Question

In explaining the taxation of Controlled Foreign Corporations, states that “a U.S. person that conducts business or invests abroad through a foreign corporation generally pays no U .S. income tax of the foreign corporation’s foreign-sourced earnings unless and until such earnings are distributed to the U.S. person or the U.S. person disposes of the foreign corporation’s stock.” Briefly explain the operation of the current “deferral system” and its replacement under the new tax law. (Not more than one page in explaining the deferral system and two pages in presenting the new law.)

Answer 1

A deferral, in accrual accounting, is any account where the asset or liability is not realized until a future date (accounting period), e.g. annuities, charges, taxes, income, etc. The deferred item may be carried, dependent on type of deferral, as either an asset or liability. See also accrual.

Deferrals are the consequence of the revenue recognition principle which dictates that revenues be recognized in the period in which they occur, and the matching principle which dictates expenses to be recognized in the period in which they are incurred. Deferrals are the result of cash flows occurring before they are allowed to be recognized under accrual accounting. As a result, adjusting entries are required to reconcile a flow of cash (or rarely other non-cash items) with events that have not occurred yet as either liabilities or assets. Because of the similarity between deferrals and their corresponding accruals, they are commonly conflated.

One of the biggest problems with the United States tax code is that it encourages multinational corporations to artificially shift their profits offshore, or even shift real investments and jobs offshore, to avoid paying taxes. A real tax reform would have put an end to tax avoidance and the tax incentives for offshoring, but the Tax Cuts and Jobs Act (TCJA) made both of these problems worse.

Under the previous tax system, companies were required to pay the full 35 percent corporate tax rate (minus any foreign taxes paid) on their offshore profits. The problem was that companies could defer paying U.S. taxes on their offshore profits indefinitely as long as they technically held them in their offshore subsidiaries. This created a huge incentive for companies to use accounting gimmicks to make their profits appear to be earned in offshore tax havens, where they could hold them on paper for years without paying taxes