XVI Foro Fiscal

Monterrey 2017

Proyecto de Reformas Fiscales en los EE UU A

Eduardo D. Gonzalez, Deloitte

Blas Montemayor, PwC

Ricardo Leon Santacruz, Sánchez-DeVanny

1. Potential Forthcoming Tax Reform: Competing Proposals & Managing the Transitiona. Setting the Tax Reform Stage: The Trump and House GOP Tax Reform Proposalsb. Border Adjustable Cash Flow-Tax Approachc. Summary of Federal and International Tax Proposals

Eduardo D. Gonzalez, Managing Director – International Tax, Deloitte Tax LLP, San Diego, CA

2. “No-Harm” Planning for the Probable: Considering most likely US tax reform scenarios and impact on Mexican companies

a. Mexican Subsidiaries: Territoriality or Low Tax Rate

b. Toll Tax

c. Border Adjustment Tax

d. Net Interest Deduction

e. Key Factors for Companies to Consider

Blas Montemayor, Partner, International Tax Services, PwC, Monterrey, NL

3. Q&A

The following materials and discussion are prepared on the basis of very general tax reform proposals which lack significant details. Changes should be expected as the reform process evolves. The materials contained herein and the opinions presented are preliminary in nature and cannot be construed as legal or tax advice.

Setting the Tax Reform Stage: The Trump and House GOP Tax Reform Proposals

Trump 2017 Proposal

The Trump administration on April 26 released a one-page fact sheet outlining

principles for overhauling the tax code

Many of the principles resemble previous proposals, but with no technical

descriptions explaining the provisions

Significantly lower rates to 15% for corporations and passthroughs (businesses

without an entity-level tax, which is currently taxed at the individual tax rate

• Will work with congress to prevent wealthy individuals from “gaming” the tax code by

recharacterizing wage income as more lightly taxed business income

Transition to territorial tax system, meaning domestic multinational businesses

would only be taxed on their income connected with the US

• Proposal would “level the playing field for American companies” and a

significant departure from previous proposals ending deferral but otherwise

retaining current worldwide regime for taxing offshore business income

One time deemed repatriation tax on previously untaxed earnings held overseas

• Fact sheet does not cite a specific rate for the one-time levy, with campaign

proposal calling for a 10% rate

• Will work with the House and Senate to determine appropriate rate and that rate would

be “competitive”

• Plan silent on bifurcation tax rate for cash and non cash assets

• No mention if tax would be paid in one year or ratably over a longer period as

proposed by Camp and House GOP tax reform blueprint

Border adjustment tax was not discussed

Plan proposes to “eliminate tax breaks for special interests”

No infrastructure proposals to use one-time revenue from business tax reform to

finance new infrastructure spending

Trump 2017 Proposal

Individual income tax rate seven tax brackets compressed (ranging from 10% to

39.6%) to three brackets of 10,25, and 35%

• No income thresholds specified

Capital gain rate to remain at 20% and repeal the 3.8% net investment income tax

Standard deduction increased to $24,000 for MFJ and $12,000 for single filers

Repeal of individual AMT and estate tax

Many current incentives targeted for elimination, such as state and local tax

deduction but preserving mortgage interest and charitable contributions

• Previous proposal had $200,000 MFJ and $100,000 single filer cap on itemized

deductions

Trump 2017 Proposal

Changes proposed by Trump largely involve lowering tax rates for business

while simultaneously broadening the base through limiting – or eliminating –

“most business tax expenditures.”

Corporate rate 15%

Pass-through

rate15%, but unclear to which entities and income it applies/other restrictions

Corporate AMT Eliminate (Trump fact sheet did not mention corporate, but mentioned individuals)

Full expensingU.S. manufacturers may elect full expensing or interest deductibility; election

irrevocable after three years (Not mentioned in 2017 proposal)Interest

deduction

International

• 2015 Proposal: Repeal deferral with FTCs

• 2016 Proposal: No discussion of possible changes to current regime

• Both: Deemed repatriation at 10% tax rate

• 2017 Proposal: Deemed repatriation, territorial regime (less specific)

Trump 2017 Proposal

• With Republicans controlling the Executive and Legislative branches next year, House Republicans are expected to press hard for action on tax reform.

