Presented to: NRF Canadian Tax Clients. New U.S. tax legislation Impact on Selected Cross-Border Transactions

Transcription

1 January 11, 2018 Presented to: NRF Canadian Tax Clients New U.S. tax legislation Impact on Selected Cross-Border Transactions Adrienne Oliver Tel: (416) William G. Cavanagh Tel: (212)

2 Scope & Coverage High level basics Selected key individual provisions Selected key business provisions Repatriation deemed taxable dividend of deferred CFC offshore profits Selected key additional international provisions Transaction examples Structure and restructuring Example 1: Repatriation: Example 2: Incorporate foreign branch Example 3: Interest deduction limitations Example 4: Hybrid instruments/entities: CFC payments: impact on recipient Example 5: Hybrid instruments/entities: USP payments on hybrid instrument (Repo): impact on payor Example 6: Loans to U.S. corporations pledging stock of CFCs 2

3 Scope & Coverage (cont d) Transaction examples (cont d) Operations Example 7: Territoriality/participation exemption; GILTI -- U.S. domestic corporate owner Example 8: Territoriality/participation exemption; GILTI -- U.S. individual owner Example 9: Foreign intangible income ( FDII ) -- foreign branch Example 10: U.S. taxation of CFC passive income Example 11: U.S. taxation Canadian inbound investment Exit strategy Example 12: M&A deals changed landscape for U.S. asset acquisitions Example 13: Sale of CFC/FC stock Example 14: Foreign partner sale of U.S. partnership Next steps on new U.S. tax law 3

4 Overview This slide deck provides a very high-level summary of some of the key provisions of the new U.S. tax law, focusing particularly on provisions impacting cross-border transactions. The high-level summary sets the stage for a series of cross-border transaction examples that provide insight into the application of these new tax law provisions. The following can be anticipated from the new U.S. tax law: U.S. companies will need to consider restructuring to optimize their U.S. tax position. Any such restructuring needs to take into account non-u.s. tax considerations. Any such restructuring also needs to take into account the likelihood that tax law changes may be enacted in other countries in response to the new U.S. tax law.

5 Selected key individual provisions Rates: 37% top rate (reduction from 39.6%); 20% capital gains tax rate retained. Alternative minimum tax: retained at the 11 th hour. Deductions Charitable deduction continues. Individual deduction for state/local taxes limited to $10,000. No deduction for most other itemized deductions (e.g., investment expenses, including the taxpayer s share of investment expenses from pass-through entities like private equity firms and hedge funds). Investment interest is still deductible. Estate tax/gift tax Increases estate tax/gift tax exemption to $11 million ($22 million for married couples); sunsets January 1, % estate/gift tax rate retained. Date of death tax basis step up retained. 5

6 Selected key business provisions Tax rates 6 Corporations: 21% corporate tax rate effective for tax years beginning after December 31, Pass-throughs (individual owners) Effective 29.6% tax rate for domestic qualified business income as defined (generally not available to lawyers, doctors, accountants, etc.). Deduction capped at greater of (x) 50% of W-2 wages paid or 25% of W-2 wages paid plus 2.5% of unadjusted tax basis of qualified property. (Second prong added to provide benefit for capital intensive businesses, including real estate). Qualified business limitation and deduction cap does not apply if taxpayer s taxable income does not exceed $315,000 (married filing jointly) or $157,000 (for older individuals). Benefit of exemption from deduction cap and qualified business limitation phased out over next $100,000 of taxable income for joint filers ($50,000 for other individuals) Active business losses Owners of pass-through business cannot deduct more than $250,000 ($500,000 for joint filers) of active losses from pass-throughs against nonbusiness income (e.g., passive activity income; wages; investment income); disallowed losses carried forward as NOLS.

