Exercises. Copyright Stephen C. Fox, FDU, Fall, Copyright Stephen C. Fox,

Transcription

1 Exercises 147

2 Interest Apportionment» Reg thru 12 Consolidated return interest expense apportioned based on consolidated return assets 3 methods: tax basis, AMT basis, FMV Apportion to all baskets having assets, whether income or not May cause losses in some baskets Expired temp. regs vs. proposed regs Overview. Try to explain in general terms. Broad example to start off: Foreign income: Branch profits 30 CFC dividend 60 Grossup 30 Total FSGI 120 Branch paid tax of 10 Total foreign tax 40 effective rate: 33% (40/120) Assets: Total 1,000 Foreign branch 50 CFC basis 20 CFC E&P 150 total foreign 200 % foreign 20% Total Interest expense 100 Foreign 20 Net FSTI 100 FTC Limit 35 Incremental US tax on Net US Tax 7 + foreign 40 = 47 Eff. Rate39% 148

3 Interest Defined Same meaning as 163 Includes: OID Imputed interest Costs for use of funds Amounts treated as interest under notional principal contracts Bond premium What is interest? above 149

4 Int.App: Partnerships Special allocations at p/s level Corp. >10% GP: look thru for assets & interest Indiv. GP or >10% LP: special rules <10% partner: directly allocate share of p/s interest exp. to p/s income treat p/s interest as asset for allocating other interest Not covering this either: but read regs: straightforward 150

5 Int.App: Corporations Reg T(f),(g),(h) US corps must use asset method Default is adjusted tax basis May permanently switch to fair market value Special rules for CFCs & foreign branches Rules for basketizing assets Special basis adjustments for this History: pre-87: gross income method or asset method: choice each year. Meant no interest apportionment unless you had FSI Now required to do assets. Two possible ways: very adjusted tax basis or FMV. Once switch to FMV, can t change back without IRS consent. Best info. says they ve never consented Will cover other rules above. Note that there are basis adjustments that apply for this purpose only. Separate calculations required for regular tax & AMT, since basis in assets is different 151

6 Int.App: Asset Method Interest expense apportioned to basket = Assets in basket Total interest x Worldwide assets Basic formula above 152

7 Int.App: Asset Values Tax Book Value: very adjusted tax basis (below) (default) Alternative Tax Value: very adjusted AMT basis Fair Market Value One time election to convert to AMT or FMV 153

8 Int.App: Basketizing Assets Single category assets: allocate value Multiple category assets: apportion value based on income they produce (typically based on GI) No yield assets: excluded from calculations Step by step basketizing of assets, based on what income the assets produce. Do simple example: 50% of sales income is foreign: Total Foreign 10/50 Cash 100 Accts. Rec. 1, based on analysis PP&E 1, under 50/50 rule of 863(b) Investment in CFC 1,000 1,000 incl. R/E Investment in 10/50 co. 1,000 1,000 incl. R/E APB 16 goodwill Book Total 5,000 1,850 1,000 Excluded assets ( 100) Book/Tax Differences ( 4,000) ,000 1,850 1,

9 Int.App: Adjustments Reg T Adjust basis in 10/50 and CFC stock for E&P Basketize CFC stock & notes: look thru Reduce basis by debt on which interest is capitalized NO apportionment to FSC or DISC stock E&P adjustment: this is second reason for basketizing subsidiary s E&P (other reason was to basketize dividends). Example below Tiering up of basketization of assets: must basketize lowest tier first (down to 4th tier, which is all passive by definition), then roll up. Put simple example on board, with 2 baskets for each sub. Have class give answers Capitalized interest, such as construction period: reduce asset basis for debt: this is ONLY for CFCs FSC/DISC should have zero basis anyway, since both are shams for tax subsidy. EXAMPLE 1: Book Tax Investment in CFC at cost 100 Earnings & profits 900 Book Equity in CFC 1, Totals 1,050 1,000 Good 1st order approximation EXAMPLE 2: Total General Passive USP F1: Sales Income (net) Interest from F2 100 apportion using F2 GI method F1 Interest from unrelateds F2: Sales Income (b4 int) 200 (Assume GI = Net) F2 Interest from unrelateds

10 Exercises 156

11 Int.App: CFC Netting Reg T(e) Interest expense must be directly allocated to interest income from CFCs Technical formula based on comparative debt ratios, using escalated base period amounts as limitations The real fun We ll do brief overview only. Won t be on test Excess is amount over base period ratio x current balances Prior CFC netting rule had an elective quadratic formula under which excess related person indebtedness equals the smallest positive amount (not exceeding the aggregate amount of related controlled foreign corporation indebtedness) that is a solution to the following formula (with X equalling the amount of excess related person indebtedness): Aggregate third party debt of Aggregate third party debt related US shareholder -X Applicable of related CFCs + X percentage = US shareholder assets -X for year Related CFC assets (the applicable percentage was a phase-in of the provision) 157

