Tax: US reforms and a week in Davos
For the benefit of UK tax practitioners, Donald Drysdale provides a broad overview of tax reforms in the US and reports on a tax avoidance debate in Davos.
For many UK tax practitioners, President Donald Trump’s signing of his Tax Cuts and Job Act (TCJA) and last week’s World Economic Forum (WEF) Annual Meeting in Davos were simply extraneous noise rather than essential news.
To those working in international tax and advising multinational businesses, such world events will have been of great moment. But for others, weighed down by the last gasps of their efforts to submit their clients’ personal tax returns by 31 January, this article aims to provide a brief overview of what TCJA is all about and some comments on tax issues discussed at the WEF meeting.
US tax reforms
TCJA, as approved by Congress and signed by Trump on 22 December, affects almost every US business and individual on a scale not seen since President Reagan’s tax reforms of the 1980s.
Headline news has focused on the massive cut which TCJA makes in the top US corporate tax rate. From 2018, this is slashed “permanently” from a maximum of 35% under the pre-existing graduated rate structure to a flat rate of 21%.
TCJA also pares back the ‘dividend received deductions’ allowed to corporations on distributions they receive from other corporations in which they own shares, cutting it from 70% or 80% (as applicable) to 50% or 65% respectively. The ‘alternative minimum tax’ for corporations has been repealed.
The system for taxing international business income has been fundamentally reformed as a result of TCJA moving the US from a worldwide to a territorial tax system. Hitherto, the ability to postpone US tax has encouraged US corporations to defer repatriation of overseas earnings. Now, the change to a territorial regime and the reduction in corporate tax rates should have the opposite effect.
Other changes will help domestic US businesses. For example, to encourage investment in qualifying new or used plant and equipment, more generous 100% bonus depreciation is available from 2018 through 2022 – followed by a phasing down of this over the succeeding five years.
In other headline news, the top federal income tax rate is reduced from 39.6% to 37%. However, while the tax reforms for corporations are generally permanent, the same is not true of the tax measures for individuals – largely to keep the impact of TCJA within budgetary constraints.
Federal income tax rates are cut, the basic standard deduction is just about doubled, the child tax credit is increased, the deduction for personal exemptions is suspended and the exemption limit for the individual alternative minimum tax is raised – but only from 2018 through 2025. For the same years, new limits are imposed on deductions for mortgage interest and state and local taxes.
Non-corporate owners of certain partnerships, closely-held corporations and sole proprietorships (‘pass-through’ entities) have been taxed until now at individual rates up to 39.6%. Temporarily, from 2018 through 2025, TCJA provides for a special 20% deduction against qualifying business income. Strict limitations seem designed to prevent service providers from enjoying this deduction.
Although there had been calls for the repeal of federal estate tax, this was not adopted in TCJA. Instead, exclusions have been doubled for deaths occurring or gifts made from 2018 through 2025.
For readers with time to spare, who wish to know more about the provisions of TCJA and the underlying tax issues considered in arriving at the reforms, useful explanations are contained in the 570-page Joint Explanatory Statement of the Committee of Conference that negotiated final agreement between the Senate and the House of Representatives.
Political impact of TCJA
In the UK almost every attempt to simplify taxes comes to naught, thwarted by politicians’ fears that there will be winners and losers.
Such concerns don’t seem to worry Trump. There is widespread criticism of his reforms, with big businesses and their wealthy proprietors seen as the biggest winners while many individuals will lose out.
In Trump’s speech at the WEF meeting in Davos on Friday, available as a 35-minute video, he claimed that his administration had just enacted the most significant tax cuts and reform in American history.
He spoke of massive tax cuts for the middle class and small businesses, and the cut in the corporate tax rate from 35% to 21%. He said Apple had announced plans to repatriate US$245 billion in overseas profits and invest more than US$350 billion in the US over the next five years.
Trump credited TCJA with raising the average American’s household income by more than $4,000, but independent commentators have disagreed. Some who have done the arithmetic suggest that the average gain will be only US$1,600, with huge variations between winners and losers.
He said millions of workers had already received ‘tax cut bonuses’ of up to US$3,000 from their employers. Some corporations are certainly sharing their tax windfall with employees, but the benefits are not evenly spread. Reportedly some corporations aim to return cash to their shareholders, while others paying bonuses are also making parts of their workforce redundant.
Trump also spoke of his tax reforms in his State of the Union Address to Congress this Tuesday (text and video here). Apparently Trump’s reforms will cost US$1 trillion by 2027, even after their favourable impact on economic growth is taken into account. The price will be high for future US taxpayers.
Tax avoidance and evasion
Tax featured elsewhere on the Davos agenda, in a panel session entitled ‘Beyond the Paradise Papers: Can Global Tax Avoidance Be Stopped?’ (1-hour video here).
In December 2016 the EU listed 30 territories regarded by member states as the world’s worst-offending tax havens. The list was re-published in December 2017 as a blacklist of only 17 non-cooperative tax jurisdictions, and last week eight of these (including Panama) were removed in an announcement that stretched its credibility to the utmost.
In the WEF debate, the EU list was criticised for omitting “serious” tax havens like the Netherlands and Switzerland, while Ireland was described as a “bad player”. Concerns were expressed that a race to the bottom on corporate tax rates – by nations including Ireland, the UK and (now) the US – might ultimately lead to global shortages of funds to address infrastructure needs, climate change, global poverty etc.
Transfer pricing was described as “rough justice”, ineffective in a global economy where intellectual property can be moved freely among countries. BEPS in its present form was seen as ineffective, particularly when led by developed OECD nations in collusion with tax avoiders, rather than by developing nations that suffer most from tax avoidance.
A modern corporate tax system is needed globally. This should be founded on transparency, and the notion that companies need privacy in their tax affairs does not withstand scrutiny.
The debate concluded that greater global co-operation is needed to limit the harmful effects of tax competition and to outlaw tax evasion. Without this, populations are being deprived of funds to provide essential services and protect human rights.
The situation will not change until citizens go out and express indignation and outrage at corporations not paying appropriate taxes.
Article supplied by Taxing Words Ltd