Tax Executives Institute

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1 Tax Executives Institute International Tax Update - Hot Topics & Planning Opportunities Ron Dabrowski Principal Washington National Tax Kimberly Roth Managing Director International Tax Houston, TX May 4, 2017

2 Notice The following information is not intended to be written advice concerning one or more Federal tax matters subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. 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. 2

3 Agenda Mandatory repatriation Executive order to review tax regulations Final Section 385 regulations Section 901(m) Temporary and proposed regulations Section 987 final regulations Section 956 and partnerships Notice Tri B/C reorganizations Final Section 367 regulations for goodwill and going concern value Temporary Section 721(c) regulations 3

4 Mandator y Repatriati on

5 Mandatory Repatriation Former Rep. Camp s TRA 14 Proposal Appears to be the Model Overview o Applied to U.S. Shareholders ( USSHs ) of CFCs and 10/50 Companies (10% US voting stock ownership) o Undistributed and untaxed post-1986 foreign earnings ( deferred E&P ) treated as subpart F income Measured as of the foreign corporation s last tax year before the territorial regime applies Inclusion by USSHs based on Section 951 pro rata share rules Deferred E&P would not have been reduced for dividends distributed in such year (i.e., add-back of current year dividends) PTI excluded 5

6 Mandatory Repatriation (continued) Overview (continued) o A subpart F income received deduction applies, determined by reference to the portion of the deferred E&P related to foreign cash position (75%) vs. other assets (90%) Leads to 8.75% effective rate for cash and 3.5% for other o Under Camp TRA 14, it appears that the subpart F inclusion is generally not separately siloed Can offset with NOLs or excess FTCs But OFL recapture does not apply 6

7 Mandatory Repatriation (continued) E&P deficits o Under Camp s proposal, USSH s pro rata share of E&P deficits in foreign corporations would have been aggregated o Aggregate E&P deficits then allocated among those foreign corporations with deferred E&P o Treatment of hovering deficits for this purpose o Impact of deficit allocation on FTC utilization? Need affirmative planning? o No aggregation of U.S. consolidated group members (for cash too)? 7

8 Mandatory Repatriation (continued) Foreign Tax Credits o Under Camp s proposal, FTC disallowed to the extent attributable to amount for which a deduction was allowed (75% - foreign cash position/ 90% remaining E&P) Commensurate reduction in Section 78 gross-up o Consider impact of current year dividend add back and E&P deficit allocations 8

9 Mandatory Repatriation (continued) Foreign cash position (under Camp Proposal) o Defined as including cash, foreign currency, net account receivables, CODs, commercial paper, US, state, and foreign government securities, short term obligations (<1 year), and other assets Treasury determines as being economically similar o Appears to exclude loan receivables (e.g., excludes PTI protected section 956 loans) o Determined, as the greater of: Aggregate foreign cash position as of the close of the last taxable year which began before the tax year in which the participation exemption system would have applied; or Average aggregate foreign cash position for the prior two years o Anti-abuse rule to disregard a transaction if the principal purpose of the transaction is to reduce aggregate foreign cash position 9

10 Mandatory Repatriation (continued) Taxable Year Considerations (under Camp Proposal) o The transition year for mandatory repatriation is the last tax year beginning before tax reform begins (assume 1/1/18) o For 12/31 CFCs, all of 2017 would be the transition year, so mandatory subpart F inclusion would make all distributions out of PTI and may limit planning o 11/30 CFCs would transition for the YE beginning 12/1/17 and ending 11/30/18; YE 11/30/17 planning would be unaffected by subpart F treatment o Note that the JCT Explanation associated with the Camp Proposal contemplates a YE 12/31/16 transition year. 10

11 Mandatory Repatriation (continued) Importance of foreign attribute analyses to facilitate: o o o o o Modeling associated with mandatory repatriation tax cost Identification and implementation of planning opportunities Readiness (tax accounting perspective): tax impacts reflected in financial statements in the period that includes the date of enactment (e.g., existing APB 23 liability assertion, deferred tax liability, etc.) Treasury and cash mobilization objectives (tax and non-tax) Available foreign distributable reserves, solvency restrictions, corporate compliance, foreign exchange controls etc. 11

12 Repatriation Planning Basic Concepts Section 312(a)(3) Upon distributions, E&P reduced by the sum of amount of money, principal amount of the obligations of such corporation, and the adjusted basis of the other property. Allows built-in loss property to eliminate E&P Section 304 Related corporations sale of stock treated as distributions Shifting basis to distributing corporation to eliminate E&P D Reorganization Built-in loss asset transfer to related corporations Boot within gain rule limits amount of taxable gain (if any) Subsequent transfers of stock received in the D reorganization allow high basis to eliminate E&P Granite Trust Reduce ownership in subsidiary to below 80% Causes taxable liquidation of subsidiary E&P generated from taxable gain offset by deficits at shareholders of subsidiary 12

