December 21, 2017
2018 Tax Law Changes- International Provisions
International Tax Provisions
- The new law adopts a participation exemption system that provides a 100% deduction for the foreign-source portion of dividends received from specified 10% owned foreign corporations by domestic corporations that are United States shareholders of those foreign corporations. No foreign tax credit or deduction is allowed for any taxes paid or accrued with respect to a dividend that qualifies for the 100% deduction.
- The new law preserves the deemed dividend treatment for investment in U.S. property by controlled foreign corporations, including corporate shareholders that will be entitled to the 100% dividends received deduction.
- The new law requires that for the last taxable year beginning before January 1, 2018, any U.S. shareholder of a foreign corporation that has at least one U.S. 10% shareholder must include in income its pro rata share of post-1986 accumulated earnings. The 10% U.S. shareholders must determine their deferred foreign income based on the greater of the aggregate post-1986 accumulated foreign earnings and profits as of November 9, 2017, or December 31, 2017, not reduced by distributions during the taxable year ending with or including the measurement date, unless such distributions were made to another specified foreign corporation.
- The effective tax rates for the deemed repatriation of foreign earnings upon transition to the new participation exemption system are established at 15.5% (for cash and cash equivalents) and 8% (for other earnings).
- U.S. shareholders subject to the repatriation tax may elect to pay the net tax liability in eight installments (8% in each of the first 5 years, 15% in year six, 20% in year 7, and 25% in year 8.
- A special rule is provided for S corporations, allowing continued deferral of the transition tax liability, unless a specified "triggering event" occurs (e.g., loss of S status, liquidation, or transfer of shares).
- The new law imposes a minimum tax on foreign earnings considered to be above a "routine" amount, termed global intangible low-tax income or "GILTI". The tax is imposed on a current basis, at a full 21% rate, subject to a 50% deduction; additionally, the tax can be offset by a reduced (80%) foreign tax credit. As a result, an overall foreign effective tax rate of at least 13.125% generally will prevent the imposition of residual U.S. tax. The 50% GILTI deduction is reduced after 2025 from 50% to 37.5%.
- The new law provides a deduction for certain foreign derived intangible income, a variation of the "innovation box" benefit provided by other countries, allowing a 37.5% deduction for income earned directly by U.S. taxpayers from serving foreign markets (foreign derived intangible income). The deduction will result in a 13.125% effective tax rate on foreign derived intangible income. The deduction is reduced after 2025 from 37.5 percent to 21.875%.
- The new law does not include a permanent extension of the CFC look-through rule of section 954(c)(6). Thus, the look-through rule will remain a "tax extender" that will need to be renewed in order to prevent its expiration after 2019.
- The new law adopts the Senate's base erosion and anti-abuse tax (BEAT) approach by imposing a new minimum tax at a rate of 10%. The BEAT is applicable to a more limited subset of multinational groups and, generally is not applicable to cross-border purchases of inventory includible in cost of goods sold. In adopting the BEAT, the Congress rejected the controversial House proposal for an excise tax on certain payments to related foreign parties that would have required multinational groups subject to the provision to choose between the gross-basis excise tax and an election by the recipient of the payment to treat the amount as "effectively connected income" subject to US tax.
- The new law provides an anti-hybrid rule denying deductions for interest and royalties paid to related foreign persons, where the payments either are not includible or are deductible in the hands of the recipient in its residence country.
- The new law provides for the denial of a dividends received deduction for hybrid dividends received from a CFC, and treats hybrid dividends as Subpart F income if received by a CFC.
- The new law provides changes to the definition of intangible property and expansions of the Internal Revenue Service's ability to apply aggregation and "realistic alternatives" theories in connection with taxing the transfer of intangible property by a domestic corporation to a foreign corporation, and repeals the active trade or business exception for the outbound transfer of other assets to a foreign corporation.
Observations
The international provisions of the final bill move the United States towards a territorial system of taxation. The existing worldwide system is not entirely abandoned, as the new law provides for certain carryover provisions that allow the United States to tax certain categories of foreign earnings of U.S. companies. Specifically, the GILTI tax provisions and the minimum tax on intangible income continue to provide the U.S. with the ability to tax foreign earnings of U.S. companies.
The participation exemption provisions of the new law provide for the long overdue movement of the U.S. to align itself with the rest of the world in terms of allowing the tax-free repatriation of foreign earnings of domestic corporate subsidiaries. The participation exemption applies only to corporate shareholders of foreign corporations and as such, individual and pass-through shareholders of foreign corporations will continue to need to plan for the potential deferral of foreign earnings. Further, the transition tax on the mandatory, deemed repatriation of accumulated post-1986 earnings and profits will require analysis of pre-2018 reporting of foreign earnings. Taxpayers will also need to assess the short-term cash impact of the deemed repatriation provisions, as taxable income inclusions may result with respect to pre-2018 tax years.
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