President Trump signed the Tax Cuts and Jobs Act into law on December 22nd. The enactment of this legislation provides the first major tax reform in over 30 years and will have a far-reaching effects on companies with international tax liabilities. This article will highlight several of the key provisions starting in 2018 that will have the most significant impact on organizations that have multi-national operations or participate in cross-border transactions.
The new law provides a 100% deduction for the foreign source portion of dividends received from specified 10%-owned foreign corporations by domestic corporations that are 10% shareholders of those foreign corporations. No foreign tax credit is allowed for any taxes paid and accrued as to any dividend for which the deduction is allowed, and those amounts are not treated as foreign source income for purposes of the foreign tax limitation.
In addition, if there is a loss on any disposition of stock of the specified 10%-owned foreign corporation, the basis of the domestic corporation in that stock is reduced (but not below zero) by the amount of the allowable deduction.
Under this new law provision, if a domestic corporation sells or exchanges stock in a foreign corporation held for over a year, any amount it receives which is treated as a dividend for Code Sec. 1248 purposes, will be treated as a dividend for purposes of the deduction for dividends received discussed above.
Similarly, any gain recognized by a CFC from the sale or exchange of stock in a foreign corporation that is treated as a dividend under Code Sec. 964 to the same extent that it would have been so treated had the CFC been a U.S. person is also treated as a dividend for purposes of the deduction for dividends received.
Under the new law, if a U.S. corporation transfers substantially all of the assets of a foreign branch to a foreign sub, the transferred loss amount must generally be included in the U.S. corporation’s gross income.
Under the new law, U.S. shareholders owning at least 10% of a foreign sub must include in income for the sub’s last tax year (beginning before 2018) the shareholder’s pro-rata share of the undistributed, non-previously- taxed post-1986 foreign earnings of the corporation. The inclusion amount is reduced by any aggregate foreign earnings and profits deficits, and a partial deduction is allowed such that a shareholder’s effective tax rate is 15.5% on his aggregate foreign cash position and 8% otherwise. The net tax liability can be spread over a period of up to 8 years. Special rules apply for S corporation shareholders and for RICs and REITs.
Under the new law, a U.S. shareholder of any CFC has to include in gross income its global intangible low- taxed income (GILTI), i.e., the excess of the shareholder’s net CFC tested income over the shareholder’s net deemed tangible income return (10% of the aggregate of the shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder). The GILTI is treated as an inclusion of Subpart F income for the shareholder. Only an 80% foreign tax credit is available for amounts included in income as GILTI.
Under the new law, in the case of a domestic corporation, a deduction is allowed equal to the sum of (1) 37.5% of its foreign-derived intangible income (FDII) for the year, plus (2) 50% of the GILTI amount included in gross income, see above. Generally, FDII is the amount of a corporation’s deemed intangible income that is attributable to sales of property to foreign persons for use outside the U.S. or the performance of services for foreign persons or with respect to property outside the U.S. Coupled with the 21% tax rate for domestic corporations, these deductions result in effective tax rates of 13.125% on FDII and of 10.5% on GILTI. The deduction rates are reduced for tax years after 2025.
The new law made several changes to the taxation of subpart F income of U.S. shareholders of CFCs. Among other things, the new law expands the definition of U.S. shareholder to include U.S. persons who own 10% or more of the total value of shares of all classes of stock of the foreign corporation. In addition, the requirement that a corporation must be controlled for 30 days before Subpart F inclusions apply has been eliminated.
To prevent companies from stripping earnings out of the U.S. through payments to foreign affiliates that are deductible for U.S. tax purposes, a base erosion minimum tax applies to corporations, other than RICs, REITs, and S corporations, with average annual gross receipts of $500 million or more that made deductible payments to foreign affiliates that are at least 3% (2% in the case of banks and certain security dealers) of the corporation’s total deductions for the year. The tax is structured as an alternative minimum tax and applies to domestic corporations, as well as on foreign corporations engaged in a U.S. trade or business in computing the tax on their effectively connected income.
Other new law provisions limit income shifting via intangible property transfers, deny deductions for related party payments in hybrid transactions or with hybrid entities, and deny qualified dividend status to dividends received by individuals from surrogate foreign corporations. The law also introduces a series of modifications to the foreign tax credit system, as well as a number of other international reforms.
Companies with multi-national operations or cross-border transactions should work closely with their tax advisors to understand the full implications of the tax bill, including how they might be impacted, and what planning opportunities might be present.
Our team of experts are continually monitoring developments for further guidance from Congress and the IRS on the above tax reform legislation provisions, and will provide updated information and analysis as necessary.
Disclaimer: Any written tax content, comments, or advice contained in this article is limited to the matters specifically set forth herein. Such content, comments, or advice may be based on tax statutes, regulations, and administrative and judicial interpretations thereof and we have no obligation to update any content, comments or advice for retroactive or prospective changes to such authorities. This communication is not intended to address the potential application of penalties and interest, for which the taxpayer is responsible, that may be imposed for non-compliance with tax law.