Transition Tax DEEMED REPATRIATION OVERVIEW

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1 Transition Tax DEEMED REPATRIATION OVERVIEW Basic Framework A 10% U.S. shareholder (a US SH ) of a specified foreign corporation ( SFC ) must recognize its pro rata share of the SFC s post-1986 accumulated E&P ( deferred E&P ). SFCs are generally CFCs and other foreign corporations with respect to which one or more domestic corporations are US SHs Deferred E&P is measured for each SFC as of 11/2/2017 or 12/31/2017, whichever results in more E&P Effective rate is 15.5% to the extent of the cash position ; 8% on non-cash Accomplished via inclusion in subpart F income and corresponding deduction of a percentage of the inclusion that yields targeted effective rates Cash Position equals (i) sum of cash, (ii) net accounts receivable and (iii) FMV of actively traded personal property and certain other assets Under Notice , the IRS intends to issue regulations to prevent double-counting of certain assets treated as cash E&P Deficit Netting US SH can reduce aggregate deferred E&P by aggregate E&P deficit of its SFCs Permits netting of E&P deficits between US SHs in an affiliated group

2 Transition Tax DEEMED REPATRIATION SPECIAL RULES Foreign Tax Credits FTCs otherwise available are disallowed in amount of 55.7% for cash portion & 77.1% for noncash portion No deduction allowed for foreign tax for which credit is disallowed Installment Payments Can elect to pay transition tax liability in 8 annual installments, starting with year of inclusion Installments are back-loaded Special Rules NOLs: Can elect to exclude transition tax for purposes of calculating or utilizing NOLs REITs: Repatriated income does not count as gross income for REIT income tests S corps: S corporation shareholders may elect to defer tax until triggering event Inversions: US SH that becomes expatriated entity within 10 years after enactment is subject to additional tax equal to 35% of effective-rate-lowering deduction

3 Transition Tax DEEMED REPATRIATION OBSERVATIONS Notice IRS intends to issue regulations relating to determining the transition tax amount, including: Determination of cash position with respect to (a) allocation between multiple inclusion years, (b) treatment of related-party transactions, and (c) treatment of derivatives and hedging Determination of deferred E&P with respect to (a) adjustments to account for certain amounts paid or incurred between 11/2/2017 and 12/31/2017, (b) distributions to SFCs, (c) SFCs with non-u.s. shareholders Treating U.S. shareholders in a consolidated group as one U.S. shareholder for purposes of cash calculations Section 961 Considerations Transition tax income included in gross income for US SH s taxable year that ends 11/30/18 with respect to CFC s with an 11/30 year-end Deferred E&P that gave rise to inclusion will constitute PTI when distributed but attendant increase in SFC stock basis occurs under Section 961 at close of taxable year Thus, any distribution of E&P before 11/30/18 can cause recognition of gain if US SH does not have sufficient basis in distributing SFC s stock Under Notice , the IRS intends to issue regulations regarding basis adjustment to amounts treated as Subpart F Income under Section 965

4 Transition Tax DEEMED REPATRIATION OBSERVATIONS (CONT D) Actively Traded Stock A publicly traded SFC s value may be taken into account as part of the cash position of another SFC while also being taken into account as a standalone SFC with respect to a US SH SFC History Only E&P accumulated when foreign corporation was an SFC is counted E&P But not limited by US SH s ownership period Installment Election for Partnerships Statute does not specify whether partnership that is US SH or the partners of such partnership make election to pay in installments Potential Additional Anti-Abuse Regulations (beyond notice ) Cash reduction E&P reduction Post-measurement date, pre-gilti transactions

