Manufacturers face pressure to be efficient. As global competition in the manufacturing space continues to accelerate, many in the industry are looking for every opportunity to streamline cost.
Chief among manufacturers’ cost-saving evaluations should be tax strategy. Recent changes to tax provisions now offer additional opportunities for you to minimize your tax burden.
Passed in December 2015, the Protecting Americans against Tax Hikes (PATH) Act makes permanent several tax deductions that previously had to be renewed each year and includes longer-term extensions of others. Manufacturers that operate internationally should take particular note of the Act’s extension of several tax reduction opportunities for conducting business abroad. The legislation could mean the chance to lower your overall effective tax rate, bringing significant benefits to your operations.
Active Financing
Under the Subpart F rules, certain income earned by controlled foreign corporations (CFCs) that are more than 10 percent owned by U.S. shareholders must be included as part of shareholders’ income even if the shareholders do not receive distributions from the CFC. Subject to the Subpart F rules, this income generally includes dividends, interest, rents and royalties, net gains or losses from property or interests in trusts, commodities transactions and foreign currency transactions as well as payments in lieu of dividends and payments received under personal contracts.
An exception to recognizing these CFC earnings exists for the U.S. parent of a foreign subsidiary if the subsidiary is substantially engaged in banking, financing or similar business. CFCs that conduct finance activities in their home country as part of their core business functions do not trigger the Subpart F income requirement because they are considered to be generating “active financing income.” As a result, the U.S. shareholder does not have to treat the CFC’s income resulting from the finance activities as Subpart F income and can defer U.S. income tax on these earnings.
Prior to the PATH Act, the active financing exception applied for tax years of foreign corporations and their U.S. shareholders beginning after Dec. 31, 1998, and before Jan. 1, 2015. The Act retroactively extends the exception for the 2015 tax year and makes it permanent.
Look-Through Rule for Payments between CFCs under Foreign Personal Holding Company Income
Another exception to the Subpart F requirement also received an update from the PATH Act. The Act created an extension for the "look-through" rule for qualifying payments between select CFCs.
Foreign base company income, including foreign personal holding company income, is subject to Subpart F treatment. Certain U.S. shareholders must include dividends, rents and royalties earned by a CFC because it qualifies as foreign personal holding company income.
An exception exists for dividends, rents and royalties received by one CFC from a related CFC, that is, a CFC that is either controlled by another CFC or controlled by the same shareholders as the first CFC. In what is known as the “look-through treatment,” the intercompany income can be excluded from Subpart F to the extent that it is not effectively connected with the conduct of a U.S. trade or business or to the extent the income is attributable or properly allocable to non-Subpart F income of the payor.
The look-through payment had applied to foreign corporations and their U.S. shareholders for tax years beginning after Dec. 31, 2005, and before Jan. 1, 2015. With the PATH Act, the look-through treatment is retroactively reinstated for the 2015 tax year and extended to include tax years that start before Jan. 1, 2020 (calendar year 2019).
Domestic Production Activities Deduction Rules for Puerto Rico Extended Through 2016
Section 199 creates incentives for U.S.-based manufacturing activities. Taxpayers can take deductions equal to 9 percent of the lesser of their qualified production activities income or their taxable income for the year. QPAI includes the domestic production gross receipts (DPGR) for the year, less any allocable costs or expenses. DPGRs for the year include the manufacturing, production, construction, sale, or exchange of tangible property conducted in significant part in the U.S.
Domestic Production Activities Deductions (DPAD) are capped at 50 percent of the wages paid by the taxpayer that are allocable to the domestic production gross receipts during that tax year. Under the PATH act, certain exceptions related to Puerto Rico continue to exist. Taxpayers can include Puerto Rico-sourced receipts if the receipts are subject to federal income tax for individuals or corporations. In computing the 50 percent wage limitation, the taxpayer can also include wages of eligible Puerto Rico residents for their services performed in Puerto Rico.
Opportunities Take Planning
To fully maximize the benefits created or extended by the PATH Act, a manufacturer with international operations should carefully consider all of the options for which you may qualify. Contact us to learn more about how you can lower your tax liability for 2015 and the years to come.
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