International Tax Overview: Moving Forward with Tax Cuts and Jobs Act (TCJA)
The international tax environment remains to be transformed by what feels like a continuous onslaught of new regulations, making your compliance to these rules as questionable as a Game of Thrones prophecy. Since the enactment of the Tax Cuts and Jobs Act (TCJA) on December 22, 2017, the U.S. Treasury Department (Treasury) and the Internal Revenue Service (IRS) issued numerous regulations and guidance which have certainly impacted many taxpayers. The following overview highlights significant regulations which will continue to transform the international tax environment for certain multi-national and foreign corporations and their shareholders.
- Global Intangible Low Tax Income (GILTI) – Proposed Regulations under Section 951A
- Foreign Derived Intangible Income (FDII) – Proposed Regulations under Section 250
- Investment of Earnings in United States Property – Proposed Regulations under Section 956
- Base Erosion & Anti-Abuse Tax (BEAT) – Proposed Regulation under Section 59A
- Transition Tax/Repatriation Tax – Final Regulations under Section 965
Global Intangible Low Tax Income (GILTI)
The Treasury and the IRS provided guidance on GILTI on September 13, 2018. GILTI and FDII (explained below) are part of the Treasury’s “Carrot-and-Stick” approach for international tax reform. Fundamentally, GILTI requires a deemed inclusion of income for using intangible property outside the United States, and FDII provides a tax benefit for the use of intangible property within the United States.
- 10%-or-more U.S. shareholders of controlled foreign corporations (CFCs) must include in income their share of GILTI.
- GILTI is determined using a complex formula but is essentially computed by applying 10% return to certain tangible assets (referred to as a qualified business asset investment, or QBAI). Any excess is treated as GILTI.
- GILTI applies to corporations, flow-through entities (Partnerships, S Corporations), and individuals.
- In the proposed regulations (explained below), only corporations and individuals making a 962 election may claim a special deduction of 50% of GILTI (37.5% for tax years starting after 2025).
A Controlled Foreign Corporation (CFC) is any foreign corporation in which US shareholders own more than 50% of the corporation’s stock on any day during the foreign corporation’s tax year.
Foreign Derived Intangible Income (FDII)
Proposed regulations for FDII were provided by the Treasury and IRS on March 4, 2019. The “Carrot” – FDII is a new benefit which allows a permanent deduction of 37.5% against a new category of intangible income. It is important to note that to qualify for the FDII deduction, it does not necessarily mean a corporation has to have intangible income from intangible assets such as patents and trademarks.
- Like GILTI, the formula for FDII is highly complex. For the purposes of FDII, deemed intangible income is essentially determined by applying a 10% fixed rate of return on a corporation’s qualified business asset investment (QBAI). Any foreign source income in excess is deemed to be generated by intangible assets.
- This export incentive effectively reduces the tax on foreign derived sales and service income base amount to 13.125% (as compared to the regular corporate income tax rate of 21%).
- Under the proposed regulations, FDII currently only applies to C corporations, including U.S. subsidiaries of foreign-based multinationals that are taxed in the U.S. as C corporations.
Investment of Earnings in United States Property
On October 31, 2018, the Treasury and IRS issued proposed regulations that closed some tax traps which impacted U.S. shareholders of a CFC. Prior to the proposed regulations, an inclusion of deemed income could occur if the earnings of a foreign subsidiary were effectively invested in U.S. property. Investment in U.S. property could be triggered by intercompany borrowings, guarantees, or even pledges. The IRS viewed these transactions as substantially equivalent to the repatriation of foreign earnings. This created a disparity with the new Section 245A deduction enacted by TCJA that allows a 100% deduction for actual distribution from a CFC for tax years beginning after December 31, 2017. To achieve the desired intent, the proposed regulations provide that the amount determined under Section 956 is reduced to the extent that the U.S. shareholder would be allowed a deduction under Section 245A if the U.S. shareholder had received an actual distribution from the CFC in an amount equal to the inclusion amount determined under Section 956, generally resulting in no income inclusion.
Base Erosion & Anti-Abuse Tax (BEAT)
On December 13, 2018, the Treasury and IRS issued proposed regulations on BEAT, another “Stick” in the Treasury’s approach to global tax reform. This new form of minimum tax applies to large multinational corporations that meet the following two thresholds:
- Average annual gross receipts of $500,000,000 for the prior three-year period; and
- A base erosion percentage of at least 3% (2% in the case of banks and securities dealers).
BEAT is equal to 10% of the taxpayer’s “modified taxable income” (5% for 2018; 12.5% after 2025), less a portion of certain tax credits. Once a taxpayer has determined that BEAT is applicable, the tax computed under BEAT is compared to the taxpayer’s regular tax liability. If BEAT is higher, the taxpayer pays the additional tax computed under BEAT.
On January 15, 2019, the Treasury and IRS issued highly anticipated final regulations regarding the transition tax provision added to the Code by the TCJA which has been impacting taxpayers since 2017. Although the final regulations mainly follow the proposed regulations which taxpayers have had since August 9, 2018, there are some notable changes.
- Determining the aggregate foreign cash position of a consolidated group by treating the consolidated group as a single U.S. shareholder.
- Treating certain changes in method of accounting (i.e., those that would result in an increase in the Section 965(a) inclusion amount) as regarded for Section 965 purposes.
- Taking only actual Section 956 inclusions into consideration in the “without” calculation when calculating the net tax liability for purposes of the installment election under Section 965(h).
- Clarifying the inclusion ordering rules, including for Section 1248 amounts and amounts paid between CFCs that are disregarded for Section 965 purposes.
These international tax provisions are highly complex and will likely continue to increase the tax compliance burdens for even the simplest corporations with foreign operations and their shareholders. As part of a 3-part series, we will continue to examine the implications of these regulations in detail and the significant changes which have been made since the enactment of the Tax Cuts and Jobs Act (TCJA).
Article written by Daniel Waszkiewicz. If you have any questions about how these international tax provisions will impact you please contact us below: