Repatriation Tax Planning: Inbound Asset Transfers, Cash Dividends and Other Strategies for Tax Professionals FOR LIVE PROGRAM ONLY TUESDAY, OCTOBER 30, 2018, 1:00-2:50 pm Eastern IMPORTANT INFORMATION FOR THE LIVE PROGRAM This program is approved for 2 CPE credit hours. To earn credit you must: Participate in the program on your own computer connection (no sharing) if you need to register additional people, please call customer service at 1-800-926-7926 ext.1 (or 404-881-1141 ext. 1). Strafford accepts American Express, Visa, MasterCard, Discover. Listen on-line via your computer speakers. Respond to five prompts during the program plus a single verification code. To earn full credit, you must remain connected for the entire program. WHO TO CONTACT DURING THE LIVE EVENT For Additional Registrations: -Call Strafford Customer Service 1-800-926-7926 x1 (or 404-881-1141 x1) For Assistance During the Live Program: -On the web, use the chat box at the bottom left of the screen If you get disconnected during the program, you can simply log in using your original instructions and PIN.
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Repatriation Tax Planning OCTOBER 30, 2018 Michael Knobler, Attorney Fenwick & West, Mountain View, Calif. mknobler@fenwick.com William R. Skinner, Partner Fenwick & West, Mountain View, Calif. wrskinner@fenwick.com
Notice ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY THE SPEAKERS FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN. You (and your employees, representatives, or agents) may disclose to any and all persons, without limitation, the tax treatment or tax structure, or both, of any transaction described in the associated materials we provide to you, including, but not limited to, any tax opinions, memoranda, or other tax analyses contained in those materials. 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.
Inbound Liquidations and Repatriation Issues Post-TCJA Strafford Webinar October 30, 2018 By: William Skinner, Michael Knobler Fenwick & West LLP
William R. Skinner Partner, Tax Group Phone: 650.335.7669 Fax: 650.938.5200 E-mail: wrskinner@fenwick.com Emphasis: International Tax Tax Planning Tax Controversy William R. Skinner, Esq. is a tax partner with Fenwick & West LLP, in Mountain View, CA. He focuses his practice on U.S. international tax in both the planning and controversy settings, and has experience with a wide range of inbound and outbound tax issues. He has also represented numerous corporate taxpayers in IRS tax controversies. He attended the University of California at Berkeley, graduating in 2001, and Stanford Law School graduating with distinction in 2005 and serving as a member of Stanford Law Review. Prior to joining Fenwick & West, Will clerked for the Hon. Carlos T. Bea, at the Ninth Circuit Court of Appeals. 6
Michael Knobler focuses his practice on a broad variety of tax matters. Mike received his J.D. in 2012 from Yale Law School, where he was an Articles Editor for the Yale Law Journal. Mike received an A.B. in English from Harvard University. Michael Knobler Associate, Tax Group Phone: 650.335.7717 Email: mknobler@fenwick.com Prior to joining Fenwick, Mike was an associate in the Washington, D.C. office of a global law firm, where he worked on issues arising in all areas of the firm s international corporate tax practice. He clerked for the Honorable Susan G. Braden at the U.S. Court of Federal Claims. 7
Repatriation of Foreign Cash in the Post-TCJA Environment TCJA significantly changed the stakes for a US corporation repatriating cash of its CFCs to the United States. Transition tax under Section 965 and repeal of deferral New GILTI tax / full inclusion system Section 245A Participation Exemption for income not subject to GILTI Repeal of Section 902 Indirect Credit 8
