U.S. tax reform adopted

On 22 December 2017, U.S. President Trump signed the bill regarding the tax reform (Tax Cuts and Jobs Act; TCJA). Previously the U.S. Senate on 18 December 2017 and the U.S. House of Representatives on 20 December 2017 adopted a common bill. Therefore the tax reform, called “historic” in the U.S. Senate’s Finance Committee’s press release, enters into force. Earlier the U.S. Senate on 2 December 2017 and the U.S. House of Representatives on 16 November 2017, passed their own versions of the TCJA (see the House Ways and Means Committee’s press release). Now is the time for German taxpayers with economic ties to the U.S.A. to look into how the new law will affect them. 

1. Legislative status and essential contents

The last major U.S. tax reform – which included decreasing the U.S. corporate tax rate from 47% to the current 35% – was in 1986 under the presidency of Ronald Reagan. Since then, there have been many discussions about overhauling the U.S. tax system, but now, with the current combination of a Republican President, a Republican majority (no matter how small) in both the Senate and the House of Representatives and the high political priority given to the issue since the presidential election campaign, the realization of the idea was for the first time possible.

The basis for the U.S. tax reform can be traced back to a policy paper drafted by the U.S. House of Representatives’ Ways and Means Committee published on 24 June 2016 called the House Republican Blueprint (“Blueprint”). The steps suggested by the Blueprint for achieving the overarching goal of economic growth in the U.S.A. included:

• changing income tax rates and brackets for individuals.
• decreasing the tax burden on transparently taxed corporate profits (“pass-through business income”, e.g. for S Corporations, LLCs, other partnerships and sole proprietorships).
• decreasing the corporate tax rate from 35% to 20% to align with a change in corporate tax developments in the OECD countries.
• eliminating the “alternative minimum tax (“AMT“) for individuals and entities, the intention of which was to ensure a minimum taxation amount by applying two calculation methods and assessing the higher tax amount.
• replacing the worldwide tax approach with a territorial tax system that provides for 100% tax exemption on dividends from foreign subsidiaries. The background is that, under the current system, a significant amount of foreign-earned profit is not being repatriated to the U.S. because this would increase to the U.S. level the tax burden on these profits (“lock-out effect”). The Blueprint also provides for a kind of mandatory tax moratorium under which these foreign-earned profits must be repatriated and taxed at a rate of 8.5% (cash or cash equivalents) or 3.5% (other assets).
• introducing an interest barrier by means of which net interest expense will not be deductible but will be permitted to be carried forward indefinitely.
• permitting immediate write-off of eligible investments (not including real estate).
• introducing a border adjustment, according to which imported goods and services expenses constitute non-deductible business expenses and income derived from export sales is exempt from taxes.

Although the “big six” (six politicians in high positions) strongly denounced the border adjustment in a joint statement issued on 27 July 2017, their policy statement published on 27 September 2017 under the title “Unified Framework for Fixing our Broken Tax Code” includes two additional important items:

• introducing rules to secure the U.S. tax base.
• limiting the immediate write-off option to five years.

These items – with more or less significant changes in content – are also found in the version of the TCJA that has now been signed by U.S. President Trump, which also contains numerous other additions. The following table provides a – rough and not exhaustive – overview of selected commonalities and differences of the previous legal position, the two initial bills as well as the finally signed bill regarding intended changes in corporate taxation:

 

