International tax analytics- Unlocking value through identification and management of critical tax attributes

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1 International tax analytics- Unlocking value through identification and management of critical tax attributes Original Publication Date: November 2nd, 2017 CPE Credit is not available for viewing archived programs Please disable popup blocking software before viewing this webcast

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4 Speakers Eric Gabbai Senior Manager International Tax Services Robert Spence Partner International Tax Services Chris Summer Senior Manager International Tax Services Ed Weaver Senior Manager International Tax Services Grant Thornton LLP. All rights reserved. 4

5 Learning objectives Identify the importance of critical tax attributes in global tax planning and compliance for multinational companies Identify and understand the value associated with planning strategies associated with the collection and management of these critical tax attributes Distinguish options available to model various planning strategies, including assessing the potential impact of various tax reform proposals Grant Thornton LLP. All rights reserved. 5

6 International tax attributes- Untapped value Introduction What international tax attributes are relevant and why do they matter? Why the big rush? Grant Thornton LLP. All rights reserved. 6

7 Agenda 1 Overview 2 Identification of relevant attributes 3 Collection and presentation of attributes 4 Planning opportunities 5 Reform with eyes wide open Grant Thornton LLP. All rights reserved. 7

8 Overview Grant Thornton LLP. All rights reserved. 8

9 Most relevant tax attributes What are some examples? Focus of this presentation is U.S. tax attributes Earnings and Profits Tax Credit Pools Foreign Tax Credit Position Basis Grant Thornton LLP. All rights reserved. 9

10 Most relevant tax attributes Comprehensive example Y Co is a US corporation with IP owned in Europe and manufacturing operations in Europe and Asia K Co is a US corporation with operations in the US, Europe and Asia K Co's foreign operations were acquired in 2009 with a valid Section 338 election made at the time. In 2014, Y Co purchased the stock of K Co in a taxable transaction with the resulting org structure below After several years of operations, Y and K would like access to the built up cash inside of their foreign structure What attributes would be relevant in considering steps to effect the combination and repatriation? Grant Thornton LLP. All rights reserved. 10

11 Most relevant tax attributes Example Grant Thornton LLP. All rights reserved. 11

12 Most relevant tax attributes Example- 1120/5471 data E&P Basis Pre-tax E&P Section 902 Tax Pool Section 902 Tax Pool ETR Y Euro 10,000 Unknown Unknown Unknown Unknown Y Asia Ops 10,000 Unknown Unknown Unknown Unknown K Euro Hold 1,000 Unknown Unknown Unknown Unknown K Euro Ops 10,000 Unknown Unknown Unknown Unknown K Asia Ops 100 Unknown Unknown Unknown Unknown Grant Thornton LLP. All rights reserved. 12

13 Most relevant tax attributes Example- Full data E&P Basis Pre-tax E&P Section 902 Tax Pool Section 902 Tax Pool ETR Y Euro 10,000 2,000 13,333 3,333 25% Y Asia Ops 10,000 5,000 15,385 5,385 35% K Euro Hold 1,000 20,000 1, % K Euro Ops 10,000 10,000 18,182 8,182 45% K Asia Ops ,000 10,100 10,000 99% Assume USD is the functional currency for all entities Grant Thornton LLP. All rights reserved. 13

14 Most relevant tax attributes Untaxed E&P - Tax pools and effective tax rate Most tax reform proposals will treat untaxed E&P as repatriated Open questions Will amounts be netted Will foreign tax credits be available? Subpart F recapture? What to do before reform? Example E&P Pre-tax E&P Section 902 Tax Pool Section 902 Tax Pool ETR CFC A 10,000 13,333 3,333 25% CFC B 10,000 15,385 5,385 35% CFC C (10,000) (10,000) 0 0% CFC D (5,000) (10,000) 0 0% Grant Thornton LLP. All rights reserved. 14

