The passage of the Tax Cuts and Jobs Act, (“TCJA”) on December 22, 2017 had significant impacts on the insurance industry, both domestic insurers and multi-nationals. With this in mind we address how provisions will impact insurers today and in the future, and how it will impact insurers’ GAAP and Statutory financial statements for the December 31, 2017 year-end and going forward. Many areas of the TCJA need further clarification, and we will monitor future guidance, rulings and regulations and advise appropriately.
The TCJA contains several changes to general corporate taxation rules that will also the insurance industry companies. Insurers will need to pay attention to these changes as several long standing and commonly accepted provisions have been amended.
REDUCED CORPORATE TAX RATES
Under the old law, corporations were subject to graduated tax rates of 15%, 25%, 34% or 35% depending on their taxable income. For tax years beginning after December 31, 2017, the TCJA amended the corporate rate to a flat 21% across all taxable income levels.
Mazars Insight: Overall, this is seen as a beneficial change for corporations in the higher income brackets. More dollars in the business’s budget can lead to increased investment and job growth.
Due to the law’s enactment in 2017, insurers will need to take the tax rate change into account when preparing their 2017 Statutory and GAAP tax provisions as any deferred tax assets and liabilities will reverse at the lower tax rate. The reduced rate will significantly reduce the value of deferred tax assets (“DTA”) on the balance sheet (notably those with sizeable net operating loss carryforwards and insurance reserves) and cause an increase in the amount of deferred tax expense that must be reported for 2017. Conversely, the reduced rate will significantly reduce the future deferred tax liabilities (“DTL”) on the balance sheet (such as companies with unrealized portfolio gains) and cause a decrease in the amount of deferred tax expense that must be reported for 2017.
Under current GAAP guidance, the difference between the DTA and DTL previously measured at the 35/ 34% tax rate and the DTAs and DTLs re-valued at the 21% tax rate will have to be reflected through the current year income statement, even for deferred tax items reflected through Other Comprehensive income (“OCI”) items. However, February 14, 2018, the FASB issued ASU No. 2018-2 (the “ASU”) which allows companies the ability to reclassify to retained earnings of tax effects of items remaining within accumulated OCI resulting from the TCJA. This would alleviate the potential effects of previously established deferred taxes on unrealized gains/losses at the old 35/34% rate while reversals are occurring at the lower 21%, thus “stranding” deferred taxes in OCI. The update would be limited in scope specifically to the TCJA. The ASU is effective fir periods beginning after December 15, 2018, but early adoption is permitted, so companies can make this reclassification in their 2017 GAAP financial statements along with appropriate disclosures.
Under current statutory accounting guidance (see SAPWG INT 18-01), the difference between the DTAs and DTLs previously measured at the 35/34% tax rate and the DTAs and DTLs re-valued at the 21% tax rate is recorded differently than GAAP treatment. This gross change in net deferred tax, excluding any change reflected in unrealized capital gains, and excluding any change in nonadmitted DTAs is to be reflected in the “Change in Deferred Income Tax” line in changes in capital and surplus. Tax effects previously reflected in unrealized capital gains (to present unrealized gains (losses) as “net of tax” shall be updated in the “Change in Net Unrealized Capital Gains (Losses) less Capital Gains Tax” line in changes in capital and surplus. Also, future tax rates in the second prong of the admissibility test will need to be revised accordingly.
AMT REPEALED AND AMT CREDIT REFUNDABLE
The TCJA repealed the Alternative Minimum Tax (“AMT”) for years beginning after December 31, 2017. For tax years beginning after 2017 and before 2022, any AMT credit carry forward balances at December 31, 2017 can offset regular tax, and any remaining unused AMT credits are refundable at 50% of the amount remaining each year to the extent they exceed regular tax through 2020, with any remaining AMT credit refunded in 2021.
Mazars Insight: Both the repeal of the AMT and the refund of the AMT credits cause cash back in the corporation’s budget, leading to greater investments. Generally, refundable credits would not create a carry forward scenario and thus not be subject to section 383 limitation. However, it should be noted that there is uncertainty as to whether AMT credit carry forwards that are now refundable by statute are subject to past section 383 limitations or future section 383 limitations based on post-2017 ownership changes and, if so, how a taxpayer should calculate the refunded amounts by year.
