Tax & Accounting Blog

BEPS and Other Notable Int’l Measures in Senate Tax Reform Legislation

BEPS, Blog, Global Tax Planning, International Reporting & Compliance December 7, 2017

The release of major tax reform legislation in the U.S. has generated great interest around the world.

On Nov. 16, 2017, the U.S. House approved H.R. 1—the Tax Cuts and Jobs Act—by a vote of 227-205. 

On Dec. 2, 2017, the U.S. Senate passed the Tax Cuts and Jobs Act (the “Act”)—by a vote of 51-49.

The next step is for the U.S. House and Senate tax bills to be reconciled into a single piece of legislation by a Conference Committee composed of U.S. House and Senate members. Although there are many similarities between the two bills, there are also a number of significant differences to be addressed by the Conference Committee.

I. Senate BEPS Project-Related Measures

In addition to lowering the U.S. corporate tax rate to 20% starting with the 2019 tax year, the Act contains the following BEPS Action 2, 3, and 4 measures (under the House legislation, the corporate tax rate reduction would go into effect starting with the 2018 tax year):

  • Denial of deduction for certain related-party payments (Action 2). The Act would deny a deduction for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity. A disqualified related party amount is any interest or royalty paid or accrued to a related party to the extent that: (1) there is no corresponding inclusion to the related party under the tax law of the country of which such related party is a resident for tax purposes, or (2) such related party is allowed a deduction with respect to such amount under the tax law of such country.
    • In general, (a) a hybrid transaction is one that involves payment of interest or royalties that are not treated as such by the country of residence of the foreign recipient; and (b) a hybrid entity is an entity that is treated by one country as fiscally transparent for federal income tax purposes but is not treated in the same manner under foreign tax law.
    • The provision would be effective for tax years beginning after Dec. 31, 2017.
  • Repeal of foreign base company oil-related income rule (Action 3). The imposition of current U.S. tax on foreign base company oil-related income would be repealed.
    • This repeal would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign subsidiaries end.
  • Inflation adjustment for Subpart F de minimis exception (Action 3)Under current law, a U.S. parent of a foreign subsidiary is subject to current U.S. tax on its pro rata share of the subsidiary’s subpart F income. However, a de minimis rule states that if the gross amount of such income is less than the lesser of 5% of the foreign subsidiary’s gross income or $1 million, then the U.S. parent is not subject to current U.S. tax on any of the subpart F income. Under the Act, the $1 million threshold would be adjusted for inflation.
    • This adjustment would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign subsidiaries end.
  • Repeal of rule taxing income when controlled foreign corporation (CFC) decreases investments (Action 3). The Act would repeal Section 955. As a result, a U.S. shareholder of a controlled foreign corporation (CFC) that invested its previously excluded subpart F income in qualified foreign base company shipping operations would no longer be required to include in income a pro rata share of the previously excluded subpart F income when the CFC decreases such investments.
    • This repeal would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign corporations end.
  • Modification of CFC status attribution rules (Action 3). Under current law, a U.S. parent of a CFC is subject to current U.S. tax on its pro rata share of the CFC’s subpart F income. A foreign subsidiary is a CFC if it is more than 50% owned by one or more U.S. persons, each of which owns at least 10% of the foreign subsidiary. Constructive ownership rules apply in determining ownership for this purpose. The Act would amend the constructive ownership rules so that certain stock of a foreign corporation owned by a foreign person would be attributed to a related U.S. person for purposes of determining whether the related U.S. person is a U.S. shareholder of the foreign corporation and, therefore, whether the foreign corporation is a CFC.
    • The above modifications would be effective for the last tax year of foreign corporations beginning before Jan. 1, 2018, and all subsequent tax years of a foreign corporation and for tax years of a U.S. shareholder in which or within which such tax years end.
  • Expansion of definition of U.S. shareholder (Action 3). Under current law, a U.S. shareholder for CFC purposes is a U.S. person who owns 10% or more of the total combined voting power of all classes of stock entitled to vote of the foreign corporation. (Section 951(b)) The Act would expand the definition of “U.S. shareholder” to include any U.S. person who owns 10% or more of the total value of shares of all classes of stock of a foreign corporation.
    • The expanded definition would be effective for the last tax year of foreign corporations beginning before Jan. 1, 2018, and for tax years of U.S. shareholders in which or within which such tax years of foreign corporations end.
  • Elimination of 30-day minimum holding period for CFC (Action 3). Under current law, a U.S. parent of a CFC is subject to current U.S. tax on its pro rata share of the CFC’s subpart F income if the U.S. parent owns stock in the foreign subsidiary for an uninterrupted period of 30 days or more during the year. Under the Act, a U.S. parent would be subject to current U.S. tax on the CFC’s subpart F income even if the U.S. parent does not own stock in the CFC for an uninterrupted period of 30 days or more during the year.
    • The provision would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign subsidiaries end.
  • Foreign subsidiary passive income exception made permanent (Action 3). Under current law, a U.S. parent of a foreign subsidiary generally is subject to current U.S. tax on passive income earned by the foreign subsidiary. However, for tax years of foreign subsidiaries beginning before 2020, and tax years of U.S. shareholders in which or within which such tax years of the foreign subsidiary end, a special “look-through” rule provides that passive income received by one foreign subsidiary from a related foreign subsidiary generally is not includible in the taxable income of the U.S. parent, provided such income was not subject to current U.S. tax or effectively connected with a U.S. trade or business.
    • The Act would make this provision permanent.
  • Repeal of tax on foreign subsidiary investments in U.S. property (Action 3). The requirement in subpart F that U.S. shareholders recognize income when earnings are repatriated in the form of increases in investment by a CFC in U.S. property would be amended by the Act to provide an exception for domestic corporations that are U.S. shareholders in the CFC either directly or through a domestic partnership.
    • The above change would be effective for tax years of CFCs beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of the foreign corporations end.
  • Business interest deduction (Action 4). Under the Act, every business, regardless of its form, would generally be subject to a disallowance of a deduction for net interest expense in excess of 30% of the business’s adjusted taxable income. The net interest expense disallowance would be determined at the tax filer level. However, a special rule would apply to pass-through entitles, which requires the determination to be made at the entity level, for example, at the partnership level instead of the partner level. Adjusted taxable income is a business’s taxable income computed without regard to business interest expense, business interest income, the deduction for certain pass-through income, net operating losses (NOLs), and depreciation, and other adjustments as provided by IRS. Any interest amounts so disallowed would be carried forward to the succeeding five tax years.
    • The Act would provide an exemption from these rules for taxpayers (other than a tax shelter) with average annual gross receipts under $15 million during the three preceding years, indexed for inflation.
    • These changes would be effective for tax years beginning after Dec. 31, 2017.
  • Denial of interest expense deduction of U.S. shareholders with excess domestic indebtedness (Action 4). For any domestic corporation that is a member of a worldwide affiliated group, the Act would reduce the deduction for interest paid or accrued by the corporation by the product of the net interest expense of the domestic corporation multiplied by the debt-to-equity differential percentage of the worldwide affiliated group. Net interest expense means the excess (if any) of: (1) interest paid or accrued by the taxpayer during the tax year, over (2) the amount of interest includible in the gross income of the taxpayer for the tax year. The debt-to-equity differential percentage means, with respect to any worldwide affiliated group, the excess domestic indebtedness of the group divided by the total indebtedness of the domestic corporations that are members of the group.
    • The change would be effective for tax years beginning after Dec. 31, 2017.

