On September 27, a group of leaders from the Trump Administration, the House Ways and Means Committee and the Senate Finance Committee released a 9-page framework describing a proposed overhaul of the U.S. tax code. Their summary is intended to serve as a non-binding template for the tax-writing committees in the U.S. Congress to develop federal tax legislation. This proposal is the most significant step to date on tax reform from the Republican leadership, as it includes input from each of the parties that have a role in ultimately enacting tax legislation. Below we describe a few key tax proposals in the framework that may be relevant to non-U.S. corporations that invest in the United States.
1. Reduction of the federal corporate tax rate to 20%.
The current federal corporate tax is imposed at a maximum rate of approximately 35%, so cutting the corporate tax rate to 20% would represent a significant reduction in the nominal tax rate. In a speech introducing this proposal, President Trump noted that the 20% corporate rate is intended to make American companies more competitive with foreign companies, and the framework makes specific reference to the 22.5% average corporate tax rate imposed in the industrialized world.
For non-U.S. companies, a 20% U.S. corporate tax rate would make taxable investments in the United States more attractive, as this rate would apply to corporate taxable income that is effectively connected with the conduct of a trade or business in the United States and to "blocker corporations" used to avoid a direct U.S. income tax filing obligations. As described below, however, the benefit of this lower federal corporate tax rate may be reduced by proposed limitations on corporate interest deductions.
2. Limitation of the deduction for net interest expense by C corporations.
The Republican tax framework indicates that the deduction for net interest expense incurred by C corporations will be partially limited, though it does not provide any further detail. The net interest expense deduction is often used to significantly offset corporate income subject to U.S. tax in the hands of foreign corporate investors and "blocker corporations" used by non-U.S. investors.
Thus, limiting this interest deduction may result in an increase in corporate income subject to tax and thus partially offset the benefit of a lower corporate tax rate.
3. New tax rate of 25% on business income earned through pass-through entities.
The introduction of a 25% tax rate on income earned through "pass-through" businesses is intended to apply in lieu of the individual tax rate applicable to those businesses' owners. As the 25% tax rate on pass-through business profits is intended to supersede the tax rate otherwise applicable to individual business owners and is not expected to apply to corporate owners of a pass-through entity, this new tax should not directly impact the taxation of foreign corporations investing in the United States through pass-through entities.
Many of the details of this proposed tax reform plan have not been articulated in the published framework and thus will need to be worked out by Congress as the legislation is drafted.
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