13 Executive Order to Review Tax Regulation s

14 Executive Order on Tax Regulations Immediate action is necessary to reduce the burden existing tax regulations impose on American taxpayers and thereby to provide tax relief and useful, simplified tax guidance Issued on April 21, 2017 Treasury to review all significant tax regulations issued on or after January 1, Earlier determinations of whether a regulation is significant under Executive Order are not controlling Interim report due June 20, 2017 identifying regulations that - Impose an undue financial burden - Add undue complexity to the tax law, or - Exceed the statutory authority of the IRS Final report due September 18, 2017 containing specific recommendations to mitigate the burdens imposed by the identified regulations 14

15 Final Section 385 Regulation

16 Final Regulations: Significant Changes The Final Regulations retain the general framework of the Proposed Regulations, but in a significantly narrower scope No bifurcation rule Only apply to instruments issued by a Covered Member (i.e., a domestic corporation) and held by a non-consolidated Expanded Group member Documentation Rules compliance deadline generally is the issuer s timely-filed U.S. tax return Expanded exceptions and reductions to the Recast Rules 16

17 Effective Dates Documentation Rules Apply for taxable years ending on or after January 19, 2017 (the General Effective Date ) with respect to instruments issued on or after January 1, 2018 Recast Rules The General Effective Date, although they also apply to transactions occurring and instruments issued after April 4, 2016 Instruments treated as stock under the Recast Rules prior to the General Effective Date (whether or not the taxable year ends prior to the General Effective Date) are recharacterized immediately after the General Effective Date Special rules provided for applying and coordinating the Recast Rules during the transition period Taxpayers can elect to apply Proposed Regulations for all instruments issued after April 4, 2016, and before October 13,

18 The Document ation Rules

19 Overview and Scope Documentation Rules facilitate debt/equity analysis of related-party instruments by establishing documentation and maintenance requirements regarding the following factors: Unconditional obligation to pay a sum certain; Creditor rights; Reasonable expectation of payment; and Debtor-creditor relationship Scope Apply to publicly-traded and large privately-held groups Apply to an interest: (i) issued by a Covered Member in the legal form of a debt instrument, or intercompany payables and receivables documented as debt in a general ledger or similar system, and (ii) held by a non-consolidated Expanded Group member or Controlled Partnership (an EGI ) Documentation generally must be in place no later than the issuer s timely-filed U.S. tax return (including extensions) for the year the EGI was issued or a year that includes a relevant date Issuer and holder must consistently treat an EGI as debt (i.e., no mismatch with disclosure) Failure to satisfy results in the EGI being treated as stock for all purposes 19

20 Exceptions Reasonable Cause If reasonable cause for failure to comply is established, taxpayer must prepare the necessary documentation within a reasonable time of establishing reasonable cause and maintain such documentation in accordance with the Documentation Rules Highly-Compliant Taxpayers If a taxpayer establishes that it is otherwise highly-compliant with the Documentation Rules, a non-compliant EGI is not automatically treated as stock, but is presumed to be stock Taxpayer can rebut this presumption if it clearly establishes that the EGI should be characterized as debt under common law; significant weight attached to the four factors described in the Documentation Rules Scrivener s Error A taxpayer can self-correct ministerial or non-material failures or errors prior to IRS discovery 20

21 The Recast Rules

22 General Rule A Covered Debt Instrument ( CDI ) issued to an expanded group member is treated as stock if it is issued in one of the following transactions: A distribution In exchange for stock of an Expanded Group member ( EG Stock ) other than an Exempt Exchange In exchange for property in an asset reorganization if the CDI is received as boot by an Expanded Group member Exempt Exchange A transfer of stock, other than by issuance, in Section 361(a) or (b) exchange (i.e., a target corporation s transfer of lower-tier EG Stock in an asset reorganization); A transfer of stock under Section 1032 or Treas. Reg if the stock is distributed pursuant to the plan of reorganization (e.g., the issuance of EG Stock as consideration for the target corporation s assets in an asset reorganization); A transfer of EG Stock by a shareholder in liquidation under Section 331 or 332; and The deemed issuance of stock in exchange for cash under Treas. Reg (b) (e.g., as stock-based compensation for employees of Expanded Group members or in a taxable acquisition of a target corporation) 22

23 Funding Rule A CDI that is not a Qualified Short-Term Debt Instrument is treated as stock if: The CDI is issued by a Covered Member (a Funded Member ) to an Expanded Group member in exchange for property, and Based on the facts and circumstances, the CDI is issued with a principal purpose of, or is otherwise treated under the Per Se Rule as, funding one of the following distributions or acquisitions by the Funded Member (each a Funded Transaction ) A distribution of property to an Expanded Group member other than in an Exempt Distribution An acquisition of EG Stock from an Expanded Group member in exchange for EG Stock other than in an Exempt Exchange A distribution of boot to an Expanded Group member in an asset reorganization Exempt Distribution Distribution of stock that is permitted to be received without the recognition of gain or income under Section 354 or 355, or, if Section 356 applies, that is not treated as boot; and A distribution of property in a complete liquidation under Section 336 or 337 The Funded Transaction is not recharacterized If a Covered Member s note distribution is not treated as stock under the General Rule, the note is treated as issued for property for purposes of the applying the Funding Rule 23

