Untangling tax reform for domestic corporations with foreign subsidiaries

One goal of the Tax Cuts and Jobs Act (TCJA) was to end the lockout effect and encourage U.S. companies to bring back cash held by foreign subsidiaries. It also sought to make the U.S. more tax competitive, so fewer U.S. businesses would move offshore.

“So far, some of the tax system’s new provisions and revisions have had a dramatic impact on domestic corporations with foreign subsidiaries,” says Joseph Calianno, partner and international technical tax practice leader at BDO USA LLP.

Smart Business spoke with Calianno about the tax environment for domestic corporations with foreign subsidiaries.

Which provisions are impacting domestic corporations with foreign subsidiaries?

First, the Internal Revenue Code (IRC) requires U.S. shareholders of certain foreign subsidiaries to pay a one-time transition tax (Section 965) on untaxed earnings, even if those earnings are still offshore.

The act also modified existing rules. The controlled foreign corporation (CFC) anti-deferral rules tax income even if the earnings aren’t repatriated. Going forward, the amount of CFC earnings taxed offshore has significantly expanded under IRC Section 951A, also called Global Intangible Low Taxed Income (GILTI). The rules for determining the GILTI inclusion are complex and require detailed calculations.

However, domestic C corporations (C-corps) may be able to take a new 50 percent deduction on GILTI amounts, subject to special rules and a taxable income limitation. With the reduced corporate tax rate, the GILTI inclusion for C-corps generally would be taxed at a 10.5 percent rate, assuming the full IRC Section 250 deduction applies. C-corps also may be eligible for a foreign tax credit relating to the GILTI inclusion, subject to certain limitations.

Moreover, the TCJA added IRC Section 245A, a 100 percent dividends received deduction (DRD). This participation exemption enables some C-corps that satisfy certain requirements to receive dividends from foreign subsidiaries without being taxed under certain conditions.

How does the TCJA target U.S. base erosion?

With the lower corporate tax rate of 21 percent, the government wanted to prevent base erosion. A new provision, IRC Section 163(j), limits business interest deductions, while the base erosion and anti-abuse tax (BEAT), under IRC Section 59A, imposes an additional corporate-level tax on certain corporations. BEAT is fairly complex but, in essence, it targets corporations making payments to foreign-related parties that reduce the U.S. tax base, when they meet a gross receipts and base erosion percentage threshold.

IRC Section 267A deals with deductions for related-party interest or royalties with hybrid instruments or entities. At a high level, this provision is designed to prevent one party from obtaining a deduction in its jurisdiction, when the other party in its jurisdiction doesn’t include a corresponding amount into income.

What are corporations doing now?

Planning is at the forefront given all of changes to the tax system. These provisions can change behavior to some degree, e.g., how much debt a corporation will incur can be influenced by the ability to deduct the interest. Guidance from the IRS and Department of the Treasury, mostly in the form of proposed regulations, provides greater certainty as to how a provision may operate or how a provision should be interpreted. Corporations are evaluating the impact on their organizational structure and transactions, and considering if they want to restructure or change how they do business.

Do you think tax reform will result in more corporations repatriating cash?

Generally, yes. Many foreign subsidiaries have previously taxed earnings, as a result of the transition tax or CFC anti-deferral rules, that, largely, may be repatriated without additional U.S. tax. This assumes there is sufficient cash in the foreign subsidiary to be repatriated — earnings don’t necessarily equate to cash. Further, the 100 percent DRD can help facilitate repatriation.

However, whether a corporation brings cash home can depend on the need for the cash in the U.S., the need for cash in the foreign jurisdiction for the foreign business, foreign restrictions on the repatriation of cash and foreign withholding taxes.

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