US investment outflow threat

An international trade body has warned the recent package of tax cuts in the US will lead to a reduction in that country’s foreign investment stock overseas, with Australia potentially vulnerable.

In its monthly publication monitoring investment trends, the United Nations Conference for Trade and Development said December’s tax reform law would affect almost half of the global stock of foreign direct investment.

Foreign direct investment is where an overseas entity controls more than 10 per cent of the equity of a company.

Almost $2 trillion of overseas funds held by US multinationals could be repatriated to the US, the report said.

That was because taxes will now only be levied on income earned in the US, not worldwide earnings, with foreign dividends 100 per cent tax deductible.

The UNCTAD said the previous arrangement had led to huge amounts of deferred tax liabilities being parked overseas, with more than $3 trillion of retained earnings cumulatively held outside the US.

“(The) US’s outward foreign direct investment stock is made up to a large extent of accumulated overseas profits, or retained earnings,” the report said.

“As these retained earnings could be deployed for capital expenditures on a pre-tax basis, the possibility to defer tax liabilities indefinitely has effectively acted as a stimulus measure for the overseas operations of US multinational enterprises.

“As the incentive for US multinational enterprises to maintain large stocks of retained earnings overseas will be much reduced, the impact on foreign direct investment patterns could be significant.

“Much of the expected outflow is likely to come from a small group of top host economies of US outward stock.”

The conference ranked Australia as the 10th most significant location for the US foreign direct investment, with about 3.1 per cent of the total, which is approximately $195 billion.

Exactly how much of that is retained earnings is unclear, although globally, retained earnings are about half of the US’s overseas foreign direct investment position.

Other measures will also affect Australia, including the reduction of the US company tax rate and changes to the deduction of capital spending items.

Treasurer Scott Morrison was recently in the US to review changes to company taxes and their impact on investment decisions, employment and wages.

Mr Morrison and Prime Minister Malcolm Turnbull have both drawn attention to the changes as a potential shock to the domestic economy, arguing it added to the need for the government’s own company tax cuts to be passed through parliament.

The coalition’s proposal is to lower the company tax rate from 30 per cent to 25 per cent, but reductions have so far only been legislated for companies with revenue of less than $50 million.