In my last post, I discussed how the Tax Cuts and Jobs Act may impact an individual’s decisions regarding estate planning. In this post, I will briefly survey several significant changes affecting the U.S. international tax realm.
Part Four: International Tax Reform
New Dividends Received Deduction
The Act enacted a new Code Section 245A which provides for a 100 percent deduction for dividends received by a U.S. shareholder of foreign corporate stock, provided that the foreign corporation is a 10 percent-owned foreign corporation, is not a passive foreign investment company, and meets all other relevant requirements under the Code Section.
The key takeaway of this code section is that for those multinational corporations that qualify for the new deduction, they will no longer be subject to the tax on dividends they receive from their foreign subsidiaries.
New tax on Global Intangible Low Tax Income
A new Code Section 951A creates a sub-category of income (GILTI income) that is formula-driven and creates a minimum threshold for income that will be subject to U.S. taxation. For tax years 2018 through 2025, U.S. corporations can deduct 50 percent of GILTI income, resulting in a 10.5 percent effective tax rate.
While this new tax aims to reduce the incentive for U.S. companies to shift assets offshore, it is less clear why the Act imposed 10 percent as the minimum threshold figure. Furthermore, due to the formula-driven nature of this new rule, U.S. corporations will have planning opportunities aimed at minimizing their exposure to the GILTI income that will be subject to tax.
New Deduction for Foreign-Derived Intangible Income
This is essentially a relief provision to the newly-enacted GILTI rules. The Act allows a deduction under new Code Section 250 for a U.S. corporation’s foreign-derived intangible income (FDII) of 37.5 percent for tax years 2018 through 2025, and 21.875 percent for tax years after 2025. Corporate taxpayers can also use up to 80 percent of foreign tax credits against their GILTI income.
The net effect of all of the deductions, foreign tax credits, and gross-ups is that the effective tax rate on FDII is 13.125 percent for tax years 2018 through 2025 and 16.406% after 2025.
New Base Erosion Minimum Tax
The new “base erosion and anti-abuse tax” (BEAT) operates as a limited-scope alternative minimum tax, which is applied by adding back to taxable income certain deductible payments made to related foreign persons. Note that this new tax, imposed under Code Section 59A, applies to taxpayers with an average annual gross receipts for the last 3 taxable years of at least $500,000,000.
The new minimum tax rate is 5 percent for tax year 2018, 10 percent for tax years 2019 through 2025, and 12.5 percent for tax years after 2025. Taxpayers now must calculate their tax liability under the new rules to determine whether they are subject to the BEAT.
One-Time Transition Tax
Finally, a transition tax imposed under Code Section 965 applies to U.S. shareholders on deferred foreign earnings as part of the transition to the new participation exemption system of taxation under the Act. Deferred foreign earnings refers to the accumulated post-1986 deferred foreign earnings. Such foreign earnings that are held as cash or cash equivalents are taxed at a rate of 15.5 percent and all other earnings are taxed at 8 percent. U.S. shareholder may elect to pay the transition tax in eight installments.