2018 Homebuilder Tax Director Roundtable. Wynn Las Vegas 7-8 May 2018

Transcription

1 2018 Homebuilder Tax Director Roundtable Wynn Las Vegas 7-8 May

2 Disclaimer EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US. This presentation is 2018 Ernst & Young LLP. All Rights Reserved. No part of this document may be reproduced, transmitted or otherwise distributed in any form or by any means, electronic or mechanical, including by photocopying, facsimile transmission, recording, rekeying, or using any information storage and retrieval system, without written permission from Ernst & Young LLP. Any reproduction, transmission or distribution of this form or any of the material herein is prohibited and is in violation of US and international law. Ernst & Young LLP expressly disclaims any liability in connection with use of this presentation or its contents by any third party. Views expressed in this presentation are those of the speakers and do not necessarily represent the views of Ernst & Young LLP. This presentation is provided solely for the purpose of enhancing knowledge on tax matters. It does not provide tax advice to any taxpayer because it does not take into account any specific taxpayer s facts and circumstances. These slides are for educational purposes only and are not intended, and should not be relied upon, as accounting advice. 2

3 Section 163(j) discussion of the implications McRae Thompson Ernst & Young LLP 3

4 Background 4

5 Old Section 163(j) Disallowed a deduction for disqualified interest paid or accrued by a corporation in a taxable year if: The payer's debt-to-equity ratio exceeded 1.5-to-1 The payer s net interest expense exceeded 50% of its adjusted taxable income (generally, income computed without regard to deductions for net interest expense, net operating losses, domestic production activities under Section 199, depreciation, amortization and depletion) Disqualified interest is interest paid or accrued to A related party when no US tax imposed on the interest An unrelated party in certain cases where a related party guaranteed the debt A real estate investment trust (REIT) by a taxable REIT subsidiary of such trust Disallowed interest expense could be carried forward indefinitely 5

6 Base Erosion and Profit Shifting (BEPS) Project Action 4 In October 2015, the Organisation for Economic Co-operation and Development (OECD) released its final report on recommended limitations on interest expense deductions (Action 4) Recommendations: Fixed ratio rule to limit net interest deductions to a fixed percentage (somewhere between 10% and 30%) of earnings before interest, taxes, depreciation and amortization Adopt a group ratio rule to supplement (but not replace) the fixed ratio rule Provide flexibility for highly leveraged groups or industry sectors Equity escape rule: interest expense allowed if an entity s debt-to-equity ratio does not exceed that of its worldwide group Allow carryforward and/or carryback of disallowed interest expense and/or unused interest capacity Exclusions for interest paid to third-party lenders on loans used to fund publicbenefit (infrastructure) projects and for entities with net interest expense below de minimis thresholds 6

7 New Section 163(j) 7

8 General rule Rule: deduction for business interest in a taxable year cannot exceed the sum of the following: Taxpayer s business interest income for the taxable year 30% of the taxpayer s adjusted taxable income for the year Taxpayer s floor plan financing interest for the taxable year 8

9 General rule: application and effective date Application Effective date House report states that, Effective date: applies to similar to old Section 163(j), taxable years beginning after new Section 163(j) is 31 December 2017 generally intended to apply No phase-in period after the application of provisions that subject No grandfathering of existing debt interest to deferral, capitalization or other limitation 9

10 Scope Applies to all business interest regardless of whether the payee is a related person Applies to all taxpayers except taxpayers that meet the gross receipts test in Section 448(c), as amended (i.e., the average annual gross receipts of the taxpayer for the three prior taxable years do not exceed $25 million) 10

11 Key terms: business interest, and trade or business Business interest is any interest paid or accrued on debt related to a trade or business Trade or business does not include: Performing services as an employee An electing real property trade or business Any business described in Section 469(c)(7)(C) (i.e., any real property development, redevelopment, construction, reconstruction, acquisition, conversion, rental, operation, management, leasing, or brokerage trade or business) Election is irrevocable An electing farm business Farming business, as defined in Section 263A(e)(4) Trade or business of a specified agricultural or horticultural cooperative, as defined in new Section 199A(g)(2) Election is irrevocable Certain regulated public utilities 11