II. Other Senate Int’l Tax Measures

The Act includes the following notable non-BEPS project-related international tax measures:

Establishment of Participation Exemption System for Taxation of Foreign Income 

  • Deduction for foreign-source portion of dividends. The current-law system of taxing U.S. corporations on the foreign earnings of their foreign subsidiaries when these earnings are distributed would be replaced. The Act would provide for an exemption (referred to here as a deduction for dividends received, or DRD) for certain foreign income. This exemption would provide a 100% deduction for the foreign-source portion of dividends received from specified 10%-owned foreign corporations by domestic corporations that are U.S. shareholders of those foreign corporations within the meaning of Section 951(b).
    • No foreign tax credit or deduction would be allowed for any taxes paid or accrued with respect to a dividend that qualifies for the DRD. There is also a provision in the Act that would disallow the DRD if the domestic corporation did not hold the stock in the foreign corporation for a long enough period of time.
    • The provision would eliminate the “lock-out” effect under current law, which encourages U.S. companies to avoid bringing their foreign earnings back into the U.S.
    • The changes would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign corporations end.
  • Limitation on losses with respect to foreign subsidiaries. Under the Act, a U.S. parent would reduce the basis of its stock in a foreign subsidiary by the amount of any exempt dividends that the U.S. parent received from its foreign subsidiary – but only for purposes of determining the amount of a loss (and not the amount of any gain) on any sale or exchange of the foreign subsidiary. This change would be effective for dividends received in tax years beginning after December 31, 2017.
  • Treatment of deferred foreign income upon transition to the new participation exemption system—deemed repatriation. Under the Act, U.S. shareholders owning at least 10% of a foreign subsidiary generally would include in income, for the subsidiary’s last tax year beginning before 2018, the shareholder’s pro rata share of the net post-1986 historical E&P of the foreign subsidiary, to the extent such E&P has not been previously subject to U.S. tax.
    • The portion of the E&P comprising cash or cash equivalents would be taxed at a reduced rate of 14.5%, while any remaining E&P would be taxed at a reduced rate of 7.5%.
    • At the election of the U.S. shareholder, the tax liability would be payable over a period of up to eight years The payments for each of the first five years equals 8% of the net tax liability. The amount of the sixth installment is 15% of the net tax liability, increasing to 20% for the seventh installment, and the remaining balance of 25% in the eighth year.
    • The Act provides a special rule for S corporations. Their shareholders would be allowed to elect to maintain deferral on such foreign income until the S corporation changes its status, sells substantially all its assets, ceases to conduct business, or the electing shareholder transfers its S corporation stock.