7 Selected key business provisions (cont d) Business interest expense: Net interest deduction limited to 30% of EBITDA (earnings before interest, taxes, depreciation and amortization, using taxable income instead of book earnings); disallowed interest carried forward indefinitely; Limitation applies to all taxpayers (including at partnership and S-corporation level) except small businesses (less than $15 million gross receipts), utilities and electing real property and farming businesses. This limitation applies immediately to all outstanding debt (related and unrelated) and to all tax years beginning before January 1, Beginning with tax years beginning on or after January 1, 2022, the cap is 30% of EBIT. This results in a lower interest deduction cap because the earnings number is reduced. Depreciation Immediate 100% expensing of tangible personal property through 2022; (expensing gradually phased out from 2023 to 2027); applies to new and used property placed in service after September 27, Like-kind exchanges: limited to real estate. 7

8 Repatriation deemed taxable dividend of deferred CFC offshore profits Deemed taxable dividend of post-1986 deferred offshore profits to U.S. shareholders by controlled foreign corporations (CFC) (and any other foreign corporation with a 10% U.S. domestic corporation shareholder). Taxable event is Tax rate: 8% for non-cash assets; 15.5% for cash assets. Tax payable over 8 years beginning for 2017 year. (8%/8%/8%/8%/8%/15%/15%/25%); pared down foreign tax credit reduces tax. Cash assets: Seemingly narrow definition of cash assets (cash; net accounts receivable; actively traded personal property; commercial paper; certificates of deposit; federal/state government securities; foreign currency; certain shortterm obligations). Broad IRS regulatory authority to expand list with similar items. Amount of taxable deferred offshore profits reduced by deficits in other CFCs; application of deficit reduction rule needs clarification. No U.S. federal income tax when deemed dividend amounts paid as actual dividend; no foreign tax credit for withholding taxes on actual dividend. 8

9 Selected key additional international provisions PFIC income: no significant change in U.S. PFIC rules (other than for certain foreign insurance companies). Subpart F income No change in Subpart F rules that 10% U.S. shareholders of CFCs are subject to tax at ordinary income tax rates on Subpart F income (including passive investment income). Final tax law did not contain proposed elimination of 956 rule that CFC s investment in U.S. property is Subpart F income. Scope of Subpart F expanded through expansion of constructive ownership rules and definitions of controlled foreign corporation and 10% U.S. shareholder. Territorial tax regime: exemption system for 10% U.S. corporate shareholders. 10% U.S. corporate shareholders generally exempt from U.S. tax on dividends received from foreign corporations, including non-cfc s. Effective for distributions made after December 31, 2017 (regardless of taxable year of payor or recipient). Territorial exemption not available to U.S. individuals/s-corporations. Unfair competitive disadvantage! 9

10 Selected key additional international provisions (cont d) High profit offshore income earned through CFC ( GILTI ): no deferral 10% U.S. shareholders of CFC taxed currently (no deferral) on CFC s global intangible income which is generally defined as the excess of the CFC s aggregate net income (with certain exceptions like Subpart F income) less a routine return. The routine return is generally equal to 10% of the CFC s tax basis in the business depreciable tangible personal property. High-taxed income of a CFC (income taxed at a foreign effective tax rate greater than 18.9%) may be excluded from GILTI income computation. The taxable amount subject to tax under this provision can be distributed to the shareholders free of U.S. federal income tax as previously taxed income. US C-corporations owning CFCs are taxed at 10.5% rate on GILTI income (increased to % for taxable years beginning after December 31, 2025). Holding period requirement for reduced tax: generally 365 days (counting days both before and after dividend). Foreign tax credit available for 80% of foreign taxes paid on GILTI income; net U.S. tax can be eliminated if foreign taxes are % or higher. Individual US shareholders owning CFCs (including through S-corporations and other passthrough) are taxed on 100% of GILTI income, absent special 962 election; efficacy of special 962 election to partially mitigate tax unclear. Potential disaster! Effective for tax years of foreign corporations beginning after December 31,

