CHOICE OF ENTITY FOR INTERNATIONAL OPERATIONS AFTER THE 2017 TAXACT

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Nelson Hamilton
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2 INBOUND 2

3 INBOUND 1. The principal change affecting inbound choice of entity is the lower corporate tax rate. 2. This increases the already existing preference for most inbound taxpayers to operate through corporate structures. 3

4 EXAMPLE OF EFFECT OF LOWER CORPORATE TAX RATE 1. By itself, the increased estate and gift tax exemption for U.S. individuals doesn t help foreign individuals (unless treaty relief). 2. However, the lower corporate tax rate may provide significant relief for strategies commonly used to block the estate and gift taxes for foreign individuals. 4

5 U.S. ESTATE AND GIFT TAXATION U.S. Citizens/Residents (residence determined under domicile test) Transfers of worldwide assets subject to tax Lifetime exemption via unified credit ($11.18 million in 2018) Annual gift exclusion ($15,000 in 2018) Unlimited marital deduction if citizen spouse, QDOT rules and annual exclusion for marital gifts ($152,000 in 2018) if noncitizen spouse No relief under U.S. treaties Nonresidents Only transfers of U.S.-situs assets potentially subject to tax Lower exemption via credit at death ($60,000) Same, but most transfers of intangible property exempt Same Treaties may provide relief 5

EFFECT OF 2017 TAX ACT Individual LTCG rate 20% US real estate Foreign individual Foreign corporation US real estate US corporate tax rate Traditionally, the standard planning approach of

6 EFFECT OF 2017 TAX ACT Individual LTCG rate 20% US real estate Foreign individual Foreign corporation US real estate US corporate tax rate Traditionally, the standard planning approach of blocking the U.S. estate tax by interposing a foreign corporation may have created a U.S. income tax cost. 35% 21% The new lower corporate rate will lessen this effect, making planning easier. 6

7 OUTBOUND 7

8 PASS-THROUGH OR CORPORATE TREATMENT? 1. The fundamental planning decision is whether outbound operations should be structured for passthrough or corporate treatment. 2. C corporations typically form corporate subsidiaries, unless there are special circumstances (e.g., start up losses). 3. The decision for individuals is more complicated. 8

9 EFFECT OF 2017 TAX ACT 1. The major new outbound rules (e.g., GITLI, Section 245A, FDII) are either limited to corporate taxpayers or designed with them in mind. 2. Their effect on individually owned structures is more problematic. 9

10 OUTBOUND CASE STUDIES U.S. taxpayer C corporation or individual Outbound structure Flow through or corporation Subpart F income? GILTI income? Foreign entity tax rate 0% or 25% Foreign withholding tax rate 0%, 5% or 15% Note: most CFCs with formerly good (non-subpart F) income under prior law will have a mixture of GILTI and non-gilti income under the new rules. 10

11 CASE #1A U.S. taxpayer C corporation Outbound structure Flow through Subpart F income? N/A GILTI income? N/A Foreign entity tax rate 0% Foreign withholding tax rate 0% 11

12 CASE #1A US C Corp Flow through Foreign income $1000 The U.S. and overall corporate tax rate is 21%. There is no exemption equivalent to the GILTI deduction or the Section 245A dividend exclusion for income earned through a foreign branch. Foreign taxes $0 U.S. tax = $210 Total tax = $210 12

13 CASE #1B U.S. taxpayer Outbound structure Subpart F income? GILTI income? C corporation Flow through N/A N/A Foreign entity tax rate 25% Foreign withholding tax rate (branch tax) 5% 13

14 CASE #1B US C Corp Flow through Foreign income $1000 Foreign taxes $ %*($750) = $287.5 U.S. tax = $0 The flow-through income is subject to current U.S. tax, but the U.S. foreign tax credit should provide relief (subject to any possible limitations under Section 904). After the 2017 tax act, the flow-through income is generally treated as foreign branch income for Section 904 basketing purposes. The overall tax rate is 28.75% (all foreign). Total tax = $

15 SECTION 904 BASKETING IRC 904(d) separate application of section with respect to certain categories of income. (1) in general. The provisions of subsections (a), (b), and (c) and Sections 902, 907, and 960 shall be applied separately with respect to (A) any amount includible in gross income under Section 951A (other than passive category income) (B) foreign branch income, (C) passive category income, and (D) general category income. 15

16 CASE #2A U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? Yes GILTI income? No Foreign entity tax rate 0% Foreign withholding tax rate 0% 16

