INTERNATIONAL ASPECTS OF TAX REFORM: ANALYSIS AND PLANNING … · International Aspects of Tax...

July 2018

INTERNATIONAL ASPECTS OF TAX REFORM: ANALYSIS AND PLANNING OPPORTUNITIES

2 International Aspects of Tax Reform: Analysis and Planning Opportunities

With You Today

FRED CORSOInternational Tax Managing Director

[email protected]

MONIKA LOVINGInternational Tax

Partner & National Practice Leader

[email protected]

BEN VESELYInternational Tax Senior Manager

[email protected]


With You Today

FABRIZIA HADLOWInternational Tax Managing Director

[email protected]

CONNIE CUNNINGHAMTax Managing

Director

[email protected]


Overview of Tax Reform with an International Lens

Section 965 Transition Tax Global Intangible Low-Taxed Income

(GILTI) Tax Reform Changes to CFC Status Section 962 Elections Foreign-Derived Intangible Income

Deduction (FDII) Base Erosion and Anti-Abuse Tax

(BEAT) Other Provisions

Agenda

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Overview of Tax Reform with an International Lens


Flashback to 2017: U.S. Tax Reform Wish List

Source: BDO’s 2017 Annual Tax Outlook Survey


The Results with an International Lens

“Hybrid” territorial tax system Payments to Foreign Hybrid Entities

Global Low-Taxed Intangible Income (GILTI)

Toll-Charge on Mandatory Repatriation of Foreign Earnings

Foreign Derived Intangible Income (FDII)

Interest expense limitations for all taxpayers

Base Erosion and Anti-Abuse Tax (BEAT)


Top 2018 Issues for U.S. Tax Executives

Source: BDO’s 2018 Annual Tax Outlook Survey

9

Section 965 Transition Tax


Amended Section 965 provides for the transition:• “Mandatory Repatriation Tax”

• “Transition Tax”

• “Toll Tax”

Establishment of Participation Exemption

Transition to a participation exemption system requires that prior year earnings & profits pools be addressed.



U.S. shareholders (as defined in section 951(b)) of deferred foreign income corporations required to include their pro rata share of accumulated post-1986 deferred foreign income as of 11/2/2017 or 12/31/2017 (whichever is greater)

• Deferred foreign income corporation is a specified foreign corporation (SFC) of the U.S. shareholder which has positive accumulated post-1986 deferred foreign income on 11/2/2017 or 12/31/2017

• SFC is (a) a CFC or (b) any foreign corporation with one or more domestic corporation U.S. shareholders (which term excludes any PFIC that is not a CFC)

• Subpart F inclusion is mechanism for inclusion

• Can apply to non-corporate U.S. shareholders

• Deficits of certain SFCs available to reduce inclusion if certain conditions are satisfied


Scaled back deemed paid FTCs for eligible domestic corporations related to subpart F inclusion

Election to pay liability in 8 installments (with amounts paid in later years increasing)

Applicable for the last taxable year of a foreign corporation beginning before 1/1/18, and with respect to U.S. shareholders for tax years in which or with which such tax years of the foreign corporation end

Very generally, 15.5% rate for E&P comprising of cash and cash equivalents/8% rate for E&P comprising of illiquid assets (see section 965(c) for specific details on computing rates)



Numerous definitions and operating rules for applying provision

Additional guidance is still forthcoming; however, the following has been issued to date: Notice 2018-07, Notice 2018-13, Notice 2018-26, IRS FAQ dated March 13, 2018.

