In today’s global environment, and as a result of supply chain issues stemming from COVID-19, a great deal of North American – or United States (U.S.) – manufacturing companies are considering ways to reshore their manufacturing operations back to the U.S. by weighing the benefits and risks. However, considerations with respect to reshoring should include the influence that reshoring can have on operations both within and outside of the U.S., given the varying tax incentives offered. Within this article, we evaluate two incentives in particular:
- Domestic manufacturing incentives offered by the Chinese government
- Foreign Derived Intangible Income (FDII) offered under the U.S. Tax Cuts and Jobs Act (TCJA)
Domestic manufacturing incentives in China
Specifically, in 2015, the Chinese government released its national strategic plan and industrial policy to develop the manufacturing sector of China, termed “Made in China 2025” or “MIC 2025.” The goals of MIC 2025 raise complexities that U.S. Multinational Enterprises (MNEs) need to consider and navigate when weighing the costs and benefits of reshoring.
Stated goals of MIC 2025
MIC 2025 is a ten-year strategic plan that was introduced by the Chinese government in 2015 to promote and modernize the country's manufacturing sector. The plan aims to transform China into a global leader in high-tech industries and make the country less dependent on foreign technology. MIC 2025 has significant implications for companies in the U.S. The plan outlines target goals such as China achieving 70% self-sufficiency, specifically within rapidly developing high-tech industries, by 2025. The plan focuses on 10 key industries including robotics, aerospace, semiconductors, and electric vehicles, among others. The U.S. is currently a global leader in these high-tech industries. Therefore, Chinese investment in these industries could threaten American companies' market share and, ultimately, their global competitiveness.
High and New Technology Enterprise (HNTE)
Another aspect for companies to consider is the research and development (R&D) super deduction. The Chinese government is in the process of implementing various policies and incentives to encourage and drive more R&D activities and innovation. High-tech enterprises that meet the government’s outlined criteria can take advantage of a reduced corporate income tax rate of 13%. If companies are willing to invest in key areas such as advanced manufacturing, green energy, and new materials, they are eligible to receive additional tax benefits. Hence, these R&D deductions are another aspect that U.S. manufacturing companies should investigate as China is in the process of actively promoting innovation to enhance its global competitiveness and drive economic growth.
FDII under the TCJA
Foreign Derived Intangible Income (FDII)
From a U.S. tax perspective, and aside from MIC 2025, manufacturers should also consider the impact of foreign tax credits and the Section 250 deduction for FDII. Foreign tax credits are generally available for income taxes paid outside the U.S. However, manufacturers should consider the potential impact of the foreign tax credit limitation of Section 904, which limits credits to the U.S. tax that would otherwise be due on foreign source income derived from intangibles, service, or products.
In addition, a tax must properly be considered an income tax in order to be creditable. Recent regulations have narrowed the definition of a creditable income tax and require that each assessment be individually analyzed to determine whether it meets new nexus, realization, cost recovery, and gross receipts requirements. The requirements are based on U.S. tax principles and many countries that take a different approach may see that their taxes are ineligible for the credit.
Finally, Section 250 allows for a 37.5% deduction (21.875% after Dec. 31, 2025) for FDII earned by U.S. corporations. FDII generally includes income derived by a U.S. corporation from the export of goods and services for use outside the U.S. over and above a 10% deemed return on tangible fixed assets. FDII remains an incentive to retain manufacturing and IP within the U.S.
Transfer pricing implications
Reshoring decisions impact all aspects of a company’s supply chain and operating model. From a transfer pricing perspective, MNE’s need to consider the impact of current state intercompany transactions and arrangements, along with the implications of future state intercompany arrangements. MNEs are recommended to consider the impact of terminating existing arrangements under existing intercompany agreements and whether termination payments are required or necessary. In addition, companies need to consider the impact on intangible property development and ownership. For example, MNEs should ensure that there is no unintended transfer or migration of intangible property. Lastly, the future state intercompany arrangements need to be aligned with the restructured operating model.
What does this mean for U.S. multinationals?
MIC 2025, HNTE R&D super deductions, and FDII may make it more complex for companies to decide whether to reshore their manufacturing operations back to the U.S. or to expand abroad, as per the following reasons:
- Reshoring may inhibit the ability for manufacturing companies to engage in public tender with local Chinese customers within the 10 key industries under MIC 2025.
- Building a manufacturing presence in China (i.e., through the increase in substance, ownership of China-specific IP rights) may lead to favorable cash-tax benefits from China-specific tax incentives (i.e., HNTE R&D super-deductions) or repatriation of cash within China (i.e., through the purchase of China-specific IP rights).
- Reshoring may allow U.S. multinationals to qualify the income associated with the foreign activity performed as Foreign Derived Deduction Eligible Income (FDDEI) under Section 250, thereby receiving a deduction reducing the overall taxes paid.
Overall, the decision to reshore has significant international tax and transfer pricing implications for manufacturing companies in the U.S. It may threaten American-based companies' competitive advantage within key industries, and it may make reshoring more challenging. On the other hand, onshoring may become more attractive as it allows companies to leverage domestic tax and business incentives, as noted above with China as an example. The best approach for companies will depend on their individual industry, their specific long-term goals, and careful consideration of the risks and benefits of both reshoring and bolstering manufacturing abroad. It’s important to consider all options since what may work best for one company and industry, may not work well for another.
Contact your advisors for more information or to start thinking through tax implications with respect to U.S. and foreign manufacturing relationships, and what international tax and transfer pricing model may work best for you.
Bradley Mainguy, Principal, National Tax – International Tax
Nick Carofano, Managing Director, National Tax – International Tax
Brian Bae, Senior Manager, National Tax – International Tax
Ali Magyaros, Senior, National Tax – International Tax
Subject matter expertise
Managing Director, International Tax
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