TEI Midyear Conference: Foreign Tax Credit Planning: Currency, E&P and Other Issues March 16, 2016

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1 TEI Midyear Conference: Foreign Tax Credit Planning: Currency, E&P and Other Issues March 16, 2016

2 Introductions Jeff Cooper Starwood Hotels & Resorts Worldwide, Inc. Manager, International Tax Operations & Strategy Marty Collins PwC Partner International Tax Services Doug McHoney PwC Principal US Integrated Global Structuring Leader PwC 2

3 Agenda Monetizing Economic Losses FX Effected Dividends Section 987 Loss Section 312(a)(3) Granite Trust Cross Chain Loan Attribute Management Non-Hovering Deficit Hovering Deficit F Reorganization PwC 3

4 Monetizing Economic Losses PwC 4

5 FX Effected Dividends Canada CFC (CAD FC) Year 1: E&P = CAD 140 (USD 127) Tax Pool = $55 ETR = 30% Year 2: Dividend = CAD 140 (USD 93) Tax Pool = $55 ETR = 37% 1 Dividend Monetize inflated tax pool effective tax rates (ETRs) caused by FX fluctuations. Relevant Facts Year 1 exchange rate = 1 USD : 1.1 CAD - Canada CFC earned 200 CAD E&P and paid 60 CAD of foreign tax (i.e., $55). Year 2 exchange rate = 1 USD : 1.5 CAD Taxpayer has CFCs that generated earnings in prior years when the CAD was stronger than it is today against the USD Tax Pool Effective Rate - CFCs maintain their E&P pool in their functional currency (e.g., the CAD) but they maintain their foreign tax pools in USD - Possible dividend with hyped FTC Tax accounting / APB 23 PwC 5

6 Section 987 Loss Recognize section 987 losses through a qualified business unit (QBU) termination or other triggering event. Relevant Facts 1 Contribution of DE 1 FHC (USD) CFC 1 (USD) DE 1 (EUR) DE 1 (EUR) DE 1 = FX loss of 50 USD FHC recognizes a loss of $50 under Section 987 Taxpayer has historically accounted for Section 987 under the 1991 Regulation approach, which imputes Section 987 g/l to every asset/liability on the books of the disregarded entity, as opposed to just the earnings or just the financial assets/liabilities PwC 6

7 Section 312(a)(3) Monetize built-in losses of CFC shares through an E&P deduction at FHC2. 1 Distribute CFC shares FHC1 FHC2 CFC 1. FHC2 distributes the shares of CFC (or other assets) to FHC1. In the share distribution, the E&P of FHC2 should be reduced by the tax basis in the distributed shares of CFC under 312(a)(3). CFC Stock basis = $100 Stock FMV = $50 Distribution of CFC to FHC1 should be subject to section 301(c) and moves any E&P from FHC2 to FHC1 up to the value of CFC. Consider timing of the section 312(a)(3) deduction. PwC 7

8 Granite Trust Monetize built-in losses of CFC shares by triggering a capital gain under section 331 and reducing E&P. FHC1 1. FHC1 transfers 30% of its interest in LossCo to FHC2. 2. A CTB election is made to treat LossCo as a partnership for US federal income tax purposes. FHC2 70% 30% LossCo Stock basis = $100 Stock FMV = $50 Accum. E&P = ($100) The CTB election should result in a deemed liquidation of LossCo under section 331 for US tax purposes. FHC1 should recognize the built-in loss on its 70% interest in LossCo as a result of the Section 331 liquidation. Such loss should be treated as a passive loss that moves into the general basket. See Treas. Reg. Sec (i)(4). FHC1 should also realize the built-in loss on the sale of its 30% interest in LossCo to FHC2. However, such loss should be disallowed under section 267(f). PwC 8

9 Cross Chain Loan Create cross-chain loan to increase tax pool rate at FHC1. 1. FHC1 issues a note to purchase CFC from FHC2. 3 Dividend FHC1 1 2 Note Interest FHC2 2. FHC1 accrues/pays interest expense which is deductible for US E&P. 3. CFC makes a dividend distribution up to FHC1. CFC CFC Deemed dividend transaction under section 304(a)(1). Section 954(c)(6) (the CFC look-thru rule). Interest expense at FHC1 creates E&P deficit. Payable Receivable PwC 9

10 Attribute Management PwC 10

11 Non-Hovering Deficit Example 2 $10 FHC CFC 1 CFC 2 E&P = $130 Tax Pool = $70 ETR = 35% Accumulated Deficit = ($100) Current E&P Deficit = ($20) Tax Pool = $10 1 $130 With current and accumulated deficits at FHC and positive E&P below, distribute up positive E&P to combine attributes without a hovering deficit. 1. CFC 2 distributes a dividend of $130 to FHC (Yr 1) 2. FHC distributes a dividend of $10 to (Yr 1) The distribution from CFC 2 should not be subject to current US federal income tax. In addition, there should be no recapture of $20 in future years as the $20 CY deficit is not reducing subpart F income Tax accounting / APB 23 FHC E&P Calculation Current Yr. Deficit (20) Dividend 130 Current Yr. E&P 110 Accumulated E&P (100) EOY E&P 10 PwC 11

