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International Tax Reform
March 19, 2018
Nicole R. Suk, CPA
Why International Reform?
• Shift to territorial system
• Protect the U.S. tax base from perceived cross-border erosion
• Incentive for economic investment in the U.S.
Agenda
• Transition Tax
• Foreign Source Dividends
• Global Intangible Low Taxed Income
• Foreign Derived Intangible Income
• Base Erosion Anti-Abuse Tax (BEAT)
• Interest Deduction Limitation
• Anti-Hybrid Rules
Transition Tax
• §965 Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation.
• Effective after December 21, 2017 – Report on 2017 tax returns.
• “Deemed” repatriation of earnings.
• Treats deferred foreign income as subpart F income unless already previously taxed.
Transition Tax
Who is Subject?
• U.S. “persons” owning at least 10% of a specified foreign corporation (SFC).
• Definition of U.S. shareholder changed.
• Specified Foreign Corporation includes
– Any CFC
– Any foreign corporation which has a U.S. corporate shareholder that owns at least 10% of the stock.
• For 2017 report SFCs on Form 5471.
Transition Tax
Who is not subject?
• U.S. individuals owning greater than 10% each, but less than 50% collectively – not a CFC or SFC.
• Shareholders in PFIC corporations, even if own greater than 50%.
Transition Tax
US Individuals or Corporation
Foreign Corporation
≥50%
Required to pay transition tax
Transition Tax
US Individual(s)
Foreign Corporation
49%
NOT Required to pay transition tax
Foreign Individuals or Corporation
51%
Transition Tax
US Individual
Foreign Corporation
10%
Foreign Individuals or Corporation
80%
10%
Required to pay transition tax
US Corporation
Transition Tax• S Corporation exception - S corporation owners may
elect to defer tax liability until triggering event:
– Ceases to be an S corporation
– Liquidates or sells assets
– Ceases business; or
– Shareholder transfers shares of stock
• Any net tax liability payment of which is deferred under the election shall be paid in the tax year of the triggering event.
Transition TaxFour Step Process
1. Inventory the entities that must be analyzed.
2. Determine the amount of income (E&P) subject to the transition tax.
3. Compute how much of the E&P relates to cash assets.
4. Calculate the transition tax.
Transition Tax
• Subpart F income inclusion for E&P determined on November 2, 2017 or December 31, 2017 (greater amount).
• May be reduced by foreign E&P deficits that are properly allocable to that person.
• E&P reduced by previously taxed income.
• Not reduced by dividends paid during transition year except to other SFCs.
Transition Tax
• Deduction allowed based on two measurements: the US shareholder’s “aggregate foreign cash position amount” and the aggregate E&P held in other assets.
• Taxed at shareholder’s 2017 rate.
• Effectively reduces tax rates to 15.5% and 8% respectively for corporations in 35% rate bracket.
Transition Tax• FTCs otherwise available disallowed in amount of
55.7% for cash portion & 77.1% for noncash portion.
• May use U.S. NOL against 965 income or elect to forgo use of NOL.
Transition TaxSample calculation
CFC1 SFC1
Nov 2 E&P $1,500 $2,400
Dec 31 E&P $1,300 $2,500
Greater of tested amounts $1,500 $2,500
Total US 965 inclusion $4,000
• Deductible intercompany payments may be eliminated from E&P under Notice 2018-07 to avoid double counting in E&P.
