Are You a US Shareholder Who Owns 10% or More of a Foreign Corporation? If So, This Bill’s Aimed at You…

You may or may not be following the US tax reform legislation that has dramatically worked its way through the House and the Senate.  A primary reason for the tax reform is to make the US a more tax-friendly environment for corporations.  Many provisions are geared toward this end, and much has been touted about changing corporate taxation.  The provision we are talking about here changes the US taxation of earnings in foreign subsidiaries.  Currently, US shareholders invested in foreign operating corporations are taxed on dividends their foreign corporations pay them (even though their foreign subsidiaries are probably already paying tax in the foreign country of incorporation).  The new provisions would reduce or eliminate the US tax on dividends those foreign subsidiaries pay their US shareholder(s).

As usual, the means to accomplish this end are complicated.  In order to transition between the two systems, the proposed legislation triggers tax on foreign earnings that have not been previously taxed by the US.  The tax on these foreign earnings would be at a special reduced rate (as yet to be determined, but probably somewhere between 7% and 15%).  The deadline to pay the tax is also to be determined, but it’s likely there will be an election available to spread the payments out over several years (the current draft is proposing 8 years).

This is all pretty wonky…so what does it mean?

Let’s talk in examples.  Say, for example, that you are a US citizen who has been living in Canada since you were 18 months old.  You grew up in Canada, got married in Canada, and your home is in Canada.  You own a plumbing business, which you have incorporated in Canada.  The customers you serve are only in Canada, the income your business generates is Canadian only, and your corporation pays Canadian income tax.

You and your Canadian spouse each own 50% of the company.  You are a US citizen so you have been diligently filing your US returns and reporting your foreign assets as is required.  Your US returns include extensive information about your corporation, but you don’t have to pay US tax on any of the corporation’s earnings unless the corporation pays you dividends.  The corporation doesn’t pay out all of its earnings as dividends each year because it’s growing and reinvesting in itself.  All is hunky dory.

But….

Along comes this new provision that says that the US wants to reduce the tax you pay on the dividends that your corporation pays you.  Great right?  However, to get you to that point, the US needs a clean slate on the undistributed earnings that have accumulated in your corporation.  To do that, the US is going to tax those earnings that haven’t already been paid out in dividends.  It doesn’t matter if those earnings haven’t been paid to you….. the US is going to tax them.  Period.

Why?

Well, the US wants to pull cash back into its borders.  It’s trying to trigger growth and jobs and other things that require cash funding.  So, the theory is if US shareholders are going to be taxed on the earnings anyway….. hopefully they’ll pull dividends out of their foreign companies and bring that cash back to the US.  Makes sense when you’re thinking about Apple or Google or another big multinational company headquartered in the US.  Doesn’t make as much sense when you’re thinking about a US citizen living and working abroad with minimal ties to the US.

Unfortunately, the details are still to be determined and we won’t know what they are until the House and Senate reconcile the two bills that have passed.  They’ve announced that they will start the reconciliation process on Wednesday the 13.  President Trump wants a bill on his desk by Christmas, so they are pushing hard to do that.  Will they?  It’s hard to say –but it’s likely a final bill will be ready for House and Senate vote soon.

So, what can you do?

Well…. unfortunately, probably not much.  In the proposed legislation, the testing date for undistributed earnings is as of a date earlier in 2017.  So you may already caught in the web.  The critical factor will be calculating your company’s Earnings & Profits, which is a US tax concept and it is what the tax will be based upon.

We are here to help you with this calculation and with the filings in general.  As we learn more about it, we’ll share that information with you.

They say in the long run it will reduce US taxation of foreign company earnings from operations, so there is that silver lining.

Contributed by Dana Cade, senior manager and Erin Stockwell, shareholder

© 2017

Read more from Anderson ZurMuehlen Blog