The U.S. House and Senate approved, and President Trump signed into law, an amended version of the Conference Agreement to the “Tax Cuts and Jobs Act” (also known as “H.R. 1” or the “Act”) on December 22, 2017. As the most significant federal tax law reform in over 30 years, the Act is a complete overhaul of the U.S. international tax system, which includes the following major provisions.
Participation Exemption System
The Act provides an exemption from U.S. tax of certain foreign income, including a 100% exemption of the foreign-source portion of dividends received by a U.S. corporation from a related foreign corporation, in which the U.S. corporation owns at least a 10% stake. The provision requires a holding period of more than one year in the stock of the foreign corporation and is subject to certain exceptions.
The deduction is not available for capital gains or directly-earned foreign income.
Deemed Repatriation of Foreign Earnings
The final legislation provides for a mandatory one-time transitional tax on a U.S. 10% shareholder’s pro rata share of the foreign corporation’s post-1986 tax-deferred earnings, at the rate of either 15.5% (in the case of accumulated earnings held in cash, cash equivalents or certain other short-term assets) or 8% (in the case of accumulated earnings in excess of the amount of the cash, e.g., property, plant and equipment). A foreign corporation’s post-1986 tax-deferred earnings are to be measured as the greater of its earnings on November 2, 2017 or December 31, 2017, without diminution by dividends distributed in its last tax year beginning before 2018.
U.S. shareholders subject to the repatriation tax may elect to pay the net tax liability in eight installments (8% in each of the first 5 years, 15% in year six, 20% in year 7, and 25% in year 8). A special rule is provided for S corporations, allowing continued deferral of the transition tax liability, unless a specified "triggering event" occurs (e.g., loss of S status, liquidation, or transfer of shares).
Global Intangible Low-Taxed Income (GILTI)
The Act includes anti-base erosion rules for intangible income that impose tax on a U.S. shareholder’s aggregate net controlled foreign corporation (CFC) income that is treated as global intangible low-taxed income (GILTI).
The anti-base erosion regime operates like a global minimum tax, with an exemption for certain earnings attributable to a routine return on tangible, depreciable assets. The tax is imposed on a current basis, at a full 21% rate, subject to a 50% deduction. The tax can be offset by a reduced (limited to 80%) foreign tax credit. As a result, an overall foreign effective tax rate of at least 13.125% generally will prevent the imposition of residual U.S. tax. The 50% GILTI deduction is reduced after 2025 from 50% to 37.5%.
Foreign Derived Intangible Income Deduction
The new law provides a deduction for certain foreign-derived intangible income; a variation of the so-called "Patent Box” benefit provided by other countries.
Domestic corporations are allowed a deduction against foreign-derived intangible income of 37.5% initially, reduced to 21.875% for tax years beginning after December 31, 2025. The deduction will result in a 13.125% effective tax rate on foreign-derived intangible income.
Base Erosion and Anti-Abuse Tax (BEAT)
The new law adopts BEAT by imposing a new minimum tax at a rate of 10% (5% for 2018). If certain thresholds are met, the “base erosion minimum tax” will be levied on an applicable taxpayer’s taxable income determined without regard to certain deductible amounts paid or accrued to foreign related persons; depreciation or amortization on property purchased from foreign related persons; and certain reinsurance payments to foreign related persons.
BEAT is generally not applicable to cross-border purchases of inventory includible in cost of goods sold. Generally, a 5% rate will apply for 2018, the 10% rate will apply for tax years after December 31, 2018 and beginning before December 31, 2025, and a 12.5% rate will apply thereafter, though a 6%, 11% and 13.5% rate will apply respectively for banks and registered securities dealers.
BPM is Here to Assist You
The Tax Cuts and Jobs Act has changed the international tax landscape and the manner in which companies will conduct foreign business transactions going forward. We encourage you to work with BPM’s international tax professionals to understand how these changes specifically affect your company’s business operations. For additional information, please contact one of the following BPM International Tax Partners: Doug Wright at (925) 296-1044 or Alex Waniek at (408) 961-6367.