Transition TaxSample calculation
Form 5471
Cash $3,000
A/R $1,500
Inventories $2,000
Net PPE $500
Total Assets $7,000
Liabilities $2,000
Equity $5,000
Accumulated E&P $4,000
965 inclusion $4,000
Aggregate cash position $4,500
Exceeds 965 inclusion
965 Inclusion $4,000
965 Deduction (55.7%) (2,228)
965 Deduction (77.1%) (0)
Net 965 Income $1,772
Tax at 35% $620
Effective Tax Rate 15.5%
Transition TaxSample calculation
Form 5471 CFC
Cash $2,000
A/R $1,500
Inventories $2,000
Net PPE $1,500
Total Assets $7,000
Liabilities $2,000
Equity $5,000
Accumulated E&P $4,000
CFC
965 inclusion $4,000
Aggregate cash position $3,500
Does not exceed 965 inclusion
965 Inclusion $4,000
965 Deduction (55.7%) (1,950)
965 Deduction (77.1%) (385)
Net 965 Income $1,665
Tax at 35% $583
Effective Tax Rate 14.6%
Transition Tax
• May elect to pay tax over 8 years
– 8% first five years; 15% in 6th year; 20% in 7th year; 25% in 8th year.
• If business is sold – all remaining installments must be paid on final tax return.
Transition Tax
Reporting
• Required to include an “IRC 965 Transition Tax Statement” in 2017 return.
• Elections must be made by due date of return, including extensions.
• Payment must be made separately from regular tax.
• Partnership, S corps and other pass through entities must attach statement to K-1s.
• Amend if a return has already been filed for 2017.
Transition Tax
Form965(a) Income
965(c) Deduction FTC Tax Liability
1040 Net inclusion -Page 1, Line 21 other income –write “Sec 965” on dotted line
Net with income
Report on Form 1116
Add total tax to Page 2, Line 44, Tax, Check box ‘c’ on Line 44 and write 965 to the right of the box.
Include as credit in total on Page 2, Line 73 the amount to be paid in installments for years beyond the 2017 year, if applicable. Check box ‘d’ on Line 73 and write TAX to the right of the box
Transition Tax
Form965(a) Income
965(c) Deduction FTC Tax Liability
1120 Do not enter on return –only reported on IRC 965 statement
Do not enter on return –only reported on IRC 965 statement
Not reported on 1118 -Report on IRC 965 Transition Tax Statement
Include in total on Page 3, Schedule J, Part I, Line 11 net tax liability under section 965.Include in total on Page 3, Schedule J, Part II, Line 19d the amount to be paid in installments for years beyond the 2017 year, if applicable.
Transition Tax
Form 965(a) Income 965(c) Deduction FTC Tax Liability
1120S Page 3, Sch K, Line 10 “Other Income”
Page 3m Sch K, Line 12d “Other Deductions”
N/A N/A
1065 Page 4, Sch K, Line 11 “Other Income”
Page 4, Sch K, Line 13d “Other Deductions
N/A N/A
Transition TaxNotice 2018-07 provides additional guidance on:
• Determining aggregate foreign cash position
• Determining accumulated post-1986 deferred foreign income
• Applying basis adjustment to repatriated amounts treated as subpart F income
• Consolidated group effects
• Determining foreign currency gain or loss
Foreign Source Dividends
• For dividends paid after December 31, 2017.
• 100% deduction for “foreign-source portion” of dividends received from “specified 10-percent owned foreign corporations”.
• Specified foreign corporations do not include PFICs.
• Only available to U.S. C corporations other than RICs and REITS.
Foreign Source Dividends
• Subject to a one-year holding period.
• No foreign tax credit (or deduction for foreign taxes paid with respect to qualifying dividends) permitted.
• Deduction would be unavailable for “hybrid dividends.”
• Does not apply to income from foreign branches.
Global Intangible Low Taxed Income• New IRC § 951A
• Imposes a foreign minimum tax on U.S. shareholder’s allocable share of “GILTI” from CFCs.
• Any 10% U.S. shareholder (individual or corporate) of a CFC must include in gross income its “global intangible low-taxed income” in a manner similar to a subpart F income.
Global Intangible Low Taxed Income• GILTI is low-taxed income of a CFC that exceeds 10%
return on capital invested in tangible depreciable property used in a trade or business.
• Does not include amounts otherwise included in subpart F.
• The GILTI computation is calculated at the shareholder level.
• Income in one CFC can be offset by losses in another CFC if there is a common shareholder.
