International Tax Reform

March 19, 2018

Nicole R. Suk, CPA

Why International Reform?

• Shift to territorial system

• Protect the U.S. tax base from perceived cross-border erosion

• Incentive for economic investment in the U.S.

Agenda

• Transition Tax

• Foreign Source Dividends

• Global Intangible Low Taxed Income

• Foreign Derived Intangible Income

• Base Erosion Anti-Abuse Tax (BEAT)

• Interest Deduction Limitation

• Anti-Hybrid Rules

Transition Tax

• §965 Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation.

• Effective after December 21, 2017 – Report on 2017 tax returns.

• “Deemed” repatriation of earnings.

• Treats deferred foreign income as subpart F income unless already previously taxed.

Transition Tax

Who is Subject?

• U.S. “persons” owning at least 10% of a specified foreign corporation (SFC).

• Definition of U.S. shareholder changed.

• Specified Foreign Corporation includes

– Any CFC

– Any foreign corporation which has a U.S. corporate shareholder that owns at least 10% of the stock.

• For 2017 report SFCs on Form 5471.

Transition Tax

Who is not subject?

• U.S. individuals owning greater than 10% each, but less than 50% collectively – not a CFC or SFC.

• Shareholders in PFIC corporations, even if own greater than 50%.

Transition Tax

US Individuals or Corporation

Foreign Corporation

≥50%

Required to pay transition tax

Transition Tax

US Individual(s)

Foreign Corporation

49%

NOT Required to pay transition tax

Foreign Individuals or Corporation

51%

Transition Tax

US Individual

Foreign Corporation

10%

Foreign Individuals or Corporation

80%

10%

Required to pay transition tax

US Corporation

Transition Tax• S Corporation exception - S corporation owners may

elect to defer tax liability until triggering event:

– Ceases to be an S corporation

– Liquidates or sells assets

– Ceases business; or

– Shareholder transfers shares of stock

• Any net tax liability payment of which is deferred under the election shall be paid in the tax year of the triggering event.

Transition TaxFour Step Process

1. Inventory the entities that must be analyzed.

2. Determine the amount of income (E&P) subject to the transition tax.

3. Compute how much of the E&P relates to cash assets.

4. Calculate the transition tax.

Transition Tax

• Subpart F income inclusion for E&P determined on November 2, 2017 or December 31, 2017 (greater amount).

• May be reduced by foreign E&P deficits that are properly allocable to that person.

• E&P reduced by previously taxed income.

• Not reduced by dividends paid during transition year except to other SFCs.

Transition Tax

• Deduction allowed based on two measurements: the US shareholder’s “aggregate foreign cash position amount” and the aggregate E&P held in other assets.

• Taxed at shareholder’s 2017 rate.

• Effectively reduces tax rates to 15.5% and 8% respectively for corporations in 35% rate bracket.

Transition Tax• FTCs otherwise available disallowed in amount of

55.7% for cash portion & 77.1% for noncash portion.

• May use U.S. NOL against 965 income or elect to forgo use of NOL.

Transition TaxSample calculation

CFC1 SFC1

Nov 2 E&P $1,500 $2,400

Dec 31 E&P $1,300 $2,500

Greater of tested amounts $1,500 $2,500

Total US 965 inclusion $4,000

• Deductible intercompany payments may be eliminated from E&P under Notice 2018-07 to avoid double counting in E&P.

