On-Demand: Tax Cuts and Jobs Act | Impact on Multinational Companies
- Nov 5, 2018
This webinar provides updates on recent IRS guidance as well as possible ways to address the Act’s impact on international tax.
Gerard O’Beirne: Thanks so much Lexi and good day to everyone. Today's focus is going to be the updates on the international tax provisions of the tax cuts and job acts also knows as TCJA. There is a lot of materials that we're going to cover so please be patient with your questions we will try to get to them at the end of the presentation. If we run out of time we will certainly follow up with emails over the next few days.
In the past several months there's been a great deal of commentary and guidance coming from treasury including several sets of regulations with much more expected to come. So please stay tuned for additional webinars in the near future. So the international tax provisions were enacted with several objectives in mind.
In my opinion the most overriding, were trying to make US businesses more competitive in the global market place. Moving the United States to more of a territorial tax system, encouraging US businesses to either locate or relocate their intangible assets in the United States and reducing tax based erosions which often accomplished through interests and earnings stripping strategies and foreign tax credit planning.
These changes are expected to product profound changes in the way US persons and corporations will structure their business, both domestically and internationally. So let me give you some broad observations here. This is the largest and overall TCJA itself was the largest tax reform legislation since 1986.
Everyone is affected, individuals, corporations, pass-through entities, and the international provisions have a huge impact on structuring these transactions. As I mentioned, there's a lot of information that has come out recently and I guess you know let's get down to it.
Charlie is going to, well actually let me go through the agenda for a moment. Today we're going to focus mainly on Global Intangible Low-Taxed Income, also known as GILTI and the Foreign Derived Intangible Income FDII. But we're also going to be discussing some important updates on section 965 and its aftermath including the participation exemption. Sale of an interest in a partnership engaged in the conduct of US trade of business.
Some definitional changes including downward attribution, why more entities are going to be CFCs. The title passage rule and the earnings stripping provisions which I alluded before which basically include the interest deduction limitation, debt equity regulations, the base erosion and anti-abuse tax also known as BEAT.
So Charlie a lot has been written on Global Intangible Low-taxed Income or GILTI since its enactment. In fact the IRS recently released their first set of regulations and at least two more sets of regulations are expected out by year end. But the term GILTI is misleading, can you give us a general overview of GILTI and what it is meant to achieve? Then give us the highlights of the new regulations?
Charles Brezak: Thank you Gerry. I would like to also mention that while the act is called the tax customs and job creation bill it doesn't contain the word simplification.
Gerard O’Beirne: No indeed it doesn't.
Charles Brezak: As we see that I think is paramount that they omitted that word. In terms of the global intangible low-taxed income nothing could be further from the truth. Although the original intent was to tax the movements of intellectual property outside the tax havens the actual law itself is much broader and basically you could have a company which does not have any intangibles overseas, subject to GILTI.
Also, interestingly enough the low-taxed income is also not necessarily true it's a canard because you could have a situation where you have high taxed income and you're still subject to GILTI. So I think that while we talk about GILTI I think that it was quite a shock although we were looking at the law as its written to explain to our clients that GILTI really has the broad reach and affects such companies as consulting companies outside the US.
One of the interesting things is how do you define whether you have an intangible or not and basically the GILTI rules take a sort of shortcut by arbitrarily saying that any income over 10% of let's say depreciable assets is deemed to be intangibles. I think that's sort of a stretch but it just shows you the breadth of the law.
Now in order to implement this the GILTI provision did rely on subpart F architecture. I like to say that it's not necessarily subpart F architecture, we're basically trying to adapt what you are familiar with today as a brand new app on your iPhone and you're trying to adapt it to run on a iPhone that maybe 10 years old.
So often times there's a lot of glitches when you try to attach a brand new provision like GILTI onto an old architecture. So as we see, as we go through this example we'll see cases where there is sort of glitches in the way this operates with subpart F. But I think that the fair way to look at this is GILTI was trying to tax the income that was not otherwise caught by subpart F. So it's almost like a super subpart F that they enacted to pick up and catch all of the situations that previously warranted deferral.
Its main difference is that when you calculate your GILTI income you don't do it on a CFC by CFC basis but you do it on a consolidated CFC basis and we'll see how that works as we go through this.
Gerard O’Beirne: It's a really shareholder level concept-
Charles Brezak: Yeah.
Gerard O’Beirne: The way corporate level concepts.
Charles Brezak: Yeah so now everybody is saying okay, what's the impact on GILTI income? Well I think that what we will do is go through a couple of alternative situations where we have a US individual shareholder a US domestic C Corporation shareholder and show you the differences as to what the impact would be.
One of the sort of canards is that GILTI is a 10.5% tax and how you get that is you take the 21% normal tax rate applicable to a domestic corp you get a deduction which I'll show you how that thing works and you basically are down to a 10.5 tax calculation on that. It's also been said that if you pay a foreign tax of 13.125% you're going to wipe out your 10.5% US tax, we'll see how that actually works and whether that is indeed true.
