Whilst that measure in and of itself is hugely important, both in the US and more broadly throughout the western world, it is some of the additional measures which are likely to cause the real ruckus.
Goods exported to the US
Most significantly, both the US House of Representatives and the Senate have a plan to raise additional revenue in relation to companies which they perceive to have engaged in practices that have, or may have, compromised the US tax base.
The House and Senate proposals are quite different both in content and effect.
- The effect of the House proposal is to raise $US 95 billion over the next decade.
- The Senate proposal aims to raise a more substantial $US 140 billion over a similar period.
Whichever is adopted, the likely flow on effect to other countries, such as Australia could be substantial, though it is not entirely clear that the effects will be as onerous as may at first appear to be the case.
The House Bill – is structured so as to ensure that if a US company sells goods which it has imported from a foreign company, part of the foreign company’s profits will be bought to tax in the US.
For example, if an Australian company sells a product to a US company for $200, which the American company then on sells for $250, US corporate tax will apply on the $50 gain at 20%, thus giving rise to $10 of tax in the US.
At this point, somewhat perversely, the US will, under this House Bill, demand that the Australian supplier file a US tax return declaring their profits on that transaction. Thus, if the Australian company had itself purchased that product for $160, thereby delivering a profit to the Australian company of $40, that $40 gain will need to be declared in the US. That $40 gain will then be taxed in the US at 20% giving rise to an $8 liability, but a credit will then be provided for 80% of the Australian tax that was paid on those profits. Presumably, the Australian tax paid on those profits would have been $12 (i.e. 30% of $40). 80% of that $12 is $9.60. The Australian tax paid would then wipe out any further liability in the US, because $9.60 is greater than $8. On that basis no further Australian tax would be payable.
If however the Australian tax for whatever reason was only $6.00 and the US tax remained at $8 the credit would only be for $4.80 (ie 80% of $6.00) and accordingly extra US tax of $3.20 would be payable.
[EDITORIAL COMMENT: It appears that this arrangement is designed to be a ‘rough justice’ transfer pricing measure for goods imported into the US – applying a foreign tax credits system to the whole of the foreign profit, raising US tax when the foreign tax rate is under 25% (the 80% gross-up of the new 20% US tax rate). This won’t affect Australian corporate exporters, even when their tax rate is reduced to 25%. US legislation requiring foreigners to lodge US tax returns, does beg the question about the legitimate territorial reach of these laws. It is similar to the recent FATCA laws, which required non-US financial institutions, to advise the US Revenue, of US residents, who held accounts with that foreign institution. Those laws were very substantially complied with, because of the strength of the US economy. The laws imposed penal sanctions on non-conforming institutions, the economic effect of which was enough to virtually guarantee their compliance. The US still has sufficient economic clout to legislate sanctions which are equally compelling.]
The Senate Bill – does not require a filing in the US by the Australian company. However, if there are payments to an overseas associate or subsidiary of amounts such as interest, royalties, or management fees, the deductibility of those payments could be effectively reversed.
[EDITORIAL COMMENT: This also appears to be a ‘rough justice’ transfer pricing measure, thin capitalisation and withholding tax measure, with an incentive to keep the US using US resources.]
There are many questions that arise as to how, exactly, this will play out in the real world, since the calculations both under the House and Senate plans are complex and difficult to apply in practice.
Flouting Double Tax Treaties – ‘unilateral treaty override’
If it does lead to a further US tax imposition, there is clearly a further question to consider as to whether the US is, in introducing these measures, continuing to comply with its many double tax Treaties. There is clearly an argument to suggest that those Treaties preclude such a tax applying particularly of the kind proposed by the US House.
Introducing laws which are in direct conflict with a negotiated Treaty position, which is known as “unilateral treaty override”. This is a practice, which is widely criticised in the international tax arena. Nonetheless, in the past, the US has shown a marked propensity to engage in this practice, where it suits them to do so and this may well be another instance where this will occur.
In this instance however the ramifications of US unilateral treaty override will be felt far and wide and the whole saga may raise the ongoing viability of the roughly 70 US Treaties which have previously been negotiated on a bona fide bilateral basis between two sovereign nations.
This may well call into question the whole current international framework of bilateral Treaties particularly if other countries take similar steps in response.
The Tax Institute’s Senior Tax Counsel, Professor Bob Deutsch’s article on Trump’s US tax reform was first published for TaxVine®, the Institute’s flagship, member-only weekly newsletter containing all the latest tax news and research. To receive TaxVine®, join up as a member with The Tax Institute. Find out more on the Institute’s website.