Congress has approved and President Trump has signed the Tax Cuts and Jobs Act (TCJA). The new legislation contains many provisions affecting foreign income and business relationships with companies abroad. Here are some of the key provisions of the law. (Unless otherwise noted, the reforms apply to years starting after December 31, 2017.)
Deduction for foreign-source portion of dividends
Prereform. U.S. citizens, resident individuals, and domestic corporations generally were taxed on all income, whether earned in the U.S. or abroad. Foreign income earned by a foreign subsidiary of a U.S. corporation generally wasn’t subject to U.S. tax until the income was distributed as a dividend to the U.S. corporation.
New law. The system of taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when the earnings are distributed has been replaced. These changes kick in for tax years of foreign corporations that begin after December 31, 2017, and for tax years of U.S. shareholders in which, or with which, such tax years of foreign corporations end.
The law provides for an exemption for certain foreign income. This exemption is referred to as a dividends received deduction (DRD). It’s a 100% deduction for the foreign-source portion of dividends received from specified 10%-owned foreign corporations.
The foreign-source portion bears the same ratio to the dividend as the undistributed foreign earnings of the foreign corporation bears to its total undistributed earnings. In this case, a specified 10%-owned foreign corporation generally is any foreign corporation other than a passive foreign investment company that isn’t also a controlled foreign corporation (CFC) of which any domestic corporation is a U.S. shareholder.
No foreign tax credit or deduction is allowed for taxes paid or accrued with respect to a dividend that qualifies for the DRD. The deduction isn’t allowed if the domestic corporation didn’t hold the stock in the foreign corporation for a certain length of time.
The provision eliminates the “lockout” effect, which encourages U.S. companies to avoid bringing their foreign earnings back into the U.S.
The DRD is available only to C corporations that aren’t regulated investment companies (RICs) or real estate investment trusts (REITs).
Specified 10%-owned foreign corporation sales or transfers
Prereform. When a U.S. corporation sold or exchanged stock in a foreign subsidiary, any gain might be considered a dividend to the extent that the foreign corporation had earnings and profits (E&P) that hadn’t already been taxed by the United States. If foreign business was conducted through a branch of a U.S. corporation rather than a foreign subsidiary, the corporation owed U.S. taxes on the foreign earnings and deducted losses as though they accrued directly to the U.S. parent.
New law. For dividends received, a domestic corporate shareholder’s adjusted basis in the stock of a “specified 10%-owned foreign corporation” is reduced by an amount equal to the portion of any dividend received that wasn’t taxed because of allowable dividends, but only for the purpose of determining losses on sales and exchanges of the foreign corporation’s stock.
If a U.S. corporation transfers substantially all of the assets of a foreign branch to a foreign subsidiary, any transferred losses incurred by the foreign branch must generally be included in the parent’s gross income.
Deferred foreign income
Prereform. U.S. citizens, resident individuals, and domestic corporations generally were taxed on all income, regardless of where it was earned. Foreign income earned by a foreign subsidiary of a U.S. corporation generally wasn’t subject to tax in the United States until the income was distributed as a dividend to the corporation.
New law. U.S. shareholders owning at least 10% of a foreign subsidiary generally must include in income their pro rata share of the net post-1986 historical E&P of the subsidiary to the extent the E&P hasn’t been taxed in the United States. This relates to the subsidiary’s last tax year beginning before 2018. The portion of the E&P comprising cash or cash equivalents is taxed at a reduced rate of 15.5%; any remaining E&P is taxed at a reduced rate of 8%.
The shareholder may elect to pay the tax in installments over up to eight years in the following manner:
- 8% of the tax liability for each of the first five payments,
- 15% for the sixth installment,
- 20% for the seventh installment, and
- 25% for the eighth installment.
S corporations and REITs
Shareholders of S corporations may elect to maintain deferral on such income until the shareholder transfers its S corporation stock or the S corporation:
- Changes its status,
- Sells substantially all of its assets, or
- Stops conducting business.
For REITs, post-1986 E&P is excluded from the gross income tests. In addition, REITs can elect to meet their distribution requirement of accumulated deferred foreign income under the same eight-year installment plan that applies to U.S. shareholders who elect for the installment plan to pay their net tax liability resulting from the mandatory inclusion of pre–effective-date undistributed CFC earnings.
