The Treasury Department issued a plethora of guidance in the international tax arena during the latter part of 2018 to address changes made by the Tax Cuts and Jobs Act (TCJA). This article provides a brief summary of the proposed regulations for the transition tax, global intangible low-taxed income (GILTI), the foreign tax credit, and the base erosion and anti-abuse tax (BEAT).
The Transition Tax
In August 2018, the Treasury Department issued proposed regulations on the one-time repatriation tax on foreign earnings under section 965, commonly referred to as the transition tax. The TCJA changed the way U.S. companies are taxed on their foreign earnings and the transition tax bridges the gap between the old and new rules.
The new rules represent a territorial-style tax system instead of a worldwide approach. The transition required a provision that would differentiate between the untaxed foreign earnings stockpiled abroad under the old rules and the post-tax reform foreign earnings that are provided an exemption from U.S. tax.
The U.S. government has estimated that there is more than $2.6 trillion of untaxed foreign income that will be subject to the transition tax provisions. The proposed rules cover the general rules and definitions contained in section 965, guidance on the determination and treatment of deductions, treatment of disregarded transactions, foreign tax credit calculations, and important election processes.
Global Intangible Low-Taxed Income
In September 2018, the Treasury Department issued proposed regulations on the Global Intangible Low-Taxed Income (GILTI) rules under section 951A and section 250. The GILTI rules were created by the TCJA and operate as a worldwide backstop to the territorial-style rules adopted by the tax reform legislation.
The GILTI provisions piggyback on the long-standing anti-abuse regime referred to as Subpart F. After determining a CFC’s Subpart F income, U.S. shareholders have to determine if they are subject to tax on the CFC’s global intangible low-taxed income (GILTI). Foreign income tainted as Subpart F or GILTI is not exempt from U.S. taxation.
The GILTI provisions impose a minimum tax on certain low-taxed income, but allow such income to be reduced by a special deduction. For 2018, the deduction amount is 50% of GILTI. The taxpayer is also allowed to take an 80% foreign tax credit. This means the GILTI tax should only apply to foreign income with an effective tax rate below 13.125% ((50% x 21 corporate tax rate)/80 percent foreign tax credit)).
The proposed rules focus on the U.S. shareholder’s pro-rata share for determining the GILTI inclusion amount, relevant aggregation rules, and the interaction of such rules with other code sections. The proposed regulations do not address the calculation of foreign tax credits. The Treasury Department has stated that such matters will be addressed in the future.
Foreign Tax Credit
In November 2018, the Treasury Department issued proposed regulations on the foreign tax credit rules for businesses and individuals. The foreign tax credit rules address changes made by the TCJA, including the foreign tax credit limitation categories, determination of deemed paid credits, and the allocation and apportionment of deductions.
The TCJA added two new foreign tax credit limitation categories to the existing general and passive categories. There is a separate limitation category for GILTI income and a separate limitation category for foreign branch income. The proposed rules provide transition rules for adopting these new separate limitation categories.
The proposed regulations also provide guidance on the determination of deemed paid credits, including situations that involve distributions by a CFC of previously taxed earnings and profits.
The TCJA repealed the fair market value method of asset valuation for purposes of allocation and apportioning general interest expense. This was a valuable tax planning tool for many companies. The proposed rules amend existing regulations to clarify how deductions are allocated and apportioned under the new provisions.
Base Erosion and Anti-Abuse Tax
In December 2018, the Treasury Department issued proposed regulations on the base erosion and anti-abuse tax (BEAT) under section 59A. The BEAT applies to corporations with at least $500 million in gross receipts. It does not apply to individuals, S corporations, RICs or REITs. There is also a de minimis exception for companies whose foreign related party payments are low relative to overall deductions.
The BEAT is generally calculated by taking 10 percent of modified taxable income. The rate is 5 percent for years beginning in 2018 to help phase-in the new regime. It increases to 12.5 percent for years beginning after 2025.
The proposed rules address anti-abuse and recharacterization rules, the treatment of net operating losses and credit carryover limitations, and administrative reporting requirements. The proposed regulations also clarify that the computation of modified taxable income and the computation of the base erosion minimum tax amount is done on a taxpayer-by-taxpayer basis.
The proposed rules define a base erosion payment as a payment to a foreign related party that falls into one of the following four categories:
A payment with respect to which a deduction is allowable;
A payment made in connection with the acquisition of depreciable or amortizable property;
Premiums or other consideration paid or accrued for reinsurance;
A payment resulting in a reduction of the gross receipts of the taxpayer that is with respect to certain surrogate foreign corporations or related foreign persons.
Additional Guidance
While the proposed regulations issued to date represent a significant portion of the changes made by the TCJA in the international tax arena, the Treasury Department has indicated that additional guidance is forthcoming.
In late December, the Treasury Department announced that it intends to issue regulations addressing situations that arise with respect to the previously taxed earnings and profits of foreign corporations. The proposed rules are supposed to address the maintenance of previously taxed earnings accounts, the ordering of previously taxed earnings upon distribution and reclassification, and the adjustment required when an income inclusion exceeds the earnings and profits of a foreign corporation. Stay tuned.
Tara Fisher has been practicing international tax for nearly 20 years. Her professional background includes working for the U.S. Congress Joint Committee on Taxation, the national tax practice of PricewaterhouseCoopers, the University of Pittsburgh, and American University in Washington D.C. She is a licensed CPA and holds both an undergraduate and graduate degree in accounting from the University of Virginia.