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One Step Closer to Tax Reform - Senate Passes Bill, International Tax Provisions at Odds with Bill Passed by the House

Firm Thought Leadership

The Senate has now passed its own version of the "Tax Cuts and Jobs Act" tax reform bill. The two tax reform bills passed by the House and the Senate now would need to be refined into one bill by a conference committee (or, less likely, the House would need to pass the Senate version without changes). While not certain, we expect a fast, informal conference to negotiate key provisions, fill in many of the details, and fix oversights and unintended consequences. Both the House and Senate tax reform bills make major changes to virtually every aspect of the Internal Revenue Code, materially affecting corporate tax, partnership tax, international tax, estate tax, executive compensation, and individual tax provisions. Perhaps their greatest changes are to the international tax provisions moving the United States towards territorial taxation and adding base erosion provisions. To help you begin your analysis, below is a high-level summary of key provisions affecting international tax issues in the Senate and House tax reform bills. A final vote by both chambers on the bill that comes out of the conference is expected by year-end. Because many changes are effective January 1, 2018, prompt review of your structure and operations is warranted to understand how the new legislation will affect you.

U.S. Senate
The Senate tax reform bill lowers the U.S. corporate tax rate to 20% in 2019.

It also moves the taxation of U.S. corporations closer to a system based on the location of the economic activity rather than residence of the taxpayer, which is known as territorial taxation. This is done through an exemption from income for dividends paid from foreign subsidiaries to U.S. parent corporations that own at least 10% of the subsidiary. U.S. corporations are not permitted to claim foreign tax credits with respect to exempt dividends.

To transition the U.S. to the territorial system, the accumulated earnings of 10%-owned foreign subsidiaries are taxed currently to the U.S. shareholder at 14.5% for liquid assets and 7.5% for other assets, payable in installments over eight years. The U.S. shareholder is permitted to claim a credit for a portion of the foreign income taxes paid by such subsidiaries. An issue remains as to whether non-corporate shareholders should have to pay this tax when they don’t get the future benefit of the dividend exemption described above.

Complex rules apply to foreign intangible income. With exceptions for income that is taxed in the U.S. in other ways, the Senate bill taxes U.S. shareholders currently on the global intangible low tax income of their foreign subsidiaries. “Global intangible low-tax income” is defined as income in excess of a 10% return on the U.S. shareholder’s pro rata share of the foreign subsidiary’s investment in business assets. After a deduction that reduces the impact by 37.5%, the effective tax rate on global intangible low tax income for U.S. corporations is 12.5%. U.S. foreign tax credits still apply, but are limited to 80% of the foreign taxes paid.

Other provisions to prevent the erosion of the U.S. tax base apply, including more restrictive limits on deductions for interest expense in the U.S., and a provision imposing tax on U.S. subsidiaries of foreign corporations with at least $500 million in gross receipts if their payments to their foreign parents for interest, royalties, management fees or reinsurance payments are too high.

U.S. House of Representatives
The House tax reform bill lowers the U.S. corporate tax rate to 20% in 2018, a year earlier than the Senate bill.

The House bill also moves the taxation of U.S. corporations closer to territorial taxation. Like the Senate, this is done through an exemption from income for dividends paid from foreign subsidiaries to U.S. parent corporations that own at least 10% of the subsidiary. U.S. corporations are not permitted to claim foreign tax credits with respect to exempt dividends.

To transition the U.S. to the territorial system, the accumulated earnings of 10%-owned foreign subsidiaries are taxed currently to the U.S. shareholder at 14% for liquid assets and 7% for other assets, payable in installments over eight years. Thus the rates are slightly lower than the Senate bill’s similar provisions. The U.S. shareholder is permitted to claim a credit for a portion of the foreign income taxes paid by such subsidiaries. As above, an issue remains as to whether non-corporate shareholders should have to pay this tax when they don’t get the future benefit of the dividend exemption.

The House bill also taxes currently a U.S. shareholder’s share of its foreign subsidiaries’ income in excess of a routine return on such foreign subsidiaries’ tax basis in their depreciable tangible property. Unlike the Senate bill, this provision does not appear to focus solely on intangible income, and includes a 50% exclusion for a 10% effective tax rate. High return income includes all foreign income except income that is otherwise subject to current U.S. tax. U.S. foreign tax credits still apply, but are limited to 80% of the foreign taxes paid.

The House bill also includes provisions to prevent the erosion of the U.S. tax base, including limiting interest expense in the U.S. for certain U.S. companies based on its share of EBITDA worldwide. It also generally imposes a 20% excise tax on a U.S. corporation’s payments to related foreign corporations (other than interest) that are deductible, included in cost of goods sold, or are amortized, unless the foreign corporation elects to treat such payments as effectively connected with a U.S. trade or business (and, thus, subject to net-basis U.S. tax).


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