Repatriation of Foreign Cash in the Post-TCJA Environment TCJA, however, introduced new rules and issues to be considered, including: FX gain or loss on large amounts of Previously Taxed Income Foreign tax credit limitation issues given the increased number of baskets under Section 904(d) Application of haircuts to some FTCs (GILTI, Section 965) Participation Exemption System of 245A Continued application of deemed dividend rules e.g., Section 367(b), Section 956. 9
Previously Taxed Income the Basics 10
Previously Taxed Income - Review Subpart F has long included rules for preventing double taxation with respect to actual repatriation of income previously taxed as subpart F income. Section 959(a) allowing actual dividends of PTI to be excluded from gross income Section 961 basis adjustment rules to reflect the inclusion of Subpart F income and distribution of PTI Due to the Transition Tax and GILTI relying on Subpart F mechanics, the PTI rules will be expected to have major importance in the future. 11
Basic Example of PTI Year 1 USP $100x Inclusion $50x Cost Basis + $100x Basis Adjustment under 961 CFC 1 $100x Subpart F Income 12
Basic Example of PTI Continued Year 2 USP $100x Distribution Excluded from Gross Income $150x Basis - $100x Basis Adjustment under 961(b) CFC 1 Earnings & Profits $100x Previously Taxed Income (PTI)?x Other Earnings 13
Implications for Section 965 and GILTI The transition dividend under Section 965(a) was effected by treating the CFC s undistributed earnings as an inclusion of subpart F income. By normal operation of Section 959, this caused the earnings to become PTI. In future years, GILTI taxed under Section 951A will also give rise to PTI under Section 959(a). PTI is equal to the gross amount of the inclusion, not reduced by the Section 965(c) deduction or the 50% DRD under new Section 250. 14
Gain Reduction Rule To address potential questions about the timing of a Section 961(a) positive basis adjustment, the Proposed Regulations include a gain reduction rule for distributions of PTI during the transition year (generally, 2017). See Prop. Reg. 1.965-2(g). To the extent a distribution is made out of PTI attributable to a Section 965 inclusion, and the reduction in the CFC s stock basis would otherwise result in gain under Section 961(b)(2), the amount of gain is reduced in lieu of making a positive basis adjustment in the following year. 15
Example of Distribution of PTI and Gain Reduction Rule USP $0 Cost Basis Inclusion at 15.5% / 8% CFC 1 $0 E&P CFC 2 $500x E&P Included under 965 As a result of the Section 965 transition dividend, $500x of CFC 1 s E&P becomes Section 965 PTI. Gain reduction rule would apply if the $500x of Section 965 PTI is distributed in the same year up through CFC 1. 16
Section 965(b) Deficit PTI Section 965(b) provides that deficits of certain E&P deficit foreign corporations are offset against positive E&P of other foreign corporations for computing the transition dividend. In addition, Section 965(b)(4) provides that the positive E&P shall become PTI and the deficit corporation s Section 959(c)(3) earnings and profits shall be increased to zero. 17
Basis Adjustment Election Prop. Reg. 1.965-2(f) To enable PTI created under Section 965(b) to be repatriated without recognition of gain under Section 961(b), the Proposed Regulations include an election of the taxpayer to increase basis of the positive E&P corporation s stock and decrease basis of the deficit corporation s stock. The election is a one-time binding election. Under the Proposed Regulations, the election is due no later than the tax return of the taxpayer for the Section 965 transition year. 18
Example of Deficit PTI USP USP includes $100 under Section 965 and Increases CFC 2 s Stock Basis to $100x $100 Stock Basis $0 Stock Basis <$100> Deficit on 11/2/2017 CFC 1 CFC 2 $200 E&P on 11/2/2017 Discuss results with and without the Section 965(b) stock basis election. 19
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FX Gain or Loss on Previously Taxed Income 21