15 Most relevant tax attributes Cash vs. operating assets Unified Framework Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. What is "cash or cash equivalent"? "Better Way" tax plan As part of the move to the modern territorial approach to international taxation, accumulated foreign earnings will be subject to tax at 8.75 percent to the extent held in cash or cash equivalents and otherwise will be subject to tax at 3.5 percent Camp Proposal Cash and foreign currency Net A/R Actively traded personal property Certain short-term obligations Grant Thornton LLP. All rights reserved. 15

16 Most relevant attributes Grant Thornton LLP. All rights reserved. 16

17 Most relevant tax attributes Recap from overview Earnings and Profits Tax Credit Pools Foreign Tax Credit Position Basis Grant Thornton LLP. All rights reserved. 17

18 Most relevant tax attributes Earnings and Profits What is Earnings and Profits ("E&P") Where does it apply in international tax Distributions Anti-Deferral Reorganization Liquidations Dispositions/Sales APB Grant Thornton LLP. All rights reserved. 18

19 Most relevant tax attributes Earnings and profits of a foreign corporation To Compute E&P of a Foreign Corporation: Step 1: Prepare local currency P&L Step 2: Make adjustments necessary to conform to U.S. GAAP Only material adjustments are required, but must consider restrictions: Must provide a clear reflection of income; The basis in physical assets (including inventory), for depreciation, depletion and amortization, must be historical cost; No systematic undervaluation of assets or overvaluation of liabilities; and, No practices designed to equalize income and expense over more than one accounting period (i.e., as special reserves which tend to level off income from year to year) Step 3: Make further adjustments necessary to confirm to U.S. tax accounting standards The foreign corporation must adopt material U.S. tax accounting methods and/or make certain elections (e.g., Sec. 441, Sec. 446, Sec. 471, Sec. 472, Treas. Regs. Sec , etc.) Grant Thornton LLP. All rights reserved. 19

20 Most relevant tax attributes Earnings and profits of a foreign corporation The importance of "significant" E&P Actions on behalf of a foreign corporation to make certain elections, adopt a tax year, or adopt methods of accounting are not required until E&P is "significant" for U.S. federal income tax purposes Treas. Regs. Sec (c)(6) defines U.S. tax significance to include, without limitation, the following events (commonly referred to as a "significant events"): An actual distribution; An amount includible in income under Subpart F/Sec. 956; An amount excluded from subpart F income by reason of Sec. 952(c) (qualified chain deficits); Any event making the foreign corporation subject to tax under Sec. 882; The foreign corporation's controlling domestic shareholders use the tax book value (or alternative tax book value) method of allocating interest expense under Sec. 864(e)(4); and, A sale or exchange of the foreign corporation's stock of the controlling domestic shareholders resulting in the re-characterization of gain under Sec Grant Thornton LLP. All rights reserved. 20

21 Most relevant tax attributes Earnings and profits of a foreign corporation The importance of "significant" E&P Once E&P becomes significant, the foreign corporation must adopt U.S. tax accounting methods and/or make certain elections (e.g., Sec. 441, Sec. 446, Sec. 471, Sec. 472, Treas. Regs. Sec , etc.) When an initial significant event occurs, the E&P must be adjusted as if methods had been adopted in the initial year, and accumulated E&P must reflect the proper amount with methods and elections being applied retroactively Going forward, the foreign corporation must continue to apply the methods and fully compute E&P annually Taxpayers may find that significant events have occurred unknowingly, which resulted in the adoption of accounting methods by a foreign corporation Correcting an error may require an IRS method change (Form 3115) and may have financial statement implications Proactive maintenance of E&P may help companies avoid pitfalls and may also allow for better tax planning Grant Thornton LLP. All rights reserved. 21

22 Most relevant tax attributes Previously taxed income Section 959 Earnings and profits previously taxed under Section 951 can generally be distributed taxfree Subpart F Section 956 Currency gains/losses Ordering rule Additional tax basis in CFC shares Increases in Section 904 limitation under Section 960(b)(1) Grant Thornton LLP. All rights reserved. 22

