Deemed Repatriation of Deferred Foreign Earnings: Calculating Accumulated E&P and Transition Tax

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1 Deemed Repatriation of Deferred Foreign Earnings: Calculating Accumulated E&P and Transition Tax FOR LIVE PROGRAM ONLY WEDNESDAY, FEBRUARY 21, 2018, 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 ext.1 (or ext. 1). 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. 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 x1 (or x1) 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.

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3 Deemed Repatriation of Deferred Foreign Earnings: Calculating Accumulated E&P and Transition Tax WEDNESDAY, FEBRUARY 21, 2018 Kimberlee S. Phelan, CPA, MBA, Tax Partner WithumSmith+Brown, Princeton, N.J. John Samtoy,Tax Principal Holthouse Carlin & Van Trigt, Costa Mesa, Calif. Mishkin Santa, JD LLM, International Tax Director The Wolf Group, Fairfax, Va.

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 Deemed Repatriation of Deferred Foreign Income: Calculating Accumulated E&P and Transition Tax Kimberlee S Phelan, CPA, MBA, CGMA WithumSmith+Brown, PC 5 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

6 Move to a Territorial System of Taxation To Understand Where We are Going, We Must First Understand Where We Have Been 6 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

7 Pre-2018 Worldwide System of Taxation The United States taxes U.S. persons on their worldwide income. A Credit System mitigates international doubletaxation. A US Person can claim a credit for the foreign income taxes imposed on foreign-source income. Income is taxed one time at the higher of the US rate or the foreign rate. Foreign tax credit limitation restricts the credit to the portion of the pre-credit US tax that is attributable to foreign-source income. 7 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

8 Pre-2018 Worldwide System of Taxation The Deferral Privilege: the U.S. does not tax foreign income earned in a foreign corporation until those profits are repatriated by the domestic shareholder through a dividend distribution. Anti-Abuse/Anti-Deferral Provisions: SubPart F (IRC Sections 951 through 965) Earnings invested in US Property (IRC Section 956) PFICs (IRC Sections ) 8 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

9 U.S. Taxation of International Activities Pre-2018 Worldwide Tax System MAGA USA Inc. (US) MAGA Ireland Limited (Ireland) $1,000,000 Net Income Net Income of $1,000,000 taxed at 12.5% Irish corporate rate Distribution to MAGA USA Inc. taxed at the U.S. corporate rate of 35% with a foreign tax credit for the $125,000 UK tax paid. Worldwide tax paid on income $350,000 9 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

10 TCJA: Establishment of Participation Exemption System for Taxation of Foreign Income Section 245A: Deduction for Foreign Source-Portion of Dividends Received by Domestic Corporations from Specified 10% Owned Foreign Corporations Domestic Corporation is a United States Shareholder Does not include PFICs which are not CFCs Undistributed Earnings = Earnings & Profits (IRC Section 964(a) and 986) Undistributed Foreign Earnings does not include: US Effectively Connected Income (IRC Section 245(a)(5)) US Dividends (non-reits) earned through Foreign Corporation 10 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

11 Dividend Received Deduction on Foreign Sourced Dividends Available on dividends from a Specified 10-percent owned foreign corporation Specified 10-percent foreign corporation is a foreign corporation that has a 10% or more U.S. shareholder that is a U.S. C corporation. The definition excludes PFICs that are not also CFCs. DRD not available for Hybrid dividends No Foreign Tax Credit allowed Dividend is disregarded for 904(a) purposes. Holding Period Requirement more than 1 year Effective for tax years beginning after December 31, WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

12 U.S. Taxation of International Activities Post 2017 Territorial Tax System MAGA USA Inc. (US) MAGA Ireland Limited (Ireland) $1,000,000 Net Income Net Income of $1,000,000 taxed at 12.5% Irish corporate rate Distribution to MAGA USA Inc. is exempt from U.S. corporate tax by virtue of a 100% Dividend Received Deduction (DRD) Worldwide tax paid on income $125,000* *Assuming no Subpart F or GILTI 12 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

13 Why the Change to a Territorial System? Increase Investment by Businesses Increase Competitiveness of US Businesses Allow US Businesses to Meet Global Demand More Efficiently Allow US Businesses to Form Stronger Corporate Synergies Create Jobs/Raise Wages for US Workers 27 OECD Countries have Territorial Systems 6 do not, and have tax rates Lower than (old) US Rates 13 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

14 United States Shareholders Subject to Deemed Repatriation 14 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

15 Section 951(b) United States Shareholder defined. For purposes of this title, the term United States Shareholder means, with respect to any foreign corporation, a United States Person (as defined in Section 957(c) ) who owns (within the meaning of Section 958(a) ) or is considered owning by applying rules of ownership of Section 958(b), 10% or more of the combined voting power of all classes of stock entitled to vote of such foreign corporation, or 10% or more of the total value of shares of all classes of stock of such foreign corporation. 15 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

16 Section 957 (c) For purposes of this subpart, the term United States Person has the meaning assigned to it by Section 7701(a)(30) except: Special Rules for Corporations and residents of US Possessions: Puerto Rico Guam American Samoa Northern Mariana Islands 16 Regulations determine whether income was derived from the active conduct of a trade or business within a possession WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

