November 28, 2017 Automotive & transportation industry gets mixed results from Senate Finance Committee tax reform plan Republicans in the Senate Finance Committee (SFC) released their version of the Tax Cuts and Jobs Act (TCJA) on November 9, 2017. After a four-day partisan markup, the SFC approved the modified version of Chairman Orrin Hatch's (R-UT) Mark on a party-line 14-12 vote late November 16. The modified Chairman's Mark contains mixed results for the automotive and transportation industry, and taxpayers should evaluate and model the effects of the proposed legislation based on their specific circumstances. This Alert focuses primarily on the provisions with the broadest reach for automotive and transportation companies. Modification to net operating loss deduction The Senate Finance Committee tax reform plan would limit the amount of net operating losses (NOLs) that a taxpayer could use to offset taxable income to 90% of the taxpayer's taxable income. The plan would allow indefinite carry forward of NOLs arising in tax years beginning after December 31, 2017, and repeal all carrybacks for losses generated in tax years beginning after December 31, 2017. As part of the repeal of NOL carrybacks, the SFC Plan would repeal Section 172(f), the special rule allowing a 10-year carryback of specified liability losses. Many automotive companies are still using up NOLs generated during the previous industry downturns and this change could greatly affect their expected timeline for being a cash taxpayer. Automotive companies, including various tiers of suppliers, have historically taken advantage of Section 172(f) when product liability claims arise after periods of profitability. A limitation of the NOL deduction and repeal of Section 172(f) would ultimately increase the tax liability of automotive and transportation companies. Amortization of research and experimentation expenditures The Chairman's Mark would require taxpayers to treat research or experimental expenditures as chargeable to a capital account and amortized over five years (15 years for foreign research). This provision would also modify Section 174 to require all software development costs to be treated as research or experimental expenditures. In addition, any capitalized research and experimental expenditures relating to property that is disposed of, retired or abandoned during the amortization period must continue to be amortized throughout the remainder of the period. Generally, purchased software may be amortized over just 36 months under Section 167(f)(1), so the provision would put taxpayers that develop their own software in a tax position that is less favorable than taxpayers that acquire it. Although this provision was not included in the original Senate Finance Committee Plan released on November 9, it has since been added through the latest modifications issued on November 14. Companies in the automotive industry incur substantial costs for research and development under Section 174 — for both tangible property and increasingly for software. Auto companies in a profitable, tax-paying position have historically taken advantage of the option to expense costs incurred under Section 174. The modifications to Section 174 would mean that auto companies will receive less immediate tax benefits from R&D efforts. Repeal of domestic production deduction The domestic production deduction relating to deductions for qualifying receipts derived from certain activities performed in the United States would be repealed for tax years after 2018 (a one-year delay from the House bill's proposal to repeal the deduction starting in tax years after 2017). Nearly every automotive producer and supplier took advantage of Section 199 during profitable years. The loss of the additional deduction will negatively impact the effective tax rate and increase cash tax paid by both producers and suppliers. Accelerated capital expensing Bonus depreciation would be increased from 50% to 100% for "qualified property" placed in service after September 27, 2017 (the date the Unified Framework was released). The increased allowance would remain until 2022. Qualified property would be defined to exclude certain public utility property. A transition rule would allow for an election to apply 50% expensing for a one-year period. Despite the movement of much manufacturing activity outside of the US, auto companies and suppliers based in the US still incur significant capital spending that would qualify for immediate expensing under the proposals. Immediate expensing would reduce overall tax liability in the short-term and likely drive accelerated capital investment through 2022. Foreign-derived intangible income (FDII) The Senate Finance bill provides for a reduced rate of tax on the foreign-derived intangible income of sale of a product or service by a US taxpayer to a non-US person for use outside the US. Based on an interpretation of the limited text, this implies a reduced tax rate for the non-routine portion of the export profit.1 Depending on the ultimate details of this provision, this could apply to the non-routine portion of a product sale or service, including potentially royalty income. US original equipment manufacturers (OEMs) and suppliers have historically developed and owned their intangible assets in the United States and licensed the intangible assets to global affiliates for use in foreign markets. A reduced tax rate for foreign-derived intangible income, and the retention of the research credit, may encourage automotive companies to continue US development, ownership and management of intangible assets here, allowing companies to efficiently repatriate foreign-derived intangible income to the US. Moreover, automotive companies that have developed or owned intangible assets in locations outside the US and want to centralize all intangible assets have the opportunity to repatriate intangible assets tax-free under the proposed legislation. This provides the potential to create further synergies and efficiencies in the development and management of intangible assets going forward. Base erosion minimum tax Under the base erosion provisions of the Senate bill, companies would compute a new alternative minimum tax that would disallow deductions for certain intercompany payments made to related foreign corporations. Payments that are deductible in a company's cost of goods sold, such as payments for tangible products, would be excluded; payments for intercompany royalties and services, however, would be subject to this provision. Inbound automotive companies licensing intangible assets from a related party or benefiting from services provided by a related party are likely to be impacted by this provision. Companies may need to re-evaluate supply chain flows or consider alternative options to payments for services or royalties to reduce exposure. ———————————————
——————————————— 1 The mechanics of the deduction imply this reduced rate would be 12.5%. | |||||||||||
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