Special rules for S corporation shareholders allowing them to elect to defer payment of tax liability until certain triggering events

Broad regulatory authority including authority to prevent the avoidance of the purposes of the provision




Prospectively, new section 245A provides for a limited participation exemption:

• “Dividends Received Deduction” rather than “Exemption”

• Foreign source portion of dividends received by domestic corporations (payee)

• Specified 10-percent owned foreign corporation (payer)

• Excludes Passive Foreign Investment Companies

• Additional guidance is forthcoming


Section 965 – Documentation is critical

Statute of limitation for assessment of the net tax liability under Section 965 extended to 6 years after the filing of the inclusion year tax return

Early indicators – Information Document Requests• Detailed tax organization information• Detailed information with respect to adjustments to specified E&P pools• Foreign Exchange Rate Information• Identification of, and support for, amounts being used as cash equivalents• Support for computation of aggregate cash positions• Support for E&P deficits taken into account and allocated amongst E&P pools • Reconciliation of E&P carryforward balances from prior years and final amounts• Support for actual distributions in the Section 965 inclusion year• Support for foreign tax pools, the reduction of FTCs, and the Section 78 gross-up

All indications support a robust level of review with an expectation of equally robust supporting documentation


Section 965 – Lessons Learned

General misconceptions:• US group parent in loss position not affected

• Not relevant to US pass-through entities or individuals

• The E&P on Forms 5471 must be the correct amounts

Gap between expected and actual levels of effort required to document and support• Volume of specified foreign corporations

• Quality of information: long histories, acquisitions & reorganizations, changes to financial accounting systems

• Foreign tax pool support: compilation, translation

• Establishment of US relevance of post-1986 E&P


Section 965 – Lessons Learned

Lack of complete and timely guidance by Treasury and IRS• Makes the Section 965 inclusion a moving target

• A mistake in calculation can have meaningful consequences

What to do when• Support and information is incomplete, or

• There are open tax technical questions?

Accounting method or not an accounting method?

Fiscal year filers and dual-inclusion year filers


Section 962 Election

The section 962 election is discussed in detail during another section

Important for individual, trust, or estate US shareholders to consider, but not a panacea

The election can be made by US shareholders of a DFIC, but not by a domestic pass-through owner that is not itself a US shareholder of a DFIC

The rate equivalent deduction can be taken into account when a valid Section 962 election is made

Net Investment Income Tax


Section 965 – Consider State and Local Taxation

Some states provide for specific subtraction from federal taxable income starting point (e.g., 85 or 100 percent Dividend Received Deduction)

Some states decouple from IRC Section 965 altogether

Some states are silent and it is currently anticipated that:

• Should qualify for (full or partial) subtraction under other states’ existing Subpart F income subtraction modifications or foreign-source DRD.

• Should not be included in a state’s federal taxable income starting point for “fixed-date” IRC conformity states that have not updated.

• Some states will include Subpart F income

20

Global Intangible Low-Taxed Income (GILTI)



Global Intangible Low-Taxed Income (Section 951A) is a new provision introduced as part of tax reform.

Mechanically, it functions as a global minimum tax and introduces a lot of issues for all US shareholders of CFCs – especially individuals and partnerships

However, rules is not limited in applicability to intangibles - will heavily impact any foreign business where profit is high relative to the fixed asset base

• Services companies

• Procurement/Distribution companies

• Software/Technology companies


POST TAX REFORMPRE TAX REFORM

Global Intangible Low-Taxed Income (GILTI)CF

C IN

COM

E

Non Subpart F

Subpart F Subpart F

GILTI

Deemed Tangible Income Return

CFC

INCO

ME



U.S. shareholders of any CFC must include in gross income for a taxable year “global intangible low-taxed income” in a manner generally similar to inclusions of subpart F income (new section 951A)

• Global intangible low-taxed income with respect to a U.S. shareholder for a tax year of such shareholder is the excess (if any) of such shareholder’s “net CFC tested income” for such year over such shareholder’s “net deemed tangible income return” for such year

• “Net deemed tangible income return” is, with respect to any U.S. shareholder for a taxable year, the excess (if any) of 10 percent of the aggregate of its pro rata share of the Qualified Business Asset Investment (QBAI) of each CFC with respect to which it is a U.S. shareholder over the amount of interest expense taken into account in determining its net CFC tested income for the taxable year to the extent that the interest expense exceeds the interest income properly allocable to the interest expense that is taken into account in determining its net CFC tested income