17 Section 7701(a)(30) The term United States Person means Any trust if A citizen or resident of the United States A domestic partnership A domestic corporation Any estate (other than a foreign estate, within the meaning of paragraph (31)), and A court within the United States is able to exercise primary supervision over the administration of the trust, and One or more United States Persons have the authority to control all substantial decisions of the trust. 17 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

18 Section 958 Rules for Determining Stock Ownership a) Direct and indirect ownership. (1) General rule. For purposes of this subpart (other than section 960), stock owned means (A) stock owned directly, and (B) stock owned with the application of paragraph (2). (2) Stock ownership through foreign entities. For purposes of subparagraph (B) of paragraph (1), stock owned, directly or indirectly, by or for a foreign corporation, foreign partnership, or foreign trust or foreign estate (within the meaning of section 7701(a)(31)) shall be considered as being owned proportionately by its shareholders, partners, or beneficiaries. Stock considered to be owned by a person by reason of the application of the preceding sentence shall, for purposes of applying such sentence, be treated as actually owned by such person. (3) Special rule for mutual insurance companies. For purposes of applying paragraph (1) in the case of a foreign mutual insurance company, the term stock shall include any certificate entitling the holder to voting power in the corporation. 18 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

19 Section 958 Rules for Determining Stock Ownership (b) Constructive ownership. For purposes of Sections 951(b), 954(d)(3), 956(c)(2), and 957, Section 318(a) (relating to constructive ownership of stock) shall apply to the extent that the effect is to treat any United States person as a United States Shareholder within the meaning of section 951(b), to treat a person as a related person within the meaning of section 954(d)(3), to treat the stock of a domestic corporation as owned by a United States Shareholder of the controlled foreign corporation for purposes of section 956(c)(2), or to treat a foreign corporation as a controlled foreign corporation under section 957, except that (1) In applying paragraph (1)(A) of section 318(a), stock owned by a nonresident alien individual (other than a foreign trust or foreign estate) shall not be considered as owned by a citizen or by a resident alien individual. (2) In applying subparagraphs (A), (B), and (C) of section 318(a)(2), if a partnership, estate, trust, or corporation owns, directly or indirectly, more than 50 percent of the total combined voting power of all classes of stock entitled to vote of a corporation, it shall be considered as owning all the stock entitled to vote. (3) In applying subparagraph (C) of section 318(a)(2), the phrase 10 percent shall be substituted for the phrase 50 percent used in subparagraph (C). (4) Repealed. Paragraph (1) shall not apply for purposes of section 956(c)(2) to treat stock of a domestic corporation as not owned by a United States shareholder. 19 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

20 Section 318 Constructive Ownership of Stock (a) General rule. For purposes of those provisions of this subchapter to which the rules contained in this section are expressly made applicable (1) Members of family. (A) In general. An individual shall be considered as owning the stock owned, directly or indirectly, by or for (i) his spouse (other than a spouse who is legally separated from the individual under a decree of divorce or separate maintenance), and (ii) his children, grandchildren, and parents. (B) Effect of adoption. For purposes of subparagraph (A)(ii), a legally adopted child of an individual shall be treated as a child of such individual by blood. (2) Attribution from partnerships, estates, trusts, and corporations. (A) From partnerships and estates. Stock owned, directly or indirectly, by or for a partnership or estate shall be considered as owned proportionately by its partners or beneficiaries. (B) From trusts. (i) Stock owned, directly or indirectly, by or for a trust (other than an employees' trust described in section 401(a) which is exempt from tax under section 501(a) ) shall be considered as owned by its beneficiaries in proportion to the actuarial interest of such beneficiaries in such trust. (ii) Stock owned, directly or indirectly, by or for any portion of a trust of which a person is considered the owner under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by such person. (C) From corporations. If 50 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such person shall be considered as owning the stock owned, directly or indirectly, by or for such corporation, in that proportion which the value of the stock which such person so owns bears to the value of all the stock in such corporation. 20 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

21 Section 318 Constructive Ownership of Stock (3) Attribution to partnerships, estates, trusts, and corporations. (A) To partnerships and estates. Stock owned, directly or indirectly, by or for a partner or a beneficiary of an estate shall be considered as owned by the partnership or estate. (B) To trusts. (i) Stock owned directly or indirectly, by or for a beneficiary of a trust (other than an employees' trust described in section 401(a) which is exempt from tax under section 501(a) ) shall be considered as owned by the trust, unless such beneficiary's interest in the trust is a remote contingent interest. For purposes of this clause, a contingent interest of a beneficiary in a trust shall be considered remote if, under the maximum exercise of discretion by the trustee in favor of such beneficiary, the value of such interest, computed actuarially, is 5 percent or less of the value of the trust property. (ii) Stock owned, directly or indirectly, by or for a person who is considered the owner of any portion of a trust under subpart E of part I of subchapter J (relating to grantors and others treated as substantial owners) shall be considered as owned by the trust. (C) To corporations. If 10 percent or more in value of the stock in a corporation is owned, directly or indirectly, by or for any person, such corporation shall be considered as owning the stock owned, directly or indirectly, by or for such person. (4) Options. If any person has an option to acquire stock, such stock shall be considered as owned by such person. For purposes of this paragraph, an option to acquire such an option, and each one of a series of such options, shall be considered as an option to acquire such stock. 21 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