24 Note Distributions as Fundings 1) $100 note distribution FP USCo Post-April 4, 2016 E&P: $100 2) $100 cash distribution Transaction 1. USCo distributes a $100 note to FP 2. In the same year, USCo distributes $100 cash to FP Result Under the Final Regulations The USCo note distribution is treated as issued for property for purposes of applying the Funding Rule (and exceptions thereto) USCo note is recharacterized as stock irrespective of ordering: - If the note is distributed first, it is recharacterized as stock under the Funding Rule - If the cash is distributed first, the note is recharacterized as stock under the General Rule 24

25 Funding Rule Per se rule: A CDI is treated as funding a funded transaction if the CDI is issued during the 72-month period beginning 36 months before the funded transaction (the Per Se Period ) If multiple CDIs are issued in the Per Se Period, the CDIs are tested in the order issued on a FIFO basis If a CDI is issued in multiple Funded Transactions Per Se Period, the CDI is treated as funding the Funded Transactions in the order of occurrence on a FIFO basis Straddle Period Limitation: A CDI is not treated as issued during a Funded Transaction s Per Se Period if: - The CDI is issued after the Funded Transaction, - The Funded Transaction occurred when the Funded Member was in an Expanded Group that is different than its current Expanded Group, and - The person that received property from the Funded Member in the Funded Transaction is not a member of the Funded Member s current Expanded Group 25

26 General Rule and Funding Rule Exceptions and Reductions: Overview The General Rule and the Funding Rule are subject to certain exceptions and reductions Two Types of Exceptions: Rules that exclude specific transactions from being general rule transactions and/or a funded transactions (the Specific Exceptions ): Subsidiary stock acquisitions; compensatory stock acquisitions; transfer pricing adjustments; securities dealers; and cascading recasts The Threshold Exception - Does not include a cliff effect i.e., all expanded groups can exclude the first $50 million of CDIs from the Recast Rules Two types of reductions that reduce the amount of General Rule transactions and/or Funded Transactions: Expanded Group Earnings Reduction Qualified Contributions Reduction Exceptions and reductions are applied in the following order: Specific Exceptions, Expanded Group Earnings Reduction, Qualified Contributions Reduction, and Threshold Exception 26

27 Section 901(m) Temporary and Proposed

28 Overview of Section 901(m) Section 901(m), effective for taxable years beginning after 12/31/2010, disallows foreign tax credits ( FTCs ) for a certain portion of the foreign income tax paid or accrued with respect to income or gain attributable to relevant foreign assets in a covered asset acquisition (a CAA ). Foreign income taxes disallowed under Section 901(m) are permanently disallowed as FTCs, but are otherwise deductible. Section 901(m) generally applies to transactions that result in a basis step-up for U.S., but not foreign tax purposes, disallowing FTCs for foreign income taxes paid on income recognized by reason of lower depreciation or higher gain on disposition under foreign law. A CAA includes: A qualified stock purchase (within the meaning of Section 338(d)(3)) for which a Section 338 election has been made; An acquisition of a partnership interest which has an election under Section 754 in place; Any transaction which (i) is treated as an asset acquisition for U.S. tax purposes, and (ii) is treated as a stock acquisition or disregarded for foreign tax purposes; and To the extent provided by the Secretary, any other similar transaction. 28

29 Overview and Background Temporary Regulations On July 22, 2014, the Treasury Department and IRS issued Notice , which described forthcoming regulations that would (i) modify the application of the Acceleration Rule, and (ii) provide rules for the continued application of Section 901(m) to a successor. The successor rules make the Section 901(m) taint an asset-based attribute. On July 30, 2014, the Treasury Department and IRS issued Notice , which extended the applicability of the forthcoming rules in Notice to CAAs and dispositions occurring prior to July 21, 2014 by reason of an entity classification election that is filed on or after July 29, On December 6, 2016, pursuant to Notice and Notice , the Treasury Department and IRS issued temporary regulations under Section 901(m). These regulations are retroactively effective for CAAs and dispositions occurring on or after July 21, 2014, including CAAs and dispositions occurring prior to July 21, 2014 by reason of an entity classification election that is filed on or after July 29,

30 Overview and Background Proposed Regulations On December 6, 2016, the Treasury Department and IRS issued proposed regulations under Section 901(m). These regulations are not retroactive and only apply when finalized. However, taxpayers may elect to apply the proposed regulations prior to finalization, subject to important consistency requirements (discussed below). The proposed regulations: Expand the scope of transactions defined as CAAs; Provide detailed rules for determining the allocation of foreign income, foreign income taxes, basis difference, and the amount of foreign tax credits disallowed under Section 901(m); Provide a Foreign Basis Election ; Provide additional rules on the determination of a successor; Provide de minimis rules; and Provide various anti-abuse rules. 30

