The 2017 Tax Cut and Jobs Act creates significant changes and new challenges for accounting for income taxes. Tax reform significantly changes the US taxation of foreign earnings. Despite the changes in US tax law, companies will need to continue to evaluate their indefinite reinvestment assertion.
Hi I’m Eric Suplee, a Director in PwC's National Office.
The 2017 Tax Cut and Jobs Act has created significant changes and new challenges for accounting for income taxes. One such change is related to the "toll charge".
The toll charge is a one-time mandatory deemed taxable inclusion of previously untaxed foreign earnings and profits or "E&P". Taxes owed from the toll charge will generally be recorded as a tax liability, and companies can elect to pay it over eight years on an interest-free basis. The tax is due regardless of whether the company actually remits or distributes the foreign earnings.
Prior to tax reform, foreign earnings were primarily taxable in the US upon an actual dividend distribution or through deemed inclusions under Subpart F. Given the 35% US tax rate, the tax cost on a dividend distribution was high. As a result of this cost and needs outside the US, many US companies asserted that foreign earnings would be indefinitely reinvested in their foreign operations. By making this assertion, companies did not measure and record deferred taxes related to those earnings.
The toll charge effectively taxes those historic foreign earnings. Additionally, the new tax law introduces international tax provisions that fundamentally change the US approach to the taxation of foreign earnings. One aspect is the implementation of a territorial or partial territorial system, which includes a 100% dividend received deduction. This means that future distributions of foreign earnings will generally not be taxable in the US.
Despite the changes in US tax law, companies will need to continue to evaluate their indefinite reinvestment assertion, for both historic and current earnings. This is important because companies that do not assert indefinite reinvestment may be subject to other taxes on those earnings. For example, the foreign jurisdiction may impose withholding taxes on any foreign earnings that will be repatriated. In this situation, companies would need to record a deferred tax liability for that withholding tax cost if the indefinite reinvestment assertion is not maintained. Any foreign currency movements related to that withholding tax liability from year to year would be recorded through the income statement rather than as a Cumulative Translation Adjustment, or CTA, in equity.
Additionally, companies that no longer assert indefinite reinvestment would need to consider potential deferred taxes related to unrealized foreign currency gains or losses on previously taxed, but unremitted foreign earnings included in the toll charge. For example, let's say a company's foreign E&P was 1 million Euro at the date of the toll tax calculation, and for US tax purposes, that translated to 1 million dollars in the calculation of the toll tax. That is, 1 Euro equals 1 dollar. Further, assume that the company has yet to repatriate the foreign E&P and that the company does not assert indefinite reinvestment. If, in the following year, the exchange rate moves such that one Euro equals 1.25 dollars, the company would need to record a deferred tax liability for the unrealized foreign currency gain through CTA.
Finally, state taxes and changes in the law for foreign tax credits would also need to be considered when evaluating the indefinite reinvestment assertion.
In summary, a company’s indefinite reinvestment assertion will continue to be an important financial statement consideration for many companies, and changes in US tax law may impact these assertions. For companies that do not assert indefinite reinvestment, foreign currency changes related to applicable withholding taxes could cause income statement volatility.
Thank you and good luck!