Professional Interpretation

The Chinese and US economies, the two largest in the world, are highly integrated. Any change to one country’s tax regime has a ripple effect on the other. The recent US tax reform act carries potential ramifications for bilateral investment between the United States and China. We take a closer look at how tax reform might affect Chinese outbound investment into the United States.

Corporate Tax Rate

The law created a single corporate tax rate of 21% starting in 2018 and abolished the company's alternative minimum tax rate. Unlike personal tax relief, these terms do not expire. Before that, the highest corporate tax rate was 35%, which was the highest tax rate for all large developed countries. With state and local taxes added, the statutory tax rate under the new law is 26.5%.

G20 corporate tax rates, 2012

Interest

The net interest deduction, which currently has no cap, will initially be limited to 30% of earnings before interest, taxes, depreciation and amortization (Ebitda). After four years, it will be capped at 30% of earnings before interest and taxes (Ebit).

Foreign Earnings

The Act stipulates that 15.5% of cash and equivalents and 8% of reinvested earnings are treated as repatriation profits.

The law introduces a territorial tax system under which only domestic income is taxable. Companies that earn more than US$500 million a year are subject to basic erosion of the Anti-abuse Tax (BEAT), which aims to offset the erosion of bases and profits, which is a tax planning strategy that involves shifting a country’s taxable profits. Low taxes to another country or no tax. BEAT is calculated by subtracting corporate tax liabilities from 10% of its taxable income, and ignores basic erosion of payments. Tax credits can offset 80% of BEAT's debt.

The law changed the treatment of overseas intangible assets. It does not define "intangible assets," but the term may refer to intellectual property such as patents, trademarks, and copyrights (eg, Nike Inc. (NKE) put its Cyclone trademark into a Dutch subsidiary). When the foreign tax rate of the foreign exchange income at the standard rate of 10% of the excess return is less than 13.125%, the legal taxation is based on the excess return below 21%, the 50% deduction, and the deduction after deduction of 37.5% of the FDII

Impact on China Outbound Investment into the United States

For Chinese investors with US subsidiaries, it is good news to reduce headline tax rates and abolish corporate alternative minimum tax rates (AMT). In addition, the US tax cuts may help U.S. companies achieve higher profitability in the future.

The dividends sent by the United States to China are still subject to China's corporate income tax (China's corporate income tax is still a global taxation system), but US federal income tax can be used to offset the Chinese corporate income tax liabilities. When the U.S. federal income tax rate is 35%, compared to the Chinese corporate income tax rate of 25%, this is not a problem. But now, with the US corporate tax rate of 21%, Chinese investors should consider whether they intend to repatriate.

The interest deduction rule may affect the investor’s choice of US subsidiary’s equity and debt financing model. After January 1, 2018, U.S. companies will deduct the upper limit of commercial interest charges and apply to related and non-related loans. The new rules not only extend the restrictions on the deduction of commercial interest expenses to related and non-related loans, but also reduce the ceiling deduction limit. Obviously, the more restrictive goal is to encourage investment in the United States in the form of equity rather than debt. Taking into account more stringent restrictions and the period between debt investment and equity investment, and the comparison of withdrawals and amounts, Chinese investors can consider and balance the ratio of debt investment and equity investment.

The tax law will also affect how investors buy American companies. The "tax law" allows 100% of the property that will be put into service between September 27, 2017 and January 1, 2023. In addition, after December 31st, 2022 and January 1st, 2022, the expenditure portion will gradually decrease by 20%. Although the goal of this cost recovery system is to encourage the renewal of infrastructure and outdated equipment and promote fixed-asset investment, However, potential buyers of U.S. companies may also use this rule. Potential buyers may purchase the target company’s assets instead of buying the US target company, but instead pay the full purchase in the current period.

Chinese manufacturers may try to benefit from the Foreign Intangible Income (FDII) rules in the tax law. The FDII rules encourage manufacturers to set up agencies in the United States and reward American manufacturers for the extra returns they receive from overseas sales by allowing them to reduce the overall tax rate for excess returns. The effective tax rate of FDII can reduce the corporate tax rate to around 13%. This is much lower than China's corporate income tax rate of 25%, and may be attractive to large Chinese manufacturers. Some Chinese manufacturers, such as Fuyao Glass (a car glass manufacturer), have already or are considering moving the factory to the United States.

Chinese investors may need to consider the impact of Chinese corporate income tax on potential controlled foreign companies (CFCs). The United States has traditionally been a white list country for the purpose of China's CFC. However, drastic reductions in tax rates under the tax law may lead the State Administration of Taxation to reconsider its status quo. According to China’s CFC rules, if the “effective tax rate” of a foreign subsidiary of a Chinese company is less than 12.5%, the foreign subsidiary may be considered as a CFC for Chinese investors. If this is the case, then CFC's profits will be deemed to have been allocated to investors and subject to CIT constraints in China. Although 21% is still significantly higher than 12.5%, considering the preferential policies of the tax law, it will be interesting to see how the State Administration of Taxation interprets the "effective tax rate" and the "effective tax rate" of US subsidiaries.

Conclusion

The recent US tax reform legislation represents the most radical change to the US tax system in decades, and will have spillover effects on businesses and individuals around the world that have nexus to the United States. This round of tax competition led by the United States may not necessarily cause adverse effects in China, despite concerns that large manufacturers might consider relocating their factories to the United States. Because of the interplay with China’s tax policies, the overall impact on China will likely be moderate, but all taxpayers will want to carefully evaluate this interplay under these new circumstances.