23 Most relevant tax attributes Section 1248 Applicable only to 1248 Shareholder for period of ownership Potential to characterize gain on Sale or Exchange as dividend If requirements or met, possible to be a Qualified Dividend Can allow companies foreign tax credits on capital gain event or potentially liquidation Point to consider: What is the amount of E&P attributable to the time a person has been a 1248 shareholder? What are the foreign taxes associated with that ownership period and 1248 amount? Grant Thornton LLP. All rights reserved. 23

24 Most relevant tax attributes Section 987 Background Triggering events Methods 1991 Temporary Regulations 2006 Temporary Regulations 2016 Final Regulations "Reasonable method" 2016 Final Regulations Effective date Elections available Grant Thornton LLP. All rights reserved. 24

25 Most relevant tax attributes Stock basis / Fair market value Stock basis Stock basis is not tracked on any recurring international tax compliance forms Basis considerations are beyond the dollar amount of basis in a company's stock. Other items to consider include: Whether the stock basis is blended or blocked Types of shares the basis is associated with Fair market value Has there been a recent acquisition? What has changed since an acquisition? How does book value compare to market EBITDA multiples? Grant Thornton LLP. All rights reserved. 25

26 Most relevant tax attributes High basis / low basis example US Corporation Parent Key attribute/facts: Stock FMV - $500 Stock Basis - $1,000 CFC 1 Country X Cash Cash Assets Stock FMV - $1,000 Stock Basis - $100 CFC 2 Country Y FMV of the CFC's stocks and assets Stock basis Tax pool effective rate E&P and cash balances Current FTC position (OFL, ODL, Excess Credit, etc. ) U.S. company tax profile CFC 1 Country X Grant Thornton LLP. All rights reserved. 26

27 Most relevant tax attributes Foreign tax credit position To further the Comprehensive Example, assume no U.S. entity in the structure has claimed a foreign tax credit in the past. Additionally, assume there has been no distribution from foreign subsidiaries, no R&D credit or Section 199 deduction has been claimed Y Co has third party debt with associated interest Before Y can claim benefit for the credits available under Example 1, it must determine whether its FTC position E&P Basis Pre-tax E&P Section 902 Tax Pool Section 902 Tax Pool ETR Y Euro 10,000 2,000 13,333 3,333 25% Y Asia Ops 10,000 5,000 15,385 5,385 35% K Euro Hold 1,000 20,000 1, % K Euro Ops 10,000 10,000 18,182 8,182 45% K Asia Ops ,000 10,100 10,000 99% Grant Thornton LLP. All rights reserved. 27

28 Most relevant tax attributes Foreign tax credit Gross foreign source income examples Dividends/Deemed dividends Should be reflected on Schedule I of the 5471s Watch out for nimble dividends, which bring no deemed paid credits Branch income/loss Should include any eliminations of intercompany amount Foreign source services revenue Services performed outside the US 863(b) income Income derived partly within and partly without the US Can be services or inventory Treaty sourced income Separate basket Payments for foreign use of IP General rule is to source where IP is used Grant Thornton LLP. All rights reserved. 28

29 Most relevant tax attributes Foreign tax credit Foreign source expenses Directly allocable expenses Directly related to FSI COGS Branch expenses Salaries Apportionable expense Interest expense Stewardship allocations R&D Section 861 allocation & apportionment methods Interest Tax basis or FMV of assets R&D Sales or gross income Stewardship Any reasonable method Gross sales Gross income For salaries by percentage of time spent on foreign operations Grant Thornton LLP. All rights reserved. 29

