Tax Reform: Impact of International Provisions on Insurance Companies

Transcription

1 Tax Reform: Impact of International Provisions on Insurance Companies 2018 Mid Year ABA Tax Section Meeting, Insurance Companies February 9, 2018, 3:30 4:30 p.m. Moderator: Clarissa Potter, KPMG, New York, NY Panelist: Surjya Mitra, PwC, Washington, DC; Norm Hannawa, EY, Chicago, IL

2 Notices 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.

3 Mandatory Repatriation

4 Mandatory Repatriation The Basics One time tax imposed on certain United States Shareholders ( USSHs ) of Specified Foreign Corporations ( SFCs ) Treats pro rata share of Accumulated Post 86 Deferred Foreign Income as Subpart F income Implemented via a deduction against the inclusion 15.5% effective rate (55.7% deduction) on cash & equivalents 8% effective rate (77.1% deduction) on non cash Election to pay over 8 years (back loaded) Inclusion for the last taxable year of the SFC that begins before 1/1/18 USSHs & SFCs USSH is determined under pre reform section 951(b) 10% voting interest SFC is any CFC and any other foreign corporation with a corporate USSH Exception for non CFC PFICs

5 Mandatory Repatriation The Basics (cont.) Accumulated Post 86 Deferred Foreign Income Post 86 E&P other than: Income effectively connected with a U.S. trade or business Previously taxed income ( PTI ) (for SFCs that are CFCs) Measured as of 11/2/17 or 12/31/17 (the greater of) Without reduction for dividends distributed in inclusion year other than dividends paid to other SFCs Deficits shared within a U.S. shareholder chain and within affiliated groups Measured on 11/2 only Other Terminology Deferred Foreign Income Corporation ( DFIC ) SFC with positive E&P on a measurement date E&P Deficit Foreign Corporation SFC with a deficit as of 11/2 Overlap?

6 Mandatory Repatriation The Basics (cont.) Foreign cash position of a SFC Determined at U.S. shareholder level Measured as the greater of: (i) the close of the relevant inclusion year; or (ii) the average of the last two tax years beginning before 11/2/2017 The sum of: Cash Net account receivables (i.e., excess over account payables) FMV of actively traded property, commercial paper, CODs, government securities, foreign currency, & short term obligations (less than 1 year) Economic equivalents as identified in regulations Double counting considerations (many addressed in Notice) Transactions with a principal purpose to reduce foreign cash position are disregarded Hair cut foreign tax credits No separate basketing/ no OFL recapture protection Election to shut off NOL carryovers and potentially current year losses

7 Notice (Issued on December 29, 2017) Treasury announced intention to issue regulations for determining income inclusions under section 965 Notice provides guidance on a number of issues; questions still remain Regulations to address (among other issues) Ordering rules governing interaction of Subpart F (generally), section 959, and section 965 in inclusion years Determination of aggregate foreign cash positions (to avoid double counting) U.S. shareholders owning SFCs with different year ends Treatment of related party transactions Adjustments to post 86 E&P Section 965 computations within a U.S. consolidated group Request for comments/additional section 965 guidance expected

8 Notice Ordering Rules Overview Inclusion year interaction between regular Subpart F and sections 959, 965 and 956 for a DFIC Five Steps Step 1: Determine subpart F income of the DFIC without regard to section 965 Step 2: Determine the treatment of distributions made (prior to January 1, 2018) from the DFIC to an SFC under section 959 Step 3: Determine the Section 965(a) inclusion for the DFIC Step 4: Determine the treatment of all distributions from the DFIC under section 959 (other than those described in Step 2) Step 5: Determine the amount of the inclusion, if any, under Section 956 with respect to the DFIC

9 Notice (Section 3.02(b) and (c)) Other Adjustments to Post 86 Deferred Foreign Income Section 3.02(b) (SFC to SFC distributions) The amount of an E&P reduction on a SFC to SFC distribution cannot exceed the amount of the inclusion in E&P in the distributee Relevant for section 312(a)(3) transactions and gain limited boot D transactions Section 3.02(c) (CFCs with non U.S. shareholders) In the case where a CFC has shareholders that are non U.S. shareholders on a measurement date, the accumulated post 86 deferred income of the CFC on such measurement date will be reduced by amounts that would be described in section 965(d)(2)(B) if such shareholders were U.S. shareholders Applies principles of Rev. Rul

