US Tax Reform and its likely impact on HK-US trade and investment

January 31, 2018

HONG KONG - The newly-enacted Tax Cuts and Jobs Act of 2017 – the most substantial revision of US tax legislation for 30 years – could prove a double-edged sword for Hong Kong businesses, according to a research report by the Hong Kong Trade Development Council. On one hand, the report says, US consumption levels could be boosted, triggering increased demand for Hong Kong exports.

On the other, it says, there is a danger that the lowering of tax rates on domestic and overseas-derived profits could encourage American firms to keep earnings onshore or even see overseas earnings widely repatriated to the US, a development that could undermine the stability of the regional and global financial markets.

The legislation will give about 80% of US households a tax cut over the next decade, and most US corporations will enjoy a lower after-tax cost of capital.

However, the programme is being criticised for widening the U.S. Government’s fiscal deficit by adding a projected US$1.5tn (HK$11.7tn) to America’s current national debt of US$20tn in the coming 10-year budget window.

“The negative effect on the U.S. Government’s finances is likely to be somewhat offset, however, by an expected boost to the economy from the tax reforms,” the report says.

“According to the U.S. Congress’s Joint Committee on Taxation, the reduction in effective marginal tax rates on wages will lead to an increase in labour supply, while the reduction in the after-tax cost of capital will potentially cause an increase in the after-tax rate of return on business investment, and thus an increase in investment.

“These two factors are projected to boost U.S. GDP by 0.7% annually on average, even though many of the personal tax cut provisions expire or are phased out towards the end of the budget window.

Another feature of the tax Bill concerns foreign and domestically-controlled multinational entities receiving foreign-source earnings from subsidiaries in which they own or control at least 10”% of the stock for a minimum of one year.

“The Bill makes significant changes to the taxation of these multinational entities, allowing them to receive these earnings without incurring U.S. tax on the income, effectively turning the U.S. corporate tax regime from a worldwide system, which often results in double taxation, to a territorial one,” the report says.

“The new tax law also makes it easier for American businesses to bring home their eligible foreign earnings and assets by creating one-time, ultra-low repatriation tax rates.

“The relevant earnings may be accounted for over an eight-year period in back-loaded increments, while all future eligible earnings can be held overseas or repatriated to the U.S. free of tax.”

The report adds: “A more comprehensive view of how U.S. tax reform is likely to impact on HK-US trade and investment will only be available when the Internal Revenue Service begins to issue regulations for the new law in late February/March 2018.

“However, the cocktail of a substantial permanent corporate tax reduction, the switch to a territorial tax system and low repatriate tax rates for foreign earnings and assets is likely to create an incentive for US corporations to bring home their current and future earnings and/or assets from overseas for domestic investment.

“It could also encourage some foreign companies to relocate their headquarters to the U.S. to take advantage of the friendlier tax regime, potentially reducing overall U.S. investment in Asia, including Hong Kong and mainland China, as well as in other regions.

“Foreign tax jurisdictions, including those of Hong Kong and mainland China, may also come under pressure to provide more favourable tax conditions so as to be able to retain and attract investment from American and multinational companies.”  www.hktdc-research@hktdc.com  (ATI).