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TCJA Changes Incentives for Corporate Behavior

Chris Gaetano
Published Date:
May 8, 2018
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The Tax Cuts and Jobs Act presents domestic and international corporations with a wave of new opportunities—and challenges—as the law’s changes call old tactics into question while bringing new ones to the fore.

Take, for instance, the popular tax avoidance maneuver of setting up a foreign subsidiary in a low-tax country like Ireland, transferring intellectual property (IP) to the new subsidiary, and then licensing it to a U.S. parent company. This maneuver is now less appealing, according to Michael J. Gargiulo, a partner at Meridion Consulting LLP and a member of the Society’s C Corporations Committee. For one thing, the new law replaced the graduated corporate tax with a flat 21 percent rate. It also introduced three new tax concepts—the base erosion and anti-abuse tax (BEAT), the global intangible low tax income (GILTI), and the foreign derived intangibles income (FDII) benefit—to make the use of foreign subsidiaries less remunerative. The BEAT and GILTI essentially penalize the use of foreign subsidiaries to house IP, and the FDII benefit rewards domestic companies that move intangible assets such as IP back to the United States.

“In the past, there was always planning around putting company IP offshore, because of the benefit of the lower rates,” Gargiulo said;  as a result of these new provisions, “that has become less attractive now.”

Ronald Carlen, a partner at Citrin Cooperman and the chair of the International Taxation Committee, said that the new tax law also changes conventional wisdom on how companies should be structured internationally. Companies with branch structures will now be at a disadvantage compared to those that create separate foreign corporate entities. Under the new law, companies can take a 100 percent deduction for the foreign-sourced portion of any dividend from a U.S. corporation with a 10 percent foreign ownership.

This provision effectively switches the United States from a global taxation system to a territorial one. Under the previous system, the United States would tax a company’s global income, both domestically and foreign sourced. Under a territorial system, a company is taxed only on domestic income. Thus, U.S. corporations will pay far less in taxes and stand on a more equal footing with companies in other countries, most of which already use the territorial system.

“Any U.S. entity that has operations overseas, in a branch as opposed to a separate incorporated entity, needs to incorporate, because 100 percent of what is generated in the branch needs to be in the U.S. tax return,” Carlen said. “Granted, it’s a 21 percent rate, but there’s no deferral, no play on that. If it’s now a foreign subsidiary, they get the exemption, and there will never be a U.S. tax on it. So we went from 35 percent to, basically, zero percent.”

While the switch from a worldwide to a territorial tax system is advantageous for multinational businesses, Carlen said it does present a challenge from a planning perspective. He said that this switch means that tax planning for multinational corporations must now be done on a country-by-country basis. This means that “we can’t go by what we’re used to here.

“In the past, to the extent you were dividing everything up, if the U.S. rate equaled or exceeded, which it likely did, the foreign rate, you would get a full credit, and you really didn’t care so much what the foreign tax was because for so many countries it was lower than our rate. Now if you’re bringing it back to a zero rate effectively, a dividend exception system, the overall effective rate will be [more dependent on] what you plan to do in the foreign country.”

Carlen said that firms will likely need to depend on their international affiliates even more for assistance and resources in helping clients do business in other countries.
Pros and cons of converting to a C corporation
Given all the benefits, why not become a C corporation and take advantage of the lowered rate plus all the new deductions and exemptions? This is a question that Bradley H. Smallberg, a tax partner at Schissel Smallberg and chair of the Partnerships and LLCs Committee, has heard from S corporation clients in service-based industries that do not qualify for the 20 percent deduction.

Jack Vivinetto, the CFO of Sugar Foods Corporation and a member of the CFO Committee, said that he predicts that many S corporations will mull such a change. While C corporations definitely got a better tax rate deal in the new law than S corporations and pass-through entities, he said, it’s still not a simple decision.

“The decision to change to a C corporation is much broader than simply comparing rates,” he said. “In particular, will profits be retained or distributed?”

The process of becoming a C corporation is often much more complicated than clients think, and carries with it the potential for unintended consequences, said Ronald B. Hegt, a tax partner at Citrin Cooperman and a member of the Taxation of Individuals Committee.

“The basic answer is that, ‘OK, you’ve put your business in a C corporation, and [it pays] a 21 percent tax,’” he said. “How are you getting your money out of the corporation? You’ll have to take it out as a dividend and pay a second tax on the earnings. These are things that are sort of turning what we have done for decades on its head and making us rethink what we’re going to do for 2018.”

Attorney Jerald David August, a tax partner at Kostelanetz & Fink, LLP, who spoke at the Foundation for Accounting Education conference "Impact of the New Tax Law: A Sid Kess Workshop" on Jan. 31, also pointed out that while “clients love the idea of 21 percent,” C corporations still have to contend with the accumulated earnings tax and the personal holding company tax, provisions that carry over under the new tax law.  

SEC filings
Calculating and reporting the tax impact of the new law in mandatory filings with the Securities and Exchange Commission (SEC) is another tricky area for companies and their CPAs. Since the bill passed in late December, there’s little time to adjust—and Gargiulo said this has led to a good deal of stress on CPAs with public company clients.

“They have an obligation to report it, but since it’s such a tight timeline, a lot of multinationals have gone to the SEC and said, ‘This is kind of crazy since everything is brand new and most companies file by March with their statements,’” he said.

Jeffrey F. Allen, a partner at Eisner Amper and a member of the C Corporations Committee, reported similar struggles with his own clients.

“Calendar-year companies, which [are] most U.S. companies, certainly have huge reporting responsibilities effective as of Dec. 31, 2017. For them, trying to figure out the impact of all the law, like the rate cut and all these international provisions, and how do we record this and how do we adjust our deferred taxes, is the most immediate need … trying to figure out what it means for each taxpayer,” he said.

Allen pointed out that it will be difficult to make these determinations without further IRS guidance. “Right now, the information is somewhat lacking,” he said.

Allen noted that the 1986 reforms took much longer for Congress to pass; by the time they were signed into law, there had already been a wealth of analysis so firms could more easily determine the impact. With this change, there are many more open questions that CPAs will, absent IRS guidance, need to work through. “But you’ve got a client [for whom] you’ve got to do something [now],” he said. “So you’ve got to impact those financials now, and analyze that and get the information.”

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