Sikich Series on Tax Reform – The New Landscape of U.S. International Tax under Tax Cuts and Jobs Act of 2017

On December 15, 2017, the House and Senate Conference Committee released an updated version of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”).  On December 20, 2017, Congress gave approval to the Conference Agreement and President Trump signed the new tax legislation into law on December 22, 2017.

The Tax Act represents the most significant overhaul of the US Tax Code in the last 30 years since the Tax Reform Act of 1986. It lowers tax rates for businesses and individuals and creates a new regime for taxation of international business operations.

Executive Summary

The Tax Act largely adopted Senate’s version of the tax reform with some changes.  In particular, in addition to adopting the territorial tax regime, the new rules impose a mandatory repatriation tax on the undistributed Earnings and Profits (“E&P”) of US-owned foreign corporations, eliminates the indirect Foreign Tax Credit (“FTC”), modifies current Subpart F provisions, introduces Foreign Derived Intangible Income (“FDII) and Global Intangible Low-Taxed Income (“GILTI”) concepts as well as the new “Base Erosion and Anti-Avoidance Tax” (“BEAT”).

In summary, the immediate “takeaways” of the new rules are the following:

• A 100-percent Dividend Received Deduction (“DRD”) for foreign-source dividends from specified 10-percent owned foreign corporations.
• A one-time repatriation tax on pre-effective date foreign E&P taxed at 15.5 percent on cash and cash equivalents, and 8 percent on all other E&P.
• Expansion of the stock attribution rule for purposes of determining whether a foreign corporation is treated as a CFC, thus, causing potentially more foreign corporation to have a CFC status.
• A new GILTI income inclusion for US shareholders which subjects CFC’s income in excess of certain routine returns to the effective tax rate of 10.5 percent for tax years ending before January 1, 2026, and 13.125 percent tax rate for tax years beginning after December 31, 2025.
• A new FDII provision which imposes an effective tax rate on intangible income associated with IP held in the US at the effective tax rate of 13.125 percent for tax years ending before January 1, 2026, and 16.4 percent for tax years beginning after December 31, 2025.
• A BEAT tax related to certain deductible intercompany payments to foreign related persons certain larger US taxpayers.
• Modification of rules limiting interest expense deduction under Section 163(j), in part, by making them applicable to both US-owned and foreign-owned US companies.
• Retention of an IC-DISC regime but making it less attractive for corporations and pass-through entities due to a reduced corporate tax rate and pass-through business income tax rate when a new Qualified Business Income (“QBI”) deduction is utilized under Section 199A.

Tip: Due to the switch from a worldwide tax regime to the territorial tax regime, certain closely held US pass-through entities with foreign operations may be faced with the question of whether to change the foreign branch status of their foreign operations (which is often utilized to maximize foreign tax credit benefits at the shareholder level to) the foreign corporation status in order to take advantage of the new DRD deduction. However, such decision needs to be weighed against the costs and risks of the GILTI and BEAT rules as well as the foreign branch loss recapture rules discussed in detail below, which may arise as a result of the conversion of a foreign branch to a CFC. Modeling of tax costs and risks may need to be performed by the taxpayers and their tax advisors to determine the best possible solution under the new rules.

Territorial Regime

100-percent DRD for the Foreign-Source Portion of Dividends

The Tax Act enacts new Section 245A, which would provide a 100-percent DRD for the foreign-source dividends received by a US corporate shareholder from its specified 10-percent owned foreign corporation. The foreign-source portion of dividends from such specified 10-percent owned foreign corporation would include only the portion of undistributed E&P that is not attributable to effectively connected income (“ECI”) or dividends from an 80-percent owned domestic corporation, determined on a pooling basis. The new rule applies to distributions made after 2017.

Under new Section 904(b)(5), a US shareholder’s FTC limitation is determined without regard to the foreign-source portion of dividends qualifying for the DRD.

