On the surface, U.S. multinational corporations say they are thrilled by the corporate tax cut approved by Congress last year. But in practice, the law has sparked more head-scratching than jubilation.
In particular, details about what will constitute the optimal tax structure for corporations with foreign subsidiaries are puzzling CFOs, accountants, and lawyers.
If you are one of those corporate officers or advisers, you might already be perusing the fine print of the 2017 Tax Cuts and Jobs Act. Or maybe you have even met with Treasury officials to discuss your questions and concerns.
But what you really may need is to be thinking anew about how to bring money back from your foreign operations. The rules have changed entirely, and for some the ability to defer foreign income may have been eliminated.
A New Landscape
There is good news and bad news here.
First, the new tax rules slash the corporate tax rate to 21% from 35% and, theoretically, end taxes on U.S. companies’ foreign profits. That will help multinationals.
However, the law also shifts from a system in which only profits earned domestically were subject to U.S. tax to one in which U.S.-based companies will now be subject to U.S. taxes regardless where their income was derived. That may or may not be good news.
Essentially, the law tries to treat U.S.-based companies operating overseas subsidiaries fairly without opening up new tax-reduction loopholes.
There are three key components in the law that will significantly affect U.S. multinationals.
First, the law ends the tax on dividends repatriated from foreign subsidiaries by letting U.S. companies deduct 100% of these dividends from their U.S. taxable income.
Second, in an attempt to collect revenue from large overseas accounts, the rules will institute a new tax on Global Intangible Low Tax Income (GILTI) accrued within foreign affiliates in excess of 10% of the firm’s tangible overseas capital investment, less depreciation, until 2025.
Companies also can claim a 50% deduction for GILTI, creating a 10.5% effective rate. And they can request an 80% credit for foreign taxes attributable to GILTI. The GILTI tax applies to income in any country with an effective rate of less than 13.125%.
Complicated? Yes, it is.
Third, the tax law allows companies to repatriate overseas earnings at lower tax rates than in the past. It imposes a one-time transition tax, collected over eight years, on the pre-2018 profits of foreign subsidiaries at rates of 15.5% for cash and other liquid assets and 8 percent for non-cash assets.
Companies will still get a foreign tax credit for the tax payments previously made, but the credit will be reduced in proportion to the cut in the U.S. tax rate on those profits.
A Challenge for Businesses
Given this new reality, there are some fundamental questions facing multinational corporations, particularly those without adequate resources to plan for these changes
Are you deferring? Companies that don’t have a significant capital base, such as service-based businesses or software firms, may get pushed out of the deferral business altogether under the new tax regulations.
In the past, the deferral rules were so broad that people got comfortable with the notion of leaving money overseas or reinvesting it in international operations to avoid paying tax in the U.S.
With GILTI, that’s no longer the case. You now have to think about how your foreign operations are going to be taxed in the United States, regardless whether you plan to bring cash back.
What’s the local tax rate? If you’re operating in a high-tax-rate location, it will be difficult to find relief. The United States isn’t the only country tuning up its international tax rules. If you’re in a low-tax jurisdiction and subject to the GILTI rule, you’re probably going to be paying tax in some fashion, too.
What’s your U.S. tax rate? The can vary significantly under post-tax reform rules, depending on whether the taxpayer is an individual or a corporation.
Are you in a country with a U.S. tax treaty? If you’re operating in a low-tax jurisdiction or a jurisdiction that doesn’t have an agreement with the United States, you might think about creating a U.S. C Corporation — something you never would have done in the past. If you’re operating in a country that does have such a treaty, it gives you a bit more flexibility.
The Treasury Department estimates it will have the tax reform rules, which will be retroactive to January 1, 2018, ironed out by the end of this year. However, it could be that finalization does not come until mid-2019.
Whatever you do, though, don’t wait until then to start deciphering the rules. The law will likely save your business money, but it will take plenty of work to figure out how and how much.
Bill Henson is a partner with the international tax practice at accounting firm and consultancy Plante Moran.