1. Global tax developments
Plenary 4
Global tax developments
April 27, 2018
IFA, New Delhi

2. U.S. Tax Reforms
Overview of key provisions
Lloyd Pinto
April 2018

3. Corporate Tax Rate Corporate Tax Rate reduced to 21% from 35%
Alternate Minimum Tax Repealed
No changes in State tax rates

4. Limitations on Interest Deduction
Net interest deduction limited to 30% of Adjusted Taxable income for tax years beginning after December 31, 2017
Adjusted taxable income will approximately equivalent to EBITDA (Earnings before Interest, Tax, Depreciation & Amortization) for first 4 years
Post Jan 1, 2022 – Adjusted Taxable income will be approximately equivalent to EBIT (Earnings before Interest & Tax)
Disallowed interest expense is carried forward indefinitely

5. Full Expensing on Tangible Property
100% bonus depreciation for qualified property placed in service after Sep 27, 2017 and before Jan 1 , 2023
Bonus Depreciation phases down in 5 years
80% in 2023
60% in 2024
40% in 2025
20% in 2026
00% in 2027

6. Limitations on Net Operating Loss Deduction
NOL Deductions can offset upto 80% of Taxable Income
80% limit applicable for NOLs arising in tax years beginning after December 31, 2017
NOL Carryback provisions repealed
NOL Carryforward period changed from 20 years to indefinite
New Carryforward period applicable to NOLs arising in tax years ending after December 31, 2017

7. Base Erosion & Anti Abuse Tax (BEAT)
It is a Minimum Tax due on an alternate Tax base known as Modified Taxable Income (MTI)
The tax base is know as Modified taxable income (MTI) and is computed by disallowance of related party expenses which are otherwise tax deductible
Applicability
3 year average annual US gross receipts > $500 mn and
Deductible related party payments exceed a base-erosion threshold of 3 % of total tax deductions
The tax is phased in at a rate of 5% for tax years beginning in 2018, 10% for tax years beginning from 2018 through 2025, and 12.5% for tax years beginning after Dec. 31, 2025
Cost of goods sold, payments for certain services at “cost” (with no markup) and qualified derivative payments may be excluded from calculations.

8. Dividends Received Deduction (DRD)
New Sec. 245A – Establishment of participation exemption system for taxation of foreign income
Participation regime is a partial territorial system that allows a deduction for the foreign source portion of dividends received by a domestic corporation which is a U.S. Shareholder of a "specified 10-percent owned foreign corporation"
Specifically, it provides:
"In the case of any dividend received from a specified 10-percent owned foreign corporation by a domestic corporation which is a United States shareholder with respect to such foreign corporation, there shall be allowed as a deduction an amount equal to the foreign source portion of such dividend."

9. One-time Transition Tax
Rate of tax:
15.5% on cash and cash equivalents
8% on non-cash assets
Foreign tax credits allowed after a haircut
Election available for tax to be payable in escalating installments over eight years
Deficits taken into account (may offset earnings and deficits within the same affiliated groups)
Election available to preserve NOLs

10. Global Intangible Low Taxed Income (GILTI)
The new law imposes current U.S. tax on excess of foreign intangible income (broadly defined) earned by a controlled foreign corporation exceeding a routine return
Routine return is 10% rate of return on depreciable assets (reduced by certain interest expense)
Calculation done entity by entity and then aggregated, loss entities included
U.S. effectively connected income, Subpart F and certain other income excluded
Limited credit provided for foreign tax but only current year foreign tax with no carryover or carryback for unused taxes

11. Foreign Derived Intangible Income (FDII)
An effective tax rate of % on excess returns earned directly by a U.S. corporation from foreign sales (including licenses and leases) or services
This rate would increase to % starting in 2026.
At a broad level FDII can be described as the income of a U.S. corporation
that exceeds a 10% return on the depreciable tangible assets of the company; and
that is considered “foreign” or attributed to export of goods or services
This excess return is considered to be the "deemed intangible income"

12. International Tax Consultant
Impact of U.S. tax reforms on
Indian companies having U.S. subsidiaries
S. Krishnan
International Tax Consultant

