Use this handy guide from the international tax experts at Freed Maxick to pinpoint your Sec 965 compliance requirements re: foreign earnings
Included in the Tax Cuts and Jobs Act of 2017, Sec. 965 requires US shareholders to pay a transition tax on certain, specified foreign earnings as if those earnings had been repatriated.
Sally P. Schreiber, J.D, writing in The Tax Advisor blog states that, “Sec. 965 applies to the last tax year of certain specified foreign corporations beginning before Jan. 1, 2018, and the amount included in income is includible in a U.S. shareholder’s year in which or with which such a specified foreign corporation’s year ends.”
Consequently, some taxpayers have discovered they are responsible for paying this transition tax when filing their 2017 tax returns.
Our team made a closer examination of who is required to comply with the Sec 965 transition tax on their April 2018 return or extension. We put our findings into a decision tree that will help you understand and discuss your obligations with your tax advisor.
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Sec 965 Tax Reform Assistance
Our international tax team is available to answer any questions about Sec 965 tax reform or other international tax compliance obligations you might have because of the new tax act.View full article
The Tax Cuts and Jobs Act signed into law by President Trump has been at the forefront of the national news since its passage in December. There are sweeping changes to the individual, business, and international taxpayers.
The Act will have an immediate and significant impact on taxpayers involved in business out of the country. For taxpayers with an ownership position in a Specified Foreign Corporations (“SFC”), the new Act requires them to pay an 8% to 15.5% “toll tax” (for individuals it could be up to 17.5%) on all deferred foreign income of these entities as of November 2 or December 31, 2017, whether a distribution has been made or not. Different tax rates are applied based on the SFC liquidity.
So how does this all work?
More About Specified Foreign Corporations
An SFC is any controlled foreign corporation (generally meaning greater than 50% US ownership) or any foreign corporation to which one or more domestic corporation(s) is a US Shareholder (generally meaning greater than 10% ownership).
This means that any US Shareholder whether a domestic corporation, partnership, individual, trust, or estate, that meets these requirements as a shareholder will be subject to this toll tax if they have deferred foreign income.
US Shareholders with interests in S Corporations that have an interest in an SFC can defer the mandatory repatriation tax as long as they make the election at the shareholder level. This election can be revoked if certain events occur.
The Basis for the New International Toll Tax: From a Worldwide to a Territorial Perspective
The Toll Tax was created by an overall change in the way international tax requirements are imposed, from a worldwide system to a modified territorial based system.
Prior to the new Act, a US person was required to pay tax on all of its income, regardless of whether it was earned in the US or in a foreign jurisdiction. However, US income tax was paid on the earnings of a foreign corporation when they were repatriated back to the US in the form of a dividend or capital gain.
This created a deferral on US income taxes for earnings of a foreign corporation between when it was earned and when it was distributed. Under this worldwide system, the US person was generally allowed a foreign tax credit to alleviate some or all of this burden.
Under the Act’s new territorial system, a US person will only pay tax on income that is earned within the United States. In most circumstance, dividends from foreign corporations will now be exempt from tax if received by a US corporation and in most other circumstances a foreign tax credit will still be available for other amounts earned in a foreign jurisdiction. In order to bridge the gap between the two international tax systems, this mandatory repatriation or “toll tax” has been put into place.
How to Calculate the Toll Tax
To calculate the “toll tax”, the US shareholders will increase their Subpart F income by the accumulated net earnings and profits of all their specified foreign entities since becoming an SFC as of December 31, 2017 or November 2, 2017, whichever is greater.
Accumulated deficits are included in this calculation to offset any accumulated earnings but not below zero. In order to arrive at the lower tax rates, 15.5% on your aggregate foreign cash position and 8% on the remainder, a deduction will be calculated at the highest corporate rate to reduce the Subpart F income included on the taxpayers’ tax return. The taxpayer is also allowed to utilize a portion of their Foreign Tax Credits to offset the mandatory repatriation tax but must also include a gross-up in its income for the amount of these taxes.
The increase in the subpart F income and correlating deduction is reported during the specified foreign entities last tax year beginning before January 1, 2018. Therefore a US Shareholder that owns a calendar year SFC will report the increase in subpart F income and relating deduction on its 2017 tax return. For fiscal year SFCs, the subpart F income and correlating deduction will be reported in its US Shareholder’s tax return in 2018.