That comes about because your 13.125 it is as a foreign tax credit to the extent of 80% and that wipes out the 10.5, but does it? We'll see in an example whether it's true or not. QBAI is a fancy word that they created to reference the fixed assets that comes under this 10% rule and we'll see how that works in an example and whether QBAI is also applicable to every corporation or whether it's just profitable companies.
I sort of give you a heads-up that you could watch out for tested loss corporations owning QBAI because then it doesn't give you a benefit.
Gerard O’Beirne: QBAI being Qualified Business Asset Income.
Charles Brezak: Yes.
Gerard O’Beirne: In other words an asset that generates qualified business income?
Charles Brezak: Yeah. So what I need to compute GILTI beyond what I previously needed? Well you know previously if you were contemplating that you were outside subpart F you had to do some reporting on 5471 but on the forms that you submit with the US return however there wasn't really any study, and you didn't really get down to all of the nuances that resulted in the calculation because the income would necessarily be the deferred indefinitely.
But now with GILTI you need to really step up and do a more profound calculation as to what that income will be, and we'll talk about that. What happens to foreign tax credits that are not used in prior years, net operating losses? Well GILTI is more like a snapshot, so it just looks at a particular year and doesn't really allow you to carry over unused foreign tax credits and used prior year net operating losses, which I think has been criticized quite a bit.
So I think from that perspective as we go through theses examples we'll see how this all comes into focus.
Gerard O’Beirne: These calculations are all based on regs that just came out recently correctly.
Gerard O’Beirne: Okay.
Moderator:We have now reached polling question number one. Why does the tax reform legislation have an impact on international planning? A, impacts worldwide effective rates. B, changes repetition of policies. C, affects intercompany transfer pricing and D, all of the above. Please remember in order to qualify for your CPE certificate you must remain logged on for at least 50 minutes and respond to three out of the four polling questions. We'll give everyone a few more seconds to respond.
We are now closing the poll and sharing the results.
Gerard O’Beirne: So Charlie why don't you give us some of the highlights and the pros to regulations?
Charles Brezak: Right, so the proposed regulations again it's a misnomer because they only cover some of the issues with GILTI and there are quite a number of open issues dealing with what we call detection 250 deduction, which is the 50% deduction I'll show you how that works. Foreign tax credit and also what really relates to this earnings stripping 163(j). That's going to be deferred until future dialogue.
I do believe also that there's going to be quite a number of comments that are made to these proposed regulations because in many respects the IRS came up with decisions as we'll go through. So I think that right now we're trying to work through some of the implications of the proposed regulations.
First and foremost and everybody was doing this sitting on their expectation that tested income would be defined. Now it's sort of interesting on this aspect of it tested income is really the income that's subject to GILTI. They use a fancy words tested income, but it's really income subject to GILTI.
There were a number of choices that you could make coming around the turn on the proposed regulations. You could have been earning some profits, it could have been book income, it could have been blah blah. But what they did is they referred to the subpart F definition of tested incomes to subpart F purposes. Which essentially mirrors a domestic corporation, and it's contained in the regulations in section 964.
What they did is they really in computing subpart F income you look at the income as translated if it were a domestic corp with certain exceptions. It's not really tied into earnings and profits, although earnings and profits did get involved with subpart F as a limitation under section 952.
I think that we believe now is that you have go through the domestic calculations as if your CFC was a domestic corporation but there are certain things in the regulations under 964 that now are very important to focus on, one is the materiality threshold in calculating income because they put that in simply because in many respects you're able to have access to every little nuance in the company's accounts. So they put in a materiality threshold.
The other thing is that because it's not tied to earnings and profits there are a lot of questions that as to what other provision would be reflected such as the limitation on the deductibility of interest and proposed regulations actually deferred that question so that there's going to be future regulations coming out and addressing that. That is going to impact a situation where you have a company that is highly leveraged or made an acquisition, they have a substantial amount of interest.
We'll have to see what comes of that, and I sense that in the final analysis it will be a calculation, compute tested income based on US domestic income, but they'll modify it to answering things like 163(j).
The proposed regulations also confirm that loss corporations cannot have QBAI, and we'll see how that works in an example. But that definitely is an important point because once you have QBAI you're going to have report more GILTI income because excluded from your GILTI is 10% of your QBAI. So if your QBAI is in a loss corporation, and you can't take into account, it's definitely going to hurt you.
Gerard O’Beirne: So as we mentioned previously this is a shareholder level concept not a CFC by CFC concept?
Gerard O’Beirne: But at the same time, at the shareholder level you look at a CFC with tested income and you get to use 10% of the qualified business assets and say that that's not GILTI income. Then you get to use the tested losses but you're not allowed to use those assets of the tested loss company of that CFC and your 10% calculation is that basically the concept?
