Tax Reform: Knowns and Unknowns. Tax Executive Institute Houston, Texas. February 26, 2018

Transcription

1 Tax Reform: Knowns and Unknowns Tax Executive Institute Houston, Texas. February 26, 2018

2 Section 163(j)

3 Overview of New U.S. Interest Expense Limitation Limits deductibility on net business interest expense 30% of taxpayer s adjusted taxable income for the tax year For tax years beginning after December 31, 2017 through December 31, 2021, the limitation is similar to: 30% of EBITDA (Earnings Before Interest, Taxes, Depreciation and Amortization) For tax years beginning after December 31, 2021, the limitation is similar to: 30% of EBIT (computed without regard to deductions for depreciation, amortization, or depletion) Disallowed deductions can be carried forward indefinitely Provision applies at the consolidated tax return filing level, according to JCT explanation; however, current legislative text is silent on the issue Exemptions from new Section 163(j) Does not apply to: certain small businesses with average gross receipts less than $25 million interest paid or accrued on floor plan financing interest investment interest employee services businesses certain regulated utilities electing real property and farming businesses 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 3

4 Mechanics General Rule: Deduction disallowed for Business Interest that exceeds the sum of: Business Interest Income + (30% of Adjusted Taxable Income + Floor Plan Financing Interest) Business Interest is any interest paid or accrued on indebtedness properly allocable to a Trade or Business and does not include Investment Interest as defined in section 163(d) Business Interest Income is the amount of interest includible in the taxpayer s gross income which is properly allocable to a Trade or Business and does not include Investment Interest Income as defined in section 163(d) Adjusted Taxable Income = taxable income computed without regard to: any income, gain, deduction or loss that is not properly allocable to a trade or business; any business interest or business interest income; section 172 NOLs; section 199A deductions; depreciation, amortization or depletion (aka EBITDA) For taxable years beginning after December 31, 2021, adjusted taxable income is reduced by depreciation, amortization or depletion (aka EBIT) Floor Plan Financing Interest is interest paid or accrued with respect to indebtedness used to finance the acquisition of motor vehicles held for sale or lease and such indebtedness is secured by the inventory so acquired 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 4

5 Mechanics Carryforward of Disallowed Interest Expense Amounts disallowed under this formula are treated as being paid or accrued in the succeeding taxable year and do not expire Carryforwards qualify as a section 381 attributes and are subject to limitation under section 382 Do old 163(j) carryforwards survive? It s not entirely clear, although the initial view is that they do because new section 163(j)(2) provides: The amount of any business interest not allowed as a deduction for any taxable year by reason of paragraph (1) shall be treated as business interest paid or accrued in the succeeding taxable year. This may be read to mean that old 163(j) carryforwards should be tested under new section 163(j)(1) KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 5

6 Basic Calculation 3 rd Party $300MM Loan C TI = $50MM Interest Expense = $30MM Interest Income = $0 172 NOL = $5MM Depreciation = $10MM 163(j) Calculation Interest Income $0 ATI (TI + Depreciation + NOL) $65 Deductible Amount (30% of ATI + Interest Income) $19.5 Disallowed Interest ($30 $19.5)* $ (j) Calculation Interest Income $0 ATI (TI + NOL) $55 Deductible Amount (30% of ATI + Interest Income) $16.5 Disallowed Interest ($30 $16.5)* $13.5 *Disallowed Interest can be carried forward to succeeding taxable year 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 6

7 Treatment of Brother-Sister US Chains Questions FP Year 2 $100 Distribution Do US 1 and US 2 have their own Section 163(j) calculations Expanded affiliated group includes all for Section 385 purposes. So it is possible for the following to occur: US 1 Year 1 $100 Loan US 2 Year 1-US 1 makes a loan to US 2 of 100. US 1 has interest income that can shelter interest expense. US 2 has interest expense subject to possible limitation under Section 163(j). Year 2- US 2 makes a distribution of 100 to FP. Ignoring the E&P and de minimis exceptions, the debt is viewed as exchanged for equity in year 2 on the date of distribution KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 7

