- 1 U.S. Hybrid Territorial Tax on Corporate Foreign Income
- 2 Complexity of Foreign Corporate Income Tax Rules
- 3 Territorial Tax vs. Worldwide Income (245A Example)
- 4 Section 951A GILTI
- 5 Section 965 One-Time Repatriation Tax Act
- 6 Not All Income Qualifies for Territorial Tax Treatment
- 7 Foreign Branch Income
- 8 BEAT (Base Erosion and Anti-Abuse Tax)
- 9 Late Filing Penalties May be Reduced or Avoided
- 10 Current Year vs Prior Year Non-Compliance
- 11 Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
- 12 Need Help Finding an Experienced Offshore Tax Attorney?
- 13 Golding & Golding: About Our International Tax Law Firm
U.S. Hybrid Territorial Tax on Corporate Foreign Income
Prior to the creation of the Tax Cuts and Jobs Act (TCJA), both individual income and corporate income were taxed on a worldwide income basis. For individuals, this would mean that when a U.S. person for tax purposes earns income overseas, they pay US tax on their worldwide income — even if, for example, they lived overseas and earned all their money from foreign sources. Likewise, the same rule applied to corporations as well (excluding Subpart F Income and other exceptions), so that when a Domestic Corporation had a subsidiary in a foreign country that earned income, they would have to pay tax to the foreign jurisdiction and then once the earnings were repatriated back to the United States they would have to pay U.S. tax on that income as well. And, while the corporation could apply certain foreign tax credits, the disparate tax treatment made it very difficult to compete in the global market knowing that they were being taxed sometimes double or triple on their foreign earnings than their foreign counterparts – and the TCJA was born to help level the playing field, kinda sorta.
Complexity of Foreign Corporate Income Tax Rules
With the enactment of the TCJA came certain rules that were developed to try to avoid the exploitation of foreign tax rules as well. For example, the Subpart F rules have been in place for many years which require certain taxpayers who generate various types of income such as passive income from abroad in a controlled foreign corporation — in a year in which the company generated earnings and profit (E&P) — to pay tax on their ratable share of income, even if it has not been repatriated or distributed from the company to the taxpayer. There was also a DRD (with limitations) as well.
Under the new corporate tax rules, the United States corporate system has switched in part to a territorial system. Therefore, when a U.S. company has a foreign subsidiary that earns income for example, and then that income is distributed back to the company in the United States as a dividend, that dividend is not taxable – aka a 100% Dividend Deduction (subject to certain requirements). It sounds simple enough, right?
Of course not.
There are various exceptions, exclusions, and limitations that make it difficult for many corporations to determine:
Which income is still taxable in the United States?
Which income qualifies as GILTI?
Does the Dividend qualify under 245A (DRD)?
How to make an Section 962/250 election to reduce GILTI Tax?
Why are U.S. Corporations still taxed on a worldwide income basis for certain income such as Subpart F, and
What happens at the state level (noting, the TCJA has made incorporating in a non-state tax US state much more alluring than in the past when Delaware was the key player for entity formation)?
Let’s tiptoe through the basics of the territorial tax system for Domestic Corporations with foreign income so that Taxpayers can help identify issues to be aware of if they’re operating abroad.
Territorial Tax vs. Worldwide Income (245A Example)
Section 245A refers to the ‘dividend received deduction (DRD).’
Let’s look at a conceptual example keeping it as basic as possible: A U.S. corporation has an entity abroad that earns (non-Sub F) $100,000 in the foreign country. That foreign country has a 12% tax rate. Therefore, The US company will pay a 10% foreign tax on the net income. Under a worldwide taxation model, the corporation will also pay income when the money is repatriated to the U.S. – and the U.S. company can then use the foreign tax credits to offset the income.
But, under the previous 35% corporate tax rate it means the company in the US is paying more than three times as much in tax as their competitor overseas. Even under the new corporate tax rate, they are paying double tax even after applying for foreign tax credits.
Thus, under the new territorial tax system, The US company that receives the dividend distribution from the foreign entity does not have to pay U.S. tax on that amount. In a simple scenario, this can be a great benefit to Domestic Corporations with foreign income – but most scenarios have additional complications such as Subpart F and PFIC.
