The U.S. House and Senate are moving quickly on The Tax Cuts and Jobs Act, with the intention of getting legislation enacted by the end of this year. On Nov. 9, the House Ways and Means Committee approved legislation with a full House vote expected this Thursday. On Nov. 13, the Senate Finance Committee began the mark-up process of its version of the bill. The House floor vote on the Tax Cuts and Jobs Act is expected to occur on November 16, 2017, at some point following an address by President Trump to a House Republican Conference meeting. We are monitoring the progress of the legislation and tracking revisions as they are made public
The Tax Cuts and Jobs Act contains significant changes to international taxation with regard to the tax treatment of U.S. corporations that own foreign corporations. These include a repatriation provision and a corresponding provision exempting from U.S. tax dividends that U.S. corporations receive from foreign subsidiaries. Most of the effective dates for the provisions are for tax years beginning after Dec. 31, 2017.
The following provides an overview of the international tax reform proposals, and some of the differences between House and Senate proposals.
- S. shareholders owning at least 10% of a foreign subsidiary will include in income for the subsidiaryshareholder’s pro rata share of the net post-1986 historical earnings and profit (E&P) of the foreign subsidiary, determined as of Nov. 2, 2017, or Dec. 31, 2017 (whichever is higher).
- Portion of E&P attributable to cash or cash equivalents would be taxed at a 14% rate, up from 12% in the original House bill; the remainder (E&P that have been reinvested in the foreign subsidiary’s business) would be taxed at a 7% rate, up from 5%f in the original House bill.
- S. shareholders can elect to pay the tax liability over eight years in equal annual installments of 12.5% of the total tax due.
- Moves to a territorial system with base-erosion rules that include 50% of excess returns by controlled foreign corporations in U.S. shareholders’ income, and an excise tax on payments made to foreign firms unless they are claimed as effectively connected income.
Deduction for Certain Dividends From Foreign Subsidiaries
- 100% of the foreign-source portion of any dividend received from a specified 10%-owned foreign corporation by a domestic corporation that is a U.S. shareholder of that foreign corporation would be exempt from U.S. taxation
- Effective for distributions made after 2017
Limitation on Losses
- For purposes of determining the amount of a loss of any sale or exchange of the foreign subsidiary, a U.S. parent would reduce the basis of its stock in that subsidiary by the amount of any exempt dividends received by the parent from its foreign subsidiary.
- Requires a U.S. corporation that transfers substantially all of the assets of a foreign branch to a foreign subsidiary to include in the U.S. corporation’s income the amount of any post-2017 losses that were incurred by the branch.
- Effective for distributions or transfers made after 2017.
Subpart F Rule: Modifications
- S. corporation would be treated as constructively owning stock held by its foreign shareholder for purposes of determining controlled foreign corporation (CFC) status, which generally requires greater than 50 percent stock ownership.
- Eliminates requirements that a U.S. parent corporation must control a foreign subsidiary for 30 days before Subpart F inclusions applies.
- Makes Sec. 954(c)(6) lookthrough rule permanent for tax years after 2019.
- (The lookthrough rule provides that the passive income one foreign subsidiary receives from a related foreign subsidiary generally is not includible in the taxable income of the U.S. parent, provided that the income is not subject to current U.S. tax or effectively connected with a U.S. trade or business.)
Repeal of Section 956 for Domestic Corporations
- Currently, a U.S. shareholder of a CFC must include in annual income its pro rata share of any U.S. property held by a CFC for any tax year, as defined by Section 956. The House bill would repeal this provision for domestic corporations beginning after Dec. 31, 2017.
The international provisions of the Senate tax reform proposal are broadly similar to the House version, although with several significant exceptions. Some of these include:
- Proposes lower rates of 10% for earnings treated as held in the form of cash and cash equivalents; and a five percent on other earnings.
- The eight-year payment for the transition tax is back-loaded with payments escalating over the eight years, unlike the ratable payment under the House bill.
- Changes to the definition of intangible property and its expansion of the IRS’s ability to apply aggregation and “realistic alternatives” theories would allow the IRS to pursue transfer pricing theories that have been repeatedly rejected by the courts, and would introduce further uncertainty into the application of the arm’s length standard; the House bill includes no such proposal.
- Moves to a territorial system with anti-abuse rules and a base erosion minimum tax of the excess of 10% of modified taxable income over an amount equal to regular tax liability.
Deduction for Foreign-Source Portions of Income
- Provides for an exemption for certain foreign income by means of a 100% deduction for the foreign-source portion of dividends received from specified 10% owned foreign corporations by domestic corporations that are U.S. shareholder of those corporations
- Tax credits and deductions excluded under certain circumstances
Termination of the Domestic International Sales Corporations (DISC) Rules
- Repeals the Code rules for DISCs and interest charge domestic international sales corporations (IC-DISCs)
- Terminates any corporate election to be treated as a DISC that is in effect for the corporation’s last tax year beginning in 2018
These tax proposals would have an immediate and wide-ranging impact on the taxation of foreign earnings. The taxation of foreign earnings, while at a lower rate, could have a significant impact on cash flow. The International Tax Group can assist with investigating current structures (corporate, S corporation, partnership, etc.) in anticipation of the new tax laws.