Where now for territorial tax under Trump?
On April 26, President Donald Trump unveiled his plan for tax reform. The one-page proposal outlines a plan focused on creating jobs, economic growth and helping low and middle-income families, but how will it work in practice?
Tax reform will only happen with bipartisan support, and lawmakers would like to pass this legislation by year-end, prior to the 2018 midterm elections. The last tax reform occurred under Republican President Ronald Reagan in 1986.
“Tax reform and the economics of it are so complicated - you have to understand the long-term view as well,” said Nadia Durant CA, senior tax advisor for a multinational oil service company.
“Reduce the tax rate and tax reliefs - that’s a short-term solution where there are immediate benefits, but longer-term impacts of things like repatriation and the border tax need to be thought through to get the policies right.”
Trump’s promised lower tax rates across the board, which will benefit everyone. But changes to the tax code have both benefits and disadvantages.
Tax reform and the economics of it are so complicated — you have to understand the long-term view as well.
A lower rate would provide corporations with after-tax profits that can be distributed to shareholders and invested, and consumers would lower their living costs.
However, corporations and consumers may need to spend these extra funds on goods, as a border adjustment tax would increase prices.
While everyone American would like a simpler tax code, larger looming issues are the rates, inversions and a border adjustment tax.
Territorial Tax Systems and Corporate Inversions
One problem for the US is that it has a worldwide tax system while most other countries have moved to a territorial system. Under a territorial system, earnings of foreign subsidiaries aren’t taxed to the parent company. Currently, a US corporation is generally subject to US tax on the earnings of its foreign subsidiaries.
A company like Apple, for example, which sells products all over the world, is subject to double taxation - once in the foreign country and again when those earnings are repatriated to the US.
While the US provides a foreign tax credit, which mitigates this double tax problem somewhat, the US does have the highest corporate income tax in the developed world, so there is likely to be residual US tax liability when foreign earnings are repatriated.
As there’s a tax disincentive to repatriating foreign earnings, Apple’s most recent financial statements disclose that it has over $200 billion reinvested offshore, said Robert Jefferson CA, international tax manager in the maritime industry.
By introducing a deemed repatriation tax, Trump has said that this would encourage investment in the US.
“Those foreign earnings are neither reinvested in the US nor distributed to shareholders, which means the foreign earnings of US multinationals are not being used to drive US economic growth.”
Trump might also introduce a deemed repatriation of funds since US companies pay tax on foreign earnings that are repatriated. “It’s estimated currently that US companies have just under $3 trillion overseas invested in foreign markets,” said Nadia. “By introducing a deemed repatriation tax, Trump has said that this would encourage investment in the US.”
There are different ways to structure a tax on overseas earnings. There could be a mandatory 10% on repatriation of funds payable over a period of time, a tax holiday where no taxes are paid over a period, or a staggered rate, said Nadia.
“The point is, [Trump] wants US companies to bring the cash back to the US to invest it in the US, but how companies invest that money is up to them, obviously, and it might not achieve what he wants them to achieve, which is to increase GDP, employ more Americans and invest in the US.”
In our next article, we discuss Trump’s plans for the corporate rate and border adjustment tax, and how to ‘thread a needle between income tax and a VAT’.
About Andrea Murad
Andrea Murad is a New York–based writer. Having worked on both Wall Street and Main Street, she now pursues her passion for words. She covers business and finance, and her work can be found on BBC Capital, Consumers Digest, Entrepreneur.com, FOXBusiness.com, Global Finance and InstitutionalInvestor.com.