US Tax reform brought significant changes to how the US taxes income. As taxpayers start to digest the full range of the consequences of the new tax law, intended and unintended, here are a few high level considerations for international tax planning. Most provisions are effective for tax periods beginning on or after January 1, 2018. However, section 965 repatriation tax applies to the last taxable year beginning before January 1, 2018, which means the 2017 calendar year for most taxpayers.
In a major policy change, the Tax Cuts and Jobs Act replaces the long-standing worldwide tax regime for US corporate taxpayers with a limited territorial tax regime. Under the previous worldwide tax regime, US corporate shareholders claimed a foreign tax credit as the primary mechanism for alleviating double taxation of foreign subsidiaries’ earnings. Under the new territorial regime, corporate shareholders are entitled to a 100% dividend received deduction to alleviate double taxation of foreign subsidiaries’ earnings, resulting effectively in a US tax exemption for dividends received.
However, first, taxpayers are subject to the section 965 tax on previously untaxed foreign earnings. The section 965 tax is non-elective – any US shareholder (including an individual), of a specified foreign corporation is subject to the tax regardless of whether foreign earnings are repatriated (paid as dividends). The tax is imposed on previously untaxed post-1986 earnings and profits of specified foreign corporations. The tax rate is 15.5% for foreign earnings invested in cash and cash equivalents, and 8% for earnings allocable to non-cash assets. A reduced foreign tax credit is available to corporate shareholders. Taxpayers need to ensure that their earnings and profits and tax pool computations are accurate and consistent with new repatriation rules in section 965. The correct calculation and application of earnings deficits and allocation of earnings to non-cash assets present opportunities to minimize tax liability. These calculations differ from what taxpayers have done in the past, which means additional effort is likely to prepare the required calculations for the 2017 year.
The repatriation tax is reportable in 2017 US income tax returns. Generally, taxpayers may elect to remit payment in eight annual installments. The first installment, equal to 8% of the total, is due on or before the original filing due date (April 15, 2018 for corporate taxpayers). Shareholders of S corporations may elect to defer payment until there is a “triggering event,” which includes the sale or cessation of the business or termination of the S election.
With regard to entity planning, taxpayers should consider the classification of any foreign entities in which they have an interest. Tax reform has brought about a switch to a territorial system and structures that used to work under the worldwide system may now cause unintended tax consequences. Taxpayers should be mindful of the consequences of an outbound transfer of US property upon any reclassification of foreign entities. Taxpayers should examine any worthless stock deductions that may have arisen prior to the effective date of tax reform. Some US taxpayers organized as flow-thru entities, (S corporations, LLCs, and partnerships), may benefit from reorganizing as C corporations. Of course, this decision has US Federal and state and local tax implications.
Taxpayers may also wish to revisit their supply chains and intellectual property strategies. Tax reform has brought about a new minimum tax called the base erosion and anti-abuse (BEAT) tax, which requires companies that make cross-border payments to perform a completely new income calculation to assess the minimum tax. Taxpayers should also review foreign subsidiaries for potential high returns and consider consequences or possible changes to structures or transfer pricing to deal with the new tax on global intangible low-taxed income (GILTI) or foreign-derived intangible income (FDII). Many taxpayers in the technology and software industries with foreign operations are likely to have exposure to the GILTI tax.
Treasury management should be another focus of taxpayers as they evaluate the impact of tax reform. Specifically, the tax bill creates new limitations on the deduction of interest expense. In addition the BEAT tax effectively denies deductions for certain payments made to foreign related persons. Thus, taxpayers should review their capital structure to assess whether a change in the proportion of debt to equity is advantageous.
Taxpayers with international activities will face additional layers of complexity. Speaking with a tax advisor can provide much needed clarity and help taxpayers meet their immediate compliance obligations.
Bert Hawkins is a Partner and Jamison Sites is a Manager with RSM US LLP.