12 Int.App: within CFCs Reg T(f)(3) Annual election of method: Asset method, as above Gross income method But may use only if not using FMV method Must use same method for all CFCs GI method: must tier up gross income of lower tier subs, excluding: Dividends Other payments except look thru interest Subpart F income, as adjusted Critical topic, as this impacts basketizing E&P for dividends. 2 options, above Consistency requirement GI method tiering up can be tricky. This isn t really a consolidation Walk thru tiering up under GI method: US owns F1 which owns 80% of F2 100% 80% F2 GI: General Passive 10 8 F2 pays dividend of 13 F1 only Tier Total F1 GI Gen Passive Div from F2 13 not counted 158

13 Impact on 904 Look Thru Rents & Royalties Same basket as rent or royalty expense is allocable or apportionable to See Interest Very easy: attribute to the basket to which the deduction is allocable. Since rent & royalty expense is generally directly related to production of income, very easy Example: US rents machine to F1 which uses in mfg: rent is general 159

14 Look Thru Interest Same basket as interest expense of CFC is apportioned: Allocation & apportionment: Follow these steps: Different than 861, discussed later Determine gross income by basket Allocate definitely related expenses Allocate related person interest expense to passive FPHC income (to the extent thereof) Unallocated balance of interest apportioned as below Interest look thru is same simple concept as rents: follow the income to which attributable at CFC level. However, since interest is fungible, must do some apportioning. Will get to general int. apport. later. Recall that in computing FSTI, int of US co. is apportioned based on assets. Mechanical steps for determining basket to which int. paid by CFC to US SH is attrib: (follow slide) Start an example on board: (specialist class only) General Passive FPHC Assets % 50% Gross income % 20% SG&A expense Interest paid to related (US) person 400 Additional admin expense attrib. to all gross income: 50 If this is all the related person interest, stop here: all is passive. But if 100 more, then must apportion 160

15 Look Thru Interest, cont. Apportion interest then other expenses to other income: Gross income method: Gross income in basket Balance x Total non-passive gross income Asset method: Assets which produce basket income Balance x Total non-passive assets or Total Gross Income or Total Assets Expand on example: (specialist class only) Balance (100) gets apportioned entirely to general, since no passive left. Further, the add l 50 of G&A is apportioned entirely to general. Thus passive is -0- and general net is ( ) = 350 But, if the interest expense had only been 100 and all unrelated instead of 400, results would have been: GI method: 20 passive, 80 general Asset method: 50 each In such case, the add l 50 of G&A would have been similarly apportioned. Result: passive would be 370 under GI method and 325 under asset method. Note how method of apportionment makes big difference. This example is not unrealistic. Other expenses including unrelated person interest is apportioned similarly. This apportionment is important in basketizing E&P for dividends. In determining value of assets, may need to basketize investment in lower tier CFC or loans to or property used by lower tier CFC. Do so by looking thru & basketizing income first, then value of asset follows. Ask class to read examples in regs at home. 161

16 Re-sourcing Losses 904(f) & regs Apportionment of expenses (esp. interest) may cause loss Current loss in basket reduces other baskets Overall or basket losses carried forward Apport of deds can cause loss in basket or overall, esp. in years of no income. Example: USP has a foreign sub, all general basket, and has de minimis FSI of its own. USP has debt, so int. is apport. to gen basket each year, generating FS loss. No effect on TI, since all interest is deducted anyway. When sub finally pays div, must recap loss. Why? otherwise could evade apport. regs Similar principle for mult. baskets: loss in one year offsets income in other baskets that year. When have income in future year, must recharacterize. 162

17 Re-sourcing Losses Future income in prior loss basket resourced to basket which absorbed loss Future income when prior overall loss recaptured: Lesser of balance of loss or 50% of current foreign source income May elect higher % Losses in basket or overall carried forward, income in future years is resourced to recapture Resourcing between basket is limited to 100% of income Resourcing of overall is limited to 50% of income or amount of loss Revised example from above: assume 96 income was only 1000 net: Simple Example: Gen Pas. Total 2005 (100) 20 (80) Res. 20 (20) -- Net (80) 0 (80) Res. Bas. (20) Res. OFL (25) 0 (25) Net May elect to recapture more than 50% of OFL: so in 96 could have recaptured all. Why? 163

18 Overall Foreign Loss (OFL) Deductions allocated & apportioned to foreign source are less than foreign source gross income Exclude NOL, expropriation & casualty loss deductions Apply both overall and by separate baskets How does OFL arise: int. apport is principle culprit As indicated, rules apply both by basket and overall 164

