A US tax reform on the way

There are a number of signals pointing towards a forthcoming reform of the tax code in the US and that this might materialize already at the end of this year/beginning of 2018. The major purpose of such a reform would be to strengthen US companies’ competiveness and boost the domestic economy. However, individual income tax rates are also expected to be covered by a possible re-write of the tax code.

As is well known, President Donald Trump campaigned on a promise to reduce the US corporate tax rate from its current 35 percent to 15 percent. At the same time, he has talked about introducing some form of import tax on foreign goods and services in order to create jobs in the US. The response to this latter idea from other countries was very negative, as it also was from US companies selling imported products. All production cannot be located in the US. In addition, foreign components are often used in manufacturing even if the actual factory is moved to the US.

In a White House decision on 27 July, it was announced that the idea of an import tax was no longer being considered. At the same time, a group of six leading politicians, “The Big Six,” formed a group to produce a proposal for a tax reform plan. This group now meets once a week and they have formulated six key elements to be incorporated in the proposal they intend to present.

These key elements were discussed at a large, international tax congress held recently by the International Fiscal Association, as were the political and economic premises for such a reform. That a reform is now seen to be probable is supported by the fact that Treasury Secretary Steven Mnuchin has stated, on a number of occasions and most recently just a couple of days ago, that there will, in fact, be a reform, and that it could come into effect perhaps already from the end of the year. Others believe, however, that 2019 is more likely in terms of the introduction of a reform. Still, whether they will succeed in reducing the corporate tax rate all the way down to 15 percent is uncertain.

Here are six key elements to be included in the reform. Note that these refer to federal tax and are points are described very generally, but detailed proposals are already being discussed.

• Reduction of the corporate tax rate from 35 percent to, if possible, 15 percent. However, many expect that the reduction won’t be greater than to 20-25 percent. It is doubtful if the reduction will cover services companies who are taxed at per taxpayer level, that is, as partnerships.
• Some form of limitation on deduction of interest expenses will apply, and this could be similar to that being discussed within BEPS and now, also, in Sweden.
• Some form of tax rebate could apply if profits outside the US are brought back to the US in order to create investments and jobs.
• A lower tax rate will be introduced for smaller companies so that they can compete with larger companies.
• There will be a reduction in income tax for US families. In this manner, companies taxed as partnerships will incur a lower tax rate.
• The discussed import tax will not be proposed. This is positive for Swedish companies.

The last time a tax reform was implemented in the US was 1986.

One challenge with a reform which reduces the corporate tax rate, and this is a real problem, is that such a reform must have the support of 60 of 100 Senators to be permanent. In another case, the reform is limited in time to ten years. Just now, Trump has the support of only 52 Republican Senators in the Senate. If a tax reform of this scope is limited to ten years, then, the effect of the reform will be limited accordingly. In other words, just when the effects begin to appear, the reform will no longer apply. How will US companies react in such a situation?

The key elements included no mention of tax rates at this stage, and neither was there any mention of how a reform is to be financed.

A concrete question for Swedish companies operating in the US is how they will finance their operations there when one has, in the end, seen what the tax reform will actually imply.

Comments

That which is new and interesting in this context is that the heavy-weight group, The Big Six, has now been formed and that, according to the information provided, it meets each week to advance the possibility of a tax reform. In addition the Treasury Secretary has invested a great deal of political prestige in this issue. This implies that something appears to be underway and this was also the shared understanding of the participants at the three seminars in which the tax reform was discussed at the above-mentioned congress. Even if unemployment in the US is low, Trump needs to create jobs generating high productivity and, thereby, providing the possibility of higher salaries in the US:

The challenges are the “traditional” split amongst Republicans, the financing of the reform and the fact that companies belong to very different industries having varying interests when it comes to the design of a possible new tax reform. These companies can mobilise strong lobbying activities. The different states in the US also have different interests depending on the make-up of their business community/economic base. In addition, there is the negative threat of a 10-year limitation if Trump fails to get 60 Senators behind the reform. How will companies react to the reform later on? Adapt now, but a reversal back to the former situation at a later date? The comments from PwC in the US were that such a time-limited reform would be seen to be a ten-year “trap”, leaving everyone guessing as to how the rules will actually function?

It is now clear that something has to happen in this context in the US. US corporate taxation is out-of-date with a tax rate of 35 percent and with no tax in the US on foreign profits if they are not repatriated back to the US. But this situation has been understood during at least 10 years without anything being done about it. However, a greater degree of political prestige has been invested in this question, now, and the key elements for the proposal incorporate a broader scope.

It goes without saying that PwC in Washington will continue to monitor these issues very closely. The next status report from The Big Six is expected to be released in October.