Tax Reform and the New International Provisions
The Tax Cuts and Jobs Act made significant changes to the rules governing international taxation. Most provisions are focused on making U.S. companies more competitive abroad and bringing more investment to the United States, but the new legislation also attempts to crack down on base erosion and profit shifting through new anti-abuse rules. The major changes for U.S. multinational entities are summarized below.
- Adoption of a Territorial Tax System. The new law establishes a participation exemption system for taxation of foreign source income. This is achieved by allowing a 100-percent ‘dividends received deduction’ (DRD) for foreign-source dividends received by domestic corporations.
The domestic corporation must qualify as a U.S. shareholder, and the foreign corporation cannot be a passive foreign investment company (PFIC).
To help patrol for abuse, the DRD is not available for any dividend received by a U.S. shareholder from a controlled foreign corporation (CFC) if the dividend is a hybrid dividend for which the foreign corporation received a deduction (or other tax benefit) from taxes imposed by a foreign country.
Further, no foreign tax credit or deduction is allowed for any taxes paid or accrued with respect to any portion of a distribution treated as a dividend that qualifies for the DRD.
The new provision includes a holding period requirement and applies to distributions made after December 31, 2017. For purposes of the holding period, a domestic corporation is not permitted a DRD with respect to any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend. For this purpose, the holding period requirement is treated as met only if the specified 10-percent owned foreign corporation is a specified 10-percent owned foreign corporation at all times during the period and the taxpayer is a U.S. shareholder with respect to such specified 10-percent owned foreign corporation at all times during the period.
- Transition Tax. For the last taxable year beginning before January 1, 2018, any U.S. shareholder of a specified foreign corporation must include in income its pro-rata share of the accumulated post-1986 deferred foreign income of the corporation. A specified foreign corporation is any foreign corporation that has at least one U.S. shareholder.
This provision is aimed at taxing foreign source income currently parked offshore.
Foreign earnings held in the form of cash and cash equivalents will be taxed at 15.5 percent, and all other earnings will be taxed at a rate of 8 percent.
The U.S. shareholder can elect to pay the net tax liability resulting from the inclusion in installment payments, instead of remitting the entire amount all at once. If installment payment is elected, payments will occur over an eight-year period. The payments for each of the first five years equal 8 percent of net tax liability, the sixth installment equals 15 percent, the seventh installment equals 20 percent, and the eighth installment equals the remaining 25 percent.
- Reduced rates on foreign-derived intangible income and global intangible low-taxed income. These provisions create a new section of the Code (section 250) to provide domestic corporations with reduced rates of U.S. tax on their foreign-derived intangible income and global intangible low-taxed income.
For taxable years beginning after December 31, 2017, and before January 1, 2019, the effective tax rate on foreign-derived intangible income is 21.875 percent and the effective tax rate on global intangible low-taxed income is 17.5 percent.
For taxable years beginning after December 31, 2018, and before January 1, 2026, the effective tax rate on foreign-derived intangible income is 12.5 percent and the effective tax rate on global intangible low-taxed income is 10 percent.
For taxable years beginning after December 31, 2025, the effective tax rate on foreign-derived intangible income is 15.625 percent and the effective tax rate on global intangible low-taxed income is 12.5 percent.
The new tax law also includes:
- Modifications to the foreign tax credit system
- repealing section 902 indirect foreign tax credit
- repealing section 863(b) source rules
- creating a new foreign tax credit basket for foreign branch income
- Modifications to the Subpart F provisions
- repealing foreign base company rules for shipping and oil related income
- modifying stock attributions rules for determining CFC status
- eliminating requirement that a foreign corporation must be controlled for 30 days before Subpart F inclusions apply
- requiring inclusion of global intangible low-taxed income in a manner similar to inclusions under Subpart F
- New provisions targeting base erosion and profit shifting
- imposing a base erosion minimum tax to curb abuse from deductible cross-border payments between affiliated companies
- revising definitions and requiring certain valuation methods to curb abuse from profit shifting through intangible property transfers
- denying a deduction for certain related party payments tied to a hybrid transaction or hybrid entity
- denying reduced tax rates on dividends received from expatriated entities (i.e., inversion companies)
The new anti-abuse rules are consistent with the base erosion and profit shifting recommendations published by the Organization for Economic Cooperation and Development (the OECD BEPS project). They are also consistent with the new Model Tax Treaty released by the U.S. Treasury Department in 2016, which requires that certain base erosion tests be met before an entity can qualify for treaty benefits.
ABOUT THE AUTHOR
Tara Fisher has been practicing international tax for over 15 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.