Because any available AMT credits are fully refundable, insurers will need to recognize this gross DTA in their STAT and GAAP provisions if previously it was subject to a full or partial valuation allowance as it is guaranteed to be utilized and/or refunded no later than 2021. As a dollar for dollar credit, the AMT credit is not impacted by the change in corporate tax rates. For insurers with AMT credits in their DTAs, even if they no longer need a valuation allowance for STAT purposes they will need to consider the favorable impact it will likely have in the admissibility test under SSAP 101 paragraph 11.b.in order to understand the true surplus impact.
NET OPERATING LOSS CHANGES
Under previous law, corporations were allowed to carry back 100% of any net operating losses (“NOL”) for two years and carry them forward for 20 years. For tax years beginning after December 31, 2017, the TCJA repeals the two year carryback for regular corporations (which will now also apply to life insurers) and limits the NOL deduction each year to 80% of taxable income. Any remaining NOLs can be carried forward indefinitely. Losses that were generated before January 1, 2018 are grandfathered in under the old NOL regime and, as such, are not subject to the 80% restriction.
It should be noted that for property and casualty (“P&C”) insurance companies, the old rules still apply (i.e., P&C companies are still allowed the two year carryback and a 20 year carry forward of NOLs, which can still be applied to 100% of taxable income, even for post 2017 NOLs). See the LIFE INSURANCE COMPANY PROVISIONS section below for more information regarding the new rules for NOLs of life insurers.
Mazars Insight: The loss of the ability to carryback current year losses, starting in 2018, to recoup prior year taxes paid could be detrimental to some corporations. The ability to carry forward the losses indefinitely is a benefit as corporations no longer need to worry about expiring NOLs. Separate tracing of NOLs for pre and post 2017 TCJA changes as well as for consolidated tax groups with both life and non-life insurance companies will be necessary. Additionally, insurers in a consolidated group containing P&C Insurers and non-insurance companies will need to track their future NOLs separately due to the differing carryback/carryforward regimes along with limitations that apply to non-insurers could be absorbed by non-limited P&C insurance companies’ losses. Could there be bumping rules akin to the existing life/non-life rules that remain unchanged by the TCJA, only time will tell.
The loss of carryback ability for future NOLs and indefinite carryforward of NOLs may require valuation allowances and DTAs to be revalued, but this should be determined on a case by case basis. For P&C insurance companies, the admissibility test pursuant to SSAP 101, paragraph 11 would remain unchanged; however, life insurance companies will have to immediately adjust the admissibility test to account for the loss of carryback ability (i.e. paragraph 11 a would no longer be applicable to life insurers) in their 2017 statutory admissibility test.
LIMITATIONS ON THE DEDUCTIONS OF BUSINESS INTEREST
For tax years beginning after December 31, 2017, the TCJA limits the deduction of net interest expense to 30% of adjusted taxable income. For tax years beginning after December 31, 2017 and before January 1, 2022, adjusted taxable income is determined without the deductions for depreciation, amortization or depletion. Any business interest disallowed as a deduction can be carried forward indefinitely. There is an exemption from these rules for taxpayers with average annual gross receipts for the three year tax period ending with the prior tax year that do not exceed $25 million.
Mazars Insight: Because the TCJA limits how much interest a corporation can deduct in a given year, companies will need to account for this as a DTA similar to NOLs. As insurers typically have sizable investment portfolios, since the limitation is based off of net interest expense, we believe that this will not likely impact most insurers.
COST RECOVERY/DEPRECIATION CHANGES
SECTION 179 – For tax year 2018, the TCJA increased the maximum amount a taxpayer may expense under Section 179 from $500,000 to $1 million. The phase-out threshold was also increased to $2.5 million. For years beginning after December 31, 2018, the maximum amount will be adjusted for inflation. As before, Section 179 expensing is limited to taxable income in a given tax year.
BONUS DEPRECIATION – For property placed in service after September 27, 2017 and before January 1, 2023, the TCJA increased the amount of first year depreciation to 100% from 50% as allowed under the prior law. Unlike the old bonus depreciation rules which limited first year expensing to only new assets, the TCJA allows additional first year depreciation for new and used assets (restrictions do apply). For tax years after December 31, 2022, the bonus depreciation deduction will phase down 20% each year until 2026 when it will be completely eliminated.
Mazars Insight: The changes to depreciation expensing rules are very beneficial to corporations, as they will be able to get the deduction for capitalized fixed assets in the tax year they outlay the cash. This may lead to companies making a greater investment in capitalized assets in the years where full expensing is in place. Although insurers are typically not capital intensive, this could very well impact pass-through income related to partnership investments that have capital intensive aspects.
