Be Prepared for Big Corporate International Tax Changes
Multi-national Corporations may want to bring back their overseas earnings
Big changes are likely to take place regarding corporate international taxes, according to President
Barack Obama’s proposed budget (released Feb 2, 2015). The current U.S. corporate tax code taxes all
corporate income earned in the United States or in foreign countries at the 35 percent federal corporate
tax rate. U.S. corporations earning income abroad must pay the income tax in the country where they
earned the income, then pay the difference between that country’s tax rate and the U.S. rate. For
example, a U.S. company in England must pay 21 percent to the British government. Then, the
corporation must pay 14 percent to the U.S. government (35 minus 21 percent).
However, U.S. corporations can delay paying the additional tax to the U.S. government as long as that
income is reinvested in ongoing foreign operations. But passive income (investment income) earned
overseas is taxed immediately by the U.S. government, whether it is brought back to the United States
Besides the high income tax rate of 35%, there is another big disincentive that multi-national companies
do not want to bring home more of their profits – U.S. accounting rules. This was a major focal point of
a 2012 Senate Permanent Subcommittee on Investigations hearing on offshore
profit-shifting and the U.S. tax code. The panel focused mainly on Microsoft Corp.
and Hewlett-Packard Co. as examples. It also spotlighted a longstanding accounting rule called
APB 23, which covers how U.S. multinationals should account for taxes they will have to pay
when they repatriate overseas profits. (APB stands for Accounting Principles Board, which was a
predecessor to the Financial Accounting Standards Board.)
Under APB 23, when corporations hold profits offshore, they are required to account on
their financial statements for the future tax bill they would face if they repatriate those
funds. Doing so would result in a big hit to earnings. But companies can avoid this
requirement and claim an exemption if they assert that the offshore earnings are
permanently or indefinitely reinvested offshore. Multinationals routinely make such an
assertion to investors and the Securities and Exchange Commission on their financial reports.
President Obama’s budget would impose a 14% one-time tax on untaxed, unremitted foreign income.
This proposal is intended to work together with another provision in the proposed budget that would
impose a 19% minimum tax on future foreign subsidiary earnings, thereby eliminating the deferral
previously available with respect to foreign income. . Besides reducing the rate, the budget would alter
how corporations are taxed by the U.S. government when they earn income overseas.
First, the proposal, if becomes law, would lower the Federal tax deferral for those profits earned from
countries where the tax rate is same or higher than 14%. Corporations would owe U.S. tax on foreign
income on a current basis.
However, his proposal would create a minimum tax on foreign earnings, which would limit the domestic
tax on foreign earned income that has paid adequate taxes overseas. If the income did not face a high
enough tax rate overseas, then additional tax would need to be paid to the U.S. government. The
proposal includes a formula for companies to determine whether or not they need to pay additional tax
to the U.S.
How will corporations know if they have paid what the U.S. determines to be enough tax? The proposal
includes this formula to make the determination. Corporations can use the following: 19 percent (the
minimum tax rate) minus 85 percent of the effective tax rate in a given country (over a 60-month
period). For example, a U.S. corporation that earned income in the United Kingdom would face a 21
percent corporate tax rate. 19 percent minus 17.85 percent (85 percent of 21 percent) = 1.15 percent,
thus the U.S. corporation would be required to pay an estimated 1.15 percent to the United States
The estimated tax rate would then be reduced by an “allowance for corporate equity.” This allowance
provides a tax exemption on income based on a risk-free return on active investments overseas. So in
the case of a corporation doing business in the United Kingdom, the allowance may reduce the tentative
minimum tax bill of 1.15 percent to zero. Thus, the United States would not tax the income earned in
the United Kingdom further.
On top of the changes to the international tax system, the proposal would strengthen several anti-abuse
policies. The plan would alter Thin-Capitalization rules to limit the amount of interest a U.S. corporation
can deduct from U.S. taxable income. Additionally, anti-inversion rules would be made more stringent,
among other changes to international tax rules.
This plan will affect a vast majority of businesses operating overseas. Some businesses may see
improvement due to a combination of a lower domestic tax rate (28 percent) and a minimum tax that
would not affect them, especially companies operating in high-tax countries. However, some
corporations that do business in low-tax countries may see higher tax bills. The proposal would force
businesses to make investment decisions based on the tax and a “corporate allowance,” rather than on
the economic and fiscal picture of a country.
Based on observation, even though a revamp of international taxes faces a tough path in the Senate, the
relief on unremitted earnings that stays outside of the US has broader support than at any time in the
recent past. Republican candidate Donald Trump’s Tax Plan, released Sep 28, 2015, and also includes the
relief as part of his tax reform. In addition, Senators Barbara Boxer (D-CA) and Rand Paul (R-KY) released
their proposal, which would be voluntary and require an actual repatriation of the foreign earnings.
Katie Hou is Tax Director in KCH & Co, P.C., an accounting firm headquarters in Denville, NJ. KCH has the
knowledge and expertise to assist in reviewing your structure, modeling the various proposals and their
potential impact to your organization, and provide planning solutions to optimize their effect on your
company’s income tax expense. If you need help planning how to handle this new tax system, you can
visit www.kchpc.com and schedule a free consultation.