The Tax Cuts and Jobs Act of 2017 (TCJA) not only changes the landscape of domestic taxation, but also overhauls the U.S. international tax regime. It creates a quasi-territorial tax system for U.S. taxpayers and adds a number of provisions intended to prevent U.S. tax base erosion. Businesses or individuals with foreign income should become familiar with the associated opportunities and obligations. Below is an overview of some of the key international provisions.
Deduction for Foreign-Source Portion of Dividends
The TCJA provides for a 100% deduction (a dividends received deduction, or DRD) for the foreign-source portion of dividends a domestic corporation receives from a foreign corporation (specifically, a 10%-owned foreign corporation). A specified 10-percent owned foreign corporation includes any foreign corporation, other than a passive foreign investment company (PFIC) that is not a controlled foreign corporation (CFC). The DRD is available only to C Corporations that are not regulated investment companies (RICs) for real estate investment trusts.
No foreign tax credit or deduction is allowed for any foreign taxes (including withholding taxes) paid or accrued with respect to an exempt dividend. The TCJA includes a six-month holding period requirement along with other ownership requirements to claim this exemption.
This provision moves the U.S. corporate tax systems away from a “worldwide tax system” and towards a territorial system, similar to many other foreign country tax systems. The shift eliminates the incentive many U.S. companies had to keep their foreign earnings abroad.
Since this 100% DRD is only available to domestic corporations, non-corporate shareholders may want to consider restructuring the ownership of their foreign subsidiaries so they can qualify for this benefit.
Deemed Repatriation of Deferred Foreign Income
Under the TCJA, a transitional rule imposes a one-time tax on the deferred earnings of U.S. shareholders of certain foreign corporations.
U.S. shareholders owning at least 10% of a foreign subsidiary must include in income their pro-rata share of the foreign subsidiary’s post-1986 earnings and profits (E&P), to the extent that income was not already taxed.
The portion of E&P in the form of cash or cash equivalents will be taxed at a reduced rate of 15.5%, while any remaining E&P will be taxed at a reduced rate of 8%. These preferential rates are achieved by allowing a deduction against the required inclusion amounts.
Taxpayers who are normally allowed a foreign tax credit for subpart F income inclusions can reduce the related tax by the underlying foreign taxes paid on this income. This credit is reduced by the same ratios applied to determine the allowable deduction against the mandatory inclusion.
U.S. shareholders can elect to pay the net tax liability over a period of up to eight annual installments:
8% of the net tax liability
15% of the net tax liability
20% of the net tax liability
Remaining balance of 25%
The TCJA provides a special rule for S Corporation shareholders to elect to further defer tax on this income until a triggering event occurs — including a termination of S Corporation status, the liquidation or sale of substantially all assets, or the transfer of an electing shareholder’s S Corporation stock.
Current Inclusion of Global Intangible Low-Taxed Income (GILTI)
Beginning in 2018, a U.S. shareholder of any controlled foreign corporation (CFC) has to include in gross income its global intangible low-taxed income (GILTI) in a manner similar to subpart F income.
Generally speaking, GILTI is:
- The U.S. shareholder’s pro-rata share of the CFC’s aggregate net income, minus
- A deemed 10% return on the CFC’s aggregate basis in depreciable tangible property.
Certain income is excluded from the definition of GILTI, including U.S. effectively connected income, subpart F income and certain other specific types of income.
Foreign tax credits are allowed for foreign income taxes paid with respect to GILTI, but are limited to 80% of the foreign income taxes paid and are not allowed to be carried back or forward to other tax years.
This provision is intended to discourage U.S. companies from holding or moving low-basis assets (such as intangibles) offshore to low-tax jurisdictions. It is much less likely that companies with foreign operating subsidiaries will be subject to this inclusion. For example, a U.S. company with a foreign manufacturing subsidiary may not be subject to this because it typically holds higher-basis assets, such as machinery and equipment.
Deduction for Foreign-Derived Intangible Income and GILTI
The TCJA allows domestic corporate taxpayers a deduction for a portion of their global intangible income inclusion and their share of foreign-derived intangible income (FDII). Specifically, a deduction is allowed in an amount equal to the sum of:
- 37.5% of the FDII income of the domestic corporation for the tax year, plus
- 50% of the GILTI amount (if any), which is included in the gross income of the domestic corporation for the tax year.
