Announcer: Welcome to the EY Business Minute Podcast series, where EY professionals explore the critical business issues impacting our industry today.
Mike Cadenazzi: Hi, this is Mike Cadenazzi. I'm a managing director in the EY Aerospace and Defense Americas practice. Welcome to the next installment of our aerospace and defense sector podcast, where we discuss topics of interest to leaders and managers and thinkers all across the A&D sector. Today I'm joined by Mr. Derrick Wagler, who is a partner in the EY Americas Tax practice, and Ms. Leah Kelly, also a partner in the EY Americas Tax practice.
We'd love to have you both to introduce yourselves. Leah, why don't you go first, give a bit about yourself and your background and then Derrick, you can go afterwards.
Leah Kelly: Absolutely. Thank you so much. And thanks for having me. My name is Leah Kelly, and I am a partner at our Tax practice in our Global Compliance and reporting group in the Tysons, Virginia office. I've been with the firm for, gosh, over 15 years now. Time flies. And, I primarily have focused the past maybe 10 years or so in the aerospace and defense industry and specifically working with clients within that space and getting to understand the unique events and challenges that can impact that industry.
Cadenazzi: Derrick, please.
Derrick Wagler: Thank you. My name is Derrick Wagler. I'm a Tax partner in our Tysons Corner, Virginia office. I am one of our Aerospace and Defense Tax leaders within the firm. I cover the Americas market as a whole. I have approximately 26 years of experience. Now, as Leah mentioned, time flies. Nearly 22 years of that have been with Ernst and Young LLP in the Tysons office, counting in the Midwest. I have spent the past 15+ years concentrating almost entirely on the Aerospace, Defense and Government Contracting industries.
There are a lot of unique positions and a lot of unique tax planning that you will see on a day-to-day basis that we've built a team at EY specialized to handle the industry. I think you're going to find some of the topics we discuss today very informative for your industry and we look forward to chatting with you further.
Cadenazzi: Twenty-six years is a lot of taxes and I have to say that having worked at other consulting firms, I am really impressed with the folks that actually understand this stuff and don’t just sort of handwave it away. And the last 15 years in A&D, we’ve certainly seen a lot of changes to taxes. And right now, with the new administration in place starting in January, there's a lot happening and there's certainly more to come.
So in particular, there's a new push around tax reforms and maybe more importantly, tax cuts for US businesses. I'd love maybe, Leah, to start with you to talk about reform, cuts and the impact on the aerospace and defense sector.
Kelly: Yeah, absolutely. Yeah. And as you said, as most of us are aware right now, there is a lot that is going on in Washington. And we are definitely paying close attention to potential tax policy changes, which some might be expected this year. Now no one has a crystal ball on exactly what eventually is going to get passed.
And whether that be extenders for the previous Tax Cuts and Jobs Act (TCJA) provisions that were changes that came in President Trump's first presidency, or, you know, whether there's going to be changes around the new global minimum tax changes in tax rate. But the key is that we and our clients should stay close to what's happening in Washington, as we do expect that there's going to be changes this year.
And these changes can have immense implications on cash taxes as well as financial statements. So one thing that we've been talking to our clients about is not only having them talk to our Washington Council so that they can be apprised on what is going on, not only in Washington, but the specific impacts to their industry. But we've also been talking to them on modeling, on some of the tax reform impacts that could be coming so that they know that depending on what happens, what may make sense for them in terms of tax planning or the impacts of their overall industry and their company.
Wagler: With everything you mentioned there, Leah. I'm in full agreement. I think it is critical for this industry to look at specifically some of the things being discussed domestically and internationally. I think from a domestic standpoint, there has been discussion around a lower rate for US manufacturing. For those familiar in the tax world, we previously had before TCJA, the domestic manufacturing deduction.
No one really understands if we were to have a 15% rate for manufacturing, how that would be implemented. But a lot of folks that are doing the scheduling, looking at this as being basically the manufacturing deduction part two. Until we have more backing from the either the U.S. House or the Senate on what that plan may be, it's just hypotheticals that we're doing in the scheduling at this time.
It is important to note that on the international level, a lot of folks out there should have already heard about these new rules coming out, known as Pillar Two. The OECD [Organisation for Economic Co-operation and Development], which for those that are not familiar with the environment, the OECD kind of overlooks and is a taxing authority that wants to try to make every country on an equal playing field from an income tax perspective.
The rules that came out are Pillar Two, these rules are really being pushed by most of Europe, parts of Asia. But it is key to point out that the United States and China and including Russia, are all counter to the OECD Pillar Two planning. And part of that reason why is Pillar Two takes away the power of a specific country to really control the income tax revenue within their jurisdiction.
For example, if the US were to come up with tax planning that would allow a corporation to have a 10% tax rate through various credits, various deductions around intangibles and fixed assets that are required, there would be something known as a top-up tax. This top-up tax would be collected by a third-party country, the UK or Germany, depending on your structure. It could be France, could be an Asian country, to where that differential between the 10% and 15%, that 5% delta, would be charged and collected by a third-party country. That would basically negate most of the planning that the US or China or Russia would have in place to potentially increase business activity in the jurisdiction. It is worth noting that this is a reality. Your company will need to file what they call a globe return, which reports your income on a global basis
It's yet to be seen how much the US may cooperate with this, or how little they may cooperate, and really what the other impacts will be. Essentially, if they were to move into the US market and pay a lower rate based on US incentives, they would have to pay the top-up tax back to their home jurisdiction or whichever country is directly in ownership of the US operations.
