Subpart F Income Rules and Sections 956, 958 and 1248: Meeting the Reporting Challenges of Controlled Foreign Corporations

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1 FOR LIVE PROGRAM ONLY Subpart F Income Rules and Sections 956, 958 and 1248: Meeting the Reporting Challenges of Controlled Foreign Corporations THURSDAY, JULY 21, 2016, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at x10 (or x10). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. You will have to write down only the final verification code on the attestation form, which will be ed to registered attendees. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service x10 (or x10) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.

2 Tips for Optimal Quality FOR LIVE PROGRAM ONLY Sound Quality When listening via your computer speakers, please note that the quality of your sound will vary depending on the speed and quality of your internet connection. If the sound quality is not satisfactory, please immediately so we can address the problem.

3 Subpart F Income Rules and Sections 956, 958 and 1248 July 21, 2016 Melinda Fellner Bramwit, Partner Rimon, New York City and Bedminster, N.J. melinda.bramwit@rimonlaw.com Chip Morgan, JD, International Tax Partner BDO, Los Angeles cmorgan@bdo.com

4 Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

5 CONTROLLED FOREIGN CORPORATIONS Melinda Fellner Bramwit, Esq., Partner Rimon PC New York New Jersey: (908) New York: (212)

6 Getting Started Controlled Foreign Corporations- why do we care? Basic rules of subpart F and how it works Definition of Controlled Foreign Corporations ( CFCs ) A foreign corporation, where more than 50% of combined vote or value is owned by US Shareholders on any day during the corporation s tax year. 6 rimonlaw.com Rimon, P.C. All Rights Reserved.

7 Getting Deeper into Definition of CFC Definition of US Shareholder Stock ownership- can be direct, indirect or constructive 7 rimonlaw.com Rimon, P.C. All Rights Reserved.

8 Tax effect to US Shareholders A US Shareholder of a CFC on the last day of the CFC tax year during which it was a CFC for an uninterrupted period of 30 days or more has a deemed income inclusion in the amount of their pro rata share of the CFC: Subpart F income Previously excluded types of Subpart F income and Increase in earnings invested in US property. Up to the amount of the corporation s E & P 8 rimonlaw.com Rimon, P.C. All Rights Reserved.

9 Five Categories of Subpart F- Number 5 is One to Focus on 1. Income from unrecognized foreign countries 2. Certain illegal bribes and kickbacks 3. Boycott income 4. Certain income from insurance of risks 5. Foreign base company income 9 rimonlaw.com Rimon, P.C. All Rights Reserved.

10 Foreign Base Company Income has 5 Sub Categories 1. Foreign personal holding company income 2. Foreign base company sales income 3. Foreign base company services income 4. Foreign base company oil related income 5. Foreign base company shipping income 10 rimonlaw.com Rimon, P.C. All Rights Reserved.

11 FPHCI Foreign Personal Holding Company income Types- dividends, royalties etc- Passive in nature Note some exceptions - active trade or business rents Same country related person dividends and interest 11 rimonlaw.com Rimon, P.C. All Rights Reserved.

12 FBCSI- Foreign Base Company Sales Income Income such as profit derived by a CFC in connection with a purchase transaction with a related person IF goods originate outside of and used outside CFC country of incorporation Examples Definition of related Manufacturing discussion- briefly- substantial operations 12 rimonlaw.com Rimon, P.C. All Rights Reserved.

13 Foreign Base Company Services Income Income in the form of compensation derived in connection with performance of services performed for or on behalf of a related person and outside CFC country of organization. Example Substantial assistance 13 rimonlaw.com Rimon, P.C. All Rights Reserved.

14 Limits and Exclusions on Subpart F De minimus rule High tax ECI E&P 14 rimonlaw.com Rimon, P.C. All Rights Reserved.

15 rimonlaw.com Melinda Fellner Bramwit Partner Rimon P.C., Law Firm Evolved New Jersey: (908) New York: (212) Washington Valley Rd, Bedminster, NJ Park Ave, 39th Floor, New York, NY 10167

16 CFC REPATRIATIONS CHIP MORGAN International Tax Partner (310) July 21, 2016

17 AGENDA CFC REPATRIATION 3 COMMON METHODS 1. Dividend to U.S. Owner: a) Ordering rule for dividends; b) Earnings and Profits ( E&P ); c) Qualified vs. Non-qualified Dividends; d) Foreign Tax Credits ( FTC ); e) Previously Taxed Income ( PTI ); 2. Sale of Stock; 3. Check-the-Box (deemed liquidation): a) Solvent liquidations; 4. Insolvent liquidations. 17

18 DIVIDEND TO U.S. OWNER 18

19 TAXABLE DIVIDEND USP CFC Cash Dividend Dividends follow the ordering rule : (1) Is it Previously Taxed Income (PTI)? (2) If not PTI: (a) Current retained Earnings & Profits ( E&P ) taxed as ordinary income; (b) Shareholder Equity. Distributions in excess of E&P nontaxable to extent of shareholder s basis (i.e., a return of capital); (c) Excess over basis is capital gain. 19

