International Provisions in the Senate Tax Cuts and Jobs Act
November 28, 2017
The Senate’s version of the Tax Cuts and Jobs Act (TCJA) includes several important changes to the taxation of multinational corporations. The international provisions of the Senate’s bill are similar to those in the House’s bill, but there are key differences in their base erosion rules. The main purpose of the international provisions in the Senate bill is to introduce a territorial system to the taxation of multinational corporate income. This includes the introduction of a participation exemption, the strengthening of base erosion rules, and transition rules for deferred income.
However, the Senate bill also includes provisions to encourage multinational businesses to move intellectual property to the United States.
Overview of Major International Rules in the Senate’s Tax Cuts & Jobs Act
- Move to a territorial system through a 100 percent dividend deduction
- Deemed repatriation of deferred foreign income
- A reduce rate on foreign-derived income
- Base Erosion Rules
- Inclusion of foreign high returns
- Limitation of interest expensing for a worldwide affiliate group
- An inbound transaction inclusion rule
Transition to a Territorial System
The Senate bill has a 100 percent dividend deduction as the participation exemption. This includes a rule to limit losses for sale or transfer when dividends are paid to the parent corporation.
To facilitate the move from a worldwide to a territorial system, the bill includes a deemed repatriation provision. Deferred earnings are subject to a 10 percent tax if cash or cash equivalent or 5 percent tax for reinvested earnings. S corporations are exempt from deemed repatriation. REITs can exclude the deferred earnings from their gross income test.
Corporations have eight years to pay the tax on deferred earnings. A minimum payment of 8 percent is required for the first five years, 15 percent for the sixth year, 20 percent for the seventh year, and 25 percent for the eighth year.
Reduced Rate on Foreign-Derived Income
Unlike the House version of the TCJA, the Senate bill includes a 37.5 percent deduction on foreign-derived income above a threshold. Businesses with income from foreign sales receive a deduction for all income above a normal return on assets related to that income. The Senate bill defines normal income as 10 percent of all tangible, depreciable assets, which excludes intangibles like patents. As such, this provision lowers the effective rate on foreign income derived from intangible assets to 12.5 percent.
The provision is not technically an innovations box, but it has the same result. Typically, innovation boxes distinguish which income receives a lower rate based on research and development expenditures, royalty payments, or intangible assets. Although this provision does not use any of these tests, it does reduce the effective tax rate on income from intellectual property.
It seems that this provision is intended to encourage multinationals to locate intangibles in the United States. The assumption is bolstered by the inclusion of special rules for transferring intangible assets from controlled foreign corporations to a U.S. shareholder. This provision allows a U.S. parent to transfer an intangible asset without triggering a taxable event, such as capital gains from the sale of the asset.
Base Erosion Rules
Inclusion of Intangible Income from Low-Tax Countries
The current year inclusion of global intangible low-taxed income by United States shareholders does not distinguish between high-tax or low-tax countries. Instead, the rule requires a U.S. parent company to include 50 percent of all foreign subsidiaries’ income above a normal return into the parent’s taxable base. This provision excludes from income any effectively connected income, subpart F income, foreign oil or gas income, or certain related party payments. The provision defines normal returns as 10 percent of all the tangible, depreciable assets held by all foreign subsidiaries within the parent’s network. In this case, U.S. parents with intangible assets, such as patents and copyrights, in any foreign country would be required to include half of the income into the parent’s taxable base.
To avoid double taxation, the U.S. parent can use 80 percent of the foreign tax credits related to the included income against their tax liability. The remaining 20 percent cannot be carryforward or backward. Most U.S. parents with intangibles in higher-tax countries should have enough foreign tax credits as to avoid the tax while U.S. parents with intangible assets in low-tax countries would have an additional liability because there are no foreign tax credits available. As such, this provision acts like an additional tax on intangible income from low-tax countries without explicitly identifying low-tax countries.
Limitation of Interest Deduction
The Senate bill also includes a limit on the interest deduction for corporations within a global network. This provision does not replace the domestic limitation of interest deduction, but it is an additional limitation stacked on top of the domestic provision. In this provision, the interest deduction for a corporation within a “worldwide affiliate group” is limited to the a portion of the total interest paid by the group, where the portion is based on the share of group’s total income earned by the U.S. corporation.
For example, a U.S. subsidiary of a foreign parent has $10 million of income within a group with a total income of $100 million. The subsidiary has $5 million in interest payments, but the group only has a total of $20 million in interest payments. In this case, the subsidiary would only be allowed to deduct $2 million in interest payments, (10/100)*20.
The inbound rule in the Senate bill acts like an alternative minimum tax for corporations that conduct business with foreign-related corporations. In the provision, corporations with effectively connected income are required to calculate their tax with two methods. First, the corporation calculates its taxes using the standard domestic method, which includes deducting payment to the foreign-related corporations. Second, the corporation calculates its taxes without deducting payments from the foreign-related corporation but applying a 10 percent rate to the base rather than the statutory 20 percent. If the second calculation is greater than the first, the corporations pays the difference between the two calculations in additional taxes.
This provision applies to all payments between a U.S. corporation and a foreign-related corporation except for goods sold.