This is detrimental to the European companies that are out there. So as of right now, I firmly believe we will see some form of Pillar Two implemented. I just don't know what the longevity would be of that without some major modifications. Now it should be worth noting that there are some special rules in place for US government contractors. Leah, why don’t you walk through some of those for us.
Kelly: Oh, yeah. Absolutely. And you know, Derrick, as you're aware, right, many of those in the industry have subsidiaries that operate all over the globe and in tons of different jurisdictions. Right? But what's unique about the industry is in some of those jurisdictions, they might be exempt from taxes, whether it's through an agreement called a SOFA, or a Status of Forces Agreement, or they operate under NATO [North Atlantic Treaty Organization] or UN [United Nations] agreements. It just can create nuances not only from an income tax perspective, but also from a global minimum tax perspective.
Right? And so that's just something that needs to be considered. And companies need to look at their specific facts, look at the agreements to determine whether or not the global minimum tax may apply to them based off the underlying agreements for those countries where there may be operating where they're not currently paying tax. And these agreements are complex.
And so it definitely requires time to make sure that you understand the facts and whether or not it's applicable.
Cadenazzi: Great. Very helpful. I did not realize the impact there. So one other topic we discussed before, Derrick, was WOTC [Work Opportunity Tax Credit]. If you could maybe give a quick overview on WOTC and sort of what firms are doing in that space.
Wagler: Sure, Mike. WOTC. Work Opportunity Tax Credit. To me, this is one of the hidden gems buried within the tax code for this industry, for our industry, for Aerospace, Defense and Government contractors. WOTC, the Work Opportunity Tax Credit, awards you an income tax credit for hiring veterans and other groups of individuals, unemployed, food stamps, for your industry. In the A&D space, really that hiring of veterans is key.
And it is worth noting in some of the budget bills and tax reform bills that are currently being passed around Capitol Hill, the benefit for hiring a veteran that may have been discharged due to injury or any other purpose that is just not a general discharge, that credit could be doubled. So we're talking upwards of $9,000 to $10,000 for each veteran that you may hire that would be beneficial to your company.
And not only is it an income tax credit, Mike. On top of the income tax credit, there's also PR benefits. The one I've seen most is you get a three, four, five, $10 million tax credit for hiring veterans. You turn around and say, “Hey, we are so good at hiring veterans that the federal government pays us to do so.”
It's really big on the income tax side, the PR side, and not to mention ESG [environmental, social and governance] as well. On the ESG side, this hiring of veterans is credit, and there's a lot of interplay there as far as basically advertising and taking benefits in addition to the income tax credit. And not to mention, most of your veteran hires are oftentimes plug and play.
They're used to their roles with the military. When they come out, oftentimes they will have a company to do to make them beneficial and make them interact and part of the team immediately. So, Mike, WOTC, we don't see a heavy group of companies in the industry doing the WOTC. But the ones that do take full advantage and they take advantage of all these different aspects.
It's really a no-brainer, Mike. As we've talked about before, it’s just really kind of overcoming some of the HR hurdles and HR software hurdles that may exist.
Cadenazzi: So, Leah, help me understand then with all these benefits, the actual benefits to operations, the PR benefits, the ESG reporting upside, helping veterans, why would firms not do this?
Kelly: So, I mean, it's all about the process and making sure on the front end that you are able to capture these benefits. So an employer must prescreen and obtain certification from the appropriate agency that the employee is a member of a specific targeted group, like veterans, as Derrick had mentioned, in order to be able to claim this credit.
So to satisfy this requirement, to prescreen an applicant on or before the day that a job offer is made, prescreening notice needs to be completed by not only the job applicant, but the employer. So it's about the process on the front end, being able to maximize and claim these credits. You need to start the process early on.
And it needs to be part of the hiring process. So once it's set up, it's smooth and it's easy to do. But there can be sometimes a barrier to entry to get that process started.
Cadenazzi: So we've covered the tax structure changes here in DC. The Pillar Two global minimum tax. WOTC. What else are we missing? What else should be top of mind for industry tax leadership at this time? Derrick?
Wagler: Well, Mike, Leah spoke earlier about everything we're seeing on Capitol Hill on tax reform. And that environment is changing so quickly. You just really need to stay with your tax advisors and the lobbyists that you may employ. But I think one other note that I wanted to make was almost all of our clients are under IRS audit for income taxes or payroll or some other portion of the tax regime that's in the US. It’s very important to note that there have been significant cuts and reductions at the IRS.
So it's worth noting that where things used to be able to be settled in six to 12 months, we're now looking at a multiple-year-type event whenever you have an IRS audit.
Cadenazzi: A slower grind. Got it. Well, I want to thank both of you for joining me today to discuss some of the developments in tax within A&D. I appreciate you listening to the latest in our discussion series around the aerospace and defense sector. Look forward to speaking to you again soon.
Thanks for listening to today's EY Advanced Manufacturing and Mobility Business podcast. We hope you found it engaging and informative. To listen to other Business Minute podcasts. You can find them at EY.com/ammpodcasts.