20 EARNINGS & PROFITS ( E&P ) E&P is a U.S. tax concept never clearly defined; E&P Includes: All items of gain, income, loss, and expense realized by the corporation, whether included or specifically excluded in computing taxable income, unless the inclusion or exclusion from taxable income was based on consideration of tax policy rather than the economic effect of the item on a corporation s net assets; E&P Represents: The net increase in corporate assets in excess of those assets received from the shareholders as contributions to capital, net of liabilities incurred; A measure of a corporation s economic ability to make distributions to its shareholders out of its nets assets in excess of the contributed capital of shareholders; E&P Calculation: A corporation s E&P is calculated by making adjustments (positive or negative) to taxable income for items that are treated differently for E&P purposes. 20

21 QUALIFIED VS. NON-QUALIFIED DIVIDENDS Not all dividends are created equal Qualified dividend: dividends paid during the tax year from qualified foreign corporations ( QFC ). A QFC is a foreign corporation: Organized in a foreign country or U.S. possession; Eligible for benefits of a comprehensive U.S. tax treaty that contains an exchange of information provision; or The stock of the QFC is regularly tradable on an established market in the U.S.; Not a Passive Foreign Investment Company (PFIC); Result - Taxed at capital gains rate; Non-qualified dividend: Does not qualify for the lower tax rates - taxed at ordinary income rate; Subpart F inclusions are not eligible for Qualified Dividend treatment. 21

22 901 AND 902 FOREIGN TAX CREDITS 901 v. 902 Foreign Tax Credits ( FTC ): 901 Direct FTC: Examples include taxes on foreign branch and disregarded entities ( DRE ) operations and foreign withholding taxes on dividends, interests, or other payments; 902 Indirect FTC: Based on foreign income taxes paid by foreign subsidiaries; When a foreign corporation pays a dividend, a 10% domestic corporate shareholder (voting stock) is entitled to claim a deemed paid FTC for a proportionate amount of the foreign corporation s foreign income taxes; Doesn t apply to individuals; E&P and tax pools: Foreign corporations compute and maintain their E&P according to the U.S. tax principles applicable to domestic corporations (IRC 964); Taxes and earnings are calculated and maintained in multi-year pools covering all post-1986 years of the foreign corporation under U.S. ownership. 22

23 PREVIOUSLY TAXED INCOME ( PTI ) Distribution by a CFC out of E&P previously included in the income of a U.S. shareholder, ( PTI ), is not included in the U.S. shareholder's income a second time (IRC 959(a)); Rule designed to prevent double taxation of a CFC's earnings; Keeping track of a foreign corporation's E&P under the IRC 959 ordering rules may be complicated; Three categories and ordering rules: IRC 959(c)(1) account, from prior-year IRC 956 inclusions; IRC 959(c)(2) account, from current- or prior-year subpart F income inclusions and IRC 1248 deemed-dividend inclusions; and IRC 959(c)(3) account (other E&P, i.e., non-pti); (PTI is considered distributed on a last-in, first-out (LIFO) basis). 23

24 SALE OF CFC STOCK 24

25 GAINS FROM THE SALE OF STOCK Serves to subject the accumulated E&P (attributable to the shares held by the shareholder; consider the holding period) of a foreign corporation to tax as if they were distributed as a dividend to the shareholder; Prevents a U.S. shareholder, (10% or greater shareholder), from accumulating earnings in a foreign corporation and converting the ordinary income into capital gains where there is a lower rate on capital gains v. dividend income; It re-characterizes a gain on the sale of stock as a dividend to the extent of the E&P attributable to the stock; FTC are available under IRC 902 to the same extent as if the earnings had actually been distributed; IRC 1248 dividends are eligible for Qualified Dividend treatment. 25

26 CHECK-THE-BOX 26

27 CHECK-THE-BOX ( CTB ) DEEMED LIQUIDATION Before USP After USP Facts: U.S. Parent ( USP ) has owned 100% of a controlled foreign corporation ( CFC ) since CFC s incorporation in year 1. In year 3, CFC makes a check-the-box ( CTB ) election to change its classification from a corporation to a disregarded entity ( DRE ). Immediately prior to the effective date of the CTB election, CFC has $10 million in accumulated E&P attributable to shares held by the shareholder. CFC DRE Results: CFC is deemed to distribute all of its assets and liabilities to USP in liquidation. CFC ceases to be a treated as corporation and is generally disregarded for U.S. federal tax purposes; However CFC continues to be treated as a corporation for foreign tax purposes. After the CTB election, USP continues to operate CFC s trade or business outside the U.S. through its interest in DRE. 27

28 CTB DEEMED LIQUIDATION OF CFC Generally, U.S. shareholder is not subject to U.S. taxation on the E&P of a CFC until the earnings are repatriated (deferral vs. subpart F anti-deferral); CTB election on eligible entities (vs. per se entities) = deemed liquidation; IRC 367(b) ensures that the previously deferred foreign earnings of a CFC do not escape U.S. taxation at ordinary rates through non-recognition transactions (e.g., IRC 332); IRC 367(b) regulations may require the U.S. shareholder to report deemed dividend income equal to the CFC s all earnings and profits amount ; IRC 367(b) triggered if the liquidation is described in IRC 332 (e.g., corporate shareholders own 80% or more of the liquidating corporation and that the liquidating corporation is solvent at the time of the liquidation); Question = What if the CFC is not solvent? 28

29 INSOLVENT CORPORATIONS Question = What if the CFC is not solvent (IRC 332 liquidation does not apply)? Two common scenarios: Worthless Stock deduction under IRC 165; Bad Debt deduction under IRC 166 (if CTB is DRE and not Partnership). 29

30 THANK YOU FOR YOUR PARTICIPATION! 30