The Journal The Authority on Global Business in Japan

On December 22, US President Donald J. Trump signed the Tax Cuts and Jobs Act of 2017, which the US House of Representatives Committee on Ways and Means presented as delivering more jobs, fairer taxes, and bigger paychecks. In its policy highlights document, the committee said, “The Tax Cuts and Jobs Act is a bold, pro-growth bill that will overhaul our nation’s tax code for the first time since President [Ronald] Reagan’s historic tax reform 31 years ago. With this bill, a typical middle-income family of four earning $59,000 (the median household income) will receive a $1,182 tax cut.”

The bulk of the public discussion about the tax overhaul has been aimed at US citizens living in the United States, and on US-based business. On the corporate front, a primary goal was lowering the corporate tax rate of 35 percent and encouraging US companies to keep operations at home.

One point in the policy highlights document states that the act “prevents American jobs, headquarters, and research from moving overseas by eliminating incentives that now reward companies for shifting jobs, profits, and manufacturing plants abroad.”

Another point addresses the inter­national tax system, stating that the act “modernizes our international tax sys­tem so America’s global businesses will no longer be an outdated ‘world­wide’ tax system that results in double taxation for many of our nation’s job creators.”

While the changes may have the desired effect on some level, it may also have unintended effects on US job creators and workers living abroad.

There are numerous changes included in the act that impact individuals; however, specific provisions related to international tax rules and companies may also have unexpected consequences for certain individual taxpayers (US citizens, Green Card holders, and residents) who do business in Japan through the use of a corporation (i.e., a KK or kabushiki kaisha as one example).

While merely a brief introduction to a complex piece of legislation, this article focuses on a few of the major updates for US individual taxpayers operating through a corporation, and identifies some common misconceptions that individual taxpayers may have regarding the new rules.

Note that, generally, self-employed individuals who do not operate their business through a corporation will not be subject to these rules.

As part of the act, the United States will no longer tax certain foreign divi­dend income earned by US corporate taxpayers beginning with the 2018 tax year.

However, in return, the United States has been granted one final opportunity to tax any pre-2018 un­remitted accumu­lated earnings generated by certain foreign corporations. This “transition tax” is a one-time tax on a deemed remittance of such unremitted foreign earnings to its US shareholders at the end of 2017.

The act also introduced a global intangible low-taxed income (GILTI) provision, which is an anti-tax deferral rule that requires US shareholders of certain foreign corporations to annually include in their taxable income the excess earnings over a stipulated rate of return from the tangible assets of a foreign corporation. This provision applies starting with the 2018 tax year.

While much attention has been paid to the impact that the tax reform will have on income earned overseas by US corporations, there may be some common misconceptions about how individuals will be affected by the act. The following five points attempt to clarify these mistaken beliefs.

These rules only target US multi­national corporations.
While the changes might be primarily targeting US multinational corpora­tions, these rules can also apply to US individuals. The specific individuals affected by the new rules will depend on the particular rule but, in general, these will impact US individuals with at least a 10-percent interest in a foreign corporation controlled by US persons. This is referred to as a controlled foreign corporation (CFC).

For example, a US citizen who owns 100 percent of a kabushiki kaisha or a godo kaisha—unless the godo kaisha has made an election for US tax purposes to be treated as an entity disregarded as separate from its owner—would be subject to the new rules. Further, a US citizen who is a partner in a US enterprise that holds a 10-percent interest in such a foreign corporation will also be subject to these rules. It is important to be aware of the identities of any other shareholders in the foreign corporation (in addition to your ownership level in the foreign corporation), as this could also have a tax impact on you if one of the other share­holders is a US corporation with a 10-percent or more interest. This is referred to as a specified foreign corporation (SFC).

GILTI does not apply if a foreign corporation does not generate intangible income.
Despite its name, GILTI does not require intangible income to apply. The provision is quite mechanical and any income (albeit with some exclusions) generated by the foreign corporation over a certain threshold must be included in a US individual shareholder’s taxable income.

GILTI rules allow for a 50-percent deduction from the taxable base to help reduce the overall effective rate of tax imposed. While this is generally true for corporate taxpayers, individuals are ineligible for such a deduction.

A foreign tax credit should be available to offset the impact of these new rules.
A partial indirect foreign tax credit is available for corporate taxpayers. However, individuals are ineligible to claim a foreign tax credit for taxes paid by a foreign corporation.
The effective rates of the transition tax are 15.5 percent to the extent the unremitted earnings consist of cash and cash equivalents, and 8 percent on the remainder.

While these rates were widely advertised in the media and by Congress, they were calculated based on the former corporate income tax rate of 35 percent. For individuals with marginal rates greater than 35 percent, the effective rate of the transition tax may be higher.

US individual taxpayers with interests in foreign corporations in Japan or elsewhere may find themselves subject to more US tax than previously expected. This could potentially start April 15, 2018, with the 2017 tax year due to the transition tax, and carry forward due to the GILTI provision.

Further, as these rules generate phantom income (deemed income inclusion without a cash remittance), some taxpayers may be in a position with a significant tax liability but no cash on hand to pay such a liability.

Therefore, it is important to determine in advance whether these rules apply to a specific situation, to calculate the potential consequences, and to identify options—if any—to mitigate adverse impact. As these new rules are quite complex and the precise application to an individual will depend on his or her specific circumstances, anyone concerned that either of these rules may apply to their situation should contact their US tax advisor.

Specific provisions related to international tax rules may have unexpected consequences for certain US individual taxpayers.