The increased deduction for fixed assets could potentially put a corporation into a DTL position. As with any tax accounting adjustment for depreciation, careful tracking will need to be done for the STAT/GAAP/Tax differences to properly determine the correct DTA or DTL.
DIVIDENDS RECEIVED DEDUCTION
In general, for corporate shareholders receiving a dividend from certain domestic corporations, the TCJA reduces the dividends received deduction (“DRD”) for the 70% and 80% brackets, to 50% and 65%, respectively. The 100% DRD remains intact for dividends from affiliated group members. The DRD provision is effective for tax years beginning after December 31, 2017. See the INTERNATIONAL PROVISONS section for DRD provisions related to the foreign dividends.
Mazars Insight: Taking into account the drop in the corporate tax rate, the change in the proration provisions of the TCJA (see below in the PROPERTY AND CASUALTY INSURANCE COMPANY PROVISIONS section under “Proration”), and the drop in the DRD percentages, the effective tax rate for P&C insurers on greater than 20% owned stock drops from 11.2% to 10.7625% and less than 20% owned stock from 14.175% to 13.125%.
PROPERTY and CASUALTY INSURANCE COMPANY PROVISIONS
The TCJA contains some relatively substantial changes to the property and casualty tax provisions in effect as of December 31, 2017. These changes were necessary for simplification as well as the industry’s contribution to budget reconciliation for ultimate passage of the bill into law. Insurers need to pay particular attention to these provisions as they are an integral part of property and casualty insurers’ taxation going forward.
LOSS RESERVE DISCOUNTING
The TCJA modifies the computation of tax basis discounted unpaid loss reserves under section 846 in the following ways:
- The interest rate used to calculate the applicable accident year discount factors is modified from the 60-month rolling average of the applicable federal mid-term interest rate (AFR) to an interest rate based on the corporate bond yield curve for the preceding 60-month period on investment grade corporate bonds. The monthly interest rate used to set the pre-2018 law discount factors, as published in Revenue Procedure 2018-13, was 1.46% as compared to an estimated corporate bond yield of that could be approximately 3.5%.
- The applicable loss payment patterns for long tail lines of business are extended to a maximum of 24 years, rather than 15 years. However, the length of the payment pattern for short tail lines remains at 3 years.
- Repeal of the section 846(e) company pay pattern election which allowed an insurer to use its own historical payment patterns for discounting unpaid losses. Generally, this provision was beneficial for taxpayers that paid claims more quickly than the industry average.
These provisions apply to taxable years beginning after December 31, 2017. For the first taxable year beginning after December 31, 2017, the difference in the amount of the tax basis discounted unpaid loss reserves at December 31, 2017 and the amount of such tax basis discounted unpaid loss reserves, determined as if the new tax law had applied for that year, is treated as a transition adjustment. This transition adjustment is brought into taxable income on a straight-line basis over eight years beginning in 2018.
Mazars Insight: Generally, the modifications increase the effect of the time value of money applied to insurers’ loss reserve tax deduction by increasing the interest rate used to determine the loss reserve discount factors and extending the period over which to recover loss reserves. Insurers will need to wait for the IRS to issue new discount factor tables for all pre-2018 accident years in order for them to determine the transition adjustment.
While the TCJA is silent on the discounting of accrued salvage and subrogation recoveries, given that the interest rate was identical to the rate used for unpaid loss reserves, it is likely that the Treasury will issue guidance modifying the determination of discounted salvage and subrogation on terms similar to unpaid loss reserves.
In general, the provision is expected to lower the amount of tax basis discounted unpaid loss reserves; accordingly, current taxable income after 2017 and the existing deductible temporary difference (including the effect of the transition adjustment) at January 1, 2018 are expected to increase. As the enactment date of this provision was in 2017, insurers should report the impact in their 2017 financial statements, meaning their DTA should increase by their tax basis discounted unpaid loss reserves with a like increase in their DTL for the transition adjustment. From a practical point of view, until the IRS issues new discount factors under the TCJA, this computation cannot be performed as of the date of this article. However, note that under statutory accounting, entities have the option of recognizing the DTA and DTL within each grouping on a net or gross basis (see SSAP No.101, Q&A 2.9). Regardless of which method an entity elects (gross or net), it is crucial that consistency is maintained within each grouping from period to period. If this is done, companies will need to revisit their reversal patterns of the loss reserve discount for the SSAP No. 101 admissibility test and determine their ability to offset the DTL created for the transition adjustment beyond three years from the end of their financial statement year-ends.