Section 986(c) Statutory Mechanics Section 986(c)(1) provides for recognition of currency gain or loss with respect to distributions of PTI attributable to exchange rate movements between the date of the inclusion and the date of the distribution. Gain is ordinary and has same source as underlying subpart F or GILTI inclusion. Section 986(c)(2) authorizes regulations to address movements of PTI through tiers of CFCs. 22
Section 986(c) Currency Gain or Loss Appropriate Exchange Rates Section 989 and the proposed regulations provide appropriate exchange rates for translating inclusions into US dollars: Subpart F income average annual exchange rate GILTI average annual exchange rate Section 965 spot rate as of 12/31/2017 Section 956 Inclusion spot rate as of the last day of the taxable year 23
Currency Gain or Loss on PTI USP 2018 Year: 100 GILTI Translated at Average Rate of 1 : $1.25 CFC ( ) June 1, 2019: 100 Distribution of PTI Translated at Spot Rate of 1 : $1.10 ($15) Difference is a Currency Loss under Sec. 986(c) 24
IRS Notice 88-71 Provided interim guidance to implement Section 986(c). CFC maintains annual layers of PTI in passive and general category, and sources dividends from most recent layers first. Dollar basis of PTI in each Section 904(d) basket is then averaged and maintained on a pooled basis. How should Notice 88-71 apply to the new broader categories of PTI (GILTI, general basket, passive)? 25
IRS Notice 88-71 Example 4 USP CFC ( ) 2019 Distributes 100 of PTI Spot rate is 1 : $0.80 Gen Limitation PTI Exchange Rate Dollar Basis 2017 150 1 $150 2018 50 1 $50 2019 200 0.9 $180 Total Dollar Basis Pool $380 Gain / Loss on Distribution $80 Value - $95 Basis ($380 Total Basis * 100 / 400 ) = ($15) Loss 26
IRS Notice 88-71 Example 4 (Alt. Facts) Gen Limitation PTI Exchange Rate Dollar Basis USP 2019 Distributes 250 of PTI Spot rate is 1 : $0.80 CFC ( ) For Section 986(c) Purposes, 150 is sourced from 2019 PTI. (100 General, 50 Passive). 100 is sourced from 2018 PTI proportionately to amounts of PTI in each category in that year. (20 General, 80 Passive) Therefore, total of 120 General and 130 Passive PTI is distributed. Passive Limitation PTI Exchange Rate Dollar Basis 2017 150 1 $150 2017 0 1 $0 2018 50 0.9 $45 2018 200 0.9 $180 2019 100 0.8 $80 2019 50 0.8 $40 Total Dollar Basis Pool $275 Total Dollar Basis Pool $220 27
IRS Notice 88-71 Example 4 (Alt. Facts) USP CFC ( ) 2019 Distributes 250 of PTI Spot rate is 1 : $0.80 Gen Limitation PTI Exchange Rate Dollar Basis Passive Limitation PTI Exchange Rate Dollar Basis 2017 150 1 $150 2017 0 1 $0 2018 50 0.9 $45 2018 200 0.9 $180 2019 100 0.8 $80 2019 50 0.8 $40 Total Dollar Basis Pool $275 Total Dollar Basis Pool $220 Gain / Loss on Distribution of General Limitation PTI $96 Value (120 * 0.8) - $110 Basis ($275 Total Basis * 120 / 300 ) = ($14) Loss 28
IRS Notice 88-71 Example 4 (Alt. Facts) USP CFC ( ) 2019 Distributes 250 of PTI Spot rate is 1 : $0.80 Gen Limitation PTI Exchange Rate Dollar Basis Passive Limitation PTI Exchange Rate Dollar Basis 2017 150 1 $150 2017 0 1 $0 2018 50 0.9 $45 2018 200 0.9 $180 2019 100 0.8 $80 2019 50 0.8 $40 Total Dollar Basis Pool $275 Total Dollar Basis Pool $220 Gain / Loss on Distribution of Passive Limitation PTI $104 Value (130 * 0.8) - $114.4 Basis ($220 Total Basis * 130 / 250 ) = ($10.40) Loss 29
Prop. Reg. 1.959-3(b) (2006) General rule. Maintain separate annual Dollar basis accounts for Section 959(c)(1) and 959(c)(2) PTI. See Prop. Reg. 1.959-3(b)(1). Under Section 959 ordering rules, distributions are generally allocated on a LIFO basis from each layer of PTI, rather than the averaging method of the Notice. Dollar Basis Pooling Election. Alternatively, the taxpayer may take into account the aggregate dollar basis of all Section 959(c)(1) and 959(c)(2) PTI. See Prop. Reg. 1.959-3(b)(3)(ii). 30
Prop. Reg. 1.959-3(b)(4), Ex. 2 USP uses separate annual layers to translate PTI USP CFC ( ) 2019 Distributes 100 of PTI Spot rate is 1 : $1.30 General Limitation PTI Exchange Rate Sec. 959(c)(1) PTI Dollar Basis Sec. 959(c)(2) PTI Dollar Basis 2017 1 100 $100 0 $0 2018 1.2 0 $0 100 $120 2019 1.3 0 $0 0 $0 Gain / Loss on Distribution $130 Value - $100 Basis (Basis of 100 of year 1 Section 959(c)(1) PTI) = $30 Gain 31
