Tax Cuts and Jobs Act - International Taxes
With the passage of the Tax Cuts and Jobs Act (“Act”), there is much concern, as well as confusion, as to the impact the new legislation has on both businesses and individuals alike. The tax changes contained in the Act are the most sweeping since the Tax Reform Act of 1986. As with any tax change, there will be winners and losers, but all taxpayers should be familiar with how the new legislation could impact their specific situation. Below we address the impact on international tax.
Mandatory deemed repatriation – The Conference bill requires all U.S. shareholders – U.S. citizens, residents, partnerships, trusts, and corporations – that own 10% or more of the voting shares of Controlled Foreign Corporation (CFC) to include their pro rata share of all CFC accumulated net earnings and profits (E&P) in their 2017 income. The effective tax rate that applies to this deemed repatriation has increased slightly from the prior House and Senate versions – cash earnings will be subject to a 15.5% tax rate, while non-cash earnings will be subject to an 8% tax rate. The rates are achieved via dividends received deduction, which brings the effective tax rate to these levels.
In addition, 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 bill also retains the 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. It is clear that 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 Conference bill 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 (similar to 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).
Changes to subpart F – The Conference bill retains existing subpart F anti-deferral rules and the section 956 deemed repatriation rules, but makes several changes. Importantly, a new category of subpart F income will require 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 over a so-called routine return on tangible depreciable business assets.
In addition to navigating the complexity of these calculations, U.S. shareholders must determine the U.S. tax basis of assets held by CFCs, which can be a daunting task. In addition to creation of the GILTI rules, 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 expanding the definition of “U.S. shareholder,” subject to the subpart F provisions, to include any U.S. person that owns at least 10% of the vote or value of the CFC, rather than only including those with 10% or more of the voting power. 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 threshold defined under these provisions. 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, reduced by certain credits. 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 Conference bill authorizes an expanded Form 5472 to capture additional information on base erosion payments as well as increased penalties ($25,000 per form versus the current $10,000 per form) for late filed or incomplete Forms 5472.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. 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 members, 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.
Insights on Impact of the Tax Cuts and Jobs Act