16 Ways the New Tax Law May Impact Technology and Life Science Companies
The recently enacted Tax Cuts and Jobs Act (“H.R. 1”) provides various provisions that may apply to technology and life science companies.
Among these are:
- Corporate Tax Rate – Reduced from 35% to 21% effective January 1, 2018. Therefore, fiscal-year filers will have a prorated tax rate for the period that spans over 2017-2018. The impact of the change in rate on existing deferred tax assets and liabilities will be recognized as a discrete item in the period in which tax legislation is enacted.
- Corporate Alternative Minimum Tax – Repealed effective for tax years beginning after December 31, 2017. Taxpayers that have AMT credit carryforwards will be able to use them against their regular tax liability and will also be able to claim a refundable credit equal to 50% of the remaining AMT credit carryforward in years beginning in 2018 through 2020 and 100% for years beginning in 2021.
- R&D Credit – Maintained. With the elimination of AMT, it should be an advantage for life science companies.
- Orphan Drug Credit – The Orphan Drug Credit will now be limited to 25% of qualified clinical testing expenses for the tax year. H.R. 1 imposes additional reporting requirements. In addition, you are now able to take a lower credit instead of adding back the entire tax credit. This provision is effective for amounts paid or incurred in taxable years beginning after December 31, 2017.
- Limitation on Business Interest Expense Deduction – The deduction for net interest expenses incurred by a business will be limited to the sum of 30% of the business’ EBITDA. For tax years beginning after December 31, 2021, the net interest expenses incurred will be limited to 30% of EBIT. This applies to company’s whose average annual gross receipts are more than $25m.
- Net Operating Loss – Net operating loss deductions are limited to 80% of taxable income effective for losses arising in taxable years beginning after December 31, 2017 and have an indefinite carryforward period. There will no longer be a NOL carryback provision. Prior NOLs continue to use the prior carryforward and usage rules.
- Amortization of Research and Experimental Costs – For years beginning after December 31, 2021, specified research or experimental expenditures, including software development, incurred in the U.S. would have to be capitalized and amortized over a five-year period. Upon retirement, abandonment or disposition of property, any remaining basis would continue to be amortized over the remaining amortization period. For costs incurred outside of the U.S., the amortization period is 15 years.
- Self-Created Intangibles – The gain or loss from the disposition of a self-created patent, invention, model or design (whether or not patented), or secret formula or process is ordinary in character, effective for dispositions of property after 2017. This is consistent with the treatment of copyrights under current law. The election to treat musical compositions and copyrights in musical works as a capital asset is repealed.
- Medical Device Excise Tax – Although H.R. 1 was silent on this tax, it is postponed until 2020.
- Other Accounting Methods – Revenue cannot be recognized for tax purposes in a period later than revenue is reported in the applicable financial statements. An exemption applies for any item of income for which a special accounting method is used. In the case of income from a debt instrument having OID, these rules would apply to tax years beginning after December 31, 2018, and any I.R.C. Section 481 adjustment made due to a change in method of accounting would be taken into account over six years.
- Cost Recovery:
- Bonus – Qualified property placed in service after September 27, 2017 and before January 1, 2023 can be immediately expensed using 100% bonus depreciation. There is no longer a requirement that the original use of the qualified property commence with the taxpayer. The bonus depreciation percentage will decrease by twenty points every year for tax periods between January 1, 2023 and January 1, 2027.
- Section 179 – The immediate expense limitation under I.R.C. Section 179 would be increased to $1,000,000 if less than $2,500,000 of eligible property was placed in service during the tax year. The $1,000,000 expense is decreased dollar for dollar for all asset additions in excess of $2,500,000. For tax years beginning after 2018, the limitations will be indexed for inflation.
- Observations – Immediate 100% expensing is now available under bonus depreciation (I.R.C. Section 168(k)) and I.R.C. Section 179. It is important to consider the state filing requirements of your business before deciding which section to choose. Each state has different depreciation modifications and these should be considered prior to filing.
- Domestic Production Activities Deduction – Repealed for tax years beginning after December 31, 2017.
Additionally, some provisions may impact companies with international interests. These include:
- Repatriation “Toll Charge” – C corporations with investments in foreign corporations will incur a tax liability on the mandatory deemed repatriation of post-1986 undistributed foreign earnings. For companies with unremitted foreign earnings, regardless of their statements in the previous financial statements, a tax liability will result. The tax will be calculated on the E&P of the foreign subsidiary at either November 2, 2017 or December 31, 2017, whichever is higher. To the extent E&P is held in liquid assets, the tax rate is 15.5%; the remaining E&P held in illiquid assets is taxed at 8%. The taxpayer can elect to pay the toll-charge over an eight-year period which would result in both current and non-current liabilities.
- Anti-base erosion rules – The global intangible low-taxed income (“GILTI”) provision from the Senate version of the Act survives. Per this concept, U.S. corporate shareholders of CFCs with GILTI shall be subject to current U.S. taxation at an effective tax rate of 10.5% (13.125% after 2025) with a deduction of 37.5% for foreign-derived intangible income. In addition, CFCs shall only be able to utilize 80% of foreign tax credits (FTCs) related to GILTI. More importantly, there is no carryforwaard or carryback of GILTI FTCs.
- Anti-hybrid entity or transaction rules - The Act targets related-party amounts paid or accrued in hybrid transactions or with hybrid entities. Under this provision and under certain circumstances, interest or royalties paid or accrued to a related party are not deductible where hybrid transactions are involved.
- Foreign derived intangible income – U.S. companies are encouraged to earn intangible income from exploiting U.S. intangibles abroad. Income from foreign-derived intangible income (“FDII”) is taxed at a preferential rate of 13.125% for taxable years beginning after December 31, 2017 and before January 1, 2026. For tax years after this window, the tax rate is increased to 16.406%. This does not include financial services income.