The Holiday season has arrived! It’s that time of year where the air is crisp, families are gathering together, and tax professionals are gearing up for a new tax season influenced by tax reform. As we “fall” back for daylight savings, let’s “spring” ahead to the 2018 tax season by discussing six ways the Tax Cuts and Jobs Act of 2017 (“TCJA”) will impact international taxation.
- Global Intangible Low-Taxed Income (GILTI)
New to the tax code this year is Global Intangible Low-Taxed Income (GILTI). Prior to the TCJA, U.S. shareholders were required to report the earnings of a controlled foreign corporation (“CFC”) only when they received a cash dividend. However, this new rule now requires U.S. shareholders to include GILTI (if any) in their income. A CFC is defined as any foreign corporation in which more than 50% of the total combined voting power of all classes of stock is owned by U.S. shareholders. The main idea of this new income inclusion is to transfer the tax on CFC income to U.S. shareholders who own more than 10% of a CFC. In addition, a brand-new deduction is allowed for U.S. corporations that own a CFC. An individual can make an election to be taxed as a corporation on CFC earnings in order to claim this deduction, as well.
- Transition Tax
The transition tax is the Pumpkin Spice Latte of tax reform, well-known and relevant. It was enacted in 2017 and was considered a one-time repatriation at reduced rates. Section 965 enforces this new transition tax on post-1986 accumulated foreign earnings of a U.S. taxpayer’s foreign corporation or subsidiary. All accumulated foreign earnings are considered repatriated, the act of physically sending money back to one’s own country, whether or not they actually are. In prior years, the earnings remained offshore and were, therefore, not included in U.S. taxable income. A tax is applied on these repatriated earnings based on the source of the earnings (cash, cash equivalents, etc.) that are held by the company.
- Territorial Taxation
As the temperature begins to change and the air becomes crisp, several tax laws have also changed in regards to how foreign income of individual and business taxpayers are taxed. C-corporations have been moved to a territorial system where they are not taxed by the U.S. on their foreign profits, though they will still be taxed by the foreign country where the income is sourced. It allows corporations a 100% dividends-received deduction (“DRD”) if the C-corporation owns 10% or more of a foreign corporation that pays out dividends. This deduction is solely based on the foreign-source portion of the qualifying dividend.
- Foreign-Derived Intangible Income
Thanks to the new tax reform bill, domestic corporations can now receive a 37.5% deduction on their intangible income resulting from serving foreign markets. This deduction can reduce the effective tax rate on the income from 21% to 13.125% for the 2018 to 2025 tax years. To take the deduction, the corporation must be able to provide proof that the foreign-derived income came from the sale of property for foreign use or from the provision of services to a person located outside the United States. In addition, a foreign tax credit can be applied to the tax generated under this newly calculated tax, with limits. Those providing services to foreign persons should be aware that there are potential limitations to this deduction.
- Base Erosion and Anti-Abuse Tax (BEAT)
While the eggs are beating in preparation for the pumpkin pie, the tax code has added their own kind of beat. The BEAT tax is intended to discourage using deductible related-party payments to shift profits from the U.S to a foreign country and distributing profits tax-free. To be subject to the tax, the taxpayer must:
- Be a C-corporation that is not a regulated investment company or a real estate investment trust,
- Have average annual gross receipts of at least $500 million over the prior three-year period, and
- Have a base erosion percentage of at least 3%. The base erosion percentage is roughly the amount of deductible payments made to foreign related parties divided by total deductible payments excluding cost of goods sold.
The BEAT rate is 5% for 2018, 10% for 2019 through 2025, and 12.5% for years after 2025. Since BEAT is in addition to the regular federal corporate income tax, it is important to carefully consider whether payments made to foreign related parties may subject your corporation to the tax.
As the time changes and the leaves begin to fall, giving thanks for changing tax codes may not be what we had in mind. However, tax professionals are here to help guide and assist you in all of your international tax reform needs. If you have any questions on how these provisions or others of the new tax law might affect you, please do not hesitate to contact your L&B professional at (858) 558-9200.