Dividends from Passive Foreign Investment Company’s (“PFIC”) purging distributions under Section 1291(d)(2)(B) are not treated as dividends for purposes of the DRD.  Also, a DRD is disallowed for any dividend received by a US shareholder (as defined under Section 951(b)) from a CFC if the dividend is a hybrid dividend. A hybrid dividend is an amount for which a Section 245A DRD would be have been allowed and for which the foreign corporation would have received a deduction (or other tax benefit) from taxes imposed by its foreign country. In other words, the Tax Act introduces a new concept for a hybrid dividend that would deny the DRD for foreign-source dividends where the foreign corporate payor also receives a deduction for the payment.   With respect to a hybrid dividend paid and received by a CFC, the Tax Act treats the dividend as subpart F income to the recipient CFC.

There is also a minimum holding period requirement that must be satisfied in order to claim the 100-percent DRD provided by Section 245A. To qualify for the DRD, a US corporate shareholder must meet the ownership requirements for more than 365 days during the 731-day period beginning on the date that is 365 days before the date on which the share becomes ex-dividend.

Transfers of Specified 10-percent Owned Corporations

Under the Tax Act, solely for purposes of determining whether there is a loss on the sale or exchange of a specified 10-percent owned foreign corporation stock, a US corporate shareholder is required to reduce (but not below zero) the adjusted basis of its stock in the specified foreign corporation by the amount of a foreign-source dividend not subject to US tax under Section 245A DRD.

Also, if a CFC sells the stock in another CFC that results in a dividend under Section 964(e)(1) (i.e., gain on certain stock sales derived by upper-tier CFCs of lower-tier CFCs recharacterized as a dividend to the extent of the lower-tier CFC’s E&P), then (i) any foreign-source dividend is treated as Subpart F income of the selling CFC, (ii) the US shareholder is required to include its pro rata share of the Subpart F income in its gross income, and (iii) a deduction under Section 245A is allowable to the US shareholder with respect to the Subpart F income in the same manner as if it were a dividend received by the shareholder from the selling CFC.

A loss that occurs on the sale of the lower-tier CFC would reduce the E&P of the upper-tier CFC. It is expected that the regulatory guidance will clarify the mechanics of the previously taxed income (PTI) or deemed-paid FTC rules that would apply to the sale or exchange of a lower- tier CFC.

When Section 1248 applies to a sale or exchange by a domestic corporation of stock in a foreign corporation held for at least one year, the amount recharacterized as a dividend under Section 1248 is treated as a dividend to the US shareholder subject to the DRD under Section 245A.

Branch Loss Recapture Rule

A US corporation is required to recapture post-2017 branch losses when substantially all of a foreign branch’s assets (as defined in Section 367(a)(3)(C)) are transferred to a 10-percent owned foreign corporation.  The recapture amount (the transferred loss amount) is equal to the branch’s previously deducted loss amount after 2017 (and before the transfer), reduced by any taxable income of the branch in subsequent years but before the close of the transfer year and any gain related to an ‘overall foreign loss’ (OFL) recapture amount.

New Definition of Intangibles and Repeal of the Active Trade or Business Exception

The Tax Act amends Section 936(h)(3)(B) to codify and put an end to a long-lasting controversies involving the transfers of foreign goodwill and going concern value by explicitly including foreign goodwill and going concern value within the definition of “intangible property” and eliminating the active trade or business exception under Section 367(a)(3) that applies when a US person transfers certain property to a foreign corporation.

Specifically, Section 936(h)(3)(B) states that workforce in place, goodwill (both foreign and domestic), and going concern value are intangible property within the meaning of Section 936(h)(3)(B), as is the residual category of ‘any similar item,’ the value of which is not attributable to tangible property or the services of an individual.

