Professional Interpretation

Abstract: On November 16, 2017, the US House of Representatives passed the tax reform bill with 227 votes in favor and 205 against. Earlier on December 2, the Senate approved the Tax Cuts and Jobs Act (“Senate bill”) with 51 to 49. If all goes well, President Trump may sign the bill before the 2018 New Year. Several provisions in the House bill and Senate bill will affect investments made in the US by Chinese enterprises. The International Investment Division of Docvit Law Firm will hereby analyze the key points of tax reform bill of the United States as follows.

A. Corporate Tax Rate

Both the House Bill and Senate bill proposed to lower the current top corporate tax rate from 35% to 21% instead of 20% earlier suggested.

The House would cut the rate for tax years beginning after December 31, 2017, while the Senate would delay the implementation for the tax years beginning after December 31, 2018. In view of current policy on foreign tax credit in China, the corporate tax rate reduction in the US may have adverse effect on the repatriation of future foreign earnings to China. Thus Chinese investors should evaluate the current shareholding structures of investments made in the US.

B. Alternative Minimum Tax (AMT)

The House-Senate Conference conferees agreed on the final version of GOP tax reform and would be eliminated for the tax years beginning after December 31, 2017.

Generally speaking, the AMT is an independent tax system that works in parallel with the regular income tax system of taxable income and income tax. The AMT was originally designed to prevent certain taxpayers from avoiding their fair share of tax liability through abusing tax preference and pre-tax deduction.

C. Immediate Expensing of “Qualified Property”

US corporations will be allowed to fully and immediately expense 100% of the cost of qualified property acquired (instead of take additional depreciation for certain qualified property).

The House bill and Senate bill proposed to allow the taxpayers to expense 100% of the cost of qualified property acquired and placed in service after September 27, 2017 and before January 1, 2023 (under current law, taxpayers may take additional depreciation in the year in which it places certain “qualified property” in service through 2019 (with an additional year for certain qualified property with a longer production period). In addition, the Senate bill also allowed allow continuing to fully expense the cost of qualified property acquired and placed in service from January 1, 2023 to December 31, 2027, at the rate phasing out by 20% per year. Despite that the full expensing of qualified property may induce temporary differences, the policy is expected to attract more domestic property investment in the US. Chinese investors should consider the impact of new provisions while planning capital expenditure.

D. Interest Expense

According to the House bill and Senate bill, the provision will be effective from the tax year after December 31, 2017. Under the current law in the US, business interest generally is allowed as a deduction in the tax year in which the interest is paid or accrued. Both bills proposed to limit the deduction of interest expense (paid to related party or unrelated party):

a. Deduction for net interest expense would be within 30% of the “business’s adjusted taxable income” (not applicable to businesses with average gross receipt under certain amount);

b. The interest expenses for US corporations that are members of an international financial reporting group (IFRG), of which the share of the IFRG’s total net interest expense exceeds a certain portion of the US corporation’ s share of the IFRG’s total earnings before interest, taxes, depreciation, and amortization (EBITDA) (whichever is lower), would be deducted with limitation.

As for the disallowed interest expense within the tax year, the House bill allows it to be carried forward for five years, while the Senate bill allows it to be carried forward indefinitely. Besides, the House bill and Senate bill have different provisions on the determination of “adjusted taxable income” and share ratio of IFRG’s members. The limitation on the interest expense deduction may cause the rise in borrowing cost. If investors seek to maintain the deduction level of interest expense, they may need to restructure their current financing arrangement of investments in the US.

E. Strengthening the Rules on Controlled Foreign Corporations (Subpart F)

Both the House Bill and Senate Bill followed the current rules of the US on the controlled foreign corporations and expanded in aspects including the definition of “controlled foreign corporation (CFC)” and “United States shareholders”. Under the bills, the subsidiary established outside US of non-US multinational corporations with subsidiaries in and outside the US shall be considered as a CFC. Chinese enterprises that invest in the US should beware that the Chinese headquarter may need to submit extra Information Return of US Persons with Respect to Certain Foreign Corporations for its US subsidiary to the IRS.

Furthermore, the House bill proposed to impose the corporate tax rate equal to 10% on the “foreign high returns” derived by CFC at the rate of lower than 12.5 outside the US. The Senate bill considered to impose a 10% tax on global intangible low-taxed income (GILTI).

