The recent tax reform has passed both the Senate and the House and signed into law by President Trump. It’s been well-established that the law is a net-win for the middle class and small business owners. However, what impact will this far-reaching change to the way our company funds growth and infrastructure support have on foreign investments?
The tax changes were widely touted to be positive for the American economy by lowering taxes for corporations, allowing them to reduce reliance on overseas dollars and bring jobs and production back to the U.S., but is that what will truly happen?
As the U.S. begins a new year with new taxation laws, developed countries are looking for ways to make their economies more attractive for capital that is internationally mobile.
Changes to the Domestic Tax Code
As tax code adjustments go into effect on January 1, 2018, corporations and individuals alike are scrambling to determine the exact impact on their particular situations. It’s important to note that not all of the changes are forever; some of the individual tax breaks are only available for a few years before reverting to higher levels.
The big news for corporations is the massive tax rate drop from 35 percent to 21 percent, and this change is permanent. However, there are limitations in the form of interest deductions to 30 percent — a dramatic change from the current laws which allow deductions from interest payments up to 100 percent.
Additionally, corporations are allowed to immediately expense large purchases, a move which will be phased out in stages from 2022 to 2026. In a move expected to greatly increase taxable dollars, research and development costs must know be spread over a period of five years.
Changes to the International Tax Code
Lawmakers have accused domestic corporations of funneling money offshore to avoid paying taxes on profits for years, and the new tax laws were written to allow U.S. businesses to keep money within the country.
Organizations with a large percentage of foreign earnings must begin bringing those dollars back to the U.S., with the one-time tax rate of 15.5 percent for cash and 8 percent for illiquid holdings expected to be a strong incentive to make a quick move.
An anti-abuse tax also makes an entry into the fray, with a sliding scale beginning at 5 percent and leaping to 12.5 percent over a period slightly less than 10 years. It is hoped that these shifts will bring additional funds and business back to the U.S. from abroad.
Expanding Our Global Nature
Advocates of the bill argued that these changes are simply bringing the U.S. into the realm of other advanced economies, as the current tax laws offer too great of an incentive to ship profits offshore.
Currently, profits made offshore by a domestic corporation are taxed at the often-lower current rate of the country where the profits were made. However, if the money is brought back to the U.S., the money is taxed yet again — but with a credit for the taxes already paid. Many companies are choosing instead to re-invest their funds internationally instead of repatriating them and taking the tax hit. The U.S. government estimates that more than $2.5 trillion in taxes have been lost due to the dis-incentive for domestic corporations to bring their funds back home.
The concept of shifting to a territorial tax system is expected to bring significant dollars back to the U.S. in a very rapid fashion as the global nature of commerce continues to expand.
Impact on Foreign Investments
The reduction in corporate tax rate and the ability of organizations to bring their dollars back to the U.S. without significant penalties will shift the balance of power away from foreign investments and back towards those made on domestic soil. Investments will flow more fluidly between countries, making it easier to invest abroad with other countries with advanced and territorial taxation policies.
Countries continue to tinker with tax rates to make their investments more attractive to investors who have access to internationally mobile capital. Foreign investors in U.S. real estate will also be affected by the changes.
The final effects of the recent tax adjustments on foreign investments remains to be seen, and investors and corporations alike are avidly watching to see how the market responds. So far, the dollar is suffering in the international currency market, but it is hoped that a mass repatriation effort will occur to help bolster both the performance of U.S. currency and the profitability of foreign investments.
Regards,
Ethan Warrick
Editor
Wealth Authority