Under the prior rules, transfers of intangible property, as defined under Section 936(h)(3)(B), by US persons to foreign corporations in certain nonrecognition transactions were subject to the deemed royalty regime under Section 367(d), while transfers of property other than Section 936(h)(3)(B) property are generally subject to immediate gain recognition under Section 367(a). The active trade or business exception under Section 367(a)(3) provides an exception to immediate gain recognition under Section 367(a). Treasury most recently addressed these issues in the regulations finalized in December 2016 (T.D. 9803).  The regulations required that outbound transfers of foreign goodwill and going concern value in a Section 351 exchange or pursuant to a Section 368(a)(1) asset reorganization were subject to gain recognition under either Section 367(a) or Section 367(d). The regulations also significantly curtailed the active trade or business exception such that it only applied to transfers of tangible property.  In Notice 2017-38, I.R.B. 2017-30, Treasury identified these regulations as a significant tax regulation that imposed an undue financial burden on US pursuant to Executive Order 13789. In October 2017, Treasury advised that it would expand the scope of the active trade or business exception to provide relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch in soon-to-be-issued proposed regulations.

The Tax Act makes the promised regulatory pronouncements moot, since the Act eliminates the active trade or business exception of Section 367(a)(3) in its entirety and explicitly includes foreign goodwill and going concern value within the definition of intangible property under Section 936(h)(3)(B).

Treatment of Deferred Foreign Income – Mandatory Income Inclusion

The Tax Act imposes the Subpart F mechanics to apply a one-time tax on the undistributed, non- previously taxed post-1986 foreign E&P of certain US-owned corporations as part of the transition to a territorial system.

Section 965 is amended to provide for the increase of the Subpart F income of a specified 10-pecent foreign corporation for the last tax year of such corporation that begins before 2018 by the corporation’s accumulated deferred foreign income. A US shareholder of the specified foreign corporation is required to include in income its pro-rata share of the increased Subpart F income. The mandatory inclusion is the higher amount as determined on measurement dates of November 2, 2017 and December 31, 2017.

As mentioned above, the accumulated deferred foreign income would include all post-1986 E&P, but excludes PTI and ECI. Dividends distributed by a specified foreign corporation during its last taxable year beginning before 2018 are disregarded.

The Tax Act allows US shareholders to deduct a portion of the increased Subpart F inclusion of the deferred foreign income to ensure that the accumulated deferred foreign income is taxed at a 15.5-percent tax rate to the extent of the US shareholder’s “aggregate foreign cash position” and an 8-percent tax rate to the extent the inclusion exceeds the aggregate cash position.  A US shareholder’s aggregate foreign cash position is the greater of (i) the aggregate of such shareholder’s pro rata share of the cash position of each of the shareholder’s specified foreign corporations determined as of the close of the last tax year of each such specified foreign corporation beginning before 2018, or (ii) the average of the amount determined as of the close of the last tax year of each such specified foreign corporation ending before November 2, 2017, plus the amount determined as of the close of the tax year preceding such tax year.

The cash position of a specified foreign corporation includes: (i) cash; (ii) net accounts receivable, and (iii) the fair market value of actively traded personal property, commercial paper, certificates of deposit, federal and state government securities, foreign currency, and certain short-term obligations.  The definition of “aggregate foreign cash position” does not exclude cash or cash equivalents held due to legal or regulatory requirements, cash held to meet working capital needs, cash sourced from US operations, or cash used to fund acquisitions.

E&P Deficit Netting

Under the Tax Act, the US shareholder’s mandatory income inclusion is reduced by a portion of the E&P deficits in specified foreign corporations. Hovering deficits (as defined under Treas. Reg. sec. 1.367(b)-7(d)(2)) may be used to offset a US shareholder’s increased Subpart F income inclusion.  Foreign income taxes associated with the hovering deficit, however, would generally not be deemed paid by the US shareholder recognizing an incremental income inclusion. The Secretary may issue guidance on how to treat foreign income taxes associated with hovering deficits.