Section 951A GILTI
GILTI refers to the Global Intangible Low-Taxed Income. GILTI requires certain CFCs to pay tax on non-Subpart F income – even if it has not been repatriated to the U.S. It is similar to Subpart F income in the fact that it is foreign income that can be taxed – even if it has not been distributed – but GILTI is not the same Subpart F. Taxpayers can claim certain deductions, elect to be treated as a corporation for U.S. tax purposes, and can apply a portion foreign tax credits (although they do not carry over to future years). Also, GILTI FTC has its own separate bucket.
When calculating GILTI, Subpart F is removed from the calculation to avoid double taxation.
Section 965 One-Time Repatriation Tax Act
As part of the TCJA, the US government requires a one-time ‘mandatory’ repatriation tax on foreign income that had not previously been taxed by the United States (and the foreign company may have accumulated for more than 25 years. We have separate resources explaining this tax travesty, noting that there is currently a case at the Supreme Court on the issue of whether that tax is even constitutional. We also have a summary of that case as well – Moore vs United States.
Not All Income Qualifies for Territorial Tax Treatment
As you may imagine, the Internal Revenue Service is not going to give a free ride to all subsidiaries/foreign branch income that distributed dividends back to their US counterparts. Therefore, there are various exceptions and exclusions to the territorial tax system, such as Subpart F income. It is important to assess the categories of foreign income when applying the rules to ensure the category of foreign income qualifies for the DRD.
Foreign Branch Income
With the introduction of GILTI came a widespread impact on all aspects of foreign income, which also includes foreign branch income. When a U.S. (Domestic) corporation operates a branch overseas, it is different than a subsidiary – the latter which is a separate entity for tax purposes. But, along with GILTI came a new bucket of foreign tax credits as well (foreign branch income), and in turn, this impacts how a domestic corporation may decide to operate abroad and further complicates the tax rules. Consolidated group limitations can reduce or eliminate the ability to claim foreign tax credits in situations in which the consolidated group nets a loss, especially if the branch operates in a high-tax jurisdiction.
BEAT (Base Erosion and Anti-Abuse Tax)
The Base Erosion and Anti-Abuse Tax is part of TCJA and directed toward large companies that have an annual average gross receipt of $500 Million in the three (3) prior years. The BEAT is an additional tax designed to avoid Base Erosion, which essentially means to prevent U.S. companies from inverting or relocating overseas to avoid U.S. Taxes (moving operations to low-tax j/x while increasing expenses/losses for U.S.-based business operations).
Late Filing Penalties May be Reduced or Avoided
For Taxpayers who did not timely file their FBAR and other international information-related reporting forms, the IRS has developed many different offshore amnesty programs to assist taxpayers with safely getting into compliance. These programs may reduce or even eliminate international reporting penalties.
Current Year vs Prior Year Non-Compliance
Once a taxpayer missed the tax and reporting (such as FBAR and FATCA) requirements for prior years, they will want to be careful before submitting their information to the IRS in the current year. That is because they may risk making a quiet disclosure if they just begin filing forward in the current year and/or mass filing previous year forms without doing so under one of the approved IRS offshore submission procedures. Before filing prior untimely foreign reporting forms, taxpayers should consider speaking with a Board-Certified Tax Law Specialist who specializes exclusively in these types of offshore disclosure matters.
Avoid False Offshore Disclosure Submissions (Willful vs Non-Willful)
In recent years, the IRS has increased the level of scrutiny for certain streamlined procedure submissions. When a person is non-willful, they have an excellent chance of making a successful submission to Streamlined Procedures. If they are willful, they would submit to the IRS Voluntary Disclosure Program instead. But, if a willful Taxpayer submits an intentionally false narrative under the Streamlined Procedures (and gets caught), they may become subject to significant fines and penalties.
Need Help Finding an Experienced Offshore Tax Attorney?
When it comes to hiring an experienced international tax attorney to represent you for unreported foreign and offshore account reporting, it can become overwhelming for taxpayers trying to trek through all the false information and nonsense they will find in their online research. There are only a handful of attorneys worldwide who are Board-Certified Tax Specialists and who specialize exclusively in offshore disclosure and international tax amnesty reporting.
Golding & Golding: About Our International Tax Law Firm
Golding & Golding specializes exclusively in international tax, specifically IRS offshore disclosure.
Contact our firm today for assistance.