International Fiscal Association USA Branch New York Region International Tax Seminar Thursday, July 13, 2017 Turmoil in Washington A Practical Perspective Patrick Brown General Electric Company Cathy Koch Ernst & Young Bob Stack Deloitte Louise Weingrod Johnson & Johnson
Setting the Stage Must do items in 2017 By August or soon after: Address Federal debt limit By September 30: Tax revenue coming in slower than expected, Mnuchin wants addressed by August House Freedom Caucus wants concessions in exchange for their support Government funding for FY 2018 All Republicans want increased defense spending BUT Conservatives want non-defense spending cuts and moderates don t Senate Republicans may seek to work on bipartisan basis McConnell: We'll have to negotiate the top-line [budget numbers] with Democrats Trump tweet: Our country needs a good shutdown in September to fix mess! FAA funding/authorization Children s Health Insurance Program Jun Jul Aug Sept July 31 - September 5: Congress summer recess September 30: Government funding; FAA funding/authority; children s health program all expire 2
Tax reform: overall state of play June 2016 Republican Blueprint for tax reform 20% corporate income tax rate/25% rate for business income of pass-throughs Immediate expensing but no interest expense deduction - small business exception likely Territorial system of taxing future foreign earnings Border adjustability: exempt exports from tax, deny deductions for imports - 5-year phase-in likely (recent modifications: 5- year phase, special relief for financial transactions, insurance) April 2017 Trump administration plan 15% business income rate; no position on depreciation, interest deductibility negotiable Territorial system of taxing foreign earnings; no position on border adjustability, likely opposed Unspecified base-broadening for corporations and individuals Senate perspectives Does not have a tax reform plan, though options being evaluated Republican Senators publicly opposed to border adjustability McConnell wants revenue neutral tax reform, Hatch not wedded to revenue neutrality Now: negotiations between House, White House, Senate on unified plan Principals: NEC Director Cohn, Treasury Secretary Mnuchin, Senate Leader McConnell, Finance Committee Chairman Hatch, Speaker Ryan, Ways and Means Committee Chairman Brady Focus on issues that include: Replacement for the revenue and anti-base erosion effects of the border adjustability proposal Base-broadening proposals generally How to treat pass-through entities 3
What s anticipated in US Tax Reform legislation Lower rates Current US tax reform proposals include a significant reduction in the business tax rate as well as individual tax rates. We believe it s likely that any final legislation will include a significant reduction in headline rates. Broader tax base To pay for the proposed lower rates, US tax reform proposals include a wide array of base broadening provisions. These proposals affect both the business and individual taxation systems and will likely come with a series of complex transition rules. New International tax system Timing Both the GOP s House Blueprint and President Trump s tax reform principles align in moving towards a territorial system of taxation. Further, these proposals align with some type of toll charge on previously untaxed accumulated foreign earnings. We believe it s likely that any final legislation will incorporate both provisions. Timing remains uncertain, but for the purpose of this plan, we are anticipating the following: House: Legislative language Sep/Oct; Passage Oct/Nov Senate: Legislative language Oct/Nov; Passage Dec/Jan Conference/Signing: Conference Jan/Feb; Signing Feb/Mar 4
What is the Path Forward? Key process decisions Bipartisan or Republican only Revenue neutral? Possible outcomes Assessing the odds Comprehensive reform (business, individual)? Business only reform? Individual only? Temporary corporate rate cut plus repatriation provision? 5
How Should Businesses Prepare? Anticipate 1) a lower rate, 2) movement towards a territorial system, and 3) a repatriation tax Domestic Considerations for US Companies Consider treatment of cash versus other E&P under repatriation tax and repatriating cash Examine structures for disappearing attributes (e.g., NOLs, E&P deficits, and loss property) Accelerate deductions in anticipation of lower rates Utilize FTCs before lower rates are implemented 6
How Should Businesses Prepare? International Considerations for US Companies Reduce foreign effective rates in anticipation of less creditability in the US Continue to refine global corporate structures Consider C by C reporting issues and entity rationalization Address substance and control under OECD TP guidance Assess impact of MLI on foreign structures, including new PE rules and principal purpose test Global debt management and BEPS Actions 2 and 4 EU ATAD provisions, including hybrid mismatch rules 7
How Should Businesses Prepare? International Considerations for US Companies (cont.) Focus on supply chain rationalization from a nontax perspective when identifying tax opportunities Consider state and local issues and opportunities Digital tax issues and the cloud How are traditional brick and mortar companies affected by cloud and other digital tax issues? 8
How Should Businesses Prepare? Everything is uncertain with tax reform timing, substance, whether it will happen at all But business tax leaders are asked every day how to forecast and what their companies should be doing to prepare 9
Modeling at a Moment of Uncertainty Mandatory Repatriation at bifurcated or flat rate Business Tax Rates: 15%, 20%, 25%, 28%? BAT: rate and phase in period Base Erosion Minimum tax: 10%, 15%? Round trip tax Other? Interest Deductibility Expensing R&D Credit 10
