President Donald Trump’s Tax Cuts & Jobs Act (TCJA)—which combines a significant decrease in the corporate tax rate and a temporary investment holiday on new fixed investment—creates significant incentives for multinationals to expand their US manufacturing footprints. Beyond US borders, the Trump tax reform enhances US multinationals’ ability to compete abroad by eliminating most forms of taxation on their overseas earnings. In a climate of strong global growth but also elevated geopolitical risk, the tax reform gives multinationals many compelling reasons to invest in US manufacturing, especially for any goods destined for US end clients.
There are four main policy changes that will impact MNCs:
- Drop in the corporate tax rate
The signature of the Trump tax reform is a cut in the federal corporate tax rate from 35% to 21%. The change to the US corporate tax rate makes some forms of US-based activity significantly more profitable on an after-tax basis. This incentivizes multinationals to expand their US-based operations in key industries, for both domestic and foreign sales, and will reduce the relative competitiveness of foreign multinationals
- Investment tax holiday
In addition to the lower corporate tax rate, the US will allow firms to fully expense new plants and equipment from 2018–2022 in the purchase year—a significant trigger that will push multinationals to change their global investment plans and increase US-based investment in the short-term. Most of this new investment will be in the form of capital intensive, automated facilities. This will be felt most of all in the manufacturing sector, where production can be largely automated with existing technology.
Even without the investment tax holiday, automated manufacturing is already cost competitive against some forms of labor-intensive manufacturing. In parts of China where wages have risen sharply over the past decade, some firms have already shifted over to automated manufacturing. The new US tax plan provides strong incentives for MNCs to consider the US as a new hub for automated manufacturing. This will lead to foreign direct investment flowing out to low-wage manufacturing economies.
- Elimination of overseas tax treatment of US MNCs
US multinationals used to be taxed on their overseas earnings, making them less competitive than foreign multinationals in overseas operations and leading to corporate inversions of US MNCs. With a few important exceptions, US MNCs will no longer be taxed on overseas earnings, making them far more competitive abroad and better able to participate in minority joint ventures on equal competitive footing.
- Annual taxation of limited overseas operations
In those specific cases where US multinationals are taxed overseas, this tax liability is paid on an annual basis—no more indefinite deferrals of overseas untaxed cash holdings. This makes US MNCs’ treasury operations nimbler and eliminates the benefits of stockpiling cash in low-tax havens like Ireland or Caribbean islands While there are still some benefits to offshoring intellectual property in tax havens, there is no longer any reason for US MNCs to maintain vast stockpiles of cash abroad. As most of this cash was held in dollars or dollar denominated assets, FSG does not expect a significant impact on the value of the dollar from the tax change.
Executives should revisit strategic plans and conduct new risk assessments
Together, these policy changes present both new opportunities and new risks for MNCs. The tax plan provides many incentives for MNCs to expand economic activity in the US. Strategic plans that were drawn up before December 2017 need to be revisited, but there are also new risks to overseas operations. A reduction in overseas investment might lead to budget shortfalls in cash-strapped emerging markets. Governments may respond by cutting their own corporate tax rates to draw back investment, but the drop in tax revenue would need to be offset by an increase in some other form of taxation – most likely consumption taxes. This may resolve the competitiveness issue, but by doing so, reduce consumption growth. Executives should Identify what concrete steps are required to mitigate high-priority risks or capture unexpected opportunities, and build pragmatic plans linked to the associated scenarios.
For our latest updates and insights, FSG clients can access the Trump Tax Reform: Impact on MNCs via FrontierView.
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