10 Notice Consolidated Returns (Section 3.04) All members of a consolidated group that are U.S. shareholders of one or more SFCs will be treated as a single U.S. shareholder. Applies for purposes of determining income under section 965 for U.S. consolidated group: Creates cash sharing among U.S. shareholder group members Potentially (?) creates E&P deficit sharing that may be different than the crosschain deficit sharing rules in section 965 Regulations will also provide for appropriate consolidated return adjustments to reflect (among other items): Amounts included in income under section 965 Impact of attributes of various members (e.g., ownership of E&P deficit companies) Minority ownership by non group members

11 Notice (Other Select Guidance) Stock Basis Adjustments (section 961) Future guidance will address appropriate basis adjustments in order to carry out the provisions of section 965. With respect to amounts included under section 965, future guidance to provide that if a United States shareholder receives distributions from a DFIC during the inclusion year that are attributable to PTI (by reason of section 965(a)), the amount of gain recognized by the United States shareholder with respect to the stock of the DFIC under section 961(b)(2) will be reduced (but not below zero) by the section 965(a) inclusion amount. Section 986(c) Currency gain/loss on distributions of PTI (by reason of section 965) reduced proportionately to the reduction in taxable income resulting from the section 965 deduction Future guidance will address ordering of general Subpart F versus section 965 PTI distributions Potential issue if section 965 PTI shelters a section 956 inclusion?

12 Base Erosion Anti Abuse Tax ( BEAT )

13 Overview: Base Erosion Anti Abuse Tax A minimum tax imposed on U.S. companies having certain deductible base erosion payments made to related foreign companies Applies in 2018 at a 5% rate After 2018 at a 10% rate For tax years beginning after 12/31/2025, 12.5% rate of tax Minimum tax liability equals excess of 10% (or other rate) of the U.S. company s modified taxable income ( MTI ) over its regular U.S. tax liability reduced by certain allowable credits (including FTCs but not R&D and certain other credits) Broadly, MTI is taxable income plus certain base erosion payments and NOLs attributed to such payments The BEAT formula allows taxpayers to retain, at least initially, the benefit of the research credit and some benefit for the three categories of applicable section 38 credits

14 BEAT: General Application Potential addition to regular tax liability Targets taxpayers making deductible payments to related parties that are foreign persons Two tier trigger applies: If there is an Applicable Taxpayer, and To the extent the BEAT tax liability exceeds the regular tax liability Application effectively reverses a portion of deductions attributable to payments to foreign related parties and certain tax credits Clawback of otherwise permitted base erosion Application for base erosion payments (discussed below) made in TYBA 12/31/17

15 Applicable Taxpayer A taxpayer that: Is a corporation other than a RIC, REIT, or S Corp Group has average annual gross receipts for the 3 year period ending with the preceding taxable year of at least $500M Apply rules similar to sections 448(c)(3)(B), (C), and (D) to determine gross receipts Gross receipts of foreign persons included only to the extent of ECI Group has a base erosion percentage of at least 3% (2% for certain financials) Base erosion percentage ( BEPct ) Base erosion tax benefits ( BETB ) all deductions for the year other than under 172 (NOL), 245A (participation exemption), or 250 (FDII/GILTI) Applied annually Sections 243 and 245 appear to be deductions

16 Base Erosion Payment BETB = deductions attributable to Base Erosion Payments Base Erosion Payments = 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 7874

17 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 (including insurance or reinsurance), restriction to low margin activities, etc. Only amounts that constitute total services cost with no "markup component Conference report notes that must use the regulations in existence at enactment

18 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, including guarantees Insurance or reinsurance Need adequate books and records

19 Calculating the BEAT BEAT is an addition to regular tax BEAT 10% Modified Taxable Income R&E Credits 80% 38 Credits [21% x TI 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 + +( ) MTI Taxable Income BETBs BEPct 172 NOL deduction for year