Charles Brezak:Yes that's basically the concept and the real thing to keep in mind Gerry as you alluded to before is that to the extent that you could have income that's not subject GILTI because it's representing 10% of your QBAI, that income actually get deferred and can be potentially subject to the participation exemption which is going to be discussed later.
So essentially this QBAI concept will define the income that's subject to current tax versus what is going to be deferred to be eligible for the participation exemption. US partnerships I'll just briefly mention that this is one of those situations where the regulations had a deal with whether the calculation with GILTI should be just reported by US partnership and split up amongst the individual partners, based on the partnership interest or do a straight look through.
What they did is they sort of cared for the hybrid rule which they said if you have something better let us know. But the hybrid rule says that if you have a 10% shareholder as a partner, you will look through as if the 10% partner was a had an interest in a foreign partnership. There is another rule and this is where you sort of come up with the integration of the GUITI rules with the subpart F rules and that's under the 952(c) provisions and 952(c) under subpart F is where earnings and profits deficits come into effect. It's play and limits the subpart F income and because your subpart F income it is excluded under GILTI there was a question as to how you sort of integration that limitation with the GILTI calculation?
So if you're in that situation the regulations definitely take you through some of the different iterations as to how to come through the matching essentially the subpart F and GILTI rules together. The anti-avoidance rules I think also need to be consulted upon if there's any restructuring to minimize GILTI and they're fairly broad and the question is whether they cover sort of basic reorganizations that you would do such as check the box in the normal course of affairs.
So I think that it's more of a robust tax, anti-avoidance provision than normally we'll be used to.
Gerard O’Beirne: So your calculations are going to address the fact that GILTI rules affect individuals and corporations differently. However, an old and infrequently used section of law has been revitalized to allow individual shareholders in the CFC to be treated as a corporation. Take us through that section of la 962 and the recently decided Smith case.
Charles Brezak:Okay good point, section 962 is a old provision which had not been used very often if at all since it's enactment in 1962. Which was to allow US individuals only CFCs to be treated as US corporations to get the foreign tax credit. Just to the way the rates actually worked at that time, in 1962 individuals had a 90% rate just to let you know.
A lot of the dynamics didn't really make this a worthwhile thing. So I would say that it's an old provision actually it's almost like you have to be a tax archeologist to go back and try to find out what this provision was all about. But it really allows you to have an individual electing to be treated as a US corporation.
Now then there was an additional tax when cash is actually pass out to the CFC and there's a very limited rule on the PTI. The original 962 rules were enacted way before the qualified dividend rules which would tax certain dividends from the domestic corps and qualified treated jurisdictions at 23.8% the current rate.
It also predated the section 250 dedication which we'll get into which was put above the new tax bill. So in trying to look at the law and trying to figure out how that rule applies it's almost as if you have an old vacuum cleaner at the back of your garage, you pull it out and say this thing works and you haven't used it in 50 years. When you pull it out you say let me look at the instruction manual. You open up the envelop and it says good luck.
So that's basically where we are in this and I think that one revelation was the Smith case but there was also sort of a precursor that under the recent 956 regulation that came out in the last couple of weeks that section 962 election distributions do not qualify for the participation exemption. That may be a precursor of what the position is going to be on some of these other issues.
So let's turn to the Smith case and this case actually as this went in the tax port and was docketed. This was a coincidence because the docketed just about the same time as the law actually as enacted in December of 2017 and it dealt with some of the questions that we currently are dealing which is whether you could get the 23.8% rate when cash is actually distributed bearing in mind that 962 would allow a hypothetical US corporation to get a foreign tax credit for the taxes paid by the CFC.
Then when it's further distributed actual cash is distributed the question is what rate is there and in the fact pattern in Smith the rate was really the issue because the CFC did not qualify for treaty benefits, could not otherwise qualify for the 23.8%. So the tax payer was arguing in tax court that the rate should be 23.8% because the distribution is coming out of a hypothetical domestic corporation which is one of the structures that this deemed US corporation was put into 962.
The court said basically forget it, it's basically we're not going to allow you to get the qualified dividend rate and the question then is what about the section 250 deduction which we'll talk about when we get to the examples. On that score there's just still a lot of controversy as to whether you get that deduction or not if you make a section 962 election.
We'll see generally as we go to the next slide when you compare a situation where an individual owns a CFC directly and let's say has no 962 where you have a US individual owning a pass through. So this is sort of an instructive example. I'm going to by pass some of the details but I'm going to assume the individuals federal state rate is about 42%.
It could be as we go through some of these examples some arithmetic errors that are not accidentally put in because they are basically put in there for what I will say is security privacy and copyright purposes. So I'm going to go through the example very quickly. What we see is that in scenario one, scenario one is where you have an individual owning an CFC and as we already know an individual is going to be taxed at 37% of the current rate and does not get a foreign tax credit even though the foreign company you see in scenario one paid $2 million of taxes there's no foreign tax credit that's afforded.
