By Shannon Lemmon, Aaron Boyer
September 12, 2018
The Tax Cuts and Jobs Act, signed December 22, 2017, significantly impacted inbound tax planning. Non-U.S. taxpayers doing business in the U.S. will need to consider the new tax laws and how they will affect their existing, or proposed, tax structure, including related compliance and prior planning.
Here is a summary of key tax law changes and the areas to consider for inbound tax planning.
Reduced Corporate and Individual Tax Rates
Effective January 1, 2018, the U.S. corporate tax rate dropped to a flat 21 percent. At the same time, the maximum U.S. individual tax rate was reduced to 37 percent, and the individual personal exception ($4,050 in 2017) was eliminated.
International tax structures created prior to tax reform should now be re-evaluated to determine whether they still produce the most favorable tax result. Transfer pricing strategies should be evaluated. And, the loss of the individual personal exemption may create the need for a non-resident individual to file a U.S. tax return.
Changes to Interest Deductibility Rules
Historically, only foreign-owned U.S. corporations and U.S. branches of foreign corporations were subject to U.S. interest deductibility limitations. Under tax reform, generally, all U.S. entities and U.S. branches are now subject to interest deductibility limitations. Broadly speaking, the limitation applies to interest expense in excess of the sum of the following:
Disallowed interest expense may be used in future years, subject to future year calculation limitations.
Certain exceptions apply. Taxpayers with gross receipts of U.S. $25 million or less are generally exempt from the limitation rule. Additionally, certain trades or businesses are exempt from the limitation including certain regulated utilities, real property and farming businesses.
Structures which utilize debt should be evaluated to determine whether the structure will limit U.S. interest deductibility, especially when the interest payment is made to a related party and U.S. withholding tax applies.
Limitations on Deductibility of Certain Hybrid Transactions
Tax reform introduced a deduction limitation on hybrid payments to related foreign persons. A hybrid payment occurs when a payment is both:
A disqualified related party amount includes any interest or royalty paid/accrued to a related party to the extent the amount is not included in income of the related party under the tax law of their resident foreign county, or the related party payee is allowed a deduction with respect to such amount under the tax law of such country, thereby offsetting the income payment.
The term hybrid transaction generally refers to a transaction, or series of transactions. Whereas, a payment is treated as interest or royalties under U.S. law, but under applicable foreign jurisdiction law is treated differently. A hybrid entity is an entity classified one way for U.S. tax purposes and differently for foreign jurisdiction purposes (e.g. corporation for U.S. purposes and a partnership for foreign jurisdiction purposes).
The IRS is authorized to issue regulations to encompass specific transactions. Considerable ambiguity exists over which types of transactions will no longer be eligible for a U.S. deduction when the foreign jurisdiction allows for favorable treatment.
Structures which include interest and royalties to foreign-related parties need to be analyzed to determine whether such payments are no longer deductible, resulting in a significant increase in U.S. taxation.
Base Erosion and Anti-Abuse Minimum Tax (BEAT)
The BEAT creates a minimum tax for certain U.S. corporations remitting deductible payments to foreign-related parties. The BEAT applies only to U.S. C-corporations who meet the following thresholds:
If the U.S. corporation meets both BEAT thresholds, the U.S. corporation will then need to compare its regular tax liability to a minimum amount. The final tax liability will be the larger of the regular tax liability or minimum amount. For 2018, the minimum amount is 5 percent of taxable income adjusted for certain deductions such as related party payments. For 2019-2025 the rate is 10 percent; the rate is 12.5 percent thereafter.
Companies who make BEAT payments should address whether the minimum tax is applicable and make appropriate adjustments to estimated tax payments. In addition, this provides an opportunity to address the company’s transfer pricing policy.
Foreign Derived Intangible Income (FDII)
Starting in 2018, U.S. corporations will receive a 37.5 percent deduction for earning FDII in the U.S. other than through a foreign corporation or foreign branch. The deduction results in the qualifying income being subject to tax at 13.125 percent. To qualify for the deduction, the U.S. corporation needs to pass a couple of hurdles:
Foreign companies should now evaluate whether it’s beneficial for U.S. activities to house qualified foreign income in order to benefit from the deduction. Such deduction, if allowed, should reduce the amount of distributions subject to U.S. withholding tax.
U.S. Deduction for Certain Pass-Through Income
Tax reform includes a provision that allows individuals, trusts and estates a 20 percent deduction for certain qualifying pass-through income. Qualifying income generally includes all U.S. trade or business income earned outside of a U.S. C-corporation, excluding investment income and income from a specified service trade or business. For taxpayers with taxable income above $157,500 ($315,000), an exclusion from QBI of income from “specific service” trades or businesses is phased in.
Additionally, the deduction is generally limited to the larger of:
Foreign individuals, trusts and estates with current or potential U.S. activity should evaluate whether it’s preferable to utilize an LLC or partnership structure to receive the 20 percent deduction rather than using a U.S. corporation.
In addition to the above listed items, there are numerous tax considerations which existed before tax reform that should now be re-evaluated including, though not limited to:
Eide Bailly’s international tax team is closely following U.S. tax reform and its impact on foreign taxpayers with U.S. investments. Please contact your Eide Bailly professional or a member of our international tax team with questions.