12 Hovering Deficit Example 1 1 CTB Election 3 $10 From CFC 1: Accumulated Deficit = ($100) Current E&P Deficit = ($20) Tax Pool = $10 FHC CFC 1 CFC 2 Calculation Hovering E&P = $130 Tax Pool = $70 ETR = 35% 2 $130 Non-Hovering FHC Deficit (100) (20) Dividend FHC E&P (100) 110 FHC Tax Pool With deficits at one 2 nd tier* CFC and positive E&P in another, potential for combining attributes at FHC. Hovering deficit rules may warrant waiting to cross a year end before monetizing the combined attributes. 1. Check-the-box (CTB) election on CFC 1 (Yr 1) Election effective as of the first day of Yr 1 2. CFC 2 distributes a dividend of $130 (non-subpart F) to FHC (Yr 1) 3. FHC distributes a $10 dividend to Hovering deficit / timing CTB eligibility of CFC 1 (per se corp, timing, etc.) Subpart F Tax accounting / APB 23 FX Issues * Or lower through 6 th tier. Below 3 rd tier, need to consider any additional limitations to bringing up credits under section 902. PwC 12

13 Hovering Deficit Example 2 1 CTB Election 3 $10 From CFC 1: Accumulated Deficit = ($100) Current E&P Deficit = ($20) Tax Pool = $10 FHC CFC 1 CFC 2 E&P = $130 Tax Pool = $70 ETR = 35% 2 $130 Calculation Hovering Non-Hovering CFC1 Deficit (110)* FHC CY E&P 120 Subtotal Pre-Distribution (110) 120 Adjustments 60 (60) Adjusted E&P (50) 60 FHC Tax Pool Pre-Adj FHC Tax Pool Post-Adj Same concept as in Example 1, but the CTB election is midyear. Need to consider adjustments for hovering versus non-hovering deficits and the associated taxes. 1. CTB election on CFC 1 (Yr 1) Election effective in the middle of Yr 1 2. CFC 2 distributes a dividend of $130 (non-subpart F) to FHC (Yr 1) 3. FHC distributes a $10 dividend to Hovering deficit / timing CTB eligibility of CFC 1 (per se corp, timing, etc.) Subpart F Tax accounting / APB 23 FX Issues * Deficit at time of the check the box election PwC 13

14 Hovering Deficit Example 3 (Accum. Deficit earn-out) 1 CTB Election 4 $130 2 $130 FHC CFC 1 CFC 2 Calculation Hovering Non-Hovering FHC Deficit (1,000) 0 Dividend (Yr 1) FHC Deficit (Beg. 0f Yr.2) (870) 0 FHC Tax Pool (Beg. of Yr.2) 9 71 Dividend (in Year 2) $130 Inclusion (with gross-up) $221 ( ) Tax Pool E&P = $130 Tax Pool = $70 ETR = 35% From CFC 1: Accumulated Deficit = ($1,000) Tax Pool = $10 3 $130 CFC 3 E&P = $130 Tax Pool = $20 ETR = 13% $91 (>35% ETR) Hovering deficit created in Yr 1 with distribution from CFC 2 followed by a nimble dividend from FHC in Yr 2 out of additional E&P received from CFC CTB election on CFC 1 (Yr 1) Election effective as of the first day of Yr 1 2. CFC 2 distributes a dividend of $130 to FHC (Yr 1) 3. CFC 3 distributes a dividend of $130 to FHC in (Yr 2) 4. FHC distributes a dividend of $130 to in (Yr 2) Hovering deficit / timing CTB eligibility of CFC 1 (per se corp, timing, etc.) Subpart F Tax accounting / APB 23 FX Issues PwC 14

15 F Reorganization F Reorg of CFC CFC 2 & CFC 3 From CFC 1: Accumulated Deficit = ($100) Current E&P Deficit = ($20) Tax Pool = $10 CFC 1 (Non-treaty jurisdiction) Calculation FHC CFC 2 E&P = $130 Tax Pool = $70 ETR = 35% EUR Loan 3 $130 4 Loan CFC 3 E&P = $130 Tax Pool = $20 ETR = 13% Current Yr. Deficit (20) Dividend 130 Current Yr. E&P 110 Accumulated E&P (100) EOY E&P 10 U.S. Sub With deficits in a 1 st tier CFC and positive E&P in other 1 st tier CFCs, potential to combine attributes in a new FHC. 1. F Reorganization of CFC 1 into FHC 2. Contribution of CFC 2 and CFC 3 into FHC (f.k.a CFC 1) 3. Dividend from CFC 2 to FHC 4. Loan from FHC to U.S. Sub GRA on outbound transfers Step transaction doctrine / North/South issue Subpart F Business purpose Non-treaty jurisdiction Timing and Size of 956 loan - Amount of Investment in U.S. Property Tax accounting / APB 23 FX Issues Hovering deficit exception PwC 15

16 Thank You PwC 16

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