Tax reform in the United States echoes a wider trend of tax changes worldwide that multinational corporations must keep in mind when they consider how provisions in the new U.S. law will impact their global businesses and financial structures. This is especially true now that significantly lower U.S. corporate taxes upset previously ingrained assumptions.
TAX REFORM AROUND THE WORLD
Ernst & Young pointed out that 56 countries are rolling out or considering tax reform. According to Cathy Koch, E&Y’s Americas tax policy leader, following the 2008 financial crisis, increased deficits across the globe led governments to try to raise revenues, through direct taxation or compliance. In recent years, as deficits have shrunk, however, it has become more important to attract corporate investment and create jobs, and lowering tax rates has increasingly been part of economic policy discussions.
Koch noted that, while the U.S. legislative system can make it challenging to enact tax legislation, other countries’ systems of government tend to enable them to adjust their tax systems more readily to meet current needs. In fact, it was uncertain whether it would come to pass through most of 2017, and the wide-ranging final bill was largely assembled and signed into law in three months.
REPERCUSSIONS FROM LOWERING THE CORPORATE RATE
Until tax reform, the 35-percent U.S. corporate rate was the highest among the 30 countries with the biggest GDPs. Now, excluding the U.S., that average rate is 26.7 percent, and U.S. corporate taxes, including the state-tax average, is a percentage point or so less than that, at about 25 percent, Koch said. She added that the average corporate tax for Organization for Economic Cooperation and Development (OECD) countries is about 25 percent.
Tax reform has major implications for countries that have significant trading relationships with the U.S., as well as companies with cross-border operations or who may be considering them. Exhibit A is Canada, which for some time has had an average corporate rate of 27 percent, combining federal and provisional taxes. Now the average U.S. rate is a tad lower, and last year Canada actually went against the tax tide and actually increased taxes modestly for some private companies.
Paul Seraganian, managing partner at Osler Hoskin & Harcourt, said that U.S. tax reform has essentially reversed long held tax-related assumptions.
“The river used to flow one way, and now it’s going in the opposite direction, and that creates a number of foreseeable and, frankly, possibly unforeseeable results,” Seraganian said. He added that notion applies especially to Canada because of its proximity and outsized trading relationship with the U.S., but similar dynamics are relevant to other jurisdictions as well.
Seraganian cited tax deductions as one example. If a company has the freedom to locate its deductions anywhere, it will harvest them in the jurisdiction with the higher tax rate. Until this year, companies operating on both sides of the border typically chose to maximize their deductions in the U.S., but in light of the new tax situation and other relevant factors, that may no longer be the case.
Now, for example, a company may decide that over time, it is preferable to centralize management in the U.S. and charge a heftier management fee to the Canadian company for U.S. services, because “it’s deflecting income at a higher rate in Canada and taking income inclusion at a lower rate in the U.S.”
Indeed, Seraganian said, the new relationship between tax regimes brings a host of other variables into play that could significantly impact a company’s operations and supporting financial structure, including depreciation deductions, capital expenditures and intellectual property (IP).
“If you’re moving intercompany items that generate deductions into Canada, that largely means you’re moving income-producing factors to the U.S., whether it’s IP, IP management or other intercompany resources,” Seraganian said.
PREDICTIONS FOR THE FUTURE
Michael Kandev, a partner at Davies Ward Phillips & Vineberg, believes it would be unwise for companies to make rash moves based on U.S. tax reform, and he doesn’t anticipate a slew of Canadian companies inverting to the U.S., as many U.S. companies have done by moving to lower tax jurisdictions. The U.S.’s high national debt and unpredictable politics could very well result in corporate rates rising in the future, if not to previous levels. However, companies may pursue smaller changes.
For example, the historical approach was to have as little taxable profit in the U.S. as possible, to minimize exposure to the 35 percent+ corporate tax rate—minimal operations earning minimal profit.
“Now, a company might change its value chain to have more profit in the U.S.,” Kandev said. “So, for example, instead of selling remotely into the U.S. market, it goes to a full distributorship model with inventory, and marketing and sales people in the U.S.”AFP 2018 features multiple sessions on tax reform in the Treasury Management track. See the full list of sessions here.