www.pwc.com Tax Executives Institute Houston Chapter Consolidated Return Updates February 28, 2018
Presenters Pavi Mani Partner, Email: pavithra.mani@pwc.com Phone: (713) 356-4040 Pavi is a Partner in the Mergers and Acquisitions Group in s Houston office. Pavi has over 16 years of experience assisting private equity and multinational clients with tax structuring, due diligence, tax modeling and other U.S and cross border deal related matters. Pavi also specializes in renewable energy transactions and IPOs. Additional areas of tax specialization include, tax-free reorganizations, post-deal restructuring, NOL planning, section 382 analysis, stock basis studies, and bankruptcy planning and workouts. Pavi is a Certified Public Accountant and holds a masters degree in accounting and a masters degree in taxation, both from the University of Illinois at Urbana Champaign. Previously, Pavi worked in the M&A tax groups of in Chicago and New York. 2
Presenters Mark P. Thompson Director, Email: mark.p.thompson@pwc.com Phone: (713) 356-5761 Mark is a director in the Mergers and Acquisitions group in s Houston office. Mark specializes in tax due diligence and the tax aspects of mergers, acquisitions, restructurings, and other major domestic and international business transactions. Mark s practice has concentrated on the identification of tax exposures associated with business acquisitions and the application and interpretation of US federal income tax law as it relates to domestic and cross-border corporate acquisitions and dispositions, tax-efficient structuring, consolidated returns, and the reorganization provisions of the Internal Revenue Code. He has consulted on numerous major transactions and has provided services in a wide variety of industries, including technology, energy, and manufacturing. Mark earned a Bachelor of Science in Accounting from the University of South Carolina and a Master in Professional Accounting from the University of Texas at Austin. He is a licensed CPA in Texas and is a member of the AICPA. 3
Agenda 1. Overview of tax reform provisions 2. Uncertainties of tax reform as it relates to consolidated returns 3. Other news in consolidated returns 4
Uncertainties for Consolidated Returns Several provisions of the TC&JA apply to a domestic corporation or the US shareholder of a CFC or the taxpayer. How should we think about applying those rules to domestic corporations that join in filing a consolidated federal income tax return? How should we think about applying those corporatiat join in filing a consolidated n? 5
Overview of Computing Consolidated Tax Liability Four steps in computing taxable income (and tax liability) for consolidated groups: 1) Each member computes separate taxable income BUT several items (such as DRD or NOL deduction) are expressly excluded from that calculation. Reg. 1.1502-12. 2) The items that were excluded in Step 1 are computed on a consolidated basis under various other 1502 regs (such as -26 for DRD, -21 for NOL). 3) All the separate taxable incomes from Step 1 are added together along with all the items computed on a consolidated basis from Step 2 to arrive at consolidated taxable income. Reg. 1.1502-11. 4) The group then computes consolidated tax liability taking into account various tax credits that are computed on a consolidated basis (such as general business credits under -3, foreign tax credits under -4, etc). Reg. 1.1502-2. 6
Key Provisions for Consolidated Groups to Consider Sec 965(a) (creating a new item of subpart F income for toll charge year focusing on specified foreign corporations ) Sec 965(b)(4) (permitting netting of E&P deficits and surpluses among specified foreign corporations owned by members of an affiliated group) Sec 163(j) (limiting interest deduction to 30% of the adjusted taxable income of such taxpayer for such taxable year ) Sec 59A(a) (imposing minimum base erosion tax on applicable taxpayer ) Sec 951A(a) (creating new item of subpart F income for United States shareholder of any controlled foreign corporation ) Sec 250(a)(2) (limiting allowable deduction associated with foreign derived intangible income and global intangible low-taxed income to the domestic corporation s taxable income) 7
Overview of Tax Reform Provisions Deemed Repatriation Toll Charge The Act: - Amends Section 965 to impose a toll charge on a US shareholder s pro rata share of certain foreign subsidiaries previously untaxed foreign earnings Previously untaxed post-1986 E&P of a CFC or a foreign corporation that is at least 10% owned by a US corporation determined as of November 2, 2017, or December 31, 2017, whichever is higher - Treats the US shareholder s toll charge inclusion amount as additional subpart F income, which may be reduced by such US shareholder s pro rata share of the deficits of certain foreign subsidiaries, including foreign subsidiaries of other US shareholders within the same affiliated group 8