The US Shareholder can elect to pay the “toll tax” over 8 years. The taxpayer will have to pay 8% of the “toll tax” in years one through five, 15% in year 6, 20% in year 7, and 25% in year 8. There are acceleration provision to the payment of the “toll tax” if the taxpayer fails to pay timely, in the case of a liquidation, or the sale of all of its assets.
International Tax Planning: Consequences for Your 2017 Tax Return and Obligations
Since calendar year SFCs will be reported on the US Shareholder’s 2017 tax return, taxpayers must keep this in mind if they plan on extending the due date of their 2017 tax returns. Extending the due date of filing a tax return does not extend the time to pay the tax due with the tax return.
Since one of the accelerated provisions is failure to pay timely, the taxpayer must ensure that they have timely paid 8% of their “toll tax” by the original date of the tax return, not the extended date. If they do not have their tax fully paid in it could cause the taxpayer to have to pay the entirety of the “toll tax” immediately instead of over 8 years.
Connect with a Freed Maxick International Tax Accountant
If you have any questions or concerns about how this mandatory repatriation tax may impact you please reach out to the International Tax Services Team at Freed Maxick for a complementary InternationalTax Situation Review.
If you have any questions or concerns, call the Freed Maxick international tax accountants at 716-847-2651 to discuss your tax situation or start the process of setting an appointment by clicking here and submitting your contact information.
For more insight, observations and guidance on the new Tax Cuts and Jobs Act, visit our Tax Reform webpage.View full article
Does your company have intercompany transactions? Do the transactions cross over multiple foreign local jurisdictions?
If you answered yes to either of these questions, you may be at risk for a transfer pricing adjustment from the IRS, foreign jurisdiction, or even a state jurisdiction. In addition, with the current OECD base erosion and profit shifting (BEPS) action items coming into the spotlight, transfer pricing should be at the forefront of all companies. Each entity should be analyzing their intercompany transactions to ensure they can be supported as arm's length transactions. This analysis can provide support that the taxpayer is not intentionally shifting profits into a lower tax jurisdiction at a rate that is unreasonable, and also provide excellent tax planning opportunities.
Intercompany transactions cover many different types of transactions. Some examples are as follows:
- Tangible transactions from a manufacturer to a related-party distributor
- Intangible transactions of know-how from one related-party to another
- Fees for services of one related-party to another
- Management fees for centralized corporate offices for services such as admin, HR, and finance
The key phrase to all transfer pricing is “arm's length.” Arm's length means that the transaction should be executed as if it were being done with a third-party. There should be no advantage to the transaction due to the intercompany nature. According to the U.S. and many foreign jurisdictions regulations, each intercompany transaction must support that their transactions are at arm’s length and the company is not trying to erroneously shift profits to lower tax jurisdictions.
Do you have support that shows the intercompany transactions are at arm’s length? Do you have intercompany agreements in place that are followed for these intercompany transactions?
If you answered no to either of these questions, you may not have the adequate support that the IRS deems necessary according to the transfer pricing regulations in Section 482. These documents are meant to be contemporaneous in nature, which means that they should exist as the intercompany transactions exist. As part of the increasing scrutiny on transfer pricing, a company that faces an IRS audit will most likely be asked for their contemporaneous transfer pricing documentation.
The documentation required by the IRS is known as the following 10 principal documents:
1. Overview of your company’s business
2. Description of your company’s organizational structure
3. Any document explicitly required by the §482 regulations
4. Description of the method selected and the reason why the method was selected
5. Description of the alternative methods considered and rejected
6. Description of the controlled transactions and internal data used to analyze them
7. Description of the comparables used, how comparability was evaluated, and what adjustments were made
8. Explanation of the economic analysis and projections relied on
9. Summary of any relevant data that your company obtains after the end of the tax year and before filing a tax return
10. General index of the principal and background documents, and a description of your record-keeping system
While these are the documents the IRS requests, companies should continue to be cognizant of the level of risk in their intercompany transactions and whether or not an entire transfer pricing study is deemed necessary according to the company’s appropriate level of risk. A more practical approach may be available if the company decides that the risk level of their transactions is minor.
What Should Companies Do?
With transfer pricing being a hot topic in the tax world, companies should have documentation on the intercompany transactions that cross over multiple jurisdictions. Taxpayers should be able to support that their intercompany transactions are being transacted at an arm's length standard to the IRS if an audit were to occur. This documentation is important as protection for the company should an audit occur and could be used as a tax planning tool to be able to reasonably, within an arm's length standard, shift profits to a lower tax jurisdiction. For expert guidance in compiling and reviewing your documentation, please contact us.View full article