Tax Cuts and Jobs Act - International Tax Update
The international tax law changes contained in the Tax Cuts and Jobs Act (TCJA) are the most sweeping since the Tax Reform Act of 1986. With those changes comes both confusion and concern about the impact of this new law on international businesses dealings. As with any tax change, there will be winners and losers, but all U.S. shareholders of foreign corporations need to become familiar with how this new legislation impacts their international tax position.
Mandatory deemed repatriation – The TCJA requires all U.S. shareholders – U.S. citizens, residents, partnerships, trusts, and corporations – that own 10% or more of the voting shares of a specified foreign corporation (including Controlled Foreign Corporations (CFC) and certain other foreign corporations with 10% or greater domestic corporate shareholders) to include in their 2017 income their pro rata share of all accumulated net earnings and profits (E&P) of those specified corporations, or include it in the first fiscal year end thereafter. Under the new rules, accumulated net E&P is measured at November 2, 2017 and December 31, 2017, and the greater of the two amounts is subject to this inclusion. However, accumulated net E&P may be reduced by the U.S. shareholder’s aggregate share of E&P deficits from any specified foreign corporations in an E&P deficit position as of November 2, 2017.
Domestic corporations’ cash earnings will be subject to a 15.5% federal tax rate, while non-cash earnings will be subject to an 8% tax rate. Individuals are subject to higher rates of up to 17.5% for cash earnings and 9% for non-cash earnings. For this purpose, “cash” is defined broadly for purposes of the deemed repatriation, and includes accounts receivable (net of accounts payable), fair market value of marketable securities, commercial paper, foreign currency, and other short term obligations or economically equivalent assets. While U.S. shareholders may elect to pay the federal tax due on such deemed repatriation in installments (over eight years), the entire amount will be due in the event a payment is late or missed. Most states have indicated that they will not allow installment payments.
Corporate shareholders of CFCs will be able to take advantage of a modified foreign tax credit that can reduce the U.S. tax due on the deemed repatriation amount. The TCJA also provides for a special rule for S corporations that are shareholders of CFCs, whereby the S corporation shareholders will not take the deemed repatriation amount into income until certain triggering events occur. Certainly U.S. shareholders of a CFC must, at a minimum, ensure they have correctly calculated the E&P of their CFC to determine the impact of the deemed repatriation. Likewise, C-corporation shareholders must calculate the foreign tax pools available to be credited under the modified foreign tax credit provisions.
Territorial tax system – The TCJA moves the U.S. to a modified “territorial tax” system, through which U.S. C corporations will not pay U.S. tax on certain profits earned outside the U.S. This change is accomplished by allowing domestic corporations a deduction (like the dividends received deduction), whereby a U.S. C corporation that owns 10% or more of a foreign corporation will not pay any U.S. tax on the foreign source portion of dividends paid by the foreign corporation. The deduction is available for dividends from any foreign corporation other than passive foreign investment companies (PFICs) or hybrid dividends.
Broader Anti-Deferral Rules – The TCJA retains existing federal subpart-F anti-deferral rules and retains the section 956 deemed repatriation rules, but it also makes several changes. Importantly, the TCJA requires U.S. shareholders to include the global intangible low taxed income (GILTI) of CFCs in current U.S. taxable income.
The mechanics of the GILTI provision are complex, but their effect is to establish a minimum tax regime that applies to U.S. shareholders of certain CFCs with income above a so-called “routine return” on tangible depreciable business assets. U.S. corporate shareholders of CFCs may take foreign tax credits for a specified portion of income taxes paid by their CFCs and are allowed a 50% deduction against GILTI (37.5% after 2025). Non-corporate taxpayers generally are not allowed indirect foreign tax credits or the GILTI deduction. U.S. non-corporate taxpayers may want to consider restructuring their holdings.
In addition to navigating the complexity of these calculations, U.S. shareholders must now determine the U.S. tax basis of assets held by CFCs, which can be a daunting task.
Furthermore, the subpart F rules are modified so that a larger class of U.S. shareholders of foreign corporations will be subject to the subpart F deemed inclusion rules. This expansion is triggered by broadening the definition of a “U.S. shareholder” subject to the subpart F provisions and now includes any U.S. person that owns at least 10% of the vote or value of the CFC, rather than only those with 10% or more of the voting power. In addition, the attribution rules, which can require the application of the subpart F rules on U.S. persons without a direct interest in a CFC, have also been expanded. U.S. taxpayers may need to reevaluate their exposure to the subpart F provisions under these expanded definitions.
Base Erosion Anti-Abuse Tax (BEAT) – The BEAT provisions will apply to U.S. corporations with an average of $500 million of gross receipts over the past three years that make certain deductible payments to related foreign persons exceeding a defined threshold. The goal of these provisions is to restrict U.S. corporations from eroding the U.S. tax base by making deductible payments to offshore affiliates. Any such corporation will pay tax under the BEAT provisions on the excess of 10% of its taxable income (modified for this purpose) over its regular tax liability for the year, but reduced by certain credits. However, registered investment companies (RICs), REITs, and S corporations are not subject to the BEAT provisions. The effort to monitor and track the application of BEAT rules will be significant. In addition, the TCJA authorizes an expanded IRS Form 5472 to capture additional information on base erosion payments, and increased penalties ($25,000 per form versus the current $10,000 per form) for late filed or incomplete Forms 5472.
Anti-Hybrid Provisions – The TCJA includes new anti-hybrid provisions that deny deductions for interest or royalties paid to related parties pursuant to a hybrid transaction. This type of transaction is defined as any transaction with respect to which payments are treated as interest or royalties for U.S. tax purposes, but are not treated as such for tax purposes in the country where the recipient is resident. Hybrid entities include entities treated as fiscally transparent for U.S. tax purposes and opaque for local country purposes or vice versa.
Interest Expense Deduction Limitation – The TCJA expands the limitation on business interest deductions. This now applies to all business interest, regardless of the taxpayer’s debt-to-equity ratio or whether the interest is paid to a related party. Taxpayer’s deductions for business interest expense are now limited to the sum of business interest income, 30% of the taxpayer’s adjusted taxable income, and any floor plan financing interest incurred by the taxpayer (related to financing of motor vehicle inventory for sale or lease). Business interest is defined as any interest paid or accrued on indebtedness allocable to a trade or business of the taxpayer. Adjusted taxable income is defined as taxable income computed without regard to items not properly allocable to the trade or business, business interest income or expense, net operating loss deductions, and for taxable years beginning before January 1, 2022, depreciation, amortization or depletion deductions. Business interest expense for which a deduction is denied under the new limitation may be carried forward to subsequent taxable years. While there are some exceptions to this new limitation, most businesses are subject to this rule.
This has been prepared for informational purposes, is general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without first obtaining professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.
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