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2018 Cross-Border Tax and Legal Risk Trends

Part 1: U.S. Tax Reform - Incentives for U.S. Foreign Investment?


A Switch to a Territorial Tax System - Encouraging Outbound U.S. Investment

The Tax Cuts and Jobs Act (passed in December, 2017) replaces the graduated tax rates for corporations (prior maximum rate of 35 percent) with a 21 percent corporate tax rate for earnings after 2017

The U.S. had been virtually alone in taxing worldwide income

  • All income for U.S. domestic corporations - whether earned in the US or abroad - had been subject to U.S. tax

  • Foreign income earned by a foreign affiliate of a U.S. corporation generally had not been subject to U.S. tax until the income had been distributed as a dividend to the U.S. (apart from types of passive income that were taxable even if not distributed)

  • That tax was at the formerly high U.S. corporate rates. Apple and others have accumulated massive amounts outside of the U.S. - so as not to be subject to such U.S. tax on its return

A new U.S. territorial system - now more attractive for a U.S. company to buy or invest in non-U.S. subsidiaries and joint ventures

  • U.S. corporations (though not LLCs) will typically be able to deduct the full amount of any dividend paid to it by a non-U.S. affiliate that is at least 10% owned by the U.S. corporation

  • That means that a U.S. client that owns a 10% or greater interest in a foreign company, including as a joint venture, and brings back earnings from its Indian, Chinese or other foreign affiliate, can deduct the full amount of the dividend from its U.S. taxable income before paying any taxes on the income

  • Apart from U.S. corporations owning foreign subsidiaries, the new provisions may also impact private equity funds that directly or indirectly own 10 percent of a foreign portfolio company

  • Note that certain types of passive and other income are subject to an anti-deferral rule (under new "GILTI" and prior "Subpart F" rules) that could subject some types of income to a tax whether or not distributed as a dividend

Yet, U.S. corporations are required to include in 2017 income their share of accumulated post-1986 foreign income

  • This is significant - a U.S. company's accumulated post-1986 foreign income must now be taxed as part of 2017 tax returns

  • But at reduced tax rates - 15.5% if the foreign amounts had been put into non-U.S. cash or cash equivalents and only 8% if the earnings had been reinvested in the corporation's business (such as in non-U.S. property, plants and equipment), and the tax may be paid over 8 years

The New York Times reported in mid January that Apple is repatriating the vast majority of its $252 billion of cash held outside the U.S. and is making a one-time tax payment of $38 billion on these amounts. That tax is mandatory and applies whether or not the cash is actually repatriated, but Apple is choosing to repatriate most of it

Thus, starting in 2018, most foreign earnings may be brought back to the U.S. as a dividend at zero tax

  • This has the effect of encouraging U.S. foreign investment, including through M&A, since the foreign income is not "trapped" abroad but may be used by the U.S. corporation to distribute to shareholders, reinvest in the U.S. or for other purposes
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