13. Reduction of federal corporate tax rate
Reduction of highest federal corporate tax rate from 35% to a flat rate of 21%
New U.S. corporate tax rate is lower than India’s reduced corporate tax rate of 25%
Impact:
New U.S. corporate tax rate would result in higher after tax earnings and cash flows of U.S. subsidiaries.
Indian MNCs operating in the U.S. as subsidiaries — especially in the information technology space, may want to keep more profits in the U.S. rather than repatriating to India in order to minimise the overall tax burden, offset the limits on business interest deduction and use those profits to expand globally.
In India, new residency test applies to overseas companies based on the Place of Effective Management (POEM) rules. Under this test, foreign subsidiaries of Indian companies could be treated as tax residents of India based on the location of control and management of the U.S. subsidiary. Such companies would be taxed on their global income (subject to foreign tax credit in India in respect of foreign taxes paid on foreign source income).

14. Reduction of federal corporate tax rate
There is little incentive for the Indian tax authorities to scrutinize subsidiaries incorporated in high tax jurisdictions from a POEM perspective, since there would be little, if any, incremental tax revenues accruing to India after giving credit for overseas taxes.
This may no longer hold true in the U.S. context under the new corporate tax rate structure. Hence, companies may be required to pay closer attention to POEM related risks in respect of their U.S. subsidiaries, going forward.

15. Full expensing of certain property
The new tax bill allows companies to expense immediately (100% bonus depreciation) the entire cost of certain depreciable assets such as machinery and equipment acquired and placed in service after September 27, 2017 and before January 1, For qualified property placed in service in calendar years 2023, 2024, 2025, and 2026, the applicable percentage is reduced to 80%, 60%, 40%, and 20% respectively.
The Act also allows otherwise qualified used property that has not been used by the taxpayer at any time prior to the acquisition and that meets certain other requirements to be fully expensed.
Impact:
Capital intense companies will benefit from this provision and this option incentivizes them to accelerate their U.S. investments to expand their U.S. operations.
New acquisitions could be made more favourably through “asset” purchases or “deemed asset” purchases, based on the immediate expensing rule for new asset investment.

16. Base Erosion Anti-Abuse Tax (BEAT) on U.S. corporations
Abolition of Alternative Minimum Tax (AMT)
Introduction of Base Erosion Anti-Abuse Tax (BEAT) on U.S. Corporations
Impact:
The term ‘‘base erosion’’ generally refers to tax reduction strategies adopted by MNCs that take advantage of differences between the tax rates/tax laws of different countries in order to minimize or eliminate the amount of corporate tax paid in a country.
The earlier U.S. tax regime enabled U.S. based MNCs to shift income from the U.S. to lower-tax jurisdictions and to defer the repatriation of active foreign source earnings. These MNCs also reduced their U.S. tax base through cross-border payments of tax-deductible interest, royalties or other fees to a foreign parent, subsidiary, or affiliate.
While a withholding tax applies to such payments, bilateral tax treaties reduced the withholding tax rates and, at times, eliminated it altogether. If a withholding tax does not apply, deductible payments of interest, royalties and management fees reduce the U.S. tax base. Under the earlier U.S. tax regime, there was no minimum tax that had to be paid on certain deductible payments to a foreign affiliate.
Under US-Ireland treaty, Interest and Royalties arising in a Contracting State (say U.S.) and beneficially owned by a resident of the other Contracting State (Ireland) may be taxed only in that other State (Ireland).

17. Base Erosion Anti-Abuse Tax (BEAT) on U.S. corporations
To address this lacuna, BEAT is effectively structured as an “alternative minimum tax”.
BEAT applies if certain “base erosion payments” to related foreign persons for the taxable year is 3% or more of all their deductible expenses (other than the net operating loss deduction, the new dividend received deduction for foreign source dividends, the new deduction for foreign-derived intangible income and the new global intangible low-taxed income, qualified derivative payments, and certain payments for services).
Generally, “base erosion payments” are tax-deductible cross-border payments such as royalties or interest to foreign related parties. It also includes any amount accrued or paid by the taxpayer to the related foreign party in connection with the acquisition of property which are subject to depreciation or amortization.
Cost of goods sold would not be a base erosion payment, except when made to a related foreign affiliate.
Base erosion payments exclude payments subject to full 30% U.S. withholding tax and cross-border purchases of inventory included in cost of goods sold.
In order to prevent companies from stripping earnings out of the U.S. through cross-border tax deductible payments to foreign affiliates, BEAT is effectively structured as an alternative minimum tax.
So, it results in computation of tax liability under an alternative methodology in addition to the regular methodology.