Global Intangible Low-Taxed Income (GILTI)
Prereform. A U.S. person generally wasn’t subject to U.S. tax on foreign income earned by a foreign corporation in which it owned shares until that income was distributed as a dividend. Several antideferral regimes modified this general rule. One of these exceptions was certain types of income earned by CFCs that fell under the heading of Subpart F income.
New law. For tax years of foreign corporations that begin after December 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end, a U.S. shareholder of any CFC must include in gross income the excess (if any) of the holder’s net CFC-tested income over the shareholder’s net deemed tangible income return; this excess is known as global intangible low-taxed income (GILTI). This must be done in a manner generally similar to inclusions of Subpart F income. The shareholder’s net deemed tangible income return is equal to 10% of the aggregate of the holder’s pro rata share of the qualified business asset investment of each CFC in which it owns stock.
GILTI is taxed at a 10% rate and doesn’t include effectively connected income, Subpart F income, foreign oil and gas income, or certain related-party payments.
Foreign tax credits are allowed for foreign income taxes paid with respect to GILTI, but they are limited to 80% of the foreign income taxes paid and can’t be carried back or forward.
Deduction for foreign-derived intangible income and GILTI
Prereform. U.S. persons were generally taxed on all income, whether derived in the U.S. or abroad. Foreign income earned through foreign corporations was generally subject to U.S. tax only when the income was distributed as a dividend.
New law. For tax years that begin after December 31, 2017, and before January 1, 2026, a domestic corporation may deduct an amount equal to the sum of:
- 5% of the foreign-derived intangible income (FDII) of the domestic corporation, plus
- 50% of the GILTI amount (if any) that’s included in the gross income of the domestic corporation.
FDII bears the same ratio to the corporation’s deemed intangible income as its foreign-derived deduction-eligible income bears to its domestic deduction-eligible income.
For tax years that begin after December 31, 2025, the allowed deduction will decrease to:
- 875% of the FDII of the domestic corporation, plus
- 5% of the GILTI amount included in the gross income of the domestic corporation.
Repeal of foreign base company oil-related income rule
Prereform. Subpart F income includes foreign base company income (FBCI). Foreign base company oil-related income was included in the Subpart F income of U.S. shareholders as a category of FBCI.
New law. For tax years of foreign corporations that begin after December 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end, foreign base company oil-related income is eliminated from FBCI.
CFC decreased investments
Prereform. Foreign base company shipping income that was a qualified shipping investment wasn’t included in Subpart F income. The previously excluded income was then recaptured if and when it was subsequently withdrawn from the qualified shipping investment. Although the 1986 Tax Reform Act repealed the exclusion for qualified shipping investments, the recapture provision was retained.
New law. A U.S. shareholder in a CFC that invested previously excluded Subpart F income in qualified foreign base company shipping operations isn’t required to include as income a pro rata share of the previously excluded Subpart F income when the CFC decreases such investments. This applies to tax years of foreign corporations that begin after Dec. 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.
CFC status attribution rules
Prereform. A U.S. parent of a CFC was subject to U.S. tax on its pro rata share of the CFC’s Subpart F income. A foreign subsidiary is a CFC if it is more than 50% owned by one or more U.S. persons, each of which owns at least 10% of the foreign unit. Constructive ownership rules applied in determining ownership for this purpose.
New law. Constructive ownership rules are amended for the last tax year of a foreign corporation that begins before January 1, 2018, for all subsequent tax years of a foreign corporation, and for the tax years of a U.S. shareholder in which or with which such tax years end. Certain stock of a foreign corporation owned by a foreign person is attributed to a related U.S. person for purposes of determining whether the related U.S. person is a U.S. shareholder of the foreign corporation and, thus, whether the foreign corporation is a CFC.
Broader definition of U.S. shareholder
Prereform. A U.S. shareholder for CFC purposes was a U.S. person who owned 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation.
New law. The definition of U.S. shareholder is expanded to include any U.S. person who owns 10% or more of the total value of shares of all classes of stock of a foreign corporation. This applies to the last tax year of foreign corporations beginning before January 1, 2018, and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.
30-day minimum holding period eliminated
Prereform. A U.S. parent of a CFC was subject to U.S. tax on its pro rata share of the CFC’s Subpart F income, but only if the U.S. parent owned stock in the foreign subsidiary for an uninterrupted period of 30 days or more during the year.
New law. A U.S. parent is subject to current U.S. tax on the CFC’s Subpart F income even if the U.S. parent doesn’t meet the ownership requirement. This applies to tax years of foreign corporations that begin after December 31, 2017, and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
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.