22 Section 318 Constructive Ownership of Stock ( (5) Operating rules. (A) In general. Except as provided in subparagraphs (B) and (C), stock constructively owned by a person by reason of the application of paragraph (1), (2), (3), or (4), shall, for purposes of applying paragraphs (1), (2), (3), and (4), be considered as actually owned by such person. (B) Members of family. Stock constructively owned by an individual by reason of the application of paragraph (1) shall not be considered as owned by him for purposes of again applying paragraph (1) in order to make another the constructive owner of such stock. (C) Partnerships, estates, trusts, and corporations. Stock constructively owned by a partnership, estate, trust, or corporation by reason of the application of paragraph (3) shall not be considered as owned by it for purposes of applying paragraph (2) in order to make another the constructive owner of such stock. (D) Option rule in lieu of family rule. For purposes of this paragraph, if stock may be considered as owned by an individual under paragraph (1) or (4), it shall be considered as owned by him under paragraph (4). (E) S Corporation treated as partnership. For purposes of this subsection (i) an S corporation shall be treated as a partnership, and (ii) any shareholder of the S corporation shall be treated as a partner of such partnership. The preceding sentence shall not apply for purposes of determining whether stock in the S corporation is constructively owned by any person. 22 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

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24 Specified Foreign Corporations 24 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

25 Definitions Specified Foreign Corporation (SFC) Any Controlled Foreign Corporation, and Any Foreign Corporation with respect to which one or more Domestic Corporations is a United States Shareholder. Controlled Foreign Corporation (CFC) Any foreign corporation if more than 50% of the total combined voting power of all classes of stock of such corporation entitled to vote, or the total value of the stock of such corporation is owned (within the meaning of 958(a) ), or is considered as owned by applying the rules of ownership of 958(b), by United States Shareholders on any day during the taxable year of such foreign corporation. 25 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

26 Controlled Foreign Corporations On ANY DAY Vote OR Value Only United States Shareholders considered All forms of ownership: Direct Indirect Constructive 26 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

27 CFC: Example 1 MAGA Co (US) 50% F1 10% 51% F2 27 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

28 CFC: Example 2 US 1 US 2 1% 1% 1% 1% 1% 1% 1% US 99 1% 1% US 100 FORco 28 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

29 Deemed Repatriation - Summary US Shareholder PFIC s not applicable Specified Foreign Corporation S Corporations..deferral until trigger 29 WithumSmith+Brown, PC Certified Public Accountants and Consultants BE IN A POSITION OF STRENGTH withum.com

30 DETERMINING E&P AND CASH POSITIONS SUBJECT TO THE DEEMED REPATRIATION TAX John Samtoy, HCVT LLP FOCUS CLARITY COMMITMENT

31 TOPICS COVERED Overview and Background Earnings and Profits Definitions and Relevant Terms Determining E&P Netting Deficits and Earnings Cash Position Aggregate Cash Position Cash Position Components Determining Cash Position T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 31

32 OVERVIEW AND BACKGROUND In the last taxable year of a deferred foreign income corporation beginning before January 1, 2018 the deferred foreign income corporation s subpart F income is increased by the greater of the accumulated post-1986 deferred foreign income as of ( measurement dates ): November 2, 2017 December 31, 2017 Netting of E&P from deferred foreign income corporations and E&P deficit foreign corporations. Reduction in the inclusion amount at the US shareholder level for the US shareholder s aggregate foreign E&P deficit that is allocated to the deferred foreign income corporation Higher tax rates on E&P that is attributable to cash positions of specified foreign corporations. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 32

33 EARNINGS AND PROFITS: DEFINITIONS AND RELEVANT TERMS Definitions and Relevant Terms - Deferred foreign income corporation Any specified foreign corporation with accumulated post 1986 E&P as of either of the measurement dates. Accumulated post-1986 deferred foreign income Post 1986 E&P except E&P attributable to ECI or E&P treated as PTI under 959. Post 1986 E&P - Does not take into account periods when the foreign corporation was not a specified foreign corporation. Also does not include a reduction for distributions made in the SFC s taxable year beginning before January 1 st 2018 except for those made to other SFCs. E&P Deficit Foreign Corporation Any specified foreign corporation if such corporation has a deficit in post-1986 E&P as of November 2 nd, DFIC status is determined first. Specified E&P deficit The deficit as of November 2 nd 2017 of any E&P Deficit Corporation. Aggregate foreign E&P deficit The lesser of the aggregate of the US Shareholder s specified E&P deficits or the aggregate of that shareholder s deferred foreign income. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 33

34 EARNINGS AND PROFITS- EXAMPLE 100% US 1 CFC 1 CFC 2 CFC 3 CFC 4 E&P as of both measurement dates: CFC 1 $-500 CFC 2 $1,000 CFC 3 $400 CFC 4 $100 CFC 2 has $100 of ECI CFC 2 and CFC 3 have $200 of PTI each Example E&P ECI PTI DFI or Deficit CFC CFC CFC CFC Total Post 1986 E&P does not take include ECI or PTI. CFC 1 is a specified E&P deficit corporation. CFC 2, 3, and 4 are deferred foreign income corporations (DFICs). If CFC 1 had a -500 deficit as of November 2 nd 2017 but $100 of E&P as of December 31 st it would be a DFIC. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 34