Transition TaxSample calculation

Form 5471

Cash $3,000

A/R $1,500

Inventories $2,000

Net PPE $500

Total Assets $7,000

Liabilities $2,000

Equity $5,000

Accumulated E&P $4,000

965 inclusion $4,000

Aggregate cash position $4,500

Exceeds 965 inclusion

965 Inclusion $4,000

965 Deduction (55.7%) (2,228)

965 Deduction (77.1%) (0)

Net 965 Income $1,772

Tax at 35% $620

Effective Tax Rate 15.5%

Transition TaxSample calculation

Form 5471 CFC

Cash $2,000

A/R $1,500

Inventories $2,000

Net PPE $1,500

Total Assets $7,000

Liabilities $2,000

Equity $5,000

Accumulated E&P $4,000

CFC

965 inclusion $4,000

Aggregate cash position $3,500

Does not exceed 965 inclusion

965 Inclusion $4,000

965 Deduction (55.7%) (1,950)

965 Deduction (77.1%) (385)

Net 965 Income $1,665

Tax at 35% $583

Effective Tax Rate 14.6%

Transition Tax

• May elect to pay tax over 8 years

– 8% first five years; 15% in 6th year; 20% in 7th year; 25% in 8th year.

• If business is sold – all remaining installments must be paid on final tax return.

Transition Tax

Reporting

• Required to include an “IRC 965 Transition Tax Statement” in 2017 return.

• Elections must be made by due date of return, including extensions.

• Payment must be made separately from regular tax.

• Partnership, S corps and other pass through entities must attach statement to K-1s.

• Amend if a return has already been filed for 2017.

Transition Tax

Form965(a) Income

965(c) Deduction FTC Tax Liability

1040 Net inclusion -Page 1, Line 21 other income –write “Sec 965” on dotted line

Net with income

Report on Form 1116

Add total tax to Page 2, Line 44, Tax, Check box ‘c’ on Line 44 and write 965 to the right of the box.

Include as credit in total on Page 2, Line 73 the amount to be paid in installments for years beyond the 2017 year, if applicable. Check box ‘d’ on Line 73 and write TAX to the right of the box

Transition Tax

Form965(a) Income

965(c) Deduction FTC Tax Liability

1120 Do not enter on return –only reported on IRC 965 statement

Do not enter on return –only reported on IRC 965 statement

Not reported on 1118 -Report on IRC 965 Transition Tax Statement

Include in total on Page 3, Schedule J, Part I, Line 11 net tax liability under section 965.Include in total on Page 3, Schedule J, Part II, Line 19d the amount to be paid in installments for years beyond the 2017 year, if applicable.

Transition Tax

Form 965(a) Income 965(c) Deduction FTC Tax Liability

1120S Page 3, Sch K, Line 10 “Other Income”

Page 3m Sch K, Line 12d “Other Deductions”

N/A N/A

1065 Page 4, Sch K, Line 11 “Other Income”

Page 4, Sch K, Line 13d “Other Deductions

N/A N/A

Transition TaxNotice 2018-07 provides additional guidance on:

• Determining aggregate foreign cash position

• Determining accumulated post-1986 deferred foreign income

• Applying basis adjustment to repatriated amounts treated as subpart F income

• Consolidated group effects

• Determining foreign currency gain or loss

Foreign Source Dividends

• For dividends paid after December 31, 2017.

• 100% deduction for “foreign-source portion” of dividends received from “specified 10-percent owned foreign corporations”.

• Specified foreign corporations do not include PFICs.

• Only available to U.S. C corporations other than RICs and REITS.

Foreign Source Dividends

• Subject to a one-year holding period.

• No foreign tax credit (or deduction for foreign taxes paid with respect to qualifying dividends) permitted.

• Deduction would be unavailable for “hybrid dividends.”

• Does not apply to income from foreign branches.

Global Intangible Low Taxed Income• New IRC § 951A

• Imposes a foreign minimum tax on U.S. shareholder’s allocable share of “GILTI” from CFCs.

• Any 10% U.S. shareholder (individual or corporate) of a CFC must include in gross income its “global intangible low-taxed income” in a manner similar to a subpart F income.

Global Intangible Low Taxed Income• GILTI is low-taxed income of a CFC that exceeds 10%

return on capital invested in tangible depreciable property used in a trade or business.

• Does not include amounts otherwise included in subpart F.

• The GILTI computation is calculated at the shareholder level.

• Income in one CFC can be offset by losses in another CFC if there is a common shareholder.

