As it relates to international taxation, there are numerous provisions in each chamber’s proposal that materially differ from the other’s. Regardless of which provisions are included in a final bill, it is likely that the reform effort will significantly alter the current US international tax regime and affect planning for businesses in the year ahead. In this article, we focus on the differences between the House and Senate plans, and which provisions in both warrant attention should they pass.
Participation exemption system differences
First, the move toward a participation exemption system is one of the focal points of both proposals, with some minor differences. Under the participation exemption system, the foreign-source portion of a dividend paid by a foreign corporation to a US corporate shareholder that owns 10% or more of the foreign corporation is exempt. Both plans mirror each other in this respect. However, the Senate plan introduces a dividend received deduction (DRD) for dividends that qualify for the participation exemption. Further, and importantly, the Senate version excludes hybrid dividends from this beneficial treatment. Under the Senate plan, hybrid dividends are defined as an amount received from a controlled foreign corporation (CFC) that would be eligible for the participation exemption and for which the specified 10% owned foreign corporation has also received a tax benefit from taxes imposed in the foreign country.
Under the participation exemption system, there would be additional changes to the tax code. For example, both plans propose changes to certain foreign tax credit rules, including the repeal of Internal Revenue Code (IRC) Sec. 902 and modifications to IRC. Sec. 960 (albeit the Senate plan offers no specifics). Also, IRC Sec. 956 would be repealed in part – allowing CFCs to invest previously untaxed earnings and profits (E&P) in the US without the investments being treated as deemed dividends. In addition, the temporary look-through rule under IRC. Sec. 954(c)(6) would become permanent.
Repatriation
Perhaps of greater importance in the context of foreign E&P is the proposed imposition of an automatic repatriation tax on foreign E&P not previously taxed in the US This provision could impact all US companies with foreign operations. Both plans support the repatriation tax, but the tax rates differ in each bill. The House version would tax earnings and profits classified as cash or cash equivalents at 14% and any remaining illiquid earnings and profits at 7%.
Under the Senate plan, corporate taxpayers would deduct a portion of this mandatory inclusion of income in order for the resulting tax rate to be 10% for cash and cash equivalents and 5% for the remainder of illiquid earnings and profits. This plan also disallows 71.5% of the foreign tax paid on the cash portion for foreign income tax credit purposes and similarly 85.7% of foreign income tax paid on the remaining (illiquid) portion. Payment of the tax liability can be equal installments over eight years under the House plan, while the Senate bill would permit 8% of the tax to be paid during the first five years, 15% in the sixth year, 20% in the seventh year and 25% in the eighth year. Both proposals envision special rules for US shareholders of S Corporations, whereby the liability would not be due until a designated triggering event occurs (e.g., cessation as an S Corporation or business activities, or the stock is transferred).
Subpart F 2.0
Both the House and Senate plans impose a potentially impactful current-year taxable inclusion for US shareholders that equals its pro-rata share of what is effectively a new category of Subpart F income. The new inclusion amount under the House and Senate bills would be referred to as foreign gigh return amount (FHRA) and global intangible low-taxed income (GILTI), respectively. This provision is geared toward taxing in the US intangible profits of CFCs earned outside the US. A US shareholder’s share of FHRA and GILTI income will be taxed in a manner similar to other categories of Subpart F income. The House and Senate provisions both generally support this, but with significant conceptual differences.
FHRA and GILTI generally equal the excess of a CFC’s aggregate income over a statutorily computed routine return. A material difference between the FHRA and GILTI rules is that while only 50% of FHRA would be includible in the House calculation, 100% of GILTI would be includible under the Senate version. In lieu of the 50% exclusion, a US shareholder would be allowed a 37.5% tax deduction for the GILTI inclusion for tax years beginning after December 31, 2017 and before January 1, 2026. For tax years thereafter, the deduction would be reduced to 21.875%.
The routine return amount is loosely computed based on the CFC’s basis in its tangible business assets. The FHRA provision applies a rate of 7%, plus the applicable Federal short-term rate, to the aggregate basis in depreciable tangible property to determine the routine return. The GILTI provision applies a constant 10% rate to compute the routine return.
The aggregate CFC income is also reduced by certain statutory categories of income. Both FHRA and GILTI provisions allow a reduction of the tested income for effectively connected income, Subpart F income, dividends from a related person, foreign oil and gas extraction income, and amounts excludible from Subpart F inclusion based on the high-tax exception. FHRA also excludes related-party income not included in Subpart F under the look-through rules, active finance income, insurance income and dealer income. The Senate report does not provide similar exclusions. Under the FHRA provision, allocable interest expense further reduces the CFC’s routine return; the Senate bill does not provide a similar reduction for interest expense.
Analogous with other Subpart F income provisions, under either bill, the inclusion amount (the excess amount over the routine return) would be taxed in the US annually, even in the absence of an actual cash distribution. Therefore, under either bill, less depreciable tangible assets utilised in the CFC’s business means that more income could be considered to be intangibles-based income, resulting in a larger Subpart F inclusion. This provision would be more impactful for companies that are not capital asset intensive.
Regarding related FTC rules, the FHRA and GILTI provisions contain a similar limited deemed-paid FTC (DPC) rule. US shareholders could claim a DPC for 80% of the foreign taxes attributable to FHRA or GILTI inclusions. Both provisions disallow DPC carrybacks or carryforwards.
Timing is everything
Both bills lower the current US statutory corporate income rate from 35% to 20%. The effective dates for the proposed House and Senate rate reductions are applicable for years after 2017 and 2018, respectively. This change will fundamentally impact all US corporations. The effective date of the rate reduction could impact companies that have tax year-ends other than December 31. This will likely result in companies exploring opportunities to change their year-ends to avail themselves of the lower rates sooner, rather than waiting for the end of their fiscal years.
Charles Schneider is the partner-in-charge, Harold Adrion is a tax principal, Charles Brezak is a director and Aninda Dhar is a senior manager in EisnerAmper’s international corporate tax services group.