• House Republicans released a tax reform “Blueprint” on June 24, showing where they want to take the debate.

• The Blueprint alters the current corporate income tax system in five major ways:

1. Lowers the corporate tax rate to 20 percent.

2. Allows for businesses to expense 100 percent of their costs (as opposed to depreciating some of them).

3. Eliminates net interest expense for businesses.

4. The corporate tax would be based on “cash flows” and “border adjustable.”

5. Adopt a “territorial tax regime” for taxing foreign income of foreign subsidiaries.

House GOP BlueprintBlueprint for Tax Reform

Border Adjustable Cash Flow-Tax Approach

The House GOP Blueprint provides border adjustments using a destination based cash-flow approach. In particular, the Blueprint provides the following:

• “The cash-flow based approach that will replace [the] current income-based approach for taxing both corporate and non-corporate businesses will be applied on a destination basis.”

• “[P]roducts, services and intangibles that are exported outside the United States will not be subject to U.S. tax regardless of where they are produced.”

• “[P]roducts, services and intangibles that are imported into the United States will be subject to U.S. tax regardless of where they are produced.”

According to the Blueprint, a border-adjusted tax will broaden the tax base by increasing the tax cost of imports. This is expected to raise revenues and help reduce the United States trade deficit.

House GOP BlueprintBlueprint for Tax Reform

• The House GOP Blueprint’s border adjusted cash-flow tax approach has elements similar to that of a consumption-based tax.

• “Border adjustments” are a feature of a destination based value-added tax (“VAT”) whereby “the tax is rebated when a product is exported to a foreign country and is imposed when a product is imported from a foreign country.”

• The GOP destination-based cash flow tax may generally operate as follows:

• Revenue from exported sales or services would not be taxable.

• The cost of imports would potentially not be deductible. For example, a business importing $1m of materials from a foreign supplier would not be able to deduct the cost of those materials against its corporate tax base.

• The House GOP Blueprint proposes that its cash-flow based approach is consistent with WTO rules regarding indirect taxes.

House GOP BlueprintBlueprint for Tax Reform

House GOP BlueprintCash-Flow Tax Approach – Export Example

US Supplier

US Co

Foreign Customer

Goods

Goods

$100

$150

Apparent Consequences:

• The $150 received by US Co from Foreign Customer is excluded from its taxable cash flow.

• The $150 received by US Co from US Customer is included in its taxable cash flow.

• While not explicit in the Blueprint, it would seem that US Co deducts the cost incurred

purchasing the goods from US Supplier.

US Customer

Goods

$150

US

Foreign

House GOP BlueprintCash-Flow Tax Approach – Export/Import Example

Foreign Supplier

Goods $100

Apparent Consequences:

• The $150 received by US Co from US Customer is included its taxable cash flow.

• The $150 received by US Co from Foreign Customer is excluded from its taxable cash flow.

• While not explicit in the Blueprint, it would seem that US Co cannot deduct cost incurred

purchasing the goods from Foreign Supplier.

US Co

Foreign Customer

Goods$150

US Customer

Goods

$150

US

Foreign

Summary of Federal and International Tax Proposals

International Tax ReformScope of US International Taxation

Border Adjustable Cash Flow-Tax Approach

Tax Reform ProposalsComparison Matrix – International Proposals

Provision Current law Trump House GOP blueprint Camp II

International provisionsRegime type Worldwide with deferral No changes currently specified

(2015 called for retaining

current-law worldwide regime

and the foreign tax credit but

repealing deferral)

Territorial system with 100% participation

exemption for foreign dividends

Participation Exemption

• DRD: 95% DRD for specified 10% owned corporations.

• Gain: No special rules for gains – 95% DRD to the

extent there is a deemed dividend under section 1248.

