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February 16, 2018

An omnipresent policy objective underpinning the Tax Cuts and Jobs Act (TCJA) has been to encourage the speedy return of cash, jobs, capital expenditures (CapEx), and tax revenue back to Uncle Sam. Many critics, and even supporters, of the TCJA have questioned the rushed pace at which the Act was put together. As these new rules rollout, it seems quite possible at least some of the new provisions will ultimately “miss the mark” from a policy standpoint. 

One of the core objectives, encouraging domestic CapEx, may in fact already be challenged by a competing international provision promulgated under the Global Intangible Low-Taxed Income (GILTI) regime. At first glance, one may think “What in the (tax) world do either of these two provisions, immediate expensing of CapEx and GILTI, have to do with one another?” But as our favorite cliché tax proverb goes: “the devil is in the details.”

Under the TCJA, our much-adored bonus depreciation applicable to the acquisition of certain tangible, depreciable assets[1] has been temporarily doubled from 50 percent to 100 percent effective September 27, 2017. The immediate expensing of CapEx will begin to phase out starting in the calendar year 2023. Two key elements of “immediate deductibility” are important to remember: 1) this “advantage” is still a “timing difference” and 2) the rule phases out eventually, meaning the unfavorable timing difference could presumably occur in a higher rate environment if the Republican party loses its stronghold on Capitol Hill and the White House. 

So how does the discussion above fit into a discussion of GILTI? For those not familiar with GILTI, the “simple” explanation is the generally favorable “participation exemption” system (i.e., a 100 percent dividends-received-deduction for dividends from specified 10 percent owned foreign corporations) is potentially “[T]rumped” by a new aspect of the Subpart F regime that creates a deemed repatriation when the earnings of a controlled foreign corporation (CFC) exceed a 10 percent return on the “qualified business asset investment” of the CFC. The definition of qualified business asset investment generally includes the same class of assets eligible for the 100 percent CapEx deduction.[2]

Using a simple example, assume a CFC earns $100K and has a qualified business asset investment base of $400K in a given year. In this case, a 10 percent return on the $400K would be $40K, leaving $60K as GILTI. The GILTI amount would be currently taxable to its U.S. parent (similar to Subpart F income), but at a lower rate due to a 50 percent deduction granted to domestic corporations against GILTI income. Ignoring the applicability of foreign tax credits, it’s obvious that even a 10.5 percent rate of tax (e.g., 50 percent of the 21 percent corporate tax rate) is a tough pill to swallow as compared to a full exemption of the income. But as compared to the alternative of operating in the U.S., a 10.5 percent rate (even assuming no FTCs) is a lot less than 21 percent (plus the state rate). [3]

There are two key elements of the new U.S. “territorial” tax system to keep in mind going forward. First, the new 100 percent participation deduction theoretically creates a “permanent difference” related to foreign income recognition (i.e., a complete exemption, as compared to the temporary deferral that was permitted by the prior system). Second, and perhaps more importantly, the new GILTI regime creates a major exception from the principle of territoriality; an exception that for many companies may overwhelm the general rule.  For those companies, the new U.S. tax system may not be a move to territoriality; but rather a move to a purer form of worldwide taxation.

An important reason for the move to a “territorial” system was to stem the tide of corporate inversions, by eliminating the tax disadvantage of operating through a domestic corporation. But it remains to be seen whether the GILTI regime will keep inversions afloat. It does not appear likely that GILTI will be high on the chopping block of a Democratic led government, meaning it seems like it may be here to stay. On top of that, there has been talk by the Democrats of abolishing the participation exemption completely, which then may dramatically change the story line to a full moon tide for corporate inversions.  

So where does this leave our friends in the tech field and other industries with profitable foreign operations? Many are wondering if and when it makes sense, under the new system, to shift operations and related CapEx back to the United States. This exercise is likely to lead many companies to consider modeling the tax impact of onshore versus offshore CapEx. If one thing is for certain, it is that nothing is for certain in the current tax landscape.

Author: Kenneth Dettman

We’d love to get your thoughts: Do you think Congress missed the mark on this matter? Does your company project to find itself in a GILTI situation and, if so, would foreign CapEx solve or mitigate the issue? Please call or email us and let us know!

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[1] MACRS assets with a recovery period of 20 years or less. See IRC Section 168(k)(2).  

[2] Note that tangible assets used predominately outside the U.S. are generally not eligible for MACRS depreciation.  Rather, they are depreciated under the “Alternative Depreciation System” or ADS.  Thus, despite the reference to Section 168(k) in the GILTI provision, the assets are not actually depreciated under MACRS for any purpose from a U.S. perspective.

[3] The impact may be even greater for individual or pass-through owners of CFCs as they may be facing the difference between full current taxation (with no indirect tax credit) at rates up to 37 percent and potential deferral then eventual inclusion at qualified foreign dividend rates (if eligible) between 15 and 20 percent). 

 

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