31 Proposed Section 901(m) Regulations Illustrative Example #1 Assets for stock and cash USP CFC 1 CFC 2 Assets Facts CFC 1 and CFC 2 are Country F corporations. In a transaction described in Section 351, CFC 1 transfers assets to CFC 2 in exchange for CFC 2 stock and cash. For Country F purposes, no gain or loss is recognized. Consequences Under Current Law CFC 1 recognizes gain under Section 351(b) to the extent of the cash received. CFC 2 s basis in the transferred assets is increased by the amount of CFC 1 s gain recognition. This transaction is not a CAA because it is not specifically described as a CAA under the statute. Impact of Proposed Regulations Under the Proposed Regulations, this transaction is a CAA because it is treated as an acquisition of assets for both U.S. and foreign tax purposes and results in a basis increase for U.S. tax purposes without a corresponding basis increase for foreign tax purposes. 31

32 Operative Rules The Disqualified Tax Amount (i.e., the amount of foreign tax credits disallowed under Section 901(m)) is equal to the lesser of: The Foreign Income Tax Amount paid or accrued by the Section 901(m) Payor for the taxable year, or The Tentative Disqualified Tax Amount. The Tentative Disqualified Tax Amount is equal to: The product of: - The sum of the Foreign Income Tax Amount and FCCTs (i.e., taxes claimed as a credit against the foreign income tax) that are paid or accrued by, or treated as paid or accrued by, the Section 901(m) Payor, and - A fraction, the numerator of which is the aggregate basis difference attributable to the year, but not in excess of allocable foreign income, and the denominator of which is allocable foreign income. Reduced by the amount of the FCCTs that is a Disqualified Tax Amount of the Section 901(m) Payor with respect to another foreign income tax. Section 901(m) Payor The person eligible to claim a foreign tax credit under Section 901(a), or a foreign corporation whose taxes paid are eligible to be claimed as credits under Section 902. Foreign Income Tax Amount With respect to a foreign income tax, the amount of tax reflected on a foreign tax return. 32

33 Elections and Anti-Abuse Rules The Foreign Basis Election In general, basis difference for a relevant foreign asset is determined by comparing the basis of the asset for U.S. tax purposes after the CAA and the basis of the asset for U.S. tax purposes prior to the CAA. The Foreign Basis Election allows a taxpayer to compute basis difference by comparing the basis of the asset for U.S. tax purposes immediately after the CAA and the basis of the asset for foreign tax purposes immediately after the CAA. The foreign basis difference takes into account foreign basis adjustments resulting from the CAA. The election may be made separately for each CAA and with respect to each foreign income tax and foreign payor. The election is made by using foreign basis to calculate the disqualified tax amount on a timely filed return; no separate statement is required. Taxpayers that make the foreign basis election prior to finalization must also consistently apply other specified provisions of the proposed regulations, including the expanded CAA categories. The election is irrevocable and ineligible for relief under Treas. Reg Anti-Abuse Rules Foreign assets with built in losses Principal purpose transactions 33

34 Section 987 Final Regulation s

35 Overview of the Regulation Package Income Calculation 987 Gain/Loss Loss Disallowance Rules Section 988 Profit and loss statement translated into the owner s functional currency Retains Balance Sheet approach proposed in 2006 Simplifying Effective immediately Loss Deferral for related party loans with respect to principal purpose transaction Election to mark to market 988 items Final regulations adopt the general framework of the Proposed 2006 Section 987 Regulations 35

36 Effective Dates Election to apply to tax years on or after January 1, 2017 Tax years beginning on or after January 1, 2018 General Effective Dates Loss Deferral Rules Effective date of December 7, 2016 for transactions entered into with a principal purpose of recognizing Section 987 loss Apply generally to transactions entered into after January 6,

37 Calculating Net Income General Rule Translation Sales Income Statement Sales Cost of Goods Depreciation SG&A Net Income/Loss Yearly Average Exchange Rate Cost of Goods Sold Simplified Method Yearly average exchange rate adjusted for cost recovery deductions (e.g., depreciation) Historic Inventory Method Depreciation Historic Exchange Rate SGA Yearly Average Exchange Rate 37

38 Theory of Final Section 987 Regulations Balance sheet approach, using special translation convention, to limit 987 gain/loss to the change in net worth of a QBU attributable to currency fluctuations Financial assets and liabilities translated at the year end spot rate All other items translated at the historic exchange rate Regulations use an 8 Step Method to isolate currency movements 38

39 Net Unrecognized Section 987 Gain or Loss Calculate change in net worth of QBU Step 1 Adjust for transfers to and from QBU Steps 2 5 Adjust for income or loss Step 6 Adjust for tax exempt income and nondeductible expenses Steps 7-8 Net unrecognized 987 gain or loss 39

40 Recognized Section 987 Gain or Loss Cumulative Net Unrecognized Section 987 Gain/Loss Remittance X = Proportion Recognized Section 987 Gain or Loss 40