35 DETERMINING E&P GENERALLY Earnings and profits for a foreign corporation are calculated according to rules that are substantially similar to a domestic corporation. See 964(a) and 986 for rules applicable to foreign corporations and 312 for rules regarding the calculation of E&P generally. E&P of foreign corporations with US owners should ideally already be tracked. The determination of the E&P of foreign corporations is important for US tax purposes. A few examples: The character of distributions (as dividends for example), Potential limits for Subpart F and 956 inclusions, 1248 recharacterization of gain on sale of CFC stock, 902 indirect foreign tax credit carried out. On the Form 5471 E&P is calculated annually on Schedule H. Accumulated E&P and PTI balances are tracked on Schedule J. The difference for Form 5471 filers (compared to a domestic corporation) is that the calculation goes directly from book earnings on Schedule C to E&P. GAAP retained earnings do not necessarily equal E&P. Adjustments may include: depreciation, reserves, valuation adjustments, unrealized gain or loss. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 35

36 DETERMINING E&P: COMPUTATION UNDER 965 Double counting Regulations will be issued with the intention of preventing double counting or double non-counting of E&P where there are transactions between related SFCs. Notice Situation could arise where there are transactions between measurement dates: deductible payments, accruals of expense or income, or distributions of E&P. Regulations will address transactions between related parties only will not account for transactions where parties are not related. Related person 954(d)(3) common control. Reduction in E&P of a SFC for a distribution made to another SFC will be limited to that other SFCs increase in E&P. The accumulated post-1986 deferred foreign income of a CFC with non-us shareholders will be reduced by the amount that would have been considered PTI (Sub F inclusions) if the other shareholders were US persons. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 36

37 DETERMINING E&P: DOUBLE COUNTING RELATED PARTY EXAMPLE Example From Notice % 100% USP CFC 1 CFC 2 November 2 nd E&P CFC 1 100u CFC 2 100u December 31 st E&P CFC 1 110u CFC 2 90u Aggregate 965(a) earnings per intended regulations 200u (i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP, CFC1, and CFC2 have calendar year taxable years. On November 2, 2017, each of CFC1 and CFC2 has post-1986 earnings and profits of 100u. Neither CFC1 nor CFC2 has previously taxed income or effectively connected income for any taxable year, and therefore each of CFC1's and CFC2's accumulated post-1986 deferred foreign income is equal to such corporation's post-1986 earnings and profits. On November 3, 2017, CFC2 makes a deductible payment of 10u to CFC1. The payment does not constitute subpart F income. CFC1 and CFC2 have no other items of income or deduction. Abbreviated analysis: Absent any adjustments, on December 31, 2017, CFC1 has post-1986 earnings and profits of 110u (100u plus 10u income from the deductible payment), and CFC2 has post-1986 earnings and profits of 90u (100u minus 10u deductible expense). The section 965(a) earnings amount with respect to CFC1 would be 110u. The section 965(a) earnings amount with respect to CFC2 would be 100u. The Aggregate 965(a) earnings amount would be 210u Under regulations to be issued by the Treasury Department and the IRS, an adjustment would be made with the result that CFC1 and CFC2 would have, in the aggregate, section 965(a) earnings amounts of 200u. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 37

38 DETERMINING E&P: DOUBLE COUNTING UNRELATED PARTY EXAMPLE Example From Notice % 100% USP CFC 1 CFC 2 November 2 nd E&P CFC 1 100u CFC 2 100u December 31 st E&P CFC 1 80u CFC 2 120u Aggregate 965(a) earnings 220u (i) Facts. Assume the same facts as in Example 1, except that CFC2 does not make a deductible payment to CFC1, and, between measurement dates, CFC2 accrues gross income of 20u from a person that is not related to CFC2, and CFC1 incurs a deductible expense of 20u to a person that is not related to CFC1. Abbreviated analysis: Absent any adjustments, on December 31, 2017, CFC1 has post-1986 earnings and profits of 80u (100u minus 20u deductible expense), and CFC2 has post-1986 earnings and profits of 120u (100u plus 20u gross income). The section 965(a) earnings amount with respect to CFC1 would be 100u. The section 965(a) earnings amount with respect to CFC2 would be 120u. The additional 20u of section 965(a) earnings amount does not arise from an amount paid or incurred between specified foreign corporations that are related. The regulations to be issued by the Treasury Department and the IRS will not adjust the aggregate section 965(a) earnings amounts of CFC1 and CFC2. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 38