20 BEAT Quota Share Example Foreign Parent US Corp. Reinsurance Premium Foreign Corp.

21 BEAT Quota Share Example 2 Does BEAT apply? U.S. or Foreign Parent Where a foreign company cedes risks to a U.S. company, are claims and other payments to the foreign company base erosion payments giving rise a base erosion tax benefit? Foreign Corp. Reinsurance Premium Claim Payments Ceding Commissions Etc, US Corp. Can claim payments be treated as reductions to gross Income ( 832(b)(3)) and therefore not base erosion payments under 59A(d)(1)? Is there a policy argument to say that no outbound flows are subject to BEAT because 59A should be encouraging inbound reinsurance?

22 BEAT Funds Withheld or Modco Insurance Foreign Parent Does BEAT apply on deemed gross flows or only net outbound settlements? BEAT would apply to outbound premium even if assets are withheld under Funds Withheld Coinsurance or Modco Interest on funds withheld/income on Modco assets paid over to assuming company should also be subject to BEAT Payments to assuming company resulting from decrease in reserves where assets supporting reserves have already been subject to BEAT should not be subject to BEAT a second time However, if reserves were increased and then decreased, payment to assuming company may be subject to BEAT US Corp. FWH or Modco Reinsurance Foreign Corp.

23 Issues and questions Loss years Amount of NOL taken into account Base erosion percentage of NOL What is included in gross receipts What is a deduction and what is an adjustment to gross income How relevant are special rules for calculating insurance company gross income under sec. 803 and 832 How are treaty benefited payments treated for purposes of the base erosion percentages Treatment of groups that include a bank or securities dealer (affiliated group vs. controlled group)

24 Section 953(d) Companies

25 Section 953(d) election BEAT is not applicable to deductible payment to a foreign corporation treated as a US corporation pursuant to section 953(d) Election. What generally happens as a result of a section 953(d) election? Treats foreign insurance company as a domestic corporation. Accordingly, foreign insurance company is taxed as a US insurance company for all purposes of the US Internal Revenue Code, avoiding CFC status and federal excise tax. Commonly used when a foreign insurer will be a CFC, its income is not eligible for deferral, and it will be receiving US risk that is not eligible for a treaty exemption from the premium excise tax Mainly used by companies in no or low tax jurisdictions Section 953(d) Elections may become more prevalent to deal with BEAT

26 Section 953(d) election requirements All of following must be met to make the election: Foreign corporation must be a controlled foreign corporation (as defined in section 957(a) by substituting 25 percent or more for more than 50 percent and by using the definition of United States shareholder under 953(c)(1)(A)) Such foreign corporation would qualify under part I or II of subchapter L for the taxable year if it were a domestic corporation Such foreign corporation meets requirements by Treasury to ensure that the taxes imposed by this chapter on such foreign corporation are paid, and Such foreign corporation makes an election to have this paragraph apply and waives all benefits to such corporation granted by the United States under any treaty

27 Section 953(d) election (cont d) Section 953(d) election consequences: Company will be treated as US insurance company effective for the first day of the tax year for which the election is made (e.g., election filed with 2018 return effective Jan. 1, 2018 for a company that meets the qualifications as of Jan. 1, 2018 through December 31, 2018) The company will file a US income tax return. It may be included in a US consolidated return Conversion from a foreign corporation to a 953(d) company is treated as an inbound type F reorganization Exemption from federal excise tax on premiums paid Taxation on worldwide income with waiver of benefits granted by the US under treaties Generally, subject to certain exceptions under the dual consolidated loss rules, the company s losses can only be used to offset its own income

28 Section 953(d) election (cont d) Procedurally Currently, the IRS does not accept the election until the tax year is complete (e.g., IRS will not accept election filed for 2018 tax year until 2019) Estimated tax payments and federal excise tax required (pending refund) during interim period while waiting to file election Financial statement impact during interim period?

