US tax code: Windfall fiscal incentive to aid US companies’ competitiveness

Anubhav SahuMoneycontrol Research

The US tax code is primed for an overhaul as Donald Trump is closer to clinch his first major legislative victory since his election in November, 2016. Last Saturday, the US Senate passed the crucial tax bill which aims to significantly reduce the US corporate taxes to 20 percent from 35 percent.

While re-rating of US equities in last one year partially reflects the execution of corporate reforms, significant improvement in US domestic companies' competitiveness, on account of fiscal incentives, is arguably underway. Indian equity investors need to keep this development on their radar.

Broad provisions of US tax bills positive for economy

Both Senate and House of Representatives have broadly cleared similar tax bills, except for some nuances. Though both bills ask for corporate tax rate reduction, in case of Senate’s bill, 20 percent rate takes effect from 2019 onwards.

For the individual tax payers, it nearly doubles the standard deductions but eliminates personal exemptions and thus for larger families it reduces the positive effect of deductions significantly.

Among the sectors which would specifically benefit are asset management firms, industrials, telecom (enhanced deductions for capital expenditure). Retail sector, as well, is expected to benefit from higher discretionary income for the individual tax payers.

However, given the slew of caps on interest expenses, R&D expense, domestic firms with low debt appear to be key beneficiaries.

Higher returns for the shareholders through buybacks

Companies in sectors having a significant level of cash parked outside USA – pharma, IT companies benefit from paying reduced tax on the repatriated earnings.

As per the research institute The Institute on Taxation and Economic Policy (ITEP), US MNCs are holding more than USD 2.6 trillion of reinvested profits offshore to avoid taxes. If today, these companies decide to repatriate money, a tax of 35 percent deducted for tax credit equal to tax paid to foreign government needs to be paid. As substantial portion of this foreign subsidiaries are registered in tax havens so net tax applicable on repatriation is of the order of ~25 percent. However, after legislation of current proposals, tax rate applicable would be ~14 percent.

As for many of these companies, cash holdings in the domestic entities are also high so a few of them can return part of their cash holdings to investors in the form of buybacks and dividends.

Nevertheless, a combination of tax rate reduction and lower rates for repatriation, would help IT and pharma companies to be more competitive.

Joint Committee on Taxation estimate net revenue loss

While tax proposals pitch for a growth boost that would take care of the tax revenue loss, the Joint Committee on Taxation raises red flag. It estimates that there could be revenue loss for the government of about USD 1 trillion over 10 years. While the tax cuts measures are expected to raise GDP by 0.8 percent on an average over 10 years, this would only reduce the deficit by USD 407 billion.

Next Step

Now the process of merging Senate’s bill with the version from the House of Representatives would start this week, leading to further deliberations on the fine print.

Events are dollar positive

Tax legislation proposals are expected to be net USD supportive. In an email conversation, Giles Keating, Chair of Investor Advisory Firm Werthstein Institute, opine that while 70-80 percent of off-shore cash holdings could already be held in USD, even 20 percent of this holdings makes a significant chunk.

Further, this fiscal stimulation could prompt the Federal Reserve to further tighten monetary policy, which aids the dollar. Though, export-oriented Indian companies can benefit from currency tailwinds improved US companies’ competitiveness can possibly offset more than that.

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