More than 50 US multinationals moved their headquarters out of the country between 2004 and 2016. In most cases, the companies merged with a foreign business in a low-tax jurisdiction like Bermuda or Ireland. This was the so-called ‘inversion boom’.
The combination of US tax reform and anti-inversion rules were supposed to end this trend. However, the global intangible low-taxed income (GILTI) rules and the base erosion anti-abuse tax (BEAT) have created an unintended imbalance in the international tax system.
“Attempts to use our tax system to wall capital and corporate headquarters in the United States when other countries are reducing the burden of taxation on international business income are no likely to be successful than King Canute’s efforts to hold back the tide,” said John Samuels, chairman of global tax at Blackstone.
“US companies will be able to avoid these tough new anti-inversion penalties by splitting off their foreign operations into smaller bite-size pieces that can be acquired by foreign corporations in transactions that won’t be technically inversions,” he explained.
As long as US shareholders own less than 60% of these companies the transactions undertaken will not count as inversions. Once technically owned by a foreign buyer, the income would be outside the reach of the anti-inversion rules and GILTI so long as the foreign tax rate didn’t drop below a certain level
“As long as the US tax system is out of line with the rest of the world it is virtually impossible for the United States to raise revenue from taxing the overseas operations of US companies without encouraging those companies to move headquarters, capital, jobs and operations,” Samuels said.
Tax reform lowered the US corporate rate from 35% to 21%, which when combined with the average state and local rate puts raises this to 25%. The trade-off for the rate cut with businesses was that the tax cuts could not cost more than $1.5 trillion and the international changes must be revenue neutral.
The TCJA included the OECD recommendation of a dividend exemption system to allow corporations to repatriate foreign earnings without paying any US tax on those foreign dividends. The cost of this move amounted to $224 billion, leading the Republicans to introduce the GILTI and BEAT provisions to raise $261 billion.
Samuels said that if Congress had only adopted the corporate tax rate cut and repatriation regime, the US would have established a competitive international tax system that was in line with the rest of the world. However, the addition of GILTI and the BEAT damaged that potential of the US tax reform.
“These new and unprecedented provisions don’t have counterparts anywhere else in the world,” Samuels pointed out.
The flight of the intangibles
Even before the TCJA was written, the US government was trying to restrain the flight of capital with a slew of anti-inversion rules from 2014 onwards. The US Tax Code was tweaked to include harsh penalties for companies inverting or transferring assets, such as patents, copyrights, know-how and other valuable intangible assets, to low-tax jurisdictions, but these deterrents did not cover transfer pricing strategy. As such, the advantages of maintaining assets offshore continues to outweigh the potential of onshoring to the US.
The GILTI rules set a minimum tax rate of 10.5% on the foreign income of US companies when such income is taxed at less than 13.125% in a foreign jurisdiction. By setting this rate, Congress may have undermined the prospects of onshoring patents and other intangible assets to the US. The costs of doing so still outweigh the rewards.
Moving the asset back to the US will incur the full 21% tax on the worldwide income on that patent, but if the MNE moves it to a country with a rate above 13.125% it will not have to pay any US tax on the worldwide income of the patent.
Tax reform has also not changed the fact that once an American company has a patent in a low-tax jurisdiction, the manufacturing plant can be based anywhere but the US. It may cost slightly more to offshore, but it’s still possible to optimise those offshore IP holdings and bring back cash assets to the US.
One tax director at a US manufacturing company claimed: “Some assets will never be repatriated because it’s simply too profitable to keep them overseas. In other cases, it will just be too difficult to bring certain assets back to the US.”
Many American businesses may find it difficult to plan around the new rules. After all, US companies now face US tax on 83.5% of their foreign income. The GILTI rate applies to 74.8% of that income and Subpart F applies to 8.7%.
“Companies are still evaluating whether to move assets out of low-tax jurisdictions,” the chief tax officer of a tech multinational said. “They won’t want to move if they have substantial investments in a country, but they will reconsider their options where they have to.”
“Companies might not pull-out because the investment is so great,” the officer said. “They might decide to restructure and plan arrangements differently.”
Even without inverting, US multinational companies could always make sure their effective tax rate is just about acceptable to bypass the GILTI rules altogether. This would make offshore holdings viable in the long-term without incurring extra costs. As Samuels put it, this is a “no brainer”.
