Current social trends in corporate taxation have a tremendous impact on how corp
ID: 2530583 • Letter: C
Question
Current social trends in corporate taxation have a tremendous impact on how corporations run their business activities. For instance, tax liabilities will affect where a corporation runs its activities—in the United States or in a foreign country—and whether or not it elects to bring cash earned overseas back to the States. In recent years, the federal government has used foreign tax credits and tax holidays on repatriated earnings to encourage corporations to bring cash back to the United States. The idea is that this cash will stimulate economic growth in the form of more jobs and revenue for the American people. However, the success of these initiatives is a great source of controversy. Select one of the following current social trends relating to corporate taxes, and consider its impact on the corporate tax filer:
Repatriation of earnings
Paying taxes on repatriated earnings
Computing tax credits to foreign countries after international consolidations
Dividend deductions for U.S. corporations with foreign subsidiaries
Explanation / Answer
Dividend deductions for U.S. corporations with foreign subsidiaries
In the past corporate tax rules, U.S. companies were taxed on all over profits earned world-wide, with a credit available for foreign taxes paid. If a U.S. corporation earned profit through a foreign subsidiary, however, no U.S. tax was typically due until the earnings were returned to the United States, generally in the form of dividends paid. This system contributed to some domestic corporations moving production overseas, and this may have led some multinational companies to keep profits outside the United States.
On 2 November 2017, United States (US) House Ways and Means Committee Chairman Kevin Brady released a long-awaited tax reform bill entitled the Tax Cuts and Jobs Act of 2017(H.R. 1), followed by a Chairman’s Mark of H.R. 1 on 3 November 2017 .
This tax reform bill seeks to reform the Internal Revenue Code, reducing the top corporate tax rate to 20%, reducing or restricting many corporate tax deductions and preferences, and substantially reforming the international tax provisions.
This new law fundamentally changes the way multinational companies are taxed, making a shift from worldwide taxation of income to a more territorial approach. Under the new rules, qualifying dividends from foreign subsidiaries are effectively exempted from U.S. tax. This is accomplished by allowing domestic C corporations that own 10% or more of a foreign corporation to claim a 100% deduction for dividends received from that foreign corporation, to the extent the dividends are considered to represent foreign earnings.
The new law also forces corporations to pay U.S. tax on prior-year foreign earnings that have accumulated outside the United States in foreign subsidiaries, through a one-time "deemed repatriation" of the accumulated foreign earnings. U.S. shareholders owning at least 10% of a specified foreign corporation* may be subject to a one-time tax on their share of accumulated untaxed deferred foreign income; deferred income that represents cash will be taxed at an effective rate of 15.5%, other earnings at an effective rate of 8%; the resulting tax can be paid in installments. The tax applies for the foreign corporation's last tax year that begins before 2018. The one-time tax is also not limited to C corporations; it can apply to all U.S. shareholders, including individuals (special rules apply to S corporations and REITs). After paying the one-time deemed repatriation payment, foreign earnings can be brought back to the United States without paying any additional tax.
* Includes controlled foreign corporations (CFCs) and non-CFC foreign corporations (other than passive foreign investment companies, or PFICs) if there is at least one 10% shareholder that is a U.S. corporation.
This step was further taken by the federal government to encourage corporations to bring cash back to the United States. The idea is that this cash will stimulate economic growth in the form of more jobs and revenue for the American people.
The following reforms are added:
100% deduction for certain dividends received from foreign subsidiaries
The bill would add new Section 245A, which would provide a 100% deduction for the foreign-source portion of dividends received by a domestic corporation from a “specified 10%-owned foreign corporation,” which is a foreign corporation with respect to which the domestic corporation is a US shareholder as defined in Section 951(b), but not including a passive foreign investment company that is not a controlled foreign corporation (CFC).
As proposed, new Section 245A would not apply to either foreign income directly earned by a domestic corporation through foreign branches or to capital gains recognized from the sale or exchange of stock in a specified 10%-owned foreign corporation. To the extent that Section 1248 treats any capital gain from the sale or exchange of CFC stock as a dividend, however, the 100% deduction should apply.
This above reform will affect where a corporation runs its activities—in the United States or in a foreign country—and whether or not it elects to bring cash earned overseas back to the States, this is to reduce its tax liability in case of dividend received and it will encourage US firms to bring back the foreign income earned back to US to further support jobs and development of citizens and corporations.
Credits and deductions for foreign taxes (including withholding taxes) paid or accrued with respect to any dividend benefiting from the 100% deduction would be disallowed. Additionally, for purposes of the foreign tax credit limitation under Section 904(a), the foreign-source income (and entire taxable income) of a US shareholder of a specified 10%-owned foreign corporation would be determined without regard to: (i) the foreign-source portion of any dividend received from such foreign corporation; and (ii) deductions properly allocated and apportioned to: (a) income with respect to stock of the specified 10%-owned foreign corporation (other than subpart F income and foreign high-return amounts); and (b) stock of the specified 10% foreign owned corporation (to the extent income with respect to such stock is not subpart F income or foreign high return amounts).
To be eligible for the 100% deduction, the domestic corporation must have held its stock in the specified 10%-owned foreign corporation for more than 180 days during the 361-day period that begins on the date that is 180 days before the ex-dividend date. For this purpose, a taxpayer is only treated as holding stock for any period if the specified 10%-owned foreign corporation is a specified 10%-owned foreign corporation for such period, and the taxpayer is a US shareholder with respect to such specified 10% foreign owned corporation for such period.
Effective date
The 100% deduction would apply to the distributions made after 31 December 2017.
Effective for taxable years beginning after December 31, 2017, a corporation which is a US Shareholder of a CFC and is not a RIC, REIT or Subchapter S corporation, may deduct 100 percent of the foreign-source portion of dividends distributed by such CFC. The deduction is not available if the foreign corporation is a passive foreign investment company that is not also a CFC; nor is the deduction available if the dividend is a "hybrid dividend" – namely, a dividend for which the dividends received deduction would otherwise be allowed and for which the CFC received a deduction or other tax benefit with respect to any income, war profits or excess profits taxes imposed by a foreign country. As noted below, under the New Tax Law, a domestic corporation will be a US Shareholder if it owns at least 10 percent of the vote or value of a CFC.
Impact of this change
This law has fundamentally changed the US taxation of foreign earnings by providing a 100% deduction for foreign-source earnings repatriated as dividends to domestic corporations from their specified 10%-owned foreign subsidiaries. The benefit of this territorial regime, however, would be limited by Section 951A, which would impose a minimum tax on foreign earnings by taxing currently half of a US shareholder’s “foreign high return amount.” Because this amount would be determined on an aggregate basis (i.e., all CFCs effectively treated as one), high-taxed and low-taxed income would be blended, increasing the likelihood of residual US tax being paid with respect to the inclusion. The additional limitations of the deduction of net interest expense would likely require multinationals to reevaluate their capitals structures.
This tax reform is a welcoming change and is going to have long term effect on US corporations and bringing back of income earned.
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