Global Intangible Low Taxed Income

GILTI Calculation:

Step 1: Calculate CFC’s “tested” income

CFC’s total gross income

Less: CFC’s U.S. ECI

Less: CFC’s Subpart F Income

Less: CFC’s dividends from related persons

Less: CFC’s foreign oil and gas extraction income

Less: other deductions including taxes

CFC tested income

Global Intangible Low Taxed Income

GILTI Calculation:

Step 2: Calculate the Qualified Business Asset Investment (QBAI)

QBAI is the quarterly average tax basis (using SL depreciation) of depreciable tangible property used in the production of the relevant income/loss.

Global Intangible Low Taxed Income

GILTI Calculation:

Step 3: Calculate the Net Deemed Tangible Income Return

10% of QBAI

Less: The net amount of interest expense taken into account in determining net tested income

Net Deemed Tangible Income Return

Global Intangible Low Taxed Income

GILTI Calculation:

Step 4: Calculate GILTI

Tested Income (Step 1)

Less: Net Deemed Tangible Income Return (Step 3)

GILTI

Global Intangible Low Taxed Income

• Deduction allowed for C corporation U.S. shareholders only.

– 50% of GILTI – creates effective tax rate of 10.5% on GILTI

– Decreases to 37.5% for years after 2025 –13.125% effective tax rate

• Foreign tax credits are available but are limited to the 80% of taxes paid and cannot be carried back or carried forward like other foreign tax credits. Only available for C corporations.

Global Intangible Low Taxed Income

Example Corp 1 Corp 2 Individual

Net income pre tax $1,000 $1,000 $1,000

Foreign tax rate 20% 5% 20%

Foreign tax 200 50 200

Tested Income 800 950 800

Asset tax basis (QBAI) 4,500 4,500 4,500

GILTI:

Tested income 800 950 800

10% QBAI (450) (450) (450)

GILTI $350 $500 $350

Inclusion % (GILTI/Tested Income) 43.75% 52.63% 43.75%

§78 Gross up (inclusion % * tax) $88 $26 $88

Global Intangible Low Taxed Income

Example Corp 1 Corp 2 Individual

GILTI $350 $500 $350

§78 Gross up 88 26 88

Total GILTI inclusion 438 526 438

50% GILTI deduction (219) (263) -

Taxable income 219 263 438

US tax rate 21% 21% 37%

US tax $46 $55 $162

FTC (80%) (160) (40) -

Net US Tax $0 $15 $162

Net Global Taxes $200 $65 $362

Global ETR 20.0% 6.5% 36.2%

Foreign Derived Intangible Income

• Known as the FDII deduction.

• Represents the portion of a domestic corporation’s income derived from serving foreign markets.

• Creates a preferential tax rate for domestic C corporations serving foreign markets.

• S corporations and individuals are not eligible for the deduction.

• Creates disincentives for movement of IP outside the U.S.

Foreign Derived Intangible Income

• Includes income derived from the sale of property to any foreign person for a foreign use.

• The term “sale” is specially defined for this purpose to include any lease, license, exchange or other disposition.

• “Foreign use” is defined to mean “any use, consumption, or disposition which is not within the United States.”

• Special rules for sales to related foreign persons.

Foreign Derived Intangible Income

• Eligible C corporations are allowed a deduction equal to 37.5% of FDII for tax years 2018-2015 and 21.875% for years after.

– Reduces the effective U.S. tax rate for eligible C corporations on foreign income treated as attributable to IP and other intangible assets to 13.125% versus 21%.

Foreign Derived Intangible Income

Deemed Intangible X Foreign Derived Deduction Eligible Income Income Deduction Eligible Income

Deductible Eligible Income = total gross income of the corporation without regard to subpart F income, GILTI, dividends received from 10% owned CFC and foreign branch income; reduced by deductions including taxes allocable to such gross income

Foreign Derived Deduction Eligible Income = DEI considered foreign derived if it is connection with property sold to a non—U.S. persons for foreign use, or services provided to any person or property outside the U.S.

