Repatriation of Foreign Earnings under the New Tax Law

alhofmeister (62)in #tax • 6 years ago (edited)

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Discussion
The purpose of this post is to review the changes the new tax law brought to the repatriation of foreign income by U.S. taxpayers. Before going into the changes, I'll discuss the original law.

General Treatment
The United States taxes U.S. corporations and U.S. residents on their worldwide income. For taxation of foreign corporations, the U.S. applies a territorial system. Only income that is effectively connected with a U.S. trade or business or income that is fixed, determinable, annual or periodic is taxable to foreign entities and individuals. Various treaties will also affect the taxability of income connected to the U.S. Foreign corporations owned by U.S. corporations or individuals are only subject to income tax when the earnings are repatriated through a dividend or other distribution. For income taxes paid to a foreign government, the foreign tax credit is available to prevent duplicative taxation and offset U.S. income tax under IRC § 901.

Subpart F Income
Earnings of controlled foreign corporations will potentially be included in the income of the owners if the corporation has subpart F income. The definition of subpart F income is provided in IRC § 952 & 954 as:

Insurance income;
Foreign base company income:
a) Foreign personal holding company income (portfolio income & personal service contracts);
b) Foreign base company sales income (purchase of personal property from a related person and subsequent sale to a third party or vice versa); and
c) Foreign base company services income (income from the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or like services by a related party).
Income from a country subject to boycott; and
Amounts paid for illegal bribes, kickbacks or other payments.

Changes by the U.S. System by the Tax Cuts and Jobs Act (TCJA)
The TCJA effectively changes the U.S. income tax from a worldwide system to a territorial system. With the change, however, comes a mandatory repatriation which will be subject to preferential tax rates. So far, the IRS has come out with two notices to clarify the application of IRC § 965 (Notice 2018-07 & Notice 2018-13). The mechanism used to repatriate pre-2018 earnings is subpart F income.

Mandatory Repatriation
Basically, IRC § 965 requires owners of deferred foreign income corporations to recognize subpart F income equal to the corporations post-1986 accumulated earnings and profits. In instances in which a U.S. corporation owns multiple foreign income corporations, deficits may be used to offset earnings as outlined in Notice 2018-13(2.02). Subpart F income recognized under this provision will be subject to preferential rates of 15.5% (accumulated earnings in cash or cash equivalents) or 8% (accumulated earnings reinvested in the business - non-cash items such as fixed assets) under IRC §965(c). The foreign tax credit can be partially used to offset the tax triggered by repatriation under IRC § 904(b)(5). Note that the tax liability may be elected to be paid in installments under IRC § 965(h).

Effect on Dividends from Foreign Subsidiaries
U.S. corporations will be entitled to deduct the full amount of dividends paid to it by foreign corporations in which the corporation owns at least 10% under IRC § 245A(a) going forward. This deduction, however, is only extended to foreign corporations that have been held for more than 1 year under IRC § 246(c)(5). Additionally, the deduction is not available to passive foreign investment companies and special rules are applied to intangible low-taxed income.

Disclosure
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties.

#changes #irs #foreign #repatriation