17 CASE #2A US C Corp The Subpart F income is subject to present U.S. tax at 21%. This is the final U.S. corporate tax, because a subsequent distribution of the earnings will qualify for PTI treatment. Foreign income $1000 (all Subpart F income) Foreign taxes $0 U.S. tax = $210 Total tax = $210 17

18 CASE #2B U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? Yes GILTI income? No Foreign entity tax rate 25% Foreign withholding tax rate 5% 18

19 CASE #2B US C Corp Foreign income $1000 (all Subpart F income) Foreign taxes $ %*($750) = $ U.S. tax = $0 Total tax = $ The Subpart F income is subject to present U.S. tax, but the tax should be offset by Section 960 credits. Alternatively, the income may qualify for deferral under the high-tax exclusion of Section 954(b)(4) (requiring foreign tax rate greater than 90% of U.S. corporate rate, or now only 18.9%). The later distribution of these earnings should be exempt under new Section 245A. The foreign withholding taxes are an additional cost. The overall rate of tax is 28.75%, all foreign. 19

20 CASE #3A U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? No GILTI income? Yes (assume minimal QBAI) Foreign entity tax rate 0% Foreign withholding tax rate 0% 20

21 CASE #3A US C Corp Before the 2017 tax act, the CFC s income would have qualified for deferral, but would have been subject to full U.S. corporate taxation (35% rate) upon actual or deemed repatriation. Foreign income $1000 (all GILTI income) Foreign taxes $0 21

22 NEW GILTI REGIME 1. The 2017 tax act establishes an effective new category of quasi-subpart F income for U.S. shareholders of CFCs attributable to global intangible low-taxed income or GILTI. See new IRC 951A. 2. GILTI is calculated as income not otherwise subject to special treatment under Subpart F over a prescribed percentage return on the basis of tangible business property (less interest expense). 3. A portion of the income inclusion will be offset by a 50 percent deduction, resulting in an effective lower rate of U.S. tax on the income (generally 10.5 percent for C corporations). 4. For C corporations, 80 percent of the attributable foreign income taxes will be allowed as a Section 960 credit, with no carryover. 5. If the applicable foreign taxes are percent or greater, there arguably should be no U.S. tax after the foreign tax credit (but the allocation of expenses against GILTI income may prevent this result). See proposed regulations issued in late November

23 CALCULATING GILTI 1. Tested income is generally gross income not subject to other Subpart F treatment. 2. Subpart F income is excluded, as well as Subpart F income excluded under the high-tax exception. 3. Foreign oil and gas extraction income is excluded. 4. Tested income is reduced by allocable expenses, including taxes. A taxable loss can result. 5. For a given U.S. shareholder, net CFC tested income is the excess of tested income over tested loss for all applicable CFCs. 23

24 CALCULATING GILTI 1. GILTI is the excess of net CFC tested income over net deemed tangible income return. 2. Net deemed tangible income return is 10% of qualified business asset investment ( QBAI ) less interest expense. 3. QBAI is the average of the CFC s average adjusted basis of its specified tangible property, i.e., depreciable tangible property used in a trade or business in the production of tested income. 4. Adjusted basis is determined using Section 168(g) ADS rules. 24

25 CASE #3A US C Corp Tested income = $ $0 = $1000 GILTI = $ %*($0) = $1000 GILTI deduction = 50%*($1000) = $500 Net GILTI inclusion = $500 U.S. tax = 21%*($500) = $105 Foreign income $1000 (all GILTI income) Foreign taxes $0 This is the total U.S. corporate tax; the earnings are PTI and can be repatriated without additional U.S. tax cost. U.S. tax = $105 Total tax = $105 25

26 CASE #3B U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? No GILTI income? Yes (assume minimal QBAI) Foreign entity tax rate 25% Foreign withholding tax rate 5% 26

27 CASE #3B US C Corp Before the 2017 tax act, the CFC s income would have qualified for deferral, but residual U.S. taxation would have applied on actual or deemed repatriation (at a 35% rate less applicable foreign tax credits). Foreign income $1000 (all GILTI income) Foreign taxes $ %*($750) = $

28 CALCULATING GILTI 1. GILTI indirect tax credit is 80% of attributable foreign income taxes, times the ratio of GILTI to tested income (Section 960(d)). 2. The GILTI tax credit is separately basketed and cannot be carried to other years. 3. Section 78 gross up is 100% of attributable foreign income taxes, times ratio of GILTI to tested income. 4. After deduction for 50% of sum of GILTI and Section 78 gross up, the GILTI inclusion is equal amount. 28