12 Key terms: business interest income Business interest income is the amount of interest includable in the gross income of the taxpayer for the taxable year that is allocable to a trade or business Does not include investment income, as defined in Section 163(d) Section 163(d) does not apply to corporations no interest received or accrued by a corporation should be investment income, including a corporation that is a holding company 12

13 Key terms: adjusted taxable income (ATI) ATI is taxable income, computed without regard to: Income, gain, deduction or loss that is not allocable to a trade or business Business interest or business interest income Any net operating loss deduction under Section 172 Any deduction allowed under Section 199A For taxable years beginning prior to 1 January 2022, any deduction allowable for depreciation, amortization and depletion Section 163(j)(8)(B) authorizes the Treasury to provide for other adjustments to the computation of ATI. Neither the statute nor the legislative history addresses the treatment of interest equivalents. 13

14 Key terms: floor plan financing interest Floor plan financing interest is interest paid on floor plan financing indebtedness Floor plan financing indebtedness is indebtedness Used to finance the acquisition of motor vehicles held for sale or lease and secured by the inventory so acquired A motor vehicle is: A self-propelled vehicle designed for transporting persons or property on a public street, highway or road A boat Farm machinery or equipment The House bill had included construction machinery and equipment, but this was removed by the Senate bill 14

15 Carryforward of disallowed interest expense The amount of business interest not allowed as a deduction is treated as business interest paid or accrued in the succeeding taxable year No limitation on disallowed business interest carryforward period No carryforward of excess limitation Business interest carried forward is a Section 381(c) item and a pre-change loss for Section 382 purposes 15

16 Example Facts In 2018, XYZ Corp has $600 of taxable income from its trade or business, which includes $100 of interest income and $400 of interest expense XYZ Corp s Section 163(j) limitation is computed as follows: 30% of ATI: ATI is taxable income, computed without regard to interest expense or interest income; therefore, ATI is $900 ($600 less the $100 of interest income, plus the $400 of interest expense) $900 * 30% = $270 Plus interest income $100 Section 163(j) limitation is $370 Therefore, XYZ Corp is entitled to deduct $370 of its $400 of interest expense, and the remaining $30 is carried forward 16

17 Application to partnerships Limitation is determined at the partnership level, and any deduction for business interest is taken into account in the non-separately stated taxable income of the partnership Thus, partnership is treated as an entity Intended to prevent taxpayers from using a partnership to avoid Section 163(j) 17

18 Application to partnerships: double counting rule ATI of each partner is determined without regard to partner s distributive share of any items of income, gain, deduction or loss of the partnership Not limited to non-separately stated taxable income of the partnership Intended to prevent a partner from using its share of partnership ATI to increase its allowable interest deduction 18

19 Application to partnerships: double counting rule Example Facts XYZ Corp holds a 50% interest in Partnership ABC ABC has $200 of ATI and $40 of business interest expense Application of Section 163(j) Under Section 163(j), the full amount of ABC s $40 of interest expense is deductible because that amount is less than 30% of its $200 of ATI ABC has $160 of net income, and XYZ Corp s share is $80 Absent the double counting rule, XYZ Corp would include the $80 of partnership income in determining its ATI, thereby increasing XYZ Corp s Section 163(j) limitation by $24 ($80 * 30%) 19

20 Application to partnerships: excess taxable income ATI of each partner is increased by the partner s distributive share of the partnership s excess taxable income (determined in the same manner of the distributive share of non-separately stated taxable income or loss of the partnership). Excess taxable income is: Partnership ATI x 30% of partnership ATI (business interest floor plan financing business interest income) 30% of partnership ATI Excess taxable income allocated to a partner is not taken into account in determining the partner s 30% of ATI limitation with respect to any business interest other than excess business interest of the partnership until the partnership excess business interest for current and prior years has been treated as paid or accrued. 20