Under pre-TCJA law, the calculation of the tax-deductible reserves for losses incurred for property and casualty insurance companies was reduced by 15% (proration percentage) of tax-exempt interest and the Dividends Received Deduction; which is treated as a reduction of a deduction (to losses incurred). The TCJA increases the proration percentage to 25%, which roughly estimates existing law after-tax impact. This provision applies to taxable years beginning after December 31, 2017. As such, it does not have an enactment date impact.
Mazars Insight: The actual language does not specifically state the proration percentage as 25% but rather the “applicable percentage is 5.25% divided by the highest rate in effect under section 11(b). This has an effect of keeping the prior law net effective tax rates the same no matter what the statutory tax rate. The prior law’s net effective tax rate of proration is 5.25%. Thus, with the statutory corporate tax rate reduced to 21%, this then drove the proration percentage increase to 25% (5.25%/21% – the new highest corporate tax rate). Note that the statute is worded such that if the maximum corporate rate changes, the proration adjustment percentage will change accordingly, based on this formula. Insurance company investment managers will need to re-evaluate the after tax yield between taxable and tax-exempt investments as the after tax yield spread between taxable and tax-exempt investments has narrowed.
SPECIAL ESTIMATED TAX PAYMENTS (“SETP”)
Under pre-TCJA law, P&C insurers were allowed to offset the impact of loss reserve discounting by designating an additional special deduction and the related special estimated tax payments. The designation did not impact the cash paid to the IRS, only the calculation of taxable income. Generally, the SETPs were treated as current year tax payments. Due to the TCJA’s repeal of this special rule, any existing balance in the special deduction account at December 31, 2017 is included in taxable income with any remaining SETPs applied against the amount of additional tax attributable to the additional taxable income.
Mazars Insight: Depending on the specific taxpayer situation, the additional tax due as a result of the reversing special deductions would be offset by application of the special estimated tax payments. Any excess tax payments will be treated as payments under section 6655. It should be noted that the application of such tax payments could result in a tax refund. As such, a current tax recoverable should be recognized for this amount.
LIFE INSURANCE COMPANY PROVISIONS
NET OPERATING LOSSES
The TCJA repeals the operating loss deduction (“OLD”) regime under pre-2018 tax law section 810 and subjects life insurance companies to the regular NOL rules that apply to general C corporations (other than P&C insurance companies), as described in the previous section (see CORPORATE PROVISIONS). The provision is effective for losses arising in tax years beginning after December 31, 2017.
Mazars Insight : OLDs generated in tax years prior to January 1, 2018 will not be subject to the same 80% taxable income limitation imposed under the post-2017 NOL rules and will continue to a have a 3 year carryback and 15 year carry forward period. The elimination of future NOL carryback ability could have significant impact to some profitable life insurers, which paid taxes in 2015-2017.
Statement of Statutory Accounting Principle (“SSAP”) 101, Paragraph A, states that, a reporting entity can admit adjusted gross DTA to the extent that it would be able to recover federal income taxes paid in the carryback period, by treating existing temporary differences that reverse during a timeframe corresponding with IRC tax loss carryback provisions. For year-end 2017, the 11a test of SSAP 101 will no longer be applicable for Life Insurer ordinary DTAs, but it still applies to capital DTAs can still be carried back 3 years to recover the capital gain taxes paid.
SMALL LIFE INSURANCE COMPANY DEDUCTION
The TCJA repeals the special deduction for small life insurance companies. The provision takes effect for tax years beginning after December 31, 2017.
Mazars Insight: The provision removes a tax preference that is provided to small life insurers. The good news is that many of these companies have been AMT taxpayers and have accumulated AMT credits that probably would have never been utilized. With the repeal of the AMT under the TCJA, the AMT credits for these small life insurers can be fully refundable no later than 2021. Overall, the tax reform package would likely add some tax burden to these small life insurers.