19 Foreign Currency / Foreign Exchange FDU, Summer

20 Foreign Currency: Concepts and SFAS 52 Exchange rate Functional currency Foreign exchange gain/loss Recognized vs. unrecognized Hedging Synthetic instruments Intro: Fluctuating currencies; foreign currency is property not money Briefly describe what each of above is, give examples Functional currency concept: all transactions are measured/remeasured in functional currency for computing TI, E&P, etc. FC is principal currency used by a business unit. 166

21 Foreign Currency Translation Translating nonfunctional currency transactions Translating functional currency statements Special tax rules: Taxes translated at accrual rate (post-97) 988 gain or loss Dollar functional currency election Recognition timing Transactions in currency other than FC must be translated to FC in order to compute TI, E&P, etc. Translating done by averaging conventions, spot rates, etc. This is method of acctg. Generally, follow books. Statements in a non $ FC must be translated to $ for US tax purposes, at some point. Branch stmts translate each year; subs stmts translate net result only when div. or Sub F Taxes: for E&P, translate to FC using average rate 988 gain/loss: what happens if expense accrued in non-fc & later paid after rate moves? gives rise to 988 g/l. Considered ordinary. Applies to income, expense, taxes (for E&P) May elect $ as FC if highly inflationary. DASTM below Foreign exchange gain/loss not recog. for tax until realized: no mark to market (except 1256, some other) Contrast to books: mark to market at year end. 167

22 Functional Currency Reg , 4 Currency in which most of business conducted Similar concept for book & tax Generally can follow book determination Dollar is mandatory after 1994 if hyperinflationary Dollar mandatory in certain other situations What is the FC? Usually no brainer Follow slide Hand out SFAS 52 functional currency list: factors on list are similar to ones for tax 168

23 Functional Currency Dollar required if: Individual with no QBU Activity of QBU primarily in dollars QBU is resident in US or possession Books of QBU kept in different currency than that of business environment US trade or business Hyperinflationary (after 1994) When must $ be used as FC: follow slide What if you acquire a German group that has a UK branch. They keep the branch books in DM. If you don t change to pounds, then will be forced to change to $ as FC. Could have interesting results. 169

24 Functional Currency Single FC required for foreign corp. Foreign corporation has its own FC independently of its QBUs Must determine P&L for each QBU with different FC under its FC Then translate using P&L method P&L method: determine each QBU s P&L in its FC. Then translate items or total at exchange rate for month or year (method of acctg as to which & how) into corporation s FC. No real magic 170

25 Qualified Business Unit (QBU) 989(a), Reg (a)-1 Separate Clearly Identified Business unit Trade or business, or Whole corporation Separate books required to be a QBU Example: branch or office What s a QBU: usually a no brainer. See above. QBU is a tax concept, but may in essence be applied in GAAP due to separate books requirement 171

26 987 Gain on Transfer Prop. Reg Gain or loss recognized on transfer of assets from branch or liabilities to branch if different FC Gain (loss) = remittance at spot rate less Remittance in branch FC x (basis pool - prior remit.) Equity pool - prior remit. Source & character determined like interest Complex topic beyond scope of course: brief overview above Detailed rules for basis & equity pool calculations Equity pool maintained in QBU s FC, basis pool maintained in taxpayer s (or foreign corporation s) FC Equity & basis pool essentially same, but different currency tracking Allocated & apportioned based on assets or gross income of taxpayer (or foreign corporation), depending on which method used for interest 172

27 Sec. 988 Gain or Loss Ordinary FX gain or loss Recognized on 988 transaction Sourced to residence of QBU on which properly booked Lengthy special rules Sec. 988 gains major topic Ordinary gain or loss Recognized when realized Sourcing follows QBU Special rules follow 173

28 Sec. 988 Transaction Following transactions if denominated in non-fc or determined by reference to non-fc(s) Acquisition of or becoming obligor under debt instrument Accruing item of income or expense which is to be received or paid later Entering into certain forwards, etc. When does 988 apply: above 174

29 Other 988 Definitions Non-functional currency Spot rate Exchange gain or loss Hyperinflationary currency Define key terms above 175

30 988 Recognition Events» Reg Disposition of nonfunctional currency Realizing item of accrued income or expense Settling forwards, etc. Special rules for interest income & expense Books recognize gain/loss at b/s date, marking to market Tax must have recognition event, as above 176

31 988 Recognition Events: Examples Use examples from exercises; hand out & solicit answers Also cover Exercise 2-1 from D&T materials Discuss differences in recognition timing 177

32 Character of 988 Gain/Loss Generally treated as ordinary May elect to treat certain identified hedges, etc. as capital 988 gain/loss on tax exempt bonds, certain swaps, integrated hedges treated as interest 178

