Navigating the New World of International Tax - Articles

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Posted by: Michael Goode on Jan 19, 2018

On Dec. 15, 2017 Congressional Republicans revealed the House and Senate Tax Cuts and Jobs Act. The bill makes sweeping changes to a wide range of taxes, from individual rate rates to the treatment of pass-through entities. International taxation is subject to particularly sweeping changes. As discussed in other articles in this TBA Connect, Tennessee has a surprising amount of foreign direct investment. As such, Tennessee has a vested interest in the effects of this thousand-plus-page bill (1097 pages, including the explanation). As advisors, it’s imperative that we begin plans to help companies navigate this new world of taxation.

Much is made in the media that the lower corporate tax rates (and corresponding pass-through lower rates) will in and of itself bring in a greater amount of foreign direct investment into the United States. However, as is often the case, the reality is far more complicated. In fact, practitioners should be ready for far greater complexity and even some new tax concepts in order to be able to serve as the guide that our clients will need. At the ABA tax conference last May in DC, the thinking was that there would be a movement to greatly simplify the tax code. Although certainly the larger standard deduction will in fact do that for a lot of people on the individual side of taxation, the corporate and business side has many new provisions that most certainly will result in many new regulations. Again, practitioners will need to be well versed in the many complex changes to come in order to be a useful guide in helping client navigate the seas of change.

The explanation of the new international tax provisions begins on page 429 of the Joint Explanatory Statement (the “explanation”). It starts with an overview of general principals of international taxation which is useful to our present discussion. The explanation discusses taxation based upon a person’s residence and also the concept of worldwide taxation. Currently, a United States tax resident is taxed on their worldwide income. Although there may be tax credits, and there may be treaties that change the ultimate tax paid, the default is to start with the idea that all income is taxed worldwide, and as such it is “the broadest assertion of taxing authority.” The next type of taxing authority discussed is source based taxation, i.e. taxing “income from activities that occur, or property that is located, within the territory of the taxing jurisdiction.” As stated in the explanation, “Most jurisdictions, including the United States, have rules for determining the source of items of income and expense in a broad range of categories such as compensation for services, dividends, interest, royalties and gains.” There are rules for entity classification, source of income, and inter-company transfer (i.e. transfer pricing rules). As for non-resident aliens and foreign corporations, they “are generally subject to U.S. tax only on their U.S.-source income” and there are various rules regarding fixed or determinable annual or periodical gains, profits and income, or income that is effectively connected with the conduct of a trade or business within the United States. There also may be withholding tax on such income, and that income can vary based upon treaty. Foreign activities of US Persons also have sets of rules, including anti-deferral regimes like Subpart F and Passive Foreign Investment Company rules.There is of course much complexity even in the current system, lots of special cases like real estate (see FIRPTA for example), that exceed that scope of this article. One aspect of international taxation to pay attention to in particular is base erosion. The explanation describes base erosion payments as “any amount paid or accrued by a taxpayer to a foreign person that is a related party of the taxpayer and with respect to which a deduction is allowable” and includes acquiring property that is subject to depreciation or amortization.

As a broad overview, this bill moves the United States away from that worldwide taxation system mentioned above, and more towards a territorial system (although not entirely). There are many pages of changes that presumably will take some time for practitioners and the IRS to understand, apply and flesh out. Some of the main takeaways to pay particular attention to include the base erosion and anti-abuse tax (BEAT) as well as a tax of global intangible low-taxed income (GILTI)(pronounced “guilty” and I am quite sure that someone in Congress is quite proud of this name). If the bill is enacted, overseas profits would be subject to an automatic tax at 15.5% for cash assets as well as an 8% for assets that are illiquid.

What to do now? It is imperative to begin the discussion with clients to see how any of these new regimes will apply to a client. As an example, BEAT applies “to any taxable year, a taxpayer: (A) which is a corporation other than a regulated investment company, a real estate investment trust, or an S corporation; (B) the average annual gross receipts of the corporation for the three-taxable-year period ending with the preceding taxable year are at least $500 million, and (C) the base erosion percentage . . . of the corporation for the taxable year is three percent or higher.” As such, it is important to begin the discussion as to whether any reorganizations, changes in entity, etc. may be necessary, and to analyze the effect on a client’s income, deductions, debt, etc. Such analysis should include not only international law changes but the changes to corporate and pass-through taxation as well (and any other relevant areas). A word of caution, however, is that some prominent tax experts have stated that the new international provisions may violate World Trade Organization rules and may violate some tax treaties as well, and it is unclear at this early stage what any potential violations will mean from a planning perspective.

The many foreign companies doing business in Tennessee, as well as the many Tennessee companies doing business internationally, will need guidance through all of the change and complexity in the tax law. Such guidance will require cooperation of not only US counsel and accountants, but internationally as well since any changes can have global effects. Properly navigating these changes are essential for the continued growth and investment in Tennessee.

Michael Goode is an attorney in the Nashville office of Stites & Harbison PLLC.