Prop. Reg. 1.959-3(b)(4), Ex. 3 USP uses dollar basis pooling election to translate PTI USP CFC ( ) 2019 Distributes 100 of PTI Spot rate is 1 : $1.30 General Limitation PTI Exchange Rate Sec. 959(c)(1) PTI Dollar Basis Sec. 959(c)(2) PTI Dollar Basis 2017 1 100 $100 0 $0 2018 1.2 0 $0 100 $120 2010 1.3 0 $0 0 $0 Gain / Loss on Distribution $130 Value - $110 Basis ($220 Dollar Basis * 100 / 200 Total 959(c)(1) and 959(c)(2) PTI) = $20 Gain 32
Translation - Section 961 Basis Adjustments As discussed above, Section 961(a) provides for an increase in CFC stock basis to reflect the amount of earnings included in gross income under Section 951(a)(1)(A) or 951(a)(1)(B). Section 961(b) provides for stock basis reduction on a distribution excluded under Section 959. Question: What rates are used to translate basis adjustments? Answer: Historic dollar cost of PTI (see TAM 200141003 and 2006 Proposed Regs. 1.961-1 and -2). 33
FSA 199949001 Simplified Facts USP $20 Basis $50 Value $20 Basis 40 Purchase Price (Spot Rate = 1 : $1.25) E&P - 0 CFC 1 ( ) 304 Transaction CFC 2 ( ) PTI 20 (Dollar basis at 1 : $1) Live E&P 0 Facts: USP sold stock in CFC 1 to CFC 2 for $50 of proceeds. USP recognized a $25 Section 304 deemed dividend sourced out of CFC 2 s PTI. USP recognized a $5 Section 986(c) gain on distribution of PTI. USP reduced basis in CFC 2 by $20 - the amount of PTI distributed. 34
FSA 199949001 Simplified Facts USP $20 Basis $50 Value $20 Basis 40 Purchase Price (Spot Rate = 1 : $1.25) E&P - 0 CFC 1 ( ) 304 Transaction CFC 2 ( ) PTI 20 (Dollar basis at 1 : $1) Live E&P 0 Question: Did USP adjust its basis in CFC 2 upward to reflect the Section 986(c) gain on distribution of PTI? Answer: No, despite Notice treatment of Section 1248 and Sec. 367(b) transactions. Result: Of the $25 not covered by PTI, $20 was a recovery of CFC 1 stock basis and $5 was a Section 301(c)(3) gain. Therefore, USP recognized a total of $10 of gain on the transaction. 35
Withholding Taxes on Distributions of Previously Taxed Income 36
Distributions of PTI Withholding Tax Issues Actual cash dividends of PTI up a chain of CFCs may result in withholding taxes imposed on the movement of the cash to the US Parent. Taxes may be imposed on US Parent directly or on a CFC receiving a dividend from a lower-tier foreign subsidiary. Relevant considerations include: Basketing of the Taxes, Foreign tax limitation, and potential application of haircuts under Section 965(g) or Section 960(d). 37
Example of First Tier Withholding Tax USP $200x Distribution <$10x> Withholding Tax CFC 1 $500x PTI Section 901/903 provides a credit for taxes imposed directly on USP. See Reg. 1.904-6 and IRC Section 960(c) for FTC limitation consequences. 38
Distributions of PTI Withholding Tax Issues Section 960(b)(1) provides for an indirect credit to a US shareholder that receives PTI for the taxes imposed on the CFC that are attributable to the portion of earnings treated as PTI and with respect to which a credit hasn t previously been claimed. Section 960(b)(2) applies the same rule to a distribution from a lower-tier CFC to a first-tier CFC, where taxes are imposed on the lower-tier CFC and attributable to its distribution of PTI. 39
Example of Second-Tier Withholding Tax USP $400x Distribution No Withholding CFC 1 $400x PTI from CFC 2 $800x Other PTI $400x Distribution <$40x> Withholding Tax CFC 2 $400x PTI GILTI Basket A Section 960(b)(1) credit for the $40x withholding taxes may be available. See Pre-TCJA Reg. 1.960-2 for ordering rules. 40
Section 965(g) Disallowance Ratio Section 965(g) provides that no foreign tax credit (or deduction) is allowed for the applicable portion of any foreign taxes imposed with respect to the transition dividend. The applicable portion is intended to apply to the portion of the Section 965 transition dividend that is not taxed. Prop. Reg. 1.965-5 extends the disallowance rule of Section 965(g) to withholding taxes imposed on a distribution of Section 965(b) PTI. 41
