Recent Proposed Changes in US Tax Laws and their Impact on India
“Since time immemorial, taxes have been imposed on income, but the form of their imposition has evolved over time. The quality, quantum and speed of this evolution has been particularly pronounced in the last decade or so– predominantly due to globalization of world economy assisted by digitalisation. However, in spite of these changes, the basic philosophy remains the same – Collection of revenue for the government, arguably, being the first priority, followed by several other socio-economic goals, such as job creation and helping industry to grow in a desired sector / location. A critical objective that has been added lately to this list is – to create a stimulus, in order to help industry get back to the pre-pandemic position and provide job opportunities. Recently, USA has joined the efforts to create such a stimulus. Read on…”
On 31st March 2021, an outline of the ‘Made in America Tax Plan’ (MATP) was introduced alongside President Biden’s ‘American Jobs Plan’ (AJP). This has been followed by release of the MATP by the US Department of Treasury, describing President Biden’s tax proposals. In this article we have analyzed the recent historical background of relevant tax laws of US, the MATP proposals, and its potential impact on India.
Historical Perspective
Last time the US tax laws underwent far reaching changes through the Tax Cuts and Jobs Act of 2017 (TCJA) signed into law by the then US President, Donald Trump, which amended the Internal Revenue Code of 1986. Some of the key changes made by TCJA were as under:
- Reduction in Corporate Tax Rate: TCJA lowered the federal corporate taxes from 35% to a flat rate of 21%. This reduction lowered the US tax rates below that of OECD’s average corporate tax rates of 23.9% (2018).
- Foreign Derived Intangible Income (FDII): Introduction of incentives for Foreign Derived Intangible Income (FDII), which represents the category of income that is not specifically traced to intangible assets, but the same is deemed to be generated from IPs. To the extent it is received from any non-US person for services provided to persons outside USA, it enjoys a 37.50% deduction allowance, thereby bringing its Effective Tax Rate (ETR) down to 13.125%.
- Global Intangible Low Taxed Income (GILTI): Imposition of tax on GILTI, which stands for Global Intangible Low Taxed Income. GILTI is earned abroad by foreign Controlled Foreign Corporations (CFCs) of US companies, from easily movable intangible assets, such as IP rights. TCJA introduced provisions requiring its inclusion in the US shareholder’s taxable income through pro rata attribution of CFC’s gross income to such shareholder. In computing this income, an exemption is allowed for the first 10% return on the CFC’s fixed assets that are depreciable as trade / business assets.
- Participation Exemption System: Introduction of ‘Participation Exemption’ system under which a US corporation received a 100% Dividends Received Deduction (DRD) for dividends received by it from a foreign company (of which, it owned 10% or more) out of foreign-sourced earnings of the latter.
- Base Erosion Anti-abuse Tax (BEAT): Introduction of Base Erosion Anti-abuse Tax (BEAT), which applies if 10% of a US corporation’s modified taxable income (computed after adding back cross-border payments to related parties) exceeded its regular tax liability (before certain specified tax credits). Objective of BEAT was to target US corporations that significantly reduced their US tax base by making payments to foreign affiliates.
Salient Features of MATP
Inter alia, the objectives of MATP can be identified as under:
- To incentivize job creation and investment in US;
- To stop profit-shifting to tax havens; and
- Ensuring that large corporations pay their fair share of taxes.
To fully appreciate the sentiments behind MATP, it may be worth noting the backdrop of AJP that focuses extensively upon revitalizing manufacturing sector in US, out-competing China (particularly w.r.t. investment in infrastructure and Research & Development), and creating good quality jobs for American citizens. The AJP also seeks to modernize the US transport infrastructure, improve its drinking water systems, renew the US electricity grid, bring affordable high-speed broadband to every American, build / retrofit / modernize residential and commercial buildings (including schools, child-care facilities and hospitals) and train Americans for future jobs. At the same time, the MATP is up-front in its intent to undo several of the changes introduced by the TCJA.
“The American Job Plan also seeks to modernize the US transport infrastructure, improve its drinking water systems, renew the US electricity grid, bring affordable high-speed broadband to every American, build / retrofit / modernize residential and commercial buildings (including schools, child-care facilities and hospitals) and train Americans for future jobs.”
Following are the changes proposed to be made by MATP, to present tax laws:
1. Increasing the federal corporate tax rate to 28%
As mentioned above, the corporate taxes were brought down by TCJA w.e.f. 1 January 2018, to a flat rate of 21%.
Similarly, the TCJA had eliminated the corporate Alternative Minimum Tax (although some states have alternative taxes). It is now proposed to re-introduce the same @ 15% on ‘book income’ of corporations.
The MATP has justified such restoration of tax rates by citing several papers and reports to highlight that the aforesaid rate cuts did not result in any long-term economic growth. Of course, one may wonder whether the economic impact of tax rate cuts could have been reasonably measured in such a short span of time (of barely over 3 years), particularly when ongoing pandemic could have significantly skewed the investment and growth statistics.