41 Character and Source Ordinary Section 987 gain/loss is ordinary Character/Source The source of Section 987 gain/loss is proportionate to the source of the income produced by the assets of the QBU Subpart F Section 987 gain/loss is treated as subpart F in same proportion to the assets of the QBU giving rise to subpart F 41

42 Annual Deemed Termination Election Election is available to recognize Section 987 gain or loss of a QBU on an annual basis. The election applies to all of the owner s QBUs as well as all QBUs owned by persons related to the owner Benefits of Election Allows taxpayer to elect to translate all QBU items at the yearly exchange rate for purposes of calculating income or loss Avoids application of loss deferral and nonrecognition rules Timing Election must be made in first year regulations are effective or in a subsequent year when the aggregate unrecognized currency gain or loss for all related QBUs does not exceed $5 million 42

43 Deferral Events and Outbound Loss Events Deferral Events Recognition deferred in connection with certain QBU terminations. These rules apply with respect to all QBUs (e.g., QBUs not generally subject to final regulations). Rules apply to QBU terminations and partnership transactions in which the assets and liabilities of the QBU remain within a single controlled group and remain subject to Section 987. Deferred gain or loss recognized when the QBU makes subsequent remittances, or when the QBU ceases to be owned by a member of the controlled group. 43

44 Deferral Events and Outbound Loss Events (continued) Outbound Loss Events Foreign exchange loss deferred when QBU assets are transferred to a related foreign person in certain outbound transactions Gains, however, are taken into account In nonrecognition transaction, the basis of stock received in the transaction is increased by the outbound loss In taxable transaction, the deferred loss is recognized when the owner and the successor cease to be members of the same controlled group 44

45 Fresh Start Transition Rules Upon the transition date (i.e., the effective date of the regulations) All QBUs are deemed to terminate the day prior to the transition date No foreign exchange gain or loss is recognized as a result of the deemed termination. The owner is deemed to transfer all the assets and liabilities of the QBU to a new QBU. - Assets and liabilities determined at their historic rate (determined based on reasonable assumptions, consistently applied) Taxpayers must consider DTAs/DTLs that may be created upon the transition date with respect to Section 987 in the quarter that includes December 7,

46 Section 956 and Partnershi ps

47 Recently Issued Regulations Under Section 956 (Final and Proposed) New Regulations (Final and Proposed) Issued on November 3, Proposed and Temporary Section 956 Regulations issued in 2015 (TD 9733) were finalized, with changes. See TD Final Regulations applying Section 956 to partnerships were issued. See Reg and -4 - Proposed Regulations impacting Reg were issued. See Prop. Reg (b) 47

48 Reg (b): Property Held Indirectly Through a Partnership Under recently issued final regulations, a partner in a partnership is treated as holding its attributable share of any property held by a partnership (domestic or foreign) A partner s adjusted basis in partnership property is the partner s attributable share of the partnership s adjusted basis in the property - An upper-tier partnership s attributable share of a lower-tier partnership s property is treated as the upper-tier partnership s property for purposes of applying the rules to the upper-tier partnership s partners A partner s attributable share is not limited by its outside basis in the partnership. 48

49 Reg (b): Property Held Indirectly Through a Partnership (continued) Attributable Share - General LVP Rule. Generally determined in accordance with the partner s liquidation value percentage (LVP) Liquidation value is the amount of cash the partner would receive with respect to its partnership interest if the partnership sold all its property for fair market value, satisfied its liabilities, and liquidated - Determined at the most recent of: (i) partnership formation; (ii) revaluation event, or (iii) the first day of the partnership s taxable year if the LVP determined for any partner on that day would differ from the most recently determined LVP of that partner by more than 10 percentage points - Special Allocation Exception: If a partnership agreement provides for book income allocation (or, where appropriate, book gain) from a subset of partnership property to a partner that differs from the partner s liquidation value in a particular taxable year, the partner s attributable share is determined by reference to special allocations if the allocations do not have a principal purpose of avoiding Section 956. (Prop. Reg (b) provides that the special allocation exception does not apply when a partner and the partnership are related within the meaning of Section 267(b) or 707(b), based on 80% standard.) 49

50 Example 1: Partnership Property USP FS FPRS U.S. Property AB: $100 FP Additional Facts U.S. property is non-depreciable property FS s LVP with respect to FPRS is 25% FPRS partnership agreement does not have any special allocations Analysis FS is considered to hold U.S. property of $25 (i.e., 25% x $100) Alternative Facts FPRS partnership agreement allocates 80% of the income of U.S. property to FS, which does not have a principal purpose of 956 avoidance Alternative Analysis FS is considered to hold U.S. property of $80 (i.e., 80% x $100) Under proposed rule, LVP must be used if FS owns at least 80% of FPRS 50