8 Partnerships The new section 163(j) limitation is calculated at the partnership level and any allowed interest is used in calculating the partnership s non-separately stated taxable income or loss. Excess business interest (EBI) (i.e., disallowed interest expense) is allocated to each partner based on its distributive share. EBI will be treated as being paid and accrued by the partners in succeeding taxable years to the extent of each partner s distributive share of the partnership s Excess Taxable Income (ETI). ETI = Pship ATI x (30% Pship ATI amount - (business interest - interest income)/ 30% Pship ATI amount) Thus, excess business interest allocated to the partner is not limited to the amount of partnership interest income. Rather, it is limited by its allocable share of the partnership s ETI with the amount of interest income being an input into the ETI formula. For purposes of computing the partner s limitation under new section 163(j), the ATI of each partner is determined without regard to its distributive share of any partnership items and is increased by the partner s distributive share of the partnership s ETI. The partner s basis in its partnership interest is reduced by the amount of EBI allocated to the partner. Upon a disposition or other transfer (whether taxable or non-taxable), the partner s basis in the partnership interest is increased to the extent of its allocable share of EBI treated as paid or accrued by the partner. Is a partnership liquidation a disposition of a partnership interest? 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 8

9 Partnership Calculation Year 1 A 75% AB ATI = 300 IE = 150 II = 0 B 25% Partnership Calculations Partnership Limitation (ATI) $300 Partnership Business Interest Expense $150 Partnership Interest Income $0 Partnership 163(j) limit = ($300 x 30%) = $90 $150 Interest Expense $60 Excess Business Interest (EBI) Partner Allocation A s Allocation of EBI $45 B s Allocation of EBI $ KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 9

10 Subsequent Tracking EBI from Partnership = to ETI from Partnership is: Treated as EBI Paid or Accrued in That Year Partner Uses in Computing Partner-level Limitation The partner needs to track its EBI to determine the amount of such EBI that may be deducted at the partner level in later years. EBI allocated to a partner is subject to a carryforward, and is treated as EBI paid or accrued by the partner in a future taxable year to the extent that such partner is allocated ETI from the partnership. In a taxable year that a portion of the EBI is treated as paid or accrued by the partner, such partner then determines its own limitation (i.e., 30% of ATI plus ETI), and deducts EBI to that extent. In determining its ATI from all sources, such partner s distributive share of partnership items (other than ETI) is ignored in determining the partner-level limitation to prevent double-counting of the partnership income or loss that determined deductibility at the partnership level. There is an ordering rule for the use of allocated partnership ETI that treats it as freeing up carried forward EBI from that partnership first, until all such EBI has been released. 10

11 Partnership Calculation Year 2 Partnership Calculations Year 1 EBI = 45 A B Year 1 EBI = 15 Partnership Limitation (ATI) $500 Partnership Business Interest Expense $150 Year 2 EBI = ETI = % AB 25% Year 2 EBI = 8.75 ETI = 20.8 Partnership Interest Income $25 Partnership 163(j) limit = $25 + ($500 x 30%) = $175 $150 Interest Expense $0 EBI ATI = 500 IE = 150 II = 25 Partner A can deduct of Year 1 EBI (62.5 x 30%) Partner B can deduct 6.25 of Year 1 EBI (20.8 x 30%) Partner Allocation ETI = $500 x ($150 ($150-$25)/$150) = $83.33 A s Allocation of ETI $62.5 B s Allocation of ETI $20.8 The full amount of Partner A and Partner B s allocable share of EBI will be treated as being paid or accrued in Year 2, subject to the partner-level section 163(j) limitation calculation 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 11

12 Broader Implications of Interest Expense Limitation Coordination of 163(j) Limitation with BEAT Base erosion and anti-abuse tax ( BEAT ) Coordination rule exists for BEAT and 163(j) in determining modified taxable income where the taxpayer is subject to interest deduction limitations Any reduction of interest deduction is first allocated to interest paid to third parties, and remaining reduction is allocated to related party interest payments If pre-reform disallowed interest expense (related to related party financing) is deductible in post reform years, does this interest get added back to determine BEAT? 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 12

13 Broader Implications of Interest Expense Limitation Interaction of 163(j) Limitation with GILTI Regime (Sections 951A and 250) What comes first GILTI deduction or 163(j) limitation? GILTI formula under section 951A Inclusion Amount = Net CFC Tested Income Net Deemed Intangible Income Return Net Deemed Intangible Income Return = 10% of Qualified Business Asset Investment Interest expense if attributable to interest income not taken into account in determining the USSH s net CFC tested income QBAI = Adjusted tax basis of tangible assets Net CFC Tested Income = Tested Income Tested Loss (on USSH basis) Tested Income = CFC gross income less ECI Sub F High-tax kick-out Related party dividends Foreign oil & gas income (FOGI) Allocable deductions Tested Loss = Excess of allocable deductions over Tested Income GILTI deduction under section 250 = 50% x (GILTI inclusion + section 78 gross up attributable to GILTI inclusion) The amount of the GILTI (+ FDII) deduction is limited to the USSH s taxable income (determined without regard to the GILTI+FDII deduction) 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 13

