New Year, new tax laws. Historically, profits earned by a foreign corporation were not taxed in the U.S. until the cash was brought into the country. One provision of the new tax act calls for a mandatory tax on foreign profits that were previously deferred from U.S. tax. In this article, we will outline what this new transition tax entails.
The Tax Cuts and Jobs Act of 2017 (“The Act”) enacted on December 22, 2017 calls for a mandatory one-time deemed repatriation (Section 965) of foreign profits that takes effect for the foreign corporation’s last taxable year that begins before January 1, 2018. Previously, U.S. shareholders would not be taxed on their foreign profits until the cash was brought back into the country, typically through a dividend. Under this new provision, these foreign profits are “deemed” to be brought back to the U.S. There is now a transition tax on foreign corporations’ earnings and profits (“E&P”) accumulated during periods in which such corporation was a foreign subsidiary to the extent such E&P has not been previously subject to U.S. tax.
The deemed repatriation provision applies to all U.S. shareholders in a “specified foreign corporation.” These are generally controlled foreign corporations (“CFCs”) and other foreign corporations that a U.S. shareholder owns 10 percent or more of the voting interest.
The deemed repatriated foreign earnings are taxed at 15.5 percent for cash and liquid assets held by the foreign corporation. The aggregate E&P held in forms other than cash or its equivalents, or illiquid assets are taxed at 8 percent. This rate is lower than the prior tax code’s corporate rate of 35 percent.
The Act allows the U.S. shareholder to elect to pay the net tax liability interest-free over a period of up to eight years. Because the tax liability can be paid in installments, the measurements are allocated as such: 8 percent of the total tax liability is paid every year in the first five years starting in 2017, 15 percent in the sixth year, 20 percent in the seventh, and 25 percent in the last year. Foreign tax credits can be used to reduce the liability to the extent of foreign taxes on the taxable portion of the deemed repatriated earnings.
If you have any questions on how this provision or others of the new tax law might affect you, please do not hesitate to contact your L&B professional at (858) 558-9200.