• Basis Adj.: Solely for purposes of determining loss, the

basis in a CFC is reduced by the amount of exempt

portion of dividend distributions.

• Branches: Generally, current law treatment of

branches. New recapture of historic branch losses upon

the conversion of the branch to a CFC – separate from

existing branch loss recapture rule.

Repatriation Repatriated foreign-

source income taxed at

full corporate rate with

allow- ance for foreign

tax credits

One-time deemed repatriation of

accu- mulated deferred foreign

income at flat 10% tax rate; no

discussion of giving companies

multiple years to pay

One-time deemed repatriation with differential

rates for cash (8.75%) and noncash assets

(3.5%), payable over eight years at the

taxpayer’s election

One-time subpart F inclusion on non-PTI post-1986 E&P of

each 10% owned foreign corporation; netting of deficits with

positive pools permitted.

• 8.75% tax on E&P retained in cash or cash equivalents

and 3.5% tax on all other E&P.

• Payable over eight years; no interest charge

• S corporation shareholders may elect to defer tax until

sale of stock, liquidation or conversion to C corporation.Prevention of

base erosionSubpart F rules limit

deferral for certain mobile

and passive foreign

income; US interest

deductions for inbound

firms may be limited by

section 163(j)

No changes specified Eliminate most subpart F rules; retain foreign

personal holding company rules for passive

income shifting

• New category of subpart F: A new residual category of

foreign base company income called Foreign Base

Company Intangible Income (FBCII) is created. FBCII

is a CFC’s gross income less 10% of CFC’s adjusted

basis in specified depreciable tangible property

• Foreign Base Company Sales Income (FBCSI): A

12.5% minimum worldwide effective rate is imposed on

FBCSI. However income earned by CFCs that are

qualified residents in a treaty jurisdiction would be

excluded

Border

adjustability of

tax base

N/A N/A Destination-based cash flow tax based on

jurisdiction of consumption and not

production; thus imposed on value of imports

but not on value of exports, similar in concept

to “border adjust- ments” in other countries’

Value Added Taxes

N/A

Border Adjustable Cash Flow-Tax Approach

Tax Reform ProposalsComparison Matrix – Domestic Proposals

Provision Current law Trump House GOP blueprint Camp II

Domestic provisions

Top corporate

rate

35% 15% 20% 25%

Research

credit

Generally allows either a 20% credit for

qualifying research expenses in excess of a base

amount, or a 14% alternative simplified credit

Retain research credit, but

repeal most other business

tax expenditures

Retain credit; Ways and Means Committee

will “evaluate options” to make it “more

effective and efficient”

• Research credit (alternative simplified

credit) would be permanent

Section 199

deduction

Up to 9% deduction under section 199 for

certain income attributable to domestic

production activities

Repeal most business tax

expenditures

except for the research credit

Repeal • Phased out repeal over two years

beginning in 2015 (6% in 2015, 3% in

2016)

• Research credit (alternative simplified

credit) would be permanent

Depreciation Taxpayers generally recover costs under the

Modified Accelerated Cost Recovery System

(MACRS) or, at their election, under the

straight-line

Alternative Depreciation System (ADS)

Firms engaged in US

manufacturing may elect

to deduct the full cost of

their capital investments

in year one; option is

revocable within first 36

months

Full expensing in year one of all assets,

tangible and intangible, other than land

• Depreciation would be computed using

straight-line method, longer recovery

periods

• Similar to current ADS

• May elect additional deduction for

inflation (year end basis multiplied by

chained CPI)

• Would apply to assets placed in service

after 2016

Interest

expense

Generally deductible Businesses that elect full

expensing in year one (see

Depreciation, above) will

lose their ability to deduct

net interest expense

• Interest expense deductible against

interest income, but no current

deduction for net interest expense;

net interest expense may be carried

forward indefinitely and deducted

against net interest income in future

years

• interest expense of financial services

companies still deductible

• Modified section 163(j) and implements

new thin cap rules

• Section 163(j) interest deduction limit for

adjusted taxable income reduced from

50% to 40%.

