On March 22, 2018, Pierre Moscovici, Tax Commissioner at the European Commission, said during a meeting of the European Parliament that the EU may challenge the foreign-derived intangible income (FDII) and base erosion and anti-abuse tax (BEAT) rules, introduced by the 2017 U.S. tax reform legislation (the “Tax Cuts and Jobs Act” or TCJA), as violating various international standards.
The FDII and BEAT rules are discussed at a high level below.
Regarding the FDII rules, Mr. Moscovici said that they may violate the OECD BEPS Action 5 recommendations on substantial activity requirements for intellectual property (IP) incentive regimes. Meanwhile, the BEAT rules may violate World Trade Organization (WTO) rules.
By contrast, on January 25, 2018, Jason Yen, Attorney-Advisor, Office of Tax Policy, U.S. Treasury, said during a panel event at a conference sponsored by the Washington, D.C. Bar that Treasury believes that the FDII rules comply with the BEPS Action 5 recommendations. Mr. Yen did not address the BEAT rules.
Mr. Yen made the comments during a panel event that focused on IP planning resulting from new global intangible low-taxed income (GILTI) and FDII rules.
Rocco Femia, Member, Miller & Chevalier Chartered, said during the January 25th panel event that while some of the patent box objectives of the BEPS Action 5 recommendations are reflected in the FDII rules, the rules do not contain any nexus requirement. Whereas the FDII rules are mechanical in application, the Action 5 recommendations use a subjective IP standard (i.e., treatment of IP income is determined under transfer pricing rules).
Mr. Femia also discussed the EU financial ministers’ letter, sent to Treasury Secretary Steven Mnuchin on December 12, 2017, regarding EU concerns with the IP incentives, which “would subsidize exports compared with the domestic consumption [and] …. therefore face challenges as an illegal export subsidy under WTO … rules.” The EU reaction creates uncertainty for U.S. taxpayers when considering medium or long-term IP planning under the FDII rules, said Mr. Femia.
FDII Background
Editor’s Note: The content in this section first appeared in the Thomson Reuters/Checkpoint Complete Analysis of the Tax Cuts and Jobs Act, released in December 2017.
Under pre-TCJA law, the U.S. had a worldwide tax system, under which U.S. persons were generally taxed on all income, whether derived in the U.S. or abroad. Foreign income earned by U.S. corporate shareholders through foreign corporations was generally subject to U.S. tax only when the income was distributed as a dividend to the U.S. corporate shareholder. However, under the Subpart F rules, U.S. shareholders of a CFC are required to include in income their pro rata share of the CFC’s Subpart F income whether or not the income is distributed.
Under new Section 250(a)(1) of the Code, in the case of a domestic corporation for any tax year, a deduction is allowed in an amount equal to the sum of the following:
- 37.5% of the FDII of the domestic corporation for the tax year.
- 50% of (1) the GILTI amount (if any) which is included in the gross income of the domestic corporation under Section 951A for the tax year, and (2) the amount treated as a dividend received by the corporation under Section 78 which is attributable to GILTI. See Section 14202(a) of the TCJA.
Coupled with the 21% U.S. tax rate for domestic corporations, these deductions result in effective tax rates of 13.125% on FDII and 10.5% on GILTI (with respect to domestic corporations) for tax years beginning after December 31, 2017 and before January 1, 2026.
The FDII rules apply for tax years beginning after December 31, 2017.
BEAT Background
Editor’s Note: The content in this section first appeared in the Thomson Reuters/Checkpoint Complete Analysis of the Tax Cuts and Jobs Act, released in December 2017.
Under pre-TCJA law, a multinational corporation resident in the U.S. was subject to U.S. tax on its worldwide income—active foreign earnings were subject to U.S. tax only when they were repatriated to a domestic parent. This system created incentives for multinational companies to shift income away from the U.S. to lower-tax jurisdictions, and to defer the repatriation of active foreign-source earnings. The TCJA generally establishes a hybrid territorial system by providing for a participation exemption (i.e., a 100% deduction for the foreign-source portion of dividends received from 10%-owned foreign corporations).
Even with this incentive, corporations with foreign operations may continue to use deductible payments to erode the U.S. tax base and shift income to foreign affiliates in lower-tax jurisdictions. As a result, new Section 59A establishes a base erosion minimum tax to prevent companies from stripping earnings out of the U.S. through payments to foreign affiliates that are deductible for U.S. tax purposes. The tax is structured as an alternative minimum tax that applies when a multinational company reduces its regular U.S. tax liability to less than a specified percentage of its taxable income, after adding back deductible base eroding payments and a percentage of tax losses claimed that were carried from another year. The tax applies to deductible payments to foreign affiliates from domestic corporations, as well as on foreign corporations engaged in a U.S. trade or business in computing the tax on their effectively connected income (ECI). SeeTCJA section 14401(a).
The base erosion minimum tax provision applies to corporations, other than regulated investment companies (RICs), real estate investment trusts (REITs), and S corporations (Section 59A(e)(1)(A)), that have average annual gross receipts of at least $500,000,000 for the three-year tax period ending with the preceding tax year (Section 59A(e)(1))(B)) and a “base erosion percentage” of at least 3% (Section 59A(e)(1)(C)) (2% for certain banks and securities dealers). In the case of a foreign corporation engaged in a U.S. trade or business, only gross receipts taken into account in determining ECI are considered. (Section 59A(e)(2)(A))
The BEAT rules apply to base erosion payments paid or accrued in tax years beginning after December 31, 2017.
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