5 New Not Quite Territorial International Tax Regime The TCJA adopts a new international tax regime that shifts the United States from a worldwide system of taxation to a quasi-territorial one. The new rules: Establish a 100% deduction for corporate recipients of foreign-source dividends (the participation exemption ) Retain Subpart F (including Section 956), with modifications Limit certain tax benefits deemed inappropriate in the context of the quasi-territorial regime that operates by way of a participation exemption Repeal an exception to gain recognition under Section 367 with respect to transfers of property used in the active conduct of a trade or business to a foreign corporation in certain nonrecognition transactions Impose, on a current basis, a minimum tax on foreign earnings deemed to be received by corporations from intangibles ( GILTI ) at a reduced tax rate Impose, on a current basis, tax at ordinary individual income tax rates, on certain non-corporate U.S. shareholders shares of a controlled foreign corporation s GILTI

6 New Not Quite Territorial International Tax Regime (Cont d) Allow a deduction for foreign-derived intangible income ( FDII ) earned directly by U.S. taxpayers from selling property or providing services outside the United States Sunset the look through rule of Section 954(c)(6) in 2019 Establish new base erosion alternative minimum tax ( BEAT ) Expand the definition of intangible property for purposes of Section 367(d) and Section 482 and expand the Internal Revenue Service s authority to challenge transfer pricing using aggregation and realistic alternatives theories Deny deductions for payments made by or to hybrid entities or in hybrid transactions Narrow active insurance exception to PFIC rules

7 The Participation Exemption Foreign-Source DRD 100% deduction of the foreign-source portion of any dividend a domestic corporation receives from a 10% owned foreign corporation (other than a PFIC) This deduction is only available to U.S. C corporations other than RICs and REITs The U.S. corporation must be a U.S. shareholder of and satisfy a holding period requirement with respect to the foreign corporation Section 1248 dividend is eligible for the deduction if the U.S. corporation held the stock of the foreign corporation for at least one year Must satisfy a 365 day in a 731 day period Limitations on Certain Tax Benefits No FTC is allowed with respect to deducted amounts. Will not apply to any hybrid dividend New Section 91 generally requires a U.S. corporation to recapture U.S. tax benefits of any losses deducted immediately upon the incorporation of a foreign branch Amends Section 961 to provide that for purposes of determining loss upon a disposition, adjusted basis in the stock of foreign corporation is generally reduced by previously allowed deductions

8 Global Intangible Low-Taxed Income (GILTI) New Section 951A will, in effect, impose a foreign minimum tax on U.S. shareholders allocable share of the GILTI of CFCs The calculation of GILTI is based on a formula that exempts from inclusion a deemed return on depreciable tangible assets, and deems the remaining income to be intangible income that is subject to current U.S. taxation Net tested income : generally the aggregate net income of all CFCs of a U.S. shareholder other than (i) ECI, (ii) subpart F income, (iii) high-taxed income, (iv) dividends from related persons, and (v) certain foreign oil and gas income Net Deemed Tangible Income Return : an amount equal to 10% of the tax basis of the depreciable tangible assets of each CFC the net income of which is taken into account in net tested income minus net interest expense taken into account in net tested income Tax basis for purposes of GILTI (as well as FDII) maintained following the alternative method of depreciation GILTI = Net Tested Income Net Deemed Tangible Income Return

9 GILTI (Cont d) A U.S. shareholder that is a C corporation will be entitled to a tax credit for 80% of the foreign taxes paid by its CFCs deemed attributable to the GILTI amount. GILTI tax credits are segregated into a separate foreign tax credit basket with no carryforward or carryback available for any excess credits. A deduction is allowed for a portion of a corporate U.S. shareholder s GILTI The deduction is available only to C corporations, while GILTI is required to be included by all U.S. shareholders For taxable years , the deduction is equal to 50% of GILTI (resulting in a minimum effective rate of 10.5%) For taxable years after 2025, the deduction is reduced to 37.5% of GILTI (resulting in a minimum effective rate of %) The amount of the GILTI deduction may be reduced if the sum of the U.S. shareholder s FDII and GILTI exceeds its taxable income

