The Tax Cuts and Jobs Act of 2017 (the Act) brought sweeping changes to the international tax landscape, including the transfer pricing arena. Intangible property is at the core of many of these changes. The impact of the new provisions generally furthers the trend of transfer pricing becoming more prescriptive, placing additional strain on and creating potential contradictions with the arm’s length standard, and may have the unintended consequence of creating double-taxation for U.S. Multinationals (MNCs) – situations in which U.S. MNCs may be taxed more than once on the same income. So while the Act lowered the headline tax rate to 21 percent, it also broadened the base that will be taxed, with the result that the Act’s effect on each company’s tax bill will be determined by the company’s specific facts and circumstances.
Intangible Property Transfers
Importantly, the Act expands the definition of intangible property for outbound transfers of intangibles. This change is consistent with prior IRS efforts to prohibit U.S. multinationals from transferring intangibles tax-free. Previously, U.S. MNCs would take the position that the definition of "intangible property" under Section 936(h)(3)(B) did not include goodwill, going concern value, workforce in place, or any other item the value or potential value of which is not attributable to tangible property or the services of an individual. The Act eliminates this position.
As a result, certain transfers of such assets by a U.S. person to a foreign corporation will be subject to Treas. Reg. Section 367(d) and also Section 482.
The Act also explicitly requires Treasury to issue regulations that would, for purposes of applying the outbound transfer rules under Section 367(d) or the transfer pricing rules under Section 482, require the valuation of intangible property on an aggregate basis or, in a nod to the U.S. cost sharing regulations (Treas. Reg. Section 1.482-7), on the basis of realistically available alternatives to such transfers.
These features of the Act will likely result in a broadening of the tax base. But at the same time, the Act reduced the tax rate, meaning that the final impact on a company’s tax bill could go either way. The following table illustrates this.
In the example above, an outbound intangible transfer might have a higher taxable value under the new law due to the inability to transfer some intangible property tax-free. However, depending on the overall taxable value, the tax cost to move the entire, more broadly defined bundle of intangible property might be significantly lower than the cost to transfer the “old law” intangible property bundle.
Foreign Derived Intangible Income (FDII)
The Act’s FDII provision is intended to encourage U.S. MNCs to maintain their ownership of intangible property in the United States. The Act specifies a 13.125 percent corporate tax on U.S. taxable income related to “foreign income earned from intangibles”. FDII defines intangible income as income in excess of 10 percent of U.S. depreciable asset tax bases.
This is the U.S.’s attempt at mimicking the incentives of a “patent-box” regime – an incentive used by many foreign countries (e.g. the UK and the Netherlands) to reward companies for maintaining ownership of intangible property in their jurisdictions. FDII is only available to U.S. C corporations – non-C Corporation taxpayers specifically do not benefit from this regime.
The computations to determine FDII are fairly complex. These calculations meld together many new and legacy international tax concepts to arrive at FDII. For instance, the computations include application of Treas. Reg. Section 861-8 Allocation and Expense Apportionment, the new “GILTI” Provisions (see next section) and Subpart F.
Global Intangible Low-Taxed Income (GILTI)
In conjunction with FDII, the Act’s GILTI provisions are intended to discourage U.S. MNCs from owning intangible property offshore. GILTI is defined as current income of a controlled foreign corporation (CFC) in excess of a 10 percent return on the CFC’s depreciable assets (as defined in Section 167) less certain adjustments. This income is taxed in the U.S. on a current basis. The tax results under GILTI have significantly different tax implications for C corporations versus pass through entities. C Corporations will be taxed at 10.5 percent and can claim foreign tax credit for 80 percent of the deemed paid foreign taxes of the CFC related to the GILTI income. If a CFC has GILTI income and an effective tax rate of at least 13.125 percent, the corporate taxpayer will not pay any tax on GILTI. Other taxpayers will pay as much as 37 percent tax on GILTI.
The new hybrid territorial regime abolishes deemed paid foreign tax credits on income on post 2017 dividend income received from 10 percent specified foreign corporations and instead allows for a “dividends received deduction” to domestic C-Corporations only. This regime will have numerous implications on company transfer pricing systems. Companies should determine the extent to which their current transfer pricing system supports their tax planning and risk management objectives. There are also implications associated with phase in process where there are foreign tax credits (FTCs). For example, a new Foreign Branch FTC Basket will allow for income of a foreign branch to enable FTC utilization as long as the FTCs are generated in a foreign branch. U.S. MNCs will need to perform transfer pricing studies to support the disregarded entity (e.g., under the check-the-box regime) income for both foreign and U.S. purposes to support the sourcing of the branch income for U.S. tax purposes.
We note the Act focuses FDII and GILTI computations on the tax basis of depreciable assets – moving away from fair market value. This focus on tangible property computations may cause U.S. MNCs to consider using asset-based profit level indicators (PLIs) as opposed to operating income PLIs to align with this trend, simplify administration and potentially manage the risks of double taxation. The Act continues the trend for the emergence of more prescriptive rules in transfer pricing – these rules tend to create tension with the arm’s length principle. Finally, the Act is clearly intended to encourage U.S. MNCs to locate their valuable global intangible property in the U.S. These are among the reasons why it behooves U.S. MNCs to take a closer look at the implications of the Act and perform the analysis, planning and restructuring required to manage their global effective tax rates and exposure to tax risks.