So the combination of the 37% plus the lack of the ability to access the foreign tax credit because it's an individual neither domestic corporation pushes the rate up very high. Scenario one is really something you want to ordinarily consider planing out to have an individual owning an CFC. Scenario two you don't have a CFC the individual either has a branch or more likely has checked the box to have the CFC treated as a disregarded entity.
You still are able to reduce the foreign tax because now instead of going through 902 calculations for the foreign tax credit and not being qualified as an individually you get a direct credit into 901 and the tax rate goes down. We're assuming in this situation that there's no section 962 election.
Gerard O’Beirne: So Charlie this is the prior planing scenario where if you had a CFC owned by an individual you basically check the box where allowed to treat it as a disregarded entity or a transparent entity so that you can avail yourself of the credit?
Charles Brezak:Yeah there are a couple of aspects to this, of course if you check the box, to make a CFC a disregarded entity after it's been set up to an individual to taxable section 331 liquidations you have to look at that. But there other different alternatives that may not involve this.
Gerard O’Beirne: Sure.
Charles Brezak: ... the comparison of the direct credit versus losing the foreign tax credit completely.
Gerard O’Beirne: Why don't you take us through the C Corporations analysis then?
Charles Brezak:Yeah a lot of the aspects of the C Corporation is really the heart and soul of how they actually wanted to implement GILTI because individuals as you saw from prior slides are really not treated that favorably under these rules. What they're originally intending to do is to negotiate with the Apples and the Googles and the other companies that have accumulated income offshore.
So a lot of the architecture in GILTI is relating to how it works with C Corporations. As you'll see as some of these aspects make it much more favorable to have a domestic corporation owning the CFC than the individual situation, but of course every fact pattern is different, you have different alternatives and of course in the prior example we didn't do the 962 election.
So let's go through and let's see how we actually work through a base case and I'm not going through all the details of these different scenarios I want to hit the base case and point out how scenario two, three and four actually are different. Then you could at your leisure go through if we have leisure go through the other scenarios to really understand how this works.
So let's go through the base case, a lot of numbers I'm throwing at you, but I think that as we go through this you'll see what this example is supposed to show and it will help you understand how GILTI works as compared to the subpart F rules. So now we see in line one and Gerry has said this at least twice that GILTI is done on a consolidated basis.
So we look at the tested income from Mexico and Canada it's really an oriented example. So we have $700,000 combined. Then we see where each of these entities have qualified business asset investments or QBAI and then we factor in the 10% tangible rate of return and the GILTI inclusion is the difference between the 10%, 305 and the original 700,000 on line one.
So we could see that that's your inclusion before all the other machinations that I'm going to through.
Gerard O’Beirne: As we'll see later FDII has the same concept.
Charles Brezak: Yeah. So we have foreign taxes accrued and paid by the CFC. We have a section, now we're going to take a foreign tax credit. We have a section 78 gross up and the section 78 gross up is basically the portion of the foreign tax that relates to the income that's not the 10% of QBAI. In other words the amount that's coming in as GILTI that's the amount of gross up.
You then include both the gross up and the GILTI together and you have now a total of 489,000 and this is the so called section 250 deduction as I'm talking about. You get and this is only available to a shareholder that's a C Corporation. 50% participation exemption so 2445 comes out. The net income is 244,500 and then the tax is at 21%. Because we've actually removed 50% of that income to the participation exemption effective you have a 10.5% tax rate.
Then we have a deemed foreign tax credit which is another funky rule in the GILTI provisions relating to C Corporations, it will only give you 80% of the section 78 gross up. But it does wipe out the US tax but unlike the regular rules and the subpart F and other baskets this is a separate basket and the 23855 foreign tax credit excess that you didn't use disappears and you don't get to use it.
So that's a incentive to reduce your foreign taxes that as much as possible because you can't get the carry forward benefit as you do under the regular baskets. Okay.
Moderator:We have now reached polling question number two. Why were C Corporations treated more favorable than individuals from an internal perspective? A, 50% deduction for GILTI. B, participation exemption. C, deemed foreign tax credit. D, all of the above? Please remember in order to qualify for your CPE certificate you must remain logged on for at least 50 minutes and respond to three out of the four polling questions. We'll give everyone a few more seconds to respond. We are now closing the poll and sharing the results.
Charles Brezak: Okay I'm basically going to just give you the key points of focusing on these other scenarios rather than take you through all the details. You'll see after looking at the base case that we have a lot a loss in Canada, we won't be able to take the QBAI attributable to Canada although we will take the loss into GILTI overall.
In this particular situation because the foreign taxes are fairly high we'll be able to avoid the US tax. Then we'll have a excess foreign tax credit of 22,230 that is lost. So this gives you an example of what happens when you don't have your QBAI in the right company.
