Four Year-End International Tax Tips for Multinational Companies
In addition to managing the usual end-of-year planning considerations, multinational corporations this year have to contend with the added dimension of the tax reform currently under way in the U.S. The last major tax reform of this scale occurred more than 30 years ago with the Tax Reform Act of 1986. Hence, as tax reform appears imminent, multinationals should be proactive rather than reactive in addressing the provisions that are applicable to their operations to determine the impacts of any potential planning opportunities, if any.
Following are several key topics multinational corporations should consider in completing their year-end international tax planning.
1. Consider Tax Reform, NOW
One of the major objectives of the tax reform is to level the playing field by making the cost of conducting business in the U.S. more competitive with the rest of the world. Post tax reform, multinational corporations will be able to repatriate the earnings of its foreign subsidiaries tax free by virtue of new dividends received deduction provided the income is not Subpart F income, or global intangible low-taxed income.
Both the House and Senate plan for tax reform contain a provision for repatriation of foreign profits. The overarching theme on both plans is to impose an immediate tax on existing foreign earnings and profits (“E&P”) not previously taxed in the U.S. The existing E&P of U.S.-owned foreign subsidiaries will be deemed repatriated at a reduced tax rate.
The House plan imposes a tax of 14% on earnings attributable to liquid assets (i.e., cash and cash equivalents) and 7% on earnings attributable to illiquid assets. The Senate plan would tax these items at an effective rate of 14.5% and 7.5%, respectively. The effective tax rate is further reduced when considering other tax attributes including foreign tax credits (“FTC”) and previously taxed income (“PTI”). The tax due under the transition tax may be paid over an eight-year period. Each plan provides rules on how the tax would be paid.
The transition tax will apply to a wide category of U.S. shareholders. Although the transition tax is imposed on all categories of U.S. shareholders of 10% owned foreign corporations, the tax attributes that may be available to offset some of the tax will vary. For example, individuals and S corporations are not entitled to any deemed paid foreign tax credits that are available to domestic corporations. Not surprisingly, individuals and S corporations will not receive any post-transition dividend received deductions on dividends received from foreign subsidiaries. The tax reform plans appear to favor domestic corporations over other categories of U.S. shareholders.
In preparation for the transition tax, all categories of U.S. shareholders should conduct a detailed analysis of all of its tax attributes including their foreign subsidiaries E&P, PTI, and FTC postures. Without modeling out the potential tax impacts, it would be difficult for U.S. shareholders to prepare for and to have a payment method in place to pay the fat transition tax check when the time comes for filing their U.S. tax returns.
Multinationals should also model out the global effective tax rate upon the U.S. transition into a territorial regime. Plans for expansion and contraction overseas, reorganizations, and consolidation of operations should be incorporated into these models. The potential corporate tax rate of 20% may put the U.S. on the map as an attractive IP holding company destination or trading company location. This is bolstered by certain provisions of the tax reform plans that would currently tax multinationals on a portion of their subsidiaries’ global intangible low-taxed income. Multinationals will generally have current inclusion of intangible income earned by its foreign subsidiaries operating in a foreign jurisdiction with a tax rate below 12.5%. Given this added layer of potential tax cost, IP migration as an international tax planning technique may no longer be as attractive, and we may even start seeing reverse IP migrations into the U.S.
The tax model should also factor in certain tax benefits that may be removed under the final law (e.g., IC DISCS, Section 199 deductions, etc). We encourage taxpayers to craft multidimensional models incorporating all the various potential impacts tax reform would create. Alternatively and simply stated, just inserting 20% instead of 35% into current models will not provide any insight into the impact of tax reform.
2. BEPS, CbC, and MF/LF Reporting Requirements
Companies with transfer pricing issues should review the latest guidance on the implementation of country-by-county (“CbC”) reporting issued by the Organization for Economic Cooperation and Development (“OECD”) in September 2017. The guidance represents the latest update to reporting requirements for multinational entities (“MNEs”) with consolidated global revenues of €750 million for OECD and $850 million for U.S. respectively or more under the Base Erosion and Profit Shifting (“BEPS”) Action 13 plan adopted by the OECD and G20 countries in 2013. Even though many MNE may not meet the threshold requirements (which may also vary on a cCbC basis), the key concepts still apply and heightened transparency focuses on aligning tax paid with the value-chain of the business.
One issue to consider is whether a given jurisdiction allows for an MNE to nominate a constituent entity to act as a surrogate parent entity and file a CbC report on a voluntary basis. Currently, nine countries have indicated that they will allow voluntary parent surrogate filing by a resident ultimate parent entity of an MNE group, while more than 45 countries will permit surrogate filing by a constituent entity that is not the ultimate parent entity of the group, as outlined here.
Another factor centers on the master file/local file (“MF/LF”) system of transfer pricing documentation. In such a system, an MNE will separate documentation into a master file to be shared with all tax authorities, and a local file that contains information specific to a particular country. A growing number of countries, including Australia, China, Germany, and Japan, have adopted the MF/LF system in their implementation of BEPS Action 13, and many countries will impose penalties on MNEs that do not comply. The number of countries requiring this format is expected to grow in the coming years, so companies should be looking to adopt it in the near future. Finally, several countries have enacted law changes scheduled to take effect in 2018 as a result of BEPS. Japan has modified its controlled foreign company (“CFC”) rules to broaden the scope of passive income in an attempt to subject the income of several types of foreign companies to the rules.
3. Review Documents for Consistency
Certain documents, like CbC reports and MF/LF reports described above, as well as rulings and advance pricing agreement (“APA”) requests, seem to find their way into the hands of tax auditors. Accordingly, companies in possession of this documentation should conduct a year-end review to ensure these have been properly prepared and filed and that they are consistent with the company’s tax positions and filings. To the extent that these documents may be deemed to represent an inconsistency of some sort, companies should consider any necessary modifications or should document any justifications for the inconsistency in case an audit is commenced down the road.
4. Review Year-End Transfer Pricing Adjustments
Taxpayers who make year-end transfer pricing adjustments when a transfer price is not at arm’s length may trigger secondary tax consequences in a multinational group. It is important for companies to review transfer pricing allocations made as a result of an IRS /foreign tax authority audit or those allocations that they make on their own initiative. One should note that a primary transfer pricing adjustment also may require a secondary (or collateral) adjustment to properly record the primary adjustment in the books of a counterparty.
Multinationals should make adjustments that lead to an accurate profit margin based on the final price setting of deliveries, services, and license fees. Factors to consider in making these adjustments include whether a company’s actual financial results materially differ from transfer pricing policy, any rationale for the reasons behind such a difference, and whether an intercompany agreement addresses the adjustment issue. Adjustments can be made following the end of a company’s fiscal year but before the books are closed and appropriately documented on a contemporaneous basis.
Finally, multinational companies should be wary that certain provisions of the tax reform essentially places a cap on the income that may be transferred to a foreign related party. For example, under certain provisions of the House and Senate plans, subsidiary income that exceeds 9-10% of its tangible base may be deemed excessive regardless of other economic factors.
Business Tax Quarterly - Fall 2017