US tax reform reaches businesses worldwide

US Capitol

The US Congress passed tax reform legislation Wednesday, approving a bill known as the Tax Cuts and Jobs Act, H.R. 1, that will enact sweeping changes to the US Internal Revenue Code. The bill will now go to President Donald Trump for his signature. The president is expected to sign the bill, but the White House has not announced when he will do so.

The bill passed the US House of Representatives on a 224–201 vote, after passing the Senate on a 51–48 vote, early Wednesday morning.

The bill’s many changes to the US tax code include a much lower corporate tax rate, changes to credits and deductions, and a move to a territorial system for corporations that have overseas earnings.

The bill will replace the current graduated corporate tax rate, which taxes income over $10 million at 35%, with a flat rate of 21%. The new tax rate will take effect 1 January 2018. The bill also repeals the corporate alternative minimum tax (AMT).

US corporations with foreign income will see many changes, including replacing the current system under which the US taxes a corporation on its worldwide income (although foreign earnings are not taxed until they are repatriated to the US).

The bill accomplishes this by providing a 100% deduction for the foreign-source portion of dividends received from “specified 10% owned foreign corporations” by domestic corporations that are US shareholders of those foreign corporations within the meaning of US tax Code Sec. 951(b). The conference report on the bill says that the term “dividend received” is intended to be interpreted broadly, consistently with the meaning of the phrases “amount received as dividends” and “dividends received” under US tax Code Secs. 243 and 245, respectively.

A specified 10%-owned foreign corporation is any foreign corporation (other than a passive foreign investment company (PFIC) that is not also a controlled foreign corporation (CFC) with respect to which any domestic corporation is a US shareholder.

The deduction is not available for any dividend received by a US shareholder from a CFC if the dividend is a hybrid dividend. A hybrid dividend is an amount received from a CFC for which a deduction would be allowed under this provision and for which the specified 10%-owned foreign corporation received a deduction (or other tax benefit) from any income, war profits, and excess profits taxes imposed by a foreign country.

Foreign tax credit: No foreign tax credit or deduction will be allowed for any taxes paid or accrued with respect to a dividend that qualifies for the deduction.

Holding period: A domestic corporation will not be permitted a deduction in respect of any dividend on any share of stock that is held by the domestic corporation for 365 days or less during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend with respect to the dividend.

Deemed repatriation: The bill generally requires that, for the last tax year beginning before 1 January 2018, any US shareholder of a specified foreign corporation must include in income its pro rata share of the accumulated post-1986 deferred foreign income of the corporation. For purposes of this provision, a specified foreign corporation is any foreign corporation in which a US person owns a 10% voting interest. It excludes PFICs that are not also CFCs.

A portion of that pro rata share of foreign earnings is deductible; the amount of the deductible portion depends on whether the deferred earnings are held in cash or other assets. The deduction results in a reduced rate of tax with respect to income from the required inclusion of pre-effective date earnings. The reduced rate of tax is 15.5% for cash and cash equivalents and 8% for all other earnings. A corresponding portion of the credit for foreign taxes is disallowed, thus limiting the credit to the taxable portion of the included income. The separate foreign tax credit limitation rules of current law US tax Code Sec. 904 apply, with co-ordinating rules. The increased tax liability generally may be paid over an eight-year period. Special rules are provided for S corporations and real estate investment trusts (REITs).

Foreign intangible income: The bill will provide domestic C corporations (that are not regulated investment companies or REITs) with a reduced tax rate on “foreign-derived intangible income” (FDII) and “global intangible low-taxed income” (GILTI). FDII is the portion of a domestic corporation’s intangible income that is derived from serving foreign markets, using a formula in a new US tax Code Sec. 250. GILTI will be defined in a new US tax Code Sec. 951A.

The effective tax rate on FDII will be 13.125% in tax years beginning after 2017 and before 2026 and 16.406% after 2025. The effective tax rate on GILTI will be 10.5% in tax years beginning after 2017 and before 2026 and 13.125% after 2025.

Definition of US shareholder: The bill will amend the ownership attribution rules of US tax Code Sec. 958(b) to expand the definition of “US shareholder” to include a US person who owns at least 10% of the value of the shares of the foreign corporation.

Alistair M. Nevius (Alistair.Nevius@aicpa-cima.com) is FM magazine’s editor-in-chief, tax.