US tax reforms: What India Inc should watch out for

A business delegation representing an industry chamber met top finance ministry officials last week as part of pre-Budget interactions. A major issue discussed in the meeting were steps required to deal with the proposed tax rate cut in the US. Corporate India’s fears that the US tax reforms will affect the competitiveness of Indian industry are not unfounded, say experts. 

The House of Representatives and the Senate have passed their versions of tax reforms Bills. Despite variations in their respective versions, broadly the Bills propose a drastic cut in the corporate tax rate from 35 per cent to 20 per cent, coupled with a territorial tax that ranges from 7 per cent to 14 per cent on foreign earnings parked in overseas subsidiaries and a tax on outbound payments by US corporations. One of the proposed provisions entails greater reporting and filing requirements on related-party payments for Indian companies with a presence in the US.

Tax experts say businesses may not get adequate time to prepare for the changes. The House of Representatives and Senate Conference Committee is expected to resolve the differences in the two versions of the Bills by the third week of December. Once the committee reaches an agreement, both the House of Representatives and the Senate must vote to pass the final Bill in identical form. The US President then signs the tax reform legislation into a law. “The optimistic expectation is that the tax reform might be enacted before the Christmas break,” says Abhishek Goenka, leader, corporate and international tax, PwC. The new tax law will come into effect either from January 1, 2018, or January 1, 2019, depending on the version that is incorporated in the final Bill. 

Experts agree that the US tax reforms will affect markets around the world. “Many multinationals may relocate their head office to the US,” says Girish Vanvari, national head, tax, KPMG in India.

While there will be pressure on other countries to reduce their corporate tax rates to remain competitive and attractive in the global market, any reduction will have a direct bearing on a country’s fiscal deficit. So reactions to the cuts in the US tax rates will depend on each country’s fiscal position and the state of its economy, say experts.

“US companies operating in India will want to look at the profits they are leaving in the country because Indian taxes will not be fully creditable in the US now and could, therefore, become a cost of doing business in India,” says Rajesh H Gandhi, partner, Deloitte India.

The US tax reforms are directed at providing a fillip to onshore activities. This is achieved through a lower tax rate and a tax that penalises US companies for making payments to non-US entities. “Some US companies could also consider shifting intellectual property back to the US,” Gandhi adds.

The tax reforms could be a double-edged sword for Indian businesses in the US. “The reduction in tax rates will spur investments in the US and may have a positive effect on Indian technology and pharmaceutical companies,” says Vanvari. The tax rate cuts are also expected to lead to a stronger dollar, which will boost realisations of Indian companies, he adds.

However, the proposal for an additional tax on certain outbound payments may hurt Indian businesses in the US. The House of Representatives has proposed an excise tax at 20 per cent while the Senate has proposed a base erosion anti-abuse tax of 10 per cent on certain outbound payments by US corporations. “The objective of this tax is to discourage outbound payments towards outsourcing. This change is likely to affect infotech outsourcing and pharmaceutical R&D companies in India,” says Goenka. US companies will now have to bear an additional tax cost that may partially mitigate the monetary arbitrage of outsourcing work to India, he adds. 

The provision for increased reporting for foreign-parented groups – treated as controlled foreign companies – will mean higher compliance requirements for Indian companies with a presence in the US. There is also a proposal to tax any sale of a partnership interest by a non-US person. Another provision that may affect Indian business in the US is the limitation on interest deductions. The provisions limit a taxpayer’s deduction for net business interest expense to 30 per cent of the adjusted taxable income.

Experts say the US tax reforms have wider implications on the business model and strategy for US companies in India and for Indian businesses in the US.

Impact on India

• Cut in the corporate tax rate — from 35% to 20% — makes the US a more attractive investment destination
• Onshore foreign profits of US companies are subject to tax. This has implications on their investments outside of the country
• Tax on outbound payments by US companies to hit Indian IT and pharma 
• Interest deduction limitations will impact interest calculations for Indian business in the US
• Increased reporting for Indian MNCs in the US
• Tax on sale of partnership interest by non-US person
• The new tax laws are expected to come into effect from January 1, 2018. Some provisions may come into effect from the current financial year