Tax Cuts and Jobs Act – Tremendous Benefit for Foreign Investment in the United States
by: Christopher Klug – International Tax Attorney,Washington DC
In December 2017, Congress passed, and President Trump signed a sweeping tax reform bill commonly known as the Tax Cuts and Jobs Act. This new Act contains several significant changes and is the most significant tax legislation in the last 30 years.
One of the more significant changes for foreign investors is a 21 percent flat corporate tax rate. This is a reduction from a corporate tax rate of up to 35 percent. Since a corporate structure is typically used for structuring foreign investment in the US, this reduction in tax rate is significant.
This opportunity has not been overlooked by large foreign companies, the CEO of the oil giant BP stated the company will increase its investments in the United States now that the corporate tax rate has dropped a steep 40 percent. Several other companies plan to do the same and have issued press releases touting the positive one-time effects the companies will receive thanks to the lowered tax rate. The Tax Cuts and Jobs Act (“TCJA”) seems to have ushered in a new era in which the US, free from the leaden weight of the highest corporate tax rate in the OECD, is being viewed afresh by foreign competitors and investors.
Consider the international media stories that developed in relation to the TCJA. The Centre for European Economic Research in Germany stated that investment in Germany will become less attractive now that the US rate is substantially lower than Germany. In Ireland, some suggested that Irish officials were a little concerned with how America’s corporate tax overhaul would affect Ireland’s corporate tax receipts and ability to draw investments to its shores.
What is certain is that foreign investment paths in the US are now wider, both on the corporate side and on the pass through side. In addition to slashing the corporate tax rate, the TCJA created a new deduction for pass through entities that applies up to 20 percent of an entity’s qualified business income. The TCJA is friendly to foreign investors due to the significant reduction in tax rates either available because of the corporate tax rate reduction or because of the qualified business income deduction, making investing in the United States 20-40 percent cheaper.
Changes to the Corporate Tax
The reduction of the corporate tax rate is the provision that has generated the most attention, even though the reduction should not have been a huge surprise. The previous 35 percent corporate tax rate gave the US the distinction of having the highest corporate income tax rate among OECD member countries.
This led to many corporate inversions of US companies looking to leave the US. In most states, in addition to the federal corporate tax rate, there is an additional state corporate tax, and in some instances, a city corporate tax. The high US corporate tax rate was blamed for reduced foreign investment and large offshore stockpiles of corporate cash held by US companies unwilling to subject the money to US corporate income taxation. The flat 21 percent tax rate under the TCJA brings the US more in line with Europe, where the average tax rate is about 19.5 percent across the continent.
The new corporate tax rate is a benefit not just too foreign corporations investing in US businesses, but also to foreign investors who want to pump money into US businesses or portfolio assets while protecting their exposure to estate taxation.
Prior to the TCJA, if a non-resident alien of the US (“NRA”) wanted to invest in the US and wanted to avoid US estate tax exposure, the NRA would have to invest through a foreign corporation and would be subject to a 35 percent tax. Under the TCJA, the NRA can make the same investments and the tax has been cut to 21 percent, a tax rate decrease of 40 percent and providing the NRA a very easy way to insulate themselves from estate tax exposure.
For foreign corporations that want to do business in the US, the typical options are to operate as a foreign branch or create a US subsidiary. The tax rules around a foreign branch are not always favorable, so often the better approach is to create a US subsidiary. The reduced corporate tax rate under the TCJA has made the decision to create a US subsidiary more favorable.
Pass Through Benefits
Pass through companies and taxpayers also receive benefits under the TCJA due to the qualified business income deduction that applies up to 20 percent of an entity’s qualifying income. Qualifying income is defined as income derived from an active trade or business. However, the amount of the deduction that an entity can receive is limited to the greater of two options:
- 50 percent of the W-2 wages the entity pays to its employees; or
- 25 percent of the W-2 wages plus 2.5 percent of the depreciable property used to create the qualified business income.
Taxpayers that fully qualify for the deduction would see a 29.6 percent tax rate, as compared with 39.6 percent under prior law. The provision for the pass through deduction sunsets on December 31, 2025.
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