On Friday, December 15, the U.S. Congress Conference Committee tasked with reconciling differences between the House- and Senate-passed tax reform bills released its Conference Report with a revised bill. Containing the most significant revisions to the U.S. Tax Code in decades, the revised Tax Cuts and Jobs Act (the Act), if enacted, will substantially change the taxation of U.S. corporations and make important modifications to the taxation of individuals and the manner in which international transactions are taxed.
What You Need To Know
- The new federal corporate income tax rate will drop to 21%, down from 35%.
- Allowance will be made for immediate expensing of most types of depreciable property other than real estate. As a result, corporate taxpayers will be able to claim a 100% deduction in the year a property is placed in service, rather than having to depreciate it over time.
- U.S. corporations will be subject to a modified "territorial" system of corporate taxation, where certain off-shore earnings will not be subject to corporate tax in the U.S., or will be taxed at lower rates.
- The above changes will make the U.S. more attractive for locating a parent of a multi-national enterprise than currently, and will level the playing field somewhat compared to other jurisdictions.
Inbound Investment in U.S. Real Estate
- The Act improves the tax landscape for inbound investment in U.S. real estate.
- Investments made by corporations or through entities treated as corporations (otherwise known as "Blockers") will benefit from the new lower corporate rate.
- Real estate businesses will now
generally be exempt from both the old and new earnings-stripping
rules of section 163(j) (with real estate business being generally
defined fairly broadly), which will allow for the use of
cross-border leverage to reduce U.S. net basis tax and take
advantage of exceptions from U.S. withholding tax for
"portfolio interest" and under provisions of double tax
treaties such as Article XI of the U.S. Canada Income Tax
- More restrictive earnings-stripping rules that would have applied to real estate subsidiaries that were part of certain international groups were dropped in Conference and will not be enacted.
Private Equity Funds
- New "carried interest" rules will impose a new three-year holding period for carried interest holders to benefit from capital gain rates, so private equity fund sponsors may not want to sell any assets until at least three years until after they are acquired.
- Corporate Blockers used by funds will benefit from the new lower corporate rate, but will be subject to the new restrictive earnings-stripping rules with respect to non-real-estate businesses, which will limit interest deduction to 30% of EBITDA.
- Full expensing of most depreciable property other than real estate will help lower effective tax rates for Blockers and taxable investors.
- Taxable U.S. investors will benefit in many scenarios from a new lower effective tax rate for pass-through income from active businesses.
- Funds may be more reluctant to sell Blocker shares for reasons discussed under M&A below, and because the tax leakage inside the Blocker on an asset sale will be lower.
- Secondary purchases and sales of interests in funds will have to deal with new rules that impose tax on gain from a sale by a non-U.S. resident on interest in a fund to the extent that a sale by the fund of its assets would have produced "effectively connected income."
- In addition, a new 10% withholding tax will apply to the sale unless no portion of the gain would be treated as effectively connected income under the new rules. The manner of certifying that the withholding tax does not apply is not specified in the Act and will have to be developed through regulations.
- The new rules allowing immediate expensing of acquired assets may tilt the field toward asset acquisitions (or transactions treated as asset acquisitions for tax purposes) rather than stock acquisitions.
- Elimination of net operating loss (or NOLs) carrybacks may cause some sellers to ask buyers to make "tax receivable" payments if and when the buyer uses the NOLs in future periods.
- New restrictions on transferring assets used in a U.S. business to non-U.S. entities will make tax-free outbound M&A more difficult and may lead to more taxable transactions or structures that don't involve outbound transfers.
- New base erosion payment regimes will make cross-border structures require more analysis to determine if payments among related parties trigger the new base erosion tax, described in further detail below.
- A new base erosion payment regime will impose an alternative tax on corporations that make deductible payments to related foreign affiliates. The regime effectively functions like an excise tax (generally 10%, rising to 12.5% in 2026) on certain payments to related non-U.S. parties.
- An additional new base-erosion anti-hybrid rule will deny a deduction for cross-border payments from U.S. entities to offshore entities or branches through "hybrid" entities or branches that are treated differently in non-U.S. jurisdictions than they are in the U.S.
The revised Act will now be voted on by the Senate and House, and, if approved, will be sent to the President for signature to become law. Further changes will not be allowed by the House or Senate, who must both approve the Act as reported by the Committee. Many of the ramifications of the Act will depend on how the statutory language is interpreted by the U.S. Treasury Department in guidance issued after the Act becomes law.
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.