April 16, 2018 - Now that tax reform is a reality, multinationals are smart to ask whether provisions in the law will affect their global supply chains. Can your value chain become more tax-efficient under the new rules? Should you onshore your manufacturing operations, intangible property, or both? No answers will fit every business, but there are various factors to consider.
The new law is ostensibly designed to prompt corporations to increase investment in domestic production capabilities and to onshore foreign operations. As companies around the world are beginning to invest more heavily in digital capabilities to drive their transformation agenda, a lower corporate tax rate in the United States may make it a more competitive jurisdiction for companies with global value chains looking for the right location for these new investments.
In addition to the lower rate, the new deduction for foreign-derived intangible income (FDII)—a low tax rate on income gained by domestic corporations serving foreign markets with goods produced in the United States—is a further incentive to operate domestically, although the way in which the benefit is calculated can mitigate the benefit for companies investing in tangible assets in the United States.
While FDII and a lower corporate tax rate may incentivize locating certain operations within the United States, other provisions are intended to increase U.S. taxation for U.S. corporations that continue to own controlled foreign companies (CFC). The law contains two provisions intended to deter U.S. corporations from transferring their operations or their intellectual property to low-tax countries: the global intangible low-taxed income (GILTI) provision and the base erosion and antiabuse tax (BEAT) provision.
GILTI refers to a non-U.S. subsidiary’s earnings from active operations minus a prescribed amount representing the portion of those earnings that can be attributed to its tangible depreciable assets. U.S. shareholders of a CFC must include GILTI in their income. Depending on your point of view, the allowance related to offshore tangible goods may be a reasonable return resulting from the business necessity of global operations, an incentive to invest in factories and other asset-intensive activities outside the United States, or maybe something else.
Under tax reform, the U.S. taxable GILTI amount has a 50 percent deduction allowance through 2025 (37.5 percent thereafter) and is taxed at 21 percent. Accordingly, your effective tax rate for GILTI, in isolation, will be 10.5 percent this year if your company has no tax obligation on the foreign pool of GILTI profits. There is double tax relief available for 80 percent of the pool of foreign tax credits attributed to the GILTI income.
The BEAT applies only to businesses that have U.S. gross receipts in excess of $500 million, aggregated on a global group basis. The provision imposes a 10 percent minimum tax on certain deductible payments made to foreign affiliates, excluding cost of goods sold. Companies with value chains that are defined by locality—for instance, a watch company that relies on a “European-made” label—may be adversely affected by these new rules.
With tax incentives supporting both domestic and foreign value chain development in different ways, some manufacturers have rightly or wrongly decided that the new law effectively neutralizes tax as a factor in deciding whether to operate in the United States or abroad.
Others are more wary in view of the uncertainty surrounding tax reform. Some companies fear that new tax provisions may be rolled back when the political winds change, putting one or the other scenario at an advantage. Moreover, there is uncertainty regarding the details under the new law, as well as potential future legislative action by foreign countries that could increase foreign taxation on a company’s value chain (e.g., in the form of denied deductions for U.S. manufacturers exporting goods abroad) and lessen or potentially eliminate the intended U.S. benefits or result in double taxation. Such uncertainty—not to mention the lack of guidance as to how tax reform rules will be applied—make it difficult to come to firm decisions about value chain management. But learning about some of the new law’s elements that may affect your operations planning is a good place to start.