Introduction
The recently enacted 2017 Tax Reform Act embraces major sweeping changes to US international tax rules. President Donald J. Trump has endorsed large changes to the federal tax code, and as per sources, the steps such as lowering rates for individuals and corporations, and further changing the taxation of overseas profits, will increase the U.S. economy. Due to the new tax reformation, U.S. firms will become more competitive internationally in the form of global businesses and cross-border investments. Let us review how to avail benefits of these new rules enacted by the U.S. administration.
New Territorial Tax System
As per the Tax Reform Act 2017, a new territorial system of taxation has been adopted, which may aid in the elimination or reduction of US income taxes based on income earned outside the US by US C corps. In the event of a C corporation owning 10% or more of an overseas foreign corporation that pays a dividend, then the C corp is liable for a 100% Dividends Received Deduction (DRD).
On the other hand, the DRD for the overseas portion of the dividend will cut or do away with the US tax imposed on the dividend. As per the conditions specified, the DRD will not be applicable in the event an overseas or a foreign corporation is a Passive Foreign Investment Company (PFIC).
The new territorial tax system is not applicable to income for by a C corp from a foreign branch. Earnings received from a foreign branch are subject to U.S. tax regulations. On the other hand, if foreign tax is imposed on those earnings, a foreign tax credit may decrease or do away with US tax. Consequently, businesses functioning as C corporations are subject to include their foreign branches to remove US tax on total business earnings.
Furthermore, the new territorial tax system can also help reduce taxable gains realized when a C corporation trades the stock of a foreign corp. The Tax Reform Act 2017 offers the provision of deemed dividend for sharing exemption system with no liability to pay any taxes.
Introduction of GILTI (Global Intangible Low-Taxed Income) Tax
The GILTI tax is a new tax imposed on US shareholders holding Controlled Foreign Corporations (CFCs) i.e. any shared foreign corporation holding earnings that exceed a 10% return on investment. In case a CFC has a passive income source or Subpart F income, then the US shareholders must take account of their earnings and share of the Subpart F income, and no dividend is liable to be paid to them.
The Tax Reform Act 2017 offers the provision that a US shareholder of any CFC must take account of its GILTI in gross income for a taxable part similarly to the addition of Subpart F income. In other words, GILTI indicates the surplus of the shareholder’s net CFC income over the shareholder’s total deemed substantial income return in that CFC.
US shareholders holding C corps are given special tax benefits that can do away with the GILTI tax. According to the newly enacted law, a C corp can remove 50% of the GILTI inclusion amount, which cuts the possible corporate tax from 21% to 10.5%. Furthermore, any amount of GILTI that is incorporated into the entire gross income of a C corp, that C corp would be considered to have paid foreign income taxes equivalent to 80% of the foreign taxes paid by the CFC earnings. In this case, if the CFC reimburses foreign taxes of 13.125% or further, this particular foreign tax credit will reduce any GILTI.
Territorial Tax Systems and OECD Countries
Most OECD countries are considering territorial tax systems as their main priorities to diminish barriers to global capital flows, and subsequently increase the genuineness of domestically headquartered global firms. These countries make rules that take into account the exception of foreign profits from taxes. Another aspect that they consider is strengthening of that effort to limit possible profit shifting. The participation exemptions lead to the way to creating a territorial tax system. They allocate companies to remove foreign profits by foreign subsidiaries from domestic taxable revenue. The controlled foreign corporation (CFC) rules intend to put off domestic multinationals from utilizing high income on dividends, interest, royalties, etc.
Main criticisms of the plan designed
Many financial advisors are unconvinced that the business viability settles on tax rates. The United States cannot match foreign jurisdictions that have tremendously much lower or unreal tax rates. In this aspect, new tax policymakers should be cautious of the competitive economy factor that supports the US more than any other foreign country in relation to the proposed new global taxation rules.
A major apprehension of many financial experts, is the anticipated increase in the budget shortfall especially with prerogative commitments, increasing interest rates and much more. It seems to be a risky time to add to the U.S. debt, which has exceeded $20 trillion in total. Some financial specialists are apprehensive that budding costs of debt service could inflict on significant defense spending.
Many other professionals advise that it is not so easy to measure if a lower corporate rate will improve U.S. companies’ viable position or pay more dividends on investments and engagements. Several other dominant factors such as the abolition of deductions and the fact that many companies already shell out much less than the approved rates, should be considered as well.
Summary
- The main objective of the new territorial tax system is to reform the U.S.’s system for applying taxes on foreign profits earned by domestic businesses.
- Reforming the corporate tax system by moving to a new territorial tax system, would help exempt foreign profits of U.S. global businesses from domestic taxation rules.
- In the past many years, a majority of United State’s largest trading partners, have shifted to territorial tax systems.
- All OECD countries with territorial tax systems are aiming at creating designed rules so as to prevent foreign-based profit sharing by international corporations.
