By Donald R. Looper of Looper Goodwine, P.C.

On Christmas Eve 2017, The United States Congress passed major Tax Legislation that made material changes to the U.S. tax law.  The most material change was to reduce the corporate tax rate from 35% to 21%.  There were many “special-interest” domestic tax provisions.  The summary below for IR Global members addresses the major international tax changes that might impact your clients.  With these changes, the U.S. now will become a tax favorable jurisdiction for parent companies as well as for U.S. operating growth companies.

Reduced Corporate Tax Rate.  The United States has had one of the highest corporate tax rates in the world at 35%.  This tax legislation reduced the maximum tax rate on net taxable income for U.S. corporations to 21%.  This was intended as incentive for foreign and U.S. persons to form corporations in the United States rather than in other low tax jurisdictions.  

Elimination of Tax on Incoming Dividends.  To encourage U.S. companies with foreign subsidiaries to promptly return earnings back to the United States, the Tax Act exempts U.S. corporations from income tax on dividends from any foreign corporations in which the shareholder owns at least 10% of the voting power of the foreign company, provided the foreign corporation was not allowed a deduction for the dividend.  The US corporation must have owned the foreign subsidiary for one year.  This is similar to the U.K. concept.  This dividend deduction (exemption from tax) is available only to dividends proportionate to foreign source revenues.  The dividend received deduction does not apply to passive foreign investment companies, in which 75% of the income of the foreign corporation is received from passive investments.  This new code section requires that the tax basis of the U.S. company in the foreign subsidiary’s stock be reduced by the amount of dividends received that are not taxed, thus reducing the amount of any loss in the event that the foreign company stock is subsequently sold at a loss.

Withholding Rates on Outgoing Dividends.  The United States has tax treaties with many countries in the world setting very low dividend withholding rates in the payor country for dividends being paid by a U.S. parent company.  The new tax law did not change the outgoing withholding rates for dividends being paid to shareholders in foreign countries.  Therefore, it is advisable that you create a foreign parent shareholder of a newly formed U.S. company in a tax jurisdiction with a favorable withholding rate.  The withholding rate for dividends paid to a shareholder in a non-treaty country remains at 30%.  The most favorable rates for wholly-owned subsidiaries would be for the formation of the parent company in the United Kingdom (zero withholding for 100% ownership).  A number of countries have a negotiated rate of 5%, which include Belgium, Canada, Cyprus, France, Iceland, Japan, Mexico, Netherlands, Portugal and Switzerland.  Therefore, the U.S. corporation can retain earnings and be taxed on 21% of net profits, while taking advantage of all tax deductions available in the United States to calculate net taxable income.  Tax deductions for depletion of oil and gas developments was retained.  When dividends are distributed, a low withholding tax rate will apply to the dividends paid to the foreign company.  Unless U.K. changes this law, the U.K. is by far the best jurisdiction, because dividends received after one year after formation are tax-free for non-U.K. persons.  In the other countries, your parent company should receive a tax credit in the pertinent country for the withholding tax.

Withholding Rate on U.S. Incoming Dividends.  The lower corporate tax rate creates an incentive for foreign persons to form companies in the United States, because the United States has tax treaties with many countries in the world setting very low dividend withholding rates in the payor country on dividends being paid to a U.S. parent company.  

Forced Repatriation of Foreign Earnings.  U.S. companies with existing foreign subsidiaries are subject to a new one-time tax imposed on the accumulated offshore earnings at November 2017 (except for passive foreign investment company income, which is taxed currently).  The tax rate is 15.5% on all cash and cash equivalents held in the foreign subsidiary, and 8% on all accumulated E&P that have been reinvested in the foreign jurisdiction.  The tax act permits the “forced repatriation” tax to be paid over an eight year period.  This is not a recurring tax after 2017.

Controlled Foreign Corporations. The United States has always required certain income, referenced as “Subpart F Income,” to be taxed currently in the United States by the shareholders of all Control Foreign Corporations (“CFCs”) which means over 50% owned by 5 or fewer U.S. persons.  Subpart F Income includes five types of income, which is generally passive income, shipping income, and income from offshore oil related activity unless the foreign subsidiary was formed in the country where the oil production occurs.  A new provision allows oil companies to set up their foreign operations in countries other than the country in which production occurs to avoid Subpart F Income.

GILTI Income.  The tax act creates a new type of foreign income referenced as GILTI, or “global intangible low-taxed income” of CFCs.  GILTI is net income of a foreign corporation in excess of a benchmark of a 10% return on investment in trade or business assets.  The tax law requires taxation of all GILTI income for individual shareholders at an effective rate of 10.5%. The net effective rate to a U.S. corporation shareholder on foreign derived intangible income would be 13.125%.  Since the law permits an 80% of corporate income tax paid in foreign jurisdictions to be treated as a tax credit on GILTI inclusions, there will be no incremental tax imposed on GILTI income of a U.S. corporate shareholder if the applicable foreign tax rate equals or exceeds 13.125%.

CFC Status.  Prior tax law allowed a U.S. person to establish a foreign corporation during the 30 day process of adding additional foreign shareholders.  As long as the U.S. persons did not own control for 30 consecutive days, the foreign corporation was not treated as a CFC.  This law was eliminated.  Therefore, if a U.S. person owns more than 50% of a corporation for even one day, it must file Form 5471 and be treated as a CFC.  The failure to file Form 5471 timely, in addition to other penalties, is U.S. $10,000.

CFC Attribution Rules.  Under prior law, a foreign resident father could own 50% of a company and his U.S. citizen son own the other 50% without causing the corporation to be treated as a CFC.  There was no attribution of ownership “downward” to the son.  The new law changes this rule.  Such corporation now would be treated as a CFC, beginning in 2017, for the current reporting tax returns due in March 2018.  

Transfers Out of the U.S.  Section 367 of the U.S. tax code has always required a shareholder transferring assets to a foreign corporation (even 100% subsidiary) to incur corporate income tax on the gain of the value of any property in excess of his tax basis of the asset transferred.  The new tax law eliminates an exception for assets used in the active trade or business.  The new tax act also imposes a new tax on goodwill on the value of intangible property transferred to a subsidiary, requiring it to be taxed as if it were royalty payments.

Conclusion.  For many years, we have been advising U.S. persons who were establishing a new corporation to form the parent company outside the U.S. if operations will be materially conducted outside the U.S.  This new tax law will definitely change the incentive and require the lawyers to analyze the long-term business plans.  I would caution, however, anyone who might rush to form companies in the United States in reliance upon the 21% rate.  The current political atmosphere in the United States is toxic, with Donald Trump and the Republicans hypocritically opposing any position that is not originated by them.  President Obama, several years ago while the Republicans did control the House of Representatives, proposed lowering the corporate tax rate to 28%, and the Republicans refused to even allow the 28% corporate tax rate reduction proposal to be submitted for a vote.  If the Democrats can regain control in 2020, or even 2018, I would expect the corporate tax rate to go back towards the 28%, because this tax rate is causing a major budget deficit in the United States.  This budget deficit will eventually fuel inflation.  Donald Trump and the Republicans do not care, because their plan would simply be to “blame the Democrats” for “raising taxes” when the tax rates are increased to reduce the budget deficit.  

If Looper Goodwine can assist you with any questions, please not hesitate to email me.  We represent clients internationally in structuring acquisitions and operations.  And Looper Goodwine, P.C., represents oil and gas companies in exploration, production and refining in several countries.