F. Limitation on Net Operating Loss Deduction

Under current law, net operating loss (NOL) may generally be carried back two years and carried forward 20 years to offset taxable income in such years. Both the House bill and Senate bill proposed to repeal all carrybacks but permit an unlimited NOL carry forward period.

Under both bills, taxpayers would be able to deduct an NOL carryover only to the extent of 90% of the taxpayer’s taxable income. The Senate bill also suggests to limit the NOL deduction to 80% of taxable income in years beginning after December 31, 2023 and allow unused NOL carry forwards to be adjusted indefinitely. In order to avoid the loss of future tax benefits of NOL, enterprises are suggested to expedite the identification of their income.

G. Capital Gains and Dividends Derived from Outside the US

Currently the US adopted the “international taxation”. The top corporate tax rate of 35% applied to the capital gains and dividends derived from outside the US. Both bills proposed to adopt territorial taxation approach to fully deduce the tax on the qualified capital gains and dividends obtained from outside the US (shareholding ratio above 10% over a certain period of time). However, the Senate bill set anti-abuse provision to stipulate the capital gains and dividends already deducted in calculating the overseas taxation to be still taxable. The new provision is aimed to prevent certain enterprises to obtain anti-dual taxation benefits by manipulating the rules of different jurisdictions on determination of capital gains and dividends.

H. Tax Base Erosion/ Excise Tax

Under current tax system, US corporations are subject to a withholding tax of 30% for the making certain payments to foreign corporations, although exemption may apply if stipulated in the applicable tax treaty. Both bills proposed solutions towards domestic corporations that making large payments to overseas related parties that may erode the tax base of the US:

The House bill proposed to impose 20% excise tax on certain deductible payments (interest and other related payment not included) made by US corporations to their non-US corporate affiliates (except those are income effectively connected with the conduct of a US trade or business). The related foreign corporations may elect not to pay the excise tax, but treat the payments as “income effectively connected with the conduct of a US trade or business”. The reform on excise stated in the bill may have impact on the future supply chain and intangible assets holding.

The Senate bill proposed to impose a 10% base erosion and anti-abuse tax (BEAT) on US corporations of which payments made to related foreign corporates are considered as “base erosion” (BEAT rate set to grow to 12.5% in 2026). Chinese enterprises that conduct trade, service and intellectual property transactions with related US corporations should pay high attention as they may be subject to taxation with regards to the relevant payments received from related US corporations.

I. Identification of Profit Derived from Products Manufactured Outside the US

Under current tax system, profit derived from products manufactured outside US and sold in the US by foreign corporates should be partially considered taxable in the US. Both bills proposed to modify the rules on the identification of profits derived from products manufactured outside the US. Thus, Chinese enterprises selling the products manufactured in China in the United States may be entitled to declare exemption in the US by asserting the profit in the US has not been received. However, if products are sold through intermediary dealers in a third country (or its subsidiary outside the US), the rule on the identification would not be applied for the tax liability exemption. Chinese enterprises may need to consider the adjustment of business model in advance.

J. Transition Tax

During the course of turning into territorial taxation, the accumulated profit that US corporations hold in cash and other assets would be deemed as repatriated back and thus taxable (at a relatively lower tax rate) in the US. Taxpayers could elect to pay the tax liability over a period of up to 8 years. Chinese investors that own US corporations with subsidiaries outside the US should pay particular attention.

K. Repatriation Tax on Profit Derived from Outside the US

As a transitional policy from international taxation to territorial taxation, both bills proposed to impose repatriation tax on profit gained by US corporations from overseas as “deemed repatriation tax”, meaning that the tax would be imposed regardless of whether the profit derived from overseas has actually been repatriated. In consideration of cash flow crunch, both bills allow the tax to be spread over 8 years. However, the Senate bill suggested a rate of 14.49% on repatriated profit represented as cash asset and a rate of 7.49% on those represented as other assets; whereas the House bill proposed slightly lower rates at 14% and 7%. As the repatriation tax on profit derived from outside the US was mandatorily imposed starting from the tax year of 2017, it is expected to have immediate effects on the cash flow of foreign subsidiaries of US multinational corporations (including subsidiaries in China).