39 DETERMINING E&P: NON-US CFC SHAREHOLDERS EXAMPLE Example From Notice USP 70% FS Total E&P 100u FP 30% 70u taxed to USP under 951 previously. Treated as PTI under 959 Remaining 30u would also be PTI if FP were a US person. Deferred foreign income is reduced by the remaining 30u of E&P and FS s remaining deferred foreign income is 0u. Example. (i) Facts. USP, a domestic corporation, and FP, a foreign corporation unrelated to USP, have owned 70% and 30% respectively, by vote and value, of the only class of stock of FS, a foreign corporation, from January 1, 2016, until December 31, USP and FS both have a calendar year taxable year. FS had no income until its taxable year ending December 31, 2016, in which it had 100u of income, all of which constituted subpart F income, and USP included 70u in income with respect to FS under section 951(a)(1) for such year. FS earned no income in Therefore, FS's post earnings and profits are 100u as of both of the measurement dates. Abbreviated analysis: 70u of such post-1986 earnings and profits is previously taxed income and, if distributed, would be excluded from the gross income of USP under section 959. Deferred foreign income of FS is reduced by amounts that would be described in section 965(d)(2)(B) if FP were a United States shareholder. Accordingly, FS's accumulated post-1986 deferred foreign income would be reduced by the remaining 30u of the 100u of post-1986 earnings and profits to which USP's 70u of section 951(a)(1) income inclusions were attributable. Accordingly, FS's accumulated post-1986 deferred foreign income is 0u. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 39

40 DETERMINING E&P: COMPUTATION UNDER 965 Specified E&P deficits will be allocated among the shareholders of a SFC s common stock in proportion to the value of the common stock held. US shareholders may elect to determine the E&P of a SFC as of October 31 st 2017 instead of November 2 nd E&P as of October 31 st will be annualized to November 2 nd. Special rules for week SFCs. Comparisons of E&P between the measurement dates should be made in the SFC s functional currency. Includible foreign income should be translated using a December 31 st 2017 spot rate regardless of the measurement date. Notice T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 40

41 EARNINGS AND PROFITS: NETTING DEFICITS AND EARNINGS Aggregate foreign E&P deficit is allocated to the deferred foreign income corporations of the US shareholder based on each deferred foreign income corporation s relative share of total accumulated post-1986 deferred foreign income. Deficit reduction = total deficit * (SFC DFI/total DFI) Impact of netting on future distributions An amount equal to the deficit reduction applied to a deferred foreign income corporation will be treated as PTI to the US shareholder. US shareholder s share of E&P of a deficit corporation is increased by the amount of the specified deficit taken into account as a deficit reduction. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 41

42 EARNINGS AND PROFITS: NETTING AFFILIATED GROUPS US shareholders in the same affiliated group may net surplus E&P and unused deficits. In an affiliated group with at least one E&P net surplus shareholder and one E&P net deficit shareholder the amount taken into account by each E&P surplus shareholder will be reduced by their applicable share of affiliated group s aggregate unused E&P deficit. Applicable share = Group ownership percentage * E&P surplus / E&P surplus of group (determined using group ownership percentage * E&P surplus for each E&P net surplus shareholder). E&P net surplus shareholder any US shareholder which would otherwise have an inclusion. E&P net deficit shareholder US shareholder whose aggregate foreign E&P deficit otherwise exceeds their E&P. Aggregate unused E&P deficit the aggregate of the E&P deficits of each E&P net deficit shareholder of the group adjusted to reflect the group s proportionate ownership of that shareholder (if a company is 90% owned then 90% of the deficit would be taken into account). T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 42

43 NETTING DEFICITS AND EARNINGS - EXAMPLE CFC 1 100% US 1 CFC 2 CFC 3 CFC 4 CFC 1 E&P Deficit $500 CFC 2 DFI $700 CFC 3 DFI $200 Given the positions on the left US 1 will reduce their share of Subpart F from CFC 2-4 by their aggregate foreign E&P deficit (generated by CFC 1) as follows: Example Deficit or DFI Deficit reduction CFC CFC CFC CFC Total DFI The deficit reduction amounts allocated to CFC 2-4 will be treated as PTI under 959. CFC 4 DFI $100 T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 43

44 EARNINGS AND PROFITS: 965 INCLUSION ORDERING RULES 965 Inclusion Ordering Rules 1. Subpart F of the DFIC is determined without regard to section 965(a) and the US shareholder s inclusion of that amount is taken into account. 2. Distributions from a DFIC, to another SFC, that are made before January 1, Section 965(a) inclusion of the DFIC is determined and the US shareholder s inclusion of that amount is taken into account. 4. Distributions from the DFIC other than those in step 2. Treatment is determined under Section 956 inclusion with respect to the DFIC and shareholder s inclusion of that amount is taken into account. See Notice T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 44

45 ORDERING RULES- EXAMPLE 100% US 1 CFC 1 $500 of E&P including $300 of PTI as of 12/31/16. $300 of E&P in $150 of Subpart F income (other than 965) in CFC 1 makes a $100 distribution to US 1 in Using the ordering rules US 1 s DFI is $350 computed as follows : 2016 E&P $ PTI $ (300) 2017 E&P $ Sub F $ (150) DFI $ 350 Subpart F (other than 965) is taken into account before the 965 inclusion. The distribution of $100 is taken into account after the 965 inclusion and will be a nontaxable distribution of PTI. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 45

46 AGGREGATE FOREIGN CASH POSITION The aggregate foreign cash position is the amount that a US shareholder needs to take into account for purposes of 965 and is equal to the greater of: The aggregate of a US shareholder s pro rata share of the cash positions of each specified foreign corporation that they own as of the close of the last taxable year of the specified foreign corporation that begins before January 1 st 2018 ( Test 1 ) or 50% of the amounts above for the taxable years of each specified foreign corporation that end in each of the two years ending before November 2, 2017 ( Test 2 ) T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 46

