Industrial Manufacturing: Building a Competitive Recovery - Part II: International Tax Changes are on the Horizon: Will Your Supply Chain Remain Tax Efficient?

HOST: Welcome to the Cherry Bekaert Industrial Manufacturing podcast. We are excited to continue our latest series, "Building a Competitive Recovery," where we will discuss the challenges of the COVID-19 recovery landscape and provide strategies to position your manufacturing business for future success.

I am Matt Brady, leader of the firm's Industrial Manufacturing Industry Group. Today, I am joined by Brian Dill, leader of our International Tax Services practice.

Brian joins me today to discuss part two of our series on the impact upcoming international tax changes will have on your supply chain efficiency. Welcome, Brian.

BRIAN DILL: Thanks, glad to be here.

MATT BRADY: Let's dive in. I know we have a lot to cover.

When it comes to the talk coming from inside the Beltway concerning tax proposals put forth by President Biden and the House Ways and Means Committee, where do the international tax proposals stand in order of importance?

BRIAN DILL: The short answer from an international tax guy is that, from a revenue-raise perspective, the international proposals score right up there with the corporate tax rate. About a quarter of the revenue raise is coming from international proposals.

What puts it over the top for companies is that these are very complex provisions. It is not just a rate increase; it is coming from many different provisions and changes to acts to cover these international revenue raisers.

This is not just an impact on a company's tax rate. Some of the bigger things that will impact our clients and taxpayers in the international arena are their accounting systems.

The way these provisions are written, tax software and accounting systems will need to be able to provide the necessary information for us to make these calculations. Calculations jurisdiction by jurisdiction, revenue by jurisdiction, and taxes by jurisdiction are going to be quite complex and difficult to extract.

I do not think many accounting systems, especially for mid-market companies, will be able to do this naturally. People are going to have to be ready for that.

If this goes through, companies should consider whether their accounting systems can handle the data requirements. In the first year, they may have to do offline calculations to provide their tax providers with the information needed to get the accounting where it needs to be.

Those are some of the things "under the hood" that people are not thinking about.

MATT BRADY: If increased taxes are not bad enough, it sounds like there is also the added compliance and the added capabilities needed to even get that compliance done.

BRIAN DILL: International tax compliance for U.S. reporting is already the most complex area when it comes to doing calculations and reporting. This is only going to make it that much more difficult and complicated.

I suspect the reporting requirements will go up. The new forms will be longer and more complex. It is going to be a huge administrative and resource burden on our clients and taxpayers in the international market.

MATT BRADY: Certainly, as we would all hope, the sooner we know the better so we can start preparing.

Brian, let's talk about the Build Back Better Act legislative proposals approved by the Ways and Means Committee. Where should industrial sector companies focus their attention when it comes to the international tax proposals?

BRIAN DILL: That is a "gotcha" question. I wish I could point to a specific statutory tax increase or a credit where you should focus.

The entire problem with the international tax proposals is that the impact is very dependent upon the particular taxpayer's structure. It depends on whether they operate through a partnership, have foreign subsidiaries, or operate through a C corporation.

It also depends on who their foreign customers are and where they operate. Operating in a high-tax country like Japan versus a low-tax country like Ireland will have different impacts.

The structure and the supply chain are going to have big impacts on the U.S. taxpayer operating internationally. CEOs and CFOs often benchmark against competitors on effective rates or cash flow, but tax effects may be very different from competitors based on the customer base and location.

At a fundamental level, what the Ways and Means Committee and President Biden are proposing will make it very difficult, if not impossible, to earn and defer taxable income earned offshore by U.S. foreign businesses through the GILTI provisions. It is going to capture more foreign income in the U.S. and subject it to tax with fewer deductions.

The proposals are also going to make it far more difficult to obtain a foreign tax credit. They tend to give it to you upfront and then take it away through stratification, where one foreign tax can only go against a certain type of foreign income.

The jurisdiction-by-jurisdiction rules they are trying to impose are significant. In my professional opinion, these proposed tax provisions run in contradiction to the way the rest of the world operates.

The rest of the world operates on what I call a territorial system basis. For example, in the U.K., if you earn money from operations there, you pay tax there, but you do not pay U.K. tax on money earned by a foreign subsidiary in the U.S.

In the U.S., we are trying to tax worldwide income, even for legitimate foreign operations and customers in foreign locations. This is going to be anti-competitive for U.S. businesses competing overseas, especially if they cannot get credits or incentives here and cannot compete on a cost basis.

MATT BRADY: It is interesting because those structures and supply chains are very complex, well-thought-out, and take time to adapt.

As we enter the fourth quarter, what do you think the timing looks like for these proposals to become law, and how do we prepare?

BRIAN DILL: Many listeners are focused on the fiscal year deadline at the end of September. Because of the debt ceiling, pushing it through in September seems like a non-starter.

The Ways and Means Committee has an 880-page text to get through. If this goes through, I suspect we will see it in Q4—October, November, or December.

Looking back at the 2017 TCJA, that was put in place late in December. It had tax professionals scrambling at the last second.

I would not be surprised if we are scrambling with these new rules at the end of the year again. Most taxpayers and clients are not going to have time to react once this is implemented, as the effective dates will take place almost immediately.

Taxpayers will be stuck with their existing supply chains and structures in what I would call a higher-taxed environment. Financial analysts and CFOs have a hard time grasping what this means because it is not always tied to a single rate.

If the new foreign tax credit rules and GILTI provisions go through, the corporate rate might go from 21% to 28%, but the effective corporate rate could easily be in the 40s.

If you are a highly leveraged business, the Section 163(j) limitations on top of that could push the effective rate close to 50%. It is difficult to compete with a U.K. company at 19% when your rate is doubling overnight.

MATT BRADY: Since we might not see a final bill until November or December, what should companies start doing now? Should they be running hypotheticals and different scenarios?

BRIAN DILL: Each company is different, and the proposals are very complex and fact-specific. However, if you are potentially facing a doubling of your income tax rate on foreign-earned income, you need to do something.

We recommend beginning to model, forecast, and run "what if" scenarios. This includes considering whether to bring jobs back to the United States or looking at transfer pricing to bring more profit back to the U.S.

You have to do that now because the implementation for most of these scenarios is not a simple switch. It involves legal work, accounting systems, and potential restructurings.

It is a long process to get this implemented. I recommend people start thinking about it now so they can have it done by the end of Q1 or Q2.

Few international taxpayers will be able to restructure overnight. The sooner you start, the quicker you will know the impact and be able to react in the marketplace.

MATT BRADY: Those are all really good suggestions. If you are a taxpayer that typically waits until November or December to start year-end planning, it probably needs to start today.

That goes for any year, but certainly for a year where we have potential change on the horizon. Brian, thanks for taking the time to bring us up to date.

We want to help our companies ensure they start working through potential adjustments in their structure or supply chain models. For our listeners, we hope this conversation provided a glimpse into the "what ifs" as they relate to upcoming international tax changes.

Additional guidance on today's subject can be found in the related guidance section of this podcast webpage or at cb.com/manufacturing. We hope you will tune in for the rest of our series on "Building a Competitive Recovery."

Next, we will highlight the pros and cons of utilizing vertical integration to ease supply chain challenges. In part four, we will focus on the benefits of the New Markets Tax Credits and what that can bring to your growth strategy.

In the final part, we will review Tax Strategies available to offset those potential expansion costs. If you missed part one regarding digital strategies for optimizing the supply chain, it is not too late to go back and listen.

Thanks again for joining us. Thanks, Brian.

BRIAN DILL: Thanks.