Anti-base erosion measures in the draft tax reform bill released last Thursday include a provision that effectively imposes a foreign minimum tax on 10% U.S. shareholders of controlled foreign corporations (“CFCs”) to the extent the CFCs are treated as having earned high net income. The minimum tax would be at a 10% rate for U.S. corporations. Because the determination of a “high return” is based on a percentage of the CFC’s tax basis in tangible assets, foreign subsidiaries that have fully depreciated tangible property or intangible property may have “high returns” with only modest profits. The stated purpose of this provision is to eliminate the incentive to shift profits from the U.S. to low-tax jurisdictions, including by moving intangibles offshore.
Basic Framework. Under the bill, each 10% U.S. shareholder of a CFC is required to include currently in its income 50% of the shareholder’s “foreign high return amount” in the applicable tax year – for a corporate shareholder, this represents a 10% U.S. tax on the foreign high return amount. The foreign high return is generally the excess of the shareholder’s “net CFC tested income” over a high return threshold. Corporate 10% U.S. shareholders will be entitled to a tax credit for 80% of the foreign taxes paid by CFCs with respect to that excess income. A separate provision of the bill would expand the CFC and 10% U.S. shareholder categories (including for purposes of the foreign minimum tax) beginning January 1, 2018 by changing the attribution rules to require downward attribution from non-U.S. persons.
Net CFC Tested Income. Unlike subpart F income, which is determined separately for each CFC, net CFC tested income is an aggregate net amount determined by reference to the shareholder’s pro rata share of the income and losses of all CFCs in which it is treated as having a 10% or greater interest.
The “tested income” (or loss) of a CFC is generally net income (or loss) other than income that is effectively connected with a U.S. trade or business, subpart F income, certain items expressly excluded from subpart F income, dividends received from related persons and commodities income.
The bill includes a separate provision that would impose a 20% excise tax on certain payments from a U.S. corporation to its non-U.S. corporate affiliates, which will be the subject of a future post. Tested income does not exclude payments subject to this 20% excise tax (i.e., the gross amount of such payments could again be subject to U.S. tax under the foreign minimum tax provision). To avoid double taxation under these regimes, a taxpayer would generally need to elect to treat such payments as effectively connected to a U.S. trade or business under the new excise tax provisions.
High Return Threshold. The threshold for determining a “high return” is an amount that generally represents a return of 7% plus the Federal short-term rate (which the drafters describe as a “routine return”) on the aggregate of the shareholder’s pro rata share of the “qualified business asset investment” of its CFCs. The “qualified business asset investment” of a CFC is its aggregate adjusted basis in depreciable tangible property used in a trade or business. The high return threshold is reduced (but not below zero) by the amount of interest expense taken into account in determining the shareholder’s net CFC tested income.
Because the high return threshold is determined by reference to the applicable CFCs’ bases in tangible assets, the high return threshold may be very low or zero for CFCs whose assets consist principally of fully depreciated tangible property or intangible property.
Foreign Tax Credits. Corporate 10% U.S. shareholders are entitled to a deemed paid credit equal to 80% of foreign taxes allocable to the shareholder’s foreign high return amount.
Such foreign taxes would only be creditable against income arising under this provision, and any excess foreign tax credits would not be permitted to be carried back or forward. As a result, temporary differences between U.S. and foreign tax bases could effectively result in the loss of credits for foreign taxes that economically relate to income taxed in the U.S. under this provision.