US Corporate Taxation

Corporate taxes are imposed in the US at state and some local levels on the incomes for the purpose of taxation. The trends of the rules and laws followed by the government are seen changing over every five years. The most notable change was the decision to shift from ‘worldwide’ to ‘territorial’ system of taxation. This article gives an overview of the trend changes and a complete understanding of US corporate tax systems along with its sub divisions.    


CONTENTS
  • History
  • The Public-Law:115-97
  • Revenue
  • Insights into Corporate taxes divisions-
  • Base Erosion and Anti-abuse Tax (BEAT)
  • State and local income tax
  • Gross transportation income taxes
  • Shareholder-level tax
  • India-US Taxation

HISTORY

The US first witnessed Worldwide taxation system for years where the resident individuals and entities are taxable on their worldwide income regardless of where the income is derived. But soon, the US tax reform legislation enacted on 22 December 2017 (Public Law (P.L.) 115-97) moved the United States from a ‘worldwide’ system of taxation towards a ‘territorial’ system of taxation, which imposes tax only on income derived within its borders, irrespective of the residence of the taxpayer. The vision about the territorial system was that it would eliminate the need for complicated rules such as the controlled foreign corporation (CFC or Subpart F) rules and the passive foreign investment company (PFIC) rules that subject foreign earnings to current U.S. taxation in certain situations. Hence, P.L. (115-97) permanently reduced the 35% CIT rate on resident corporations to a flat 21% rate for tax years beginning after 31 December 2017*. [1]


THE PUBLIC LAW:115-97[4]

List of bills passed under Public Law No: 115-97

Under this segment, the tax cut or jobs act(TCJA) was reformatted in 2017 which includes nearly doubled standard deduction, new limitations on itemized deductions, reduced income tax rates, and reforms to several other provisions. Most of the reformed bills are stated below-

  1. S.2490 — 116th Congress (2019-2020)

Child Tax Credit Extension Act –This bill makes permanent changes to the child tax credit enacted by the Tax Cuts and Jobs Act (P.L. 115-97), including increasing the amount of such credit from $1,000 to $2,000.

  • H.R.589 — 116th Congress (2019-2020)

Middle Class Savings Act- This bill modifies the tax brackets that apply to taxes on capital gains. The bill aligns the thresholds with the brackets for the regular income tax rates enacted in P.L. 115-97 (commonly known as the the Tax Cuts and Jobs Act).

  • S.1996 — 116th Congress (2019-2020)

Net Operating Loss Clarification Act of 2019- This bill amends the Tax Cuts and Jobs Act of 2017 (P.L. 115-97) to provide that the net operating carryforward and carryback modifications in that Act are effective for net operating losses arising in taxable years beginning after December 31, 2017 (instead of tax years ending after December 31, 2017).

  • H.R.217 — 116th Congress (2019-2020)

Permanent Tax Relief for Working Families Act– This bill makes permanent the modifications to the child tax credit that were included in P.L. 115-97 (commonly known as the Tax Cuts and Jobs Act). (The provisions increased the amounts of the credit and created a nonrefundable credit for a taxpayer’s dependents who are not qualifying children. Under current law, the provisions are scheduled to expire at the end of 2025.)

  •  H.R.3587 — 116th Congress (2019-2020)

To amend the Internal Revenue Code of 1986 to modify the effective date for the modification to net operating loss deductions in Public Law 115-97 This bill amends the Tax Cuts and Jobs Act of 2017 (P.L. 115-97) to provide that the net operating carryforward and carryback modifications in that Act are effective for net operating losses arising in taxable years beginning after December 31, 2017 (instead of tax years ending after December 31, 2017).

The bill also allows an extension of the deadline for filing an application for a tentative carryback adjustment for net operating losses arising before January 1, 2018, and ending after December 31, 2017.

  • H.R.957 — 116th Congress (2019-2020)

Tax Cuts and Jobs Middle Class Enhancement Act- he bill makes permanent the tax reductions and other provisions for individuals that were enacted in P.L 115-97 (commonly known as the Tax Cuts and Jobs Act) and are scheduled to expire at the end of 2025.

The bill also increases the standard deduction,

  • makes permanent the reduction in the adjusted gross income threshold that must be exceeded before a taxpayer is allowed to claim an itemized deduction for medical expenses, and
  • increases the refundable portion of the child tax credit.

REVENUE

     Revenues from the Corporate Tax Rate are an important source of income for the government of the United States as it serves about 7% of the revenue to the country’s economy (as seen in the flowchart).

Revenue contribution by taxation sectors

Taxable corporate profits are equal to a corporation’s receipts less allowable deductions—including the cost of goods sold, wages, and other employee compensation, interest, depreciation, and advertising. US-based corporations owned by foreign multinational companies generally face the same US corporate tax rules on their profits from US business activities as US-owned corporations. The corporate income tax raised $230.2 billion in fiscal 2019, accounting for 6.6 percent of total federal revenue, down from 9 percent in 2017*.[2]

Corporate income tax trends

     US Corporate taxation is mainly subjected to the reduction of foreign-derived intangible income (FDII) of domestic corporations along with additional tax computations of base erosion and anti-abuse tax (BEAT), state, and local income taxes with Gross transportation income taxes. 


