On January 15 2020, US President Donald J Trump signed phase one of a trade agreement with China. While the US would continue to impose $550 billion worth of tariffs on Chinese products, and for China, $185 billion of tariffs on American products, many companies found this 'phase one' agreement to be a sign of hope. If both parties were able to meet the terms of this trade agreement, a lowering of tariffs was possible and global supply chains might again provide the cost saving attributes originally envisioned. Since the signing of this trade agreement, much has changed globally.
On March 11 2020, the World Health Organisation (WHO) declared COVID-19 a pandemic. The health and economic impact, and toll on global economies and people worldwide caused by COVID-19 is staggering. As of May 26 2020, there were an estimated 5.5 million cases, and more than 350,000 deaths. Economic and health uncertainty surrounding the virus is widespread. When we will develop a vaccine ready for widespread use and when economies will recover to pre-COVID-19 levels are questions that have no clear answers.
In the context of US investment considerations, one theme is clear. Under the Trump administration, the US is likely to continue to become a more competitive place to do business through the passing of tax policies, increased use of US federal, state and local incentives, and other non-tax related measures. Recent examples of this include:
- President Trump's signing of The Tax Cuts and Jobs Act of 2017, which among other actions reduced the corporate tax rate from 35% to 21%;
- The bipartisan bill in Congress, called The Securing America's Medicine Cabinet Act of 2020, which would encourage pharmaceutical drug producers to innovate and move operations to the US through the authorisation of $100 million to develop centres of excellence in advanced pharmaceutical manufacturing; and
- The bipartisan bill in Congress, entitled Industries of the Future Act of 2020, which would require the US federal government to increase spending related to research and development in specific industries including artificial intelligence, advanced manufacturing, quantum information science, synthetic biology, and next-gen wireless networks and infrastructure.
As the US economy begins to recover from COVID-19 and President Trump campaigns for re-election, the US is likely to sustain a tough stance against China on the global stage. This would likely be through the utilisation of tariffs and the sponsoring and signing of US congressional bills that incentivise companies to move operations to the US from China.
Key tax and incentive considerations for a US investment
In anticipation of the continued rise of global nationalism, protectionism and isolationism, many multinationals have begun reconsidering and moving operations to the US. While historically the US has been viewed as an expensive place to manufacture products, particularly in comparison to countries in North and Southeast Asia, in recent years, the US has implemented favourable tax legislation and policies, and reduced regulation to support US cost competitiveness. The US federal, state and local governments can also provide companies with significant upfront and ongoing cost savings through the granting of business incentives.
When following a proactive approach, companies may be able to obtain savings through the use of incentives valued upward of 20% or more of capital investment commitments assuming a capital-intensive project, or worth up to tens of thousands of dollars per job that is anticipated to be created.
Triggers for incentives extend well beyond the creation of a manufacturing or headquarters facility. Typical business triggers for incentives include:
- Capital investment commitments of at least $10 million over a five-year period, which may relate to routine investment, equipment replacement, facility expansion, etc.;
- Job creation, reduction or relocation commitments of at least 20 full-time employees over a five year period, which may be due to footprint consolidation, increase in automation, etc.;
- Real estate footprint restructuring, including office lease expiration or renewal, leasing or purchasing of additional land or buildings, etc.;
- Investments in sustainability or green activities such as renewable energy generation or equipment to reduce greenhouse gas emissions;
- Increased research and development (R&D) spend; and
- Employee training, retraining and upskilling plans.
Incentives in the US can take many forms, whether financial, tax or intangible. Such examples include, but are not limited to:
- Financial incentives: cash grants for investment or hiring activities, infrastructure grants or assistance, discounted land/buildings, employee training grants, utility discounts, and forgivable loans;
- Tax incentives: job creation and investment tax credits (refundable and non-refundable), payroll tax rebates, federal and state corporate income tax credits including R&D credits, sales and use tax exemptions and rebates, and real and personal property tax abatements; and
- Intangible incentives: port expansion, inter-modal development, improved access to public transportation, and airport expansion.
While some incentives, such as the US federal R&D tax credit and most state R&D tax credits are statutory, (i.e. 'as of right'), the most impactful incentives related to investment and job creation projects, such as cash and infrastructure grants, tend to be discretionary and negotiated with state and local economic development agencies.
For example, many state and local governments will only provide certain incentives to companies that have competitive projects, and a company may be required to pass a government's 'but-for' test. Whether through the submission of a detailed application, a statement signed by a senior officer of the company, or the presentation of project facts, governments may only provide a substantial level of incentives to companies that can effectively demonstrate that, in the absence of such incentives, the company's project would either not move forward or would proceed in an alternative jurisdiction.
If certain actions are taken by a company during the incentive negotiation process, but before incentive agreements have been finalised, incentives may no longer be available. The following project-related actions should not occur until after incentive agreements are executed and a project announcement has been discussed with the relevant government and economic development agencies:
- Purchase or lease of land, building(s) or equipment;
- Hiring of new employees; and
- Private or public announcement of the company's decision to move forward with a specific project at a specific location.
When comparing incentive offers from multiple jurisdictions, it is critically important to layer incentive projections within a cost comparison model. The 50 US states all have their own systems of taxation, and companies generally have a larger tax burden with the state and local levels of government compared to the US federal government. State and local governments can, therefore, offer more incentives through the offsetting of future taxes, offering of cash and infrastructure grants, and potentially providing free or discounted buildings and land that are owned by state and local government.
The three most noteworthy tax types that US state and local governments levy on businesses are property taxes, corporate income and/or franchise taxes, and sales and use taxes. All of these taxes can be offset or mitigated for an extended period of time through incentives.
