The TCJA imposes a transition tax that requires a deemed repatriation of accumulated and untaxed post-1986 foreign earnings and profits (E&P) of specified foreign corporations (SFC).

This also provides for a partial deemed dividends received deduction so that offshore earnings invested in cash or cash equivalents are taxed at an effective tax rate of 15.5%.

Cash equivalent assets include certain net accounts receivable, personal property actively traded on an established financial market, commercial paper, certificates of deposit, securities of the Federal government and of any US State or foreign government, any foreign currency, any obligation with a term of less than one year (“short-term obligation”), etc.

Residual earnings held in illiquid assets, meanwhile, are taxed at an effective tax rate of 8%.

Depending on the applicable income tax bracket, the effective tax rates can be slightly higher for US taxpayers other than C corporations because they get the same US dollar partial dividends received deduction. However, their post-deduction income is subject to a marginal tax rate of 39.6% compared to 35% for corporations. This results in maximum effective tax rates of around 17.5% on cash or cash equivalents and 9.1% on other assets—not considering net investment income tax.

The effective rate is increased for any company that inverts within the next 10 years. The tax is assessed based on the higher of accumulated E&P as of November 2, 2017, or December 31, 2017. The new rules allow for the netting of positive earnings of one SFC against the deficit of others.

The November 2, 2017, measurement date is intended to prevent manipulations of the accumulated E&P amount by taxpayers between November 2, 2017, when the concept was publicly introduced by the United States Congress, and year-end.

SFCs, or specified foreign corporations, include controlled foreign corporations (CFC) and foreign corporations that are at least 10% owned by a US corporation. A foreign corporation is a CFC if US shareholders own more than 50% of the total combined voting power of its stock or more than 50% of the stock’s total value. A US shareholder in this context is defined as a US person owning at least 10% or more of the total combined voting power—or value under the TCJA—of the corporate stock.

Foreign tax credits may reduce or eliminate the transition tax, subject to general limitations and a foreign tax credit haircut corresponding to the exclusion of offshore earnings under the partial dividends received deduction. Ten percent or greater corporate shareholders may claim a foreign tax credit for foreign taxes paid or accrued by the foreign subsidiary when a dividend is paid or deemed paid.

Taxpayers may elect to pay the resulting liability in back-loaded annual installments over eight years. Alternatively, shareholders of S corporation may elect to defer the tax until a triggering event occurs. If a triggering event occurs, owners of S corporations will still have the opportunity to pay the tax over eight years, should they elect to do so.

Triggering events include the following:

• Change in the status of the corporation as a S corporation
• Sale of substantially all corporate assets
• Termination of the company or end of business
• Similar events

Taxpayers may use existing NOLs to offset the transition tax; however, in many cases it may be beneficial to make an election to use the NOLs against profit that’s subject to the higher standard tax rates rather than the reduced transition tax rates.

Gathering the information and working through the computations will take time, so there’s value in starting early—the first transition tax payments will be due April 15, 2018, for calendar-year taxpayers with calendar year SFCs.

There are a number of key elements to document for purposes of the transition tax. In particular, taxpayers should do the following:

• Prepare an inventory of entities subject to the transition tax
• Calculate the aggregated offshore E&P as of November 2, 2017, and December 31, 2017, subject to the transition tax
• Determine how much of the E&P relates to foreign cash positions taxed at the 15.5% rate and the residual E&P taxed at 8%
• Substantiate the creditable foreign taxes for taxpayers who may be eligible to claim a foreign tax credit with respect to the transition tax

As another step against US income stripping, the TCJA imposes a US tax on global intangible low-taxed income (GILTI), effective for tax years beginning after December 31, 2017.

Under the new GILTI rules, a US shareholder of a CFC is required to include in gross income for the current tax year its GILTI, regardless of whether it was actually distributed. In effect, the tax on GILTI is intended to function as a minimum tax on taxpayers who pay foreign taxes on their foreign intangible income at a rate that the United States deems to be too low.