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Section 245A Participation Exemption 43
Introduction The exemption provides a 100% deduction for certain dividends received by a domestic corporation that is a United States shareholder under Section 951(b). RICs and REITs are not eligible. Only specified foreign corporations with one or more domestic corporations as a United States shareholder qualify. PFICs are excluded from Section 245A. TCJA Conference Report at fn. 1486 notes that CFCs may be considered domestic corporations for purposes of Section 245A. 44
Undistributed Foreign Earnings Only dividends paid from the foreign source portion of the foreign corporation s undistributed earnings and profits as of the end of the taxable year qualify for the exemption. Undistributed earnings and profits mean the earnings and profits of the corporation as of the end of the taxable year, without diminution for dividends distributed during the year. Earnings from US source income or ECI generally don t qualify. Distributions of Previously Taxed Income (PTI) are not dividends and thus are tax-free regardless of 245A (see discussion above). 45
Basic Example of Section 245A US Corp 100% $300 Distribution Foreign Corp Earnings & Profits $200 Previously Taxed Income $300 Undistributed The first $200 of the distribution is tax-free out of Previously Taxed Income under Section 959. The balance of $100 is potentially eligible for a DRD under Section 245A. 46
Disallowance of Foreign Tax Credits No deduction or credit is allowed for foreign taxes associated with a dividend that qualifies for a Dividends Received Deduction under Section 245A. Section 245A(d). This disallowance provision applies to foreign withholding taxes on payment of the dividend. Note due to the repeal of Section 902, there would generally not be an indirect credit for taxes imposed on the foreign corporation in any event. 47
Holding Period Requirements of Section 246 To qualify for a DRD, the domestic corporation must hold the stock of the foreign corporation for at least 365 days of the 731 day period around the ex-dividend date. Section 246(c)(3). The taxpayer must also satisfy the requirements of being a 10% US shareholder in the foreign corporation throughout that period. Section 246(c) rules for tacked holding periods and transactions that reduce the taxpayer s risk of loss also apply for this purpose. 48
Section 1059 The Other Holding Period Requirement In addition to qualifying for the DRD, the taxpayer should also consider potential application of Section 1059 to extraordinary dividends. Where Section 1059 applies, the taxpayer s basis in the stock is reduced by the amount of the DRD allowed under Section 245A(a). If the basis reductions exceed the taxpayer s basis in the stock, the taxpayer is required to recognize gain. 49
Section 1059 Thresholds for Application Section 1059(a) generally applies only where dividend is extraordinary i.e., 10% of taxpayer s basis (or at the taxpayer s election, fair market value) in the stock and the taxpayer did not satisfy a holding period requirement. The Section 1059 holding period requires the taxpayer to hold the stock for at least 2 years before the ex-dividend date. Exception for certain corporations where the taxpayer owns the same % interest throughout the corporation s entire existence. Section 1059(e) provides that certain redemptions, Section 304 transactions, and other transactions are subject to Section 1059 even if the taxpayer satisfied the 2-year holding period requirement. 50
Section 245A Holding Period Example 1 Assume USP Acquired CFC s Stock on November 1, 2017 and Sells CFC s Stock on January 1, 2019. Basis $300x Value $300x USP Dividend December 1, 2018 $100x CFC No Previously Taxed Income $100x Undistributed Earnings 51
Section 245A Holding Period Example 2 USP Acquired CFC s Stock on March 1, 2018 and Holds CFC s Stock Thereafter. USP Basis $300x Value $300x $100x Dividend Paid on December 1, 2018 CFC 1 $100x Undistributed Earnings 52