11 Selected key additional international provisions (cont d) Offshore income earned by U.S. domestic corporations through branches ( FDII ): reduced tax rate. 11 Special % tax rate applies to FDII income (foreign-derived intangibles income) earned by U.S. domestic corporations on sales of goods to, and services performed for, non-u.s. customers. (Increased to % for tax years beginning after December 31, 2025). Foreign tax credit available Individual U.S. shareholders (including S-corporations and other pass-throughs) do not benefit from reduced tax rate on FDII. Unfair competition! Domestic base erosion payments minimum tax ( BEAT ) Applies to U.S. domestic corporation (but not S-corporation, regulated investment company (RIC) or real estate investment trust (REIT)) as well as foreign corporations with U.S. effectively connected income with annual gross receipts of at least of $500 million for the past three years that makes deductible foreign related-party payments (e.g., interest rents, royalties, service fees, etc.). Payments included in cost of goods sold as well as at cost service payments are not included. De minimis exception if such payments are less than 3% of the domestic corporation s total expenses. (2% for financial group members). Effect of rule is to subject excess related party expenses to minimum tax. Effective for tax years beginning after December 31, 2017.

12 Selected key additional international provisions (cont d) Hybrid interests/entities: The new tax law contains two separate provisions dealing with hybrid instruments/entities. Character of income received CFC payments of hybrid dividends: This provision generally characterizes the tax nature in the hands of the income recipient, of hybrid dividends paid from (x) a lower tier controlled foreign corporation ( CFC ) to its CFC parent and (y) from a CFC to its U.S. parent corporation. (A hybrid dividend is a payment treated as a dividend for U.S. tax purposes and as deductible for foreign tax purposes). Deduction disallowance interest/royalties: This provision generally disallows the deduction for interest or royalties paid to a related foreign party pursuant to a hybrid transaction or by, or to a hybrid entity to the extent the amount is not taxable to the related foreign party either because (x) there is no corresponding income inclusion by the related party or (y) the related party is allowed a deduction with respect to the payment. A hybrid transaction or instrument generally includes payments treated as interest or royalties for U.S. tax purposes that are not taxable under tax laws of the recipient country. Effective date: Both provisions are effective for tax years beginning after December 31, 2017; there is no transition relief for existing hybrid instruments/entities. 12

13 Structure and Restructuring 13

14 Example 1: Repatriation: U.S. taxation of deferred offshore profits Transaction Parent (US) CFC Post-1986 offshore profits U.S. multinational companies reportedly hold $3 trillion of tax deferred offshore profits in their CFCs. New tax law result Deemed dividend of post-1986 deferred offshore profits Taxable event: 2017 (calendar year taxpayers) Tax rate: 8 % for non-cash assets; 15 ½ % for cash assets. Tax payable over 8 years (8% / 8% / 8% / 8% / 8% / 15% / 15% / 25%) No U.S. federal income tax when deemed dividend amounts paid as actual dividend (previously taxed income); no foreign tax credit for withholding taxes Observations Actual dividends Source of $ Which CFC pays Foreign withholding taxes CFC to Parent (US) loans Respected by foreign jurisdiction 14

15 Example 2: U.S.-P contributes foreign branch to CFC Before After Parent (US) Foreign Branch Parent (US) CFC New tax law result Taxable gain recognition Active trade or business exception repealed Good will/going concern exception repealed; subject to 367(d) deemed royalty regime Other assets subject to taxable gain recognition Valuation based on synergistic value of assets (Cf Altera case) Bottom-line: tax $ $ $ Observation: Transaction Parent (US) contributes foreign branch assets to foreign corporation (CFC) Inventory Workforce Machinery & equipment Supply contracts Intellectual property Goodwill/going concern value Modify business practice to form foreign corporation earlier Tradeoff-loss of U.S. tax deduction 15

16 Example 3: Limitations on interest deductions 30% Interest limitation 30% rule Parent (US) loan interest Lenders related/ unrelated New tax law result Net interest deduction cap 30% EBITDA for all tax years beginning before January 1, % EBIT for all tax years beginning of or after January 1, Determined at partnership/s-corporation level (not partner/s-corporation shareholder level) Carry forward: indefinite Exceptions: small business (less than $15 million gross receipts); utilities; electing real property and farming businesses. Transaction Parent (US) borrows from related/unrelated third parties and pays interest. Observation: Impact on private equity highly-leveraged acquisitions. Need to push down debt for foreign acquisitions. Limit on debt-pushdown for foreign acquisitions of U.S. target