Accounting

methods

• Last-in, first-out (LIFO) and lower of cost

or market (LCM) included among

permissible inventory accounting

methods

• Cash method of accounting permissible

for certain non-C corp and other entities,

subject to an average annual gross

receipt limit of $5 million (gross receipt

limit does not apply to personal service

corporations)

No changes specified • Retain LIFO; Committee will

continue to evaluate ways to make

inventory accounting more efficient

• No specific discussion of LCM or cash

methods

• Section 481(a) adjustment would be

taken into account beginning in the first

tax year beginning after 2018 as

follows — 10% in 2019, 15% in 2020,

25% in 2021, and 50% in 2022

• Special 7% tax rate on reserve

recapture of entities with 100 or fewer

owners as of February 26, 2014

“No-Harm” Planning for the Probable: Considering most likely US tax reform scenarios

and impact on Mexican companies

By Blas Montemayor

One time effect on balance sheet of the US

• Similar to the effect that occurred in Mexico when the IETU became effective

• Timing of financial statement effect is at the enactment of the law

• This will affect many companies regardless of sector

• Understand your parent company’s deferred tax asset or liability position

• What are the planning opportunities that your parent company could benefit from through the Mexico business?

Mexican Subsidiaries: Territoriality or Low Tax RateAccessing Foreign Tax Credits

• Both territoriality or a lower rate will encourage use of FTCs sooner

• Deadline for extracting foreign tax credits depends on timing of the reform. There will be a limited window of opportunity.

• Focus on accelerating foreign taxes prior to the deadline

• Indirect Credits can also be accessed through transactions that are considered a dividend for US tax purposes regardless of the Mexican treatment.

• Understand the company’s deferred tax asset or liability position.

• Putting in perspective the REFIPRE rules and a low US tax rate.

‐ Exceptions under the MITL and the Mexican Administrative Tax Rules.

‐ Active vs passive income.

• Effects on current tax and cash strategy.

• Does the reduction in the rate compensate the effects of the loss of the net interest deduction?

Structuring considerations:

• Regional holding structure.

‒ Dividend exemption.

‒ Capital gains.

‒ Withholding tax modeling.

• Financing structure.

• Current financial position.

‒ Profitable or in a loss position.

Mexican MNCs: Territoriality or Lower Rate

• Foreign tax credits.

• Need of evaluating a shareholding restructure?

• Change in the treatment of Mexican entities from a U.S. tax perspective.

• Tax attributes planning.

• Tax-efficient cash extraction.

‐ Additional corporate income tax, if any.

‐ Withholding tax under the U.S.-Mexico tax treaty, if any.

Toll Tax

Border Adjustment Tax

• Impact would depend on existing business model.

• Need to model impacts under different scenarios.

• Restructure business model? – full vs. contract or limited risk manufacturer.

• Re-evaluate supply chain – flow of goods and suppliers would be key.

• Re-evaluate pricing strategies.

• How the Mexico tax system will be adapted to this new environment?

• Option of full expensing of capital investments and the deductibility of interest expense.

‒ Re-evaluate the capital structure.

‒ Impact on financing structures.

‒ Modeling exercise focused on broadening the tax base (e.g., ETR, cash tax, etc.).

Net Interest Deduction

Key Factors for Companies to Consider

• Net exporter or net importer?

• Domestic-only operations or active in global markets?

• Reliance on debt or equity for investments?

• High profit margins or low profit margins?

• Capital intensity of operations?

• Transition rules?, Details?, Modelling exercises?.

Eduardo D. Gonzalez

Managing Director – International Tax

T: (619) 237-6638

E: egonzalez@deloitte.com

Blas Montemayor

Partner, International Tax Services

T: (+ 52 81) 8881-4149

E: blas.montemayor@mx.pwc.com

Ricardo C. LeónPartner, Sánchez-DeVannyT: (+52-81) 8153-3914E: rls@sanchezdevanny.com

Border Adjustable Cash Flow-Tax Approach

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