One of the situations with the participation exemption is that you have a limitation that you can't increase a domestic loss or take advantage of it in domestic loss situation. So when you look down at this example you see that 50% participation exemption is none and then the calculation works through from there.
Scenario four is where you have a foreign tax credit limitation and this particular example the foreign tax credit limitation is caused by the interest expense allocation under 1.861 and you wind up in a situation where you won't be able to the credit. Here's the 861 calculation, here's the fact that we have a 44,345 credit but we paid a lot more taxes and we're basically have some US tax due of 7,000.
But this really indicates that in this example that even if you have a high tax, if you have an 861 calculation that's going to limit you on your foreign tax credit, you could still wind up paying additional US income tax. So Gerry I guess right now we'll just have a brief discussion on some of the bottom line of all of this.
I think that's helpful in terms of focusing a lot of the subject matter and just making sure that we're looking at the right stuff. Just going through this quickly you want to make sure that you don't have QBAI in the wrong spot. You might be able to do a restructuring to set up a holding company and then check the box for your operating company and your company with the loss so that the QBAI is in one company.
You want to look at your 861 you want to also make sure that reduce your foreign tax credit with foreign taxes is always possible because you can't get a carry over or a carry back of any excess. You want to look at the regulations and see how for example the subpart F definition applies and you want to compare the FDII model with this.
Also, the GILTI provision were designed to really cover areas that were not previously subpart F income so cancellation of debt is really a situation that has been coming up where it's not subpart F because of the IRS position on this but it could be GILTI income.
Gerard O’Beirne: Charlie I'm going to cut you off there. Very informative, thank you so much. In the interest of time, we do need to move on and again we will take questions at the end if time allows. If not, we will follow up. So Hal let me turn to you for a moment. As mentioned earlier one of the reasons for the international provisions was to incentivized US businesses to keep their IP in the US and export their products and services from the US thus preventing businesses from eroding the US tax base. The two main provisions that achieved this is GILTI and foreign deemed intangible income also known as FDII or FDII. GILTI is often referred to as the stick and FDII is the carrot, can you explain this and give us some of the recent developments with respect to FDII?
Harold Adrion: Sure I'll be glad to Gerry. Just as an overall view FDII and GILTI as Charlie mentioned are designed to encourage the use of intangibles in the US and when intangibles were outside the US to essence penalized companies that have parked intangibles offshore. FDII is often referred as the carrot of the carrot and the stick, however as we're going to see FDII is fairly narrow in who it benefits.
Charlie had mentioned previously that GILTI particularly harms US individual who are owners are CFCs. FDII only applied to US C Corporations. So individuals and entities that entities such as partnerships do not derive a benefit from FDII. FDII in terms of comparing it to GILTI it is the sort of analog to it but it operates a little bit differently and in places where you would think that the rules would be favorable they're actually not as favorable.
I think that the best way to look at this is to look at the definitions that lead to the FDII deduction. There are number of terms that go into the FDII deduction. It's a rather complex process to compute and I have a couple of examples that illustrate how the computations works. I think the best way to go through that is just to go through the examples that I've provided.
The first example I've taken a case where a US corporation has only a service piped income or income from intangibles so that there is no QBAI. Charlie has referred to the QBAI concept in the terms of GILTI and in that context it's often very beneficial to have a corporation that has qualified business assets.
In contrast, with the FDII computation it's not as favorable because it takes away from the foreign component of the income that goes into the deduction. So in this very simple example where all the income is foreign source and there is no QBAI they get the full benefit of the deduction at 37.5%. In this example is $100,000 of deduction eligible income. There's no QBAI so we don't have to worry about that.
The percentage of foreign derived income to deductible eligible income is 100%. So all the income would qualify for a deduction. Again this is an oversimplified example but it's designed to illustrate the favorable aspect of FDII in terms of deriving income from the sales of goods or the receipt of income from the licensing of royalties.
So in this example where all the income is foreign source the deduction is equal to 37.5% of $800,000 of income. Applying the 21% tax rate gives you an effective tax rate of 13.125%. Again in actuality you'll probably never run into this. But this in essence illustrates the application of FDII to foreign sourced income either from the sale of goods or the licensing of intangible property.
Gerard O’Beirne: So interesting it seems that GILTI is the minimum tax of 13.125% where FDII gives you the benefit of a lower tax rate to 13.125%?
Harold Adrion: That's correct. Again just to amplify this point, FDII the deduction under FDII is only available to US C Corporations. It is not available to C Corporations that have foreign branches, so the have to be operating in the US and deriving sales income from sales of goods outside the US and from those license of intangible property outside the US.
