Tax Executives Institute International Tax Update (Detroit) Dates: October 26, 2017 Presenter: Seth Green Partner WNT International Tax
Notice 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. 2
Tax Reform Where we are and Where we might be going
Key proposals Business Trump Administration Framework Corporate rate Owners of passthroughs and proprietorships Carried interest Cost recovery Interest expense 20%; tax-writing committees also might consider methods to reduce double taxation of corporate earnings (e.g., dividends paid deduction) Top individual income rate of 35%, with possible additional rate for progressivity For business income, rate capped at 25%; guardrails to be developed to prevent characterization of personal income into business income Not mentioned Full and immediate expensing for investments in depreciable property other than structures; applies to investments after Sept. 27, 2017 and for at least five years Interest deductions for C corps partially limited; Congress to evaluate appropriate treatment of noncorporate taxpayers 4
Key proposals International Trump Administration Framework Territorial system Repatriation of existing earnings and profits (E&P) Minimum tax on foreign earnings Other provisions Implement a 100% exemption for dividends received from certain foreign subsidiaries (10% or greater) Foreign earnings accumulated under old system deemed repatriated; dual rate for cash/cash equivalents and for illiquid assets; tax payable over several years Foreign profits of U.S. multinationals to be taxed at an undetermined reduced rate Other rules to level the playing field between U.S.- headquartered and inbound multinationals 5
Key proposals Unknowns Trump Administration Framework Rate Expensing Minimum tax on foreign earnings Repatriation Interest deductions Passthrough rate Capital gains/dividends/interest Corporate integration Base erosion Would the proposed rate reductions be permanent or temporary? Would there be an additional top rate (above 35%) for individuals? How broad would the expensing regime be? More than 100% bonus but less than Blueprint rule? And what would happen in year six? What would the rates be and how would foreign earnings be defined/calculated? What would the two repatriation rates be? And how and when would E&P be measured? To what extent would interest deductions be limited? Would there be a limitation for passthrough entities? Would the limitation rule be permanent or linked to expensing phase-out? What businesses and what income would qualify for the lower rate? What rate would apply to investment income? Would 3.8% net investment income tax be retained? How would a dividends paid system mesh with the other proposals? Are there other base erosion proposals yet to come? Tax attributes What would happen to tax attributes (credit carryforwards, etc.)? 6
What is the political and procedural process for tax reform? Tax reform and the budget simplified illustration Can tax reform become law? Can Big Six agree on a tax reform deal? Yes Can bill get 60 votes in Senate? No Budget reconciliation needed to pass bill with 51 votes Can use reconciliation rules for tax reform Yes Can Congress pass FY18 Budget? Does the bill add to the deficit beyond budget window? No Can the bill get >50% votes in the House? Yes Can the bill get 51 votes in the Senate? Yes Will the President sign the bill? Yes Violates reconciliation rules 7
International tax reform under the framework Three tiers of reform 1. 100% exemption for certain foreign income 2. Anti-base erosion applied to 10%-owned foreign subsidiaries - Reduced rates on a global basis 3. Playing field levelers 8
International tax reform under the framework (continued) Options Exempt v reduced appears based on tax rate of the entire subsidiary group - Rejection of activity based or ordinary return exceptions Playing field levelers - Domestic incentives e.g., patent/intangible property box - Anti-inversion - Other inbound limitations beyond interest limitations 9
International tax reform under the framework (continued) Open issues What s the rate (could be static or set as percentage of domestic rate)? Does current subpart F (passive or base company income) survive? Foreign tax credits - Are offshore earnings a separate basket? - Treatment of pre-reform FTC carryforwards Temporary vs permanent (interaction with rate and transition) Transition mandatory repatriation of pre-reform earnings Bi-furcated rates (cash and earnings in excess of cash) Rates not specified Tax paid over a period of years When do you calculate cash and earnings? Treatment of foreign tax credits 10
Mandatory Repatriation How it might work and why that matters
Mandatory Repatriation What is the model for additional transition tax Reference to Camp s new Section 965 proposal as starting point to illustrate concepts and frame planning considerations Overview Camp s new Section 965 would have subjected any U.S. Shareholder ( USSH ) that owned 10% of a foreign corporation to a deemed repatriation of the corporation s undistributed and untaxed post-1986 foreign earnings ( deferred E&P ) for the last tax year of the foreign corporation which began before the year in which the participation exemption system would have applied. Deferred E&P becomes subpart F income Inclusion by USSHs based on Section 951 pro rata share rules Deferred E&P would not have been reduced for dividends distributed in such year (i.e., add-back of current year dividends) Impact of tax year end changes (e.g., 11/30 year ends) PTI excluded Includes both CFCs and 10-50 companies A deduction would have been allowed, determined by reference to the portion of the deferred E&P related to foreign cash position (75%) vs. other assets (90%) Leads to 8.75% and 3.5% rates 12
