With 2019 around the corner, international businesses still have an opportunity to restructure ownership and operations to exploit the dramatic changes made by the Tax Cuts and Jobs Act (TCJA or the Act). Prior ownership and operational structures may be outdated and inefficient and must be reviewed to assess the benefits of restructuring. Inaction may result in loss of tax incentives and unanticipated income tax liability from foreign operations in 2018.
In this Friedman Tax Alert, we will highlight the following international business issues.
- Global intangible low-taxed income (GILTI) regime which imposes a current year and minimum income tax on US Shareholders of controlled foreign subsidiaries or corporations (“CFCs”)
- Foreign-Derived Intangible Income (FDII) export US corporate income tax incentive, on licensing, sales, services and royalty income for US C corps servings foreign markets
- Participation exemption or 0% DRD for active dividend distribution from foreign subsidiary corporations to their US C corporation shareholders
- Unexpected (and undesirable) CFC status or US Shareholder status, which may lead to additional informational reporting and US federal income tax liability
- Holding Passive Foreign Investment Companies(“PFICs”) has a high compliance cost that may exceed the income they generate – consider a sale before year end.
We strongly recommend a review of your organizational structure for potential tax incentives, restructuring, and mitigation of the potentially adverse tax effects of GILTI especially to individual and pass-through owners.
GILTI - NEW MINIMUM TAX ON FOREIGN OPERATIONS
An entirely new tax regime governing Global Intangible Low-Taxed Income (GILTI) imposes an effective “minimum tax” on U.S. Shareholders of CFCs on a current basis regardless of whether funds are repatriated. CFCs are foreign corporations that are owned more than 50% by U.S. Shareholders.
Effect. Ownership structures and operations originally designed to pay little or no taxes overseas may inadvertently be subject to a minimum U.S. tax of 10.5% or more (e.g., “deemed dividend” similar to subpart F income). Additional informational reporting for GILTI will be required.
US C corp shareholders of CFCs obtain much more favorable treatment, including, (i) foreign tax credits with 80% limitation, (ii) 50% GILTI deduction, and (iii) resulting in a minimum effective tax rate of 10.5% to 13.125%.
Individual U.S. taxpayers are adversely affected by GILTI with (i) no foreign tax credits, (ii) no GILTI deduction, and (iii) an effective tax rate on income from foreign operations of up to 37% plus NIIT of 3.8%.
Recommendation. Review structure to minimize or eliminate the harsh impact of minimum tax particularly on individuals and consider advantages of corporate form. Where feasible, affirmatively utilize the GILTI regime in combination with transfer pricing for optimal and efficient operations.
NEW TAX INCENTIVE: FDII
The Foreign-Derived Intangible Income (FDII) regime provides an [export] tax incentive for U.S. C corporations to serve foreign markets by allowing qualifying FDII a preferential effective tax rate of 13.125%, instead of regular 21% rate. FDII includes the sale, exchange, lease or license of property to foreign persons for foreign use, or from services provided to foreign persons (outside the United States) or with respect to foreign property.
Recommendation. US based companies should review their existing structure and operations to maximize the tax incentive benefits of FDII including (i) determining what existing income qualifies for the reduced rate, (ii) assessing the advantages of corporate form, and (iii) considering structuring business to qualify for this new tax benefit. Individuals taxed at up to 37% should rearrange their affairs utilizing a corporate structure to reduce the effective tax rate on FDII to 13.125%
PARTICIPATION EXEMPTION – DRD
US C corporations may receive tax-free dividends from at least 10% owned foreign corporations, starting January 01, 2018. Thus, 2018 may be the opportune time to repatriate income.
In particular, a US C corporation which owns 10% or more of the vote or value of a foreign corporation may deduct up to 100% of the dividends it receives from such foreign corporation. Certain categories of income of foreign corporations are not permitted to benefit from the participation exemption, including Subpart F income (certain types of mobile income), Passive Foreign Investment Company income, and GILTI. Individuals and pass-through entities do not benefit from the participation exemption.
Recommendation. U.S. corporations should consider repatriating funds tax-free. International businesses should assess doing business under a corporate structure.
UNEXPECTED CFC STATUS
Beginning in 2018, certain unsuspecting U.S. owners and shareholders may be surprised to learn that they are now considered “US Shareholders” (e.g., a US person that owns 10% of a CFC) of a CFC and subject to informational reporting requirements and current taxation, regardless of whether there is a repatriation of funds.
US Shareholder by value test. New rules add a value test to determine whether a foreign corporation is a CFC and a U.S. shareholder owns 10% or more of the company.
Downward attribution through 958(b)(4). A 10% U.S. shareholder may find that under the new “downward attribution” rule, it owns a CFC. For example, stock owned by a foreign corporation is now treated as constructively owned by its domestic subsidiary.
Repeal of 30-day ownership rule. Now a foreign corporation is a CFC if it is a CFC on any day during the tax year.
Observations. Remember US Shareholders of a CFC are subject to current taxation (subpart F income) and to GILTI minimum tax regardless of whether foreign funds were repatriated; and onerous information reporting and compliance requirements.
HOLDING PFIC INVESTMENTS
The Act provided no relief from the enormous compliance burden imposed on direct and indirect investors into passive foreign investment companies (“PFICs”) which include foreign mutual funds. As more “fund of funds” are formed and invest globally, more taxpayers are discovering they have many small investments in PFICs and separate filing is required for each investment.
Observation. Many investors will pay more for PFIC reporting than the profits they will generate from those investments. Consider selling small PFIC investments before year end to start 2019 without this burden.
A collaborative and timely approach is necessary to review your international business operations and existing ownership structure in light of the international provisions of the TCJA. There are several other provisions that may apply to your business. Please contact the Friedman LLP International Tax Services group for planning opportunities.