The Tax Cuts and Jobs Act of 2017 was signed by U.S. President Donald Trump on December 22, 2017. It introduces sweeping changes to how corporations, individuals and international transactions are taxed.
Corporate Tax Rate
The new lower corporate tax rate will reduce the tax leakage imposed on Blockers and U.S. corporations. Even with new limits on certain deductions, including new earning-stripping rules limiting interest deductions, the effective tax rate will be significantly reduced.
- The new corporate tax rate will be 21% (reduced from 35%).
- There are restrictions on the use of net operating losses (NOLs). NOLs can now only be carried forward (not back) and used to offset only 80% of taxable income.
- Restrictions are now imposed on deductions of interest (earnings-stripping) to 30% of EBITDA. Certain businesses, such as real estate businesses, are exempt from this restriction.
- Full expensing of certain depreciable assets is now allowed, which creates an immediate deduction upon acquisition of eligible assets.
New withholding rules will impose a 10% withholding tax on a sale of an interest in a partnership that is engaged in a U.S. trade or business or earns any effectively connected income (ECI). Unless the IRS institutes a de minimis exception, this rule has the potential to significantly complicate secondary fund sales.
- Ten percent withholding tax will be imposed on the sale of a partnership interest by a non-U.S. investor if the partnership has any assets that generate effectively connected income (other than real estate assets subject to FIRPTA).
Several new provisions covering how U.S. corporations are taxed on their international operations will significantly affect how acquisitions involving a U.S. business should be structured. Important considerations are listed below.
- The new base erosion provisions will effectively deny deductions for certain payments by U.S. corporations to related parties and for certain "hybrid" payments that are treated differently by a foreign country than they are by the U.S.
- GILTI tax—or the tax on global intangible low-taxed income—will tax U.S. shareholders of controlled foreign corporations on certain off-shore earnings, based on a formula that is not directly tied to intangible assets. The rules will put a premium on structuring non-U.S. asset acquisitions so there is a "step-up" in the assets' basis for U.S. tax purposes where a controlled foreign corporation is involved.
- Tax-free outbound transfers of assets, particularly intangible assets, from the U.S. to foreign entities will become increasingly difficult to structure.
- Full expensing of certain depreciable assets will tilt the market to prefer asset acquisitions over share acquisitions. This includes structures treated as asset acquisitions for tax purposes, such as taxable forward mergers and stock acquisitions that the parties elect to treat as asset acquisitions.
New rules that affect how U.S. individuals are taxed may affect fund managers, sponsors, and management investors in M&A and private equity transactions. Important points to note are listed below.
- New carried interest rules will require a three year hold period for investment assets in certain circumstances to obtain favorable capital gain rates.
- New lower pass-through rates will allow U.S. individuals in certain businesses, including investors in REITs, to obtain a lower effective tax rate on income from these businesses.
- New loss restriction rules will limit the ability to use losses from one business or activity to offset income from a separate business or activity.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.