18. Base Erosion Anti-Abuse Tax (BEAT) on U.S. corporations
BEAT will not trigger if the payments are made for services or cost reimbursements that have no mark-up.
BEAT will impact U.S. inbound companies that have inter-company debt, rely on services from affiliates outside the U.S. or have intellectual property held by a foreign affiliate.
“Applicable taxpayers” are corporations with average annual gross receipts of at least $500 million for the three-year-tax period ending with the preceding year.
All related companies with more than 50% common ownership are treated as a single corporation for purposes of these tests. However, only income earned in the United States is taken into account.
BEAT would not be a withholding tax since it is a minimum tax on the U.S. taxpayer.
BEAT applies if 10% of the cross-border payments to related parties exceed the U.S. company’s regular U.S. tax liability.

19. Base Erosion Anti-Abuse Tax (BEAT) on U.S. corporations
Large corporations would have to calculate two amounts each year: A and B.
A = the corporation’s regular tax liability excluding R&D tax credit (100%) and 20% of production tax credits (modified taxable income).
B = 10% of the corporation’s modified taxable income after adding back two amounts: deductible cross-border payments to affiliates and a percentage of any tax losses claimed that were carried from another year.
If A (regular tax liability) is less than B, then the U.S. government will collect the entire difference as Base Erosion Minimum Tax (BEMT).
The tax rate for calculating B will be only 5% in 2018, making 2018 a transition year.

20. Base Erosion Anti-Abuse Tax (BEAT) on U.S. corporations
Under existing U.S. transfer pricing rules, certain low-margin services—including accounting and administrative services—do not require a mark-up. Accordingly, these cost-based transactions would not be subject to BEAT. However, while no mark-up is required for U.S. tax purposes, India tax authorities may require a mark-up for such services. Consequently, the marked-up transaction would be subject to BEAT.
If a group’s transfer pricing policy regarding low-margin services is to apply a mark-up, the group companies have to choose between paying BEAT in the U.S. or revising its transfer pricing policy to remove the mark-up and face the risk of tax audit in India. This would result in the Indian company incurring additional time and cost of responding to the audit along with any tax, penalties and interest that may result from an adverse audit outcome.

21. Limits on business interest deductions
Use of debt to finance U.S. operations is widespread in U.S. inbound structures.
From tax year 2018, deduction for interest paid or accrued on debt allocable to a trade or business will be limited to the sum of:
the interest income of the taxpayer allocable to a trade or business, and
30% of the “adjusted taxable income” of the taxpayer for the taxable year.
For tax years beginning in 2018 through 2021, adjusted taxable income is calculated by adding back interest, depreciation, amortization and depletion deductions (i.e., similar to EBITDA). From tax year 2022, adjusted taxable income is determined without adding back depreciation, amortization and depletion deductions (i.e., similar to EBIT).
Disallowed interest may be carried forward to future years indefinitely.
Taxpayers with average annual gross receipts of $25 million or less for the three previous tax years are exempt from the interest deduction limitation. In the case of a group of affiliated companies that file a consolidated return, the Act clarifies that the limitation applies at the consolidated tax return filing level as opposed to an entity level.

22. Limits on business interest deductions
Impact:
This limitation restricts the tax benefits arising from debt structures.
This limitation and the BEAT provision on related party payments may lead to re-evaluation of the capital structure of U.S. subsidiaries – both existing and proposed.

23. Limits on use of Net Operating Loss deduction
The new provision restricts the use of NOLs to 80% of the taxpayer’s taxable income for the year, but permits taxpayers to carryforward NOLs indefinitely.
Unlike in the past, the new provision does not allow carrybacks of NOLs to 2 prior years.
The 80% limitation, indefinite carryforward rule and no carryback rule of the new provision are effective for NOLs arising in taxable years beginning after 2017.
Existing net operating losses (including for 2017) can continue to be carried back two years or carried forward for up to 20 years and can offset 100% of taxable income.