Global Intangible Low Taxed Income
GILTI Calculation:
Step 1: Calculate CFC’s “tested” income
CFC’s total gross income
Less: CFC’s U.S. ECI
Less: CFC’s Subpart F Income
Less: CFC’s dividends from related persons
Less: CFC’s foreign oil and gas extraction income
Less: other deductions including taxes
CFC tested income
Global Intangible Low Taxed Income
GILTI Calculation:
Step 2: Calculate the Qualified Business Asset Investment (QBAI)
QBAI is the quarterly average tax basis (using SL depreciation) of depreciable tangible property used in the production of the relevant income/loss.
Global Intangible Low Taxed Income
GILTI Calculation:
Step 3: Calculate the Net Deemed Tangible Income Return
10% of QBAI
Less: The net amount of interest expense taken into account in determining net tested income
Net Deemed Tangible Income Return
Global Intangible Low Taxed Income
GILTI Calculation:
Step 4: Calculate GILTI
Tested Income (Step 1)
Less: Net Deemed Tangible Income Return (Step 3)
GILTI
Global Intangible Low Taxed Income
• Deduction allowed for C corporation U.S. shareholders only.
– 50% of GILTI – creates effective tax rate of 10.5% on GILTI
– Decreases to 37.5% for years after 2025 –13.125% effective tax rate
• Foreign tax credits are available but are limited to the 80% of taxes paid and cannot be carried back or carried forward like other foreign tax credits. Only available for C corporations.
Global Intangible Low Taxed Income
Example Corp 1 Corp 2 Individual
Net income pre tax $1,000 $1,000 $1,000
Foreign tax rate 20% 5% 20%
Foreign tax 200 50 200
Tested Income 800 950 800
Asset tax basis (QBAI) 4,500 4,500 4,500
GILTI:
Tested income 800 950 800
10% QBAI (450) (450) (450)
GILTI $350 $500 $350
Inclusion % (GILTI/Tested Income) 43.75% 52.63% 43.75%
§78 Gross up (inclusion % * tax) $88 $26 $88
Global Intangible Low Taxed Income
Example Corp 1 Corp 2 Individual
GILTI $350 $500 $350
§78 Gross up 88 26 88
Total GILTI inclusion 438 526 438
50% GILTI deduction (219) (263) -
Taxable income 219 263 438
US tax rate 21% 21% 37%
US tax $46 $55 $162
FTC (80%) (160) (40) -
Net US Tax $0 $15 $162
Net Global Taxes $200 $65 $362
Global ETR 20.0% 6.5% 36.2%
Foreign Derived Intangible Income
• Known as the FDII deduction.
• Represents the portion of a domestic corporation’s income derived from serving foreign markets.
• Creates a preferential tax rate for domestic C corporations serving foreign markets.
• S corporations and individuals are not eligible for the deduction.
• Creates disincentives for movement of IP outside the U.S.
Foreign Derived Intangible Income
• Includes income derived from the sale of property to any foreign person for a foreign use.
• The term “sale” is specially defined for this purpose to include any lease, license, exchange or other disposition.
• “Foreign use” is defined to mean “any use, consumption, or disposition which is not within the United States.”
• Special rules for sales to related foreign persons.
Foreign Derived Intangible Income
• Eligible C corporations are allowed a deduction equal to 37.5% of FDII for tax years 2018-2015 and 21.875% for years after.
– Reduces the effective U.S. tax rate for eligible C corporations on foreign income treated as attributable to IP and other intangible assets to 13.125% versus 21%.
Foreign Derived Intangible Income
Deemed Intangible X Foreign Derived Deduction Eligible Income Income Deduction Eligible Income
Deductible Eligible Income = total gross income of the corporation without regard to subpart F income, GILTI, dividends received from 10% owned CFC and foreign branch income; reduced by deductions including taxes allocable to such gross income
Foreign Derived Deduction Eligible Income = DEI considered foreign derived if it is connection with property sold to a non—U.S. persons for foreign use, or services provided to any person or property outside the U.S.
