The Senate has passed its version of the Tax Cuts and Jobs Act, which includes substantial changes to the corporate and international business taxation rules. Senate passage was probably the most significant political and procedural hurdle for the legislation. The stage now appears to be set for reconciliation of the House and Senate bills and final enactment of the legislation before the end of 2017.
The Senate approved its version of the Tax Cuts and Jobs Act (Senate Bill) early in the morning on December 2, 2017, after a marathon Senate floor session. Like the House Bill that preceded it, the Senate Bill includes fundamental changes to the US corporate and international business taxation rules. Of all the steps in the legislative process, the Senate floor presented the most significant political and procedural obstacles to the legislation, and thus the approval of the bill by the full Senate represents a particularly important milestone.
Now the House and the Senate will work to reconcile the differences between their respective bills, which may be accomplished either through a formal conference committee or through less formal processes eventually resulting in approval of the same legislative text by both chambers. While there remain important policy differences to resolve, and there could be further bumps in the road, it appears likely that final legislation will be enacted before the end of 2017.
This article notes several important provisions of the Senate Bill in the areas of corporate and international business taxation, focusing in particular on changes made to the Senate Bill compared with the version that was reported by the Senate Finance Committee on November 16, 2017, and on significant differences between the Senate Bill and the House Bill.
Key Changes from the Senate Finance Committee Version
- Deduction for qualified business income of pass-through businesses (sole proprietorships, subchapter S corporations and businesses taxed as partnerships) increased from 17.4 percent in the Committee-reported bill to 23 percent in the final Senate Bill
- Bifurcated effective tax rates for transitional deemed repatriation of foreign earnings increased from 10 percent to 14.5 percent (for cash and cash equivalents) and from 5 percent to 7.5 percent (for other earnings), bringing the Senate Bill’s rates roughly into line with (but slightly higher than) those in the House Bill
- Corporate alternative minimum tax (AMT) retained (with a combination of intended and apparently unintended revenue-raising consequences)
- Extension and phase-down of bonus depreciation
- Technical changes to the interest limitation (including phase-in of limitations) and foreign-derived intangible income provisions
Major Areas of Difference Between the Senate Bill and the House Bill
- The Senate Bill defers the implementation of the 20 percent corporate income tax rate until 2019, whereas the House Bill implements it immediately in 2018.
- The Senate Bill preserves the corporate AMT, whereas the House Bill repeals it.
- The two bills take significantly different approaches to reducing effective tax rates on pass-through income. Notably, the Senate Bill’s reduced rates apply to various types of services income.
- The Senate Bill provides an “innovation box” of sorts by allowing a 37.5 percent deduction for income earned directly by US taxpayers from serving foreign markets, along with a measure reducing tax barriers to transferring intangible property from foreign affiliates to a US affiliate. The House Bill provides no such measure.
- The Senate Bill does not include the House Bill’s controversial 20 percent excise tax on certain payments to related foreign parties that would cause multinational groups subject to the provision to choose between the gross-basis excise tax and an election by the recipient of the payment to treat the amount as effectively connected income. The Senate Bill instead includes a new base erosion alternative minimum tax, which is somewhat more narrowly drawn, applicable to a more limited subset of multinational groups and, in most cases, not applicable to cross-border purchases of inventory includible in cost of goods sold.
- The Senate Bill, but not the House Bill, includes a new anti-hybrid rule denying deductions for interest and royalties paid to related foreign persons, where the payments either are not includible or are deductible in the hands of the recipient in its residence country.
- The Senate Bill includes changes to the definition of intangible property and expansions of the Internal Revenue Service’s ability to apply aggregation and “realistic alternatives” theories in connection with outbound transfers, whereas the House Bill includes no such proposal.
- The two bills differ materially in their limitation on interest expense. The House Bill limits deductible interest expense to 30 percent of an EBITDA-like measure, and the Senate Bill limits deductible interest expense to 30 percent of an EBIT-like measure. Both bills have a further limitation based on a measure of whether a worldwide group’s US entities are overleveraged compared to the group as a whole, with the House Bill applying a debt-to-EBITDA measure and the Senate Bill applying a debt-to-equity measure. The Senate Bill allows unlimited carryforwards of disallowed interest expense, whereas the House Bill allows only a five-year carryforward.
- The two bills have various technical differences with respect to their participation exemption regime, transition tax rules and minimum tax provisions.
- Various provisions in the Senate Bill will change near the end of the 10-year budget window because of the requirements of budget reconciliation procedures, unless specified revenue targets are met. For example, rules affecting net operating loss deductions, the minimum tax, deductions for foreign-derived intangible income and the base erosion minimum tax all have the potential to change around 2026.
While many important technical and policy issues remain to be resolved, it would be surprising if any of the differences noted herein were to stand in the way of enactment of tax reform legislation at this point. The differences between the two bills with respect to non-business taxation are perhaps more significant but again appear unlikely to stand in the way of enactment.
Final passage of the legislation by the end of 2017 would mean a major year-end sprint for taxpayers and policymakers alike. Perhaps the most challenging part of this sprint for multinationals involves the application of the transition tax. The transition tax in both bills would apply to the last taxable year beginning before January 1, 2018, meaning that taxpayers (and their financial auditors) will need to quickly assess the potential impact of the tax, possibly with little additional guidance from the Congress or the Internal Revenue Service.