_US Tax Reform: 4 Things to Consider in Asia Pacific

2017 came to an end with President Trump’s most significant legislative achievement, as he signed into law the biggest tax overhaul in the US since 1986. The tax reform package will lower tax rates on individuals, corporations, pass-through entities and estates – while moving the US towards a territorial-style system for taxing foreign-source income of US multinational corporations (MNCs). Perhaps the most eye-catching is the reduction in the corporate tax rate from an upper marginal rate of 35% to a flat 21%, closing the gap with most other developed countries.

In terms of the potential impact on US corporate behaviour and regional capital flows – here are four things to consider from an Asia-Pacific perspective:

1. Asia-Pacific capital flows to feel gravitational pull towards the US 

According to Goldman Sachs, there is over US$ 3.1 trillion of untaxed earnings held offshore by US corporates, some of which sits in the Asia-Pacific region. With favourable tax rates for the repatriation of overseas profits, there is likely to be a significant amount of money heading back to the US, to be invested, not only in share buybacks and for a reduction in debts – but also for business operations, plant and machinery and real estate.

But it is not only US corporate revenues that will feel this pull, as Asian investors and developers turn towards real estate opportunities in the US as they look to benefit from more favourable taxes along with a potential boost in demand for property. This is likely to be reinforced by a lower effective tax rate for pass-through entities including REITs, sole proprietorships, partnerships and S-corporations. One potential counter-balancing factor in the US is the rising cost of debt, as interest rates are set to continue to rise in 2018 (although this has also encouraged many to seek more US$ exposure).

One potential knock on impact of these “pull-factors” is a slower, or more tentative than expected, easing of the capital controls in China, which many were hoping to see in 2018.

2. Impact on US investment in Asia Pacific dependent on sector

With the “America first” policy of the current administration a motivating factor behind the tax reforms, there are now increased incentives for MNCs to re-shore or re-domicile to the US to help boost growth and employment. 

In the manufacturing space, related capital expenditure will now be fully deductible in the year they are incurred – a strong incentive for US (and potentially other country’s) companies to manufacture in the US. Those firms more cost (or politically) sensitive could therefore consider moving operations back to the US, with some knock effect on demand for industrial property in the region. For those with complex existing Asia-Pacific supply chains however, the push to re-shore back to the US could prove difficult or detrimental to their existing business models. 

In the tech sector, the picture is murkier. Effective tax rates are significantly lower in many of the Asia-Pacific jurisdictions in order to continue to attract and encourage the growth of businesses in the sector (e.g. in China corporate tax for recognised technology companies is 15%). The war for talent in the tech and creative industries will continue to mean that companies working in big data or artificial intelligence are courted by the major countries and cities around the region.

Longer term, the levels of investment in Asia Pacific by US corporates and investors will depend on the strength of the growth of the US economy. While some capital and investment is likely to be heading stateside, the importance of Asia Pacific both as a production and a consumption market will ensure US corporates remain active in the region’s property markets.

3. Sustainability of US growth a key consideration

Goldman Sachs has estimated that the tax reform would boost US GDP growth by 0.3 percentage points in both 2018 and 2019. With at least a short-term boost to corporate earnings expected, stronger growth in the US has traditionally been transmitted through sentiment and trade linkages to stronger growth in the Asia-Pacific region. Commercial and residential property markets in the region could therefore benefit from this. However, the bigger question could be whether the tax cuts lead to stronger long-term growth in the US, or a larger debt issue further down the road – which would be detrimental to demand within the region

4. Fiscal stimulus from Asia Pacific markets a possibility

Historically, the reduction of tax in one major jurisdiction can be followed by further tax reform in competing countries. Indeed, the US tax reform of 1986 was followed by numerous tax reforms in OECD countries as a competitive response. 

If we examine the key Asia-Pacific markets, the possibility of some tax reform in order to compete is not out of the question. While Taiwan, Hong Kong and Singapore already have some of the lowest levels of corporate tax globally, a number of other countries could examine their corporate tax levels over the next 12 to 24 months.

Perhaps the most interesting question is whether China will respond. The growing importance of the Chinese market for MNCs and internal pressure to reform is likely to lead to some reform of the tax code, although probably not as a direct reaction to the US overhaul.

Source: KPMG, Knight Frank Research

*upper rates of marginal US federal corporate tax; effective corporate tax rate could also include state level taxes

Ultimately, tax is not the only consideration driving corporate and investor behaviour. Other factors are often equally or even more important, including labour availability, connectivity, real estate costs and other incentives or policies. Keeping an eye on all of these, often changing factors, are key to understanding regional markets.