- The tax act imposes a one-time “toll tax” on the undistributed, non-previously taxed, post -1986 foreign earnings and profits (E&P) of certain U.S.-owned corporations as part of the transition to a new partial territorial tax regime. The act generally requires, for the last taxable year of a foreign corporation beginning before January 1, 2018, all U.S. shareholders of “controlled foreign corporations” (CFCs) to include in income their pro rata shares of the accumulated post-1986 deferred foreign income that was not previously taxed. The tax rates for this toll charge range between 8% - 15.5%. However, taxpayers can elect to pay over eight years. Since previously untaxed foreign earnings of U.S. companies are now taxed, there would now be fewer incentives to retain these earnings offshore.
Since the U.S. tax reforms went into effect this year, the near- and long-term implications have been the focus of much discussion. While multinational corporations are re-thinking the cost of capital, re-balancing and re-allocating debt and equity, and offshore cash repatriation, it is important to note that the reforms could also serve as a catalyst to review global cash management strategies. There may be untapped opportunities to optimize working capital across U.S. and non-U.S. companies. Strategies such as combining pooling solutions and re-distributing the return on global cash could be places to start.
There are two primary aspects to the big picture.
Fundamental to the reforms is a distinctive move towards a more global tax regime. Specifically, global earnings of U.S. companies are now included in the taxable base; both past earnings and future earnings. Coupled with additional scrutiny, and limitations, on interest expense deductions resulting from U.S. company borrowing from foreign affiliates, the intent of the reforms serves to remove many of the historic incentives for retaining earnings offshore. Rather they may motivate U.S. companies to direct those earnings onshore.
1
Changes for U.S. companies
(U.S. and foreign headquartered)
- The deduction for net interest expense is generally limited to 30% of adjusted taxable income and there is no grandfathering for pre-2018 debt and the interest deduction disallowed in a given year can be carried forward indefinitely.
- Historically, certain U.S. multinationals may have borrowed in the U.S., equity funded in low-tax jurisdictions and then on-lent to high-tax foreign affiliates. This would have had the effect of shifting interest expense deductions to U.S. companies. The new earnings stripping rules limit these deductions.
- As a result, there may be less benefit in structuring intercompany funding from the U.S. to the CFCs.
- BEAT adjusts taxable earnings and applies a minimum tax for foreign-related party base erosion payments, thereby creating an alternative (and larger) tax base. BEAT is applicable to corporate groups where global gross receipts average more than $500 million.
- Base Erosion Payment Percentage > 3% (2% for financial services entities)
With the new tax law’s intent of addressing earnings stripping, the interest expense paid by a U.S. company to foreign affiliates may be subject to BEAT. As a result, there may be fewer benefits in structuring intercompany loans from foreign affiliates to the U.S.
Implications for U.S. companies (U.S. and foreign headquartered)
- U.S. companies are likely to be less sensitive to pooling foreign cash with U.S. cash, potentially resulting in more cross-border pooling than before because income earned by a CFC is now generally either exempted or subject to the greatly expanded anti-deferral rules. However, BEAT implications should be considered where CFCs are lending to the U.S. company and with the intent to deduct the interest expense.
- Further, amounts taxable under the deemed repatriation create previously taxed income (PTI) accounts for the U.S. shareholders. Distributions from a CFC to the U.S. Company are generally not taxed when paid out of PTI, further incentivizing those earnings to be repatriated.
- The combination of deemed repatriation and the new system for taxing CFC earnings implies that companies may have diminished concern regarding the potential application of Section 956 as there is less incentive to structure intercompany loans from CFC to U.S. companies.
The interest deduction limitation applies to interest expense in excess of interest income. Where notional pools are viewed as bank deposits or credit support, opportunity may exist to maximize net interest income while minimizing interest expense in the U.S.
2
Changes for U.S. companies
(U.S. and foreign headquartered)
- The definition of a CFC now includes 10% shareholders as measured by either value or vote.
- Qualifying dividends from U.S.-owned foreign corporations are eligible for the 100% dividend received deduction.
- Income earned in a CFC that is not Subpart F income or not meeting other limited exemptions is taxable at an effective 10.5% tax rate for corporate shareholders.
- Income includes loans by the CFCs to U.S. affiliates, CFC guarantees of U.S. affiliate debt or other CFC investments in U.S. property. Section 956 effectively overrides the participation exemption when triggered.
With the adoption of the GILTI regime, the foreign earnings now included in the taxable base for U.S.-HQ companies is broad, with only limited exceptions to current taxation available. However, although the base is broader, the effective rate is lower. As a result, there may be less incentive to retain these earnings offshore.
Implications for U.S. companies
(U.S. and foreign headquartered)
- Fewer incentives to leverage the U.S. group due to lower corporate tax rate
- The interest deduction limitation stacks on top of BEAT creating a further limitation on the tax benefits of leverage for applicable taxpayers
- Payments made to unrelated parties, absent a conduit situation, should be made outside of the BEAT alternative tax. Where notional pools are viewed as bank deposits or credit support, opportunity may exist to optimize intra-group transfers while accessing group liquidity.
To identify and leverage competitive advantages, treasurers may want to review their liquidity management strategies while considering the following:
- Are there opportunities to optimize pooling arrangements involving U.S. and non-U.S.affiliates?
- To what extent are notional pools treated exclusively as credit support?
- Can interest income in the U.S. be increased by maintaining positive balances in the U.S., while retaining interest expense into CFCs?
Now could be a good time to work with your tax professional to fine-tune your treasury structure to realize tax efficiencies. J.P. Morgan has the flexible liquidity solutions to support your overall corporate goals.
Contact your J.P. Morgan Representative to learn more.
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