International Tax Year-end Update and Planning Considerations
Year-end planning for 2018 takes place against the backdrop of a new tax law, the Tax Cuts and Jobs Act (TCJA or the Act). Signed into law on December 22, 2017, the Act is the most significant tax overhaul in thirty years. The Act has presented us with sweeping changes to the US taxation of international transactions and reporting of foreign assets. These new rules present planning opportunities and require a review of a company’s tax structure that involves foreign entities/assets to determine whether changes need to be made to a company’s international tax structure. If you currently own foreign entities or have an interest in a foreign business/asset, we highly recommend that you contact us or your tax advisor, to discuss how these tax law changes may affect you and whether planning is necessary to optimize your tax position and to meet your business needs.
The transition tax under §965 introduced by the 2017 tax act was a one-time tax imposed on previously untaxed earnings and profits of a controlled foreign corporation (“CFC”) via a deemed income inclusion. The transition tax applies to all US taxpayers and is assessed on untaxed earnings and profits through the corporation’s last year that began before 2018. Many taxpayers already addressed the transition tax on their 2017 tax returns. That said the transition tax is still relevant in 2018 for certain taxpayers such as 10% shareholders of CFCs that have fiscal year ends, taxpayers who have previously made the 8-year payment deferral election, and S-corporation taxpayers who are allowed to defer payments until a triggering event (such as a sale) occurs.
Expansion of Controlled Foreign Corporation Attribution
The definition of a “US shareholder” has been modified to include any US person that owns stock in a foreign corporation constituting 10% or more (by either vote or value) of the stock of the corporation. The definition was previously limited to voting stock. The attribution rules were also modified and now allow for downward attribution from foreign persons to US persons for purposes of determining CFC and US shareholder status.
Subpart F Income and Investments in US Property
Modifications to the controlled foreign corporation (“CFC”) rules expand the requirements to include Subpart F income. Under prior law, U.S. shareholders of a CFC only had the Subpart F inclusion requirement if the foreign corporation had also been a CFC for an uninterrupted period of at least 30 days during the taxable year. This restriction no longer applies.
Domestic corporations are still allowed the foreign tax credit associated with subpart F inclusion under §960 on a current year basis. However, individual taxpayers are not eligible for these indirect tax credits unless the taxpayer makes a §962 election to be treated as a corporation. As a result of the reduced corporate income tax rate and the availability of the foreign tax credits under §960 individuals may consider making the election where they have not previously.
For domestic corporations, certain amounts that may have been treated as investments in US property under §956 will no longer be includible in income. Guidance on this was issued to be in line with the §245A dividends received deduction. Individual taxpayers that are US shareholders of CFCs must continue to include as income deemed distributions under §956.
Global Intangible Low-Taxed Income (GILTI)
Tax reform implemented the global intangible low-taxed income (GILTI) regime. The GILTI regime requires US shareholders of any controlled foreign corporation (“CFC”) to include, as income, a deemed distribution equal to their allocable share of the earnings and profits of the CFC that are considered GILTI earnings. GILTI earnings are essentially earnings of a CFC that are in excess of a deemed return on its tangible assets. A US domestic corporation shareholder will be able to take a 50% deduction on the GILTI amount in 2018 (subject to limitations) and is entitled to an 80% deemed foreign tax credit. The above deduction and deemed tax credit do not apply to individuals, and individuals are subject to tax on GILTI income at ordinary rates at up to 37%. An individual may elect to be treated as a corporation for purposes of computing the tax on GILTI income by making an election under §962.
Foreign-Derived Intangible Income (FDII)
Foreign-derived intangible income (FDII) is a new regime implemented by the TCJA to encourage export sales by US corporations. Income that is derived from property sold to a non-U.S. person that is for foreign use and income derived from services provided by the taxpayer to non-US persons or with respect to property located outside of the US may qualify as FDII. Domestic corporations are entitled to a reduced rate of tax on FDII by means of a deduction. The deduction is 37.5% of FDII from 2018 - 2025, and 21.875% starting in 2026.
Deductions for Dividends Received from Foreign Corporations by Domestic Corporations
Effective January 1, 2018, a domestic corporation is allowed a deduction equal to the foreign-source portion of any dividend received from a specified 10-percent owned foreign corporation. This is also known as the participation exemption under Section 245A. This exemption means that domestic corporations will not pay tax on dividends from foreign companies to the extent they qualify for this exclusion. Note that a domestic corporation is allowed no credit or deduction for a foreign income tax on dividends from a foreign corporation if it is allowed a deduction for the dividend under these rules. Restrictions on the deduction apply with respect to a required holding period and to hybrid dividends.
Sale of Partnership Interest by a Foreign Person
If a partnership is engaged in a U.S. trade or business, then a sale (occurring on or after November 27, 2017) of that interest by a nonresident alien individual or foreign corporation is considered effectively connected income (ECI) to the extent a sale of the assets of the partnership would have been considered ECI. In order to facilitate collecting the tax on such transactions, a withholding requirement is imposed on the sale of a partnership interest by a foreign person. The transferee is now required to withhold 10% of the gross amount realized on the sale or exchange of the partnership interest by a foreign person unless certain documentation is provided showing that no ECI gain applies. If the transferee fails to withhold, the partnership may also be liable for withholding.
The outbound transfer of property by a U.S. person to a foreign corporation is taxable unless an exception applied. One such exception was for certain outbound transfers of property for use in an active trade or business. This exception was repealed for transfers occurring after 2017.
Base Erosion and Anti-Abuse Tax (BEAT)
The base erosion and anti-abuse tax (BEAT) is a new regime implemented by tax reform to discourage the stripping of earnings from the US tax base through the use of deductible payments made to foreign related parties. The BEAT regime applies only to large corporations with average annual gross receipts of at least $500 million for a three-year period. Corporations subject to BEAT may be subject to an additional liability on deductible payments made to foreign related parties.
Form 5472 Reporting Requirements Extended to Single Member LLCs
Effective for the 2017 tax year, Form 5472 reporting requirements were extended to single-member limited liability companies (LLCs) that are wholly owned by foreign persons or entities. The regulations treat US single-member LLCs as domestic corporations for purposes of the reporting requirements. Reportable transactions are those between the LLC and related parties, including the foreign owner. A foreign-owned single-member LLC may have a Form 5472 filing requirement even though it has no other US tax filing requirements and is otherwise treated as a disregarded entity.
FBAR and Foreign Financial Asset Reporting
Each U.S. person that has a financial interest in or signature authority over a foreign financial account is required to file Form 114 Report of Foreign Bank and Financial Accounts (“FBAR”) if the aggregate value of all foreign financial accounts exceeds $10,000 at any time during the calendar year. The due date for 2018 is April 15, 2019, with an automatic six-month extension to October 15. In addition to the FBAR there is required reporting of foreign financial assets, including foreign bank accounts on a Form 8938. This report is required for both individuals and certain domestic entities.
Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS)
Banks, brokerages, private equity funds, and other entities that are considered "financial institutions" are now required to collect documentation for US FATCA and the Organization for Economic Co-operation and Development's (OECD) CRS from their account holders. CRS, which is modeled after US FATCA, is part of the OECD's push towards global transparency. A majority of countries have currently committed to complying with the reporting requirements. Persons opening accounts or investing offshore should expect to be asked to complete detailed disclosures related to FATCA and CRS reporting.
Again, we hope this information is helpful as you plan for year-end 2018. If you have any questions, please do not hesitate to contact your HCVT tax advisor directly, or see additional contact information below.
Curt Giles | International Tax Partner | firstname.lastname@example.org
John Samtoy | International Tax Principal | email@example.com