Two of the major international changes of the TCJA of 2017 are:
Both were effective with tax returns beginning after December 31, 2017. During 2019, the IRS issued both final and proposed regulations as well as several notices regarding these provisions.
GILTI was designed to deter US-based multinational companies from “offshoring” intellectual property (IP) and other intangibles which generate non-US Source taxable income. GILTI is effectively a new form of immediate income inclusion, like Subpart F. GILTI income is essentially the income in excess of a 10% return on the adjusted basis of the fixed assets of a Controlled Foreign Corporation (CFC). C Corporations can reduce the GILTI income inclusion by 50% under IRC Section 250, and then claim 80% of the related foreign taxes paid as a Foreign Tax Credit (see below as well). Non-C Corporation owners of CFCs cannot claim either the Section 250 50% reduction in GILTI income or the 80% Foreign Tax Credit. Taxpayers subject to GILTI should consider three alternatives for ameliorating the tax impact:
In June 2019, a GILTI High-Tax Exception was proposed. If finalized, this may provide relief to taxpayers conducting business in high tax jurisdictions in future years (note: not applicable for the 2018 tax year). At the election of the taxpayer, income subject to a tax rate greater than 18.9% in the host country could be excluded from the GILTI inclusion. If a taxpayer has GILTI from multiple jurisdictions, this election should be made carefully.
An individual taxpayer should review making an IRC Section 962 Election to be taxed for purposes of a foreign entity as a C corporation. This election has been overlooked previously, but with the advent of the GILTI, there is renewed interest in and benefit from making such an election. If a foreign company is subject to tax at a rate of at least 13.125%, making this election may be beneficial. The election would allow a beneficial tax result to a US individual taxpayer without interposing a C Corporation into the ownership structure.
If an individual US taxpayer owns a business operating in a non-high tax, non-treaty country, creating a US C corporation holding company may be an appealing way manage (reduce) the world-wide effective tax rates by both reducing the GILTI impact as well as converting non-qualified dividends from a non-treaty country into qualified dividends. As GILTI is imposed as of the CFC’s year-end, restructuring must be completed prior to the taxpayer’s year-end including the CFC’s year.
The FDII Provisions provide a tax benefit to C Corporations with sales of goods or services to foreign customers (located outside the US). FDII was designed to encourage on-shore development of Intellectual Property (IP) and other intangibles while discouraging “off-shoring” of the same. The actual FDII calculation can be cumbersome, but it mirrors the GILTI inclusion, allowing a reduced rate of tax on foreign income in excess of 10% of the corporation’s adjusted basis of depreciable assets. The FDII deduction can effectively reduce a corporation’s federal tax on foreign earnings from 21% to 13.125%. Please note that the World Trade Organization may challenge the FDII deduction claiming that it is an unfair subsidy favoring US corporations and the regime therefore violates International Trade Law.
In November 2018, the IRS issued proposed regulations regarding Foreign Tax Credits. The long and complex provisions were necessary due to the new participation exemption/territorial system of taxation and GILTI regime. The proposed regulations deal with issues such as:
While the IRC Section 965 Deemed Repatriation/Transition Tax was effective December 31, 2017, many businesses and individuals are required to continually report the deemed repatriation over the 8 years of deferral – in fact, Forms 965 were introduced for the 2018 tax year and will need to be filed for the duration of the recognition period. The IRS has announced it will be reviewing the Earnings & Profits computations from which the Deemed Dividend Repatriation was calculated. If taxpayers have not yet disclosed their Deemed Repatriation, doing so immediately via an amended 2017 return is recommended. Note, the time to elect to defer the tax over 8 years has expired.
The whole world is changing! The Digital Economy is outpacing tax reforms (and will continue to do so). We expect the IRS will provide more guidance and clarifications in the coming year. The World Trade Organization and the Organization for Economic Cooperation and Development will provide input on not just US tax issues, but on world-wide tax regimes and schemes as the Base Erosion and Profit Shifting Action items continue be implemented in full.
At Withum, we will continue to provide proactive, accurate and efficient international tax solutions in this ever evolving and ever-changing global environment.