In the statutory accounting admissibility computations, components that relate to the 11.b test under SSAP No.101 will need to be modified to remove the small life company deduction. Additionally, as any available AMT credits are fully refundable, insurers will need to recognize this DTA in their STAT and GAAP provisions, if previously it was subject to a full or partial valuation allowance, as it is guaranteed to be utilized and/or refunded no later than 2021. As a dollar for dollar credit, the AMT credit is not impacted by the change in corporate tax rates. For insurers with AMT credits in their DTAs, even if they no longer need a valuation allowance for STAT purposes they will need to consider the favorable impact it will likely have in the admissibility test under SSAP No. 101 paragraph 11.b.in order to understand the surplus impact.
ADJUSTMENT FOR CHANGE IN COMPUTING RESERVES
The TCJA repeals the 10-year spread rule under Section 807(f) regarding a change in a life insurance company’s basis of computing reserves, and will now have such, subject to the regular change in method of accounting rules under Section 481. Section 481 adjustments that result in a decrease in taxable income will be recognized in one year. Section 481 adjustments that result in additional taxable income will be recognized ratably over four years. This provision is effective for tax years beginning after 2017.
Mazars Insight: The provision eliminates the tax preferential treatment that life insurers had with regards to the adjustment for change in computing reserves. As such, life insurers are subject to the same Sec. 481 adjustment rules as general corporations. The change will be treated as an automatic accounting change. The TCJA does not address how to treat the existing 10 year spread of Sec. 807(f) amounts. Practically speaking, we assume that there will be no change.
SPECIAL RULE FOR DISTRIBUTION TO SHAREHOLDERS FROM PRE-1984 POLICYHOLDERS SURPLUS ACCOUNT
The TCJA repeals Section 815, which provides the special rule for distributions to shareholders from pre-1984 Policy Holder Surplus Accounts (“PSA”). Tax rules enacted in 1959 included a rule that only half of a life insurer’s operating income was taxed when the company distributed it, and a PSA kept track of the untaxed income. In 1984, this deferral of taxable income was repealed, although existing PSA balances remained untaxed until they were distributed. Law enacted in 2004 provided a two year holiday that permitted tax-free distributions of these balances during 2005 and 2006. During this period, most companies eliminated or significantly reduced their balances.
The provision applies to tax years beginning after December 31, 2017, and companies with PSA balances will be required to pay taxes in eight annual installments.
Mazars Insight: Under the TCJA, the few companies which still have PSA balances will need to pay tax annually on the 1/8 of PSA balances in addition to the tax on life insurance company taxable income under Section 801. The good news is that companies will be paying taxes on PSA balances at a lower tax rate.
COMPUTATION OF LIFE INSURANCE RESERVES
The TCJA simplifies the calculation of tax reserves, allowing the amount of life insurance tax reserves on the greater of the net surrender value of a contract or 92.81% of the amount determined using the tax reserve method applicable to the contract. A statutory cap on reserves would still apply. The revised reserve computation goes into effect for tax years beginning after December 31, 2017. A transition relief allows 1/8 of any excess between the prior year-end reserves computed on the old basis, and on the new basis, to be taken into account as of January 1, 2018 for each of the 8 succeeding tax years as either income or a deduction.
Mazars Insight: In general, the provision is expected to lower the amount of tax reserves; accordingly, current taxable income after 2017 and the existing deductible temporary difference (including the effect of the transition adjustment) at January 1, 2018 are expected to increase.
As the enactment date of this provision was in 2017, insurers should report the impact in their2017 financial statements, meaning their DTA should increase by the expected increased discount in their tax basis loss reserves, with a like increase in their DTL for the transition adjustment. Some companies may not have the time or resources to determine the transition amount at this time. However, under statutory accounting, entities have the option of recognizing the DTA and DTL within each grouping on a net or gross basis (see SSAP No.101, Q&A 2.9). Regardless of which method an entity elects, it is crucial that consistency is maintained within each grouping from period to period. In any event, companies will need to revisit their reversal patterns of the tax reserve for the SSAP No. 101 admissibility test and determine their ability to offset the DTL created for the transition adjustment beyond three years from the end of their financial statement year-ends.
DIVIDENDS RECEIVED DEDUCTION-PRORATION RULE
The TCJA modifies and simplifies the life insurance company proration rules for the DRD under Section 805(a)(4) by defining the company share to be 70% and the policyholder share to be 30%. The provision applies to tax years beginning after December 31, 2017.
Mazars Insight: Under pre-TCJA law, the computation of company share/policyholder share was complex and the percentages could vary for each company and each tax year. The TCJA simplifies the rule and brings some certainty to the computation of the proration adjustment.