14 Broader Implications of Interest Expense Limitation Interaction of 163(j) Limitation with GILTI Regime (Sections 951A and 250) In calculating the section 163(j) limitation, should the GILTI deduction under section 250 reduce ATI? If yes, more interest expense will be disallowed (because ATI is lower), which in turn will increase the CFC s Tested Income (because the allocable deductions are lower). This becomes a circular calculation because the newly computed section 250 deduction must reduce ATI, and because the deduction is higher, it will further reduce ATI and so on Potential approaches (to be hopefully clarified by guidance) Calculate section 163(j) limitation first with no GILTI deduction against ATI Calculate section 163(j) limitation first with full GILTI deduction to reduce ATI Iterative approach: Calculate the 163(j) limitation with full GILTI deduction then use the higher GILTI deduction to re-calculate the section 163(j) amount and repeat until the 163(j) limitation is reduced by a very small amount and GILTI deduction is increased by a very small amount Others? 2018 KPMG LLP, a Delaware limited liability partnership and the US member firm of the KPMG network of independent member firms affiliated with KPMG International Printed in the USA. FOR INTERNAL USE ONLY. Not for distribution to clients unless the technical and policy review requirements of Tax Services Manual section 23.7 are satisfied. DRAFT For Discussion Purposes Only 14

15 Foreign Subsidiary Taxation

16 7 Ways To Make a Non-U.S. Dollar Offshore Onshore Dividend (245A) Subpart F GILTI Foreign Branch Section 956 FDII Non-FDII Effective Rates (%) Foreign Tax Credits (%) None 100% 80% 100% 100% 100% 100% FTC Carryforwards None 10yr carryfwd None 10yr carryfwd 10yr carryfwd 10yr carryfwd 10yr carryfwd Other Creates exempt income/ partially exempt asset Rare GL or passive Separate Basket Separate Basket Converts Exempt Income Multiple year FTCs? Most income US source no FTCs Most income US source no FTCs Avoid/ get in FDII 16

17 Overview Three categories for controlled foreign corporations (CFCs) Exempt Income Full US Taxation Minimum US Taxation (GILTI) 17

18 Exempt Income Foreign Oil and Gas Extraction Income Section 1248 and 964(e) dividends Pre-1987 / non-sfc earnings and profits (E&P) Routine return for non-subpart F income (QBAI) High-taxed subpart F income 18

19 Full US Taxation Effectively Connected Income Current subpart F income rules, except foreign base company oilrelated income Section 956 not repealed thus any exempt income can become fullinclusion income (intentionally or accidentally) 19

20 Global Intangible Low-Taxed Income (GILTI) Regime

21 Minimum Taxation: GILTI US Shareholders include as income all non-exempt and non-subpart F income annually as global intangible low-taxed income (GILTI) Section 250 Deduction: 50% for tax years beginning before December 31, % thereafter Total GILTI and foreign-derived intangible income (FDII) deduction limited by taxable income (without regard to GILTI and FDII) Consolidate US group impact: the GILTI income is determined on a US shareholder by US shareholder basis. The deduction, however, is determined at the consolidated group level. Effective for CFC tax years beginning after December 31,

22 Minimum Taxation: GILTI GILTI is the excess of a US shareholder s Net CFC Tested Income over its Net Deemed Tangible Income Return Net Deemed Tangible Income Return 10% return on CFCs depreciable property bases (QBAI) Reduced for allocable net interest expense (section 163(j) applies at CFC level) Determined under ADS cost recovery Net CFC Tested Income Tested Income less allocable deductions less allocated Tested Loss Tested Income is gross income other than ECI, subpart F income, hightaxed subpart F income, related-party dividends, and FOGEI 22

23 Minimum Taxation: GILTI US shareholder is deemed to pay foreign income taxes associated with GILTI 20% haircut of FTC Adjusted for Tested Losses (i.e., FTC fraction is GILTI / Tested Income) Separate FTC category FTCs cannot be carried forward or back Section 78 gross-up is not subject to 20% haircut and is not considered GILTI 23

