In this guest white paper, CliftonLarsonAllen’s James Guthrie discusses how the US tax reform impacts Utah companies doing international business.
Tax reform legislation substantially changes how U.S. individuals and businesses are taxed on worldwide income. Prior to the Tax Cuts and Jobs Act, U.S. citizens, U.S. resident alien individuals, and domestic corporations were required to report and pay tax on both domestic and foreign income. The new law eliminates this system of worldwide taxation for certain domestic corporations, but leaves it mostly intact for U.S. citizens, U.S. resident alien individuals and domestic flow-through entities (i.e., partnerships, LLCs, S corporations, estates and trusts). Provided below are highlights of the salient changes to provisions governing taxation of foreign income.
Participation exemption system for taxation of foreign income
The new participation exemption system is implemented through a 100 percent dividends-received deduction for domestic C corporations receiving dividends from 10 percent specified foreign corporations after January 1, 2018. As the United States moves to a territorial system of taxation, there is a transition tax on deferred foreign earnings for all U.S. persons that are 10 percent shareholders in a specified foreign corporation. Foreign earnings that have not been previously subject to U.S. taxation held in cash and cash equivalents are subject to a 15.5 (domestic corporations) or 17.5 (U.S. citizens and U.S. resident alien individuals) percent rate, while non-cash amounts attract an 8 (domestic corporations) or 9.05 (U.S. citizens and U.S. resident alien individuals) percent rate. The tax on the deferred foreign earnings is eligible to be paid over eight years on an escalating scale, and S corporation shareholders may elect to defer the tax until a triggering event (e.g., sale of S Corp stock, liquidation of S Corp, etc.).
As noted, the transition tax applies to all U.S. persons that are 10 percent shareholders in a specified foreign corporation (“SFC”). A foreign corporation is a SFC if it is either:
• A controlled foreign corporation (“CFC”) as defined under IRC Section 957, or
• A foreign corporation that has at least one domestic C corporation that is a 10% shareholder.
• Note that Passive Foreign Investment Companies (“PFICs”) are excluded.
Thus, if there is no 10% domestic C corporation shareholder, or if the foreign entity is not a CFC, the transition tax will not apply. For Utah entrepreneurs and C corporations that must pay this transition tax, it will be important to work with qualified tax advisors to identify earnings subject to this tax and determine the proper rate(s) to apply.
Rules related to passive and mobile income
There is now a 37.5 percent deduction for foreign-derived intangible income for U.S. corporations and a global intangible low-taxed income (GILTI) inclusion provision for income earned in controlled foreign corporations offshore that exceeds a minimum rate of return on tangible assets, which is applicable to all U.S. persons owning these foreign entities. These provisions employ the “carrot-and-stick” approach to ensure that moveable intangible income is taxed at a minimum rate of 13.125 percent for FDII and 10.5 percent for GILTI. The FDII provision is similar to “patent box” regimes used by foreign jurisdictions to encourage locating and maintaining intangible property within their jurisdiction by providing a favorable tax rate on income associated with intangibles. It has yet to be determined whether the FDII provisions will be challenged by the World Trade Organization (WTO) as an illegal export subsidy.
Changes related to the foreign tax credit system
For taxable years beginning after December 31, 2017, domestic corporations will no longer be able to claim indirect (IRC Section 902) credits or deductions for foreign taxes paid on amounts that are eligible for the participation exemption as IRC Section 902 was repealed with tax reform. Indirect subpart F (IRC Section 960) credits remain available to domestic corporations, although they must now be computed on a current year basis. There is no change to the direct (IRC Section 901) foreign tax credit.
New foreign tax credit limitation baskets have been added under IRC Section 904 for foreign branch income and Global Intangible Low-Taxed Income.
James W. Guthrie, Jr., CPA, CGMA
Principal, Global Tax Services
6955 South Union Park Center, Suite 300
Salt Lake City, UT 84047-4191