Following the enactment of the 2017 Tax Act, foreign-owned U.S. corporations are, in general, subject to a federal corporate income tax rate of 21% of their world-wide taxable income, as well as to state income taxes that range from 3% to 12%. Dividends paid by such corporations to their foreign shareholders are subject to a statutory withholding tax of 30%, which may be reduced to as low as 5% (and in some rare cases, eliminated) when paid to qualified residents of countries with which the United States has an income tax treaty.
The recent tax act introduced two provisions, one unfavorable and one favorable, that could affect the income tax liability of U.S. corporations, particularly those that are foreign-controlled. On the one hand, U.S. corporations are limited in the amount of interest expense that they may deduct for federal income tax purposes, a factor that may make significant debt capitalization less attractive. In calculating their taxable income, such corporations’ interest expense is deductible only to the extent that it does not exceed 30% of their net income without regard to interest expense (i.e. their EBIT) and, before 2022, without regard to depreciation and amortization deductions as well (i.e., their EBITDA). On the other hand, to the extent that a U.S. corporation whose income represents a greater-than 10% return on its depreciable tangible assets manufactures products for ultimate sale to foreign customers for foreign use or consumption, the corporation could realize a federal income tax rate of less than 21%.
Special income tax rules apply to U.S. corporations that engage in transactions with foreign affiliates. First, all foreign-controlled U.S. corporations must specially file annual reports identifying their foreign shareholders and describing transactions with and payment flows to their foreign affiliates. Second, in determining their federal and state income tax liability, such corporations must report the income tax results of transactions with their foreign shareholders and affiliates – including income from the sale of goods, and deductions for royalties and license fees for the use of intangible property and for fees for services provided to them - that reflect arm’s length economic returns as validated by the results of comparable unrelated party results. In this respect, it is generally prudent to have in place written agreements governing all significant intercompany transactions that set forth the parties’ respective functions, obligations, ownership and use of intangible property and allocation of risk in order to maximize the likelihood that reported transfer pricing results will be sustained even if challenged by U.S. (and foreign) tax authorities. Third, as a result of the 2017 Tax Act, U.S. corporations that are members of multinational affiliated groups with average annual gross receipts of at least $500 million are potentially subject to a 10% minimum tax to the extent that they make substantial deductible payments (e.g., intellectual property royalties) to, or purchase depreciable property from, foreign affiliates that otherwise reduce their federal income tax liability below a certain threshold.