International tax provisions and implications of the Tax and Jobs Act of 2017

In November 2017, the United States Congress’ House of Representatives House Ways and Means Committee released its version of a tax reform Bill entitled the Tax Cuts and Jobs Act of 2017 (H.R. 1) (the “Bill”).  The Bill seeks to reform the Internal Revenue Code, reducing the top corporate tax rate, reducing or restricting many corporate tax deductions and preferences, and substantially reforming the international tax provisions.

With respect to the International rules, the Bill would affect 3 key areas:

• Enact a 100% deduction for dividends received from 10% or greater owned foreign subsidiaries after 2017.
• Tax on a current basis 50% of a US shareholder’s controlled foreign corporations’ (CFCs’) “foreign high return amounts,” attributable to CFC tax years beginning after 2017.
• Cap interest deductions, in tax years beginning after 2017, by reference to the lesser of:
• 30% of adjusted taxable income, or
• 110% of financial reporting group net interest expense multiplied by the ratio of US EBITDA to group EBITDA.

Key changes

Dividends by 10% foreign subsidiaries received after 2017 to domestic corporations

The Bill would grant domestic (US) corporations a 100% dividends received deduction (DRD) (new Code section 245A) for the “foreign-source portion” of any dividend made after 2017 and received from a foreign corporation (other than a non-CFC passive foreign investment company [PFIC]) by a domestic corporation that is a “US shareholder” in the foreign corporation. Section 956 (which generally triggers the inclusion of CFC earnings in the gross income of a US shareholder by reference to “United States property” treated as held by the CFC) would no longer apply to US shareholders that are corporations.

Income inclusion for foreign “high returns” — new section 951A

Under proposed new section 951A, a US shareholder would include in gross income 50% of its CFCs’ income for the year that is deemed to represent “high” returns on investment. Generally, the provision results in the current inclusion of 50% of a US shareholder’s pro rata share of the aggregate CFC net income5 not currently subject to US tax, if it exceeds a set percentage of the US shareholder’s pro rata share of the aggregate tangible depreciable asset basis of all its CFCs (so-called “foreign high return amount”).

Implications

New Section 951A is more far-reaching than most anticipated. It would effectively establish a global minimum tax on foreign earnings. Because intangible property would not be treated as a qualified business asset investment, Section 951A will be particularly significant for US taxpayers with considerable offshore intangible property. Further, because the bill would also repeal current Section 958(b)(4), which does not prevent stock owned by a foreign person to be attributed downward to a domestic subsidiary, the provision would also affect foreign-parented groups with US subsidiaries that partially own non-US subsidiaries that would become CFCs because of the repeal.

Under the 20% US corporate tax rate proposed by the Bill, new section 951A would ensure that the “high returns” on the “tested” income of a US shareholder’s CFCs will bear current worldwide income tax at a rate (across all income of all of a US shareholder’s CFCs) of no less than 10%; for example, in a case where no foreign tax was paid or accrued by a US shareholder’s CFCs. However, the total worldwide tax often will be more than 10%. As a result, if the CFCs paid or accrued foreign income taxes attributable to the “tested” income in the inclusion year, but the average effective rate of such taxes for the year is less than 12.5%, then there would be additional tax imposed by the United States.

Limitations on Interest Deductibility

The Bill would rewrite section 163(j) so as to cap deductions for “business interest” by reference to a fixed percentage of adjusted taxable income, similar to that imposed by other countries such as Germany. Under this provision, the “business interest” deduction of every taxpayer (corporate or otherwise) would be limited to the amount of the taxpayer’s business interest income plus 30% of its business’ adjusted taxable income. “Business interest” and “business interest income” are interest paid or accrued on indebtedness properly allocable to a trade or business, and includible interest income properly allocable to a trade or business, respectively. Any disallowed deductions would be carried forward for five taxable years. The proposal would not apply to a business with average gross receipts of $25 million or less, as well as to certain regulated utilities and real property trades or businesses.