Overview of Tax Reform Provisions Deemed Repatriation Toll Charge (continued) The Act (continued): - Allows a deduction on the toll charge amount to the extent necessary for the foreign E&P attributable to cash and other liquid assets to be taxed at an effective rate of 15.5% and all residual foreign E&P at an effective rate of 8% - Makes available to offset the toll charge FTCs for the portion of earnings subject to the tax - Permits a US shareholder to elect to pay the tax liability imposed under the toll charge over eight years (first five years - 8%, sixth year - 15%, seventh year - 20%, eighth year - 25%) - Makes the provision effective for the last tax year of a foreign corporation that begins before January 1, 2018, and with respect to US shareholders, for the tax years in which or with which such tax years of the foreign corporation ends 9
Uncertainties in Applying Rule to Consolidated Groups Repatriation Uncertainty whether the calculation of income subject to the repatriation toll charge will be determined on a consolidated basis. Notice 2018-7 guidance under Section 965 o Provides that the netting of E&P deficits and surpluses is done on a consolidated basis 10
Overview of Tax Reform Provisions Global Intangible Low-Taxed Income (GILTI) The Act: - Subjects US corporate shareholders of CFCs to current US taxation on global intangible low-taxed income (GILTI) with a deduction of 50% (reduced to 37.5% for tax years beginning after 2025) of GILTI - Provides that GILTI is computed annually as the excess of each US corporate shareholder s net CFC tested income over the shareholder s net deemed tangible income return Net deemed tangible return is 10% of tax basis in depreciable assets Net deemed tangible return is reduced for interest deducted in the determination of a US shareholder s net CFC tested income - Permits a FTC for 80% of foreign taxes deemed paid by the US shareholder with respect to the GILTI inclusion 11
Uncertainties in Applying Rule to Consolidated Groups GILTI Whether the GILTI pursuant to new section 951A is applied on a US shareholder-by-us shareholder basis or on a consolidated group basis. - In computing the GILTI amount, the net CFC tested income must be determined. Net CFC tested income is excess of the aggregate of the US shareholder s pro rata share of the tested income of each CFC over the aggregate of its pro rata share of the tested loss of each CFC - Unclear as to whether the tested income of one member of a group is offset by the tested loss of another member 12
Overview of Tax Reform Provisions Base Erosion and Anti-abuse Tax (BEAT) The Act: - Imposes a new BEAT equal to the excess of o o (1) 10% of taxable income (5% for tax years beginning in calendar year 2018 and 12.5% for tax years beginning after 2025) generally determined without regard to deductible amounts paid or accrued to a foreign related party (with exceptions including, but not limited to, certain COGS and certain services at cost), including amounts includible in the basis of depreciable or amortizable assets, over (2) regular tax liability, determined after reduction by credits other than R&D credit and capped amounts of other general business credits (regular tax is reduced by all credits for tax years beginning after 2025) - BEAT taxable base adds back deductible payments to related parties 13
Uncertainties in Applying Rule to Consolidated Groups Base Erosion and Anti-abuse Tax (BEAT) Unclear whether BEAT should be applied on a consolidated group basis Unclear how to apply base erosion percentage to NOL deductions allowed under Section 172 14
Overview of Tax Reform Provisions Foreign-Derived Intangible Income (FDII) The Act: - Applies to exports of property, licensing and services in which such property/services are used/performed outside the US with a third party - Allows a 37.5% deduction (reduced to 21.875% for tax years starting after 2025) for FDII produced in the United States - Provides several requirements that must be satisfied to constitute FDII subject to the preferential rate 15
Uncertainties in Applying Rule to Consolidated Groups FDII Statute indicates that FDII and the deduction for FDII and GILTI is determined at the entity level However, it is unclear whether taxable income means consolidated taxable income under Reg. 1.1502-11 or separate taxable income of the member under Reg. 1.1502-12. 16