To net the deficits, first, the US shareholder must combine its pro rata share of foreign E&P deficits in each specified foreign corporation with an E&P deficit and then allocate the aggregate deficit amount among the specified foreign corporations with positive accumulated deferred foreign income. The allocation to each specified foreign corporation with positive accumulated deferred foreign income is proportional to the US shareholder’s relative pro rata share of positive accumulated deferred foreign income in that corporation. The netting of deficits against positive E&P allows to reduce the repatriation tax to a US corporate shareholder.

Ownership Attribution Rules for Specified Foreign Corporations

The definition of specified foreign corporation for purposes of the repatriation tax mandatory inclusion includes (i) CFCs, and (ii) non-CFCs (other than PFICs) with respect to which one or more domestic corporations is a US shareholder (as defined in Section 951(b)).  Constructive stock ownership rules of Section 318(a)(3) are used to determine CFC and US shareholder status for the year of the mandatory income inclusion.

The attribution rules of Section 318(a)(3) may impact private equity or asset management funds by causing certain foreign investment portfolio companies to become specified foreign corporations subject to mandatory income inclusion

Statute of Limitations on Mandatory Inclusion Extended to 6 Years

The Tax Act extends the assessment period for tax underpayments related to the mandatory inclusion (including related deductions and credits) to six years from the date on which the tax return initially reflecting the mandatory inclusion was filed.

Installment Payments

The Tax Act permits a US shareholder to elect to pay the net tax liability resulting from the mandatory inclusion in eight annual installments. Each installment payment must be made by the due date for the tax return for the tax year, determined without regard to extensions. No interest is charged on the deferred payments, provided they are timely paid.

S corporations are also subject to the repatriation tax with the net amount flowing up to their shareholders. S corporation shareholders could elect to defer payment of the toll tax until the year in which a triggering event occurs (e.g., a termination of S status, liquidation or sale of substantially all of the assets, or any transfer of any share of stock in such S corporation). If a shareholder elects to defer the tax, the S corporation becomes jointly and severally liable for such tax if not paid.

Reduction of Deemed Paid Foreign Taxes with Respect to Mandatory Inclusion

A corporate taxpayer that is required to include in income its pro rata share of the increased Subpart F income of a specified foreign corporation would  treat the inclusion as a dividend carrying deemed paid foreign taxes under Section 902 in the year of the inclusion. The Tax Act  disallows 55.7 percent of the foreign taxes deemed paid with respect to the portion attributable to the aggregate cash position plus 77.1 percent of the foreign taxes paid with respect to the remainder of the mandatory inclusion.

Modifications to Subpart F

The Tax Act generally retains the current subpart F provisions of the Code with certain modifications discussed below.  One of the modifications relates to the stock attribution rules and definition of US shareholder.

The predecessor Section 958(b) attributes stock owned by a 50 percent or greater shareholder of a corporation, a partner of a partnership, a beneficiary or owner of a trust, or a beneficiary of an estate to the corporation, partnership, trust, or estate respectively. However, an exception in current Section 958(b)(4) prevents domestic corporations, partnerships, trusts and estates from being treated as owning stock held directly or indirectly by their foreign shareholders, partners, beneficiaries, or owners. The Tax Act repeals Section 958(b)(4) so that the foreign subsidiaries (but not the foreign parent) of foreign-parented groups with at least one controlled US subsidiary or an interest in at least one US partnership are treated as a CFC, even if they are not held under a US entity.

Also, the Tax Act modifies the definition of US shareholder to include a US person who owns 10 percent of the total vote or value of all classes of stock of a foreign corporation.  These modifications result in treating more foreign corporations as CFCs and more US persons as US shareholders. The change to the attribution rules would be made retroactive to the last year of the CFC that begins before 2018. As a result, foreign corporations may be treated as CFCs and US persons may be treated as US shareholders in 2017 even if they are not under current law.

GILTI

A US shareholder must include in income the GILTI of its CFCs. The GILTI is includible in the US shareholder’s income, and is then reduced by a 50-percent deduction in tax years beginning after December 31, 2017 and before January 1, 2026, and a 37.5-percent deduction in tax years beginning after December 31, 2025.