51 Section 956 Regulations: Partnership Obligations Domestic Partnerships: The obligation of a domestic partnership is an obligation of a U.S. person Disregarded Entities: The obligation of a disregarded entity is an obligation of its owner Foreign Partnerships: General Rule: A foreign partnership s obligation is treated as a separate obligation of its partners to the extent of each partner s share of the obligation - A partner s share of an obligation is determined in accordance with partner s LVP No special allocation exception to LVP An upper-tier partnership s share of a lower-tier partnership s obligation is treated as the upper-tier partnership s obligation for purposes of applying the rules to the upper-tier partnership s partners Unrelated Partner Exception: A foreign partnership s obligation is not treated as a separate obligation of its partners if neither the lending CFC nor any related person (Section 954(d)(3)) is a partner in the partnership 51

52 Reg (c): Foreign Partnership Obligation Analysis FS 90% LVP USP FP The Unrelated Partner Exception does not apply and, thus, the FPRS obligation is treated as the obligation of USP (90%) and FP (10%), based on LVP USP s $90 obligation is U.S. property with respect to FS 10% LVP $100 Loan FPRS 52

53 Foreign Partnership Obligation and Guarantees or Pledges FS Lender Guarantee $100 Loan 90% LVP USP FPRS FP 10% LVP The guaranty and pledge rules apply to obligations treated as held by partners of foreign partnerships under the foreign partnership obligation rules Analysis The Unrelated Partner Exception does not apply and, thus, the FPRS obligation is treated as the obligation of USP (90%), and FP (10%), based on LVP FS is treated as holding the obligations of USP that it guaranteed USP s $90 obligation is U.S. property with respect to FS 53

54 Notice Tri-B/C Reorganiza tions

55 Notice : Example Facts USP FS 2 acquires $100 of FS 1 voting stock for $60 of cash and $40 of FS 2 stock. FS 1 USS FS 2 uses the FS 1 voting stock to acquire all of the stock of FT from USS in a reorganization under Section 368(a)(1)(B). USS files a GRA. Assume the FS 2 stock received by USS is at least 10 percent (by vote) of FS 2. FS 1 Stock $60 Cash $40 FS 2 Stock FS 2 FT E&P $0 E&P $60 FS 1 Stock for FT Stock FT FMV $100 A/B $20 Sec E&P $50 Consequences Under Notice Section 367(a) applies only to the exchange by USS of FT stock for the $40 of FS 1 stock that was acquired by FS 2 in exchange for FS 2 stock. However, gain recognition is deferred because USS filed a GRA. Because FT is a foreign corporation, the Coordination Rule does not apply. Thus, the acquisition by FS 2 of FS 1 stock in exchange for $60 of cash is treated as a deemed distribution under Treas. Reg (b)-10, all $60 of which is a dividend under Section 301(c)(1). This is true regardless of whether the $60 dividend is excluded from Subpart F income under Section 954(c)(6). Legend FS 1 = P FS 2 = S FT = T USS must include $30 as a deemed dividend (i.e., 60% of the $50 Section 1248 amount), and recognize $18 of gain (i.e., 60% of the full $80 gain ($48), reduced by the amount of the deemed dividend ($30)). 55

56 Notice : Overview of Modifications Notice announced forthcoming regulations that modify the application of Section 367(a) and Section 367(b) with respect to triangular reorganizations. Modifications to Section 367(a): Section 367(a) will only apply to a triangular reorganization that is an indirect stock transfer to the extent the stock received by T s shareholder in exchange for the T stock was not acquired by S in exchange for property. Modifications to Treas. Reg (b)-10: - The Coordination Rule does not apply if T is a foreign corporation. - The term property includes NQPS. Modifications to Treas. Reg (b)-4: To the extent T s shareholder exchanges T stock for P stock that was acquired by S in exchange for property, T s shareholder must: - Include a deemed dividend the Section 1248 amount attributable to the T stock exchanged for P stock that was acquired by S in exchange for property, and - After increasing its tax basis in the T stock resulting from the deemed dividend, recognize all gain attributable to the T stock exchanged for P stock that was acquired by S in exchange for property. 56

57 Notice : Overview of Modifications (continued) Notice also announced forthcoming regulations that modify the determination of the All E&P amount. Modifications to All E&P Amount Determination: If there is Excess Asset Basis with respect to the inbounding CFC, the All E&P amount will be increased by the Specified Earnings of the inbounding CFC. - Excess Asset Basis is the amount by which the basis of the assets of the inbounding CFC (the Inside Basis ) exceeds the sum of (i) the E&P of the inbounding CFC attributable to outstanding stock of the inbounding CFC, (ii) the aggregate basis in the outstanding stock of the inbounding CFC immediately before the inbound transaction (the Outside Basis ), and (iii) the aggregate amount of liabilities of the inbounding CFC that are assumed by the acquiring U.S. corporation. - Specified earnings are the lesser of: The sum of the E&P of foreign subsidiaries of the inbounding CFC that are attributable to the stock of the inbounding CFC under Section 1248(c)(2) ( Lower-Tier Earnings ), The product of the Excess Asset Basis and the Specified Percentage, or The amount of gain that would be realized by the exchanging shareholder if, immediately before the inbound transaction, it had sold its stock in the inbounding CFC for fair market value, reduced by the exchanging shareholder s all E&P amount (determined without regard to Notice ) (the Specified Stock Gain ). - The Specified Percentage is a fraction, expressed as a percentage, the numerator of which is the exchanging shareholder s Specified Stock Gain, and the denominator of which is the sum of the aggregate Specified Stock Gain with respect to all exchanging shareholders to whom the inbound transaction rules apply and the gain realized by all other exchanging shareholders. 57

