Tax reform Client event 6 February 2018 1
Business tax highlights of tax reform bills Reduction of corporate tax rate: Permanently reduces the 35% corporate income tax rate to a flat 21%, beginning in 2018. Repeal of AMT: Repeals the corporate alternative minimum tax (AMT), beginning in 2018. Limitation of NOL deduction to 80% of taxable income for losses arising after 2017. Increased bonus depreciation: 100% bonus depreciation five years; additional five year phase out (20% reduction each year starting in 2023) Participation exemption : Domestic corporations allowed a 100% deduction for the foreign-source portion of dividends received from owned foreign subsidiaries. (Deduction not available for capital gains or directly-earned foreign income). One time transition tax: Transition tax on deferred foreign earnings: 15.5% / 8%. 2
Business tax highlights of tax reform bills Change of CFC related definitions and new anti-deferral provision (GILTI): New broad-based anti-deferral provision taxes global intangible low-taxed income (GILTI) on a current basis at 10.5% effective tax rate (some FTCs are available). Foreign-derived intangible income deduction (FDII): New deduction for foreign-derived intangible income (effective tax rate 13.125% increased to 16.4% in 2026) Limit on interest deduction: Limits interest deduction to 30% of Adjusted Taxable Income (EBIDTA), and starting 2022 30% of EBIT. Base erosion anti-abuse tax (BEAT): Anti-base erosion measures include minimum tax of (5% in 2018, and 12.5% starting 2025), applied on income determined after adding back certain deductible payments made to related foreign persons. 3
One Time Transition Tax (Sec 965) New 965 imposes a one-time transition tax on a shareholder s pro rata share of a specified foreign corporation s ( SFC ) post-1986 tax-deferred earnings accumulated as of 2/11/2017 or 31/12/2017 (based on the highest). All E&P (positive + negative) are aggregated. Foreign tax credit is partially taken into account. Shareholder SFC SFC Tax liability arise in 2017. Can be paid in 8 installments (8% first 5 years, 15%, 20% and 25% in years 6-8 respectively). Effective Tax Rate: Corporate taxpayers: 15.5% of E&P held in cash or liquid assets; 8% of non-liquid E&P. Individuals and trusts: 17.54% of E&P held in cash or liquid assets; 9.05% of non-liquid E&P (assuming TY 2017 as the transition year). SFC 4
One Time Transition Tax (Sec 965) Who is subject to the Tax Shareholder = Any person (e.g., citizen or resident individual, corporation, fund) That holds by vote or value in a Specified Foreign Corporation ( SFC ). Which foreign corporation is relevant = SFC = CFC (foreign corporation held in more than 50% (vote or value) by Shareholder ; or Any foreign corporation with at least one corporate shareholder Example 1 Example 2 Example 3 Example 4 F shareholders and Non- Investors partnership CFC 45% Shareholders 45% F Shareholders U.S. Corporation foreign partnership 100% 20% Foreign Corporation individual 70% F corporation F Funds CFC/ Not CFC 80% partnership partnership corporation Not CFC Individual 80% Foreign Corporation 5
Change of CFC related definitions and new anti-deferral provision (GILTI) CFC = a foreign corporation that is more than 50% owned (by vote or value) by U.S. Shareholders. Old Shareholder definition = a person holding at least by vote. New Shareholder definition = a person holding at least by vote or value. As a result More foreign corporation will become CFCs. Why does it matter? A foreign corporation that is a CFC can easily become a PFIC under the PFIC assets test that will be applied on adjusted basis in the assets (vs. FMV) affecting all small shareholders of the foreign corporation. Shareholders will be subject to Subpart F, 956 and new GILTI inclusions. 6
Global Intangible Low-Taxed Income A U.S. shareholder of any CFC is required to include in gross income for the current tax year profits of the CFC referred to as "GILTI", regardless of whether such profits were actually distributed. In general, GILTI is computed as the income of the CFC (aggregated for all the CFCs of that Shareholder) that is in excess of return on certain tangible property of the CFC. A Corporate Shareholder is entitled to: 50% deduction + 80% of FTC for foreign tax paid at the CFC level as a result it will be taxed at maximum 10.5% and there will be no additional tax if the GILTI was subject to foreign tax of at least 13.125%. A individual is taxed at the ordinary tax rate on such GILTI income (37%) with no 50% deduction and no indirect FTC. If it holds at least it can make an election to be taxed at 21% corporate rate with indirect FTC, but still with no 50% deduction. Example: F Shareholders individuals 45% partnership LTD Foreign individuals 45% Shareholders 7
Section 163(j) interest deduction limitation Prior to the tax reform, the "old" Section 163(j) generally limited the deductibility of interest expenses paid to related non- persons if (1) the payor's debt-to-equity ratio exceeded 1.5 to 1 (the safe harbor ratio); and (2) the payor's net interest expense exceeded 50% of its EBITDA. The new Section 163(j): Applies to interest payments to related as well as to third parties, foreign and. Does not contain a safe harbor; and Limits the deductibility of interest to 30% of the EBITDA until December 2021 and 30% of the EBIT from January 2022 onward. For partnerships, the interest expense disallowance is determined at the partnership's level and any deduction for interest is taken into account in the non-separately stated taxable income of the partnership. i.e., the partnership is treated as an entity. ATI of each partner is determined without regard to partner s distributive share of any items of income, gain, deduction or loss of the partnership. While the old Section 163(j) provided that all members of the same affiliated group are treated as one taxpayer, the new rule does not contains such language. Example: Prior to the tax reform $ for acquisition After the tax reform Check 30% limit LTD SPV Target Tax rate: 23% Interest payments Tax rate: 40% Consider pushing debt down to where EBIDTA exists Consider moving excess debt to other jurisdictions where the deduction is valuable/contribution to capital Consider other financing methods (factoring) 8
Base Erosion and Anti Abuse Tax (BEAT) Applies to all corporations with average annual domestic gross receipts of $500M over the preceding three tax years, Example: That pay base erosion payments, and The base erosion payment exceeds 3% of their total expenses. In general, Section 59A imposes an additional tax in an amount equal to the excess of: (5% for taxable years beginning in 2018; 12.5% for taxable years beginning after 2025) of the modified taxable income (generally taxable income computed after disallowing deductions for base erosion payments); OVER The corporation s regular tax liability for the year generally reduced by allowable credits. Payments that do not qualify as COGS LTD INC IP Limited risk distributor Base Erosion Payments : Deductible amounts paid or accrued by the corporation to a related foreign party (including amount paid to buy depreciable property from a related foreign party). Exclusions: Payment subject to full WHT; Reductions of income incl. COGs, unless paid to inverted foreign related party.; Certain derivative payments; Payments for services eligible to be charged at cost described at 1.482-9 (e.g., certain back office services, accounting, auditing, payroll, budgeting, not R&D services or reselling). 9
Action Items One time transition tax any corporate or individual shareholder or fund that owns interest in a foreign corporation must: Map whether the foreign corporations are SFCs. Check whether the foreign corporations have positive E&P. If so, compute transition tax and available foreign tax credit. Change of CFC related definitions and new anti-deferral provision (GILTI) funds as well as foreign funds must: Confirm CFC/PFIC status of their foreign corporations. Consider change of holding structure if inefficient. Section 163(j) interest deduction limitation Check limitation on interest expense on debt of corporations/partnerships. Measures should be taken to handle excess interest situations. Consider push down debt among entities. 10