Let’s talk a little more about one of the consequences of Trump Tax Reform that I mentioned in the first part of this series, to wit—a mandatory repatriation tax that is now included in the new Tax Cuts and Jobs Act. Remember, one little change in the new Act—“Section 958(b) is amended by striking paragraph (4)”—causes a bunch of foreign entities to now be considered “controlled foreign corporations” if the foreign parent of those entities owns a US subsidiary (please read the first part of this series to understand why). This change means that the US subsidiary will now be responsible for filing with the IRS onerous forms 5471s for ALL its non-US brothers and sisters that are now considered “controlled foreign corporations.”
This change also means that a “US shareholder” of any of the foreign entities may now have to PAY TAX on earnings of the “new” controlled foreign corporations. Let me repeat that, a “US shareholder” of a foreign corporation before this change would not have had to pay any tax on the earnings of the foreign corporation and its subsidiaries before this change in the law if the foreign corporation and its subsidiaries were not already considered “controlled foreign corporations.” But now that the law creates a bunch of “new” controlled foreign corporations (read my first article in this series), any “US shareholder” of the controlled foreign corporations must pay two “new” taxes: 1. A mandatory repatriation tax payable on all earnings of the controlled foreign corporation earned in 2017, and 2. Tax on all “subpart F income” earned by the controlled foreign corporations starting January 1, 2018 and beyond.
A “US shareholder” is a US person who holds 10% or more of the stock of a foreign corporation. Remember, a foreign corporation is only a “controlled foreign corporation” if more than 50% of its stock is held or controlled by US shareholders. The reason this new law is so crazy is that it creates a fiction that the foreign entities are owned 100% by their US subsidiary/brother corporation. Since the US subsidiary is considered to own all the stock owned by its foreign parent, all the foreign entities owned by the foreign parent are considered to be owned by the US subsidiary and thus considered a “controlled foreign corporation” if that stock ownership is over 50%. So the only reason that a “US shareholder” must now pay these two taxes is because the foreign entities are now considered “controlled foreign corporations.”
Lets revisit the example from my first article. Non-US corporation FCo holds all the stock of its US subsidiary USCo. FCo also holds all the stock of its two non-US corporate subsidiaries FSub1 and FSub2. FCo has only one shareholder who is a US person, John Mustang. Mr. Mustang holds 11% of the stock of FCo.
Before the change in the law, neither FCo nor any of its non-US subsidiaries were considered “controlled foreign corporations,” nor was John Mustang required to pay tax on earnings of FCo or any of its non-US subsidiaries. After the change in the law FSub1 and FSub2 are considered controlled foreign corporations—the stock of FSub1 and FSub2 is attributed to USCo, in the jargon of tax code section 318. After the change in the law John Mustang must now pay: 1. the mandatory repatriation tax on earnings of FSub1 and FSub2 earned in 2017, and 2. tax on all “subpart F income” of FSub1 and FSub2 starting on January 1, 2018. Note that FCo itself is NOT considered a controlled foreign corporation in this scenario. “Why?” you ask? Because the quirky attribution rules don’t require a parent to attribute its own stock to its own subsidiary. That is the only good news in this fiasco.
The Tax Cuts and Jobs Act now imposes a mandatory repatriation tax of either 15.5% or 8%(the tax rate and its calculation is complex and beyond the scope of this article) on the earnings of FSub1 and FSub2 in 2017; the tax must be paid by John Mustang. In other words, because FSub1 and FSub2 are now considered “controlled foreign corporations,” John Mustang must pay this new mandatory repatriation tax.
The purpose of the mandatory repatriation tax is to incentivize US companies to bring back an estimated USD $3 Trillion in profits that is parked overseas in bank accounts in Luxembourg, Ireland, Malta, etc.(Please read my earlier articles starting with “The Trump Tax Plan is Bad for Europe…and other Truisms”). For that reason Apple just announced last week that it would be “bringing back” to the United States USD $250 billion in profits that Apple has parked outside the US—and announced that it would be paying a tax of USD $36 billion on that mandatory repatriation.
Remember that Apple’s entire USD $250 billion was taxed by European tax havens at very low rates over the years, so Apple escaped paying the full US 35% corporate tax rate on those profits at the time. Now the mandatory repatriation tax imposes a one-time tax of 15.5% or 8% on those profits, much less than the 35% it would have had to pay on those profits and even less than the new 21% US corporate income tax rate. Good for Apple! Bad for John Mustang.