17 Example 4: Hybrid instruments/entities: CFC payments on hybrid instruments: impact on recipient New tax law result Parent (US) stock stock CFC-1 CFC-2 hybrid instrument #1 hybrid instrument #2 Hybrid Instrument #1 Taxable dividend to Parent (US). Does not qualify for U.S. federal income tax rates under new territorial participation exemption. Hybrid Instrument #2 Observation: Payment is taxable Subpart F income for Parent (US). Does not qualify for CFC-to-CFC dividend exclusion. Luxembourg CPEC and similar instruments Hybrid entities can also run afoul of these rules. Restructuring needed. Transaction Hybrid Instrument #1 Payment by CFC-1 to Parent (US) is dividend for U.S. tax purposes (equity) and deductible interest for CFC-1 country purposes (debt instrument). Hybrid Instrument #2 Payment by CFC-2 to CFC-2 is dividend for CFC-1 country purposes (equity) and deductible interest for U.S. tax purposes (debt instrument)

18 Example 5: Hybrid instruments/entities: USP payments on hybrid instrument (Repo): impact on payor stock Parent (Foreign) Parent (US) hybrid instrument Transaction Payment by Parent (US) to Parent (F) treated as interest for U.S. tax purposes and dividend for Parent (F) country tax purposes (e.g., repo) New tax law result Parent (US) cannot deduct payment for U.S. tax purposes if the amount is not included in the income of the foreign party (or is included at reduced rate) because either (i) the interest or royalties are characterized differently for foreign tax purposes or (ii) the transaction involves an entity that is fiscally transparent in one jurisdiction but not the other jurisdiction. ( Related party is based on a more than 50% (vote or value) ownership test). The statutory language disallows the deduction to the extent that the amount is not included in the statutory income of the related party or the related party is entitled to a deduction for such amount. The new tax law gives the IRS the authority to expand upon this language by writing regulations that, inter alia: Observation Treat a tax preference as an exclusion from income if such tax preference has the effect of reducing the generally applicable statutory rate by twenty-five percent or more. Disallow the deduction for interest/royalties if such amount is subject to a participation exemption system or other systems which provides for the exclusion or deduction of a substantial portion of such amount. Treat certain conduit arrangements involving hybrid instruments/entities and certain structured transactions as giving rise to disallowed deductions. The classic transaction that may be caught by this provision is a REPO transaction (REPOs are treated as debt for U.S. tax purposes and equity for local country tax purposes)

19 Example 6: Loans to U.S. corporation pledging stock of CFCs Parent (US) 19 CFCs loan Lenders Transaction Lending syndicate lends $ to Parent (US). Parent (US) pledges stock of CFCs 100% of CFC stock or 65% of CFC stock New U.S. tax law result Existing U.S. tax law rule retained that loan by CFC to Parent (US) triggers taxable Subpart F income to U.S.-P as 956 investment in U.S. property. Observation: Parent (US) pledge of 100% of CFC stock treated as taxable 956 investment in U.S. property. Parent (US) pledge of 65% of CFC stock is not taxable. Earlier version of bill would have repealed this rule; unclear why Congress backed off repeal. Until now lenders have accommodated U.S. companies by accepting conventional 65% pledge limitation. Query whether lenders will view the issue differently now. Parent (US) pays tax currently on GILTI income anyway. New law brings Parent (US) tax current on U.S. tax on accumulated offshore profits. U.S. federal corporate tax rate has been reduced to 21%

20 Operations

21 Example 7: U.S. taxation of future CFC offshore active business profits: (territorial exemption) and GILITI override U.S. domestic corporation owner Parent (US) CFC Active Business income Transaction CFC earns active business income in non-u.s. jurisdictions. New tax law result CFC dividend to Parent (US) not subject to U.S. federal income tax (territorial participation deduction). Current tax on CFC s global intangible low taxed income ( GILTI ). Observations GILTI is excess of CFC s aggregate net income (with certain exceptions like Subpart F income and high-taxed income) over routine return. Routine return is generally equal to 10% of CFC s tax basis in CFC s depreciable tangible personal property. U.S. C-corporation subject to 10.5% U.S. federal income tax on GILTI income; pared back indirect foreign tax credit available. GILTI cuts back on U.S. tax benefit from new territorial exemption rules

