Tax Law Changes

Tax Law Changes

By now, I am sure you have read the tax law changes as they are applicable to individuals, pass-through businesses, and corporations.  In this email, I want to focus on the international tax law changes.  Specifically, how the changes in these provisions affect your small to middle market multinational clients.   I will highlight four provisions which I think will have the most impact and will provide a bullet point summary of the remaining changes.   Please reach out to me any time you want to have a discussion on these new laws and how they will impact your multinational clients.

Section 245A – Participation Exemption

In general, Section 245A allows a US corporate shareholders to receive a 100% dividend received dividend for dividends received from a foreign corporation.    There are three main requirements under Section 245A:

  1. Dividend must related to foreign earnings (i.e. dividends attributable to a US trade or business do not qualify)
  2. Shareholder receiving the dividend must own at least 10% in vote or value of the foreign corporation
  3. Shareholder must be a domestic corporation

As you can see from the requirements, the 100% dividend received deduction is only available to corporate shareholders.  Therefore, foreign corporation shareholders that are individuals, partnerships, S-Corporations will not qualify for the 100% dividend received deduction.   In the small to middle market space, we often see individuals or flow-through entities as shareholders of foreign corporations.  Since these types of shareholders will not be able to benefit from this aspect of the new tax legislation, a holistic review of the current structure may be needed.

Section 965 – Transition Tax  

As a way to transition to the participation exemption system, Section 965 requires the recognition of income, as subpart F income, for all undistributed earnings of a foreign corporation.  This provision applies to “the last taxable year…..which begins before January 1, 2018”, which means foreign corporations with 12/31/2017 year-ends are included.   Therefore, the transition tax will be applicable on the tax returns that are due April 18, 2018

At a very high level, the amount of the transition tax is calculated by taking the greater of E&P amounts on 11/2/2017 and 12/31/2017.  The amount of the E&P that is related to cash positions and liquid assets is taxed at 15.5% and the remaining is taxed at 8%.

The transition tax is applicable to US shareholder of a specified foreign corporation (“SFC”).  A US shareholder includes domestic corporations, partnerships, and individuals that own directly, indirectly, or constructively more than 10% vote or value of the foreign corporation.  A SFC is any controlled foreign corporation (“CFC”) or any foreign corporation with at least one domestic corporation as  US shareholder.

As you can see, the transition tax can apply to minority individual US shareholders of CFCs.   Therefore, it is important to have the conversation with your clients now about the potential impact of the transition tax on the 2017 tax return.  Also, additional budget should be incorporated to the tax return to factor in:

  1. E&P calculations on 11/2 and 12/31
  2. Review of liquid assets
  3. Calculation of the transition tax

Section 951A – Global Intangible Low-Taxed Income (GILTI)

The Tax Cuts and Jobs Act introduced a new form of subpart F income:  Global Intangible Low-Taxed Income, or GILTI.  The term “intangible” can be misleading, as the scope of GILTI covers a broad spectrum of income.  In general, Section 951A requires a US shareholder of any CFC to include GILTI in the shareholder’s gross income during the current year.  At a very high level, GILTI is defined as:  CFC’s net tested income less shareholder’s net deemed tangible income return.

  • Net tested income – With a very limited amount of exceptions, net tested income is any gross income of the CFC
  • Net deemed tangible income return – 10% of the CFC’s depreciable assets

In contrast to the Section 245A DRD, which is only applicable to corporations, GILTI is applicable to all US shareholders.  Therefore, an individual US shareholder in a CFC may be subject to GILTI.  Currently, US corporate shareholders are eligible for a deduction equal to 50% of GILTI, thus US corporate shareholders are able to achieve an effective tax rate of 10.5% on GILTI.  However, this deduction is only available to US corporate shareholders.   Furthermore, since GILTI is a form of subpart F income, GILTI will be taxed at the individual shareholder’s ordinary tax rate.   Note, however, an individual may make an election under Section 962 to be treated as a corporation for subpart F purposes.

I expect most CFCs that are in the consulting and IT industries to be impacted by GILTI due to the minimal amount of fixed assets required to operate the business.   Therefore, tax planning conversations should include the potential US tax impact of the CFC’s operations on a go forward basis and exploring ways to eliminate or minimize GILTI (i.e. check-the box election).   In additional, GILTI should also be factored into when performing estimated tax analysis.

Changes in Attribution Rules

The Tax Cuts and Jobs Act eliminated Section 958(b)(4).   As a result, a foreign corporation’s ownership in an affiliated foreign corporation may be attributed to a US shareholder.  For example, if a domestic corporation owns 9% of a foreign corporation (FC 1), and the remaining shares of FC1 is owned by the domestic corporation’s foreign parent, then FC 1 would be considered a SFC for purposes of the transition tax and also a CFC for purposes of GILTI.

The repeal of Section 958(b)(4) will have an impact on your inbound clients.  I recommend reviewing existing structures to see if any of your US shareholders who owns a minority stake in a foreign corporation can potentially be exposed to subpart F, GILTI, and the transition tax as a result of this change.

Other Notable Changes

  1. Subpart F rules
    1. Foreign base company oil-related income rule is repealed
    2. US Shareholder definition now includes 10% vote OR value (previously it was only vote)
    3. Elimination of 30-day minimum holding period for CFC
  2. BEAT – Based Erosion and anti-abuse tax
    1. This tax applies to corporations with average annual gross receipts of at least $500 million for the three-year period ending.  This is a tax that prevents US corporations from making deductible payments to foreign affiliates.
  3. Foreign Tax Credit
    1. Repeal of Section 902 indirect credit
    2. New separate basket for foreign branch income
    3. Change in the sourcing rules from sales of inventory – income from the sale of inventory produced partly in, and partly outside of the US, must be sourced based on where the inventory was produced (i.e. eliminate the 50/50 rule)