US Congress scrambles to approve tax reform

The Republican majorities in the US House and Senate are racing against a self-imposed year-end deadline to come up with legislation to transform a tax system widely seen as complex and inefficient into one that brings jobs and investment back home. Whatever they come up with will have important consequences for both domestic and foreign multinationals.

The effort, however, faces several obstacles. Differences between the House and Senate versions, the addition of $1.5 trillion to the deficit over 10 years, failure to seek the Democrats’ input, pushback from business groups of all stripes and controversy over the decision by Republican senators to incorporate the seemingly unrelated repeal of a key health insurance mandate are just the start.

Both bills move the U.S. from a ‘worldwide’ tax system to a ‘territorial’ system. Under the current system, US-headquartered corporations must pay tax on all income, whether earned in the US or overseas, when that income is repatriated to the US. To avoid this tax, US multinationals have become adept at stashing their foreign profits – estimated to total between $2.5 trillion and $3 trillion – offshore.

By switching to a territorial system that mainly taxes income earned in the US, legislators hope those corporations will repatriate their foreign earnings and invest them in the US. “In both proposals, dividends from foreign subsidiaries would be tax-free in the US so companies would not have to worry about the cost of bringing money home,” explains Mitch Thompson, an international tax partner in the Cleveland, Ohio office of the global law firm Squire Patton Boggs. However, each bill imposes a form of one-time tax, payable over eight years, on the liquid or illiquid earnings “deemed repatriated”.

An especially controversial element of the House bill that has multinationals in fighting mode would impose a 20% excise tax on payments by US corporations to related foreign corporations – often in connection with global supply chains or “legitimate business operations” – unless the foreign company elects to be treated as “effectively connected with a US business” and therefore subject to US taxes.

Given the highly technical nature of each bill, and the difficulties certain to arise in reconciling them, there is some scepticism about whether legislators can achieve their ambitious target date. “There are so many moving pieces,” says Mr Thompson. “There will be winners and losers from industry to industry, and from taxpayer to taxpayer. Whether it will be as comprehensive as envisioned or get pared down to something less substantial remains to be seen.”