CAPITALIZATION OF DEFERRED POLICY ACQUISITION COSTS (“Tax DAC”)
The TCJA amends the current capitalization rules of specified policy acquisition costs under Section 848(a)(2) by extending the 120-month amortization period to 180 months, and amends Section 848(c) by increasing the capitalization percentages in each category of contracts. For annuity contracts, the percentage is now 2.09% (up from 1.75%); for group life insurance contracts, the percentage is now 2.45% (up from 2.05%); and for all other specified insurance contracts, the percentage is 9.2% (up from 7.7%). The provision does not change the special rule providing for 60 month amortization for the first $5,000,000 of specified policy acquisition expenses.
Mazars Insight: This provision applies to tax years beginning after December 31, 2017. Any existing unamortized Tax DAC balances as of the enactment date will continue their amortization period. The new capitalization percentages and amortization period apply to net premiums received in 2018 and thereafter. The increase in the capitalization rates will steadily increase taxable income of life insurers over time with more Tax DAC capitalized at greater rates being amortized over longer lives, but it may not necessarily increase cash tax due to the drop of the corporate tax rate to 21%. This will have to be evaluated based on each taxpayer’s fact pattern. When assessing the valuation allowance and scheduling the reversals for DTA admissibility, the new provision should be taken into account starting in 2018. With the longer amortization period, admitted DTAs related to three year Tax DAC reversals will start dropping over the course of the next three years (this assumes premium writings similar to those prior to 2018).
The TCJA contains substantial changes to the international taxation principles currently in effect, bringing the US closer to a territorial-based regime and curtailing the ability to defer tax on foreign source income. Insurers need to pay particular attention to these provisions if they are part of a global organization having intercompany charges and ceded reinsurance transactions.
DEEMED REPATRIATION OF DEFERRED FOREIGN INCOME
The TCJA moves the United States from a worldwide tax system to a participation exemption system by providing corporations a 100% dividends received deduction for dividends distributed by a controlled foreign corporation (CFC). To accomplish this transition generally requires that, for the last taxable year of a foreign corporation beginning before January 1, 2018 all US shareholders of any CFC or other foreign corporation that is at least 10-percent US-owned but not controlled (other than a PFIC), must include in income their pro rata shares of the accumulated post-1986 deferred foreign income that was not previously taxed. Income inclusion is to be taxed (a Transition tax) at a 15.5% rate on accumulated post-1986 foreign earnings held in the form of cash or cash equivalents, and 8% rate on all other earnings. To accomplish this, the TCJA permits a deduction in an amount necessary to result in a 15.5% tax on foreign earnings held in cash or cash equivalents, and an 8% tax on foreign earnings held in illiquid assets.
The TCJA allows a US shareholder to elect to pay the transition tax over eight years at 8% for the first five years, 15% in the sixth year, 20% in the seventh year and 25% in the eighth year.
Mazars Insight: We strongly suggest the performance of earnings and profits studies related to any relevant specified foreign corporations in order to accurately determine accumulated post-1986 deferred foreign income that would be subject to the transition tax. Companies utilizing net operating loss carry forwards in 2017 should consider not electing the eight year spread of the transition tax.
Companies’ 2017 year-end tax provisions need to consider this as the tax is a 2017 event. Also, if a company has made the assertion that their investment in the applicable foreign subsidiary is not being permanently reinvested, the taxable income recognized under this provision would be an increase in its tax basis in the foreign subsidiary and as such would be treated as a temporary tax difference subject to deferred tax. Otherwise, the increase in taxable income is a permanent tax adjustment.
DEDUCTION FOR FOREIGN SOURCE PORTION OF DIVIDENDS RECEIVED
The TCJA provides a 100% dividends received deduction in relation to the foreign portion of dividends received by US C-Corporation shareholders from 10% owned foreign subsidiaries. Additional features of this provision include:
- No foreign tax credit is permitted with respect for qualifying dividends;
- Hybrid dividends are not subject to the deduction;
- Dividends from Passive Foreign Investment Companies will not be eligible for the deduction;
- Dividends received by a domestic corporation from a specified foreign corporation via a partnership are eligible for the deduction provided certain requirements are met;
- Dividends received by CFCs from specified foreign corporations that are treated as subpart F income may also qualify for the deduction; and
- US shareholders must satisfy a holding period requirement of more than 365 days during the 731 day period that begins on the day that is 365 days before the ex-dividend date.