Mandatory Repatriation (continued) E&P deficits Under Camp s proposal, USSH s pro rata share of E&P deficits in foreign corporations would have been aggregated Aggregate E&P deficits then allocated among those foreign corporations with deferred E&P Treatment of hovering deficits for this purpose? Alternatives to access FTCs in deficit companies? Impact of deficit allocation on FTC utilization? FTC Under Camp s proposal, FTC disallowed to the extent attributable to amount for which a deduction was allowed (75% - foreign cash position)/ 90% (other assets) Commensurate reduction in Section 78 gross-up Consider impact of current year dividend add back and E&P deficit allocations Potential separate basketing Use of existing excess FTC carry-forwards Consider use of splitters? 13
Mandatory Repatriation (continued) Foreign cash position (under Camp Proposal) Defined, under Camp Proposal, as including cash, foreign currency, net account receivables, CODs, commercial paper, US, state, and foreign government securities, short term obligations (<1 year), and other assets Treasury determines as being economically similar Appears to exclude loan receivables (e.g., application to PTI protected 956 loans) Cash positions of foreign pass-through entities are taken into account Determined, as the greater of: Aggregate foreign cash position as of the close of the last taxable year which began before the tax year in which the participation exemption system would have applied; or Average aggregate foreign cash position for the prior two years Anti-abuse rule to disregard a transaction if the principal purpose of the transaction was to reduce aggregate foreign cash position 14
Foreign Attribute Analyses Importance of foreign attribute analyses to facilitate: Modeling associated with mandatory repatriation tax cost Identification and implementation of planning opportunities Readiness (tax accounting perspective): tax impacts reflected in financial statements in the period that includes the date of enactment (e.g., existing APB 23 liability assertion, deferred tax liability, etc.) Treasury and cash mobilization objectives (tax and non-tax) Relevant information and attributes include (for both CFCs and 10-50 foreign corporations): E&P (both undistributed and PTI) E&P deficits Section 902 pools Outside stock and inside asset bases Identification of BIL assets including stock (e.g., recent acquisitions, Section 338(g) elections, impairments, assets held by deficit companies, etc.) Foreign cash position (Camp definition as starting point (?)) Distributable reserve and related cash mobilization profile, by entity (including withholding tax analyses, clearances, etc.) Section 901(m) Exposure 15
Overview of Deficit and FTC Planning Mandatory Repatriation Considerations for FTCs - Leave taxes in CFC & 10/50 pools and utilize in mandatory repatriation (with a haircut) - Bring back excess credits for immediate use excess limitation or ability to generate excess limitation - Excess credits go on 10 year carry-forward Expectation of favorable tax reform transition rules? Year End Considerations - Distributions in transition year may be PTI 16
Overview of Deficit and FTC Planning Access existing high-tax FTC pools Use E&P deficits to: (i) reduce historic E&P; and/or (ii) access/increase the tax rate on remaining Section 902 FTC pools. Examples include: PositiveCo pays dividend to DeficitCo; If need be, consider transfer of PositiveCo to DeficitCo in nonrecognition transaction prior to dividend DeficitCo is seller in Section 304 transaction PositiveCo distributes BIL property (Section 312(a)(3)) PositiveCo triggers BIL (disallowed loss reduces E&P) Affirmative use of nimble dividend rule Techniques to access FTCs in the U.S. 1st Tier CFC: actual or deemed distribution (Section 956) 2nd Tier CFC: Section 304 transaction with U.S. as seller Section 302 redemption of USSH Cross-chain Section 304 or Section 302 redemption following by repatriation in subsequent transaction Consider need and related alternatives to increase X s foreign source income and excess limitation position 17
Regulatory/Administrative Update/Outlook
Background In April, Executive Order 13789 directed the U.S. Treasury to examine recent tax regulations to determine whether any of the regulatory projects: (1) imposed an undue financial burden on U.S. taxpayers; (2) added undue complexity to the federal tax laws; or (3) exceeded the statutory authority of the IRS. According to the executive order, Treasury was to take appropriate steps to delay or suspend the effective date of the identified regulations, and to modify or rescind the regulations, through notice and comment rulemaking. The IRS on July 7, 2017, released Notice 2017-38 providing an interim list of the eight tax regulations under the Executive Order. The regulations relevant to international tax were: The section 385 regulations (both documentation and recast rules) issued via T.D. 9790; The 987 regulations (governing functional currencies of branches and othe QBUs) issued via T.D. 9794; The 367 regulations (substantially changing the rules governing incorporation of active branches and their associated intangible assets) issued via T.D. 9803. 19
