The international tax provisions of United States tax laws were expanded and modified by the Tax Cuts and Jobs Act ("TCJA"), which was signed into law on December 22, 2017. The changes provide for a complicated maze of rules for multinational corporations, by adding to an already quite complex landscape.
For the past year and a half US taxpayers and tax practitioners have been acclimating to the new law and quickly trying to absorb the thousands of pages of new Treasury regulations that have been, and are still being, released. Taxpayers have had to perform careful analyses of the impacts of TCJA on their international structures, with continued updates needing to be made as more Treasury regulations are released.
International Tax Changes
Although some changes were well received, such as the lowering of the corporate income tax rate from 35 percent to 21 percent and elimination of the corporate alternative minimum tax (AMT), some international tax provisions resulted in much angst, including the tax on "global intangible low-taxed income" (GILTI) discussed below. While the TCJA was being publicized as a change to a territorial tax system due to the inclusion of a participation-based exception in the new US Internal Revenue Code section 245A, it really introduced a worldwide tax system with foreign subsidiaries' earnings being subject to a US minimum tax. US companies had an inclusion that was required under section 965 (the transition tax) and will continue to have inclusions under GILTI and subpart F.
The Treasury and IRS have been active in releasing regulations, with most being related to the TCJA and some being published as a result of the IRS's overall approach of decreasing and updating pre-TCJA regulations. Each set of regulations has its own effective date rules. The intricacies of effective dates adds to the complexity of analyzing the interplay of various regulations.
One-Time Transition Tax
One of the TCJA provisions that resulted in immediate impact was the amendment of section 965, the transition tax. The transition tax was intended to transition the US tax system to a "territorial" tax system with tax-free repatriation of foreign profits under section 245A, which as noted is generally limited to amounts that would not have otherwise been taxed in the United States as subpart F income or GILTI. The transition tax generally resulted in a one-time immediate tax on previously deferred offshore earnings of US taxpayers.
While the transition tax amounts were already due, virtually all taxpayers elected to pay them in installments. Certain transactions, including the sale of assets of the US taxpayer, can trigger an acceleration of these installments and, thus, an immediate inclusion of the section 965 liability. However, an agreement can be entered into to allow for the continuation of the installment payment treatment. As a result, it is important to identify situations when a section 965 liability may be triggered, such as a liability of a target prior to a merger, so an agreement can be timely entered into to avoid an immediate lump-sum inclusion.
The TCJA includes a new section 951A that requires a US shareholder to include in its income as GILTI income of a CFC that exceeds a certain return on tangible assets. GILTI is subject to a reduced effective tax rate of 10.5 percent with an allowance for foreign tax credits, although the foreign tax credit rules have become somewhat complicated under proposed Treasury regulations. The included income, or tested income, is treated as subpart F income and is deemed to be currently distributed to a CFC's 10 percent US shareholders.
As a result of this change to the TCJA, generally much of a CFC's income is currently included by a US corporate holder either as subpart F or GILTI, with little, if any, being subject to the dividends received deduction under section 245A unless the CFC has a lot of tangible assets.
An Export Incentive
The TCJA includes a new code section that results in a taxable rate of approximately 13.125 percent, rather than 21 percent, on foreign derived intangible income ("FDII"). FDII is generally foreign source income earned by a domestic US corporation from selling property to a foreign person for foreign use or from providing services to persons located outside of the United States or with respect to property located outside of the United States. Notably, this export incentive is limited by the domestic corporation's taxable income.
The proposed Treasury regulations that were released in March 2019 provide that FDII can only be taken advantage of if numerous documentation requirements are met by the domestic corporation. As a result, any domestic corporations with foreign activities that qualify for the FDII deduction should carefully review these requirements, some of which are quite burdensome and may require requesting information from or amendment of contracts with foreign purchasers or service recipients.
Minimum Tax on Base-Erosion Payments
To curb the use of "base-erosion payments," a new section 59A was enacted as part of the TCJA and operates as an alternative minimum tax on US corporations that have average annual gross receipts of at least $500 million during the preceding three tax years and have a "base erosion percentage," or generally the percentage of its deductions that are "base erosion payments," of at least 3 percent during the current year. This base-erosion and anti-abuse tax ("BEAT") largely applies with respect to "base erosion payments" at a rate of 5 percent for 2018 and 10 percent starting in 2019.
Generally, base erosion payments increase the base erosion percentage. Base erosion payments most commonly include payments that are made to a foreign related party, generally determined with 25 percent ownership overlap, for which the taxpayer can take a current deduction and deductions for amortization or depreciation allowable to a taxpayer from a purchase of property from a foreign related party. The proposed Treasury regulations define "purchase" in a very broad manner to include deemed stock payments for property in otherwise tax-free transactions such as a section 351 capital contribution by a shareholder who owns 100 percent of the foreign corporation and in a section 368 tax-free reorganization. As a result, multinational corporations need to consider any BEAT impacts of internal restructurings or post-acquisition reorganizations that prior to the TCJA might have been standard practice.
Business Interest Deduction Limitation
Changing to conform with many European countries, the TCJA includes a new section 163(j) that limits annual business interest deductions to 30 percent of a US taxpayer's adjusted taxable income (ATI). The proposed Treasury regulations that were released in November 2018 address two important key questions: (1) whether and how section 163(j) applies to CFCs' tested income and subpart F income, and (2) how inclusions from CFCs affect a US corporation's section 163(j) limitation. The proposed regulations generally provide that a CFC is subject to section 163(j) when computing its tested income and subpart F income. In addition, the proposed regulations state that a special "grouping election" can be made to eliminate interest income and expense on debt between CFCs and include GILTI and subpart F in a US taxpayer's ATI, which typically results in an increase in the section 163(j) limitation. However, the grouping election is irrevocable.
Not only has the international tax landscape after the TCJA changed dramatically, it continues to change with the continued release of proposed and final Treasury regulations almost on a weekly basis. For example, final Treasury regulations were released in May 2019 that effectively repealed section 956 for corporations, a section that was not amended by the TCJA. Section 956 resulted in an inclusion similar to subpart F if a CFC held certain US property, such as loans to a US shareholder or stock in a US corporation. With important changes occurring via regulations, a quick interpretation of new Treasury regulations is key to understanding whether and how they might impact or update a multinational corporation's tax analysis.