Using property tax as an example, roughly half of the US states tax both real property (e.g. land, buildings, building improvements, etc.) and personal property (e.g. machinery and equipment, furniture and fixtures, etc. while the other half of US states only tax real property. A state that taxes both real and personal property may provide a company contemplating an expansion of operations a very large incentive package that reduces property tax for a five-year period compared to an alternative state that does not tax personal property.
However, the actual projected benefit to the company cannot be fully understood unless both scenarios are modelled out before and after considering tax. Furthermore, while incentives may show that from a property tax perspective it is initially more inexpensive to operate in state A compared to state B, a company should model out the taxes over a 10- or 20-year period to understand the tax consequences once potential incentives are no longer active.
Before finalising incentives negotiations or making a public announcement, it is imperative to properly articulate the proposed project to relevant governmental agencies, including the project's anticipated economic and community impacts. Beyond the direct jobs and investment that a project may bring to a jurisdiction, a project is likely to also have indirect and induced benefits on the region it operates in. Examples include suppliers and other businesses locating or expanding operations in close proximity to the project, construction jobs needed during the initial years of investment, and new employees may bring spousal and additional household income and spending to the local economy.
If the positive anticipated impacts from a project are properly and effectively communicated to the state and local government, greater benefits may be offered to the company as the government can utilise the economic and social impact projections to demonstrate to their constituents why a certain level of taxpayer dollars are being directed to a project.
In addition to considering state and local taxes as well as incentives, key items to model and consider when comparing sites between taxing jurisdictions include labour, logistics, utilities, construction, and real estate to name a few. If a company is comparing the cost of operating in specific US locations compared with a non-US location, it is important to consider US federal corporate income tax and related planning strategies.
US corporate income tax considerations
In general, US corporations are subject to US federal taxation at 21% on their worldwide income (preferential rate might be available for certain types of income) and applicable state income taxes ranging from 0% to 12%. While foreign corporations are subject to the same tax on income that is effectively connected with a US trade or business. Foreign corporations are also subject to a 30% withholding tax on dividends, interest, royalties, and branch remittance.
However, if the foreign corporation is eligible to claim the benefits under an income tax treaty, only the foreign corporation's business profits that are attributable to a permanent establishment in the US are subject to US taxation at 21% and the 30% withholding tax may be reduced.
Treaty qualification and holding company selection
An inbound company may want to invest directly in the US or choose to make its US investments through an intermediary holding company jurisdiction that aligns with the US business and also be tax-efficient.
The concept of business purpose is particularly important for holding companies. In fact, most double income tax treaties that the US has entered into have very strict anti-avoidance provisions that deny tax treaty benefits to companies set up for treaty shopping and tax avoidance purposes.
In addition to considering the shareholder of the US investment, it is also important to consider the funding means of the US investment (e.g. through equity and/or debt). The US has several provisions and extensive case law that must be considered in evaluating whether a purported debt instrument is considered debt or equity for US tax purposes.
Funds loaned to a corporation by a related party may be recharacterised by the tax authority as equity if a prohibited distribution (or similar) transaction occurs. As a result, the corporation's deduction for interest expense may be disallowed, and principal and interest payments may be considered distributions to the related party and be subject to withholding tax.
If an instrument is properly considered debt, the Internal Revenue Service (IRS) still has the authority to reallocate deductions, including interest deductions, between related parties to reflect the arm's-length standard. Section 163(j) of the Internal Revenue Code, with some exceptions, limits the deduction for business interest to 30% (increased to 50% for 2019 and 2020 by the CARES Act) of adjusted taxable income (ATI). Before 2022, ATI is computed without regard to depreciation, amortisation, or depletion. Thereafter, ATI will be decreased by those items, thereby making the computation 30% of net interest expense exceeding earnings before interest and taxes. Disallowed interest may be carried forward to future years and allowed as a deduction. In addition, interest expense accrued on a loan from a related foreign lender must be actually paid before the US borrower can deduct the interest expense.
For these reasons, it is important for companies to consider the US tax considerations relating to the funding of the US investment.
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Jeremy Litton is EY's US tax desk network leader based in the Hong Kong SAR office. With more than 20 years of experience, his main line of practice has been in the international tax consultation area including planning and compliance.
He has worked on projects involved with international tax reform, tax planning, transaction tax structuring, supply chain structuring and due diligence considerations. He also has in-depth experience reviewing and advising clients on ASC 740 tax accounting issues from an international tax perspective.
Jeremy holds a bachelor's degree from Millsaps College and a JD from the University of Mississippi School of Law.
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Brian Smith is the global incentives, innovation and location services and Americas indirect tax inbound leader. With more than 22 years of site selection and incentives negotiation experience, he is responsible for helping companies navigate the complexities as they consider investing around the global, from initial entry through expansion of existing operations.
He aligns clients' needs with the breadth and deep knowledge of tax and advisory practices and global networks, to mitigate companies' tax and financial burdens while helping them increase their return on investment by securing economic development incentives and other tax and business savings opportunities. He has conducted studies on five continents and has secured more than $10 billion in subsidies for his clients.
Brian holds a bachelor's degree from Pennsylvania State University and a JD and master's of law degree from Capital University Law School.
T: +852 3471 2784
Zachary Weinstein is a senior manager based in the Hong Kong SAR office. As a leader of Asia-Pacific's global incentives, innovation and location services practice, he supports businesses with strategic investment decisions, including assistance with site selection and negotiation of governmental incentives.
With more than six years of relevant experience, he has assisted companies in securing more than $5 billion in country, state, and local government incentives in support of business expansion, relocation and consolidation decisions. Industries that he has supported include automotive, transportation, distribution, logistics and technology.
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