An Overview of International Provisions for Privately Owned Entities
By Stella Chen, CPA
The Tax Cuts and Jobs Act (the “Act”) is the biggest and most comprehensive overhaul of the United States tax system in the past 30 years. So, what impact do these new international provisions have on privately owned companies, the majority of which are structured as pass-through entities?
Territorial Tax System
Previously in order to avoid double taxation, the US tax system allowed foreign tax credits to offset foreign sourced dividend income to be remitted back to the United States. The Act results in a modified territorial tax system, which generally taxes businesses only on income earned within a country’s borders. It allows a 100% dividend received deduction for the foreign source portion of dividends received by a US corporation if the dividends are distributed by a controlled foreign corporation (CFC).
However, such a provision is not applicable to pass-through entities. Therefore, pass-through entities would include foreign source income in their worldwide income computation and foreign taxes paid could only be used as a deduction, but not a dollar-for-dollar credit to reduce US federal income taxes.
Global Intangible Low-Taxed Income (GILTI)
GILTI is a new regime introduced by the Act. It imposes a current tax on certain income that exceeds an applicable return on certain tangible property. The Act introduces a provision which requires US shareholders of controlled foreign corporations to include certain items in excess of a fixed return on specific tangible property in gross income. However, a C corporation will be allowed to take a deduction, which is equal to 50% of GILTI and may utilize 80% of the foreign tax credit to offset income tax generated by GILTI.
The GILTI provision is applicable to pass-through entities, but neither the 50% deduction nor the 80% credit is allowed. In essence, a pass-through entity’s owners could potentially pay a much higher tax rate on GILTI, without getting any favorable tax treatment. Conversely, a C corporation’s GILTI is taxed at a reduced rate, while the C corporation could still utilize the foreign tax credit on GILTI to reduce a GILTI related tax liability.
Foreign – Derived Intangible Income (FDII) Deduction
The Act allows a US corporation to deduct 50% of certain income, which is derived from property sold or services provided to non-US persons. This deduction is only applicable to C corporations.
The FDII deduction is not applicable to pass-through entities. Therefore, domestic exporters would see significant differences in tax rates if the entities are structured as pass-through entities versus C corporations.
Summary
The Tax Cuts and Jobs Act introduced several complex international tax provisions. The implementation of those provisions depends heavily on the entity type. We strongly encourage a pass-through entity with potential GILTI exposure or with significant export business to reconsider its entity choice and seek further tax advice.