As foodservice companies continue to find new markets to operate in, foreign reporting for tax purposes has grown in complexity due to an increased level of scrutiny in the last several years.
U.S.-based foodservice companies with foreign subsidiaries use Form 5471 to report activity abroad on its U.S. tax return. This form requires, among other things, to report the activity of the subsidiary, including a calculation of the ongoing earnings and profits (E&P) or deficit. Simply put, this is total income or loss of the foreign subsidiary over the time period for which it has been in business, with certain adjustments.
Historically, U.S. companies could defer tax from the foreign subsidiary’s E&P. In order to do this, cash had to stay offshore. Recently; however, sweeping changes were made through the Trump administration’s new tax reform bill. One of those changes, which will affect many foodservice companies, is a one-time “Transition Tax” on previously untaxed foreign E&P from their global subsidiaries.
To determine if a company is affected, it must have a 10 percent or greater interest in a deferred foreign income corporation (DFIC). “10 percent or greater interest” is considered either 10 percent or more of the voting rights or 10 percent or more of the value of the subsidiary. Knowing what type of ownership a company has is paramount, as it can often be overlooked when understanding if it is subjected to the transition tax. For example, a U.S. company could have a direct, indirect or constructive stake in a foreign entity:
- Direct—The U.S. company owns 100 percent of a foreign corporation.
- Indirect—The U.S. company owns 50 percent of a domestic subsidiary and that domestic subsidiary owns 100 percent of a foreign corporation. The company would own, indirectly, 50 percent of the foreign corporation.
- Constructive—A foreign corporation owns 50 percent of another foreign corporation and 50 percent of a U.S.-based company. The U.S. company would constructively own 50 percent of the foreign corporation.
Foreign subsidiaries that meet the DFIC definition are those with positive E&P that haven’t been previously subject to U.S. tax. It’s important to note that this tax is not limited to U.S. corporate shareholders, but may include individual taxpayers as well.
Once the company has determined which foreign entities are subject to the Transition Tax, the income with respect to this tax is calculated for each foreign business based on two tiers. The first is a 15.5 percent on E&P related to cash and cash equivalent items and 8 percent on the remaining E&P. The due date of the tax is based on the last day of the last taxable year before January 1. Calendar year companies’ tax would have been due on or before April 17. If a company is a fiscal year company, their tax may not yet be due.
The transition tax is not all bad news in that it allows for future tax-free repatriation of foreign earnings. Companies previously hesitant to bring back cash may now be tempted to do so more regularly. There are also several other positives that exist, including: installment payments over eight years of the tax (interest free), previously taxed earnings are not subject to this tax, and an election exists for individuals to be treated as a corporation for purposes of this tax to claim a foreign tax credit.
Companies, especially in the foodservice industry with operations across the globe, that are unsure of the next steps or haven’t discussed this issue with their tax advisor should reach out for clarity as soon as possible. Additional work may be necessary to ensure that the transition tax is calculated correctly and the company is in compliance.
Like all new changes to tax law, further guidance and clarity is expected as this tax continues to be analyzed and put into practice.
Derek White is a tax supervisor in the San Francisco office of OUM & Co. LLP. He has over 11 years of experience providing ASC 740 review/prep, tax compliance, and consulting services to mid-market companies, private and public companies, and startups in a variety of industries including Consumer and Industrial Products (emphasis in food and beverage and restaurants), Life Science, Technology, and Real Estate.
Wendy Weiss is a tax partner in the San Francisco office of OUM & Co. LLP. She has almost 20 years of experience providing tax compliance and consulting services to start-up and middle market companies in a variety of industries, including consumer and industrial products, food and beverage, and technology companies.