29 CASE #3B US C Corp Tested income = $ $250 = $750 GILTI = $750 10%*($0) = $750 GILTI tax credit = 80%*($750/$750)*$250 = $200 Section 78 gross up = $250 Gilti deduction = 50%*($750 + $250) = $500 Foreign income $1000 (all GILTI income) Foreign taxes $ %*($750) = $ U.S. tax = $0; total tax = $ Net GILTI inclusion = $500 U.S. Tax = 21%*($500) = $105 (completely offset by $200 GILTI tax credit, subject to any Section 904 limitations; no carryover) There is no residual U.S. Corporate tax; the earnings are PTI and can be repatriated without additional cost. 29

30 CASE #4A U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? No GILTI income? No (assume sufficient QBAI) Foreign entity tax rate 0% Foreign withholding tax rate 0% 30

31 MOVE TO PARTIAL EXEMPTION SYSTEM 1. The 2017 tax act establishes a 100-percent dividends received deduction ( participation DRD ) for foreign-source portion of dividends received from specified 10-percent owned foreign corporations by domestic corporations that are 10-percent U.S. shareholders of such foreign corporations within the meaning of Section 951(b). See new IRC 245A. 2. No foreign tax credit or deduction is allowed for any taxes, including withholding taxes, paid or accrued with respect to a dividend qualifying for the participation DRD. 3. Participation DRDs are subject to a one-year holding period requirement. See new IRC 246(c)(5). 31

32 CASE #4A US C Corp There is no present U.S. inclusion. A later distribution of the earnings should qualify for exemption under Section 245A. There is no U.S. or foreign tax. Foreign income $1000 (no GILTI income) Under prior law, a residual 35% U.S. tax would have applied upon actual or deemed repatriation. Foreign taxes $0 U.S. tax = $0 Total tax = $0 32

33 CASE #4B U.S. taxpayer C corporation Outbound structure Corporation (CFC) Subpart F income? No GILTI income? No (assume sufficient QBAI) Foreign entity tax rate 25% Foreign withholding tax rate 5% 33

34 CASE #4B US C Corp There is no present U.S. inclusion. A later distribution of the earnings should qualify for exemption under Section 245A, with no foreign tax credits allowed. There is no U.S. tax, just the foreign tax. Foreign income $1000 (no GILTI income) Foreign taxes $ %*($750) = $

35 CASE #5 U.S. taxpayer Outbound structure Subpart F income? GILTI income? Foreign entity tax rate Foreign withholding tax rate C corporation Operate domestically to claim FDII exclusion N/A N/A N/A N/A 35

36 FDII RULES: INCENTIVE FOR STAYING IN THE U.S. 1. The 2017 tax act establishes a 37.5 percent deduction for foreign-derived intangible income earned by domestic C corporations, reducing effective tax rate to percent (same as minimum foreign tax rate when GILTI fully offset by foreign tax credits). 2. There are serious concerns as to whether this provision violates U.S. trade law obligations (under the rules of the World Trade Organization): there are rules against exportcontingent income tax incentives. 36

37 CASE #5 US C Corp Operate Domestically To extent income qualifies for FDII deduction, the applicable U.S. tax rate is %. To the extent it does not, the applicable U.S. tax rate is 21%. Total income $1000 FDII income $0 to $1000 U.S. tax: Between $ and $210) 37

38 OUTBOUND PLANNING FOR INDIVIDUALS US Individual The changes wrought by the 2017 tax act significantly impact the choice of entity decision for individuals. Pass-Through Corporation Single tax; flow through of foreign income and tax credits Double tax: foreign tax on corporation and separate U.S. taxation of dividend 38

39 CASE #6A U.S. taxpayer Individual Outbound structure Flow through Subpart F income? N/A GILTI income? N/A Foreign entity tax rate 0% Foreign withholding tax rate 0% 39

40 CASE #6A US individual Flow through Foreign income $1000 The U.S. individual will have currently taxable ordinary income (no exemption for foreign operations). The U.S. and overall tax rate will be 37%. Foreign taxes $0 U.S. tax = $370 Total tax = $370 40

41 CASE #6B U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Flow through N/A N/A Foreign entity tax rate 25% Foreign withholding tax rate (branch tax) 15% 41

