The US tax changes announced recently by President Donald Trump are one of the most dramatic and fundamental changes to US taxation of foreign earnings since 1986 and are already having a major impact on global supply chains. Global taxpayers are facing some major decision points. Affected companies will need to:
- Model the effect of the complex US Federal tax changes including the respective state income tax effect;
- Re-evaluate their global supply chains and transfer pricing arrangements;
- Re-evaluate their capitalisation due to interest deduction denial rules; and
- Consider the effects on their financial reporting.
Unfortunately, the 2000 pages of legislation were released without detailed explanatory memoranda. Further guidance has recently been issued but not at the rate to help businesses and their advisors alike to gain a sense of fully comprehending the mechanics of the new law.
However, we do know enough to set out one example illustrating why global supply chains are already changing.
Firstly, let’s summarise four of the changes aimed at bringing manufacturing back to the US:
- 100% bonus tax depreciation on assets with a recovery period of less than 20 years that is acquired post October 2, 2017.
- Unlimited carry forward of losses available to offset against a maximum of 80% of taxable income each year.
- The Federal corporate tax rate reduced to a maximum of 21% (plus state taxes, many of which are intending to follow Federal tax changes).
- An effective 13.125% Federal corporate tax rate on goods exported out of the US.
Let’s look at an example of the tax impact on the choice of whether a company expected to earn significant profits should set up a plant in Australia or the US to manufacture to export to the rest of the world.
- Australia: A 30% corporate tax rate on profits, reduced by depreciation on the plant, equating to a blended depreciation rate of say 15%.
- US: A 13.125% corporate tax rate on exports plus state taxes, say 7% (but potentially nil), giving a total of approximately 20% on taxable profits. However, there may be minimal actual tax payments due for a period of time, due to the 100% bonus deprecation for the cost of the manufacturing asset (as compared to Australia’s blended 15% depreciation rate). In addition, the excess bonus depreciation may also be able to carry forward losses to offset 80% of future taxable income each year.
The US could therefore have an effective corporate tax rate which is more than 1/3 less than that of Australia, with actual tax payments being far less in the early periods. Of course, this is a simplified example, and the complexity of the US rules themselves mean global businesses should do modelling exercises to determine the relative effects.
The US has moved from a relatively high tax jurisdiction to now having a competitive advantage in that area over Australia and many other developed countries, reflected in the recent decisions by many global businesses to increase their manufacturing presence in the US. Australia is further disadvantaged by the fact our current Australian controlled foreign company (“CFC”) rules essentially exclude US CFC’s income.
Stay tuned and please connect if you would like to further understand the impact of these changes on your business. You can email me via Sam.Neale@crowehorwath.com.au
Senior Partner – Tax Advisory – International Tax Committee member