Deloitte Tax LLP Partner John Womack, national manufacturing industry leader for tax, discusses the structural cost issues that affect U.S.-based manufacturers’ ability to compete in the global marketplace, and how certain tax strategies may be employed to help level the playing field.
Corporate taxes have long been one of the critical factors affecting United States-based manufacturing companies’ ability to compete in the global marketplace. Why is this so, and what has been the impact on these companies?
The United States eventually taxes every piece of revenue that a U.S.-based company earns across the globe. When non-U.S. earnings are brought back to the U.S., they are subject to U.S. tax, regardless of whether or not the company has paid taxes in the country in which they were earned. If a company earns money in Ireland and pays taxes at a rate of 12.5 percent, and then repatriates those earnings back to the U.S., they must pay what’s called a top-up tax. A top-up tax is the difference between the U.S. tax rate of 35 percent and Ireland’s 12.5 percent tax rate. Many other countries do not impose this top-up tax on their companies, so they can enjoy the lower income tax rates on earnings made in other low-tax countries. This disadvantage may ultimately serve to eliminate the incentives such as tax holidays.
Since U.S.-based manufacturers face a larger tax burden, what are some of the strategies they should be considering to help minimize it?
Absent lobbying efforts that have been underway for a long time and will continue to push for a better tax system for U.S.-based manufacturers, the available planning and structuring alternatives for U.S. tax minimization focus on two areas: U.S. tax planning and foreign tax credit and repatriation planning.
With respect to U.S. tax planning, there are a couple of incentives for the manufacturer. One is the fairly new deduction allowed for products manufactured in the U.S., known as the qualified production income or
Section 199 deduction. Companies also may take a
research and development credit. Since product development requires a significant amount of R&D, it’s a major benefit for U.S. companies.
With foreign tax credit and repatriation planning, opportunities may exist when companies have moved their operations offshore to lower cost and lower tax jurisdictions. The trick here is to keep the benefit of a potentially lower income tax rate and minimize the impact upon repatriation of money back to the U.S.
One way to minimize this impact is to keep offshore earnings offshore. If a company plans to continue to invest offshore, this may make a lot of sense. Another way is to keep high tax earnings separate from low tax earnings. When money is repatriated, companies tap their high tax earnings so they don’t have to pay the top-up tax. This type of solution requires a significant amount of planning and coordination, but the goal is to structure your offshore investments so that when and if money is needed back in the U.S., it costs as little as possible. It’s a very delicate balance.
Are there other tax-related strategies you might use to minimize structural tax issues?
Companies should consider foreign tax credit expense allocation planning to ensure repatriated funds are taxed as minimally as possible. Our foreign tax credit system is quite complicated, and ultimately requires that expenses of the US parent to be allocated against foreign source income thereby haircutting the foreign tax credit. For example, if a company has to pay 35 percent tax in Mexico, one might think there’s no further expense in the U.S. because the rate is the same. But interest, research and development or administrative charges get allocated in such a way that requires U.S. companies to pay U.S. income tax upon repatriation. In many cases, optimizing expense allocations is just as important as minimizing your non-U.S. income tax.
Companies should consider foreign tax credit expense allocation planning to ensure repatriated funds are taxed as minimally as possible. Our foreign tax credit system is quite complicated, and ultimately requires that expenses of the US parent to be allocated against foreign source income thereby haircutting the foreign tax credit. For example, if a company has to pay 35 percent tax in Mexico, one might think there’s no further expense in the U.S. because the rate is the same. But interest, research and development or administrative charges get allocated in such a way that requires U.S. companies to pay U.S. income tax upon repatriation. In many cases, optimizing expense allocations is just as important as minimizing your non-U.S. income tax.
How can U.S. manufacturers rationalize their operations by moving offshore or consolidating within the U.S.?
Manufacturing plant consolidation within the U.S. is very common. And, in many cases, incentives are available for companies making a significant investment in a particular state. For example, if a company has two plants, one in State X and one in State Y, and they decide to consolidate into one plant, perhaps one of those states will offer an incentive, such as property tax abatement, to the company for staying open in their state and, through consolidation, adding jobs to the state.
Outside the U.S., other types of incentives are common. Tax holidays, as we’ve discussed, are common in the Far East and Central Europe. Also, customs duties and
value-added tax (VAT) are indirect taxes that can offer opportunities for tax planning. For example, if a company imports a $100 product into another country, there’s a customs duty paid at the border. Through planning, it might be possible to reduce the customs value of that product $80, which minimizes customs duty.
The bottom line is, it’s important to consider those so-called above-the-line taxes that are not based on income because they offer a real opportunity for savings.
How does one best integrate tax considerations into business decisions so they are made to combat structural cost issues?
First and foremost, companies must take a more holistic approach to their taxes. It’s not all about saving U.S. taxes or saving non-U.S. taxes – it’s about cash management and integration with a company’s business strategy. We have developed a framework called the
Global ST2EPS methodology, which looks at a company’s tax characteristics, cash flow predictions and needs, as well as overall business strategy, to pull together a counterbalanced tax strategy that falls in line with the company’s overall objectives. Having a complete view ensures that decisions are not made in a vacuum, and that’s the best way to make sure that whatever the company is doing from a business perspective, they can also arrive at the best tax answer.
For more information, view John’s December 8
tax structural cost program from the Dbriefs Webcast archive, where he discusses the above in more detail.
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Last Updated: April 27, 2006
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Source: Deloitte & Touche USA LLP - United States (English)
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