30 Most relevant tax attributes Foreign tax credit Net operating losses Must recapture NOLs as they are utilized US vs Foreign source Included in the FSI calculation on Page 1 of Form 1118 Overall Foreign Loss (OFL)/Overall Domestic Loss (ODL) Gross FSI Even if no FTC being claimed expense allocations must be done to determine these attributes OFL/ODL recaptures are required OFL is recaptured at 50% of the foreign source ODL is recaptured at 50% of US Source Income Grant Thornton LLP. All rights reserved. 30

31 Most relevant tax attributes Foreign tax credit Calculation for foreign tax credit pool Tracked in USD Different than E&P, so currency fluctuations may impact ETR of pool Must have support for taxes paid Limitations on ability to benefit under splitter and covered asset rules Grant Thornton LLP. All rights reserved. 31

32 Collection and presentation of attributes Grant Thornton LLP. All rights reserved. 32

33 Collection and presentation of attributes Attributes tracked within US federal income tax return Form 1118 Foreign Tax Credit Carryforwards (Sch K, Form 1118) Overall Foreign Losses (Sch J, Form 1118) Overall Domestic Losses (Sch J, Form 1118) Form 5471 Earnings & Profits (Sch H/J, Form 5471) Previously Taxed Income Sch J, Form 5471) Current Tax Pool Layers (Sch E, Form 5471) Form 8858 Current Remittances & Sec 987 Gain/Loss Grant Thornton LLP. All rights reserved. 33

34 Collection and presentation of attributes Attributes tracked elsewhere Detailed E&P computation Methods for adjusting for Sec 964 Adjustments for taxes (current vs deferred, etc.) E&P baskets tracked in workpaper support Tax pools Can be tracked by obtaining historical Forms 5471 Often tracked in workpaper support for FTC Tax provision workpapers Detailed FTC computation Sec 861 methods often tracked in workpaper support Grant Thornton LLP. All rights reserved. 34

35 Collection and presentation of attributes Attributes often not tracked Tax Basis Initial contribution Funding transactions Debt vs equity Outside vs. inside Fair market value Requires some level of valuation analysis Grant Thornton LLP. All rights reserved. 35

36 Global tax strategy Transfer pricing compliance Tax authorities around the world continue to increase their scrutiny of multinationals' transfer pricing compliance continues to increase in importance Consistency in pricing outcomes across jurisdictions with similar functional and risk profiles is an area of focus in the era of CbC reporting Pre-tax operating margin SG&A/Sales Return on net operating assets Evaluating and memorializing the reasons for differences in pricing outcomes is critical in supporting a company's transfer pricing position, as are written intercompany contracts that reflect the actual conduct of the parties Grant Thornton LLP. All rights reserved. 36

37 Collection and presentation of attributes Tools used to centralize data Financial accounting system Can centralize data within the system Tax is not the primary focus of the software Often times lacks necessary tracking capabilities related to tax However, tied directly to financials Excel Can be more centralized More user friendly Often times becomes overly cumbersome Higher risk of user error and computational errors Licensed tax software systems (CorpTax, Orbitax, etc.) Highly centralized Limits user error with rollforward information Often times includes ability for scenario modeling/forecasting However, costly to license Self developed software systems Highly customizable However, often the most costly option Grant Thornton LLP. All rights reserved. 37

38 Planning opportunities Grant Thornton LLP. All rights reserved. 38

39 Ability to influence Earnings and profits Opportunities to influence E&P Tracking and method consistency Methods evaluation Trigger built-in losses Absorb E&P deficits Grant Thornton LLP. All rights reserved. 39

40 Ability to influence Earnings and profits of a foreign corporation Sample method changes to consider: Defer advance payments Defer recognition of disputed income Depreciation review to identify misclassified assets or cost segregation Deduct repairs and maintenance costs/partial dispositions Deduct software development costs Inventory related adjustments Prepaids Grant Thornton LLP. All rights reserved. 40