Rules Related to Passive and Mobile Income

  • Current-year inclusion of global intangible low-taxed income. Under the Act, a U.S. shareholder of any CFC would have to include in gross income for a tax year its global intangible low-taxed income (GILTI) in a manner generally similar to inclusions of subpart F income. GILTI means, with respect to any U.S. shareholder for the shareholder’s tax year, the excess (if any) of the shareholder’s net CFC tested income over the shareholder’s net deemed tangible income return. The shareholder’s net deemed tangible income return is an amount equal to 10% of the aggregate of the shareholder’s pro rata share of the qualified business asset investment of each CFC with respect to which it is a U.S. shareholder.
    • GILTI does not include effectively connected income, subpart F income, foreign oil and gas income, or certain related party payments. GILTI is taxed at a rate of 10%.
    • Foreign tax credits are allowed for foreign income taxes paid with respect to GILTI, but are limited to 80% of the foreign income taxes paid and are not allowed to be carried back or forward to other tax years.
    • The change would be effective for tax years of foreign corporations beginning after Dec. 31, 2017, and for tax years of U.S. shareholders in which or within which such tax years of foreign corporations end.
  • Deduction for foreign-derived intangible income. In the case of a domestic corporation for its tax year, the Act would allow a deduction equal to a percentage of the lesser of (1) the sum of its foreign-derived intangible income plus the amount of GILTI that is included in its gross income, or (2) its taxable income, determined (without regard to this provision). The foreign-derived intangible income of any domestic corporation would be the amount which bears the same ratio to the corporation’s deemed intangible income as its foreign-derived deduction eligible income bears to its deduction eligible income.
    • The percentage would be 50% for tax years beginning after Dec. 31, 2017 and before Jan. 1, 2026. For later tax years, the percentage would be 37.5%.
    • This provision would be effective for tax years beginning after Dec. 31, 2017.
  • Transfers of intangible property from CFCs. Under the Act, for certain distributions of intangible property held by a CFC on the date of enactment, the fair market value (FMV) of the property on the date of the distribution would be treated as not exceeding the adjusted basis of the property immediately before the distribution. If the distribution is not a dividend, a U.S. shareholder’s adjusted basis in the stock of the CFC with respect to which the distribution is made would be increased by the amount (if any) of the distribution that would, but for this provision, be includible in gross income.
    • The provision would apply to distributions made by the CFC before the last day of the third tax year of the CFC beginning after Dec. 31, 2017.

Prevention of Base Erosion 

  • Tax on base erosion payments. Under the Act, certain corporations with average annual gross receipts of at least $500 million would be required to pay a tax, the “base erosion anti-abuse tax” (BEAT), equal to the “base erosion minimum tax amount” for the tax year. In general, the base erosion minimum tax amount would mean, with respect to an applicable taxpayer for any tax year beginning before Jan. 1, 2026, the excess of 10% of the modified taxable income of the taxpayer for the tax year over an amount equal to the regular tax liability, reduced by excess (if any) credits.
    • The tax would be 12.5% of the modified taxable income of the taxpayer for the tax year over an amount equal to the regular tax liability of the taxpayer for the tax year, for tax years beginning after Dec. 31, 2025. The regular tax liability would be reduced by an amount equal to all credits allowed, including the general business credit, for tax years beginning after Dec. 31, 2025.
    • Members of affiliated groups that include a bank or securities dealer will pay the BEAT tax at an 11% rate, increasing to 13.5% after 2025.
    • The Act would generally exclude an amount paid or incurred for services if those services meet the requirements for the services cost method under Section 482 and if such amount is the total services cost with no markup, for tax years beginning after Dec. 31, 2017.
    • There is also an exception for certain derivative payments made in the ordinary course of a trade or business.
    • The tax would apply to base erosion payments paid or accrued in tax years beginning after Dec. 31, 2017.
  • Limitations on income shifting through intangible property transfers. The Act would address recurring definitional and methodological issues that have arisen in controversies in transfers of intangible property for purposes of Sections 367(d) and 482, both of which use the statutory definition of “intangible property” in Section 936(h)(3)(B).
    • The Act would revise that definition and confirm the authority to require certain valuation methods. It would not modify the basic approach of the existing transfer pricing rules with regard to income from intangible property. Under the Act, workforce in place, goodwill (both foreign and domestic), and going concern value would be intangible property within the meaning of Section 936(h)(3)(B), as is the residual category of “any similar item” the value of which is not attributable to tangible property or the services of an individual.
    • The provision would apply to transfers in tax years beginning after Dec. 31, 2017.

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