A sub question here in computing this is what happens when you're selling goods to related parties? If you manufacture something sell it to a related party and they use it, do you qualify? The answer is yes and no depending upon whether they in turn dispose of that, sell that property outside the US. Or a whole series of rules that apply to when property is actually sold for use outside a lot of the industries in the manufacturing have asked for guidance on when products are actually sold for use outside the US, when they're sold to another US user of the product.
So let's go through the FDII examples too which I think kind of is more on point in illustrating a real life example here. The QBAI which Charlie referred to before in the context of GILTI is certainly a concept that applies here. It doesn't apply in a favorable context however unlike in the GILTI context where you have a 10% return on the QBAI that's not subject to current inclusion under GILTI.
In the FDII context it's not as favorable because you have to reduce your deemed intangible income by this QBAI number. So in the first line here we see deemed intangible income a million dollars minus the 10% of 2.5 million which his 25,000 it gives you 750,000 of deemed intangible income. But the next step is to compute the percentage that is US versus foreign, in this case 800,000 is foreign source income versus a million of total income.
So that gives you a percentage to apply. So it's 80% of the 750 gives you $600,000. It's that $600,000 that's the FDII deduction is computed on. The $225,000 deduction ends up giving you income of 375,000. So the tax on that is 78,000 and then the remaining amount the 600 minus the million is taxed at regular rates. So it reduces the rate in this scenario to 16.28% rather than the 13% as if all the income had been from a foreign source.
So if we modify this a little bit to have all the income, the one million from a foreign source and have no QBAI which is not realistic we would get down to a rate of 13.5%.
Gerard O’Beirne: But even with all the income being foreign sourced the QBAI is still going to reduce that-
Harold Adrion: That's right.
Gerard O’Beirne: ... income.
Harold Adrion: That's correct. Outlook for FDII, there have been a lot of press reports that the WTO might institute a complaint regarding it, it just remains to be seen. From my perspective it's not that abusive, there are other provisions which I'll talk about later which probably are more abusive and more contrary to what would be regarded as WTO compliant.
Gerard O’Beirne: My understanding is that it actually is that they're waiting for the guidance.
Harold Adrion: More guidance that's right.
Gerard O’Beirne: To see if it is. So to your point about not necessarily being abusive they're not really sure yet.
Harold Adrion: That's right.
Moderator:We have now reached polling question number three. What is the impact of FDII on structuring US operations? A, no impact. B, encourages moving operations to the US. C adverse impacts. D encourages transfer pricing. Please remember in order to qualify for your CPE certificate you must remain logged on for at least 50 minutes and respond to three out of the four polling questions.We'll give everyone a few more seconds to respond. We are now closing the poll and sharing the results.
Gerard O’Beirne: So Hal let's move on then, section 965 the deemed repatriation provisions and the downward attribution rules, those are the only provisions that were retroactive to tax years beginning in 2017. For calender year tax payers section 965 is passé yet the IRS just released over 150 pages of regulations and its expected to release more. Can you explain the importance of 965 and its aftermath vis-à-vis the participation exemptions?
Harold Adrion: Sure I'd be glad to. 965 was enacted sort of as a precursor to the participation exemption. It in essence allowed the slate to the wiped clean with the regard to earnings and profits that were in foreign corporations. So they essentially require US shareholders of foreign corporations to include an income of post 1986 earnings and profits. That's pretty much been done as Gerry alluded to, it's sort of history now in terms of what tax payers have to do.
Just a couple of observations on this, as is true with GILTI this provision hit hardest those tax payers who are not C Corporations. Individuals who are shareholders in CFCs were particularly hit hard by this because they had to have a current income inclusion or if could be deferred if they satisfied certain requirements.
But going forward unlike C Corporations they don't get the benefit of the participation exemption, which is primarily why this 965 was enacted. They wanted to wipe the slate clean and have going forward the ability to have earnings repatriated tax free under the repatriation while individuals and members of partnerships that owned CFCs were particularly hit hard because they don't have the ability to use the participation exemption, and they got hit with a tax on all this income.
If I could just make a couple of observations regarding what's in effect now the participation exemption. The exemption is fairly limited. It's limited to C Corporations, it does not apply to REITs, RICs trusts sub S corporations, LLCs that are treated as partnerships, partnerships, trusts. It's limited to C corporations that own 10% or more of the stock in a CFC.
There are other limitations that apply here in terms of receiving dividends from hybrid entities or hybrid characterization payments for example a Luxembourg entity that issues a return on PECs or CPECs will be regarded as a return on equity in the US or a dividend would not qualify for this because in Luxembourg it's treated as interest.
So you have to be very careful in terms of even C Corporations that are receiving distributions to ensure that the entity paying it, it is a considered a dividend from it as well. So the participation exemption is limited to C Corporations in which they've held stock for over a year, it does not apply to hybrid dividends which a hybrid instrument or a hybrid vehicle and it does not apply to foreign branches of US corporations.