Foreign Derived Intangible Income
Deemed Intangible X Foreign Derived Deduction Eligible Income Income Deduction Eligible Income
Deemed Intangible Income = DEI reduced by 10% of the qualified business asset investment
Foreign Derived Intangible Income
Example: Assume U.S. company has:
• Net taxable income of $1,000,000
• Foreign derived portion of $200,000 (20%)
• Qualified business asset basis of $2,500,000
Deductible Eligible Income (DEI) $1,000,000
Deemed Intangible Income (DII) $1,000,000 – ($2,500,000 x 10%) $750,000
FDII $750,000 X ($200,000 / $1,000,000) $150,000
FDII Deduction $150,000 x 37.5% ($56,250)
Net FDII Income $150,000 - $56,250 $93,750
Tax on FDII $93,750 x 21% $19,688
Tax on non-FDII ($1,000,000-$150,000) X 21% $178,500
Total U.S. Taxes $178,500 + $19,688 $198,188
Overall ETR $198,188/$1,000,000 19.82%
Foreign Derived Intangible Income
Example: Assume U.S. company has:
• Net taxable income of $1,000,000
• Foreign derived portion of $800,000 (80%)
• Qualified business asset basis of $2,500,000
Deductible Eligible Income (DEI) $1,000,000
Deemed Intangible Income (DII) $1,000,000 – ($2,500,000 x 10%) $750,000
FDII $750,000 X ($800,000 / $1,000,000) $600,000
FDII Deduction $600,000 x 37.5% ($225,000)
Net FDII Income $600,000 - $225,000 $375,000
Tax on FDII $375,000 x 21% $78,750
Tax on non-FDII ($1,000,000-$600,000) X 21% $84,000
Total U.S. Taxes $78,750 + $84,000 $162,750
Overall ETR $162,750/$1,000,000 16.28%
Base Erosion Anti-Abuse Tax (BEAT)
• Code §59A
• Effectively an alternative minimum tax on large multinational corporations.
• Applies to domestic C corporations part of a group with at least $500M of average annual domesticgross receipts over a three-year period.
• Applies to foreign corporations engaged in a U.S. trade or business for purposes of determining their effectively connected income tax liability.
Base Erosion Anti-Abuse Tax (BEAT)
• Applies when corporations are making payments to related foreign persons and a deduction is allowed for such related party payment in the U.S.
• Includes asset acquisitions if depreciation is taken.
• Excepted payments:
– Inventory purchases included in COGS.
– Payments for services under the 482 cost method with no markup component.
– Any qualified derivative payment.
Base Erosion Anti-Abuse Tax (BEAT)
• Calculated in 2018 as the excess of 5% of the modified taxable income over the regular tax liability.
• Tax rate will go to 10% after 2018; after 2025 up to 12.5%.
• Does not apply if the foreign recipient elects to be subject to U.S. income tax on the amounts received or if payments made with full 30% withheld.
• A foreign tax credit of 80% of applicable foreign credits are allowed against the U.S. tax liability imposed by this provision if an election is made.
Interest Deduction Limitation
• Amend 163(j) to limit interest deduction of any taxpayer for any tax year for net business interest expense to 30% of the taxpayer’s adjusted taxable income.
• Regardless of whether interest paid to related or unrelated parties (foreign or domestic).
• Exception for taxpayers with average annual gross receipts less than $25M during prior 3 year period.
Anti Hybrid Rules• A deduction will be disallowed for any disqualified
related party amount paid or accrued pursuant to a “hybrid transaction” or by or to a “hybrid entity”.
• Interest and royalty paid if not included in income in the foreign jurisdiction.
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Contact Information
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Nicole Suk, CPAPrincipal
Windham Brannon3630 Peachtree RoadSuite 600Atlanta, Georgia 30326Main: 404.898.2000Direct: 678.510.2785Fax: 404.898.2010Email: [email protected]