At a high level, FDII is the portion of a U.S. corporation’s intangible income derived from serving non-U.S. markets. Generally speaking, FDII is:
- The taxpayer’s net export income, minus
- A deemed 10% return on the taxpayer’s aggregate basis in depreciable tangible property.
Given the TCJA’s reduction of the corporate tax rate to 21%, this results in an effective tax rate of 13.125% on FDII and an effective U.S. tax rate on GILTI (with respect to U.S. corporate shareholders) of 10.5%.
The FDII benefit clearly rewards U.S. corporations for maintaining intangible value in the U.S. and using that to generate income from foreign markets. It is possible, however, that the World Trade Organization will challenge this provision as an illegal export subsidiary.
Both of these preferential deductions are available only to domestic corporations. This factor is yet another reason that non-corporate owners may consider restructuring to a corporate holding company for foreign subsidiaries.
Changes to Controlled Foreign Corporation (CFC) Provisions
The TCJA makes modifications to the rules surrounding whether or not a CFC exists. A CFC is a foreign corporation that is more than 50 percent owned by U.S. shareholders with at least 10 percent ownership. Only foreign corporations that are considered CFCs will be subject to subpart F and certain other international tax provisions.
Traditionally, some U.S. taxpayers structured companies and transactions in a way that avoided CFC status, so as not to contend with a number of anti-deferral provisions. The provisions of the TCJA combat these planning techniques by eliminating some of the prior law’s exceptions.
Expansion of Stock Attribution Rules
Certain foreign corporation stock owned by a foreign person is now attributed to a related U.S. person to determine whether or not a “U.S. shareholder” exists for purposes of determining whether or not the foreign corporation is a CFC. Under prior law, certain stock owned by a foreign shareholder was not attributed to a domestic subsidiary.
Expansion of Definition of “U.S. Shareholder”
The definition of a U.S. shareholder has been expanded to include any U.S. person who owns 10% or more of the total voting power or total value of all classes of a foreign corporation’s stock. Under prior law, only U.S. persons who had at least 10% of the voting power were counted for purposes of determining whether a CFC existed.
Elimination of 30-Day Minimum Holding Period for CFC
A U.S. parent is now subject to current U.S. tax on the CFC’s subpart F income — even if the U.S. parent does not own stock in the CFC for an uninterrupted period of 30 days or more during the tax year. Under prior law, a U.S. shareholder of a CFC was required to recognize a subpart F inclusion only if the related foreign corporation was a CFC for at least 30 consecutive days during its tax year.
Base Erosion and Anti-Abuse Tax
The TCJA imposes a base erosion minimum tax (generally referred to as BEAT). BEAT generally applies to C Corporations:
- With average annual gross receipts of at least $500 million (based on a three-year look-back period), and
- That have made certain related party deductible payments (determined by reference to a base erosion percentage of at least 3%).
The base erosion percentage for any tax year would be the aggregate amount of base erosion tax benefits for the year divided by the total aggregate deductions for the year (with some modifications).
Generally, the base erosion minimum tax is equal to 10% of the U.S. corporation’s modified taxable income (adding back deductible payments to related foreign persons), minus the U.S. corporation’s regular tax liability.
This provision clearly targets large U.S. corporations who use base-erosion techniques to strip income out of the U.S. tax system. Going forward, corporations will need to consider the BEAT tax when structuring their related-party payments.
Limitations on Intangible Property Transfers
The TCJA clarifies that the outbound transfer of certain intangible assets can be considered a taxable event. Under prior law, it was possible that U.S. taxpayers could shift value outside the U.S., tax-free, by transferring “soft” intangibles such as workforce in place, goodwill (both foreign and domestic), and going concern value. These assets are now explicitly included in the definition of intangible property and therefore will be subject to the existing outbound tax provisions.
The international provisions of the TCJA provide U.S. taxpayers with both challenges and opportunities. The provisions are complex, and add onto an already complicated international tax regime. If you have foreign operations or income of any kind, carefully consider these new rules with your tax team to ensure you are structured in the most tax-efficient manner.
Please contact Ray Polantz at firstname.lastname@example.org for further discussion.
Cohen & Company is not rendering legal, accounting or other professional advice. Information contained in this post is considered accurate as of the date of publishing. Any action taken based on information in this blog should be taken only after a detailed review of the specific facts, circumstances and current law.