58 Final Section 367 Regulations for Goodwill and Going

59 Final Section 367(a) and (d) Regulations Section 367 Treatment of Outbound Property Transfers ( ) Tangible Property Section 367(a) Taxable unless qualifies for the Active Trade or Business (ATB) Exception, subject to certain limitations Intangible Property Section 367(d) Defined in Section 936(h)(3)(B) Always taxable as either a contingent sale (deemed royalty) or a straight sale 59

60 Section 367(a) Rules and Intangible Property ATB Exception: Gain is not recognized under Section 367(a) if the property is transferred for use by the foreign transferee corporation in an active trade or business outside the United States - Hot Asset Exception: The ATB Exception does not apply to the transfer of (i) inventory, (ii) accounts receivable (or similar property), (iii) foreign currency or foreign currency-denominated property, (iv) certain leased property, and (v) intangible property with the meaning of Section 936(h)(3)(B) ( Section 936 Intangible Property ) - Other Exceptions to the ATB Exception: Depreciation recapture, branch loss recapture, and outbound asset reorganizations Section 936 Intangible Property is defined as: Patent, invention, formula, process, design, pattern, or know-how; Copyright, literary, musical or artistic composition; Trademark, trade name or brand name; Franchise, license or contract; Method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical date; or Any similar item 60

61 Final Section 367(a) and (d) Regulations Section 367 Treatment of Outbound Property Transfers ( ) Foreign Goodwill and Going Concern Value Not clear if it s a Section 936(h)(3)(B) intangible If an intangible, exempt under Section 367(d) If tangible, can generally qualify for ATB exception Lead to numerous disputes between taxpayers and the IRS 61

62 Final Section 367(a) and (d) Regulations (continued) Proposed Section 367(a) and (d) Regulations (Sept. 16, 2015) Tangible Property Property eligible for the ATB Exception narrowed Intangible Property Minor changes to deemed royalty mechanics; no 20 year limit Foreign Goodwill and Going Concern Value Still not clear if it is a Section 936(h)(3)(B) intangible Tangible Property no ATB Exception Intangible Property deemed royalty or gain 62

63 Final Section 367(a) and (d) Regulations (continued) Items of Note Regulations finalized with no material changes Generally retroactive to September 14, 2015 Election for non-atb eligible tangible property Elimination of ATB eligibility for certain property denominated in nonfunctional currency Improved organization of Section 367(a) Tangible Property Rules and ATB Exception 63

64 Temporary Section 721(c) Regulation

65 Background Section 721(c) grants regulatory authority to override Section 721(a) if a transferor realizes gain on a transfer of property to a partnership and that gain, when recognized, would be includible in the gross income of a foreign person (see also Section 367(d)(3)) Partnerships must allocate income, gain, loss, and deduction with respect to contributed property in accordance with Section 704(c) Treasury and IRS became aware of transactions in which a taxpayer contributes property to a partnership and income and gain from that property are allocated to related foreign partners that are not subject to U.S. tax - Traditional method or traditional method with curative allocations adopted - Valuation techniques are inconsistent with the arm s length standard Treasury and IRS believe that built-in gain in contributed property would be allocated to the contributor more properly if: - Remedial method applies and - Section 704(b) book items related to contributed property are allocated consistently among the partners and income is not separated from related deductions 65

66 General Rule and Exceptions In general, Section 721(a) does not apply to a contribution of Section 721(c) Property to a Section 721(c) Partnership (the General Rule ) Exceptions - A U.S. Transferor s direct contribution to a partnership if the transferor and Related Persons own less than 80% of the interests in the partnership s capital, profits, deductions, or losses (the Unrelated Transferor Exception ) - Contributions to a Section 721(c) Partnership during a taxable year in which the sum of the Built-in Gain with respect to Section 721(c) Property contributed in that year does not exceed $1 million (does not include contributions that satisfy the 80% Exception) (the De Minimis Exception ) - The Gain Deferral Method is applied to the contributed Section 721(c) Property 66

67 Key Definitions Term Section 721(c) Partnership Section 721(c) Property Excluded Property Definition A foreign or domestic partnership to which there is a contribution of Section 721(c) Property and, after the contribution and all related transactions: i. Related Foreign Person with respect to the U.S. Transferor is a Direct or Indirect Partner, and ii. The U.S. Transferor and Related Persons own at least 80% of the interests in partnership capital, profits, deductions, or losses Property, other than Excluded Property, with Built-in Gain that is contributed to a partnership by a U.S. Transferor i. Cash equivalents; ii. Securities; iii. Tangible property with either a Built-in Gain equal to or less than $20,000, or a built-in loss; or iv. An interest in a partnership, provided at least 90% of the value of the property held, directly or indirectly (through an interest in a partnership that is not Excluded Property), by the partnership consists of property identified in (i), (ii) and (iii) (an Excluded Partnership Interest ) 67

