This year’s tax extender law, the Protecting Americans from Tax Hikes (PATH) Act, modified a couple of key international provisions, making permanent the Subpart F active financing exception and extending the so-called controlled foreign corporation (CFC) look-through rule through December 31, 2019.
This is good news for businesses, because it adds certainty to some significant US tax considerations, which has been lacking in recent years. Obviously the permanency of the active financing exception in Subpart F is a best-case scenario; however, the five-year extension of the CFC look-through rule is also a welcome development for businesses with certain types of cross-border, intercompany payments.
Who Will Be Affected?
Many businesses have structured their international operations to take advantage of the two straightforward and logical exceptions to Subpart F. These exceptions allow financing and operating cash flows to proceed without a punitive US tax consequence. Importantly, these exceptions are broadly applicable, because they impact both cash taxes—the predominant concern for private companies—as well as GAAP tax expense, which is usually of greater importance to public companies.
The active financing exception allows for an exception to Subpart F for commercial lending and other financing activities, and it affects those particular industries only. The CFC look-through rule, in contrast, applies to certain types of common intercompany transactions, making it applicable across most industries. The CFC look-through rule permits companies to engage in internal (and offshore) financing, licensing, and dividends without incurring a current US tax bill, provided the transactions take place among the US parent’s CFCs. In particular, manufacturing, technology, life sciences, pharmaceutical, and other industries with a lot of intellectual property rely on the royalty component of the CFC look-through rule.
Active Financing Exception
The Subpart F exception for active financing income, which has now been made permanent, allows income from the active conduct of a banking, financing, or similar business—or from conducting an insurance business (collectively referred to as “active financing income”)—to be excluded from Subpart F income. The law permits the US parent of a foreign subsidiary to defer US tax on that subsidiary's earnings if the subsidiary is predominantly engaged banking or finance and conducts “substantial activity” with respect to the active financing business. In order to take advantage of the active financing exception, the subsidiary must also pass an entity-level income test to demonstrate that the income is active and not passive income.
CFC Look-Through Rule
The PATH Act retroactively extends look-through treatment for related CFCs for five years. It applies to foreign corporations’ tax years beginning before January 1, 2020, and to US shareholders’ whose tax years include December 31, 2019.
Essentially, a CFC is a controlled foreign subsidiary of a US corporation, partnership, or individual or a foreign company controlled by a group of 10 percent or more US shareholders. The provision permits dividends, interest, rents, and royalties received by one CFC from a related CFC to be excluded from being subject to US tax under the Subpart F foreign personal holding company income category if the activities that generate the payments aren’t allocable to Subpart F income and aren’t effectively connected with the conduct of a US trade or business.
We Can Help
To learn more about how the PATH Act impacts your international business arrangements, or for insight on how you can better benefit from these permanent and extended provisions, contact internationaltax@mossadams.com.