In December of 2017, the United States (U.S.) enacted tax reform commonly known as the “Tax Cuts and Jobs Act” (TCJA), which was initially thought to “establish a territorial tax system for multinational companies.” Over time, however, tax professionals began to understand that the TCJA layered a territorial tax system that exempted foreign earnings from the U.S. income tax (exemption tax system) on top of a residence-based worldwide tax system that used a foreign tax credit (FTC) to protect against juridical double taxation (worldwide tax system). Furthermore, the U.S. exemption tax system is severely limited by the worldwide tax system. This Article continues an analysis developed in a companion paper, Is the Tax Cuts and Jobs Act GILTI of Anti-Simplification?, which demonstrates that previously taxed income (PTI) is the keystone used to determine whether dividends are taxed as part of the worldwide or exemption tax system.
Historically, PTI was used to prevent a United States shareholder from paying taxes twice on certain earnings of its foreign corporations. Without a method to track income taxed by the United States, a U.S. shareholder would potentially pay taxes twice on the same earnings— once as an inclusion required by Subpart F (Subpart F) and again as a payment of dividends. Section 959 tracked previously taxed earnings and profits to ensure that earnings taxed as a Subpart F inclusion were excluded from gross income when actually distributed to the U.S. shareholder.7 Prior to the 2017 tax reform, § 959 implemented the policy goals of “avoiding double taxation and allowing United States persons to receive the full benefit of their PTI at the earliest possible time.”8 However, when the TCJA effected an exemption for the foreign source portion of dividends distributed to corporate U.S. shareholders,9 the actual distribution of earnings was no longer a taxable event. This precipitated the question: Does the United States still need the concept of PTI after the TCJA?
This Article examines the operation of previously taxed income rules after enactment of the TCJA and whether PTI is still a necessary part of the U.S. international tax system. This paper is organized as follows: Part II summarizes the statutory law related to previously taxed income before and after the TCJA. Part III presents a hypothetical multinational corporation and demonstrates how the PTI rules affect the determination of U.S. corporate income tax. Part IV considers whether tax policy historically supporting PTI is still valid. Part V demonstrates how the post-TCJA laws function to override the U.S. exemption tax system and effectively create a pure worldwide tax system without deferral for multinational corporations with a large amount of PTI. Part VI concludes.
Christine A. Davis, More Anti-Simplification: How PTI and GILTI Override the Section 245A Exemption and the U.S. Territorial Tax System, 71 Mercer L. Rev. 471 (2020). Available at: https://digitalcommons.law.mercer.edu/jour_mlr/vol71/iss2/3/