Do You Need to Bring Foreign Earnings Home by 12/31?

Did you pay tax on a Section 965 inclusion in 2017? Do you plan to repatriate cash out of the earnings that were taxed under Section 965?

If so, it is important to consider distributing the cash before the end of your 2018 tax year. If you are a calendar-year taxpayer, cash should be distributed by December 31, 2018.

Section 904(c) provides that foreign taxes paid can be carried forward 10 years and carried back one year. The Section 965 tax on historical earnings of specified foreign corporations has brought forward an issue that has long existed when inclusion under Subpart F rules resulted in the U.S. taxing foreign-source income before any applicable withholding taxes are levied by a foreign government on the actual distribution of cash. If a U.S. taxpayer didn’t distribute cash from its foreign subsidiary when the underlying earnings were taxed by the U.S., a future cash distribution could result in stranded withholding tax credits. Section 965 doesn’t present any new issues, but in most cases the amounts — and the potential for double taxation — are far greater because all of the foreign earnings became taxable in 2017.

Since Section 904(c) only provides a one year carryback of the foreign tax credit, it will be important to ensure that any withholding taxes associated with cash distributions be levied by a foreign jurisdiction no later than the next tax year after the Section 965 inclusion.

Consider the following example.

A U.S. citizen operates a toy manufacturing business and is a calendar-year taxpayer. The U.S. business activities are conducted through a Texas Limited Liability Company that is treated as a partnership for U.S. tax purposes. The U.S. LLC has conducted its manufacturing activities in Mexico through an S. de R.L. since the early 2000s. The taxpayer has elected to treat the wholly owned Mexican subsidiary as a corporation for U.S. tax purposes. The U.S. taxpayer has no other foreign business activities. The Mexico subsidiary has never distributed its profits to the U.S. shareholder.

In tax year 2017, Section 965 would have caused U.S. taxation of all of the Mexico accumulated profits at a reduced U.S. tax rate. Now that U.S. taxes have been paid on the profits the U.S. taxpayer wishes to distribute excess cash within the Mexican subsidiary back to the U.S. When the cash is distributed, Mexico will levy a 10% withholding tax on all or a portion of the distribution. If the U.S. taxpayer does not distribute the cash by December 31, 2018, the Mexican 10% withholding tax may never be able to be utilized as a foreign tax credit. True, the credit will carry forward for 10 years. However, based on the taxpayer’s operating model in Mexico and sources of foreign income, it is unlikely the company will ever be able to utilize the credits if they are carried forward.

Whether or not this issue affects you is highly dependent on your unique set of facts and plans for repatriating foreign cash. Weaver is actively helping many of our clients manage these complex considerations, and we would be happy to discuss how our international tax team may be able to help you.

For questions about this issue or other international tax matters, please contact us.