TAKING AN INSIGHT INTO ALL THE CORPORATE TAXES-

Base Erosion and Anti-abuse Tax (BEAT)

P.L. 115-97 created a new US federal tax called the ‘base erosion and anti-abuse tax’ (BEAT) which targeted US tax-base erosion by imposing an additional corporate tax liability on corporations that have average annual gross receipts for the three years ending with the preceding tax year of at least USD 500 million and that make certain base-eroding payments to related foreign persons during the tax year of 3%. The BEAT is imposed to the extent that 10% of the taxpayer’s ‘modified taxable income’ that exceeds the taxpayer’s regular tax liability net of most tax credits. For tax years beginning after 31 December 2025, the percentage of modified taxable income increases to 12.5% and allows all credits to be applied in determining the US corporation’s regular tax liability.[3]

State and local income tax

CIT rates vary from state to state and generally range from 1% to 12%. The most common taxable base is federal taxable income which is based on apportionment formula consisting of: tangible assets and rental expense, sales and other receipts, and payroll. State and municipal taxes are deductible expenses for federal income tax purposes.

Gross transportation income taxes-

Foreign corporations and non-resident alien individuals are subject to a yearly 4% tax on their US-source gross transportation income (USSGTI), which has an exception for income connected with a US trade or business. Transportation income is any income derived from, or in connection with the use of a vessel or aircraft or the performance of services directly related to the use of a vessel or aircraft.

Shareholder-level tax

Corporate profits can also be subject to the second layer of taxation at the individual shareholder level, both on dividends and on capital gains from the sale of shares. Non-qualifying dividends and short-term capital gains are taxed as ordinary income at current rates of up to 40.8 percent, by contrast, the maximum tax rate on qualifying dividends and long-term capital gains is currently 23.8 percent.

 However, shareholders of S Corporations and mutual funds are taxed currently on corporate income and do not pay tax on dividends.

The current rules and laws favor till 2025 and further improvisation withstands later.


INDIA-US TAXATION[5]

CONTENTS:

  • Introduction
  • Taxes covered
  • Residential status
  • Relief from Double Taxation

INTRODUCTION

The annexed convention between the two government of India and the US have come into force where they have decided for the avoidance of double taxation and prevention of fiscal evasion with respect to the taxes on income. The basic vision behind this treaty was to give a relief to NRI from paying heavy taxes and to cut down on their tax implications on the income earned in India. DTAA also reduces the instances of tax evasion. To sum up, governments enter into a Double Taxation Avoidance Agreements with the intent of providing relief to the tax-payers by either exempting the income earned abroad or by providing credit to the extent of tax already paid in the contracting countries.


TAXES COVERED
  1. The existing taxes to which this Convention shall apply are :
  2. In the US-
  3. The Federal income taxes imposed by the Internal Revenue Code (excluding the earning tax, security tax and the personal holding company tax).
  4. “US tax” which are paid on insurance premiums paid to foreign insurers and with respect to private foundations.

Provided; convention shall exercise tax imposed on insurance premiums paid to foreigners, making sure that it is not reinsured by a person entitled to the exempt of the taxes under this or any other convention which applies to these above stated taxes.

  • In India-
  • the income-tax including any surcharge thereon, but excluding income-tax on undistributed income of companies, imposed under the Income-tax Act.
  • “Indian tax”- the surtax.

RESIDENTIAL STATUS

The term “resident of a Contracting State” means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, citizenship, place of management, place of incorporation, or any other criterion of a similar nature.

If the person is a resident of both the states, then the residence will be determined as follows:

  • Owns a permanent house- Deemed to be a resident of the country in which personal and economic relations are closer.
  • If the above rule is unclear to the person and he/she cannot determine the vital interests then, he shall be deemed to be a resident of the State in which he has an habitual abode.
  • If possessing habitual adobe in both states, deemed to be a resident of the State of which he is a national.
  • If he is a national of both States or of neither of them, the competent authorities of the Contracting States shall settle the question by mutual agreement.

RELAXATION FROM DOUBLE-TAXATION

USA shall allow the credits against US tax with respect to-

  • the income-tax paid to India by or on behalf of such citizen or resident.
  • if the United States company owning at least 10 per cent of the voting stock of a company which is a resident of India and from which the United States company receives dividends, the income-tax paid to India by or on behalf of the distributing company with respect to the profits out of which the dividends are paid.

India shall allow the amount equal to the income tax paid in the United States as a deduction if an Indian resident derives an income and same is taxed in the US and shall be deemed to arise as:

  • Income derived by a resident of a Contracting State which may be taxed in the other Contracting State in accordance with this Convention.
  • income derived by a resident of a Contracting State which may not be taxed in the other Contracting State in accordance with the Convention shall be deemed to arise in the first-mentioned State.
REFERENCES

*Switch to territorial taxation has made U.S. more competitive over three years but as mentioned in the article above, the BEAT sector has seen a diminishing gain.

[1] “Tax Policy Center” < https://www.taxpolicycenter.org/briefing-book/how-does-corporate-income-tax-work> accessed 5th June 2020.

[2]  “Receipts by Source as Percentages of GDP: 1934–2025.” < https://www.whitehouse.gov/omb/historical-tables/> accessed 5th June 2020.

[3]“Historical tables” <https://www.whitehouse.gov/wp-content/uploads/2020/02/hist02z3_fy21.xlsx> accessed 5th June 2020

[4]“congress.gov” <https://www.congress.gov/search?q={%22congress%22:[%22116%22],%22source%22:%22all%22,%22search%22:%22P.L.%20115-97%22}&searchResultViewType=expanded&KWICView=false>accessed 6th June 2020

[5] “Income Tax Department” <https://www.incometaxindia.gov.in/pages/international-taxation/dtaa.aspx> accessed 6th June 2020

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