New Considerations for Cross-Border Structures Following the Tax Cuts and Jobs Act

New Considerations for Cross-Border Structures following TCJAThe 2017 Tax Cuts and Jobs Act (“TCJA”) made several key changes that will need to be reviewed in determining the most tax efficient structure for US companies with cross-border operations.  Business owners will need to review current structures and determine whether they are structured properly with the changes made under the TCJA. This article briefly reviews the key changes under the TCJA that affect cross-borderstructuring.  

One key change is the corporate tax rate changing from a progressive tax with a top rate of 35 percent and moving to a flat tax rate of 21 percent.  The new corporate tax rate is below the top individual tax rate of 37 percent, below the individual capital gains rate of 23.8 percent (after including the net investment income tax), and the worldwide average corporate tax rate of 22.96 percent.  

The TCJA provides a deduction for individuals who operate through a US passthrough entity.  Under prior law individual owners of a passthrough entity paid tax on the profits at individual income tax rates.  Under the TCJA, individual owners of a passthrough entity are permitted a 20 percent deduction on their qualified domestic business income when computing their taxable income.  This deduction lowers the top effective tax rate on passthrough income to 29.6 percent. This deduction is only available for domestic income and is not available for passthroughs generating foreign-source income.  The passthrough deduction expires at the end of 2025 unless there is legislation to extend or make the provision permanent.

The key change to international tax is the implementation of a quasi-territorial tax system that exempts corporate tax on earnings distributed from foreign subsidiaries other than US income inclusions for subpart F and global intangible low-taxed income (“GILTI”).  The US tax exemption for foreign earnings will be applied through a 100 percent dividends received deduction on distributions from a 10 percent owned corporate subsidiary to a US parent company (new IRC §245A).  This provision does not apply to foreign income earned by a domestic corporation directly or through foreign branches. There is a one-year holding period requirement and no foreign tax credits are allowed for any taxes relating to the exempt dividend.

considerations-crossborder-structures-tcjaAs a result of the new international tax rules, companies may consider transferring directly held foreign branch assets to a foreign corporation subsidiary.  The TCJA provides a recapture of any loss the domestic corporation recognized from the foreign branch in order to avoid a double benefit. Also, the tax-free transfer of assets to a foreign corporation that is an active trade or business is no longer available to offset the US charge resulting from outbound transfers of branch assets.

For companies with foreign branches, the companies will have to allocate the income to a new and separate basket in determining the foreign tax credit.  This eliminates the company’s ability to cross-credit foreign tax credits with a high tax jurisdiction against income from a low tax jurisdiction.

The new section 951A provides that a US shareholder of a controlled foreign corporation (“CFC”) must include its share of CFC’s GILTI in its gross income, similar to the inclusion of subpart F income.  Generally, GILTI refers to the residual income of a CFC in excess of a fixed 10 percent return on tangible assets. GILTI income is subject to US tax at an effective rate of 10.5 percent after applying a 50 percent deduction for corporate shareholders.  The GILTI tax may be offset by up to 80 percent of the foreign tax credits paid on the GILTI inclusion.

Foreign derived intangible income (“FDII”) is income that US corporations derived from marketing, selling, or providing services using US based intangibles abroad.  The FDII provision uses a series of increasingly formulaic calculations to divide a domestic company’s income amounts among two key taxable categories: (1) deemed tangible income return taxed at 21 percent; and (2) FDII taxed at 13.125 percent.  The reduced FDII rate is only available to corporations, individuals and noncorporate entities are subject to full tax on FDII.

 

Conclusion

As result of the changes made under the TCJA as noted above, determining the most tax efficient structure for cross-border operations is more complicated.  As a result of the changes, a US business owner that receives income from foreign subsidiaries from a flowthrough structure may find a US corporation would reduce overall taxation.  Since operations abroad range in size and have different combinations of US and foreign owners, detailed analysis is needed to determine the optimal structure for purposes of US taxation.  

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