33 Source of 988 Gain Generally residence of QBU Individual: country of residence QBU: principal place of business Whole corp.: where incorporated Whole p/s: where organized 179

34 Hedging Overview Reg , Concept of hedge: reduces risk on asset Corn Products and Arkansas Best Hedges vs. straddles Notional principal contracts Interest & gain components Not covered in detail in this set of courses: very advanced topic What is a hedge hedge cases notional means computed by ref. to a hypothetical principal amount Example hedge: Bank promises to sell $50M DM at particular date in 1997 at today s rate. Hedge is priced so bank is compensated for risk of movement. Part of payments are considered interest under regs, esp. on interest rate hedges. Do hedging Exercise 2-2 from D&T materials. Discuss book/tax timing differences Hand out Exercise 2-3 and answer as items to consider outside class 180

35 SFAS 52 vs. Tax Books recognize gain/loss as accrued, whether or not realized Tax recognizes gain/loss when realized (i.e., only upon closing a transaction) Book also recognizes gain/loss on currency movement on investment in subsidiary Book is worldwide consolidated vs. tax is US stand alone (cost basis) Why cover SFAS 52 in this course: Accounting people often ask nearest int l person (usually tax) how to do it You must understand to be able to get from book to tax Goal of SFAS 52 is to remeasure or translate foreign currency operations and balance sheet into reporting currency. Assume for balance of presentation that reporting currency is US$ and principal operating currency of 1st tier subsidiary is DM. Point out that tax methods are similar to old SFAS 8 SFAS 52 uses current rate method: all items translated at current rate (average for operations, year end rate for b/s): operations results likely to be similar for tax for subsidiaries, but will differ under P&L method. Translating at current rate means retained earnings won t balance: must plug at year end. 181

36 E&P FDU, Summer

37 Earnings & Profits Why important Limits amount of dividend from foreign corp Limitation on Subpart F income Used to determine amount of 902 credit Tax concept equivalent to retained earnings Many of same issues for domestic corp. Very brief coverage of E&P: not a difficult topic follow slide 316: distribution is dividend to extent or current or accumulated E&P Q: Can a distribution be other than a dividend if the corporation has E&P? A: Yes. 302 Discuss concept of 312: adjusted earnings 183

38 E&P 312 Definition Cumulative taxable income or loss adjusted for certain items Reduced (but not below zero) by distributions Includes tax exempt income and most nondeductible expenses Exempt income Non-deductibles (except fines & penalties, illegal bribes & kickbacks), including T&E, etc Gets to equivalent of retained earnings 184

39 E&P Common Adjustments Different depreciation methods & lives Alternative depreciation system, straight line Corresponding adjustment to gain or loss on dispositions Construction period interest, IDC, 248 amortization LIFO reserve Installment sales Adjustments: Depreciation must be on alternative method, straight line: note: this is req d for foreign use assets anyway. Corresponding adjustment to gain/loss on disposals FIFO (Note: could be on LIFO for Subpart F calculations) No completed contract method: 100% percentage of completion Cost basis depletion only. No deduction for IDC: capitalize & amortize 185

40 E&P--902 Method 986(b), Reg , Applies for 902 Same as 964 method after 1986: based on functional currency Before 1986: similar to 964, but no (d) or (e) Note: (d) & (e) repealed in 1986 (d): Translation of E&P to US$: now in FC (e): Optional recognition of exchange gain or loss Translated to dollars on distribution at spot rate Gain/loss on distribution of previously taxed earnings Old 902 method was all in $ as earned Now is in functional currency (change due to enacting ) Subpart F causes inclusions, which are translated at year end rate from FC. When these are actually distributed, they are retranslated at spot rate on date of distribution, giving rise to FX g/l 186

41 E&P Elections All normal methods of accounting Depreciation methods Inventory methods Other foreign corporation must make E&P elections if its E&P impacts a U.S. person. Elections made by controlling US s/h, if there is one, otherwise by any U.S. shareholder. Notification requirements to other s/h All normal tax accounting elections are potential elections of forn. corp. Time for making: with return (per rev. proc. on automatic changes) Make elections by filing statement with IRS. Change by filing Form 3115 (same deadline) 187

42 Basketizing E&P Look thru of dividends for 904(d) means must segregate E&P into 904 baskets Requires tracking separate pots of E&P Requires allocating & apportioning expenses Optional gross income method for CFCs We covered this earlier. Review 188

43 Resourcing E&P Losses Deficit in basket of E&P reduces other baskets Deficit carryovers or carrybacks become significant only on distribution Deficit in post-86 E&P carried back to extent of prior E&P Pre-87 deficits carried forward only Resourcing like 904(f) Same re-sourcing rules apply to foreign corporations. Covered before, just reminder Do a quick example on board 189