Again several observations on the participation exemption. First it is as I mentioned very limited in application. Subpart F inclusions GILTI inclusions, are not included in the participation exemption. It does not apply to individuals, and lastly in practice and I think Charlie alluded to this is that the 10% return that is available under the GILTI provision drove out 10% to accumulate tax rates.
It's going to be that and Gerry can get into this the high tax subpart F. Do you want to mention?
Gerard O’Beirne:Sure in the past we all tried to avoid subpart F income but you know given GILTI you know this participation exemption as you stated is very limited because given the fact that we have now GILTI there's going to be very little income that's going to be repatriated that's going to be subject to this rule.
But as I just mentioned in the past we always try to work around subpart F income. It seems to me now that if you're in a high tax jurisdiction, you might actually want to create subpart F income to stay out of GILTI and therefore get into this section of law and get a actually tax free, if you're a C Corporation tax free income.
So if you have failed between related parties you might want to make them create some type of farm based sales income or services income in order to generate-
Harold Adrion: If it's high tax?
Gerard O’Beirne: If you're in a high tax. So it's all comes down to modeling. Just you know everybody is always asking should I be a C Corp to take advantage of FDII? Should I be C Corp in order to get around the 250 dedication and foreign tax credits and GILTI. This all comes down to modeling, you got to take pencil to paper.
For individuals and partnerships it's fairly more straight forward because GILTI is so negative to them. But quite frankly businesses really need to model this out and make a determination. So we're running short on time, Hal I'm going to ask you to briefly tell us about foreign persons, selling US partnerships that have assets that generate effectively connected income and then related withholding taxes?
Harold Adrion: Sure, this is actually kind of interesting, there's a lot of interesting history to this. Tax payers I think have correctly taken the position in the past that when a non resident sells an interest in a US partnership or a foreign partnership that's engaged in a US trader business, they were subject to US tax because the code essentially treats them as selling an interest in a security an equity, just like they sold stock on a US company they would not be subject to US tax.
The IRS has long maintained going back to 1991, in a ruling that these individuals are taxable in the US when they show an interest in a partnership that's engaged in a trader business. Ultimately this went to the tax court and the tax court sided strong with the tax payer in the recent mining case. So now the rule is under 864(c)(8) that non residents are taxed when they disposed an interest in a US partnership.
There was a withholding obligation under 1446 of 10% on the purchaser of the partnership interest. This has raised a number of issues in terms of its administer ability. The biggest issue I think and I think it's there has been a little bit of guidance issue here but this is the point that where no guidance has been issued yet.
When you have a non US partnership owning a US partnership and somewhere in that partnership sells an interest how do you know that an interest has been sold because they don't ... The US partnership has no way of knowing, whether an interest to your partnership has been sold.
Ultimately though there could be a liability at the US partnership level because an interest in it has effectively been sold and there has been no withholding. Here it is raised the issue of what do you do when you have non residents of a foreign partnership selling an interest in a partnership which in turn owns a US partnership?
The IRS has issued some guidance, it noticed 2018-29 some of the withholding issues however a lot more guidance is going to be needed to become compliant with this. This is a side not, a lot of countries realize this is an issue and simply don't try and go after non resident to sell interest in partnerships.
Some countries do, it varies all over the board.
Gerard O’Beirne:We're going to run about 5 to 10 minutes over but in order for people that can't say the extra 5 to 10 minutes we're going to give the final polling questions. Lexi is going to give the final polling question now.
Moderator:We have now reached polling question number four. What is the likely impact for chapter four on the status of foreign corporations as CFCs? A, no effect. B, reduced number of CFCs. C, less complexity. D, increased potential number of CFCs. Please remember in order to qualify for your CPE certificate you must remain logged on for at least 50 minutes and respond to three out of the four polling questions. We are now closing the poll and sharing the results.
Gerard O’Beirne:Charlie can you please take us briefly through the title passage rule and what the effects are on FTC planning?
Charles Brezak: Yeah the title passage rule change is enormous because the disposition of inventory allowed as where titled past outside the US, allowed at least 50% of the income associated with that transactions to be foreign source eligible to zero foreign tax credit. This was really one of the biggest historical ways to utilize foreign tax credit.
Gerard O’Beirne:But this is for manufactured products?
Charles Brezak:This is for both companies that are manufacturing in the US and which 50% would be deemed to be foreign and prepares title outside or if the company actually was not manufacturing just trading in the US and selling outside then it could get 100%. So without ... There was very, very careful planning on this because as long as you make sure that you aren't taxed overseas on the sale you could get a free pass our foreign source income and now that is gone.
So now in order to get foreign source income on such transactions you have to actually have production. There's a production test overseas. So without getting too much in the details on that, one of the things you have to worry about is that maybe sort of fools gold because when you now have production overseas you can be taxed overseas and generally on taxes and it goes into a separate basket.