2. Introduction of a Global Minimum Tax
The core philosophy of this proposal is to bring to an end, the ‘race to bottom’ between countries to bring down their respective corporate tax rates, thereby creating tax arbitrage opportunities of shifting profits to low tax jurisdictions (or much worse, tax havens). As a matter of fact, in her recent address at the Chicago Council of Global Affairs, the US Treasury Secretary Ms. Janet Yellen has also called out all the countries to introduce a global minimum tax.
3. Doubling the minimum tax on foreign CFCs with GILTI from 10.5% to 21%
In tandem with the pursuit for the global minimum tax, the MATP also proposes to double the minimum tax on US shareholders of foreign CFCs with GILTI, from 10.5% to 21%, and removing the initial exemption therein of 10% of return on its tangible depreciable property.
Presently, GILTI computation is undertaken at the shareholder’s level, allowing corporations to offset income in one CFC against losses in another. It is now proposed that the said computation will be made on a country-by-country basis, so that it hits the profits diverted to low tax jurisdictions.
It may be worth noting that where any tax is paid on such income (GILTI) in a country other than US, the present law allows a credit of 80% of the amount of such tax, against the US tax liability on the said income. This tax credit has not been curtailed by the MATP, which is a saving grace for US shareholders that are subjected to GILTI taxes.
4. Removal of tax incentives for Foreign Derived Intangible Income (FDII)
The MATP also proposes to remove the tax incentives for Foreign Derived Intangible Income (FDII). As discussed above, FDII represents an income from export of services (or property) which is taxed at a low rate – even if such an export is made to a related party – which could incentivize US corporations to shift their assets abroad. This discontinuance of FDII deduction is aimed at neutralizing the abuse of such incentives as a means to reduce group level tax costs.
5. Disallowing write-off / deduction of expenses from off-shoring jobs
Disallowing write-off / deduction of expenses from off-shoring jobs and granting a tax credit to support on-shoring of jobs. The specifics of this proposal, as regards manner of identification of the expenses targeted to be disallowed, are still awaited.
6. Replacement of BEAT with SHIELD
It is proposed to replace BEAT with Stopping Harmful Inversions and Ending Low-tax Developments or SHIELD (full points for another sleek acronym!). SHIELD should deny US tax deduction by reference to payments by MNEs to related parties that are subject to a low ETR. Such ETR threshold will eventually be defined through / agreed under a multilateral agreement; however, till the time such an agreement is reached, the GILTI tax rate of 21% could act as the trigger point for SHIELD.
7. Provisions making inversions of US entities difficult
MATP proposes to introduce provisions that will make inversions of US entities difficult. Inversion is a device through which a taxpayer resident in a particular jurisdiction, changes its tax domicile (often to a low tax country). This is often achieved by merging with a foreign entity, undertaking a share-swap with an intermediate holding company located in a tax friendly jurisdiction, or by simply shifting one’s headquarters.
At one point of time, tax inversions were rampant in USA. Even presently, it is common for US corporations to externalize their tax domicile through questionable means, to avoid US taxes.
8. Eliminating special preferences for fossil fuel industry & clean energy tax incentives
MATP proposes to eliminate special preferences (by way of subsidies, special foreign tax credits, etc.) for fossil fuel industry, to penalize polluters through tax disincentives, and to restore tax on polluters to pay for Environmental Protection Agency’s clean-up costs associated with Superfund sites1.
Further, it proposes to provide a 10-year extension of the production tax credit and investment tax credit for clean energy generation and storage and making those credits direct pay2. It is also proposed to create incentives for long distance transmission lines, state-of-the-art carbon capture and sequestration projects.
9. Reversing trend of reduced tax audits of large corporations
Lastly, the MATP makes no reservations in proposing to reverse the trend of reduced tax audits / scrutinization of large corporations. It is expected that broader enforcement initiatives shall be announced, to address tax evasion by corporations and high income Americans.
1 Superfund sites are polluted locations (such as oil refineries, smelting facilities, mines, and other industrial areas) in USA requiring a long-term response to clean up hazardous material contaminations.
2 Direct pay allows taxpayers (such as clean energy developers) to treat certain tax credits as an overpayment of taxes and monetize them as cash refunds from the Treasury after filing their annual tax returns.
“Taxation is considered, as one of the tools to revitalize economy. The challenges for all jurisdictions are manifold – protect their economy from sliding down, protect their tax bases and encourage foreign investments.”
Likely Impact on India
1. Increased US tax costs:
Several of the MATP proposals will result in an increased tax cost for US companies. In short-term, this could make doing business in India, more tax competitive. At the same time, it will adversely affect Indian MNC groups with US subsidiaries and affiliates.