Treatment of Section 1248 Amount Section 1248 was amended so that a section 1248 deemed dividend is treated as eligible for Section 245A to the same extent as an actual dividend. Section 1248(j). Similar rules apply at the lower-tier CFC level, where one CFC sells another CFC and the US shareholder satisfies the requirements of Section 245A at the first-tier CFC level. See Section 964(e)(4). 53
Example of a Section 1248 Deemed Dividend USP Third Party Buyer Sale for $300x $100x Basis $300x Value CFC $100x Undistributed Earnings Under IRC Section 1248, $100x of USP s gain on the sale is re-characterized as a dividend to the extent of USP s share of CFC s Section 1248 E&P. USP may claim a Section 245A DRD of $100x to the same extent as would be the case for an actual dividend. 54
Hybrid Dividends Section 245A(e) denies the participation exemption for hybrid dividends. No foreign tax credit is allowed with respect to hybrid dividends, despite the absence of a DRD. See Section 245A(e)(2). In the case of a CFC receiving a hybrid dividend from another CFC, the hybrid dividend is considered to be subpart F income to the US shareholder. Definition of a Hybrid Dividend: An amount received by the shareholder for which there is a deduction under Section 245A, and For which the controlled foreign corporation receives a deduction or similar tax benefit for foreign income tax purposes. 55
Section 367(b) After the TCJA 56
Inbound Liquidations and Reorganizations (Reg. 1.367(b)-3 Paradigm case USP CFC Checks the Box to become a Disregarded Entity Foreign Disregarded Entity (DRE) 57
Overview of Treas. Reg. 1.367(b)-3 Reg. 1.367(b)-3 applies to all transactions in which a domestic corporation acquires the assets of a foreign corporation in a 332 liquidation or 368(a)(1) reorganization. Any United States shareholder (within the meaning of 951(b)) in a foreign corporation undergoing such a transaction must include in its income, as a deemed dividend, the all earnings and profits amount with respect to its stock in the foreign corporation. All E&P amount generally means the undistributed E&P attributable to the shareholder s stock under Section 1248. 58
Example of Inbound Liquidation DC (U.S.) Results: (1)Generally tax-free liquidation under Section 332. (2)Inclusion of the $500x of PTI and $100x of Undistributed E&P Consider whether 245A applies to the $100x. FC checks the box and liquidates into DC FC (Foreign) Previously Taxed Income 500x Undistributed E&P 100x Stock Basis $200x FMV $1,500x 59
Inbound Transactions under Reg. 1.367(b)-3: Impact on Tax Attributes Attribute Carryover Rules: DC generally takes a carryover basis in the assets of FC under 334 or 362 (but see discussion of 362(e)(1) below). FC s earnings and profits are generally eliminated unless attributable to a US trade or business of FC (see Reg. 1.367(b)-3(f)). FC s net operating losses are eliminated unless connected with a US trade or business. See Reg. 1.367(b)-3(e). Previously taxed income accounts of FC are eliminated; however, DC must recognize currency gain or loss immediately before their elimination under 986(c). See Reg. 1.367(b)-2(k). 60
Inbound Transactions Section 362(e) Limitation on Importation of Net Built-in Loss General rule ( 362(e)(1)(A)). If, in a transaction described in 362(a) or 362(b), there would be an importation of a net built-in loss, then the basis of all property received in the transaction shall be its fair market value. Note Section 334(b) includes a similar rule for inbound liquidations governed by 332. Key Definitions: Built-in-gain or loss with respect to property is considered to be imported to the extent that a sale by the transferor before the transaction would not be subject to US taxation. A net built-in-loss exists if the aggregate adjusted basis of property acquired by the transferee would, but for 362(e)(1), exceed its aggregate FMV. 61
Any Questions? 62