The Tax Cuts and Jobs Act of 2017 (TCJA) significantly changed the way the U.S. taxes multinational earnings, especially if the company in question is based in the United States. The TCJA tries to move U.S. multinational tax policy from a “worldwide taxation” approach to a more territory-based tax system.
Many legislators and tax policy experts believe that this change will make U.S.-based multinationals more competitive in global markets and that it might encourage more international businesses to expand operations within the U.S. Below is a high-level summary of three of the most significant international provisions in the TCJA: the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and base erosion and anti-abuse tax (BEAT) rules.
Global Intangible Low-Taxed Income (GILTI)
The TCJA establishes a system of exemptions that allows some earnings of a “controlled foreign corporation” (CFC) to be repatriated via dividends that could be excluded from the taxable income of the U.S. parent corporation. In effect, it extends what is commonly known as the “dividends received” deduction.
The GILTI provision tries to limit abuse of the dividend exclusion and reduce deferral of income earned outside the U.S. In short, the provision subjects to U.S. tax in the current year all income of a CFC in excess of 10 percent of the net tax value of its depreciable (i.e., “tangible”) assets. The law presumes that any dividends exceeding this percentage must be derived from intangible assets such as goodwill. This logic results in annual repatriation of foreign income, preventing U.S.-based multinationals from accumulating wealth offshore.
Foreign-Derived Intangible Income (FDII)
The FDII rules are meant to create an incentive for U.S.-based multinationals to export to other countries. The provision works by calculating a baseline fixed rate of return on business assets — 10 percent of a company’s qualified business asset investment (QBAI), or depreciable assets. Income that exceeds that baseline is analyzed to determine how much is derived from foreign sources. That amount is the taxpayer’s FDII for the tax year, and it is taxed at a favorable rate of 13.125 percent in the U.S., as opposed to the regular corporate income tax rate of 21 percent.
Base Erosion and Anti-Abuse Tax (BEAT)
The TCJA’s BEAT rules attempt to reduce the permanent shifting of U.S. income to low-tax jurisdictions. The rules are meant to keep the U.S. in compliance with international efforts to prevent tax avoidance. If a U.S. multinational has enough income to trigger this tax, the computation starts by calculating BEAT-specific “modified taxable income.” Basically, this is the corporation’s taxable income for the current year plus otherwise deductible payments made to related foreign persons.
Once modified taxable income is determined, the BEAT is applied at a rate that changes over the life of the provision. In 2018, BEAT is calculated at 5 percent; from 2019 to 2024, 10 percent; and beginning in 2025, 12.5 percent.
BEAT applies both to domestic corporations and to foreign corporations that derive income from U.S. operations, but corporations whose annual gross receipts are less than $500 million (for the three taxable years ending with the preceding year) are not subject to the BEAT. There are also specific exemptions for individuals, S corporations, regulated investment companies and real estate investment trusts. For corporations that don’t meet those exemptions, there are de minimis exceptions for businesses with foreign-related payments that are relatively low compared to overall deductions.
Talk to your tax advisor
These descriptions are brief, high-level summaries of some complicated tax provisions. Talk to your tax professional to learn how the new rules apply to your specific situation and how they impact your domestic and international growth goals.
April 29, 2019