US Shareholder’s GILTI is determined by first calculating the aggregate “net CFC tested income,” which is the excess (if any) of the aggregate of the US shareholder’s pro rata share of the “tested income” of each of its CFCs over the aggregate of such US shareholder’s pro rata share of the “tested loss” of each of its CFCs.

The tested income of a CFC is the excess, if any, of (i) the US shareholder’s pro rata share of the gross income of the CFC without regard to ECI, subpart F income, income excluded from foreign base company income under the high-tax exception of Section 954(b)(4), dividends received from related persons, and any foreign oil and gas extraction income; over (ii) allocable deductions (including foreign taxes). The tested loss is the opposite of tested income (i.e., the excess of the allocable deductions over the gross tested income).

To finally determine GILTI, net CFC tested income is reduced by the US shareholder’s net deemed tangible income return. Net deemed tangible income return equals 10 percent of the CFCs’ aggregate Qualified Business Asset Investment (“QBAI”), reduced by interest expense taken into account in calculating the CFCs’ net CFC tested income to the extent the interest income attributable to such expense is not taken into account in determining such shareholder’s net CFC tested income. GILTI is then grossed up by 100 percent of the foreign taxes deemed paid or accrued with respect to the CFCs’ gross tested income.

FTCs are available for 80 percent of the foreign taxes imposed on the US shareholder’s pro rata share of the aggregate portion of its CFCs’ tested income included in GILTI (compared to the 100 percent of such taxes by which GILTI is grossed up). For FTC purposes: (i) GILTI is treated as a separate Section 904(d) category, meaning that FTCs deemed with respect to GILTI inclusion can only reduce such an inclusion, and (ii) Section 904(c) will prevent US shareholders from carrying excess GILTI FTCs to other tax years. A GILTI inclusion is treated as a Subpart F income inclusion under Section 951(a)(1)(A).

FDII

For tax years beginning after 2017 and before January 1, 2026, the Tax Act allows as a deduction an amount equal to 37.5 percent of a domestic corporation’s Foreign-Derived Intangible Income (“FDII”). For tax years beginning after December 31, 2025, the deduction is reduced to 21.875 percent.

FDII can possibly be viewed as opposite of GILTI in that it measures the intangible income associated with the IP held within the US rather than the IP held overseas through the CFCs.  FDII equals Deemed Intangible Income multiplied by a fraction: Foreign-Derived Deduction Eligible Income over Deduction Eligible Income. Deduction Eligible Income is all gross income of the domestic corporation except for subpart F income, GILTI, Section 904(d)(2)(D) financial services income, dividends received from CFCs, domestic oil and gas income, and foreign branch income, reduced by allocable expenses. Foreign-Derived Deduction Eligible Income is the portion of deduction eligible income that is derived in connection with property sold, leased, or licensed to, and services provided to foreign persons. Proceeds from the sale, lease, or license of property to a related foreign person are included if the related foreign person further resells the property to an unrelated foreign person, and the taxpayer establishes that the ultimate sale is for foreign use.  Income from services provided to related foreign persons are included if the taxpayer establishes that the related person does not perform substantially similar activities for US persons.  Deemed Intangible Income is a corporation’s Deduction Eligible Income, less 10 percent of QBAI.

For example, when a corporation has $200 of Deduction Eligible Income, $50 is Foreign-Derived Eligible Income, and it has $600 of QBAI, its Deemed Intangible Income would be $140 ($200 Deduction Eligible Income – [10 percent of QBAI ($600)]). Thus, the corporation’s FDII is $35 ($140 (Deemed Intangible Income) x $50 (Foreign-Derived Deduction Eligible Income) /$100 (Deduction Eligible Income)).

This deduction effectively subjects domestic corporations to tax at a reduced rate on net income derived in connection with sales to, or services performed for foreign customers.