47 AGGREGATE FOREIGN CASH POSITION - EXAMPLE US 1 100% 100% Given the cash positions on the left US 1 s aggregate foreign cash position in 2017 is $1,050 which is the greater of US 1 s cash position under the two tests. CFC 1 CFC 2 Example Test 1 Test 2 CFC 1 12/31/17 year end $400 Cash Position as of 12/31/17 CFC 1 $ 400 $ % of 500 $300 Cash Position as of 12/31/16 $200 Cash Position as of 12/31/15 CFC 2 12/31/17 year end $500 Cash Position as of 12/31/17 CFC 2 $ 500 $ % of 1,600 Total $ 900 $ 1,050 $800 Cash Position as of 12/31/16 $800 Cash Position as of 12/31/15 T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 47

48 AGGREGATE FOREIGN CASH POSITION: FISCAL YEAR SFC For Test 1 - If a specified foreign corporation has a non-calendar year end a US shareholder may not be able to determine the specified foreign corporation s cash position by the time they file their return. To address this the IRS announced that regulations will be issued that will state that if a specified foreign corporation has an inclusion year that ends after the date a return for a US shareholder is timely filed (including extensions) the specified foreign corporation s cash position will be treated as zero. If the amount was treated as zero and the actual cash position under Test 1 ends up being more than Test 2 the US shareholder will be required to make adjustments to reflect that its cash position should have been higher. The adjustments are pending further guidance. (Notice ) T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 48

49 AGGREGATE FOREIGN CASH POSITION FISCAL YEAR EXAMPLE Example From Notice (i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP USP is a calendar year taxpayer. CFC1's inclusion year ends December 31, 2017, and CFC2's inclusion year ends November 30, The cash position of 100% CFC1 on each of December 31, 2015, December 31, 2016, and December 31, 2017, is $100. The cash position of CFC2 on each of November 30, 2015, and CFC 1 November 30, 2016, is $200. CFC1 has a section 965(a) inclusion amount. 100% CFC 2 CFC 1 12/31/17 year end CFC 2 11/30/18 year end Abbreviated analysis: In determining its aggregate foreign cash position for its 2017 taxable year, USP may assume that its pro rata share of the cash position of CFC2 will be zero as of November 30, Therefore, USP's aggregate foreign cash position is treated as $300. If USP's pro rata share of the cash position of CFC2 as of November 30, 2018, in fact exceeds $200, which would result in USP's aggregate foreign cash position being greater than $300, USP must make appropriate adjustments to reflect a higher aggregate foreign cash position, under future guidance to be issued by the Treasury Department and the IRS. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 49

50 CASH POSITION: COMPONENTS Cash position Cash held by the foreign corporation Net accounts receivable - corporations account receivable over accounts payable. Accounts receivable means receivables described in 1221(a)(4) Accounts payable means payables from the purchase of property in 1221(a)(1) or 1221(a)(8) or the receipt of services from vendors or suppliers (Notice ) Fair value of: Personal property that is actively traded for which there is an established financial market Commercial paper, certificates of deposit, securities of a government entity Foreign currency Any obligation with a term of less than one year (not already included as an account receivable) Demand loans will be treated as short term obligations regardless of the stated term of the instrument (Notice ) T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 50

51 CASH POSITION: COMPONENTS Cash position (continued) Fair value of: Derivative financial instruments that are not bona fide hedging transactions including notional principal contracts, options contracts, forward contracts, future contracts, short positions in securities and commodities, and any similar financial instruments. In aggregate the value of all derivative financial instruments cannot be less than zero. Derivatives between related specified foreign corporations will be disregarded. Bona fide hedging transactions are those described in (a)(4)(ii). If a bona fide hedging transaction is hedging a cash equivalent asset the value of the asset must be adjusted by the FMV of the hedging transaction (except to the extent the value of the hedged asset would be reduced below zero). Any asset that is deemed to be equivalent to one of the above T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 51

52 DETERMINING CASH POSITION Cash positions of indirect non-corporate entities will be taken into account where the entity is held by a specified foreign corporation and the entity would be a specified foreign corporation to the US shareholder if it were a foreign corporation. Double counting intention is to prevent double counting of cash positions Net accounts receivable, personal property, and obligations are not included in the cash position of more than one specified foreign corporation by the same US shareholder. Intended regulations will address coordination where specified foreign corporations have inclusion years that end in different years of a US shareholder. Regulations will limit the aggregate foreign cash position taken into account in a second year allowing for a reduction equal to the amount taken into account in a preceding year. (Notice ) Members of a consolidated group that are US shareholders will be treated as a single US shareholder for purposes of determining the includible amount under 965. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 52

53 CASH POSITION NON-CORPORATE ENTITY EXAMPLE US 1 Example Indirect Non-Corporate Entity Because FP 1 is held by a specified 100% CFC 1 Cash Position $100 foreign corporation and would be a specified foreign corporation to US 1 if it were a foreign corporation then US 1 is 60% FP 1 60% of Cash Position is $50 required to take into account the cash position of FP 1. Total cash position US 1 must take into account for CFC 1 and FP 1 is $150. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 53