22 Example 8: U.S. taxation of future CFC offshore active business profits: territorial exemption and GILTI override U.S. individual owner U.S. Individual CFC Active Business income Transaction CFC earns active business income in non-u.s. jurisdictions. New tax law result CFC dividend to US individual subject to full U.S. federal income tax (territorial participation deduction not available). Current tax on CFC s global intangible low taxed income ( GILTI ). Observation: GIITI is excess of CFC s aggregate net income (with certain exceptions like Subpart F income and high-taxed income) over routine return. Routine return is generally equal to 10% of CFC s tax basis in CFC s depreciable tangible personal property. U.S. individual subject to full U.S. federal income tax; no indirect foreign tax credits (cf. treatment of U.S. corporations); efficacy of special 962 election to partially mitigate tax unclear. Very costly for U.S. individuals to own CFC s directly or through pass-throughs (partnerships, LLCs or S- corporations) because limited deferral unless hightax exception applies. Consider owning CFC through U.S. domestic C-corporation. Consider foreign branch rather than CFC (no deferral but foreign tax credit benefit)

23 Example 9: U.S. taxation of foreign branch income ( FDII ) Parent (US) Foreign Branch New tax law result ( FDII ) U.S. effective rate of tax on this income is %. Compare 10.5% U.S. effective tax rate if IP is held offshore. Congress is seeking to level playing field between foreign branches and CFCs. Observation Transaction Parent (US) sells goods and services abroad to (x) third parties or (y) to related parties which onsells the goods or services to third parties for foreign use. Foreign tax credits can equalize the U.S. taxes on GILTI income and FDII income. Individual U.S. shareholders (including S-corporations and pass-throughs owned by U.S. individuals do not benefit from FDII tax rate. Unfair!

24 Example 10: U.S. taxation of CFC passive income Parent (US) CFC New tax law result Result: No change to current rule. Current U.S. corporate tax to Parent (US) under Subpart F at 21% U.S. federal corporate tax rate. Does not qualify for new U.S. territorial participation regime. Passive Income Transaction CFC earns passive income (third party dividends, interest, rents, royalties)

25 Example 11: U.S. taxation Canadian inbound investment Investors (U.S./non- U.S.) Equity LP U.S. or Cayman GP Loan Debt Lender LP-U.S. (partnership) CanCo is corporation for U.S. tax purposes CanCo is CFC because U.S. LP owns 100% U.S. investors taxed currently on CanCo GILTI income; ; consider 962 election ; possible high-tax exception deferring U.S. tax until dividend is paid No foreign tax credit for Canadian taxes paid by CanCo CanCo is pass-through for U.S. tax purposes No CFC because CanCo is passthrough U.S. investors taxed currently at 37% U.S. tax rate on all CanCo income Foreign tax credit for Canadian taxes paid by CanCo CanCo Active Business LP-Cayman (partnership) CanCo is corporation for U.S. tax purposes CanCo is not CFC U.S. investors own less than 50% No current GILTI tax (because no CFC); U.S. investors taxed at 37% rate on dividends from CanCo No foreign tax credit for Canadian taxes paid by CanCo. U.S. qualified dividend tax rate for dividends CanCo is pass-through for U.S. tax purposes No CFC because CanCo is passthrough U.S. investors taxed currently at 37% U.S. tax rate on all CanCo income Foreign tax credit for Canadian taxes paid by CanCo Transaction Limited partnership ( LP ) with U.S. and non- U.S. investors acquires Canadian CanCo; less than 50% U.S. investors (no U.S. corporations) LP is alternatively (x) U.S., (y) foreign (e.g., Cayman) or (z) U.S. corporation LP-U.S. (corporation) CanCo is corporation for U.S. tax purposes CanCo is CFC because U.S. corporation owns 100% LP-U.S. currently taxed at 10.5% U.S. tax rate on CanCo GILTI income; possible high tax exception eliminating all U.S. tax Foreign tax credit for Canadian taxes paid by CanCo Investors subject to U.S. dividend tax on dividends paid by LP-U.S. CanCo is pass-through for U.S. tax purposes No CFC because CanCo is passthrough LP-U.S. currently taxed at % tax rate (FDII) on all CanCo income Foreign tax credit for taxes paid by CanCo Investors subject to U.S. dividend tax on dividends paid by LP-U.S. CanCo is alternatively (x) corporation for U.S. tax purposes or (y) pass-through for U.S. tax purposes)