Given the 37.5 percent FDII deduction and 50 percent GILTI deduction, the new tax rules provide a “carrot and a stick” approach. If a US-based group holds its IP offshore, any returns from exploiting that IP will be taxed at an effective rate of at least 10.5 percent (50% of 21% tax rate). If the same group holds its IP in the United States, the 37.5-percent FDII deduction for sales and services income provided to unrelated foreign persons, effectively provides an ETR of at least 13.125 percent on returns to the same IP. The small rate differential significantly decreases the advantage under current law of holding IP offshore.

Hybrid Transactions and Hybrid Entities

The Tax Act denies a US deduction for interest and royalty payments paid or accrued by a US corporation to a related foreign party pursuant to a hybrid transaction or made by, or to, a hybrid entity, to the extent that there is no income inclusion by the foreign related party under the tax laws of its country of residence or the related party is allowed a deduction with respect to such amount under the tax laws of its country of residence under new Section 267A.

Consistent with the OECD’s BEPS Action 2 (Hybrid Mismatch Arrangements), this provision eliminates tax benefits for certain hybrid debt transactions that typically allow a US corporation a deduction for interest expense (subject to any applicable interest limitations) while the related foreign corporation typically does not have an income inclusion because the payment is viewed as a dividend (rather than interest income) and subject to low or no tax under a participation exemption regime. The Secretary is authorized to issue regulations including specific items such as conduit transactions, structured transactions, and preferential tax regimes.

Interest Expense Deduction Limitation – New Section 163(j)

The Tax Act adopts new Section 163(j), which limits US net business interest expense deductions to the sum of “business interest” income, 30 percent of ATI, plus floor plan financing interest of the taxpayer for the taxable year.  The new Section 163(j) interest limitation applies to the “business interest” of any taxpayer (regardless of form) and regardless of whether the taxpayer is part of an inbound group or an outbound group.

Please note that new Section 163(j) is not limited to foreign-owned US companies (unlike the predecessor version of Section 163(j)) and applies regardless of whether the interest payment is to a foreign person or a US person. ATI is roughly equivalent to EBITDA (similar to current Section 163(j)) until January 1, 2022.  Thereafter, ATI would include depreciation and amortization. Disallowed business interest expense can be carried forward indefinitely.

The provision is effective for taxable years beginning after 2017. There are no grandfather or transition rules, which poses a question regarding the continuation of disallowed pre-2018 interest carryforwards or excess limitation carryforwards in post-2017 tax years.

BEAT

The Tax Act imposes an additional corporate tax liability on corporations (other than a RIC, REIT or S corporation) with average annual gross receipts for the three-year period ending with the preceding taxable year of at least $500 million and that make certain payments to related foreign persons for the taxable year of three percent or more of all their deductible expenses (other than the NOL deduction, the new DRD for foreign source dividends, the new deduction for FDII and the new GILTI, and certain payments for services).

The BEAT will be calculated as a difference between: (i) 10 percent (5 percent for the 2018 calendar year) of the modified taxable income (generally taxable income adding back any base eroding tax benefit plus the base erosion percentage of the NOL deduction) and (ii) the taxpayer’s regular tax liability over the sum of (i) the credit allowed under Section 38 (general business credit) for the taxable year that is properly allocable to the research credit determined under Section 41(a), plus (ii) the portion of the applicable Section 38 credits not in excess of 80 percent of the lesser of the amount of such credits or the base erosion minimum tax amount.

A base eroding payment generally is any amount paid or accrued by the taxpayer to a related foreign person that is either deductible or for acquiring property subject to depreciation or amortization and reinsurance payments.  A base erosion payment will not include any amount paid or accrued by a taxpayer for services if such services meet the services cost method described in Treas. Reg. Sec. 1.482-9.

The provision is effective for base erosion payments paid or accrued in tax years beginning after December 31, 2017. The BEAT increases to 12.5 percent and allows all credits to be applied in determining the US corporation’s regular tax liability in 2026.

