, as well as limitations in place that primarily impact non-US based multinationals, and how they deal with their US operations.
Okay, and we will come on to what that means in practice in a moment, and maybe some of the wider reaction around the world, but just, Will, maybe, to bring you in quickly.
In the US there seemed to be two camps about whether this was good or bad reform, what will be your view on that?
In any piece of legislation, you are going to have winners and losers; and obviously lowering the rate was very advantageous to some people, cutting back on some of the benefits around interest deductibility were going to hit other types of businesses.
So, yeah, winners and losers. So, some people view it as very favourably, some not. I think on balance it was the lowering the rate, which almost everybody could agree about, and some of the more detailed provisions where people disagree.
Okay, so we've got through reform, some of those headline measures have come through, there will be winners and losers.
Will, what are the main consequences you are expecting now that has come through?
What is really interesting, and there is a sort of initial point, which was how the US was viewed by the rest of the world, which I think is really interesting, because the US system was viewed certainly by governments as being, you know, totally sclerotic, old fashioned, very high rate as you said, but also with a foreign tax credit.
Therefore, amongst governments at least, there was a perception that US businesses could be taxed and that would get paid by the US government ultimately.
So, that drove a fair amount of non-US tax policy. So, that's one big change from the government’s point of view. As far as other folks are concerned, and you know the perceptions of that, the US has in some senses become a more attractive place to do business, in other senses a more difficult place to do business.
Again, you know there's good news and bad news, all tangled up in this, but I think we are going to need to see how it plays out, because certainly, as we know from talking to our colleagues, you know, the brightest amongst them are still finding things in there that they didn't expect two months after the legislation was passed. Very lengthy piece of legislation passed very quickly and with not a huge amount of time to test out some of the stuff. So, you know, the consequences are still emerging.
Yeah, but we certainly saw some of that in the media, but like any big reform, there is quite a lot of detail to get through to understand your own position.
So, Tom, maybe, shifting back to you, there is this piece around it's going to free up, you said, huge amount of cash that’s trapped offshore, whatever it is. Is that really going to happen, and what type of uses are organisations going to put that cash to?
Right, so the old system, as I was saying, kind of, incentivised US multinationals to keep cash offshore right, and I’ve seen estimates as high as three-and-a-half trillion dollars, the amount of, you know, so called cash that's locked up.
So, huge amounts of earnings that haven’t been repatriated to the US, and in transitioning into the new system, all those earnings in effect become taxable, and what that does is, it allows those earnings to be repatriated to the US without further taxation, because they are just subject to tax, you know, as we transition into the new roles.
The reality is, a lot of those earnings are not actually in cash accounts, they are in corporate bonds, they are in treasury, treasury bills, and so the knock on implications of what it means to free up that cash are still being thought through.
There could be an impact on the bond market, it could wind up with the rise in interest rates, lower bond prices. We could expect to see a spike in the deal market. So, if cash comes back to the US, maybe some consolidation of businesses that are out there, that might then drive prices up in terms of the deal space.
Then some of that cash, we might expect to see go out to shareholders as well. So, you know, I think that’s the most significant issue that we are seeing in the short run about the actual impact of these things, as what does it mean for liquidity in our businesses.
Okay then, certainly on that shareholder, you know, return of cash, I’ve already seen the number this week that suggests corporate buyback programmes of up to 178 billion already have been announced.
So certainly some of it is coming true.
I mean the numbers are gigantic, right.
They are, but, Will, any comment on that aspect from you.
Yes, I mean, you know, one of the question that people are asking is about what this means, what the US companies are going to do with this cash if they don't repatriate it, and obviously one of the obvious thing to do with it is to spend it, and to spend it on buying other corporations.
There are now tax advantages for US corporations to acquire tangible assets overseas, because of the way some of the numbers work out in the calculations, but also there are no longer the disadvantages for US corporations.
So while, you know, the old stuff that we saw around inversions has been made much, much more difficult by this legislation to the extent it wasn’t hard already, it has been made much more difficult. We are actually going to see, I think, probably more acquisitions by US corporations of overseas businesses.
Some of that might be a price issue as well, right. So, if the US deal markets spikes and prices go up, then non-US businesses might work proportionately cheaper as a result.
Okay, so quite a lot to play out deal market dynamics, just as much as tax reform. We haven't concentrated an awful lot yet on businesses this side of the pond, and what these tax reforms mean for UK PLCs, so to speak, what should we expect there?
Well, I guess the first thing to think about is, there is a set of rules in the package that are designed to level the playing field between US and non-US based multinationals, and how US profits are taxed, and that’s resulted in to a degree of fundamental rethink of how you run and operate a US business underneath a non-US multinational.