10 Foreign-Derived Intangible Income (FDII) A deduction is allowed for a portion of a U.S. corporation s net income (other than GILTI and certain other income) that exceeds a deemed 10% rate of return on the U.S. corporation s tangible depreciable business assets and that is attributable to certain sales of property to foreign persons or to the provision of certain services to any person, or with respect to any property, located outside the United States For taxable years , the deduction is equal to 37.5% of FDII (resulting in an effective rate of %) For taxable years after 2025, the deduction is reduced to % of FDII (resulting in an effective rate of %) The amount of the FDII deduction may be reduced if the sum of the U.S. shareholder s FDII and GILTI exceeds its taxable income

11 Base Erosion and Anti-Abuse Tax (BEAT) Base erosion minimum tax regime Applies to corporate taxpayers (other than RICs, REITs and S corporations) that have average annual gross receipts of at least $500 million for the prior three-year period and have a base erosion percentage of at least 3% (or 2% for financial group members) Base erosion percentage generally determined by dividing deductions taken by the applicable taxpayer for base erosion payments by the overall number of deductions taken by the taxpayer (excluding NOL carrybacks and carryforwards and certain other items) Applicable base erosion tax rate is generally 5% for tax years beginning in 2018, 10% for tax years beginning after Dec. 31, 2018 but before Jan. 1, 2026 and 12.5% for tax years beginning on or after Jan. 1, 2026 Banks and registered securities dealers and their affiliates subject to 1% higher base erosion tax rate

12 BEAT(Cont d) Corporations subject to the BEAT required to pay a tax equal to the applicable base erosion tax rate multiplied by the excess of its modified taxable income over its regular tax liability for the year (reduced by certain tax credits) Modified taxable income is generally taxable income calculated without regard to base erosion tax benefits or the base erosion percentage of any NOL carrybacks or carryforwards Base erosion tax benefits generally include (i) amounts paid or accrued to a related foreign person for which a deduction is allowable, (ii) amounts paid or accrued to a related foreign person in connection with the acquisition of depreciable or amortizable property, (iii) certain reinsurance payments paid to a related foreign person and (iv) certain payments to expatriated entities that are members of the entities expanded affiliated group that represent cost of goods sold. Special exception for qualified derivative payments Observations: No exception to the definition of base erosion tax benefits for payments made to U.S. branches or non-u.s. partnerships with U.S. partners Questions about how aggregation rule works; treatment of U.S. consolidated group Because credits reduce regular tax liability and therefore increase the potential base erosion tax liability, a taxpayer subject to the base erosion tax will effectively lose a percentage of its credits equal to the applicable base erosion tax rate (effectively a new AMT)

13 Anti-Hybrid Rules For Certain Related Party Amounts New Section 267A denies deduction for any disqualified related party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity. A disqualified related party amount includes any interest or royalty paid or accrued to a related party if (i) there is no corresponding inclusion to the related party under the tax law of its country or (ii) the related party is allowed a deduction with respect to the payment under the tax law of its country A hybrid transaction is generally any transaction one or more payments with respect to which are treated as interest or royalties for U.S. tax purposes and which are not so treated under the law of the recipient A hybrid entity is an entity treated as fiscally transparent for U.S. tax purposes but not for purposes of the tax law of the foreign entity (or vice versa) Observations: Similar to recommendations set for in OECD s BEPS project No grandfathering or transition rule for existing arrangements

14 Active Insurance Exception to PFIC Rules Narrows exception to PFIC rules that treats certain income earned by foreign insurance company as non-passive New quantitative test imposed that requires applicable insurance liabilities to constitute more than 25% of the total assets of the company Calculation of assets and liabilities is made by reference to the company s financial statements Regulations may be issued for relief if applicable percentage is at least 10% For the purposes of this test, applicable insurance liabilities includes loss and loss adjustment expenses, as well as reserves for life and health insurance risks/claims Conference report states that applicable insurance liabilities includes loss reserves for property and casualty and annuity contracts, but these are not specifically mentioned in the TCJA Provision is nearly identical to proposal by Sen. Ron Wyden (D-OR) in 2015