The new BEAT provisions raise questions about whether certain provisions conflict with US tax treaties. This provision, which is restricted to payments made to related foreign corporations.  There is a risk that BEAT is conflicting with the principles of the business profits article of US tax treaties as an indirect tax on the business profits of the recipient of the payment, which generally may not be taxed unless the business profits are attributable to a recipient’s US permanent establishment.

Sale of Partnership Interest

In response to the recent tax court decision, in Grecian Magnesite Mining v. Comm’r, 149 T.C. 3 (Jul. 13, 2017), the Tax Act treats a foreign partner’s gain or loss from the sale or exchange of a partnership interest as ECI to the extent the partner would have had effectively connected gain or loss if the partnership had sold all of its assets in a taxable sale at fair market value and allocated the gain or loss to the foreign partner.  The new rule applies to a foreign partner that directly or indirectly owns an interest in a partnership that is engaged in a US trade or business.

A new provision added to Section 1446 (which generally requires a partnership to withhold tax on effectively connected taxable income (ECTI) allocable to a foreign partner) requires the transferee of a partnership interest to withhold 10 percent of the amount realized on the acquisition of a partnership interest if any portion of the gain is treated as ECI under the new rule unless the transferor certifies that it is not a foreign person. At the request of the transferor or transferee, the Treasury Secretary may prescribe a reduced amount of withholding tax if the Secretary determines that the reduced amount will not jeopardize the collection of tax on the amount of gain treated as ECI under the provision. If the transferee fails to withhold, the partnership is required to withhold from the transferee partner an amount equal to the amount the transferee was required to withhold.

Section 904(g)(5) Election

The Tax Act modifies Section 904(g) by allowing taxpayers to elect during an applicable taxable year (i.e., a taxable year after 2017 and before 2028) to increase the percentage of domestic taxable income to be offset by any ‘pre-2018 unused overall domestic loss’ (ODL). If the Section 904(g)(5) election is made, the pre-2018 unused ODL would be recharacterized as foreign source income for purposes of calculating a taxpayer’s FTC limitation. Further, the Act provides that any ‘pre-2018 unused ODL includes an ODL arising in a qualified taxable year prior to 2018, and the ODL has not been used before 2018. The election is available in taxable years beginning after 2017.

Inventory Sourcing

The Tax Act modifies current Section 863(b) with respect to income, profits, and gain from the sale of inventory by sourcing such amounts entirely to the place of production rather than by reference to the location of production and sales. The rule is effective for tax years beginning after 2017.  In other words, all income from the sale of inventory manufactured in the United States is considered domestic source. However, it also applies to foreign corporations selling into the United States inventory manufactured outside of the United States.

Rules for Domestic International Sales Corporations (DISCs)

The Tax Act has left the IC-DISC elections unchanged resulting in the continued tax treatment of dividend distributions at qualified dividend rates.  However, the tax rate differential between the deduction of the IC-DISC commission and the IC-DISC dividend is significantly reduced by the 21% corporate tax rate or the effective tax rate of 29% on pass-through entities resulting from the QBI deduction.

Other New Provisions

Additionally, the tax act:

• Eliminates foreign base company oil-related income as a category of foreign base company income, and eliminates the requirement that a foreign corporation must be a CFC for 30 days in order for its US shareholders to have subpart F inclusions.
• Denies favorable rates under Section 1(h)(11) on dividends paid from surrogate foreign corporations.
• Repeals Section 902. FTCs would only be available under Section 960 to the extent foreign taxes are imposed on the item of income (e.g., subpart F income) included in a US shareholder’s gross income.
• Introduces new FTC limitation rules related to foreign branch income from a qualified business unit.
• Repeals the fair market value method for allocating and apportioning interest expense under Section 864(e).

To discuss international tax reform or to see how tax reform affects your business or you as an individual, please reach out to one of your local Sikich Advisors at www.sikich.sikichdevelopment.com.