Some of the changes did, kind of, take the sting out of, you know, with the non-US companies looking at a US acquisition, and looking at the other assets underneath it, what does that mean in terms of the overall price, and so this has, kind of, eased the sting off that a little bit.
I think it’s, you know, to a degree it’s a rethink of how the business is actually structured. I think as a consequence of these things, it does feel little bit at times that it's more a bad news than good news for non-US multinationals, primarily because of this levelling the playing field aspect of it, in a different environment.
I mean, just to pick up on, sort of, 3 specific points. First is the, so-called BEAT, the anti-base erosion provision, which essentially draws more income into the US by disallowing certain deductions. So, that’s hitting some non-US businesses very heavily, particularly in FS, so banks with inter- company funding and reinsurance, so that's point one.
The other two points relate to techniques, which non-US businesses have used for a long time to get money out of the US, obviously interest deductibility is one, and the use of hybrids is another, and there are provisions in the legislation, which cut back severely in the case of hybrids almost totally, in the case of interest deductibility quite substantially.
So, techniques, which non-US businesses have used to get cash out of the US are no longer available.
So, you know, lower rate, great news, but the base has been broadened.
Okay, so again, it just is, there is a new game in town, you have to figure out the new rules of that game, and how you run your business might have to adapt accordingly.
But massive amounts of detail.
Okay, now we mentioned earlier some of the reaction within the US to tax reform. I did say at the start about the IMF’s view on tax reform but, Will, as policy, what do you expect and what do you hear from other nations and governments, what’s going to happen next?
It's really interesting. I mean, there has been a lot of reaction, not just from Europe, although Europe has probably been the most vociferous on this, but you know, China has set up a group within the government to look at this, other countries are doing the same.
I think what we see is, if I put this, sort of, relatively bluntly, is a mixture of fear and anger basically, and I’ll explain both of those. There is annoyance that the US has done things like the BEAT, and that's why we are hearing talk about referrals to the World Trade Organisation, but there is also fear that the US has actually constructed a more competitive tax regime, or to put it slightly differently, has dialled back from the less competitive tax regime that it had. Therefore, other countries are going to need to respond to that.
There is a lot of, quite frothy talk, I think, about you know a race to the bottom. I keep pointing out that if you add the state rate back into 21%, you get to 25%. So, this is perhaps a race to the middle.
You know, nevertheless, there is a concern, I think, amongst countries, who understand that with the US, you know, the natural advantages of a very large market like the US, plus the tax system, which has become less uncompetitive, that actually they face a competitive threat, which they need to address.
Okay, so no surprise really that nation states compete. Tax is part of their policy armour and tax competition remains. So, probably shouldn't be a surprise, but big reform like this will always create change and noise.
I think, the real surprise was that America managed to do it.
Okay so we are there, we are living it; and actually it’s been done. We've gone through some of the impacts, and maybe, Will, if I come to you just for a final comment on, you know, what's next, are we finished, is there more coming, before Tom, last one or two practical points for anybody listening.
Yes, I mean, I think what we hear in Washington is that, you know, again as people go through this, I mean there were things that people knew about when the legislation was actually going through that didn't appear quite to work, more things have emerged as people look at it.
Can they fix that quickly? Maybe one or two things, but I think this is a long-term processes. Again, as my colleagues are fond of pointing out to me, after the 86 Act it took two years to get technical corrections through, and that’s even putting aside, you know, some of the bigger issues, so this will take time to work out.
Okay, and Tom because it's going to take time, you will have technical corrections for two years or more.
What are the last 2 practical tips for everybody?
Well, I guess, the part of the thing to bear in mind in terms of guidance is, I’ve actually been surprised as how quickly the IRS and Treasury have had some guidance that is out there.
So, we've had some responses from the IRS already, and we have heard the message that they are listening, and so, I think, there is just 1 key point out there in terms of, you know, in the areas where there are uncertainties is, identify those areas. The government is at least opening to hear them, and you know, if it is within their authority to fix it, they are willing to listen.
So, I think, you know, as we are making our way through this, it is important to, you know, to raise those issues and discuss them, and you know, make sure that, you know, the government is hearing, where there are these odd issues that might pop out of the legislation.
o, US tax reform, it actually happened, huge amounts of detail to figure out for any business or any person dealing with US, you’ve got to take account of the details, your own circumstances.
Will, Tom, thanks for a fascinating insight into that.
For all of you listening, thanks for your time. We’d love to hear more from you, whether it's about your own business, your own views on what will happen to your pensions, if they are invested in the market? What will happen to government policy in this country as result of tax reform?
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