QBAI means, with respect to any CFC for a taxable year, the average of the aggregate of its adjusted bases, determined as of the close of each quarter of the taxable year, in specified tangible property used in its trade or business and of a type with respect to which a deduction is generally allowable under section 167. The adjusted basis in any property must be determined using the alternative depreciation system (ADS) under current section 168(g) and by allocating the depreciation deduction with respect to such property ratably to each day during the period in the tax year to which such depreciation relates, notwithstanding any provision of law which is enacted after the date of enactment of this provision (unless such later enacted law specifically and directly amends this provision’s definition)

Specified tangible property means any property used in the production of tested income. If such property is used in the production of both tested income and income that is not tested income (i.e., dual-use property), the property is treated as specified tangible property in the same proportion that the amount of tested gross income produced with respect to the property bears to the total amount of gross income produced with respect to the property


How is GILTI Computed?

Net CFC Tested Income = CFC Tested Income – CFC Tested Loss

Certain items are excluded from CFC Tested Income:• Subpart F income

• Subpart F income qualifying for the high tax exception

• Effectively connected income (US)

• Dividend from a related person

• Foreign oil & gas extraction income

Net CFC Tested Income 10% of QBAI GILTIAllocable interest

expense



Ordering rules / coordination with Subpart F provisions:• Subpart F

• GILTI

• Section 956



Generally, domestic C corporations receive a deduction of 50% of the GILTI inclusion

• Coordination provision with the deduction for foreign derived intangible income (FDII)

• Limitation based on taxable income

• Results in effective tax rate of 10.5% on GILTI inclusions for C corporations (considering new 21% corporate rate)

Individuals are not eligible for the deduction so would be taxed (absent 962 election) at full ordinary individual rates on GILTI inclusion with no 50% deduction


GILTI and Foreign Tax Credits

Foreign tax credits (FTCs) are allowed against the GILTI inclusion but are calculated in their own FTC limitation basket and are subject to a 20% haircut

20% haircut means residual US tax can arise even where the foreign tax rate exceeds the US rate of 10.5%, i.e., 10.5% / .8 = 13.125%

• “Inclusion percentage” (GILTI/total tested profits without reduction for tested losses) further limits the availability of FTCs – before the 20% haircut above

No carryforward or carryback of FTCs – use it or lose it• High taxed GILTI results in complete loss of FTC

• Foreign tax of 13.125% or higher doesn’t mean “no GILTI,” just means no additional US tax – still lose the excess FTC

• GILTI can be worse than Subpart F


GILTI and Foreign Tax Credits

Expense allocation at US shareholder level can further reduce GILTI income for purposes of the FTC limitation

• Stewardship

• Interest expense (no FMV method)

• Per-shareholder calculation; no cross-chain sharing of profits and losses

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Tax Reform Changes to CFC Status


Modifications to Subpart F

Expansion of the definition of U.S. shareholder to include U.S. persons who own 10% or more of the total value of all classes of stock of a foreign corporation• Applicable to taxable years of foreign corporations beginning after 12/31/17 and to

taxable years of U.S. shareholders in which or with which such taxable years end

Elimination of the requirement that a corporation be controlled for an uninterrupted period of 30 days before subpart F inclusions apply• Applicable to taxable years of foreign corporations beginning after 12/31/17 and to

taxable years of U.S. shareholders in which or with which such taxable years end


Section 958(b)

Section 957(a) – CFC status based on 958(a) (direct/indirect) and 958(b) (constructive)

Mainly references Section 318 rules with certain modifications/exceptions (958(b)(1) through (4))

TCJA repealed Section 958(b)(4)

Former 958(b)(4) – ‘Subparagraphs (A), (B), and (C) of section 318(a)(3) shall not be applied so as to consider a United States person as owning stock which is owned by a person who is not a United States person’

