When domestic tax reform officially arrived in December of 2017, it affected everyone in the United States. For some U.S. individuals and businesses, international tax reform measures are especially important to monitor. On this episode of “Unique Perspectives – The DGC Podcast,” our guest is Scott Thomas, a Consultant at DGC. He gives us a summary of our current international tax system, and a look at where we’re headed in the new world of tax reform.
Here is a partial transcript of Scott’s interview with host Tom Annino:
Tom Annino: Let’s begin with an overview of the current system.
Scott Thomas: What we have right now is called a Worldwide Taxation System. Under this system, what we do is if you’re a U.S. person, which could be a U.S. corporation or a U.S. individual, we impose a tax on all of your income. Now, we’ll give you a credit for a tax that you pay to another jurisdiction but we’ll impose a tax on all of your income. The way this system ultimately works out is you’ll end up paying the U.S. tax rate. Not the other jurisdiction’s rate but in the credit mechanism system, you end up paying the U.S. tax rate. There’s a different system that works in other countries. Most industrialized countries use what’s called a Territorial System. So instead of paying tax on your Worldwide income and getting a credit, what you do instead is you only pay tax on income in your jurisdiction. Think of a U.S.-based company doing business outside of the United States. Under the Worldwide system, they pay tax on all of their income and get a credit for the tax they pay to another country. Under the Territorial System, there’s no need for a credit because you just pay tax to each of the jurisdictions independently on what’s sourced to those jurisdictions. So there’s no duplication in that arena. What the politicians have wanted us to do is move to a Territorial System because what it does is, under the old tax rates that we had, it allowed for better competition in a foreign jurisdiction. So think of that same U.S. company doing business in “Country A” with a 20% or a 15% tax rate. That was lower than our tax rate or, at least, it certainly used to be. You’re competing there. So the U.S. company would ultimately end up paying tax at something close to 35% on income earned in that jurisdiction. If you’re competing against a company that’s solely in that jurisdiction, they would be paying a lower rate of 15% or 20%. Our U.S. based companies were disadvantaged. That was the rationale behind moving a Territorial System and that’s where we started down that path.
TA: So that’s where we started. Let’s phrase it this way: Where are we headed and where were we supposed to go?
ST: We were aiming at Territorial System. We got part of the way there. We might’ve veered off just a little bit and put some other policy considerations in here. The way we got part of the way there is one of the things that we’ve done is if you’re a U.S. company that owns a foreign subsidiary, when that foreign subsidiary pays a dividend back to the United States, we’re not going to subject it to tax. Now this provision only applies to C Corporations, not individuals or S Corporations in that way. So it helps bigger companies out a little bit more than not. Also, if those U.S. corporations sell the stock, that’s also not taxable. Unfortunately, the flipside of that system is for all of those large companies that have kept cash and other earnings outside of the United States that they have not brought back because they’ve wanted to avoid the tax on the income, they get hit with what is called a Transition Tax. That’s going to be large and it can be paid out over eight years. So this was our transition to getting something a little bit closer to a Territorial System. We handled the dividends part of it and not so much the other. The dividends were important because, according to the Treasury, I think we have over $3 trillion dollars sitting offshore that isn’t coming back because U.S. corporations do not want to pay the tax when the dividend comes home.
So what are some notable provisions that people should be aware of? Scott will tell you why the terms “GILTI” and “FDII” are ones you should familiarize yourself with. Click here to listen to the episode or click on the Soundcloud player above.
To access our podcast archives, click here.