Foreign Derived Intangible Income

Deemed Intangible X Foreign Derived Deduction Eligible Income Income Deduction Eligible Income

Deemed Intangible Income = DEI reduced by 10% of the qualified business asset investment

Foreign Derived Intangible Income

Example: Assume U.S. company has:

• Net taxable income of $1,000,000

• Foreign derived portion of $200,000 (20%)

• Qualified business asset basis of $2,500,000

Deductible Eligible Income (DEI) $1,000,000

Deemed Intangible Income (DII) $1,000,000 – ($2,500,000 x 10%) $750,000

FDII $750,000 X ($200,000 / $1,000,000) $150,000

FDII Deduction $150,000 x 37.5% ($56,250)

Net FDII Income $150,000 - $56,250 $93,750

Tax on FDII $93,750 x 21% $19,688

Tax on non-FDII ($1,000,000-$150,000) X 21% $178,500

Total U.S. Taxes $178,500 + $19,688 $198,188

Overall ETR $198,188/$1,000,000 19.82%

Foreign Derived Intangible Income

Example: Assume U.S. company has:

• Net taxable income of $1,000,000

• Foreign derived portion of $800,000 (80%)

• Qualified business asset basis of $2,500,000

Deductible Eligible Income (DEI) $1,000,000

Deemed Intangible Income (DII) $1,000,000 – ($2,500,000 x 10%) $750,000

FDII $750,000 X ($800,000 / $1,000,000) $600,000

FDII Deduction $600,000 x 37.5% ($225,000)

Net FDII Income $600,000 - $225,000 $375,000

Tax on FDII $375,000 x 21% $78,750

Tax on non-FDII ($1,000,000-$600,000) X 21% $84,000

Total U.S. Taxes $78,750 + $84,000 $162,750

Overall ETR $162,750/$1,000,000 16.28%

Base Erosion Anti-Abuse Tax (BEAT)

• Code §59A

• Effectively an alternative minimum tax on large multinational corporations.

• Applies to domestic C corporations part of a group with at least $500M of average annual domesticgross receipts over a three-year period.

• Applies to foreign corporations engaged in a U.S. trade or business for purposes of determining their effectively connected income tax liability.

Base Erosion Anti-Abuse Tax (BEAT)

• Applies when corporations are making payments to related foreign persons and a deduction is allowed for such related party payment in the U.S.

• Includes asset acquisitions if depreciation is taken.

• Excepted payments:

– Inventory purchases included in COGS.

– Payments for services under the 482 cost method with no markup component.

– Any qualified derivative payment.

Base Erosion Anti-Abuse Tax (BEAT)

• Calculated in 2018 as the excess of 5% of the modified taxable income over the regular tax liability.

• Tax rate will go to 10% after 2018; after 2025 up to 12.5%.

• Does not apply if the foreign recipient elects to be subject to U.S. income tax on the amounts received or if payments made with full 30% withheld.

• A foreign tax credit of 80% of applicable foreign credits are allowed against the U.S. tax liability imposed by this provision if an election is made.

Interest Deduction Limitation

• Amend 163(j) to limit interest deduction of any taxpayer for any tax year for net business interest expense to 30% of the taxpayer’s adjusted taxable income.

• Regardless of whether interest paid to related or unrelated parties (foreign or domestic).

• Exception for taxpayers with average annual gross receipts less than $25M during prior 3 year period.

Anti Hybrid Rules• A deduction will be disallowed for any disqualified

related party amount paid or accrued pursuant to a “hybrid transaction” or by or to a “hybrid entity”.

• Interest and royalty paid if not included in income in the foreign jurisdiction.

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Contact Information

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Nicole Suk, CPAPrincipal

Windham Brannon3630 Peachtree RoadSuite 600Atlanta, Georgia 30326Main: 404.898.2000Direct: 678.510.2785Fax: 404.898.2010Email: nsuk@windhambrannon.com