Section 318(a)(3) – downward attribution – example - ‘(C) - If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person’

Repeal of 958(b)(4) now allows downward attribution from a foreign person to a US person


Foreign Corp(FC)

U.S. Corp(DC)

U.S.Individual

Unrelated Foreign

Section 958(b)(4) Repeal

100%100%

15%85%

Foreign Fund(FP)


Repeal of 958(b)(4)

Senate Finance Committee explanation on 958(b)(4) repeal:

“This provision is not intended to cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under section 318(a)(3) to a U.S. person that is not a related person (within the meaning of section 954(d)(3)) to such U.S. shareholder as a result of the repeal of section 958(b)(4).”

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Election to be taxed as a corporation with respect to Subpart F, GILTI.

Allows individual CFC shareholders to be treated as domestic corporations with respect to section 951(a) inclusions

When actual distributions are made from CFC, those amounts are includible in gross income (minus any corporate tax paid in connection with the 962 election)

Restriction to 10% owners of CFCs? See Notice 2018-26

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Foreign-Derived Intangible Income Deduction (FDII)


Permanent deduction for C corporations starting in 2018 If fully maximized, deduction results in a rate reduction of almost 8% on FDII Some overlap with section 199 (but broader?)

Foreign-Derived Intangible Income (FDII) Deduction


If a taxpayer’s combined FDII and GILTI exceed taxable income, the amount of FDII and GILTI is reduced pro-rata by the excess

Unclear if taxable income limitation is applied before or after any NOL deductions

Interaction with GILTI


Sale, lease, license, exchange or other disposition of property sold by taxpayer to a non-U.S. party for foreign use

Services provided by taxpayer to any person, or with respect to property, not located in the U.S.

Special rules for property/services provided to related parties

What Qualifies for FDII?


How is FDII Computed?

Deduction Eligible Income: total gross income minus ineligible income streams (e.g., subpart F and foreign branch income)Foreign-Derived Deduction Eligible Income: subset of Deduction Eligible Income related to qualifying activities


QBAI: average aggregate of adjusted bases in tangible property used in a taxpayer’s trade or business (determined using the alternative depreciation system under section 168(g))

What is Deemed Intangible Income?

Deduction Eligible Income 10% of QBAI Deemed

Intangible Income


Manufacturers

Retailers/distributors

Software developers

Franchisers

Construction/engineering firms

Other service providers/consultants

Potential Beneficiaries of FDII

44

Base Erosion and Anti-Abuse Tax(BEAT)


BEAT Overview - Section 59A

BEAT is an additional minimum tax imposed on “applicable taxpayers” that make certain “base erosion payments” to foreign related parties

Applies to base erosion payments paid or accrued beginning after December 31, 2017

BEAT is a complex calculation, but generally is the excess of the rates below of a corporation’s “modified taxable income” (MTI) over its regular tax liability adjusted for certain credits

5%CY 2018

10%CYs 2019 -

2025

12.5%Cys 2026 +

BEAT MTI RATES


Applicable Taxpayer - Section 59A(e)

Very generally, an applicable taxpayer is each of:• A corporation (other than a RIC, REIT or S corporation)

• Has average annual gross receipts for the prior 3-taxable year period of at least $500 million

• Has a “base erosion percentage” of 3% or more for the tax year (2% where a bank or securities dealer is part of the affiliated group)

Certain aggregation rules apply for purposes of these threshold tests (see Section 59A(e)(3))


Base Erosion Payment - Section 59A(d)

Base erosion payments generally are paid or accrued to a related foreign person and:• Are deductible under the Code

• Are connected to a property acquisition subject to allowances for depreciation or amortization

• Are premiums or other consideration for reinsurance payments under Sections 803(a)(1)(B) or 832(b)(4)(A)

• Result in a reduction of the gross receipts of the taxpayer for payments to certain related post-11/9/17 expatriated/inverted groups

Certain exceptions apply. For example: • COGS

• Amounts paid that are eligible under the Section 482 Services Cost Method (SCM), without regard to the business judgment rule


Base Erosion Percentage - Section 59A(c)(4)

BASE EROSION % COMPUTATION

Aggregate Amount of Base Erosion Tax Benefits

Aggregate Amount of Deductions Allowed for

the Taxable Year

Base Erosion %


Section 59A(c)(1) Modified Taxable Income

MTI COMPUTATION

MTI Taxable Income

Base Erosion Tax

Benefits

Base Erosion %

Sec. 172 NOL

Deductions for Year


BEAT Example

Parent (Non-U.S.)