41 Ability to Influence Repatriation/foreign tax credit planning Identify/maximize high tax pools Requires reliable data and tracking practices Utilize strategies to reduce E&P Instances where it makes sense to trigger foreign tax now FTCs worth more before Tax Reform rather than after (based on proposed changes) Cash repatriation needs at a low tax cost regardless of Tax Reform Potential for tax reform transition rules that limit FTC's during period between enactment and effective date Consider splitter and 901(m) rules Grant Thornton LLP. All rights reserved. 41

42 Ability to Influence Repatriation/foreign tax credit planning Ensure ability to access high-tax pools Sec 304 transactions Local country foreign exchange and capital rules (i.e., China, South Africa, etc.) Tee up for use at appropriate level in structure Lower tier vs. up to parent Consider transition rules & potential restrictions Although not clear yet, transition rules may be established to limit the benefits of such planning Grant Thornton LLP. All rights reserved. 42

43 Ability to Influence Repatriation/foreign tax credit planning Local taxes on PTI distributions e.g., Withholding Taxes, India Dividend Distribution Tax, South African Dividend Taxes, etc. Attribute tracking necessary Consideration of Section 904 limitations Grant Thornton LLP. All rights reserved. 43

44 Ability to influence Foreign tax credit distribution planning Back to the comprehensive example, below are our facts on the foreign tax credit Grant Thornton LLP. All rights reserved. 44

45 Ability to influence Foreign tax credit distribution planning Back to the Comprehensive Example, below are our facts on the Foreign Tax Credit Impact on a distribution of $5,000 from K Asia Ops. Tier up of $100 of E&P and $10,000 of taxes to K Europe Holdings to make a high-taxed distribution to the U.S. How would the distribution be different if it came from Y Euro Ops Grant Thornton LLP. All rights reserved. 45

46 Ability to influence Consider need for global strategy changes post-tax reform Minimizing foreign taxes Will become even more important (i.e., withholding taxes) Modifications to supply chain Potential U.S. anti base-erosion provisions (e.g., minimum tax provision) may drive changes May become more efficient to operate in different jurisdictions than historically BEPS risk assessment Impact of lower US corporate tax rate All such items potentially require some level of consideration from a transfer pricing perspective. Therefore, transfer pricing planning is a driving force restructuring global strategy Grant Thornton LLP. All rights reserved. 46

47 Global tax strategy Transfer pricing planning An analysis of certain tax attributes across operating jurisdictions may assist a multinational in identifying transfer pricing planning opportunities Planning may take the form of harmonizing attributes across jurisdictions in which the company has a similar functional and risk profile Planning may also include restructuring as a result of identifying a sub-optimal tax attribute in an operating jurisdiction Developing a roadmap to move from the current state to the desired state is critical to supporting a company's transfer pricing position Written intercompany agreements that match the actual conduct of the parties are critical as well Grant Thornton LLP. All rights reserved. 47

48 Reform with eyes wide open Grant Thornton LLP. All rights reserved. 48

49 5 Things Multinational businesses are doing to become agile in the face of tax reform 1. Modeling Make effective business decisions Identify international planning opportunities 2. Managing international tax attributes Understand global footprint and reform impact Proactively monitor attributes amidst uncertainty 3. Tax efficient structuring Prepare for the next in global taxation Efficiently manage any tax reform outcome Grant Thornton LLP. All rights reserved. 49

50 5 Things Multinational businesses are doing to become agile in the face of tax reform 4. Foreign tax credit utilization Importance of allocating and apportioning deductions Significant tax savings and potential cash tax refunds 5. Inbound financing Balance between operational need and tax efficiency Act now and benefit from "grandfather" provisions Grant Thornton LLP. All rights reserved. 50

51 Synopsys Tax reform planning On September 8, 2017, Synopsys, and US based electronics company announced that it's board approved a plan or repatriate approximately $775-$850 million in cash currently held offshore during 2017 The repatriation is planned in anticipation of potential corporate tax reform and the company expects to be able to realize the benefit of existing R&D credits to reduce the tax due as a result of the repatriation The GAAP tax expense expected is approximately $160 to $180 million while a cash tax payment of approximately $40-$50 million is expected Following Ford and others Synopsys is the latest US based multinational to do significant foreign repatriation planning ahead of tax reform Grant Thornton LLP. All rights reserved. 51

