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The Tax Cuts & Job Act: International Provisions

April 12, 2018 3:30 PM | Vaughn Lawrence (Administrator)

By Thomas Barber, Steven Greene, Jay Wang and Erin Schatzle of Mazars

The TCJA contains substantial changes to the international taxation principles currently in effect, bringing the US closer to a territorial-based regime and curtailing the ability to defer tax on foreign source income. Insurers need to pay particular attention to these provisions if they are part of a global organization having intercompany charges and ceded reinsurance transactions.

Deemed Repatriation of Deferred Foreign Income

The TCJA moves the United States from a worldwide tax system to a participation exemption system by providing corporations a 100% dividends received deduction for dividends distributed by a controlled foreign corporation (CFC). To accomplish this transition generally requires that, for the last taxable year of a foreign corporation beginning before January 1, 2018 all US shareholders of any CFC or other foreign corporation that is at least 10-percent US-owned but not controlled (other than a PFIC), must include in income their pro rata shares of the accumulated post-1986 deferred foreign income that was not previously taxed. Income inclusion is to be taxed (a Transition tax) at a 15.5% rate on accumulated post-1986 foreign earnings held in the form of cash or cash equivalents, and 8% rate on all other earnings. To accomplish this, the TCJA permits a deduction in an amount necessary to result in a 15.5% tax on foreign earnings held in cash or cash equivalents, and an 8% tax on foreign earnings held in illiquid assets.

The TCJA allows a US shareholder to elect to pay the transition tax over eight years at 8% for the first five years, 15% in the sixth year, 20% in the seventh year and 25% in the eighth year.

Mazars Insight: We strongly suggest the performance of earnings and profits studies related to any relevant specified foreign corporations to accurately determine accumulated post-1986 deferred foreign income that would be subject to the transition tax. Companies utilizing net operating loss carry forwards in 2017 should consider not electing the eight year spread of transition tax.

Companies’ 2017 year-end tax provisions need to consider this as the tax is a 2017 event. Also, if a company has made the assertion that their investment in the applicable foreign subsidiary is not being permanently reinvested, the taxable income recognized under this provision would be an increase in its tax basis in the foreign subsidiary and as such would be treated as a temporary tax difference subject to deferred tax. Otherwise, the increase in taxable income is a permanent tax adjustment.

Deduction for Foreign Source Portion of Dividends Received

The TCJA provides a 100% dividends received deduction in relation to the foreign portion of dividends received by US C-Corporation shareholders from 10% owned foreign subsidiaries. Additional features of this provision include: 

  • No foreign tax credit is permitted with respect for qualifying dividends;
  • Hybrid dividends are not subject to the deduction;
  • Dividends from Passive Foreign Investment Companies will not be eligible for the deduction;
  • Dividends received by a domestic corporation from a specified foreign corporation via a partnership are eligible for the deduction provided certain requirements are met;
  • Dividends received by CFCs from specified foreign corporations that are treated as subpart F income may also qualify for the deduction; and
  • US shareholders must satisfy a holding period requirement of more than 365 days during the 731 day period that begins on the day that is 365 days before the ex-dividend date.

Mazars Insight: While the participation exemption brings the US closer to a territorial tax system, at least with respect to the earnings of foreign corporations, it is worth noting that Subpart F is still very much alive, and further, the bill introduces additional current tax on certain types of foreign income, described in more detail below. The overall effect is to reduce tax deferral on foreign income while modestly expanding the base. 

New Base Erosion and Anti-Abuse Tax

The TCJA introduces a base erosion and anti-abuse tax (“BEAT”) which essentially operates as a minimum tax applicable to taxpayers that are subject to US net income tax, have average annual gross receipts equal to or exceeding $500 million (over a three year period ending with the preceding tax year), and have paid or accrued certain related party deductible amounts included in regular taxable income (i.e., base erosion payments). Note that the gross receipts test is based on controlled group rules which would require inclusion of foreign members of the controlled group, but only to the extent the foreign members’ gross receipts relate to effectively connected income (“ECI”). For insurance companies, premiums paid for gross premiums written on insurance contracts during the taxable year are also considered base erosion payments. These taxpayers will incur the BEAT tax if it exceeds their regular tax.

This minimum tax equals the excess of 10% (25% for tax years beginning after December 31, 2025) of a taxpayer’s “modified taxable income” for a tax year over the taxpayer’s regular tax liability for the tax year, with an allowance for certain credits under Chapter 1 of the Code. Modified taxable income is calculated by adding back certain deductions attributable to payments to related foreign companies and related NOLs. There are certain exceptions to the BEAT tax for small tax paying groups (i.e., taxpayers with a base erosion percentage of less than 3% for the tax year, or 2% for certain banks and securities dealers), as well as, certain types of payments excluded from the definition of what constitutes base erosion payments. Unlike the repealed AMT regime, any BEAT in excess of regular tax will not be creditable in the future.

 Mazars Insight: Here is where we really see Subpart F remnants in the US taxation system, albeit at a reduced rate. However, there is still quite a bit undefined in this provision. For example, is the $500 million gross receipts test on gross of ceded reinsurance earned or written? Can ceded loss and claim reimbursements be netted from the ceded premium that’s treated as a base erosion payment? Insurers have already begun to evaluate and change their ceded reinsurance agreements in order to minimize the impacts of the BEAT. Taxpayers should begin to model projections on a regular tax and on a BEAT basis in order to determine where the breakeven point is. If taxpayers have any latitude on business income/expenses and/or timing of adjustments to taxable income (e.g., bonus depreciation), permanent tax savings may be available to them. We expect the Treasury Department to prescribe regulations as appropriate to define, with more granularity, the nature of how to calculate adjustments to modified taxable income, particularly with respect to certain industries like insurance. We also expect an explicit anti-abuse provision preventing planning to circumvent BEAT. 

On January 10th the FASB in Staff Q&A TOPIC 740, NO. 4 ACCOUNTING FOR THE BASE EROSION ANTI-ABUSE TAX indicated that the BEAT is to be treated as a period cost and that deferred tax assets and deferred tax liabilities should be recorded at the regular rate. We would suspect that Statutory Accounting rules under SSAP No. 101 would follow the lead of the FASB on this issue.

Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income

The TCJA permits intangible income from Foreign-Derived Intangible Income (“FDII”) to be taxed at 13.125% (the effective tax rate of 13.125% is arrived at by computing a FDII deduction). The FDII deduction can only be made if the income derived is not from a low-taxed jurisdiction.

US shareholders of CFCs are required to include in income their “global intangible low-taxed income” (“GILTI”). The mechanism for taxing such amounts would be similar to Subpart F. That is, a shareholder’s GILTI, generally equal to the excess of the shareholder’s CFC net income over a routine or ordinary return would be currently taxable and subsequently increase the shareholder’s basis in its CFC stock.

Mazars Insight: As a result of the deduction available to corporate shareholders equal to 50% of the GILTI through 2025, US shareholders will be taxed at an effective rate of 10.5% on these amounts irrespective of whether any amounts are distributed. The GILTI provision effectively increases the type of earnings subject to immediate taxation under Subpart F, indicating potential concern that the move toward a territorial system could result in profits permanently shifted offshore.

This article was featured in the PAMIC 360.

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