One of the most significant changes under the TCJA is the
permanent reduction of the top corporate U.S. federal income tax
rate from 35% to 21%, the lowest corporate tax rate in the United
States in almost 80 years.
In addition, the TCJA eliminated the
corporate alternative minimum tax. These changes should result
in immediate benefits to non-U.S. based multinational groups with
significant U.S. operations in the form of increased after-tax returns
and, depending on the particular operations of a group, these
changes to the U.S. corporate tax regime may make the United
States a much more attractive option for conducting business
These changes may also influence the structuring
of mergers and acquisitions by making inversion transactions (i.e.
transactions to relocate a company to another tax juristiction) less
compelling and increasing interest in structuring transactions as
asset purchases instead of as stock purchases. U.S. corporations
may also be incentivised to dispose of non-core assets in light of the
reduction in tax cost on any gain on such dispositions.
New rules introduce a beneficial deduction for individual owners of businesses organised as passthroughs (i.e., partnerships and LLCs) of 20% of business income. This rule doesn’t apply to passthroughs in certain service businesses, such as accounting, consulting, financial services, health and law.
These changes are likely to influence the ways that U.S. businesses are set up and may create structuring challenges for incentivising management in acquisitions of smaller and middle market U.S. businesses, as managers may prefer to hold partnership or LLC interests eligible for this beneficial tax treatment, instead of stock in a corporation.
The TCJA introduced a new cap on interest deductions to the extent
that a company’s net business interest expense exceeds 30% of its
“adjusted taxable income” (i.e. EBITDA for taxable years beginning
before 1 January 2022, and EBIT thereafter). This may reduce the
benefits of using leverage to finance acquisitions, as debt becomes
more expensive if interest is not deductible.
For the next five years, taxpayers will be able to immediately deduct
100% of the amount paid for certain depreciable property instead of
capitalising the purchase price and depreciating the cost over time.
This rule applies not only to new property, but also to used property
acquired from third parties. Goodwill and other intangible property
are not eligible for full expensing and continue to be amortisable
over 15 years. Nonetheless, this change is likely to spur additional
capital expenditure by U.S. businesses and further increase the
appeal of asset acquisitions.
Due to the significant benefits of the full
expensing rule in the context of asset acquisitions, there is likely to
be an increased interest in agreeing on purchase price allocations in
advance of signing deals in order to avoid disputes after closing.
Prior to the TCJA, U.S. multinationals generally were subject to tax
in the United States on all of their worldwide income. However,
U.S. tax on operating income generated by foreign subsidiaries
(i.e. controlled foreign corporations) generally was deferred until
the income was repatriated. In addition, audit rules generally
allowed U.S. multinationals to avoid recording a deferred tax liability
to the extent that they intended to permanently reinvest foreign
earnings outside the United States.
As a consequence, many U.S.
multinationals built up significant cash reserves outside the United
States and were incentivised to invest those reserves in capital
projects and acquisitions outside the United States.
The TCJA eliminates the U.S. system of worldwide taxation by
introducing a quasi-territorial tax system. The primary feature of
the change to a territorial system is a new participation exemption.
Dividends paid by foreign subsidiaries to their U.S. corporate
shareholders are now exempt from U.S. tax, provided the U.S.
corporation owns at least 10% of the foreign corporation. Gains
from the sale of stock may also be eligible for full or partial exemption
under this rule (i.e. to the extent they are recharacterised as
This change makes bringing cash back to the United
States much more attractive. As a consequence, U.S. multinationals
may be less interested in non-U.S. acquisitions and capital
investments, and more inclined to pursue domestic mergers and
acquisitions, repay debt, and return cash to shareholders in the form
of stock buybacks and dividends. In addition, the elimination of tax
on certain stock dispositions may make internal restructurings to
move foreign corporations out from under U.S. shareholders more
In connection with the move to a territorial taxation regime, the TCJA
imposed a one-time tax on the deferred foreign earnings of foreign
subsidiaries of U.S. corporations. The tax is imposed at a rate of
15.5% for cash and cash-equivalents and 8% on other items. The
tax is imposed on the U.S. shareholders of the foreign subsidiaries
that own 10% or more of the stock of the foreign subsidiaries on
the last day of the subsidiary’s year that began before 2018.
As a consequence, for foreign subsidiaries with a fiscal year ending
on 30 November, the U.S. shareholder that owns the stock on 30
November 2018 would be liable for the tax. Accordingly, acquirers
will need to carefully consider the impacts of this rule in connection
with their acquisition of foreign corporations, including U.S. groups
that own foreign subsidiaries, in order to ensure that the cost of the
tax is borne by the target’s selling shareholders.
Although the reduction in tax rates and move to territorial
taxation will generally reduce tax costs for groups doing business
in the United States, the TCJA introduces guardrails designed to
prevent U.S. corporations from reducing their U.S. tax base or
shifting profits overseas.
The base erosion and anti-abuse tax, commonly referred to as
“BEAT”, is intended to protect the U.S. tax base by increasing taxes
on corporations making significant deductible payments to non-U.S.
related parties. Such deductible payments (also known as “base
erosion payments”) include payments of interest and royalties and
amounts paid or accrued to acquire depreciable or amortizable
assets. However, payments treated as cost of goods sold are not
considered as base erosion payments for purposes of BEAT.
The BEAT tax calculation is based on a complex formula that
compares a U.S. group’s tax base with and without these base
erosion payments. The BEAT tax applies if the difference between
the two calculations exceeds a certain threshold. Multinational
groups will need to determine whether they will be subject to
the BEAT tax.
If the BEAT tax is likely to apply, restructuring to
reduce or eliminate the impact of BEAT may be warranted and
further consideration should be given to determine whether certain
payments could be recategorised in a manner that allows them
to be excluded from the BEAT calculation. Among other things,
replacing intra-group loans with third-party borrowing (possibly with
a parent guarantee) may help to reduce the likelihood of the BEAT
Although the TCJA generally moves the U.S. to a territorial system
of taxation and eliminates the system of deferring tax on operating
income generated by foreign subsidiaries, it also introduces a new
tax on certain excess income generated by foreign subsidiaries
(referred to as “global intangible low-taxed income”, or “GILTI”).
tax applies if the operating income of a foreign subsidiary exceeds a
10% return on the tax basis in the tangible business assets owned
by the subsidiary. Foreign tax credits may be used to reduce or
offset this tax liability.
Non-U.S. multinationals that have U.S. entities that own interests
in foreign subsidiaries (i.e. sandwich structures), should consider
restructuring in order to eliminate these structures in order to
avoid the GILTI tax.
In addition, U.S. acquirers are more likely to
prefer asset acquisitions (or elections that allow transactions to
be treated as asset acquisitions) to step-up the basis of assets for
purposes of determining whether the GILTI tax will apply. U.S. sellers
will likely prefer stock sales, since income from asset sales will
increase income for purposes of calculating GILTI and stock sales
may generate tax-free income to the extent gain is eligible for the
participation exemption discussed above.