54 CASH POSITION NON-CORPORATE ENTITY EXAMPLE 100% CFC 1 Cash Position $100 US 1 99% Example Indirect Non-Corporate Entity US 1 holds 99% of FP 1 directly and 1% of FP 1 through CFC 1. How much of FP 1 s cash position does US 1 have to take into account? Without guidance to the contrary 100% of FP 1 s cash position or $50 may be includable. 1% FP 1 Cash Position $50 FP 1 is treated as a specified foreign corporation if any interest in such entity is held by a specified foreign corporation. Aggregate cash position is limited to pro rata share of cash position of each specified foreign corporation of a US shareholder. US 1 owns 100% of FP 1 which is treated as a specified foreign corporation. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 54

55 CASH POSITION FISCAL YEAR EXAMPLE Example From Notice % 100% USP CFC 1 CFC 2 CFC 1 12/31/17 year end CFC 2 11/30/18 year end $400 cash position for all measurement dates. Concern is that without guidance the rules could be read to require using $400 as the cash position limitation for both 2017 and (i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP is a calendar year taxpayer. CFC1's inclusion year ends December 31, 2017, and CFC2's inclusion year ends November 30, The cash position of each of CFC1 and CFC2 on all relevant cash measurement dates is $200, with the result that USP has an aggregate foreign cash position of $400. For its 2017 taxable year, USP takes into account CFC1's section 965(a) inclusion amount of $300, and for its 2018 taxable year, USP takes into account CFC2's section 965(a) inclusion amount of $300. (ii) Analysis. USP's aggregate foreign cash position taken into account in 2017 is $300, the lesser of USP's aggregate foreign cash position ($400) or the section 965(a) inclusion amount ($300) that USP takes into account in The amount of USP's aggregate foreign cash position taken into account in 2018 is $100, USP's aggregate foreign cash position ($400) reduced by the amount of its aggregate foreign cash position taken into account in 2017 ($300). T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 55

56 CASH POSITION RELATED SPECIFIED FOREIGN CORPORATIONS 100% 100% US 1 CFC 1 CFC 2 Fixed Asset Short term obligation Treasury intends to issue regulations providing that a receivable or payable of a specified foreign corporation from or to a related specified foreign corporation will be disregarded to the extent of common ownership by the US Shareholder if the specified foreign corporations are related persons within the meaning of 954(d)(3). Notice In the example on the left if CFC 1 issued CFC 2 a short term obligation so that CFC 2 could acquire an asset or pay operating expenses the short term obligation would by default be included in the cash position of US 1. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 56

57 IRS GUIDANCE I think that the election to pay that tax and to assume that tax needs to be addressed very quickly. It's important to the IRS. It's important to the businesses who pay that tax. Marjorie A. Rollinson, Internal Revenue Service associate chief counsel (International) Guidance so far: Notice , Notice , Rev Proc (limitations on electing a short taxable year) Issues pending guidance: year end accruals and differences between measurement dates (taxes accrue at year end), reporting. T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 57

58 JOHN SAMTOY INTERNATIONAL TAX PRINCIPAL HCVT LLP T A X A U D I T B U S I N E S S M A N A G E M E N T M E R G E R S & A C Q U I S I T I O N S 58

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60 Deemed Repatriation of Deferred Foreign Earnings Mishkin Santa, J.D., LL.M The Wolf Group P.C. The Wolf Group, PC Fairfax, VA Washington, DC New York, NY (703)

61 Agenda Rates for Cash and Non-Cash; FTCs Relevant Sections - IRCs 965(c), 11, 965(g), Example of Calculating the Tax as a Multinational Example of Calculating the Tax as an Individual Shareholder of a CFC Installment Agreement 61

62 IRC 965 (c) Application of Participation Exemption to Included Income 965(c)(1) In General In the case of a United States shareholder of a deferred foreign income corporation, there shall be allowed as a deduction for the taxable year in which an amount is included in the gross income of such United States shareholder under section 951(a)(1) by reason of this section an amount equal to the sum of 62

63 Sum of - 965(c)(1)(A) the United States shareholder's 8 percent rate equivalent percentage of the excess (if any) of o 965(c)(1)(A)(i) the amount so included as gross income, over o 965(c)(1)(A)(ii) The amount of such United States shareholder's aggregate foreign cash position (AFCP), plus 965(c)(1)(B) the United States shareholder's 15.5 percent rate equivalent percentage of so much of the amount described in subparagraph (A)(ii) as does not exceed the amount described in subparagraph (A)(i). 63

64 When Does the 15.5 apply? 965(c)(2)(B) The term 15.5 percent rate equivalent percentage means, with respect to any United States shareholder for any taxable year, the percentage determined under subparagraph (A) applied by substituting 15.5 percent rate of tax for 8 percent rate of tax. What does 965(c)(2)(A) say? The term 8 percent rate equivalent percentage means, with respect to any United States shareholder for any taxable year, the percentage which would result in the amount to which such percentage applies being subject to a 8 percent rate of tax determined by only taking into account a deduction equal to such percentage of such amount and the highest rate of tax specified in section 11 for such taxable year. 64