24 GILTI Example #1 USP CFC1 CFC1 Gross Income $200 Deductions $0 Tangible Assets $0 Excluded Interest $0 Expenses Apportioned to GILTI $0 Foreign Taxes $50 GILTI Amount Calculation Net CFC Tested Income CFC1 Tested Income (Loss) $ Total $ Net Deemed Tangible Income Return 10% of QBAI $0.00 Excluded Interest $(0.00) Total $0.00 GILTI Amount $ GILTI Deemed Paid Taxes Calculation Inclusion Percentage GILTI Amount $ Tested Income $ Inclusion Percentage 100% GILTI Haircut 80.0% Tested Foreign Income Taxes $50.00 GILTI Deemed Paid Taxes $40.00 Deduction Calculations GILTI Deduction (50% of GILTI Amount) $75.00 Residual US Tax Calculation GILTI $75.00 US Corporate Rate 21% Tentative US Tax $15.75 Less: GILTI Deemed Paid Taxes $40.00 Residual US Tax (Excess FTCs) ($24.25) KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International 24 24

25 GILTI Example #1 (cont) USP Section 78 Implications CFC1 Section 78 Deemed Dividend $50.00 Section 78 Deduction (50%) ($25.00) Total $ % $5.25 Assume no general limitation tax credits CFC1 Total US Tax $5.25 Gross Income $200 Deductions $0 Tangible Assets $0 Excluded Interest $0 Expenses Apportioned to GILTI $0 Foreign Taxes $ KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International 25 25

26 GILTI Example #2 USP owns CFC1 CFC1 Gross Income $200 Deductions $(25) Tangible Assets $100 Excluded Interest $5 Expenses Apportioned to GILTI $(10) Foreign Taxes $50 GILTI Amount Calculation Net CFC Tested Income CFC1 Tested Income (Loss) $ Total $ Net Deemed Tangible Income Return 10% of QBAI $10.00 Excluded Interest $(5.00) Total $5.00 GILTI Amount $ GILTI Deemed Paid Taxes Calculation Inclusion Percentage GILTI Amount $ Tested Income $ Inclusion Percentage 96% GILTI Haircut 80.0% Tested Foreign Income Taxes $50.00 GILTI Deemed Paid Taxes $38.40 Expenses Apportioned to GILTI (e.g., 861) GILTI Foreign Source Income GILTI Amount $ GILTI Deduction ($60.00) GILTI Foreign Source Income $60.00 Expense Apportionment ($10.00) Net GILTI FSI $50.00 FTC Limit after Expense Allocation $10.50 Deduction Calculations GILTI Deduction (50% of GILTI Amount) $60.00 Residual US Tax Calculation GILTI $60.00 US Corporate Rate 21% Tentative US Tax $12.60 Less: GILTI Deemed Paid Taxes $10.50 Residual US Tax (Excess FTCs) $2.10 Section 78 Implications Section 78 Deemed Dividend $48.00 Section 78 Deduction (50%) ($24.00) Total $ % $5.04 Assume no general limitation tax credits Total US Tax $ KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International 26 26

27 Base Erosion Anti-Abuse Tax (BEAT) Regime

28 Examples of Deductible Payments: BEAT Analysis # DESCRIPTION INBOUND/OUTBOUND 1 Related Party Interest INBOUND 2 Rents INBOUND 3 Royalties INBOUND 4 SG&A (with mark-up) INBOUND 5 Related Party Purchases of Equipment INBOUND/OUTBOUND 6 Services/Fees INBOUND/OUTBOUND 7 Cost Sharing Payments INBOUND/OUTBOUND 8 Toll Manfuacturing Fees INBOUND/OUTBOUND 9 Captive Insurance INBOUND 28

29 Section 59A Base Erosion Anti-Abuse Tax (BEAT) Potential addition to regular tax liability Targets taxpayers making deductible payments to related parties that are foreign persons Triggers 1. If there is an Applicable Taxpayer 2. To the extent the BEAT tax liability exceeds the regular tax liability 3. Average annual gross receipts (over 3 year period) > $500 million 4. Base erosion percentage of at least 3% (2% for certain financials) Application for base erosion payments (discussed below) made in TYBA 12/31/17 29

