In this 2018 year-end update, we cover some of the most important tax issues for companies in the technology, communications and media, and life sciences industries and highlight what your organization can do to stay ahead of them.
Here’s a look at some of the major changes we saw in the fourth quarter of 2018 as well as some of the most prevalent developments effective for the year.
There were many revisions to the international tax landscape in 2018, including introduction of global intangible low-taxed income, known as GILTI; taxes on digital tax services and foreign dividend income; changes introduced through the 2017 tax reform reconciliation act, referred to as the Tax Cuts and Jobs Act (TCJA); and many others.
Part of the TCJA’s fight against base erosion includes the imposition of a tax on global intangible low-taxed income, known as GILTI. The law imposes a US tax on income from a foreign subsidiary that has an overall rate of return greater than a 10% on the entity’s tangible assets. It’s intended to incentivize companies to return these activities to the United States.
Many entities will likely be subject to this new provision, unless they own significant depreciable foreign assets. GILTI is especially relevant to technology companies, which are often less capital intensive and tend to make large investments in intellectual property.
Foreign-Derived Intangible Income
To incentivize companies to grow US sales offshore, the TCJA introduced the Foreign-Derived Intangible Income (FDII). FDII creates a US tax deduction based on excess returns from goods and services sold offshore by US C corporations, and it’s available to offset GILTI.
The FDII deduction is calculated by multiplying the deemed-intangible income by the percentage of foreign derived deduction-eligible income compared to total deduction-eligible income. Deduction-eligible income includes property sold or licensed or services provided to foreign persons. Companies should track these activities to benefit from this deduction.
Base-Erosion and Anti-Abuse Tax
Effective for tax years after December 31, 2017, applicable companies must consider the base-erosion and anti-abuse tax (BEAT), which is essentially a minimum tax designed to prevent companies from reducing taxable earnings by making payments to foreign affiliates. An entity must pay this tax if the amount is greater than the entity’s regular tax liability and the entity meets all of the following criteria:
- It’s a corporation other than a regulated investment company, a real estate investment trust, or an S corporation.
- It has average annual gross receipts that are at least $500 million for the three-tax-year period ending with the preceding taxable year. This is called the gross receipts test.
- It has a base erosion percentage of 3% or higher for the tax year, or lower for certain financial businesses.
EU Proposal to Tax Digital Business Activity
Earlier this year, the European Commission proposed new provisions that would create a virtual permanent establishment. Under these provisions, a company would have a virtual permanent establishment if it meets any of the following criteria:
- Holds more than €7 million in annual revenue in a member state
- Sustains more than 100,000 users in a member state in a taxable year
- Creates more than 3,000 business contracts with business users for digital services in a taxable year
UK Digital Services Tax
In its 2018 budget, the UK government announced it will unilaterally introduce a 2% UK digital services tax on the revenue of certain digital businesses beginning in 2020.
The UK government intends for this measure to apply to large, global technology companies, rather than smaller start-ups. It should also only apply to organizations with global turnover in excess of £500 million on in-scope business lines, focusing on digital-platform businesses located and profitable in the United Kingdom.
This means the tax would affect multinational groups with UK subsidiaries and non-UK companies with permanent UK establishments. It will specifically apply to revenue generated from search engines, social media platforms and online market places linked to the participation of UK users.
There will be exemptions for loss-making businesses and a reduced tax rate on businesses with very low profit margins. However, the UK government hasn’t yet disclosed how it will implement the tax or how it will identify UK participants.
To learn how revisions to tax law are changing the ways multinational businesses are taxed for federal income purposes, read our Alert.
Limitations and Deductions
While there are many significant changes in the TCJA, here are two that are getting a lot of attention.
Executive Compensation Limitation
Prior to the TCJA, publicly held companies were limited under Internal Revenue Code (IRC) Section 162(m) on the deductibility of compensation exceeding $1 million for covered employees.
The TCJA changed the definition of a covered employee to include the three highest-paid officers other than the principal executive officer and principal financial officer. This change could have significant implications for how executive compensation is taxed at publicly traded corporations. For requirements and exceptions to the new revision, please see our Alert.
Limits on Deductibility of Meals Expenses
The TCJA also introduced changes to business meals and entertainment. Prior to 2017, entertainment and business meals relating to the taxpayer’s ordinary and necessary business expenses were subject to a 50% deduction.
Now, entertainment expenses paid or incurred after 2017 are 100% disallowed, and there have been changes regarding which business meals are considered nondeductible versus subject to a 50% limitation.
For additional regulations and examples illustrating how the rules apply to business meals in an entertainment setting, see our Alert.
To detect identity thieves filing fraudulent US tax returns, the IRS has discontinued automatic filing extensions for Forms 1099-MISC and W-2. These forms will be due on January 31. To learn how this change affects filing regulations and nonemployee compensation, see our Alert.
Credit Savings Opportunity
Companies that incur qualified R&D costs may be eligible for tax credits that could provide significant savings of annual state and federal taxes. A company qualifies for the R&D credit based on a tax credit study that measures the following four factors:
- Process of experimentation
- Technological in nature
- Qualified purpose
Companies that don’t perform an R&D tax credit study bear the risk of improperly calculating the credit and lacking sufficient documentation in the case of an IRS audit. However, the IRS’s new Accounting Standards Codification (ASC) 730 Safe Harbor Directive presents an opportunity to reduce this type of risk while increasing the amount of credit received.
To discover documentation requirements and implications for taxpayers with qualified research expenses, watch our complimentary webinar.
Wayfair Ruling: Significant Changes to State Taxes
Following the US Supreme Court’s decision in South Dakota v. Wayfair, Inc. in June 2018, many states enacted economic nexus laws similar to those in South Dakota, which require remote sellers to pay sales tax to any state where they do business.
Twenty-eight states have already enacted laws similar to South Dakota, while remaining states with sales tax have active proposals underway. A few other states have laws providing that placing cookies on a computer create nexus. It’s expected that these states will enact Wayfair-type provisions.
These changes will have far-reaching impacts on US companies of all sizes.
We’re Here to Help
For more information about the TCJA and additional changes covered in this year-end update, visit our Tax Planning Guide. It covers key opportunities and developments that could help you make decisions at year-end and through the following year. We’ll continue updating the guide as additional information becomes available. Please check back for changes.
You can also contact your Moss Adams professional with questions or visit our dedicated tax reform web page.