Signals from US territorial tax

Emerging markets like India could well be beneficiaries

One measure of polarisation in the public discourse in the US is clear from the divergent analyses on the impact of the “territorial tax” proposal in the impending tax reform Bill. Yet one thing is certain. Among the many sweeping changes in the Bill — the Senate and House of Representative versions are being reconciled before it goes for the President’s signature — the territorial tax will have some impact on US corporations’ overseas investment decisions and, therefore, on emerging markets like India. The territorial method of taxing profits from the overseas subsidiaries of US corporations essentially aligns US tax methods with those of most developed jurisdictions.

Currently, US corporations repatriating profits from overseas subsidiaries pay a steep 35 per cent on their original pre-tax profits minus the tax paid in the foreign jurisdiction. For example, if Apple had repatriated profits from its subsidiary in Ireland, which charges a competitive 12 per cent rate, it would have had to pay 23 per cent tax. This kind of punitive rate is the key reason US companies rarely repatriate offshore profits. The territorial tax will enable US corporations to repatriate their profits at little or no tax. There is, in addition, a minimum 10 per cent tax on profits above a certain threshold from foreign subsidiaries of US companies, to prevent companies from moving income abroad to avoid taxes, and a new 20 per cent tax on any money multinationals move from the US abroad. All these provisions, plus the sharp reduction in the domestic corporate tax rate to 20 per cent in the Bill, are designed to encourage US corporations to reinvest in the American economy and generate jobs.

Prima facie, US corporations may well conform to this hopeful Trumpian template. It is also possible that they will simply stash the profits in high-yielding financial instruments or use them for buybacks and dividend distribution. One analysis suggests that the benign nature of the territorial tax may encourage USA Inc to invest overseas more freely without the attendant hassle of tax planning. Another suggests that the tax on outgoing investment may simply encourage more US corporations to expand their dependence on offshoring. Add in the relatively high wages and low productivity of American labour and this looks like a plausible scenario. In other words, Apple may expand contract-manufacturing in China even though it may no longer stash profits from overseas sales in Ireland or Luxembourg.

Predicting corporate behaviour is notoriously difficult and in the case of US corporations, it is dependent on several other elements. One is the Trump administration’s immigration and trade policies — he is tightening the first, including the work visa regime, and is inclined to repudiate the other. The other is tax changes in competing OECD (Organisation for Economic Co-operation and Development) jurisdictions, not least the Multilateral Instrument that 70 countries, including India, signed in June this year that is designed to reduce the incidence of the notorious practice of base erosion and profit shifting. Significantly, the US is not yet a signatory, suggesting that US corporations may still indulge in treaty shopping. Either way, the message for Indian policymakers is clear: A steady improvement in the “doing business” environment beyond the World Bank’s narrow metrics and a simplification of the tax administration should remain sharply in focus.