42 CASE #6B US individual Flow through Foreign income $1000 Foreign taxes $ %*($750) = $ The flow-through income is subject to current U.S. tax, but the U.S. foreign tax credit should provide relief (subject to any possible limitations under Section 904). After the 2017 tax act, the flow-through income is generally treated as foreign branch income for Section 904 basketing purposes. The overall tax rate is 37%. U.S. tax = $370 42

43 CASE #7A U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? Yes GILTI income? No Foreign entity tax rate 0% Foreign withholding tax rate 0% 43

44 CASE #7A US individual The Subpart F income is subject to present U.S. tax at 37%. Foreign income $1000 (all Subpart F income) What if the individual makes a Section 962 election? Foreign taxes $0 U.S. tax = $370 Total tax = $370 44

45 SECTION Under Section 962, individuals can elect to be taxed on Subpart F income at corporate rates, and claim available Section 960 indirect credits. 2. Upon an actual distribution of the earnings, PTI treatment does not apply to the extent the earnings exceed the U.S. corporate tax imposed. See Smith v. Commissioner, 151 T.C. No. 5 (9/18/2018) (actual dividend only qualifies for qualified dividend rate if from treaty country corporation). 3. The election has the effect of allowing possible reduction or elimination of present Subpart F taxation, at the cost of an eventual double tax. 4. Under the 2017 tax act, including the reduction of the U.S. corporate rate, this election may be more useful. 45

46 CASE #7B U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Corporation (CFC) (Section 962 election) Yes No Foreign entity tax rate 0% Foreign withholding tax rate 0% 46

47 CASE #7B US individual Foreign income $1000 (all Subpart F income) With a Section 962 election, the U.S. individual would be subject to present U.S. tax of $210 (21% corporate rate). On a later distribution of the $790, a 37% rate would apply, for $ in tax. The total U.S. tax would be $ Foreign taxes $0 Section 962 election 47

48 CASE #7C U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? Yes GILTI income? No Foreign entity tax rate 25% Foreign withholding tax rate 15% 48

49 CASE #7C US individual Foreign income $1000 (all Subpart F income) Foreign taxes $250 The individual would be subject to present U.S. tax of $750, without allowance of any foreign tax credits (effective double tax). However, since the income is high taxed within the meaning of Section 954(b)(4), the individual could elect to turn off the Subpart F inclusion, and only pay U.S. tax when the $750 is distributed, possibly at qualified dividend rates. The individual would also need to be mindful to avoid Section 956 inclusions, which would be taxed at full ordinary rates. 49

50 CASE #7D U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Corporation (CFC) (Section 962 election) Yes No Foreign entity tax rate 25% Foreign withholding tax rate 15% 50

51 CASE #7D US individual Foreign income $1000 (all Subpart F income) Foreign taxes $250 If a Section 962 election is made, the individual would be subject to present U.S. tax of $1000, but at corporate rates (21%) and with allowance of Section 960 credits. This should eliminate present U.S. taxation. The $750 of E&P should be taxed only when distributed, possibly at qualified dividend rates. The individual would also need to be mindful to avoid Section 956 inclusions, which would be taxed at full ordinary rates Section 962 election 51

52 CASE #8A U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? No GILTI income? Yes (assume minimal QBAI) Foreign entity tax rate 0% Foreign withholding tax rate 0% 52

53 2017 TAX ACT: WHAT ABOUT INDIVIDUALS? 1. Individuals can be subject to present taxation of GILTI income, but the 50-percent deduction does not apply. It is unclear whether individuals can obtain the deduction by making a Section 962 election. 2. The dividends-received deduction of new Section 245A does not apply to individuals, so double taxation is still a concern with individually owned corporate structures. 3. Individuals could alternatively hold CFCs through U.S. C corporations to obtain the GILTI deduction and qualified dividend treatment on distributions from the C corporation. 4. Individuals are not allowed the FDII deduction. The existing IC-DISC rules of Sections , which can effectively allow individuals a lower rate of tax on certain export transactions, were retained in the 2017 tax act. 53

54 CASE #8A US individual Before the 2017 tax act, the CFC s income would have qualified for deferral but have been subject to taxation upon actual or deemed repatriation. Foreign income $1000 (all GILTI income) Foreign taxes $0 Now the GILTI income is subject to present U.S. tax at 37 percent. What if the U.S. individual makes a Section 962 election? U.S. tax = $370 Total tax = $370 54

55 CASE #8B U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Corporation (CFC) (Section 962 election) No Foreign entity tax rate 0% Foreign withholding tax rate 0% Yes (assume minimal QBAI) 55

