As a part of the Tax Cuts and Jobs Act (TCJA), there are tax provisions that will affect U.S. shareholders of controlled foreign corporations (CFCs) for tax years beginning after December 31, 2017. The IRS recently issued guidance on these changes.
The TCJA shifts the U.S. corporate taxation of foreign earnings to a “quasi-territorial” system, which, for corporate shareholders of a foreign corporation, may result in no U.S. tax with respect to income of a CFC. However, ownership of a foreign corporation by a U.S. shareholder that is not a C corporation may produce less favorable results under the TCJA.
Prior to the TCJA law, with regard to ownership of a foreign corporation, U.S. shareholders (whether corporations or individuals) were defined as a U.S. person that holds at least 10% of the total combined voting power of all classes of stock entitled to vote in a foreign corporation. Previously, shareholders were taxed on the CFC’s earnings only upon receipt of a distribution from the CFC. The primary exception has been a series of rules generally referred to as the “Subpart F rules,” which require the inclusion of certain types of income earned by a CFC on a current basis, regardless of whether or not a distribution from the CFC is received. Therefore, when a U.S. taxpayer structured its operations in a manner that took into consideration the Subpart F rules they generally were able to defer U.S. tax on income earned by a CFC until the U.S. taxpayer received a distribution from the CFC.
The TCJA, amended the definition of U.S. shareholder of a CFC to include a U.S. person that holds at least 10 percent of the total value of shares of all classes of stock of the foreign corporation, without regard to voting rights. The new law also requires a U.S. shareholder of any CFC for any taxable year, to include their global intangible low-taxed income (GILTI) in their gross income. The proposed regulations under section 951A provide guidance for U.S. shareholders to determine the amount of GILTI to include in gross income, the “GILTI inclusion amount” (in addition to any other Subpart F income), regardless of whether any amount is distributed to the U.S. shareholder. The tax on GILTI basically serves to tax the U.S. shareholder currently on its allocable share of CFC earnings for a tax year to the extent those earnings exceed a 10% return on the shareholder’s allocable share of tangible assets held by CFCs. The tax on GILTI applies equally to U.S. shareholders that are C corporations or flow-through taxpayers; however, only C corporations may claim a deduction of 50% of GILTI (37.5% for tax years starting after 2025) and certain indirect foreign tax credits. In addition, flow-through taxpayers are not eligible for the deduction (Sec 245A) for qualifying dividends received from CFCs that the TCJA provides for C corporations.
Also part of the TCJA, there is a one-time repatriation tax on certain previously untaxed income generated by CFCs. It requires 10% U.S. shareholders of a “deferred foreign income corporation” to increase its foreign corporation’s Subpart F income (for the last tax year of the foreign corporation that begins prior to Jan. 1, 2018) in an amount equal to its “accumulated post-1986 deferred foreign income”. However, taxpayers generally may elect to pay the tax in eight annual installments without interest. S corporations, generally can elect to defer the repatriation tax liability unless a specified triggering event occurs; however, partnerships and sole proprietorships cannot elect to defer.
The tax law provides many opportunities and caveats with respect to deferring U.S. taxation of foreign earnings. You should talk with your advisor to review your specific situation. The detailed calculations and implications of the TCJA law on foreign taxes can be found on the IRS website.