The 2018 Tax Cuts and Jobs Act (TCJA) contains many tax law changes. The following summary covers the highlights of the TCJA for foreign income tax.
Previously, the U.S. applied a worldwide regime with deferral and foreign tax credit offsets to both corporate and individual taxpayers. The TCJA changes this to a participation exemption regime with a 100% dividends-received deduction (see below) that is only available to corporations.
Deduction for Foreign-Source Portion of Dividends
The current law taxing U.S. corporations on the foreign income distributed by their foreign subsidiaries is replaced under the TCJA. For foreign corporation tax years beginning after 2017, the TCJA introduces a deduction for foreign dividends received by U.S. corporations. A domestic corporation that owns 10% of a foreign corporation receives a 100% deduction for the foreign-source portion of dividends. The foreign-source portion is the amount that bears the same ratio to the dividend as the subsidiary’s undistributed foreign earnings bear to the subsidiary’s total undistributed earnings.
Deduction for Foreign-Derived Intangible Income (FDII) and Global Intangible Low-Taxed Income (GILTI)
For tax years beginning in 2018 through 2026, a U.S. corporation is allowed a deduction, for the applicable tax year, equal to: 37.5% of the FDII of the U.S. Corporation, plus 50% of the GILTI amount included in the gross income of the U.S. Corporation. For tax years after calendar year 2025, the deduction for the applicable tax year will be 21.875% of the FDII of the U.S. Corporation, plus 37.5% of the GILTI amount included in the gross income of the U.S. Corporation.
Expanded Definition of a “U.S. Shareholder”
Previously, a U.S. Shareholder was defined as a person who owns 10% or more of the voting power of all stock classes with the power to vote. Under the new Act, the definition is broadened to include any U.S. person owning 10% or more of the total value of shares of stock classes of a foreign corporation.
Base Erosion and Anti-Abuse Tax
Previously, there was no minimum tax that was mandated to be paid on certain deductible payments to a foreign affiliate. For tax years beginning in 2018, some U.S. corporations with average gross receipts of $500 million will be required to pay “base erosion anti-abuse tax” (BEAT). BEAT is equivalent to the base erosion minimum tax amount for the applicable tax year.
Limitations on Income Shifting through Intangible Property Transfers
For transfers in tax years beginning in 2018, the TCJA focuses on recurring issues that have come into play in controversial transfers of intangible property. The TCJA states intangible property to be workforce in place, foreign and domestic goodwill, and going concern value. The TCJA also includes the residual category of any comparable item for which the value is not related to tangible property or individual services.
Denial of Deduction for Certain Related Party Payments
For tax years beginning in 2018, the TCJA repudiates a deduction for any disqualified related party amount paid or accrued with respect to a hybrid transaction or by, or to, a hybrid entity.
Disqualified Related Party Amount – Any interest or royalty paid or accrued to a related party as long as:
- there is no parallel presence to the related party under the tax law of the related party’s country of residence, or
- the related party is allowed a deduction with respect to such amount under the tax law of their country of residence.
Hybrid Transaction – Interest or royalties paid or accrued that are not considered as such by the country of residence of the foreign recipient.
Hybrid Entity – Treated as fiscally transparent for federal income purposes only.
Surrogate Foreign Corporation Dividends Are Not Qualified
Dividends paid in tax years beginning in 2018 to individual shareholders are not taxed at the lower rates on qualified dividends. This only applies to dividends received by corporations that are a proxy foreign corporation, other than those considered to be a U.S. corporation, and which first became a foreign proxy subsequent to the enactment date.
Indirect Foreign Tax Credits Repealed
A U.S. corporate 10% owner of a foreign corporation was formerly allowed a credit for foreign taxes that the U.S. corporation was treated as having paid when the foreign-taxed income was distributed to the shareholder as a dividend.
After December 31, 2017, no foreign tax credit is allowed for any taxes (including withholding taxes) paid or accrued with respect to any dividend to which the deduction for the foreign-source portion of dividends applies. However, a foreign tax credit is allowed for any subpart F income that is included in the income of the U.S. shareholder on a current-year basis.
Election with Respect to Foreign Tax Credit Limitation
Previously, for purposes of the limitation on the foreign tax credit, a taxpayer with an overall domestic loss for any tax year could characterize as foreign-source income an amount equal to the lesser of the full amount of the loss to the extent not carried back, or 50% of the taxpayer’s U.S.-source taxable income for the succeeding tax year. For tax years beginning after 2017 and before 2028, the taxpayer may elect to apply an amount greater than the 50% above but less than 100% with respect to pre-2018 unused overall domestic losses.
Excise Tax on Insider Stock Compensation of Expatriated Corporations Increased
An excise tax applies to the value of stock compensation held by disqualified individuals if a corporation expatriates, and gain on any stock in the expatriated corporation is recognized by shareholders at the time of expatriation. Previously, the excise tax was 15% of the stock value; under the TCJA , the tax is 20% for corporations expatriating after the date of enactment.
Foreign-held earnings and profits
Pre-TCJA tax law deferred U.S. tax on foreign-held earnings and profits (E&P) until the income was repatriated. Under the TCJA , there will be deemed repatriation of previously untaxed E&P at a rate of 8% (noncash) or 15.5% (cash & equivalents), payable over eight years. There will be a clawback of this rate reduction if a company inverts within 10 years after the TCJA is enacted.
Previously, foreign-derived intangible income was untaxed. Under the TCJA , such property is taxed at 20% with a 37.5% deduction through 2025, and then at 21.875%.
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