Retention of Obama-era rules In July, the IRS announced in Notice 2017-36 that the effective date for the documentation rules in Treas. Reg. 1.385-2 would be delayed by one year, so that they will generally take effect for instruments issued on or after January 1, 2019. In early October, the Treasury issued the report mandated by EO 13789. - In addition to the delayed effective date of Treas. Reg. 1.385-2 it also provided for a one year delay in the effective date for the regulations under section 987 until January 1, 2019 and signaled an intent to propose modifications to the final regulations to permit taxpayers to elect to adopt a simplified method section 987 computations. - Other international rules, however, were permitted to remain in effect at least temporarily. The section 367 regulations were retained but the government stated that it is actively working to develop a proposal that would expand the scope of the active trade or business exception to include relief for outbound transfers of foreign goodwill and going-concern value attributable to a foreign branch under circumstances with limited potential for abuse and administrative difficulties. The recast rules of Treas. Reg. 1.385-3 were retained because after careful consideration, Treasury believes that proposing to revoke the existing distribution regulations before the enactment of fundamental tax reform, could make existing problems worse. If legislation does not entirely eliminate the need for the distribution regulations, Treasury will reassess the distribution rules and Treasury and the IRS may then propose more streamlined and targeted regulations. 20
Priority Guidance Plan On October 20, the IRS and Treasury released their 2017-18 Priority Guidance Plan Items to be reviewed under EO 13789 together with new items referred to as Near Term Burden Reduction accounted for 27 of the items on the list, including two significant new international-focused items: - Guidance under section 871(m), including with respect to non-delta-one transactions - Guidance under both FATCA and traditional FDAP withholding. Other notable items on the plan relevant to cross-border transactions or investment include: - Interaction of the new partnership audit regime with international provisions of the Code. - Guidance on PFICs - Guidance on the 2015 changes to FIRPTA - Regulations governing triangular reorganizations under 367 (per Notices 2014-32 and 2016-73) - Treatment of foreign taxes incurred through partnerships and disregarded entities - Sourcing regulations on IP and digital transactions - Guidance on hybrid entities under section 894 and treaties 21
Chamber of Commerce v. IRS What it means for the regulatory process
Background The US Chamber of Commerce (on behalf of Allergan plc) sought to have Treas. Reg. 1.7874-8T held invalid on the basis that The process followed in adopting the regulations failed to comply with the requirements of the Administrative Procedures Act (the APA ), and The substance of the regulations was arbitrary and capricious and in excess of the authority delegated to the IRS and Treasury under section 7874. The IRS sought to have the suit dismissed on the basis that The remedy sought was barred by the Anti-Injunction Act (i.e., that the validity of the regulations could not be litigated other than through a traditional challenge to an assessment in Tax Court or refund claim in District Court). Section 7805(e) of the Code provides special rules for temporary tax regulations which supplant the relevant portions of the APA as to temporary tax regulations. 23
What the court held The District Court rejected the IRS s jurisdictional and procedural defenses - Anti-Injunction Act Even though its holding of invalidity could ultimately impact the amount of tax to be assessed by the government, the court concluded that the plaintiffs sought the ability to make a reasoned decision about whether to engage in a potential future transaction that would subject them to taxation which was not itself directly a restraint on the assessment and collection of tax. The Fifth Circuit (in which the Western District of Texas is located) has traditionally taken a narrow view of the Anti-Injunction Act. Other circuit courts have taken a broader view. Thus, it is unclear how likely other courts would be to follow this holding - Administrative Procedures Act The court viewed the distinction between substantive rules regulations (which as subject to the APA) and interpretative rules (which are not) as critical to the case. It viewed Treas. Reg. 1.7874-8T as a substantive rule. The court viewed section 7805(e) as imposing specific restrictions on all tax regulations (whether substantive or interpretative) in addition to the APA requirements that exist as to substantive rules. 24
What it means going forward Precedential value Presumably limited in the absence of an IRS appeal How many regulations subject to similar challenge? Most temporary regulations are issued with immediate effective dates (as opposed to the 30 days required under the APA) Query, however, how many would be characterized as a substantive rules by a court for APA purposes? Can the IRS easily cure defects? Section 7805(b)(4) states that the government may provide that any regulation may apply retroactively to correct a procedural defect in the issuance of any prior regulation. What significance (if any) to distinction between effective dates (when the regulation become a part of the Code of Federal Regulations) and dates of applicability (transactions/taxable years that are governed by the rules articulated in the regulation). 25
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