US Tax-Consequences for US Citizen Owners of Israeli Corporations and other Foreign Corporations

The US tax reform (or “Tax Cuts and Jobs Act”) was enacted on 22 December 2017 with most of the international provisions in force since the beginning of 2018.  The US tax reform includes both tax-reducing and tax-increasing measures, which generate new planning opportunities.

This brief will describe the obligations for with regard to information and disclosure filings and to relevant revisions in the tax provisions that may trigger a tax obligation.

Filing requirements

Liability for U.S. income taxes payable by an individual is based on citizenship, as well as residence.  As a U.S. person, one must file annual U.S. income tax returns regardless of where the person lives or how long the person has been out of the U.S.  For U.S. tax purposes, all worldwide income from all sources is required to be reported.  This does not change ones obligation to as a foreign resident to file a tax resident based tax return and pay tax in the resident country.  However, there is relief from double-taxation due to Treaty based agreements.

U.S. citizens who are officers, directors, or shareholders in certain foreign corporations are responsible for filing Form 5471, Information Return of U.S. Persons with Respect to Certain Foreign Corporations. The form and attached schedules are used to satisfy the reporting requirements of transactions between foreign corporations and U.S. persons.

The categories of U.S. persons potentially liable for filing Form 5471 include:

• U.S. citizen and resident alien individuals,
• U.S. domestic corporations,
• U.S. domestic partnerships, and
• U.S. domestic trusts.

The filing requirements for Form 5471 relate to persons who have a certain level of control in certain foreign corporations. This includes a U.S. citizen or resident who is an officer or director of a foreign corporation in which a U.S. person has acquired (in one or more transactions) stock which meets the 10% stock ownership requirement (Regulation section 1.6046-1(f) (1), revised December 2017)

A controlled foreign corporation is any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders on any day during the taxable year of the corporation.

In addition, the Foreign Account Tax Compliance Act (FATCA) oversees a U.S. person’s foreign holdings.  The Treasury Department’s FATCA is an important development in U.S. efforts to combat tax evasion by U.S. persons holding accounts and other financial assets offshore.

U.S. persons must file Form 8938 if there is an interest in specified foreign financial assets and the value of those assets is more than the applicable reporting threshold.

Specified foreign financial assets include foreign financial accounts and foreign non-account assets held for investment (as opposed to held for use in a trade or business), such as foreign stock and securities, foreign financial instruments, contracts with non-U.S. persons, and interests in foreign entities.

Reporting thresholds vary based on whether you file a joint income tax return or live abroad. If you are single or file separately from your spouse, you must submit a Form 8938 if you have more than $200,000 of specified foreign financial assets at the end of the year and you live abroad; or more than $50,000, if you live in the United States. If you file jointly with your spouse, these thresholds double. You are considered to live abroad if you are a U.S. citizen whose tax home is in a foreign country and you have been present in a foreign country or countries for at least 330 days out of a consecutive 12-month period.

U.S persons that are shareholders in a foreign corporation must file Form 926 to report certain transfers of tangible or intangible property to a foreign corporation (IRC section 6038B, revised December 2017).

Generally, a U.S. citizen or resident, a domestic corporation, or a domestic estate or trust must complete and file Form 926 to report certain transfers of property to a foreign corporation that are described in section 6038B(a)(1)(A), 367(d), or 367(e).

A U.S. person that transfers cash to a foreign corporation must report the transfer on Form 926 if (a) immediately after the transfer, the person holds directly or indirectly, at least 10% of the total voting power or the total value of the foreign corporation, or (b) the amount of cash transferred by the person to the foreign corporation during the 12-month period ending on the date of the transfer exceeds $100,000. (Regulation section 1.6038B-1(b) (3))

Tax Provisions

As a result of the new international tax provisions, the US owners of a foreign corporation, which are controlled by US persons, may be subject to (i) Subpart F income, (ii) a “transition tax”, and (iii) a tax on deemed “global intangible low-taxed income” (GILTI).

Subpart F Income

A major tax advantage of using a foreign corporation to conduct foreign operations is income tax deferral: generally, U.S. tax on the income of a foreign corporation is deferred until the income is distributed as a dividend or otherwise repatriated by the foreign corporation to its U.S. shareholders.