52 Questions? Grant Thornton LLP. All rights reserved. 52

53 Speakers Eric Gabbai Senior Manager International Tax Services Robert Spence Partner International Tax Services Chris Summer Senior Manager International Tax Services Ed Weaver Senior Manager International Tax Services Grant Thornton LLP. All rights reserved. 53

54 Disclaimer This Grant Thornton LLP presentation is not a comprehensive analysis of the subject matters covered and may include proposed guidance that is subject to change before it is issued in final form. All relevant facts and circumstances, including the pertinent authoritative literature, need to be considered to arrive at conclusions that comply with matters addressed in this presentation. The views and interpretations expressed in the presentation are those of the presenters and the presentation is not intended to provide accounting or other advice or guidance with respect to the matters covered For additional information on matters covered in this presentation, contact your Grant Thornton LLP adviser

55 Caveats Our analysis is limited to the issues addressed in this document, and are based on facts, assumptions, documents and representations we have received from company personnel and on any assumptions stated herein. We have neither independently investigated nor verified these facts, representations, and assumptions, although we have considered their reasonableness. If any of the facts, representations or assumptions reflected in this document are not accurate, this may adversely impact our conclusions. It is therefore imperative that you inform us of any such inaccuracies immediately This document is provided solely for the use of the company, in connection with the consideration of the specific transactions described above and for no other purpose and by no other person without our prior written consent in each instance. In the event that other persons or entities are provided with a copy of this document, they should not rely upon it with respect the tax consequences they may face. Instead, they should seek separate advice with respect to their situation from their tax advisor In providing this analysis, we have considered the applicable provisions of the Internal Revenue Code of 1986, as amended, the regulations thereunder, and judicial and administrative interpretations thereof. These authorities are all subject to change, and such change could have retroactive effect. Any such changes could thus have an effect on the validity of our conclusions. Unless you specifically request otherwise, we will not update this document for subsequent changes or modifications to these authorities. Further, this document is based on our interpretation of these authorities; another knowledgeable party (such as the IRS or a court hearing the same facts) might reach different conclusions. Any such changes could also have an effect on the validity of this analysis

56 Disclaimer * * * * * * * * * * * * * * * * * * * * * * IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the U.S. Internal Revenue Service, we inform you that any U.S. federal tax advice contained in this PowerPoint is not intended or written to be used, and cannot be used, for the purpose of (a) avoiding penalties under the U.S. Internal Revenue Code or (b) promoting, marketing or recommending to another party any transaction or matter addressed herein. * * * * * * * * * * * * * * * * * * * * * The foregoing slides and any materials accompanying them are educational materials prepared by Grant Thornton LLP and are not intended as advice directed at any particular party or to a client-specific fact pattern. The information contained in this presentation provides background information about certain legal and accounting issues and should not be regarded as rendering legal or accounting advice to any person or entity. As such, the information is not privileged and does not create an attorney-client relationship or accountant-client relationship with you. You should not act, or refrain from acting, based upon any information so provided. In addition, the information contained in this presentation is not specific to any particular case or situation and may not reflect the most current legal developments, verdicts or settlements. You may contact us or an independent tax advisor to discuss the potential application of these issues to your particular situation. In the event that you have questions about and want to seek legal or professional advice concerning your particular situation in light of the matters discussed in the presentation, please contact us so that we can discuss the necessary steps to form a professional-client relationship if that is warranted. Nothing herein shall be construed as imposing a limitation on any person from disclosing the tax treatment or tax structure of any matter addressed herein Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd. All rights reserved. Printed in the U.S. This material is the work of Grant Thornton LLP, the U.S. member firm of Grant Thornton International Ltd.

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