21 Application to partnerships: excess taxable income Example Facts: XYZ Corp holds a 50% interest in ABC Partnership. ABC has $200 of ATI and $40 of business interest expense. Excess taxable income is: ATI x 30% of ATI (business interest floor plan financing business interest income) 30% of ATI Therefore: $200 x 30% * $200 ($40 $0 $0) 30% * $200 Excess taxable income = $66.67; XYZ s share is $33.33 XYZ increases its ATI by $33.33, thereby allowing XYZ to increase its Section 163(j) limitation by $10. 21

22 Application to partnerships: carryforwards of business interest Excess business interest of the partnership is carried forward at the partner level. Excess business interest allocated to the partner can only be deducted in succeeding taxable years to the extent that the partner is allocated excess taxable income from the partnership. The adjusted basis of a partnership interest is reduced by the amount of excess business interest allocated to the partner. If a partner disposes of a partnership interest, adjusted basis is increased immediately before the disposition by the excess of the basis reduction over the portion of excess business interest that has been treated as paid or accrued by the partner. No deduction is allowed to the transferor or transferee for any excess business interest resulting in a basis increase. 22

23 Application to S corporations Rules similar to those for a partnership and partners apply to an S corporation and its shareholders 23

24 Notice guidance The Treasury Department issued Notice on 2 April 2018, announcing its intent to issue proposed Section 163(j) regulations, which will address: Prior Section 163(j) disqualified interest carryforwards that will survive under new Section 163(j) but will be subject to the new limitation rules after 31 December 2017 The elimination of excess limitation carryforwards under the old Section 163(j), which is consistent with the new approach In the case of C corporations, that all interest paid or accrued will be deemed business interest and subject to the new limitations (including rules for C corporation members in noncorporate entities such as partnerships) The application of Section 163(j), which will not affect whether or when business interest reduces earnings and profits of a corporate taxpayer 24

25 Notice guidance Consolidated groups The application of the interest limitation provisions at the consolidated group level Affiliated groups not filing consolidated returns will not generally be treated as a single taxpayer The allocation of the 163(j) limitation among group members The treatment of disallowed interest carryforwards when members join (i.e., separate return limitation year, or SRLY) and depart the group The application of Section to disallowed interest deductions The application of the real property trade or business elections when some, but not all, members are engaged in such trade or business activities 25

26 Notice guidance Partnerships A partner cannot include its share of partnership business interest income in adjusted taxable income at the partner level except to the extent of the partner s share of the excess of the partnership s business interest income over the partnership s business interest expense 26

27 Planning for Section 163(j) Consider converting income that would be ATI into business interest income Consider converting interest expense to other types of expenses/deductions: Guarantee fees Capitalized interest expense (e.g., Section 263A) Leasing expenses Consider the potential use of tiered entity structures to meet the small-business gross receipts exception Need to consider the source, timing and character of the non-interest expense or income 27

28 Potential reasons to postpone election out of Section 163(j) The election is "irrevocable, and there is limited guidance to address complex tiered-entity structures, which may include multiple lines of trade or business The making of such election may trigger mandatory change(s) in accounting method with respect to nonresidential real property, residential real property and qualified improvement property An election out might not be needed until 2022, when adjusted taxable income is based off of EBIT (rather than earnings before interest, taxes, deprecation and amortization, or EBITDA) and as a result of the preemptive application of Section 263A during the production period (which may limit the impact of the new rules subject to additional guidance being issued) 28

29 Q&A 29

30 EY Assurance Tax Transactions Advisory About EY EY is a global leader in assurance, tax, transaction and advisory services. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. We develop outstanding leaders who team to deliver on our promises to all of our stakeholders. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. EY refers to the global organization, and may refer to one or more, of the member firms of Ernst & Young Global Limited, each of which is a separate legal entity. Ernst & Young Global Limited, a UK company limited by guarantee, does not provide services to clients. For more information about our organization, please visit ey.com. Ernst & Young LLP is a client-serving member firm of Ernst & Young Global Limited operating in the US Ernst & Young LLP. All Rights Reserved ED None ey.com 30