68 Gain Deferral Method Generally The General Rule does not apply if a partner contributes Section 721(c) Property to a Section 721(c) Partnership and the Partnership adopts the Gain Deferral Method with respect to the property Gain Deferral Method requirements - Section 721(c) Partnership adopts the Remedial Method for Section 721(c) Property and applies the Consistent Allocation Method - U.S. Transferor recognizes Remaining Built-in Gain with respect to Section 721(c) Property on an Acceleration Event or a portion of Remaining Built-in Gain on a Partial Acceleration Event or Section 367 transfer - Procedural and reporting requirements - U.S. Transferor extends statute of limitations on assessment for items related to Section 721(c) Property for eight years - Tiered partnership rules 68

69 Acceleration Events: In General Unless otherwise provide, an Acceleration Event with respect to an item of Section 721(c) Property is any event that would reduce the Remaining Built-in Gain that the U.S. Transferor would recognized under the Gain Deferral Method if the event did not occur Acceleration Events include: A contribution of Section 721(c) Property to another partnership by a Section 721(c) Property; A contribution of an interest in a Section 721(c) Property to another partnership; and When any party fails to comply with a condition of the Gain Deferral Method with respect to Section 721(c) Property (a failure to comply with procedural and reporting requirements must be willful) Acceleration Event does not include a reduction in Remaining Built-in Gain in a partnership interest that is Section 721(c) Property resulting from the allocation of book deductions/losses or tax income/gain A U.S. Transferor may treat an Acceleration Event as occurring by: Recognizing the Section 721(c) Property s Built-in Gain as if the property was sold; and Satisfying certain reporting requirements Applied on a property-by-property basis 69

70 Acceleration Events: Exceptions Three types of Acceleration Event Exceptions: - Termination Events (Section 721(c) Property is no longer subject to the Gain Deferral Method) - Successor Events (Gain Deferral Method continues to apply) - Partial Acceleration Events (Gain Deferral Method continues in part) Special rules apply to the transfer of Section 721(c) Property in a Section 367 exchange If the U.S. Transferor or an UTP sells a portion of its interest in a Section 721(c) Partnership in a fully taxable transaction, an Acceleration Event does not occur with respect to the retained portion 70

71 Example 1 (Reg. Section 1.721(c)- 7T(b)) USP is a U.S. transferor The patent is Section 721(c) property The security has BIG but is excluded property The machine has BIL and is excluded property PRS1 is a Section 721(c) partnership Section 721(a) does not apply to USP s contribution of the patent unless PRS1 applies the Gain Deferral Method 1. Patent BV = $1.2M B = $0 2. Security BV = $100K B = $20K 3. Machinery BV = $200K B = $600K USP CFC1 50% 50% PRS1 $1.5M 71

72 Example 2 (Reg. Sec (c)-7T(b)) 1. In year 1, USP and CFC1 form PRS1 2. PRS1 contributes the patent to PRS2, and CFC2 contributes $150 million to PRS2, in exchange for partnership interests Conclusions PRS1 is a Section 721(c) Partnership USP is treated as contributing to PRS2 its share of the patent that PRS1 actually contributes to PRS2 PRS2 is a Section 721(c) Partnership Section 721(a) does not apply to PRS1 s contribution unless the Gain Deferral Method is adopted Because PRS1 is a Controlled Partnership with respect to USP, the Gain Deferral Method must be applied to PRS1 s interest in PRS2 CFC2 Patent: BV = $300M B = $30M 33.3% $150M 2 PRS2 1 USP 50% 50% 66.6% PRS1 CFC1 $300M Patent: BV = $300M B = $30M 72

73 Example 3 (Reg. Sec (c)-7T(b)) In year 1, USP and CFC1 form PRS1. The parties apply the GDM. CFC1 contributes other property for a 40% interest. USP contributes a trademark with a BIG of $5 million for a 60% interest. In year 4, CFC1 sells its entire interest in PRS1 to FX. There is no plan for a related foreign person with respect to USP to subsequently become a partner in PRS1. Results PRS1 is a Section 721(c) Partnership. The sale is a termination event because PRS1 no longer will have a partner that is a related foreign person and there is no plan for a related foreign person to subsequently become a partner in PRS1 (or a successor). The trademark is no longer subject to the GDM. Trademark: BIG = $5M USP 60% 40% PRS1 Other property 40% PRS1 1 CFC1 FX $[x]m 2 73

74 What Questi ons Do You Have?

75 Presenters Ron Dabrowski KPMG LLP (202) Kimberly Roth KPMG LLP (713)

76 Thank you

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