Tax Rate Modeling in the New World of US International Tax: Foreign branch versus CFC and the GILTI high-tax exclusion are two essential modeling imperatives.

• Author: Gasbarra, Mark
• Position: Controlled foreign corporations, global intangible low taxed income

The world is getting smaller and more complex. National economies are more integrated globally, but national deficits and the need for tax revenues are driving unilateral measures. The original objective of the base erosion and profit shifting (BEPS) project has been described as ensuring that profits are taxed where economic activities creating those profits are performed or where value is created. Yet there is no widespread consensus as to what value is created, how it should be measured, and how it should be taxed. Here are the key elements of the Organisation for Economic Co-operation and Development's (OECD's) policy response:

* BEPS Action 13--country-by-country reporting;

* Pillar One--new taxing rights for market jurisdictions;

* Pillar Two--agreed per-jurisdiction minimum tax, otherwise subject to a top-up tax in the parent jurisdiction; and

* the multilateral instrument (MLI)--an overlay to bilateral treaties.

Meanwhile, individual jurisdictions are imposing unilateral measures, including digital services taxes.

The US and the End of Deferral--GILTI as the Ultimate Unilateral Measure?

The 2017 Tax Cuts and Jobs Act (TCJA) pursued several overdue policy objectives designed to bring the United States' international tax system into conformity with its major trading partners, thereby ending a steady stream of corporate tax inversions. These major objectives included:

* lowering the corporate income tax rate--now twenty-one percent;

* moving toward a territorial system whereby the global intangible low-taxed income provision (GILTI) eclipses Section 245A;

* reducing complexity--though not quite; and

* providing greater tax certainty--hmm, let's see what happens next!

The TCJA's primary goal of moving toward a territorial system, where active foreign earnings are not subject to tax when repatriated, was to eliminate the lockout effect. At the time the TCJA went into effect, there were approximately two to three trillion dollars of unrepatriated foreign earnings. A major component of the TCJA was the Section 965 transition tax, which immediately taxed formerly unrepatriated profits as subpart F income at a very low effective tax rate. This transition tax resulted in previously taxed earnings and profits (PTEP) that can be repatriated free of US income tax. The end result of the TCJA's complex and highly interrelated (and sometimes circular) international tax provisions has created a situation where even the most basic corporate transactions, including repatriation planning (PTEP distributions trump Section 245A), need to be modeled to determine their US tax impact.

Two Essential Modeling Imperatives

Here we describe the whys and wherefores of two essential US international tax modeling scenarios: foreign branch versus controlled foreign corporation (CFC) and the GILTI high-tax exclusion.

FOREIGN BRANCH VERSUS CFC AND SUBPART F VERSUS GILTI

A foreign branch for US tax purposes is generally defined as a qualified business unit operating a trade or business in a foreign country and is generally subject to the income tax laws in the foreign country in which it operates. The income, deductions, losses, and credits of a foreign branch held by a US person are taken into account in calculating tax liability, which may be beneficial if the branch generates losses that can offset its owner's other income. However, the TCJA introduced two negative aspects to the tax treatment of foreign branches:

* foreign branch income is excluded from the definition of deduction eligible income (DEI) and is therefore denied the 37.5 percent foreign derived intangible income (FDII) deduction; and

* foreign branch income has a separate foreign tax credit (FTC) limitation basket, which has the impact of creating excess foreign tax credits if the blended effective tax rate of all...