29 Issues Related to Ownership of Foreign Entities

30 Overview: Participation Exemption for Certain Foreign Dividends Replacement of FTC (or related deductions) with a 100% foreign source portion dividend exemption regime distributions made after 12/31/17 from 10% or greater foreign subsidiaries holding period requirement (1 year within a 2 year window) doesn t apply to hybrid dividends (i.e., if payor receives local country deduction for dividend payment) Stock basis adjustment for exempt distributions to limit loss transactions from sale of stock Does not apply to exempt gains from shares unless 1248/964e

31 Foreign Subsidiary Taxation For TYBA 12/31/2017, a corporate U.S. shareholder s ratable share of CFC income is generally either: (1) taxed immediately (under a revised Subpart F system); (2) completely exempt; (3) included in GILTI calculation; taxed under sec. 956 Exempt income (section 245A) 100% DRD for dividends paid to corporate shareholders (10% vote or value) Applies to Routine return 10% of QBAI (see GILTI discussion below) High tax subpart F income (by election) = 19% (in a 21% rate environment) Pre 1987 CFC income Foreign Oil & Gas Extraction Income (907(c)) Dividends from 10/50 companies to USSHs (but make it more likely foreign corp will be CFC

32 Foreign Subsidiary Taxation (cont.) Taxed Immediately Subpart F retained except FBCORI repealed Eliminates section 951 thirty day rule USSH = 10% vote OR value 954(c)(6) still sunsets (for TYBA 12/31/19) Section 956 lives Keep some PTI back? Planning opportunity (scored as a loser) Trap for the unwary 958(b)(4) repeal Global Intangible Low Tax Income ( GILTI ) see next section And ECI Maybe taxed later

33 Global Intangible Low Taxed Income (GILTI)

34 GILTI: High Level Computation Inclusion Taxes U.S. corporate shareholders on their portion of a CFC s global intangible low taxed income Current inclusion similar to subpart F Can be oversimplified as 10.5% ETR threshold ratcheting up to % ETR threshold for tax years beginning after 12/31/25 Effective for tax years of CFCs beginning after 12/31/17 Very broadly, GILTI is the excess of the U.S. shareholder s share of each CFC s non subpart F / non ECI income over a 10% return on tangible depreciable property Allowable FTCs: Capped at 80% of foreign taxes New separate basket, and No carryforwards or carrybacks

35 GILTI: High Level Computation Inclusion GILTI Total CFC Tested Income Net Deemed Tangible Return Income Net Deemed Tangible Income Return Qualified Business Asset Investment 10% Interest expense

36 GILTI: High Level Computation Inclusion Computation done on a USSH by USSH basis, not CFC by CFC Expense allocations important QBAI determined on a quarterly average basis using basis determined under ADS principles No QBAI from tested loss property Interest Expense = interest expense paid by CFCs outside of the USSH s chain No loss sharing within consolidated group

37 GILTI: High Level Computation Inclusion Routine return on QBAI reduced by interest expense taken into account in determining net CFC tested income. Impact of Loss CFCs on FTCs and ETR threshold FTC Capacity 11/30 CFCs Delayed applicability

38 GILTI: What is Tested Income Tested Income includes all gross income of a CFC other than: ECI Subpart F income Income meeting the high tax exception under section 954(b)(4) Dividends received from a related person Foreign oil and gas extraction income Less: deductions allocable to such gross income under rules similar to section 954(b)(5)

39 GILTI: High Level Computation FTC and Section 78 Gross Up Deemed Paid Credit: 80% Inclusion Percentage Aggregate Tested Foreign Income Taxes Section 78 Gross Up Inclusion Percentage Aggregate Tested Foreign Income Taxes Inclusion percentage GILTI income/aggregate Tested Income Tested Foreign Income Taxes only those taxes which are properly attributable to CFC s Tested Income (i.e., no taxes attributable to entities with Tested Losses or to exempt income) Separate FTC basket except not sec. 78 gross up? GILTI and losses

40 FTCs in the Future Baskets General, Passive, GILTI, Foreign Branch (last two at USSH level) Passive wins an overlap with GILTI (but in what cases?) No transition rules; left to regulations Section 902 repealed Section 960 subpart F and section 956, mintax, and taxes on PTI GILTI Taxes No FTC carryover Pressure on income tax character determination Redeterminations SLLs likely lead to permanent loss of credits Other notables ODL recapture election FMV method repealed Section 864(f) is not accelerated

