A loophole in the Tax Cuts and Jobs Act (TCJA) could allow multinational corporations like Apple to avoid paying billions of dollars in taxes on profits stashed overseas.

The TCJA imposes a transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. companies by deeming those earnings to be repatriated. But the law contains a loophole that allows taxpayers to convert income that would otherwise be taxed at 15.5% (cash holdings) into income that is taxed at 8% (more illiquid investments).

And multinationals could have leeway to shift foreign earnings into the 8% tax bracket.

Calculating the deduction

A U.S. shareholder of a deferred foreign income corporation is allowed a deduction equal to the sum of:

  • The U.S. shareholder’s 8% rate equivalent percentage of any excess of: (a) the amount included as gross income, divided by (b) the amount of the U.S. shareholder’s aggregate foreign cash position, plus
  • The U.S. shareholder’s 15.5% rate equivalent percentage of the amount described in item (b) above that doesn’t exceed the amount described in item (a) above.

The loophole that allows bracket-shifting involves a formula for calculating the amount of foreign earnings that are subject to the higher tax rate. The benchmark is a company’s foreign cash position, calculated as the greater of either the average of the past two tax years, or the cash balance at the end of the last tax year begun before January 1, 2018.

Companies would pay the 15.5% rate on amounts up to their foreign cash position. Anything over that would be subject to the 8% rate.

How it works

So, by reducing their foreign cash balances between now and the end of their last tax year that began before January 1, 2018, U.S. shareholders can convert what otherwise would be 15.5%-taxed income into 8%-taxed income. The converted amount is dollar for dollar of reduced foreign cash if:

The aggregate of such U.S. shareholder’s pro rata share of the cash position of each specified foreign corporation of such U.S. shareholder determined as of the close of the inclusion year exceeds the average of that aggregate for the shareholder’s past two tax years. A lower amount would be converted if B exceeds A.

Timing of conversions

Because the deemed repatriation tax applies for the last tax year of a deferred foreign income corporation that began before January 1, 2018, calendar year corporations would have had to make such conversions before that date. But, fiscal year corporations can make such conversions now.

For a no-obligation discussion on the possible impact and steps you should take now, contact Lien Le, the head of our International Tax practice.

© 2018