October 6, 2017 Tax reform 'Framework' provisions would impact banking sector The Unified Framework for tax reform released by President Trump and leading Congressional Republicans on 27 September (the Framework) includes a number of business and international provisions that would impact banks. This Alert highlights these provisions and their implications for the banking sector. For a general discussion of the Framework, including individual tax changes not discussed here, see Tax Alert 2017-1563. Corporate tax rate reduction The Framework would lower the corporate tax rate from 35% to 20%. This is the same corporate tax rate proposed by the 2016 House Republican Tax Reform Blueprint (the Blueprint, see Tax Alert 2016-1111), although higher than the 15% rate Trump called for in his plan released in April 2017 (see Tax Alert 2017-692). In comments made the day the Framework was released, President Trump called the 20% rate the "perfect number" and non-negotiable (see Tax Alert 2017-15-69). The lower rate would generally favor banks by increasing future earnings and capital. Because much of substantive tax reform negotiations are just beginning, it is unknown when the new rate would be effective, if enacted. However, some speculate it could become effective January 1, 2018. Congress could also adopt a phase-in of the reduced rate, as was included in then House Ways and Means Committee Chairman Camp's 2014 tax reform plan (the "Camp plan," see Tax Alert 2014-389). For financial statement purposes, a bank's deferred taxes would require adjustment to account for the new corporate tax rate, with a corresponding increase or decrease to earnings in the quarter of enactment. The effect of this adjustment, for financial statement and regulatory capital purposes, will vary, depending on each bank's particular profile. For example, some institutions may already have a reduction in their capital calculation for certain deferred tax assets (DTAs), and the change may have no impact on their net regulatory position as a result. Some banks may want to accelerate deductions or defer taxable income to reduce the effect of DTA write-downs to the extent they are projected. Such tax planning can favorably impact the amount of the deferred tax adjustment and thereby generate a permanent benefit to earnings and capital. Corporate AMT repeal In addition to reducing the corporate tax rate, the Framework aims for the elimination of the corporate Alternative Minimum Tax (AMT), as recommended by the non-partisan Joint Committee on Taxation (JCT). The Framework provides no further detail on the possible elimination of the corporate AMT, including the effect on existing AMT credit carryforwards. Although uncertain at this time, many expect AMT credit carryforwards would continue to be eligible for carryforward. Territorial tax regime, with deemed repatriation tax The Framework's plan would allow a 100% exemption for dividends from foreign subsidiaries in which the US parent owns at least a 10% stake. This would shift the US from its current worldwide tax system, in which US tax can be deferred on foreign active business income until it is repatriated, to a territorial tax regime. As part of the transition to the new system, accumulated foreign earnings currently held by US multinational companies would be treated as repatriated and subject to tax. The Framework does not specify the rate that such accumulated foreign earnings would be subject to tax. However, it does specify that a lower rate would apply to illiquid assets than to foreign earnings held in cash or cash equivalents. The Blueprint, which called for a similar approach, did include specific rates: 8.75% to the extent held in cash or cash equivalents and 3.5% to the extent held in other assets. The Framework states that it would spread out this liability "over several years"; the Blueprint specified an eight-year period. A bank's controlled foreign corporations (CFCs) often hold the bulk of their assets in cash and cash equivalents, meaning associated accumulated foreign earnings would be subject to the higher deemed repatriation rate. Some have suggested that banks should have the benefit of the reduced rate for cash that is held to meet local capital requirements, because these assets are not available for distribution to the US, similar to other industry's illiquid assets. It is unclear yet if legislators will adopt for this purpose the 8.75% rate proposed by the Blueprint and what assets may qualify for the lower "illiquid asset" rate. The Framework is silent on whether the Section 902 foreign tax credit will be available for use in reducing the repatriation tax. However, the Blueprint's plan would allow a partial foreign tax credit in an amount corresponding to the partial inclusion amount (specifically, 25% for CFCs with cash equivalent assets, 10% for other assets). The Framework notes that the territorial regime would be executed through a 100% dividend received deduction (DRD) for foreign subsidiaries that are greater than 10% owned by a US entity. It is unclear how or whether income of foreign branches of US banks would be included in US taxable income, as under current law, or if foreign branch income would be excluded under a territorial regime. While the Framework does not address this specifically, some earlier proposals (e.g., the Camp plan) have excluded the income of foreign branches of US banks as part of their territorial regime. It is expected that, as further details of the territoriality provisions are released, the treatment of foreign branches will be clarified. The Framework references measures to be drafted to address general base erosion concerns. This would presumably prevent banks from excessively shifting income from the US to low-taxed foreign subsidiaries that would be eligible for exemption under territoriality. While some believe this could involve a minimum tax on foreign earnings, the Framework leaves the details of such provisions to be worked out by congressional committees. There is nothing in the Framework to indicate changes with respect to current law regarding foreign tax credits or determination of foreign source income. Business deductions and credits The Framework explicitly preserves the research and development (R&D) tax credit and low-income housing tax credit (LIHTC). However, it broadly envisions repealing many other deductions and credits. Reduced corporate tax rates will decrease some of the benefits from LIHTC investments, because a portion of the tax benefit from LIHTC investments arise from depreciation deductions that will have less value at reduced tax rates. It is unclear what other domestic tax credits may be preserved. Many people believe that most domestic credits will continue until their targeted expiration dates under current law. Expensing of capital investments The Framework would allow for 100% expensing for fixed assets other than "structures" if placed in service for at least five years. The Framework leaves the definition of "structures" to the committees. Therefore, it is unclear if the term "structures" includes leasehold improvements. To the extent a bank's corporate customers do not have the tax capacity to utilize the new expensing deductions, it may raise demand for leasing transactions. Interest expense The Framework would also limit net interest expense deductions for C corporations, but it does not offer further details with respect to how it would do so. Under the Blueprint's proposal, taxpayers could deduct interest expense against interest income (and any net interest expense could be carried forward indefinitely as a deduction against interest income in future years), but net interest expense would not be available as a current deduction. The limits on interest deductibility would likely not directly impact most banks, because they have net interest income. This provision could potentially impact a bank's corporate customers (and certain loan products) as well. If enacted, banks may wish to begin offering alternative financing solutions to their corporate loan customers, such as leasing, preferred equity, trade receivable financing and inventory buy/sell financing. Revenue raisers The Framework largely leaves the issue of revenue raisers for congressional tax committees to work out. It is unclear what provisions may be adopted in the legislative process. The American Bankers Association has expressed concerns that a limitation on deductions for interest expense could have adverse economic consequences. Timeline The timeline for tax reform enactment remains unclear. Republican leaders have continued to advocate for passing reform before the end of year, but many acknowledge this might not be realistic. Some suggest early 2018 might be a more realistic timeframe for reform, if enacted. Implications/next steps Planning opportunities for banks vary, based upon their tax profile. Many banks will seek to accelerate deductions or defer taxable income in anticipation of the corporate tax rate reduction. Some banks, such as those with substantial tax attribute carry forwards, may prefer not to accelerate deductions or defer taxable income if they consider utilization of carry forwards to be a higher priority. In anticipation of the repatriation tax, US banks with foreign subsidiaries will seek to recognize earnings in jurisdictions with high-tax pools and defer those with low-taxed pools. With no details on the timing of the repatriation tax, planning for foreign subsidiary earnings is time sensitive. Naturally, time is also of the essence for those banks seeking to engage in discussions with people involved in the lobbying process to influence proposed provisions impacting their institutions. Further, banks need to continue to revise their models and assumptions based upon the framework and continue to monitor the progress of provisions of importance to them. ———————————————
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