Posted by Aurelia E Weems CPA

New Participation Exemption System for the Taxation of Foreign Income Under the Tax Cuts and Jobs Act

New Participation Exemption System for the Taxation of Foreign Income Under the Tax Cuts and Jobs Act

The participation exemption system will allow the United States to transition to a quasi-territorial system that will effectively replace the current external tax credit system. Under the exemption system, 100% of the portion of foreign dividends paid by a foreign company to a U.S. corporation that owns 10% or more of the foreign company would be exempt from U.S. tax.


Participation Exemption System

The Tax Cuts and Jobs Act (TCJA or "the Act") adds a new section 245A, which would allow a 100% deduction of foreign dividends received by a domestic company from a "10% specified foreign company".

A 10% foreign corporation is a foreign corporation whose U.S. shareholder is a domestic corporation. The 100% deduction of dividends received is only available for domestic C companies that are not real estate investment funds or regulated investment companies. Therefore, internal partnerships, S corporations, and individuals are not considered eligible U.S. shareholders.

Dividends from passive foreign investment companies are not eligible for the 100% DRD (Dividend Received Deduction), and a DRD is not possible for any hybrid dividend. A hybrid dividend is commonly defined as an amount received from a foreign affiliate. The foreign company has received a deduction or other tax benefit related to taxes withdrawn from a foreign country.

The law allows certain dividends estimated in article 1248 to benefit from a 100% DRD. In particular, if a domestic company profits from the sale or exchange of shares of a foreign company that it holds for at least one year, any amount considered to be a dividend in accordance with article 1248 would be eligible for 100% of DRD. Entries in subsection F are not eligible for a DRD.

Under the participation exemption system, if a U.S. shareholder that is a domestic company received a dividend from a foreign company that is entitled to 100% DRD, for the sole purpose of causing the loss of the company national through the sale of shares of foreign companies. , the domestic company reduces its participation in the foreign company by an amount equal to 100% DRD.

When a U.S. business transfers substantially all of the assets from a foreign affiliate to a foreign affiliate, the U.S. business must include in its income the number of losses after 2017 (year of issue) suffered by the affiliate.


Effective date

The 100% deduction for the share of foreign-source dividends would apply to distributions made after December 31, 2017.


Calculation of the foreign source's portion of a dividend

The share of a foreign dividend would be equal to the same proportion of the dividend as the foreign company's foreign profits correspond to the total undistributed earnings. The undistributed external income of a foreign company would include all undistributed income, except income related to the management of a business or business in the United States and dividend income received from a foreign corporation national company owned by the United States. Total retained earnings include all earnings without deduction of dividends distributed during the year.


Foreign Tax Credit Implications

Under the participation exemption system, an FTC or foreign tax deduction, including withholding taxes, taxes paid, or accrued, would not be permitted for any 100% deductible dividend.

Additionally, for purposes of limiting the FTC under Section 904 (a), foreign income would be determined without taking into account the foreign share of dividends received by that foreign corporation and the corresponding deductions for expenses attributable to an exempt dividend.

Foreign tax deductions will be available to offset the current dividend inclusion tax, estimated per the provisions of Subpart F and the new global intangible low-taxed provision ("GILTI") taxes. The foreign tax deduction available to offset GILTI's income will be limited.

Holding Period Requirement

A domestic company would not receive 100% DRD for a dividend paid on a share held for 365 days or less in the 731 days of the 365 days before the due date that the dividend is paid. Also, the foreign company must qualify as a specific 10% foreign company, and the domestic company must qualify as a 10% shareholder at any time during the applicable period.


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