The big corporate tax increase from Washington may be aimed at giants such as Amazon and Bank of America, but the regulatory burden will also fall significantly on many smaller companies with overseas operations.
That new law, signed by President Joe Biden in August, came after widespread reports of how some of the world’s most profitable multinationals had been paying comparatively low effective tax rates. For companies that report more than $1 billion in profits to shareholders, the act imposes a 15% corporate alternative minimum tax based on book income.
While the new law aims to reap more tax revenue from large corporations, it also raises the cost of doing business for many smaller operations. Both the 2017 and 2022 tax laws increased reporting requirements for all-size companies — changes more easily afforded by the biggest businesses.
Consider that the basic Internal Revenue Service (IRS) form to report ownership in a foreign corporation has ballooned from around 6 to 8 pages pre-2017 to anywhere from 26 to 35 pages – with a $10,000 penalty for any mistakes. Corporate income tax reporting is the portion of the income tax “iceberg” that remains hidden underwater.
For many Plante Moran clients — small and midsize companies, including many Midwest-based manufacturers — the cost to complete annual forms has jumped from $3,000-$4,000 per form prior to 2017 to up to $15,000 per form this year. The IRS is struggling to keep up with the growing complexity of its rules on companies with foreign interests, adding further delays and expense to the process.
Any talk in Washington about changing the corporate tax rate should include a realistic analysis of the regulatory burden of additional tax reporting requirements. The specter of bad behavior by large multinationals should not overshadow these reporting requirements that disproportionately hurt small and midsize businesses.
In reality, a low tax rate is just one of many factors that companies weigh before deciding to outsource production abroad.
Mexico and India have been two of the biggest offshoring plays of recent decades despite having relatively high corporate tax burdens. A low-cost labor force, good infrastructure, and ease of access to the U.S. market have been the keys to Mexico’s rise as a manufacturing hub and India’s as a “back-office.”
Recently, a multinational with a parent company in Italy and operations in the United States was denied a deduction on its U.S. taxes for royalties it paid to Italy. The reason was that the Italian company had benefited from local tax incentives long provided by the Italian government. Although there was no suggestion of this being a deliberate tax evasion or avoidance strategy, the company ran afoul of “anti-hybrid” rules passed under the 2017 tax reform.
The reason behind many of these tax changes is to snuff out the tax competition between countries that has helped big tech shield their profits. Critics say the tactic often leads to jobs being outsourced.
Yet the days of the tax haven are effectively over already due the huge increase in regulatory scrutiny and political pressure. Egregious abuses have become the preserve of a few bad actors rather than run-of-the-mill occurrences.
Companies like Apple and Google, that built up untaxed profits abroad, did so based on their intellectual property, not through outsourcing a large number of jobs. That money (and intellectual property) has started to flow back to the United States thanks to the 2017 overhaul, but it’s far from clear the shift boosted domestic employment.
What is clear, however, is the rising and costly burden of regulatory reporting requirements that come with changes in corporate tax law.
The rising tide of tax red tape is reaching the point where it will seriously impact the viability of overseas operations. If an overseas opportunity needed to be good prior to 2017, to be worthwhile it now needs to be great.
Setting up shop abroad was never the bonanza portrayed. Now, companies will need to perform more intensive due diligence and analysis to understand whether an overseas opportunity makes economic sense. Companies with up-to-date tech capabilities in finance accounting systems that talk to each other will have a big advantage over those that still inhabit the spreadsheet world.
With international tax bureaucracy set to get worse before it gets better, companies have little choice to adapt their practices and overseas strategies accordingly.
Bill Henson is an international tax partner at Plante Moran, specializing in cross-border tax planning.