The new U.S. Federal tax legislation includes some important revisions to the U.S. international tax rules. These rules are applicable to U.S. taxpayers with outbound, cross-border activities in other countries. The following are some important highlights that could have an impact on your U.S. Federal tax obligations beginning January 1, 2018.
- The participation exemption. The dividends that a U.S. C corporation receives from a foreign corporation will be exempt from U.S. Federal corporate income tax. The U.S. C corporation must own 10% of the stock of the foreign corporation and hold the stock for more than one year. The dividend distribution must be from foreign source earnings to qualify for the exemption. Dividends referred to as “hybrid dividends” are not exempt if the foreign corporation received a deduction or other tax benefit from foreign taxes with respect to the distributed earnings. The tax exemption is allowed in the form a 100% dividend received deduction. The foreign tax credit is no longer allowed for foreign taxes paid on the foreign corporation’s distributed earnings since the exempt dividend income is not subject to U.S. tax.
- The participation exemption for deemed dividend on sale of CFC stock. A U.S. C corporation will qualify for the participation tax exemption on a deemed dividend that results from the sale of stock in a controlled foreign corporation (CFC). A controlled foreign corporation is any foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders that each own at least 10% of the stock. If a U.S. shareholder that owns at least 10% of the stock in a CFC sells the stock, the gain is recharacterized as ordinary dividend income to the extent of the U.S. shareholder’s share of the CFC’s undistributed earnings.
- Mandatory deemed repatriation of a foreign corporation’s earnings. Any U.S. shareholder that owns 10% of the stock of a controlled foreign corporation (CFC) is required to report and pay U.S. Federal income tax on their share of the foreign corporation’s post-1986 accumulated earnings and profits, i.e., undistributed net income. A controlled foreign corporation is any foreign corporation of which more than 50% of the vote or value is owned by U.S. shareholders that each own at least 10% of the stock. The deemed repatriation rule also applies to U.S. shareholders who own 10% of a foreign corporation that is not a CFC if there is at least one shareholder that is a U.S. C corporation. The U.S. Federal tax rate is 15.5% of the U.S. shareholder’s share of the foreign corporation’s undistributed earnings that consist of cash and cash equivalents. The U.S. Federal tax rate is 8% of the U.S. shareholder’s share of the foreign corporation’s undistributed earnings that do not consist of cash and cash equivalents. The U.S. shareholder is allowed to elect to pay the U.S. tax over an eight-year period. A special exception will allow an S corporation to defer the U.S. tax on its share of the foreign corporation’s earnings until the S corporation changes its status, sells substantially all of its assets, ceases business operations, or a shareholder of the S corporation transfers their S corporation stock.
- New foreign tax credit basket for foreign branch income. The foreign tax credit allows the U.S. taxpayer to offset U.S. tax on income earned in a foreign country with foreign income tax paid or accrued. The new law creates a new foreign tax credit basket for foreign source income from a branch in a foreign country. This means that foreign source branch income is classified in its own basket and it is not combined with other types of foreign source income. This rule will effectively prevent U.S. taxpayers from being able to maximize their foreign tax credits by blending foreign source branch income with other types of foreign source income that may be subject to a higher or lower foreign tax rate.
- Deemed inclusion of global intangible low-taxed income (GILTI). This new rule is designed to target businesses with offshore intangibles that have significant value outside the United States. U.S. shareholders that own 10% of a controlled foreign corporation (CFC) are required to report and pay U.S. tax on a new category of undistributed income from the CFC. The GILTI rule taxes the U.S. shareholders in CFCs on income that is considered to be excessive as compared to the CFC’s tangible assets.
- Disallowed deduction for related party hybrid payments or accruals. U.S. taxpayers may not claim tax deductions for disqualified interest or royalty expenses paid or accrued to a related party that is a hybrid entity or pursuant to a hybrid transaction. The expenses are disqualified if the related party is not required to include the income and pay foreign tax on it in the related party’s country of tax residence. In a hybrid transaction, the United States recognizes the transaction as an interest or royalty expense but it is not characterized as such in the related party’s country of residence. A hybrid entity is a foreign entity that is a foreign company that is classified differently for tax purposes in the United States than in the foreign country of formation. An example of a hybrid entity is a foreign company that elects to be classified as a foreign disregarded entity or foreign partnership for U.S. tax purposes but is classified as a foreign corporation under foreign law.
- Expanded definition of 10% U.S. shareholder for CFCs. The determination of whether a foreign corporation is a CFC and whether a U.S. person is a 10% shareholder now takes into account the percentage of the value of all classes of shares owned in addition to the voting power.
- 30-day control no longer required for CFC deemed dividend inclusions. It is no longer a requirement that a CFC must be controlled for an uninterrupted period of 30 days during the year before U.S. shareholders that own at least 10% are required to pay U.S. tax on inclusions of the CFC’s undistributed income.
- Constructive ownership of foreign corporation stock. Stock of a foreign corporation that is owned by a foreign person is now counted in determining whether a U.S. person related to the foreign person constructively owns the stock. This impacts the determination of whether the foreign corporation is a controlled foreign corporation (CFC) and whether the U.S. shareholder owns at least 10% of the CFC.
- Other provisions. Other key U.S. international tax provisions in the new legislation include the GILTI deduction for U.S. corporations, the base erosion anti-abuse tax (BEAT) for U.S. corporations with average annual gross receipts of at least $500 million, and limitations on shifting income through intangible property transfers.
Please contact our international tax advisors at 301.231.6200 for more information regarding how the new U.S. international tax provisions may affect you.