WW IP Co(Non-U.S.)

CFC (Non-U.S.)

U.S.Group

License U.S. IP

$70M Royalties

$50M Interest & $5M Service Fee

(SCM Eligible)

3rd Party Customers

Sales$10M Service

Payments(not SCM Eligible)


BEAT Example - Assumptions

For US Group (USG):• USG average gross receipts for 2016 through 2019 ≥ $500M

• USG 2019 taxable income = $100M

• $5M tax credits ($3M are R&D credits)

• USG related party payments:- $50M interest paid to Parent ($5M limited under new 163(j))

- $70M royalties to WW IP Co

- $5M shared services fees that qualify the SCM method (no markup)

- $10M service payments to CFC (not SCM eligible)

- USG All expenses = $400M

- Parent and WW IP Co are US tax treaty eligible

- No USG depreciation / amortization deductions in connection to property acquired from post-2017 related-party transactions


Calculate Base Erosion Percentage• Deductions attributable to base erosion tax benefits

• All deductions

BEAT Example - Step 1

Related Party Transactions Amount

Base Erosion

PaymentsBase Erosion Tax Benefits Note

Interest Paid to Parent 50$ 50$ 45 [a]Royalties to WW IP Co 70$ 70$ 70 Shared Services Fees (no mark-up - SCM eligible) 5$ [b]Service payments to CFC (not SCM eligible) 10$ 10$ 10 Total 135$ 130$ 125$

Base Erosion Tax Benefits 125$ Total of all deductions 400$ Base Erosion Percentage 31.25%

Notes[a] $5M of the interest paid to Parent is disallowed under the new section 163(j)[b] Payments eligible for the SCM method (without regard to the business judgement rule) are excluded from the definition of Base Erosion Payments


Determine Tax Liability Floor for BEAT • Regular tax liability (21% x taxable income) – tax credits (excluding R&D)



Determine MTI• MTI = Base Erosion Tax Benefits + Taxable Income



10% of MTI 22.5$ BEAT Floor 19$ Base Erosion Minimum Tax Amount/BEAT liability 3.5$

Determine BEAT Liability• Base Erosion Minimum Tax Amount = 10% of MTI – BEAT Floor



Determine Overall Tax Liability• Overall Tax Liability = Regular Tax Liability (with credits) + BEAT Liability



Tax Issues Related to BEAT

Cost of Goods Sold Exception • Assess whether cost previously charged separately can be incorporated into

intercompany product charges (COGS)

Services Cost Method Exception • Some discussion of bi-furcating cost from the markup

• Closer look at whether any costs previously charged with a markup would qualify for SCM election

• Closer look at whether any duplicative services and/or shareholder expenses can be identified and carved out

• OECD Guidelines Chapter VII provides for an election for low cost services similar to SCM using a 5% markup

• Likely to see support for cost-based charges under the SCM and then address rationale for no mark up with local jurisdiction under audit

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Other Provisions


Other Provisions

Interest Expense Limitation

Sale of Partnership Interest


Summary

Significant changes require analysis and re-assessment of existing structures

Additional guidance is forthcoming and should be monitored carefully to continue assessment of tax reform impacts


Monika Loving - [email protected] Fred Corso - [email protected] Ben Vesely - [email protected] Fabrizia Hadlow - [email protected] Connie Cunningham - [email protected]

Questions?

mailto:[email protected]





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