65 What is Section 11? Section 11 is the Corporate Tax Rate. 11(b)(1)(A) 15 percent of so much of the taxable income as does not exceed $50,000, 11(b)(1)(B) 25 percent of so much of the taxable income as exceeds $50,000 but does not exceed $75,000, 11(b)(1)(C) 34 percent of so much of the taxable income as exceeds $75,000 but does not exceed $10,000,000, and 11(b)(1)(D) 35 percent of so much of the taxable income as exceeds $10,000,

66 Disallowance of Foreign Tax Credits 965(g)(1) - No credit shall be allowed under section 901 for the applicable percentage of any taxes paid or accrued (or treated as paid or accrued) with respect to any amount for which a deduction is allowed under this section. So what do we use? 965(g)(2)(A) 965(g)(2)(B) 66

67 965(g)(2)(A) 965(g)(2)(A) multiplied by the ratio of 965(g)(2)(A)(i) the excess to which subsection (c)(1)(a) applies, divided by o Reminder (c)(1)(a) 8% - Non-Cash 965(g)(2)(A)(ii) the sum of such excess plus the amount to which subsection (c)(1)(b) applies, plus o Reminder - (c)(1)(b) 15.5% - Cash 67

68 965(g)(2)(B) 965(g)(2)(B) multiplied by the ratio of 965(g)(2)(B)(i) the amount to which subsection (c)(1)(b) applies, divided by o Reminder - (c)(1)(b) 15.5% - Cash 965(g)(2)(B)(ii) the sum described in subparagraph (A)(ii). o This is the sum from the previous slide. 68

69 Last Part Coordination with Section 78 With respect to the taxes treated as paid or accrued by a domestic corporation with respect to amounts which are includible in gross income of such domestic corporation by reason of this section, section 78 shall apply only to so much of such taxes as bears the same proportion to the amount of such taxes as 965(g)(4)(A) the excess of 965(g)(4)(A)(i) the amounts which are includible in gross income of such domestic corporation by reason of this section, over 965(g)(4)(A)(ii) the deduction allowable under subsection (c) with respect to such amounts, bears to 965(g)(4)(B) such amounts. 69

70 Example - Multinational Assume AFCP is $1500, Foreign Tax Pool = $250 Calculate Cash Inclusion $1,500 Deduction (835.50) Subtotal $ Section 78 Gross Up $ Total Taxable Income $ Section 11 35% $ FTC (110.75) (FTP goes to $0) Net tax $

71 Example - Individual Assume AFCP is $1500, Foreign Tax Pool = $250 Calculate Cash Inclusion $1,500 Deduction (835.50) Subtotal $ Net 39.6% $ ETR = 17.5% 71

72 But what if we made a 962 Election for the Individual? Assume AFCP is $1500, Foreign Tax Pool = $250 Calculate Cash Inclusion $1,500 Deduction (835.50) Subtotal $ Section 78 Gross Up $ Total Taxable Income $ % $ FTC (110.75) (FTP goes to $0) Net tax $

73 What about the Net Investment Income Tax? The 965 tax is based on a deemed repatriation of income. When the actual income is repatriated, will the NIIT be due on this income? Assume AFCP is $1500, FTCs = $250 Calculate Cash Inclusion $1,500 Deduction (835.50) Subtotal $ % $ % $57 Net Tax $ ETR = 21.34% 73

74 965(h) Election To Pay Liability In Installments 965(h)(1) In General In the case of a United States shareholder of a deferred foreign income corporation, such United States shareholder may elect to pay the net tax liability under this section in 8 installments of the following amounts: 965(h)(1)(A) 8 percent of the net tax liability in the case of each of the first 5 of such installments, 965(h)(1)(B) 15 percent of the net tax liability in the case of the 6th such installment, 965(h)(1)(C) 20 percent of the net tax liability in the case of the 7th such installment, and 965(h)(1)(D) 25 percent of the net tax liability in the case of the 8th such installment. 74

75 965(h)(2) Date For Payment Of Installments If an election is made under paragraph (1), the first installment shall be paid on the due date (determined without regard to any extension of time for filing the return) for the return of tax for the taxable year described in subsection (a) and each succeeding installment shall be paid on the due date (as so determined) for the return of tax for the taxable year following the taxable year with respect to which the preceding installment was made. First Payment is Due on April 17 th, 2018 for calendar year filers. 75

76 965(h)(3) Acceleration Of Payment If an election is made under paragraph (1) to pay the net tax liability under this section in installments and a deficiency has been assessed with respect to such net tax liability, the deficiency shall be prorated to the installments payable under paragraph (1). The part of the deficiency so prorated to any installment the date for payment of which has not arrived shall be collected at the same time as, and as a part of, such installment. The part of the deficiency so prorated to any installment the date for payment of which has arrived shall be paid upon notice and demand from the Secretary. This subsection shall not apply if the deficiency is due to negligence, to intentional disregard of rules and regulations, or to fraud with intent to evade tax. 76

77 965(h)(5) Election Any election under paragraph (1) shall be made not later than the due date for the return of tax for the taxable year described in subsection (a) and shall be made in such manner as the Secretary shall provide. So first payment is due on April 17 th, 2018, but the election can be made on the extended return due October 15 th,