The Subpart F provisions eliminate deferral of U.S. tax on some categories of foreign income by taxing certain U.S. persons currently on their pro rata share of such income earned by their controlled foreign corporations (CFCs). This approach is based on the principles underlying the United States’ taxing jurisdiction. In general, the United States does not tax a foreign corporation if the foreign corporation neither receives U.S.-source income nor engages in U.S.-based activities. However, the U.S. does generally tax all income, wherever derived, of U.S. persons. The Subpart F rules operate by treating a U.S. shareholder of a CFC as if it actually received its proportionate share of certain categories of the corporation’s current earnings and profits (E&P). The U.S. shareholder is required to report this income currently in the United States whether or not the CFC actually makes a distribution (I.R.C. § 951(a))

Under Subpart F of the IRC, certain types of income earned by a CFC are taxable to the CFC’s U.S. shareholders in the year earned even if the CFC does not distribute the income to its shareholders in that year. Subpart F operates by treating the shareholders as if they had actually received the income from the CFC.

There are many categories of Subpart F income. In general, it consists of movable income. For example, a major category of Subpart F income consists of investment income such as dividends, interest, rents and royalties.  For U.S taxpayers in a CFC, a common source of Subpart F income is the shareholder loan.  The loan to the U.S. shareholder will be considered a “deemed dividend” and taxed to the shareholder in the tax year that the loan is granted.

Transition Tax

The “transition tax” (IRC section 965) requires a mandatory inclusion of the accumulated foreign earnings of a controlled foreign corporation (CFC) and other foreign corporations with a 10% domestic corporate shareholder, collectively referred to as “specified foreign corporations” (SFCs).

Section 965(a) provides that, for the last tax year of a deferred foreign income corporation (DFIC) beginning before 1 January 2018 (the inclusion year), the subpart F income of the corporation shall be increased by the accumulated post-1986 deferred foreign income of such corporation determined as of 2 November 2017, or  31 December 2017 (whichever is greater).

The Section 965 mandatory inclusion would be subject to tax at reduced rates of 15.5% or 8%.

The 15.5% transition tax rate applies to an amount of the Section 965 mandatory inclusion equal to the aggregate foreign cash position of the DFIC, and the 8% transition tax rate applies to the remaining amount of the Section 965 mandatory inclusion.

In general, US taxpayers may elect to pay the net tax liability resulting from the Section 965 mandatory inclusion in installments. The “net tax liability” as a result of Section 965 is determined based on the US taxpayer’s net income tax rate for the tax year in which a Section 965 mandatory inclusion is recognized.

GILTI

The introduction of the taxation of “global intangible low-taxed income” or “GILTI” of foreign companies, adds a new category to the US “CFC-Rules” (US-Controlled Foreign Corporations Rules).

Under the TCJA, Congress has implemented GILTI as a new anti-deferral tax on certain earnings of a CFC, effective starting with the first tax year of the CFC beginning after Dec. 31, 2017.  Similar to the taxation of Subpart F income, a 10% U.S. shareholder of one or more CFCs will be required to include its GILTI currently as taxable income (in addition to any Subpart F income), regardless of whether any amount is distributed to the U.S. shareholder.

Specifically, a U.S. shareholder’s GILTI is calculated as the shareholder’s “net CFC tested income” less “net deemed tangible income return” determined for the tax year.   Net CFC tested income is calculated by determining the U.S. shareholder’s pro rata share of tested income or tested loss of each CFC held by the U.S. shareholder, and aggregating those amounts.   Tested income or loss generally is calculated as a CFC’s gross income after excluding items of high-taxed foreign base company income, Subpart F income, related-party dividends, certain foreign oil and gas extraction income, and income of the CFC taxable in the United States as effectively connected income, less deductions allocable to tested income.    Thus, in the simple case where a single shareholder owns 100% of a CFC with none of the categories of excluded income, net CFC tested income will equal the CFC’s net income.

The tax on GILTI essentially serves to tax the U.S. shareholder currently on its allocable share of CFC earnings for a tax year to the extent such earnings exceed a 10% return on the shareholder’s allocable share of tangible assets held by CFCs. The tax on GILTI applies equally to U.S. shareholders that are corporations or flow through taxpayers.