As is well known, there is a fairly clear divide on tax ideology between the Republicans and Democrats in the US. In general, Republicans stand for lower taxes, more entrepreneurship and less government. We saw the epic manifestation of this ideology in the pathbreaking corporate tax proposals in the Tax Cuts and Jobs Act (TCJA) introduced by President Donald Trump in 2017.
At the centre of this change was the drastic and unprecedented reduction of federal corporate tax rate from 35% to 21%, the lowest since 1939, making the US one of the lowest corporate tax jurisdiction globally. Simultaneously, TCJA placed limits on interest deduction to the extent of 30% of income, while allowing businesses to deduct 100% cost of depreciable assets in one year, instead of having to amortise them over several years. TCJA also eliminated the corporate alternative minimum tax (AMT) of 20%.
These proposals are meant to encourage more business investments by ploughing back profits of US corporations and discourage excessive borrowings. TCJA contained far-reaching changes in tax treatment of global US corporations. For instance, it introduced the concept of global intangible low-taxed income (GILTI) tax of 10.5% on profits earned by foreign subsidiaries of US companies.
This was, again, meant to encourage US corporations to onshore their activities in the US itself, and avail of the new attractive business tax regime, rather than keep their businesses offshore in other countries. The Joe Biden-Kamala Harris presidential election campaign had made the following proposals for amending TCJA: Corporate tax is proposed to be increased from 21% to 28%, which probably represents the steepestever increase in recent years in any country globally. Along with this proposal, there is a new ‘Make in America’ tax credit to the extent of 10% on specific investments made in the US for revitalising existing closed facilities, retooling any facility to advance manufacturing competitiveness and employment, restoring and expanding job-creating production in the US, and expansion of manufacturing payroll.
GILTI tax is proposed to be doubled to 21% on the entire foreign-sourced income at the level of each foreign subsidiary. The current exemption of the first 10% of such profits is sought to be removed.
Also, a new offshoring tax penalty is proposed by way of 10% surtax on profits of any production by a US company overseas for sales back to the US. This surtax is also proposed to apply to call centres or services by a US company located overseas but serving the US. Finally, there is a proposal to deny all deductions and expensing write-offs for moving jobs or production overseas. The effective corporate tax rate, including the ‘offshore penalty surcharge’, will thus increase to 30.8%.
It is proposed to reinstate a minimum 15% tax on book income above $100 million. Taken together, the above proposals seek to substantially undo TCJA changes introduced three years ago, which does not augur well for certainty and stability of the US corporate tax system. Another business-critical change proposed is of a significant jump of the current tax capital gains tax rate of 20% to nearly 40%, in line with the proposed hike in the top individual tax rate to nearly 40%.
(The Trump campaign had proposed a further reduction of the top capital gains tax rate from 20% to 15%.) To revive the economy, Biden has called for the next government stimulus and relief package to be a lot bigger than $2 trillion. He has pledged investments in manufacturing, supply chains, infrastructure and clean energy, as well as R&D for electric vehicles, 5G and artificial intelligence (AI). Biden has also vowed to protect and expand the Affordable Care Act (ACA), with a plan to insure more than 97% of Americans at a cost of $750 billion over 10 years. According to the Biden-Harris campaign, the proposed sweeping changes in tax laws will fund these physical and social infrastructure plans.
The Biden-Harris proposals to increase taxation will spark a big debate, with major ramifications for global businesses. At the least, the global tax incidence of multinationals operating in the US will likely increase, as the ability to absorb the higher US taxes back in the home country may be constrained. This is because, on the back of Britain earlier and the US later dropping their corporate tax rates, many countries were nudged to follow suit to remain competitive in attracting global investments. Conversely, for US companies with subsidiaries abroad, the relatively lower corporate tax rates in countries such as India (which reduced the rate to 25% for existing companies and 15% for new manufacturing companies) may become more attractive destinations.
However, the one area that could be the cause of major concern in India is the proposed new ‘offshore penalty surcharge’ of 10% on top of the proposed corporate tax rate of 28% (effectively 30.8%). Inasmuch as it is sought to be extended to offshoring services as well, in addition to goods, it does raise the spectre of higher cost for US companies continuing to offshore services to India, or contemplating increasing the supply chain manufacturing in India. Indian tax authorities would do well to provide greater certainty on transfer pricing on offshoring of services and manufacture of goods to ensure that the overall tax cost for US companies remains attractive.
(The writer is national tax leader, EY India)