	Previous legal position	U.S. House of Representatives	U.S. Senat	Adopted bill
Corporate tax rate (federal)	35%	20% (as of 1 January 2018)	20% (as of 1 January 2019)	21% (as of 1 January 2018)
Taxation of pass-through income	Taxation at entrepreneur- individual rate	Decrease highest tax rate to 25%	Deduction for non-wage portion of pass-through income	Deduction for non-wage portion of pass-through income
AMT	AMT of 20%	Eliminate the AMT after 2017	Retain the AMT	Eliminate the AMT after 2017
Immediate write-off	Write-off over duration of use.	Complete write-off for investments after 27 September 2017 until 31 December 2022.	Complete write-off for investments after 27 September 2017 until 31 December 2022. Afterwards, the draft provides for an annual 20% reduction of the write-off  until 31 December 2026.	Complete write-off for investments after 27 September 2017 until 31 December 2022. Afterwards, the draft provides for an annual 20% reduction of the write-off  until 31 December 2026
Interest barriers	No barrier	Similar to the German interest barrier in section 4h German Income Tax Act Einkommensteuergesetzt, EStG), but in two increments (with slightly varying characteristics):		Positive interest balance deductible at 30% of tax EBITDA with no time limit on interest carried forward.
		Positive interest balance deductible at 30% of tax EBITDA with five-year limit on interest carried forward. Debt/equity ratio test (comparison with U.S. company with worldwide group of companies as regards EBITDA).	Positive interest balance deductible at 30% of tax EBITDA with no time limit on interest carried forward. Debt/equity ratio test (comparison with U.S. company with worldwide group of companies as regards debt-equity ratio).
Tax approach	Worldwide income approach	Territorial system with exemption of foreign dividends if qualified participation (10%)
Mandatory tax moratorium for unrepatriated profits	35% upon repatriation	14% (cash or cash equivalent) 7% (other assets) as on 2 November 2017	14.5% (cash or cash equivalent) 7.5% (other assets) as on 31 December 2017	15.5% (cash or cash equivalent) 8% (other assets) as of 2 November 2017 or of 31 December 2017, whichever is higher
Rules to secure U.S. tax base	Currently no restrictions in this regard	Depending on size, 20% excise tax on payments (other than interest) to foreign group companies that are directly (business expenses) or indirectly (acquisition / manufacturing costs) deductible at the U.S. company (tax on gross). Options: Taxation of the corresponding income of the foreign group company in the USA using a profit margin (net taxation) instead of gross taxation.	Depending on size, besides regular taxation, a kind of minimum taxation: Additional calculation of separate taxable income taxed at 10%. No expense-related services to foreign group companies are deductible. The higher tax amount between the regular calculation and the minimum taxation is assessed.	Depending on size, besides regular taxation, a kind of minimum taxation:   Additional calculation of separate taxable income taxed initially at 5%, as of 1 January 2019 at 10%. No expense-related services to foreign group companies are deductible. The higher tax amount between the regular calculation and the minimum taxation is assessed.
Loss deduction	Two years carryback, 20 years carryforward	Limited to 90%, unlimited carryforward with compensation for inflation, basically no carryback	Limited to 90% (80% as of 1 January 2023), unlimited carryforward, basically no carryback	Limited to 80%, unlimited carryforward, basically no carryback

  

2. Consequences for German taxpayers with U.S. ties (“outbound investments”)

The consequences for German taxpayers with U.S. ties must be determined separately for each individual case, and the benefits or disadvantages can be significant. Thus, the following – by no means complete – list of consequences must be examined in the context of an overall viewpoint at company as well as group level regarding their effect on tax structuring, tax returns and (group) accounting:

• Subject to profit calculation according to German principles for the U.S. corporations involved, due to the decrease in the U.S. federal corporate tax to 20%, a low taxation within the meaning of section 8(3) of the German Act on Taxation with Foreign Involvement (Aussensteuergesetz; AStG) could be given and, for German shareholders with U.S. subsidiaries, lead to controlled foreign corporation (CFC) rules, with all of the accompanying declaration obligations and a possibly significant tax burden. In this context, an eye should be kept on the possible reformation of CFC taxation in German law in the context of the implementation of the EU Anti-Tax Avoidance Directives I and II (ATAD I and II).
• On the other hand, especially for individuals, the privileges provided for in the TCJA (25% maximum tax rate or decrease in taxable income, see above) could make future pass-through business income advantageous and lead to tax reduction.
• The tax benefits and reductions implemented by the TCJA are to be considered in light of a (compensatory) expansion of the U.S. tax base – especially at the cost of cross-border structures. The tax burden involved (especially regarding the interest barrier, the restriction on loss deduction and the rules to protect the U.S. tax base in international groups of companies) is to be calculated based on each individual case and – depending on the current structuring of group-internal deliveries and services – can also constitute an occasion to review and adjust presently practiced business models.

In summary, there is currently a great deal of uncertainty as to what impact the U.S. tax reform will have on tax and accounting for German taxpayers. Nevertheless, the basic principles of the adopted bill have been set and should be taken into consideration in the tax and accounting (group) planning of German taxpayers with U.S. ties as soon as possible.