So I think that there's going to be a lot more careful planning necessary to bypass the restriction in favor of how to structure your transactions because that benefit is no longer available. So on the next slide I'm just going to briefly mention that the 30 day rule, which is a rule that said that a US shareholder did not have to pick up income under subpart F if the entity was not a CFC for at least 30 days.
This was previously used quite a bit to structure transactions where you created a CFC in December and you therefore did not have a CFC For 30 days. So that is gone now, if you have a CFC for any day if you have a US shareholder he maybe required to pick up incomes. So on the downward attribution I'll allow Hal to work through the side that is related to that issue.
Gerard O’Beirne:Hal in the interest of time let's try and be brief here because I'd like you hit this and the base erosion anti-abuse tax the minimum tax.
Harold Adrion: Sure be glad to.
Gerard O’Beirne:Thank you.
Harold Adrion: In order to hit some of the inversion transactions that were going on, they repealed a provision that prevented downward attribution. Inadvertently it hit a lot of tax payers, and it was a mistake. There's legislative history that I've put in here you can see where it's pretty clear that this wasn't the intent. But because it went into the code, there is a feeling now the treasury is going to have to come up or there'll have to be some type of technical corrections to fix this issue.
The IRS has issued a couple of notices that to some extent but there is still some significant issues. In the first scenario you have a foreign parent that owns a foreign sub and a US sub each are owned 100%. Prior to the repeal the foreign sub would not be considered a controlled foreign corporation because it's owned 89% by foreign shareholders, and the 11% owned by US shareholders didn't amount to it being a CFC.
Under the downward attribution the US sub is now considered a shareholder, and it is considered a shareholder of the US sub since it owns 100%. If the sub is now considered a CFC and that results, since the US sub doesn't own any stock, and it doesn't have a subpart F inclusion, but the US shareholder does.
This was clearly a mistake, and it's going to have to be corrected. It has hit a lot of the funds because they are organized offshore they have numbers that own US subsidiaries that ownership is attributed through the fund and has created a number of this ... Hopefully this will be corrected in the next technical corrections act.
Gerard O’Beirne:Let me suggest that people read Business Life 41 if you are interested, Hal put together some really nice slides, the two slides preceding this, 39 and 40 are very informative. So please do read those slides. How about B Hal.
Harold Adrion: We've got polling question four do we want to-
Gerard O’Beirne:We did that already.
Harold Adrion: Okay. All right B is another base erosion provision as a practical matter a company has to be earning over 500 million in receipts. So I don't know how many in the audience this impacts. There are ... The way it's computed is relatively simply. You simply look at its income and if it's making payments to a foreign party you add the royalty payments back in, and depreciable assets from a foreign party you add back in the depreciation or the amortization on this asset.
So it pumps up the income and then there's a 10% tax on that. So it's almost like an alternative minimum tax is the way it's operates. This has been subject to a lot of controversy. Just very quickly most of our treaties have a provision in it that the actual article is described as a non discrimination provision and it typically says that it's considered discriminatory if a foreign party doesn't obtain the same types of deduction that a US party would if the payment had been made to a US party.
This would clearly, I think run a foul of the non discrimination provisions in our treaty network and it may run a foul on the WTO provisions. Again this is how the provision is going to impact a lot in the audience. Charlie do you want to go over treaty parties?
Gerard O’Beirne:You know, I think we're going to have to wrap up right now we're almost 10 minutes over a lot of time. The two sections that we're not going to speak on are 385 and the 163(j) rules. Please be aware that we will address your questions and we will have further webinars as the regulations come up.
I want to thank Charlie and Hal for their fabulous presentations. As you can see these subjects could take an hour each at least by themselves. We were trying to bring you all the updates in one quick presentation, hopefully we succeeded in peeking your interest in some of these subjects and you will be reaching out to your consultants and accountants and attorneys for advice on further guidance. Thank you so much and thank you very Lexi for all your help.
Moderator:We hope you enjoyed today's webinar. Please look out for a follow up email with a link to the survey and presentation. For those who meet the criteria you will receive a CPE certificate within 14 business days of confirmed course attendance. Thank you for joining us today.
Transcribed by Rev.com
What's on Your Mind?
Gerard O’Beirne is a Partner and the National Leader of the firm’s International Tax Group, with more than 25 years of experience. Gerry has extensive experience with both inbound and outbound structuring, including mergers and acquisitions.l
Start a conversation with Gerard
Explore More Insights
On-Demand: Financial Services Year-End Tax Planning Webinar Series | Part 2Read More
On-Demand: Tax and Accounting Update and Year-End Work Planning for Real Estate CompaniesRead More
On-Demand: Alternative Investments Year-End Audit Planning Webinar Series Part II - Venture Capital Valuation ConsiderationsRead More
On-Demand: Financial Services Year-End Tax Planning Webinar Series | Part 1Read More
Receive the latest business insights, analysis, and perspectives from EisnerAmper professionals.