2. Global Minimum Tax:
While convincing all the countries (particularly the one’s that strive on their preferential tax regimes) to adopt a global minimum tax could pose a tall challenge, the same should, in the medium-to-long run, create a level playing field. It should also discourage unfair tax competition, particularly affecting high-tax economies such as India, which are often susceptible to base erosion through use of tax havens.
3. Increase in GILTI taxes:
This increase should not affect India significantly, since Indian group companies of US entities are seldom the recipients of any such IPs that could redirect towards them, any royalty income of the group / US parent. Even otherwise, there is no significant gap between 80% of tax rate applicable to most Indian companies, and the US GILTI rate of 21%.
4. Removal of FDII deduction:
This could result in an increased tax costs for asset-lean US subsidiaries of Indian groups that may be undertaking functions such as R&D, etc. Conversely, the increased tax cost of US companies from rendering services to foreign clients will, in all likelihood, be passed on to such clients, including Indian service recipients.
5. Dis-incentivizing off-shoring of jobs and production:
While the exact mechanics of this proposal are still awaited, it could have the most far reaching impact for India, given a significant degree of dependence of the Indian outsourcing industry on US. Also, it is clear that India has been trying to benefit from the anti-China sentiments in global policy-makers’ community, by positioning itself as the global manufacturing hub; and this MATP proposal could put a dampener on such aspirations. Many Indian IT companies are strengthening their subsidiaries / branches with US employees. This may reduce the impact. But, nonetheless, it may have adverse impact on India.
6. Backstop for Inversions:
As regards proposals creating a backstop for externalization, they are unlikely to have a significant impact on India Inc – given that India has hardly ever been a choice for such US corporations, to externalize to.
Conclusion
Tax laws are not static - they undergo changes with the need of economic, social and political situations. The proposed changes in US are driven by these factors, accentuated by COVID-19 pandemic which has been damaging the economy of countries across the globe. Taxation is considered, also, as one of the tools to revitalize economy. The challenges for all jurisdictions are manifold – protect their economy from sliding down, protect their tax bases and encourage foreign investments, under these conditions, staying abreast with the changes in US is indispensable for Indian tax and finance professionals too, since it is natural that such significant changes in tax laws of the most powerful economic jurisdiction could have a significant impact on India Inc, as well as on Indian policy makers.
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Index of some useful articles taken from Periodicals for the reference of Faculty/Students & Members of the Institute:
1. Accountancy
- Accounting services quality: A systematic literature review and bibliometric analysis by Vitor Azzari and Emerson Wagner. Asian Journal of Accounting Research, Vol.6/1, 2021, pp.80-94.
- Financial Accounting: A new normal by Scott Dietz. International Accountant, January/February 2021 pp.16-17.
- IND AS/IGAAP- Interpretation and practical application: CSR-Whether a day 1 obligation? by Dolphy D’souza. Bombay Chartered Accountant, Vol.52-B/2, March 2021, pp.63 & 69.
2. Audit
- Rebuilding faith in audit by Stuart Cobbe. International Accountant, January/February 2021, pp.14-15.
- Staying vigilant against fraud during the pandemic: Internal controls need to be front and center, as the COVID-19 crisis has increased the incentive and opportunity for fraud by Cecilia. Journal of Accountancy, March 2021, pp.17-19.
3. Economics
- Growth transitions in India : Myth and Reality. Economic and Political Weekly, Vol.56/11, 13th March 2021, pp.43-49.
- Unconventional Monetary Policy in Times of Covid-19. R.B.I Bulletin, Vol.75/03, March 2021, pp.41-51.
4. Investment
- Spillover effects in the financial year cycle for Indian Markets by Parul Bhatia. Asian Journal of Accounting Research, Vol.6/1, 2021, pp.38-54.
5. Management
- Antecedents and consequences of brand hate: Empirical evidence from the telecommunication industry by Olavo Pinto and Amelia Brandao. European Journal of Management and Business Economics, Vol.30/01, 2021, pp.18-35.
- How to shift from selling products to selling services: It takes different skills and a different focus by Doug J. Chung. Bombay Chartered Accountant, Vol.52-B/2, March 2021, pp.48-51.
- Strategic Management and corporate governance-Two sides of the same coin by A Sekar. Chartered Secretary, Vol.51/3, March 2021, pp.105-108.
- Strategy: The heart of business-Part 1 by V. Shankar. Bombay Chartered Accountant, Vol.52-B/2, March 2021, pp.11-13.
6. Taxation and Finance
- Acquiring the tax benefits of a corporation: Avoid recharacterization of tax losses in M & As by Ray A. Knight and Lee G Knight. Journal of Accountancy, February 2021, pp.36-41.
- Future of inheritance tax by Dennis Petri. International Accountant, January/February 2021 pp.22-23.
- Taxation of Digitised economy- Significant economic presence and extended source rule by Mayur B. Nayak and Tarun Kumar G. Singhal. Bombay Chartered Accountant, Vol.52-B/2, March 2021, pp.56-62.