The Tax Cuts and Jobs Act makes fundamental changes to how multinational businesses are taxed for federal income tax purposes.
The new provisions are complex, and there are some significant unanswered questions. The repatriation transition tax provision, in particular, requires immediate action because it will require many companies to compute what’s known as post-1986 foreign earnings and profits (E&P).
The IRS is expected to issue more guidance in the coming weeks and months as companies and tax professionals grapple with these monumental changes in the tax regime for multinational companies. The following is a summary of some of the most significant potential implications.
Mandatory Deemed Repatriation
For the last tax year beginning before January 1, 2018, the act imposes a new tax on a US shareholder’s pro rata share of post-1986 accumulated foreign earnings of a specified foreign corporation. This is generally any foreign corporation controlled by US owners or with at least one 10% US shareholder that is a C corporation. There are special rules for S corporation taxpayers who are US shareholders of a specified foreign corporation.
The tax is imposed through section 965 and provides for an offsetting deduction intended to reduce the rate of tax imposed to 15.5% for earnings held in cash or cash equivalents. There’s a further reduced rate of 8% for earnings invested in other assets. The actual liability that results from the inclusion will depend on the entity type and its tax attributes. A reduced foreign tax credit is allowed for taxes attributable to the section 965 inclusion.
Taxpayers can elect to pay the resulting liability over an eight-year period, which is more heavily weighted to the later years.
Those taxpayers will be required to compute their:
- Foreign subsidiaries’ net cash (or cash equivalent) positions
- Accumulated post-1986 foreign E&P, their inclusion amounts, and deductions for 2017 tax provisions and tax filings
- Attributable foreign taxes paid (for C corporation shareholders)
This will be a significant exercise for many taxpayers. We strongly recommend that taxpayers begin analyzing the impact of this new provision as soon as possible. The first payment will be due at the same time as the original due date for the return for the year in question (April 15, 2018, for calendar-year corporations, for example).
To learn more, please read our insight on the transition tax.
Modified Territorial and Participation Exemption System
The act allows for a 100% dividends received deduction for US C corporation shareholders of specified 10%-owned foreign corporations, effective for tax years beginning after December 31, 2017.
Essentially, this means that dividends from foreign affiliates may, in the future, not be subject to US federal income tax—unless the income is subject to Subpart F or another antideferral provision. The 100% deduction is in lieu of the prior foreign tax credit system (section 902) that was utilized by the United States to avoid double taxation.
This provision allows low-taxed, foreign-sourced income to be repatriated tax-free for federal purposes. There is a one-year holding period requirement and an exclusion for what’s known as hybrid dividends. Any foreign withholding taxes associated with the dividend are neither creditable nor deductible.
New Subpart F
The definition of a US shareholder has changed under the new tax law to include US persons owning 10% or more of the total value of all classes of stock.
This means that holders of nonvoting preferred shares in a foreign company may now be subject to Subpart F inclusions. Previously, a US shareholder was a US person who owned 10% or more of the total combined voting power of all classes of stock of a foreign corporation.
Prior law prevented stock owned by a foreign person from being re-attributed to a US person, which is now permitted under the new law. With the law change, a US corporation is now considered to constructively own the shares that its foreign controlling shareholder owns. Many practitioners believed this rule created an unintended section 5471 filing requirement based on constructive ownership of CFC shares.
On January 18, 2018, the Treasury issued Notice 2018-13, which stated that US persons won’t be required to file Form 5471 with respect to a CFC for which they’re considered to own stock solely due to attribution of ownership from a foreign person under section 318(a)(3).
Finally, the Subpart F provisions associated with oil-related income for a foreign-based company was repealed.
Base Erosion—A New Concept
New Taxable Events
The act has additional provisions that are similar to those being implemented in many foreign countries under the Organisation for Economic Co-operation and Development’s base erosion and profit shifting initiative, which is known as BEPS.
As a starting point, the new tax law repeals the active trade or business exception to gain recognition on outbound transfers. It also expands the definition of intangible property to include goodwill, going concern, workforce in place, and similar previously excluded intangibles.
The combination of these two rules effectively defines the following as taxable events:
- Outbound transfers of a trade or business
- Incorporation of a foreign branch office
Global Intangible Low-Taxed Income Tax
The second part of the law’s fight against base erosion is the imposition of a tax on global intangible low-taxed income, known as GILTI. This is a significant shift is US tax law—akin to the US imposing a required minimum tax on foreign income.
Under the new GILTI rules, the shareholder of a controlled foreign corporation with an overall rate of return greater than a 10% rate of return on the entity’s tangible assets will potentially be subject to a minimum, or top-up, tax in the United States.
Many profitable entities will likely be subject to this new provision, unless they own significant depreciable foreign assets. In essence, for tax years 2018 through 2025, the intangible profit earned by a CFC will be subject to a US top-up tax unless the CFC pays an effective foreign tax rate of 13.125%. Intangible profit is defined as most CFC earnings reduced by a 10% return on depreciable assets. After 2025, that minimum tax rate increases to 16.406%.
However, under a congruent provision for foreign-derived intangible income, the act created an incentive under section 250(a) that will allow US companies to pay a reduced tax rate of 13.125% on foreign intangible income. This provision is presumably intended to incentivize US persons to keep and maintain their intangible or intellectual property rights in the United States rather than migrating those rights to a foreign jurisdiction.
There’s an additional anti-abuse provision—the section 59A base erosion and profit shifting tax (BEAT). This will apply to large corporations (those with $500 million of US group revenue) making service or purchase payments to related parties. The BEAT operates as an alternative tax and may be thought of as a replacement for the repealed corporate alternative minimum tax.
We’re Here to Help
We’ll continue to keep you up to date as we learn of additional guidance. If you’d like to learn more about how your business is affected by this historical change in tax law, contact your Moss Adams professional or email firstname.lastname@example.org. You can also visit our dedicated tax reform webpage