Territoriality & Base Erosion Goals: protect the US base, parity, simplicity BAT Minimum Tax Roundtripping Tax Option D: graduated DRD plus deemed current dividends 11
Option D: graduated DRD + deemed current dividends Assume US Tax Rate DRD Foreign ETR Total ETR on Foreign Income General Rule 25% 95% 15% [or greater] 16.25% Reduced DRD - 85% 25% 85% 14.9% 18.65% Reduced DRD - 85% 25% 85% 7.5% 11.25% Reduced DRD - 75% 25% 75% 7.49% 13.74% Reduced DRD - 75% 25% 75% 3.75% 10% Reduced DRD - 75% 25% 75% 0% 6.25% Reduced DRD - 60%* 25% 60% 7.49% 17.49% Reduced DRD 60%* 25% 60% 0% 10% * Applies if CFC has tax rate less than 7.5% and CFC is domiciled in a jurisdiction that does not have a tax treaty/possession status/tiea (or similar relationship) with the United States. Tax Rate measured by effective tax rate of the CFC pool (i.e., multiyear balance), not statutory. Current taxation of Non-Exempt Foreign earnings No indirect foreign tax credits unless a minimum tax is enacted 12
Broader International Implications How will other countries react to US tax reform? Rates Race to the bottom? No statutory tax rate below the US min tax floor? Arm s Length Standard will a round trip tax destabilize the case for the arm s length standard Carrots Will US carrots lead to non-deductibility of COGS or royalties in other countries 13
What if Tax Reform Stalls or Dies? All available oxygen is being taken up with tax reform, which seems appropriate, but what if it doesn t happen? Trump administration has signaled a much more pro business approach, But there is virtually no one in the Treasury Department who is not a holdover. How realistic is it to seek a re-examination of policies that were promulgated recently from the very people responsible for them? 14
What if Tax Reform Stalls or Dies? If we had a worldwide system, deferral and a foreign tax credit for the foreseeable future, what would we change? Stated differently it is January 20, 2021, and President Warren has just taken the oath of office. Tax reform didn t happen. What will US businesses regret not asking for during the Trump years? 15
What if Tax Reform Stalls or Dies? US international tax rules are fundamentally incoherent and becoming more so. We are more out of step with other countries (only member of G-7 that is not territorial, one of only a handful in OECD, etc.) US international rules often no longer advance any identifiable policy goals. Can they be fixed without reform? If so, how? Where to begin? 16
What if Tax Reform Stalls or Dies? Subpart F For its first 34 years, subpart F advanced the policy goal of capital export neutrality, in large part by targeting foreign tax reduction strategies. check the box regs (inadvertently?) blew a hole in that policy goal (1996); Treasury openly questioned targeting foreign tax reduction strategies in a 2000 policy study; 4 years later, CFC look-through was enacted; 3 years after that, Notice 2007-13 did the same thing with substantial assistance rule in FBC services regs; 17
What if Tax Reform Stalls or Dies? Base company sales and services rules still target foreign tax reduction. Why? Other less obvious contradictions abound, including inconsistent treatment of branches. What can be done? Narrow FBC sales and services rules so they don t apply to foreign-to-foreign transactions; Test branches as separate CFCs for all purposes under the base company sales and services rules; 18
What if Tax Reform Stalls or Dies? Subpart F (continued) Eliminate the assignment rule in FBC services regs such income is either foreign-to-foreign or already subject to tax under section 367 or 721 Provide a substantial contribution standard under foreign base company services rules cf. PLRs applying sub con to services income. 19
What if Tax Reform Stalls or Dies? Foreign tax credit system 1986 Act reflected a policy of forced pooling of FTCs within baskets; 2004 Act reduced baskets from 9 to 2, increasing blending. 2010 introduced section 909, which suspends FTCs that are separated from related income. Is this blending or stratifying? 20
What if Tax Reform Stalls or Dies? Foreign tax credit system Same act introduced section 901(m), which denies credits entirely based on determination that foreign tax is being imposed on income that is not subject to US tax not blending Inconsistent with 1.904-6, which allows a credit for base difference taxes. Section 960(c), in same act, opts for blend I win, don t blend you lose for 956 inclusions 21
What if Tax Reform Stalls or Dies? What can be done? Repeal 960(c) it advances no defensible policy goal and is, at best, an avoidable obstacle for the well-advised and a highly punitive trap for the unwary. Repeal section 901(m) more subtle, but also a heads I win, tails you lose approach. 22
What if Tax Reform Stalls or Dies? Repatriation Policy Worldwide taxation with deferral is almost universally viewed as bad policy why would a country deliberately make it harder for its own taxpayers to invest there? So why do Treasury and IRS continue to tighten the screws on self-help strategies to repatriate offshore earnings? Why expand the reach of other anti repatriation provisions (e.g., section 956)? 23
What if Tax Reform Stalls or Dies? What can be done? Section 956 should be narrowed, not expanded. Recent partnership rules go beyond policing true repatriations anyway what goal is served? Consider repealing or relaxing restrictions on cross-border mergers and other repatriation strategies, which effectively represent basis recovery first strategies. Note that other countries (Canada) explicitly allow this by election. Do we want the cash or not? 24