Mazars Insight: While the participation exemption brings the US closer to a territorial tax system, at least with respect to the earnings of foreign corporations, it is worth noting that Subpart F is still very much alive, and further, the bill introduces additional current tax on certain types of foreign income, described in more detail below. The overall effect is to reduce tax deferral on foreign income while modestly expanding the base.
NEW BASE EROSION AND ANTI-ABUSE TAX (“BEAT”)
The TCJA introduces a base erosion and anti-abuse tax (“BEAT”) which essentially operates as a minimum tax applicable to taxpayers that are subject to US net income tax, have average annual gross receipts equal to or exceeding $500 million (over a three year period ending with the preceding tax year), and have paid or accrued certain related party deductible amounts included in regular taxable income (i.e., base erosion payments). Note that the gross receipts test is based on controlled group rules which would require inclusion of foreign members of the controlled group, but only to the extent the foreign members’ gross receipts relate to effectively connected income (“ECI”). For insurance companies, premiums paid for gross premiums written on insurance contracts during the taxable year are also considered base erosion payments. These taxpayers will incur the BEAT tax if it exceeds their regular tax.
This minimum tax equals the excess of 10% (25% for tax years beginning after December 31, 2025) of a taxpayer’s “modified taxable income” for a tax year over the taxpayer’s regular tax liability for the tax year, with an allowance for certain credits under Chapter 1 of the Code. Modified taxable income is calculated by adding back certain deductions attributable to payments to related foreign companies and related NOLs. There are certain exceptions to the BEAT tax for small tax paying groups (i.e., taxpayers with a base erosion percentage of less than 3% for the tax year, or 2% for certain banks and securities dealers), as well as, certain types of payments excluded from the definition of what constitutes base erosion payments. Unlike the repealed AMT regime, any BEAT in excess of regular tax will not be creditable in the future.
Mazars Insight: Here is where we really see Subpart F remnants in the US taxation system, albeit at a reduced rate. However, there is still quite a bit undefined in this provision. For example, is the $500 million gross receipts test on gross of ceded reinsurance earned or written? Can ceded loss and claim reimbursements be netted from the ceded premium that’s treated as a base erosion payment? Insurers have already begun to evaluate and change their ceded reinsurance agreements in order to minimize the impacts of the BEAT. Taxpayers should begin to model projections on a regular tax and on a BEAT basis in order to determine where the breakeven point is. If taxpayers have any latitude on business income/expenses and/or timing of adjustments to taxable income (e.g., bonus depreciation), permanent tax savings may be available to them. We expect the Treasury Department to prescribe regulations as appropriate to define, with more granularity, the nature of how to calculate adjustments to modified taxable income, particularly with respect to certain industries like insurance. We also expect an explicit anti-abuse provision preventing planning to circumvent BEAT.
On January 10th the FASB in Staff Q&A TOPIC 740, NO. 4 ACCOUNTING FOR THE BASE EROSION ANTI-ABUSE TAX indicated that the BEAT is to be treated as a period cost and that deferred tax assets and deferred tax liabilities should be recorded at the regular rate. We would suspect that Statutory Accounting rules under SSAP No. 101 would follow the lead of the FASB on this issue.
DEDUCTION FOR FOREIGN-DERIVED INTANGIBLE INCOME AND GLOBAL INTANGIBLE LOW-TAXED INCOME
The TCJA permits intangible income from Foreign-Derived Intangible Income (“FDII”) to be taxed at 13.125% (the effective tax rate of 13.125% is arrived at by computing a FDII deduction). The FDII deduction can only be made if the income derived is not from a low-taxed jurisdiction.
US shareholders of CFCs are required to include in income their “global intangible low-taxed income” (“GILTI”). The mechanism for taxing such amounts would be similar to Subpart F. That is, a shareholder’s GILTI, generally equal to the excess of the shareholder’s CFC net income over a routine or ordinary return would be currently taxable and subsequently increase the shareholder’s basis in its CFC stock.
Mazars Insight: As a result of the deduction available to corporate shareholders equal to 50% of the GILTI through 2025, US shareholders will be taxed at an effective rate of 10.5% on these amounts irrespective of whether any amounts are distributed. The GILTI provision effectively increases the type of earnings subject to immediate taxation under Subpart F, indicating potential concern that the move toward a territorial system could result in profits permanently shifted offshore.
Please contact your Mazars USA LLP professional for additional information.