24. Impact of U.S. tax reforms on India
As the U.S. tax system moves from a worldwide tax regime to a territorial tax regime, the Act imposes a transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. companies by deeming those earnings to be repatriated.
The transition tax is applicable on profits of any foreign corporation in which the U.S. shareholder owns at least 10%. The U.S. parent company may elect to pay its net tax liability on the deemed repatriation over 8 years in a pre-defined ratio.
Thus, income-tax may become payable in the U.S., even though the earnings from India may not have been actually repatriated to the U.S. In addition, the tax reasons for retaining profits overseas no longer remain. This could lead to actual distributions from India. Such distributions would entail payment of Dividend Distribution Tax which is not creditable against U.S. taxes, resulting in a significant tax cost for the Indian subsidiary.
A lower tax rate will generally lead to increased valuations of U.S. companies. However, in the context of acquisitions, one may also need to factor in the impact of changes relating to use of NOLs, deferred taxes and other tax attributes, such as available foreign tax credits. Specifically, the new tax provisions could make tax attributes less valuable, while deferred tax liabilities would become less costly.

25. Impact of U.S. tax reforms on India
With the reduction in U.S. tax rates, there is increased need for U.S. corporations to evaluate their tax costs overseas, including specifically in high tax countries like India. This may warrant a rethinking of the entire India tax strategy including funding options for Indian entities, debt infusion, transfer pricing and supply chain policies, consolidation as well as repatriation options.

26. Changing Australian environment
Contraction of tax base =
Attempted expansion of tax from international corporates –
MAAL
DPT PE
Royalty
Service fee/royalty
“embedded royalty”
Tech Mahindra

27. Tech Mahindra Tech Mahindra Limited v Commissioner of Taxation [2016] FCAFC 130 Tech Mahindra Limited v Commissioner of Taxation [2015] FCA 1082
What does the decision tell us?
If an Indian entity performs services in India (payments for which fall within the extended definition of royalty in the treaty) for an Australian buyer-
Then, because the payments are within the royalty definition, they are deemed by the treaty to be Australian sourced income.
But they are not royalties under Australian domestic law, simply Australian sourced services income
And the Indian company will pay tax on the profit (calculated using the Australian “assessable income” rules) from the contracts in Australia.
Even though it pays no withholding tax, and has no PE

28. Tech Mahindra Why? Because of Article 23: Article 23 Source of income
(1) Income, profits or gains derived by a resident of one of the Contracting States which, under any one or more of Articles 6 to 8, Articles 10 to 20 and Article 22 may be taxed in the other Contracting State, shall for the purposes of the law of that other State relating to its tax be deemed to be income from sources in that other State.
(2) Income, profits or gains derived by a resident of one of the Contracting States which, under any one or more of Articles 6 to 8, Articles 10 to 20 and Article 22 may be taxed in the other Contracting State, shall for the purposes of Article 24 and of the law of the firstmentioned State relating to its tax be deemed to be income from sources in that other State.

29. Unresolved issues
Identification of affected
Application of article 23
Calculation of profit attributed
Treatment of flow through/subcontract models

30. Tech Mahindra Structure
Indian Head Co
Statements of work
India
Services
Invoices
Australia
Australian Permanent Establishment
Australian Customers
Services
Payment for services (Australian bank account controlled by Indian Head Co)
April 2018

31. Australian subsidiary structure
Indian Head Co
Intercompany service fee
Services
India
Statements of work (which allow the Aus sub to procure services from other Group Co’s)
Australia
Australian Subsidiary
Australian Customer
Services
Key differences from TM:
Contracting parties
Invoices
Payment
Invoices
Payment for services
April 2018

32. Australian PE Structure
Indian Head Co
Invoices
Cost + 7% markup
India
Statements of work (to provide services to end users)
Payment
Australia
Australian Permanent Establishment
Australian Customers
Services
Key differences from TM:
Recipient of services (end customers)
Payment
Services
End User Customers
April 2018