56 CASE #8B US individual It is unclear whether the U.S. individual will be entitled to the 50 percent GILTI deduction. If the deduction is available, the current U.S. tax would be $105 (10.5%); otherwise it would be $210 (21%). Foreign income $1000 (all GILTI income) Foreign taxes $0 Section 962 election Total current tax = $105 or $210 Tax on repatriation = 37% * ($895 or $790) = $ or $ Total tax = $ or $

57 CASE #8C U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? No GILTI income? Yes (assume minimal QBAI) Foreign entity tax rate 25% Foreign withholding tax rate 15% 57

58 CASE #8C US individual Before the 2017 tax act, the CFC s income qualified for deferral but was subject to U.S. taxation upon actual or deemed repatriation, possibly at qualified dividend rates. Present tax (foreign) = $250 Foreign income $1000 (all GILTI income) Foreign taxes $250 U.S. tax upon repatriation = 20% * $750 = $150 Total tax (part current, part deferred) = $400 58

59 CASE #8C US individual The GILTI income, net of the foreign taxes, is now presently taxable at a 37 percent rate. There is no high-tax exception for GILTI income. Full current double taxation results. Foreign income $1000 (all GILTI income) Foreign taxes $250 U.S. tax = 37% * $750 = $ Foreign tax = $250 Total tax = $ The foreign withholding taxes may be an additional cost, subject to potential relief under Section 960(c). 59

60 CASE #8D U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Corporation (CFC) (Section 962 election) No Foreign entity tax rate 25% Foreign withholding tax rate 15% Yes (assume minimal QBAI) 60

61 CASE #8D US individual Foreign income $1000 (all GILTI income) Foreign taxes $250 If the individual gets the 50% GILTI deduction by making the Section 962 election, the current U.S. tax should be wiped out by the 80% available foreign tax credits, resulting in the 25% foreign tax being the only current tax. If the 50% GILTI deduction is not available, the residual U.S. tax should be 1% (21% Section 962 tax less 20% foreign taxes allowed as credits (80% of 25%)). Total current tax = $250 or $260 Tax on repatriation = 20% * ($750 or $740) = $150 or $148 Total tax = $400 or $408 61

62 CASE #9A U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? No GILTI income? No (assume sufficient QBAI) Foreign entity tax rate 0% Foreign withholding tax rate 0% 62

63 CASE #9A US individual Foreign income $1000 (no GILTI income) As before the 2017 tax act, the CFC s income qualifies for deferral, and is only taxed on repatriation, possibly at qualified dividend rates. The individual would need to be mindful to avoid Section 956 inclusions, which would be taxed at full ordinary rates. Foreign taxes $0 63

64 CASE #9B U.S. taxpayer Individual Outbound structure Corporation (CFC) Subpart F income? No GILTI income? No (assume sufficient QBAI) Foreign entity tax rate 25% Foreign withholding tax rate 15% 64

65 CASE #9B US individual Foreign income $1000 (no GILTI income) Foreign taxes $250 The income would qualify for deferral for U.S. purposes, but an eventual double tax still would result. Upon distribution, the earnings would be taxed to the U.S. individual, possibly at qualified dividend rates. The individual would need to be mindful to avoid Section 956 inclusions, which would be taxed at full ordinary rates. 65

66 CASE #9C U.S. taxpayer Outbound structure Subpart F income? GILTI income? Individual Corporation (CFC) (Section 962 election) No Foreign entity tax rate 25% Foreign withholding tax rate 15% No (assume sufficient QBAI) 66

67 CASE #9C US individual A Section 962 election would not affect the results; it has no effect in this circumstance. Foreign income $1000 (no GILTI income) Foreign taxes $250 67

68 CASE #10 U.S. taxpayer Outbound structure Subpart F income? GILTI income? Foreign entity tax rate Foreign withholding tax rate Individual Operate domestically to claim Section 199A benefit and IC- DISC treatment N/A N/A N/A N/A 68

69 CASE #10 US individual Flow through Income qualifying for the full Section 199A deduction will be taxed at 29.6% (37% * 80%). Income qualifying for IC-DISC treatment will be taxed at qualified dividend rates (generally 20%). The remaining income will be taxed at 37%. Operate domestically; Run export sales through IC-DISC $1000 total income 69

70 THE END 70

International Tax: Strategies for cross-border investing after tax reform

International Tax: Strategies for cross-border investing after tax reform Today s Presenters Brittain Cunningham, CPA Senior Manager, International Tax Services brittain.cunningham@weaver.com 832.320.3461