The U.S. Fiscal Climate in Transition (Again)

by Dr. Dagmar Möller-Gosoge and Janine Kickler-Kreuz

 
On May 28, 2021, the new U.S. government announced the budget for 2022. At the same time, the U.S. Department of the Treasury published comments in the form of the so-called Green Book. The Green Book presents and explains in detail the tax reform proposals (called revenue proposals) of the Biden administration, some of which are already known.

Even though it is not yet clear to what extent the reform proposals can be implemented into the U.S. tax policy, they should nonetheless be examined now and taken into account in M&A transactions with a U.S. nexus.

Objective of the tax reform proposals

The Green Book includes two packages of measures: the American Jobs Plan and the American Families Plan. The American Jobs Plan is particularly relevant for M&A transactions. Its key objective is to reform corporate taxation so that companies, especially international corporations, pay their fair share of taxes. Other objectives of the American Jobs Plan are to create incentives for relocating jobs and business activities to the USA and to promote renewable energies. The tax reform proposals are generally intended to create additional tax revenue that will increasingly be used for education, infrastructure and clean energy.

What significant changes are planned

The planned tax changes highlighted in the American Jobs Plan essentially include: 

• Increase in the corporate income tax rate from 21 to 28 percent at federal level
• Tightening of the Global Intangible Low-Taxed Income (GILTI) rules, such as the elimination of Qualified Business Assets Investments (QBAI), a type of tax allowance when determining GILTI
• Repeal of the Base-Erosion and Anti-Abuse Tax (BEAT) rules and introduction of the Stopping Harmful Inversions and Ending Low-Tax Developments (SHIELD) rules disallowing the deduction of certain payments to corporations in low-tax countries
• Repeal of the deduction for Foreign-Derived Intangible Income (FDII) and introduction of incentives for research and development
• Imposition of a 15 percent minimum tax on book profits of large corporations
• Introduction of an additional interest limitation in cases of excessive debt financing of U.S. companies.

Furthermore, the American Jobs Plan includes other proposals that primarily deal with the reduction of certain tax loopholes and benefits, such as the limitation of foreign tax credits from sales for hybrid entities.

In addition, there are far-reaching reform proposals related to the taxation of individuals, which are primarily addressed in the American Families Plan. The proposals include: 

• Increasing the top income tax rate at federal level from 37 to 39.6 percent
• Reforming the taxation of capital income, such as taxing long-term capital gains and qualified dividends on income in excess of USD 1 million at ordinary income tax rates (thus including, for example, raising the top tax rate on such income from the current 20 percent to 37 or 39.6 percent).

According to the Green Book, most of the above-mentioned changes would be effective for tax years beginning after December 31, 2021. However, the proposals also provide for exceptions that would become effective upon implementation of the proposals into law, such as the aforementioned change in the taxation of capital income.

Impact on M&A transactions

At first glance, the planned changes appear to have primarily negative effects on M&A transactions with U.S. nexus. The main reason for this is the increase in the corporate income tax rate, resulting in a combined tax rate of 32.4 percent on average, which would lead to the United States having the highest tax rate among all OECD countries, thus making M&A deals expensive. The tightening of the GILTI rules, the introduction of the SHIELD rules and the higher taxation of the so-called high-income earners are also likely to make M&A deals in the United States less attractive if the prerequisites are met.

However, the reform proposals that incentivize M&A deals in the United States should not be ignored. In particular, the planned incentives for locating jobs in the United States, for research and development or for investing in low-carbon technologies offer many new opportunities and thus increase the attractiveness of M&A activities in the United States.

Since U.S. President Biden's general goal is to make the United States even stronger, more competitive and more resilient and, above all, to invest more in infrastructure, the M&A market in the United States is not expected to decline in importance as a result of the planned tax reform. However, it might be advisable to carry out M&A transactions soon in order to take advantage of certain regulations that are still in force. In addition to the low tax rates, such advantages include the possibility of immediate depreciation of capital goods, which is soon to expire.

Conclusion

The Green Book, published on May 28, 2021, was the official go-ahead for the U.S. tax reform envisaged by U.S. President Biden. Unlike the U.S. tax reform of 2017 under U.S. President Trump, which strongly favored M&A transactions in the United States, the current reform proposals in the Green Book move in two different directions. On the one hand, they herald additional burdens and disadvantages for M&A deals – not least due to the planned increase in the tax rate from 21 percent to 28 percent. On the other hand, however, they provide for certain reduced burdens and offer advantages for M&A deals, for example for manufacturing or technology companies. Therefore, M&A deals should be evaluated early on with respect to the potential effects.