The name of the tax appears to target intangible income of technology companies with intellectual property. However, the GILTI tax will have a much broader reach and apply to income far beyond mere profit from intellectual property; it’s computed as the income that’s in excess of a statutorily assumed routine return of 10% on the adjusted (or depreciated) basis of the CFC’s active foreign tangible business assets.

This will place high-profit companies with what might be considered excess profit—from foreign production facilities, equipment, and inventory—within the scope of GILTI even in cases where they don’t hold any intangibles.

A US shareholder computes GILTI in the aggregate for all CFCs, which means that CFCs with losses can offset CFCs with income.

GILTI may incentivize US taxpayers to “stuff” CFCs with business assets to increase the routine return amount and decrease the impact of GILTI. This probably wasn’t the intention of the TCJA, which aims to grow production in the United States. A CFC making an acquisition of another corporation may elect to step-up the tax basis of the assets or buy assets instead of stock. Also, since certain interest expense can be deducted from GILTI, there’s an incentive to leverage the asset purchase.

C corporations (other than regulated investment companies or real estate investment trusts) may take a deduction equal to 50% (37.5% for taxable years beginning after December 31, 2025) of the GILTI inclusion. This results in an effective tax rate of 10.5% based on the new standard 21% corporate tax rate. This preferential tax rate on intangible income is intended to increase the United States’ competitiveness with other tax-favored foreign jurisdictions with low statutory tax rates, at least with regards to corporate taxpayers.

Further, C corporations may claim a foreign tax credit for the foreign income tax paid or accrued by the CFC, but it’s limited to 80% of the foreign tax and any excess credits aren’t allowed to be carried back or forward. Essentially, the credit will eliminate the tax on GILTI if foreign tax of 13.125% or more is paid.

All other 10% shareholders that are not C corporations aren’t eligible to take the 50% GILTI deduction; and they can’t take a foreign tax credit as well. As a result, they may be taxed on GILTI up to the maximum US tax rate on individuals of 37%, a significant disadvantage compared to C corporations owning offshore CFCs.

For taxable years beginning after December 31, 2017, but on or before December 31, 2025, a US C corporation is allowed a deduction equal to 37.5% (21.875% for taxable years beginning after December 31, 2025) of its foreign-derived intangible income (FDII). This is a category of income that isn’t specifically traced to intangible assets; rather, the TCJA assumes a 10% routine rate of return on depreciable business assets and the residual income is the income deemed to be generated by intangibles. To the extent it’s received from foreign persons, it generally qualifies for the FDII deduction.

Under the new corporate tax rate of 21%—and as a result of the deductions—the effective tax rate on FDII is 13.125%, which will increase starting 2026.

The FDII deduction will be an incentive for C Corporations in the service or technology industry or any other industry that doesn’t have significant amounts of fixed assets.

Similar to inbound investments into the United States discussed in the first section of this article, the minimum BEAT tax will also have an impact on how US multinational corporations structure their offshore investments downstream.

Base erosion payments to foreign subsidiaries should stay below the 3% base erosion percentage (or 2% in case of banks or registered security dealers) in order to avoid the application of BEAT.

While taxes aren’t the only factor to consider when choosing a business structure, the US tax reform will require multinational companies, US- or foreign-owned, to take a fresh look at their current structure.

Some taxpayers currently in a pass-through structure with an international footprint may consider setting up their business as a C corporation given the many tax benefits granted to them under the TCJA, including:

• Reduced 21% corporate income tax rate
• Dividends received deduction on foreign source dividends
• GILTI and FDII deductions

However, there are drawbacks to C Corporations. Most significantly—unlike pass-through entities—they’re subject to two layers of US taxation—one at the corporate level and one at the shareholder level.

When considering the overall options in response to the new laws, taxpayers need to be aware that certain mechanics for restructuring multinational groups may not be available anymore since other provisions of the TCJA include anti-inversion rules or limit the ability of taxpayers to move appreciated business assets offshore out of the US tax system without triggering a toll charge on unrealized built-in gains.