41 Fiscal Year End CFCs Mandatory Repatriation tax not imposed until 2018 (and payable over 8 years therefrom) GILTI doesn t start until, e.g., TYE 11/30/19 CFC income post mandatory repatriation measurement date and pre 11/30/18 is eligible for 245A deduction beginning 1/1/19 Allows time to address remaining FTC pools But E&P shielded by allocated deficits turns into PTI in the inclusion year Can 960(a)(3) apply??? Taxes trapped behind Tested Losses

42 Foreign Derived Intangible Income (FDII)

43 What is FDII? A domestic corporation s FDII is the amount that bears the same ratio to the Deemed Intangible Income of such corporation as the Foreign Derived Deduction Eligible Income of the corporation bears to the Deduction Eligible Income of the corporation. The FDII can be depicted as: FDII Foreign Derived Deduction Eligible Income Deduction Eligible Income Deemed Intangible Income

44 FDII Definitions Deduction Eligible Income equals the excess of the domestic corporation s gross income (determined without regard to certain amounts) over the deductions properly allocable to such gross income. Items excluded from gross income: Any amount included in gross income under Section 951(a)(1), i.e. traditional Subpart F; GILTI income; Financial services income (as defined in section 904(d)(2)(D)); Dividends from CFCs of the domestic corporation; Domestic oil and gas extraction income; and Foreign branch income. Allocable deductions include taxes and interest.

45 FDII Definitions Continued Foreign Derived Deduction Eligible Income means: any Deduction Eligible Income which is Property sold (or leased, licensed, or exchanged) to non US persons for use, consumption, or disposition outside the US; and Services provided to any person, or with respect to property, located outside the US. Special rules for sales to and services performed for foreign related parties Property or services provided to unrelated domestic intermediaries does not qualify, even if ultimately a foreign sale/use arises. Deemed Intangible Income equals the excess of Deduction Eligible Income over Deemed Tangible Income Return of the corporation. The Deemed Tangible Income Return of the corporation equals 10% of the corporation s QBAI. QBAI determined under GILTI rules except: Includes QBAI that produces Deduction Eligible Income, instead of tested income ; and Determined without regard to whether the corporation is a CFC.

46 FDII Issues and Questions QBAI for an US insurance group is likely to be small or negligible as compared to other assets Deduction Eligible Income does not include financial services income (as defined in section 904(d)(2)(D)) Open questions as to as to the type of income defined in section 904(d)(2)(D) Predominately engaged in the active conduct of an insurance business? Treatment of non insurance related income Policy reason for excluding financial services income

47 PFIC Insurance Exception The Act would limit the active insurance exception to cases where a foreign insurance company has insurance liabilities that constitute more than 25 percent of its total assets For this purpose, insurance liabilities would include loss and loss adjustment expenses, and life and P&C reserves, but would exclude unearned premium, deficiency and contingency reserves (as reported on the corporation s applicable financial statement) Note that this is not strictly speaking a liabilities test, but a combination of reserves, liabilities, and expenses An alternate test would be available for a company whose insurance liabilities constitute at least 10 percent of its assets, if its reserves percentage falls below 25 percent solely due to run off or rating related circumstances The provision would be effective for tax years beginning after 2017

48 PFIC Applicable Financial Statement The term 'applicable financial statement' means a statement for financial reporting purposes which "(i) is made on the basis of generally accepted accounting principles, "(ii) is made on the basis of international financial reporting standards, but only if there is no statement that meets the requirement of clause (i), or "(iii) except as otherwise provided by the Secretary in regulations, is the annual statement which is required to be filed with the applicable insurance regulatory body, but only if there is no statement which meets the requirements of clause (i) or (ii). "(B) APPLICABLE INSURANCE REGULATORY BODY. The term 'applicable insurance regulatory body' means, with respect to any insurance business, the entity established by law to license, authorize, or regulate such business and to which the statement described in subparagraph (A) is provided."