26 Exit Strategy

27 Example 12: M&A deals changed landscape for U.S. asset acquisitions 27 U.S.-Target Assets cash Buyer Assets Transaction Buyer purchases assets from U.S. Target for cash Direct purchase of assets Purchase of partnership holding assets 338(h)(10) deemed asset purchase New tax law result Purchase price for depreciable tangible property, new or used, subject to immediate 100% tax writeoff. WOW! Observations Buyer: maximize purchase price allocable to qualifying property. Seller: potential ordinary income from depreciation recapture. Historic practice: allocate purchase price to goodwill/intangibles (15 year write-off); Seller agnostic because capital gain treatment for intangibles Now adverse tax position buyer and seller. New tax law is big value add for Buyer!

28 Example 13: Sale of CFC Parent (US) CFC Transaction Parent (US) sells stock of CFC. New tax law result Sale of CFC stock is taxable to Parent (US) same as current law. Participation exemption does not cover stock sales. Same results on sale of stock in foreign corporation that is not CFC. Taxable gain on sale (but not loss) takes into account increased tax basis due to CFC earnings eligible for participation exemption. Observation New U.S. tax rules are not in sync with European participation exemption

29 Example 14: Sale by foreign partner of partnership conducting U.S. business Foreign Partner New tax law result Partnership Transaction U.S. Business Foreign partner sells partnership engaged in U.S. business. Historic IRS position: Foreign partner is taxable on sale. Recent Tax Court case: Foreign partner is not taxable on sale. New tax law: Foreign partner is taxable on sale. Observation Short-lived planning opportunity created by Tax Court case vanishes

30 Next steps on new tax legislation Need for IRS guidance Need for technical corrections - Separate technical corrections bill - Legislative history - Grant of regulatory authority U.S. restructuring foreign county tax implications U.S. tax law changes have broad implications and U.S. tax advisors are just beginning to scratch the surface 30

31 Speakers Bill Cavanagh Partner, Norton Rose Fulbright Tel: (212) Adrienne Oliver Partner, Norton Rose Fulbright Tel: (416)

32

33 Disclaimer Norton Rose Fulbright US LLP, Norton Rose Fulbright LLP, Norton Rose Fulbright Australia, Norton Rose Fulbright Canada LLP and Norton Rose Fulbright South Africa Inc are separate legal entities and all of them are members of Norton Rose Fulbright Verein, a Swiss verein. Norton Rose Fulbright Verein helps coordinate the activities of the members but does not itself provide legal services to clients. References to Norton Rose Fulbright, the law firm and legal practice are to one or more of the Norton Rose Fulbright members or to one of their respective affiliates (together Norton Rose Fulbright entity/entities ). No individual who is a member, partner, shareholder, director, employee or consultant of, in or to any Norton Rose Fulbright entity (whether or not such individual is described as a partner ) accepts or assumes responsibility, or has any liability, to any person in respect of this communication. Any reference to a partner or director is to a member, employee or consultant with equivalent standing and qualifications of the relevant Norton Rose Fulbright entity. The purpose of this communication is to provide general information of a legal nature. It does not contain a full analysis of the law nor does it constitute an opinion of any Norton Rose Fulbright entity on the points of law discussed. You must take specific legal advice on any particular matter which concerns you. If you require any advice or further information, please speak to your usual contact at Norton Rose Fulbright. 33