30 Applicable Taxpayer A taxpayer that: Is corporation other than a RIC, REIT, or S Corp Has average annual gross receipts for the 3 year period ending with the preceding taxable year of at least $500MM Apply rules similar to sections 448(c)(3)(B), (C), and (D) to determine gross receipts Gross receipts of foreign persons are included only to the extent of ECI Has a base erosion percentage (discussed below) of at least 3% (2% for certain financials) Aggregation rules Apply only for purposes of determining whether a taxpayer is an Applicable Taxpayer and for determining the base erosion percentage All persons treated as a single employer under section 52 are treated as 1 person Applies 1563 control group rules, but includes foreign corporations (limited to ECI attributes) Seems to imply that US Sub to ECI branch payments are disregarded for purposes of the gross receipts and base erosion percentage exceptions 30

31 Applicable Taxpayer (cont.) Consolidated groups Strong argument that consolidated groups are treated as one taxpayer for purposes of applying the BEAT (that is, after applying the aggregation rules to determine which taxpayers are potentially subject to the BEAT) In other words, full controlled group is tested to see whether all members will be applicable taxpayers After that, it appears that all members of the consolidated group are treated as one taxpayer for purposes of calculating BEAT liability BEAT liability appears to be calculated on an entity-by-entity basis for controlled group members that are not members of a consolidated group Partnerships Treatment unclear Seems highly likely that BEAT will apply at partner level (aggregate treatment). E.g.: Payments by partnership treated as deducted at partner level Payments to U.S. partnership with foreign partners treated as base eroding Payment to foreign partnership with only U.S. partners not treated as payment to foreign person Relatedness may be tested at partner level 31

32 Base erosion percentage To be an applicable taxpayer, must have a BEPct of at least 3% (2% for certain financials) BEPct = Base Erosion Tax Benefit (BETB) all deductions (excluding 172, 245A, or 250) BETB = deductions attributable to base eroding payments Applied annually The BEPct denominator does not include COGS. COGS is considered a reduction to gross receipts and not a deduction KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International 32 32

33 Base erosion payment Amounts paid or accrued to a related foreign person that Are deductible Does not include COGS and other payments that reduce gross receipts Includes interest expense interest disallowed under section 163(j) is allocated first to payments to unrelated persons Are for the acquisition of property that gives rise to a depreciation or amortization deduction Are premium or other consideration for any reinsurance payments taken into account under sections 803(a)(1)(B) or 832(b)(4)(A) Result in a reduction of gross receipts (including COGS) of the taxpayer if the payments are made to a post-11/9/17 inverted company or a member of its expanded affiliated group under section

34 Base erosion payment (cont.) Related Party 25% owner of the taxpayer Anyone in a 267(b) or 707(b)(1) relation to the taxpayer or a 25% owner (generally 50% control standard) Any person related under section 482 (e.g., acting in concert) First 2 rules apply section 318 constructive ownership, using 10% for purposes of section 318(a)(2)(C) (attribution from corporations to shareholders) 34

35 Base erosion payment (cont.) Service Cost Method Qualification Covered Service Rev Proc lists 101 qualifying services Or markup of less than 7% Excluded activities Manufacturing Production Extraction, exploration, or processing of natural resources Construction Reselling, distribution, sales agency, commissionaire, or similar R&D/R&E Engineering, scientific Financial transactions, incl guarantees Insurance or reinsurance Need adequate books and records 35

36 Base erosion payment (cont.) Exceptions Amounts paid for services that would qualify for the section service cost method safe harbor Ignore the business judgment rule in determining whether services would qualify But presumably don t ignore other regulatory requirements, including blacklist of bad activities, restriction to low-margin activities, etc. Only amounts that constitute total services cost with no "markup component" Statute is ambiguous, but better reading is that the exception is available to the extent of the cost component of payments for qualifying services, even if a markup is also paid Consistent with colloquy by Sens. Portman and Hatch suggesting that payments for cost and markup be separated into two accounts Conference report notes that must use the regulations in existence at enactment 36

37 Base erosion payment (cont.) Exceptions (cont.) Qualified Derivatives Payment Taxpayer under Mark-to-Market Income treated as ordinary Exceptions Split derivatives & nonderivatives Embedded BETBs 37

