No major legislative initiative would be complete without an arm-long list of new acronyms. Dodd-Frank had its CCPs (Central Counter Parties), DCOs (Designated Clearing Organizations) and LEIs (Legal Entity Identifiers). Obamacare had its ACOs (Accountable Care Organizations), HIEs (Health Information Exchanges) and EHRs (Electronic Health Records). The Tax Cuts and Jobs Act is no different. Even its name has been co-opted by shorthand to become TCJA.
As accounting firms, corporate tax departments, CFOs and tax software companies start digesting the new law and incorporating many of its new buzzwords into the vernacular of corporate finance speak, there are still a fair amount of pregnant silences and quizzical looks out there when tax pros start rattling on about BEAT, FDII, GILTI and QBAI.
So, for those of you still trying to crack the code on your kids’ text messages, consider this your guide to the new alphabet soup of corporate tax reform.
GILTI and QBAI
The new tax law is similar to a participation exemption tax system, which contains a number of details that change the way United States-based corporations need to address foreign income. Under previous law, which was rooted in a worldwide tax system, U.S.-based corporations were taxed on all income, whether it was derived in the U.S. or abroad. Foreign income was then subject to tax when it was repatriated back into the U.S.
The new law creates a new category of foreign income called Global Intangible Low Taxed Income (GILTI), which is applicable to U.S. shareholders who own 10 percent or more of a foreign corporation. GILTI income is defined as any foreign income that exceeds 10 percent of a foreign subsidiary’s Qualified Business Asset Investment (QBAI), which is essentially the fixed assets of each foreign subsidiary with U.S. tax depreciation rules applied.
The GILTI definition assumes that 10 percent of a corporation’s profit is attributable to tangible, fixed assets, or QBAI, that are depreciable as trade or business assets.Any profit in excess of that 10 percent is GILTI. The GILTI computation is done at the foreign subsidiary level and then combined to the common shareholder level, so income in one corporation can be offset by losses in another corporation if they have the same owner.
For tax years beginning in 2018 and ending in 2025, U.S. corporations are allowed to deduct 50 percent of their GILTI. After 2025, the GILTI deduction is lowered to 37.5 percent.
There’s more. Under the new law, a U.S.-based corporation can claim a deduction for 37.5 percent of its Foreign-Derived Intangible Income (FDII) for tax years 2018 through 2025. After 2025, that FDII deduction drops to 21.875 percent. What that means is for the next seven years, U.S. corporations will only be charged 13.125 percent tax on this “intangible” foreign income. After that initial seven-year period, corporations will be charged 16.406 percent tax on their FDII.
If that sounds a little complicated, it’s because it is. The FDII calculation applies a complex series of formulas to determine how much of the US corporation’s income is considered intangible. Similar to the GILTI calculation, it assumes that any foreign income in excess of a 10 percent return on the corporation’s U.S. depreciable assets is FDII. That excess amount is the part that’s subject to the lower tax.
In layman’s terms, all of this means that the U.S. government is basically assuming that companies should get a routine return of 10 percent on their tangible assets. Anything in excess of that is deemed attributable to an intangible asset, which is subject to the new deduction. The calculation is designed to carve out income from patents and other intellectual property that extend beyond routine, tangible income, thereby incentivizing the development of valuable intellectual property inside the U.S.
As if the GILTI acronym weren’t enough to inspire all manner of clever wordplay among accounting firm analysts, the new tax law also brought us a BEAT tax. BEAT refers to Base Erosion Anti-abuse Tax and is designed to discourage U.S. corporations from trying to reduce their U.S. tax liability by making cross-border payments to foreign-based affiliates.
In a nutshell, the BEAT will impose a 10 percent minimum tax on certain deductible payments made to foreign affiliates, including things like royalties and management fees, but excluding cost of goods sold. This would apply to U.S. companies that are potentially paying no U.S. tax currently and generating tax losses with allowable deduction for services and royalties paid to their foreign-affiliated companies.
BEAT will have a big impact on multinational corporations that engage in overly aggressive profit- shifting strategies, whereby a U.S.-based corporation transacts business with one of its foreign subsidiaries in a low-tax regime in order to only pay taxes on that activity in the low-tax country.
Under BEAT, these types of “tax deductible” payments made between foreign subsidiaries will be added back to taxable income and taxed at a rate of 5 percent for the first year and will eventually grow to 12.5 percent by 2025.
Where’s my rosetta stone?
Even the most clearheaded effort to explain these new tax concepts in a concise, accessible manner is easily thwarted by complexity. To truly understand a concept like FDII, for example, you must first understand a convoluted set of formulas used to separate tangible assets from intangible assets and a sliding timeline of implementation dates before you can begin to figure out what’s deductible and what’s taxed.
Part of this is due to the fairly muddled language of the law itself, which was put together very quickly, and is short on detail when it comes to explaining exactly how these new tax concepts should be implemented. And part of it is due to the pure newness of the law. The accounting firms, law firms and consultancies of the world have only just begun to digest the information and project the impact the law will have on large corporations.
The Treasury Department has indicated that providing additional guidance on GILTI and BEAT is a priority for the agency and it hopes to provide that guidance by the end of this year. As more analysis continues to be published, and as more companies go through the physical process of determining their 2018 taxes, precedents will be set and best practices will be established. Until that happens, at least you’ll know what the acronyms mean!
A version of this article originally appeared on Forbes.