US tax changes – an issue for UK pension schemes

US tax changes – an issue for UK pension schemes

Historically, US companies have been able to defer paying tax on some of their foreign earnings by not repatriating their cash into the US. In recent years the relatively high corporate tax rate in the US of 35 per cent has been a factor causing some major US corporations to relocate some of their business operations to a lower corporate tax rate country, either through being acquired by an overseas parent (‘tax inversion’) or establishing an overseas business and rebasing there. As a result, several multi-national businesses have built up significant levels of cash in various overseas subsidiaries. 

How will changes to the legislation affect businesses?

Recent tax law passed in the US requires that US companies pay a one-time tax on foreign earnings they have deferred overseas. It is a 'deemed' repatriation, meaning that the tax is due whether the cash is actually repatriated or not. This one-time tax will be at a reduced rate of either 15.5 per cent or 8 per cent depending on whether the earnings are held in cash or assets. The tax is payable over 8 years. We are already seeing signs of multi-national businesses planning to repatriate cash to the US or to reorganise their tax and financing arrangements to take advantage of this.

What is the effect on pension schemes? 

UK pension schemes supported by business within US multi-nationals may be affected by these changes. For example, they may be supported by a UK employer group with substantial levels of cash resources which are now going to be repatriated to the US. That could happen in a variety of ways, for example inter-company dividends, payments of interest or royalties. 

This poses difficulties for trustees of UK schemes faced with a prospective change to the covenant ‘strength’ of their employers. The Trustees may for instance have developed a funding plan which takes account of a defined level of balance sheet strength. There are ways to mitigate this, such as inter-company guarantees, but these also can introduce new complexities. 

The covenant assessment needs a careful understanding of the technicalities of corporate financing and tax in order to enable a proportionate view to be taken by the Trustees. It is important therefore that the key parties involved in such matters - the tax, treasury and pensions teams - work together to avoid unintended consequences.

For more information please contact Donald Fleming