Risk & Economy » Brexit » How will the UK respond to US tax reform?

George Bull, senior tax partner at RSM UK, explains how the US tax reforms could impact the UK

Under recent American presidents, the deadlock between Republicans and Democrats prevented any significant progress in reforming the US tax system.

The high rate of business tax was felt by some to stifle growth in the US domestic economy. Without a doubt, it also had the effect of discouraging US-headquartered multinational corporations from repatriating overseas profits.

On the campaign trail, Donald Trump promised to reform the US tax system, with the express intention of boosting economic growth and creating new American jobs.

When US Treasury Secretary Steven Mnuchin held his press conference in April to announce the broad shape of US tax reform, many thought that the significance was in the timing of the message – the end of President Donald Trump’s first 100 days – rather than the probability that the new administration could actually deliver all these changes.

That, as they say, was then; this is now. In the intervening weeks, after overcoming significant early opposition, the Trump administration is well on the way to repealing Obamacare. With that in mind, the proposed tax changes are now being taken more seriously and are being factored into companies’ future business plans.

Consistent with his election-trail promises, President Trump’s goals for US tax reform are to grow the economy and to create millions of jobs.

He aims to simplify the US’ burdensome tax code, to reduce the business tax rate from one of the highest in the world to one of the lowest, and to reduce the tax burden on middle-income families.

In what seems set to be the biggest gamble on the Laffer curve the world has ever seen, the US business tax rate will be reduced from 35% to 15%.

At the same time, the tax system will move to a territorial basis, to level the playing field for American companies.

In a closely watched announcement, the Treasury Secretary also proposed a one-time tax on trillions of dollars of profits held overseas. However, no detail on that has yet been published.

If the administration judges the nature and rate of the one-time tax correctly, then it is likely to usher in the biggest movement of funds the world has ever seen.

These proposals, which sit alongside a range of other tax reforms, will be the subject of listening sessions being held by the Trump Administration in May this year, with a view to producing specific proposals during the summer.

Even before any details are known, many believe that this will put an end to tax inversions which have driven many large overseas acquisitions in recent years.

We can also expect to see US companies using the proposed tax rate reduction by moving quickly to sell assets that are currently standing at a loss, to maximise the tax relief available at the current high rate of tax. Similarly, gains may be deferred until after the tax rate has been reduced so minimising the tax liability.

How does this affect UK policy on corporation tax?
At around £53 billion a year, corporation tax raises much less for the UK Treasury than income tax (£175 billion), VAT (£143 billion) or National Insurance (£130 billion)

But the headline rate of corporation tax has a totemic significance. When I began my career in taxes, the main rate of corporation tax was an eye-watering 52%. Before the great financial crisis, that figure had fallen to 28%. It currently stands at 19% and will be cut to 17% in 2020.

The declining rates are not expected to have much impact on the amount of corporation tax collected for two principal reasons; economic growth and the hope that a low rate of tax will encourage overseas businesses to establish themselves in the UK. At least, that’s what recent Chancellors are expecting to see as they consciously try to position the UK as having the lowest rate of corporation tax in the G20.

On the face of it, this policy is enormously attractive to companies who pay UK corporation tax. Predictably, however, other members of the G20 have been less enthusiastic, branding the UK policy as harmful tax competition.

Other people have expressed concerns that the policy will result in the UK becoming a tax haven with all the unsavoury connotations that go with that. These latter concerns are not entirely well-founded, as the UK operates high standards of transparency in its tax system and is helping lead the charge on the application of the OECD BEPS initiative.

But let’s return to the policy itself. At a stroke, Steven Mnuchin’s announcement of the likely shape of US tax reform clearly identifies that the current 35% US business tax rate (one of the highest in the G20) is to be reduced to 15%. That will undercut the UK and every other country in the G20.

How might the UK respond?
Unless the UK continues the race to the bottom with a reduction to 14 per cent, the slogan ‘the lowest corporation tax rate in the G20’ will have to be quietly buried.

The Treasury then has two choices. First, to abandon the slogan while continuing with the move towards an eventual corporation tax rate of 17%. Second, to quit the game and to allow UK corporation tax rates either to stabilise at the current rate of 19%, having reached 17%, to then drift up again.

Ironically, while future UK policy on corporation tax rates is bound to attract high levels of attention, OBR analysis suggests that the total yield from the tax won’t change significantly.

 

George Bull is a senior tax partner at RSM UK