38 Calculating the BEAT Addition to regular tax BEAT Liability = [10%] Modified Taxable Income ( MTI ) R&E credits 80% certain section 38 credits)-(21% Taxable Income all credits) MTI rate is 5% in 2018, 10% from 2019 through 2025, and then 12.5% for TYBA 12/31/25 Rates for banks and securities dealers are 1% higher 6% in 2018, 11% through 2025 and 13.5% thereafter Specified section 38 credits LIHTC Renewable electricity production Energy credit Addition to tax means that deductions and credits are used for regular tax, but then economically reversed out 38

39 Calculating the BEAT (cont.) MTI Taxable Income + BETBs + ((BEPct) x section 172 NOL deduction for year) Issues Is BETB just deductions that reduce gross income or is it all BETB deductions, even if there s an NOL? Appears to be all BETBs in a year and the BEPct is calculated based on gross deductions as well What year is the BEP determined for the 172 NOL rule? If it s current year, then BEAT applies to pre-tax reform NOLs that are carried into a post-tax reform year If it s the year in which the NOL arises then, because the effective date of BEAT is for payments in TYBA 12/31/17, then BEAT would not apply to pre-reform NOLs Structure and language suggests that current year is right; policy/fairness would suggest a relate back approach 39

40 US Base Erosion Anti-Abuse Tax (BEAT) Funding US Operations For determining a taxpayer s MTI Base Erosion Payments : Base erosion payment generally means any amount paid or accrued to a related foreign party that generates a deduction or is used to acquire depreciable/amortizable property (including also premiums and reinsurance payments) Payments that qualify as FDAP income and subject to 30% WHT in the US are excepted. But if the WHT rate is lower because of a tax treaty, then only a corresponding portion of the payment is excluded from the MTI calculation. A significant risk exists that payments by a US sub to a US branch be treated as a base erosion payment, even if the branch picks up the payment as US income. Payments by US branches to another branch (of another sister corporation) could be base erosion payments if they are respected for federal income tax purposes Treaty Method vs. Treas. Reg Method (interbranch payments not recognized) 40

41 Analysis of BEAT BEAT Management Manufacturers looking at items that should be included in COGS (production vs distribution costs) Many companies historically deduct certain costs such as production based royalties on a current basis. BEAT analysis may include analyzing for royalties and other similar payments to determine if such costs qualify as COGS. Services peeling apart payment streams to distinguish services from non-services (e.g., cost reimbursements or payments to related administrative parties, to be passed on to unrelated service providers) Need to be very careful not to trigger additional, trickle down exposures Customs import value is tied to COGS per section 1059A Change in method of accounting required for moving costs above the line May raise questions about treatment of other (non-beatable) expenses incurred in open years 41

42 Recharacterization Considerations Recharacterizing deductible payments as COGS for BEAT purposes could result in the following: A. Potential increase in dutiable value of imported goods B. Depending on accounting methods and sales patterns, possible delay in recovering items moved into COGS C. Audit exposure for other deductible payments that are domestic and/or unrelated (i.e., not in any case subject to BEAT) 42

43 BEAT Example Illustrative Transaction Flows $50M Interest & $5M Service Fee (SCM eligible) Parent (Non-US) US Group $70M Royalties WW IP Co (Non-US) $10M Service Payments (not SCM eligible) Sales License U.S. IP WW IP CFC (Non-US) 3 rd party customers 43

44 BEAT Calculation Assumptions for US Group (USG) USG average gross receipts for 2016 thru 2019 $500M USG 2019 Taxable Income = $100M $5M tax credits ($3M are R&D credits) USG related party payments: $50 million interest paid to Parent ($5M limited under new 163(j)) $70 million royalties to WW IP Co $5 million shared services fees that qualify the SCM method (no markup) $10 million service payments to CFC (not SCM eligible) USG all expenses = $400M Assume Parent and WW IP Co are US tax treaty eligible and no US Group depreciation / amortization deductions in connection to property acquired from post-2017 related-party transactions BEAT Calculation Step 1: calculate BEPct deductions attributable to base eroding payments All Deductions % Step 2: Determine your floor: regular tax liability (21% X TI) - tax credits (excluding R&D) $21M $5M $3M = $19M Step 3: Determine MTI: Taxable income + Base Erosion Tax Benefits $100 M + $125M = $225M Step 4: Determine BEAT Liability 10% MTI Floor= Base erosion min tax amount 10% $225M $19M = $3.5M Step 5: Overall Tax Liability regular tax liability (wih credits ) + BEAT Liability $16M + $3. 5M = $19. 5M 44

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