Overview of Tax Reform Provisions Interest Deduction Limitation The Act: - Limits deduction for business interest expense to sum of business interest income plus 30% of the adjusted taxable income (ATI) of a taxpayer for the tax year Adjusted taxable income is defined similar to EBITDA for tax years beginning after 2017 and before 2022, and similar to EBIT (computed without regard to any deduction for depreciation, amortization, or depletion, and without regard to Section 199) for tax years beginning after 2021 - Allows disallowed interest deductions to be carried forward indefinitely - Exempts taxpayers with average gross receipts for the three-year period ending with the prior taxable year that do not exceed $25 million - Provides that limitation applies to both related-party and unrelated-party debt -- does not apply to investment interest income - Excludes certain trades and businesses 17
Uncertainties in Applying Rule to Consolidated Groups Interest Deduction Limitation Unclear whether the limitation is calculated at the consolidated group level or on a separate entity basis
Overview of Tax Reform Provisions Net Operating Losses The Act: - Limits NOL deduction to 80% of taxable income for NOLs arising in taxable years beginning after December 31, 2017 - Generally repeals carryback of all NOLs arising in a tax year ending after 2017 - Permits indefinite carryforward for all such NOLs 19
Uncertainties in Applying Rule to Consolidated Groups Net Operating Losses Uncertainty with respect to the application of the 80% limitation on the utilization of pre-reform and post-reform NOL carryovers Example: Pre-reform NOL carryovers of $90M Post-reform NOL carryovers of $10M 2020 pre-nol taxable income of $100M
Uncertainties in Applying Rule to Consolidated Groups Net Operating Losses Example (continued): Approach 1 80% limit is absorbed by pre-reform NOL deduction o $100 pre-nol TI x 80% = $80M o $100 - $90M of pre-reform NOLs = $10M TI o $80M of limitation is absorbed entirely by pre-reform NOL deduction Approach 2 80% limit is not absorbed by pre-reform NOL deduction o $100M - $90M of pre-reform NOLs = $10M o Remaining $10M of TI can be offset in full by $10M of post-reform NOL carryover Approach 3 80% limit applied against TI after deduction of pre-reform NOLs o $100M - $90M of pre-reform NOLs = $10M o $10M x 80% = $8M limitation o TI = $10M - $8M of post-reform NOLs = $2M o Post-reform NOL carryover to future years = $10M - $8M = $2M
Treasury Priority Guidance Plan (2/7/2018) Consolidated Returns General Guidance: Regulations under 1.1502-36 and related provisions regarding losses on subsidiary stock Regulations under 1.1502-75(d) regarding group continuation. Final Regulations were published on September 8, 1966. Final regulations under 1.1502-76 regarding when a member joins or leaves a consolidated group. Proposed regulations were published on March 6, 2015. Final regulations under 1.1502-91 regarding the redetermination of consolidated net unrealized built-in gain and loss. Proposed regulations were published on October 24, 2011. 22
Other News in Consolidated Returns 23
ILM 201726012 In this ILM, the IRS applied the consolidated return regulations to disallow certain amortization and depreciation deductions associated with a special increase in the adjusted basis of partnership assets following a series of non-recognition transactions as part of a corporate reorganization. The ILM concludes that although a non-taxable transfer of a partnership interest within a consolidated group may result in an increase to the adjusted basis of the partnership s assets with respect to a transferee partner, the consolidated group members are not entitled to claim, as part of the consolidated group s taxable income, the increased amortization and depreciation deductions associated with the increase to the adjusted basis of the partnership s assets. 24
IRS Statement The IRS has released a statement setting forth new guidelines for processing private letter ruling requests. Specifically, in connection with the gross receipts test of Section 165(g)(3), the IRS no longer will rule on a consolidated group member's ability to determine the character of gross receipts generated from an intercompany transaction by reference to the character of the source of the funds possessed by the counterparty to the intercompany transaction. 25
Duquesne Light Holdings v. Commissioner A recent Third Circuit decision raises questions as to the scope of the Supreme Court s 1934 Ilfeld decision where taxpayers claim more than one deduction for one economic loss. In Duquesne Light Holdings v. Commissioner, No. 14-1743 (3d Cir. 2017), the Third Circuit applied the Ilfeld doctrine to deny a consolidated taxpayer s attempt to claim two deductions for a single economic loss. 26
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