Key tax reform provisions for foreign inbound U.S investments
On December 22, 2017, President Trump signed into law the Tax Cuts and Jobs Act (“TCJA”) which represents the most sweeping changes to U.S. tax law since 1986. Stated drivers of the reform include spurring growth in the domestic economy, increasing domestic employment rates, and creating a competitive landscape for foreign investment in the U.S.
Without question, the reaction to the TCJA has been mixed, and there are a range of opportunities and challenges to be considered -especially with respect to foreign multinational companies investing into the U.S. This alert seeks to address a few key provisions in the TCJA that French parent companies of U.S operations should consider on a go-forward basis.
Interest Expense Limitation
For companies that are torn between injecting debt or capitalizing their U.S. investment with equity, it is now critical to take into account the new U.S. thin capitalization rules under Section 163(j). These rules limit interest deductions at the level of the U.S. company to 30% of earnings before interest, tax, depreciation and amortization (EBITDA) for tax years through 2021, and 30% of earnings before interest and tax (EBIT) thereafter. As a result, U.S. subsidiaries of foreign companies may now find themselves unable to deduct all of their interest in computing U.S. taxable income.
Few items could still be considered to limit the impact of this new limitation e.g. increased business interest income can “free up” otherwise disallowed interest; consider shift of adjusted taxable income not fully subject to US tax; compare NOL deduction with the disallowed interest carryforward etc. In light of this, French parent companies may wish to review and rethink their capitalization structure within the U.S.
Further tax costs with respect to interest payments and certain other types of base erosion payments (e.g., rents, royalties, service fees, etc) from the U.S. to foreign related parties may also now be subject to the Base Erosion Anti-Abuse Tax (BEAT). BEAT imposes a minimum tax on corporations with U.S. gross receipts of $500 million or greater over a three year period, and base erosion payments of at least 3% (in comparison to total deductions). The BEAT tax, itself, equals the excess of 10% of the corporation’s modified taxable income for the year over the corporation’s regular tax liability, reduced by certain credits. Large U.S. and foreign corporations may find themselves subject to BEAT if they have insufficient non-base erosion payments (e.g., payroll expenses) to disqualify them from the threshold conditions above.
Planning considerations such as French companies paying the services fees on behalf their US subsidiaries need to be carefully monitored to identify the French tax consequences of such a position.
In any case, this would be an opportune time to review related party transactions, consider restructuring if the business needs support it, and confirm appropriate transfer pricing.
Net Operating Losses
The TCJA now limits the deduction for net operating losses to 80% of a taxpayer’s taxable income, repeals the two-year carryback provisions (certain industries excepted) and allows for an indefinite carryforward of unused losses. As indefinite-lived DTLs may be an additional source of taxable income for NOLs, impact of this limitation could be closely monitored at the level of certain French groups.
Sales of Partnership Interests
French companies with an investment in a partnership that is engaged in a U.S. trade or business, any gain realized on the sale of that partnership interest could be treated as U.S. effectively connected income and subject to U.S. tax. This is a direct repeal of the decision by the U.S. Tax Court in Grecian Magnesite Mining in which such sales were held to not be subject to U.S. tax. French buyers and sellers of interests in U.S. investment partnerships should be wary of this provision’s impact.
These are just a few key provisions of which French multinational companies should be cognizant.
This article was written by Tifphani White-King and Iosif Cozea