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Plans for U.S. Tax Reform and its Consequences for German Companies

Plans from the Republican-dominated U.S. House of Representatives provide for a sweeping reform of corporate taxation in the United States. Under the new U.S. President Donald Trump the proposal could become a reality.

A com­pany’s taxable pro­fit would then be cal­cu­la­ted using a straight cash flow sta­te­ment. The cor­po­rate income tax rate is set to fall from 35% to 20%. Com­bi­ned with export sub­si­dies for U.S. com­pa­nies with simul­ta­neous taxa­tion of imports, the reform obviously aims to help reduce the Uni­ted Sta­tes’ for­eign trade defi­cit. The Uni­ted Sta­tes’ plans could have serious con­se­qu­en­ces for Ger­man com­pa­nies.

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Taxa­tion of the cash flow means that the com­pany’s taxable pro­fit is cal­cu­la­ted as the dif­fe­rence bet­ween income and expen­di­tu­re—in­de­pen­dent of the car­rying amo­unts and dep­re­cia­tion or amor­tiza­tion of the assets.

Example: If a U.S. com­pany purcha­ses a machine worth USD 100,000, the com­pany can deduct the full expen­di­ture of USD 100,000 from its “cash flow” tax in the busi­ness year in which the acqui­si­tion was made rather than wri­ting down the expense over a num­ber of years.

This con­cept is simi­lar to the imme­diate write-off of low-value assets that is well known in Ger­man tax law, but wit­hout any cap on the amo­unt. The “cash flow” tax would result in sig­ni­fi­cant liqui­dity and inte­rest rate advan­ta­ges for U.S. com­pa­nies. The plan­ned reduc­tion of the tax rate would furt­her ease the bur­den on these enter­pri­ses.

For Ger­man com­pa­nies with busi­ness rela­ti­onships in the Uni­ted Sta­tes, the pic­ture is less rosy. Ano­ther core ele­ment of the draft refor­m—the bor­der tax adjust­men­t—has poten­tially serious rami­fi­ca­ti­ons. Exports of tan­gi­ble and int­an­gi­ble pro­ducts and ser­vices are expec­ted to be exempt from the new U.S. tax. At the same time, pro­duc­tion costs incur­red for these exports can con­ti­nue to be deduc­ted wit­hout res­tric­tion. Con­ver­sely, it is expec­ted that cor­res­pon­ding imports into the Uni­ted Sta­tes will be taxed in full. The draft does not yet con­tain details of how this will be put into practice, howe­ver. In the case of imports to U.S. com­pa­nies, it is ulti­ma­tely likely that the tax deduc­tion will sim­ply be with­held by the U.S. com­pany.

Aufwand steuerlich nicht abziehbarExpenditure not tax-deductible
Border AdjustmentBorder adjustment
Einnahmen steuerfreiIncome tax free
US-UnternehmenU.S. companies
Aufwand steuerlich vollständig und sofort abziehbar Erwerb USA Expenditure fully tax deductible immediately Purchase in USA
Cash Flow SteuerCash flow tax
Einnahmen steuerpflichtig Verkauf USA Income taxable Sale in USA

Example: If a U.S. com­pany imports a machine pro­du­ced in Ger­many cos­ting USD 100,000, the U.S. com­pany can­not claim a tax deduc­tion (eit­her imme­dia­tely or through a write-down). Howe­ver, if the com­pany buys a machine pro­du­ced in the Uni­ted Sta­tes, it can deduct the full amo­unt imme­dia­tely, which effec­ti­vely leads to tax relief of 20% in the busi­ness year in which the acqui­si­tion was made. The U.S. machine, which in prin­ciple costs the same amo­unt, would the­re­fore effec­ti­vely cost the U.S. com­pany just USD 80,000.

As a con­se­qu­ence, from a taxa­tion view­po­int the impor­ting Ger­man manu­fac­tu­ring com­pany is at a disad­van­tage com­pa­red with its U.S. coun­ter­part because the impor­ted item is USD 20,000 or (USD 20,000/USD 80,000 =) 25% more expen­sive from the per­spec­tive of the buyer in the U.S. This could put cor­res­pon­ding price pres­sure on impor­ted goods and, in an ext­reme case, lead to the price that can be obtai­ned from the Ger­man impor­ter’s per­spec­tive being redu­ced by the amo­unt of the U.S. tax charge (20%). This would mean that, finan­cially, the Ger­man com­pany would be sub­ject to the U.S. tax charge even though it was not requi­red to pay the U.S. tax at all.

Eco­no­mists believe, howe­ver, that the U.S. tax reform could cause the U.S. dol­lar to app­re­ciate in the medium to long term. This would mit­i­gate the effect of the discri­mi­na­tion against imports because the com­pa­nies impor­ting into the Uni­ted Sta­tes would bene­fit from a more favora­ble exchange rate. Yet unless coun­ter­mea­su­res are intro­du­ced in Ger­man taxa­tion (for example in the form of a deduc­tion of the U.S. tax charge from the Ger­man assess­ment basis), Ger­man expor­ters are likely to end up with an addi­tio­nal tax bur­den.

Note: For groups with com­pa­nies in Ger­many and the Uni­ted Sta­tes, the U.S. tax reform would greatly inc­rease the sig­ni­fi­cance of the trans­fer pri­ces bet­ween the com­pa­nies. The bor­der tax adjust­ment would effec­ti­vely lead to inter­com­pany deli­ve­r­ies and ser­vices from the Ger­man com­pany to the U.S. com­pany being taxed in Ger­many wit­hout this resul­ting in a tax deduc­tion in the Uni­ted Sta­tes. Con­ver­sely, inter­com­pany deli­ve­r­ies and ser­vices from the U.S. com­pany to the Ger­man group com­pany would be exemp­ted from export tax in the Uni­ted Sta­tes and be tax deduc­ti­ble in Ger­many. The U.S. tax reform would thus lead to an effec­tive tax rate dif­fe­rence in the amo­unt of the Ger­man tax rate. Wit­hin the limits of the arm’s length prin­ciple, trans­fer pri­ces could be expe­di­ent here.

It is not yet pos­si­ble to pre­dict with any cer­tainty whe­ther the new pre­si­dent would actually be wil­ling to embark on such an ambi­tious tax reform and would in fact be able to push it through. Espe­cially as regards the pos­si­ble imp­le­men­ta­tion of the bor­der tax adjust­ment, there is still no detai­led infor­ma­tion available (for example about a poten­tial tax lia­bi­lity of the for­eign impor­ter). Ger­man com­pa­nies with busi­ness rela­ti­onships in the Uni­ted Sta­tes should nevert­he­less keep a close eye on the reform plans in the U.S.—mainly because of their far-rea­ching con­se­qu­en­ces. Parti­cu­larly when con­clu­ding lon­ger-term (sup­ply) agree­ments, they would be well advi­sed to already take into con­s­i­de­ra­tion the pos­si­bi­lity that a bor­der tax adjust­ment may be intro­du­ced (for example by wri­ting opti­ons for extra­or­di­nary notice of ter­mi­na­tion or agree­ment to rene­go­tiate the agreed pri­ces into the con­tracts).

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