Section 965 Toll Charge: FTCs, NOLs and Recent IRS Guidance Leslie Alston, Partner, International Tax Services Carrie Koshkin, Director, International Tax Services May 11, 2018
Introduction Purpose Statement Most taxpayers have calculated their Section 965 Toll Charge. Rather than discussing the detailed mechanics, we will review recent guidance. Overview of Section 965 Passed on December 22, 2017. Imposes a one-time tax on pre-effective date foreign E&P taxed at 15.5% on cash and cash equivalents, and 8% on all other E&P. 2
Guidance Guidance Released After the Tax Cuts and Jobs Act December 22, 2017: Staff Accounting Bulletin 118 December 29, 2017: Notice 2018-07 January 19, 2018: Notice 2018-13 February 13, 2018: Revenue Procedure 2018-17 March 13, 2018: IRS Q&As April 2, 2018: Notice 2018-26 April 6, 2018: Publication 5292 3
Staff Accounting Bulletin 118 Overview Issued by the SEC staff on December 22, 2017 Intended to provide clarity in the application of US GAAP to the accounting for tax reform Provides Guidance for Registrants under Three Scenarios Measurement of certain income tax effects is complete Measurement of certain income tax effects can be reasonably estimated Measurement of certain income tax effects cannot be reasonably estimated 4
Staff Accounting Bulletin 118 Disclosures when Accounting under ASC 740 is Not Complete Disclosure of Qualitative disclosure of income tax effects of the 2017 Act for which the accounting is incomplete; Disclosure of items reported as provisional amounts; Disclosure of existing current or deferred tax amounts for which the income tax effects of the 2017 Act have not been completed; The reason why the initial accounting is incomplete; The additional information that is needed to be obtained, prepared, or analyzed in order to complete the accounting requirements under ASC 740; The nature and amount of any measurement period adjustments recognized during the reporting period; The effect of measurement period adjustments on the effective tax rate; and When the accounting for the income tax effects of the 2017 Act has been completed. 5
Notice 2018-07 Overview Example Released on December 29, 2017 Guidance Provided Calculating Aggregate Foreign Cash Position ( AFCP ) Allocation between Multiple Inclusion Years Year 1 - AFCP taken into account will equal the lesser of the US shareholders (1) AFCP or (2) total section 965(a) inclusion amounts for that year. Year 2 - AFCP will be reduced by the amount taken into account in the preceding year. Related Party Transactions - Any receivable or payable of an SFC from or to a related SFC will be omitted to the extent of the common ownership of such SFCs by the US shareholder. US Parent CFC 1 CFC 2 965(a) inclusion: $300 Cash: $200 Year-end: 12/31/2017 2017 965(a) inclusion: $300 Tax @15.5%: $300 Tax @ 8%: $0 965(a) inclusion: $600 Cash: $150 Year-end: 11/30/2018 2018 965(a) inclusion: $600 Tax @15.5%: $50 Tax @ 8%: $550 6
Notice 2018-07 (cont d.) Guidance Provided (Cont d.) Accumulated Post-1986 Accumulated Deferred Foreign Income Adjustments to tested E&P by reason of distributions to SFCs - The dividend reduction rule does not apply to the portion of the distributing SFCs tested E&P reduction that exceeds the increase to the distributee SFCs tested E&P. Ordering rules for distributions and Subpart F inclusions in the inclusion year (1) Subpart F income (2) Distributions from DFIC to other SFCs (3) 965 Toll charge (4) Distributions other than those in (2) (5) Section 956, Investment in US property 7
Notice 2018-13 Overview Released on January 19, 2018 Guidance Provided Determining DFIC or E&P Deficit Foreign Corporation Status Determine if a corporation is a DFIC before determining if it s an E&P deficit foreign corporation. If it is a DFIC, then it is not an E&P deficit foreign corporation. Elective Alternative Method for Calculating E&P For November 2 measurement date, SFCs will be allowed to use the 10/31 financials, plus annualized E&P amount. Annualized E&P amount = 2 x CY E&P as of 10/31/2017 # of days through 10/31/2017 8
Notice 2018-13 (cont d.) Guidance Provided (cont d.) Foreign Currency Translation E&P should be compared on measurement dates in functional currency. The Section 965(a) earnings amount should be translated into USD at spot rate as of 12/31/17. Downward Attribution After Repeal of Section 958(b)(4) - Filing Requirement Clarification Example Foreign Sub Foreign Parent US Sub Form 5471 Category 5 filing requirement exception for CFC with no direct or indirect US shareholder. Exception applies to a foreign corporation that is only a CFC due to downward attribution. 9
Revenue Procedure 2018-17 Overview Released on February 13, 2018 Guidance Provided Change of taxable year - A foreign corporation subject to the toll charge is precluded from changing its taxable year if: 1. Its tax year would otherwise end on 12/31/17, 2. The change would result in the foreign corporation s first effective year beginning on 1/1/17 and ending before 12/31/17, and 3. Without the change, the foreign corporation would have at least one US Shareholder that would include an amount in income pursuant to the toll tax. 10
IRS Q&As Overview Released on March 13, 2018 Guidance Provided Who is required to report Section 965 amounts? 1. A US shareholder of a DFIC 2. A direct or indirect partner in a domestic partnership that is a US shareholder of a DFIC 3. A shareholder of an S corporation that is a US shareholder of a DFIC 4. A beneficiary of a pass-through entity that is a US shareholder of a DFIC Forms 5471s should be filed for all SFCs for which a person is a US shareholder, regardless of CFC status (e.g., a foreign corporation with a corporate US shareholder). 11
IRS Q&As (cont d.) Guidance Provided (cont d.) Report Section 965 Amounts on IRC 965 Transition Tax Statement 1. Amount required to be included under section 965, 2. The aggregate foreign cash position amount, and 3. The Section 965 related elections made. 12
Notice 2018-26 Overview Released on April 2, 2018 Anti-Avoidance Rule Provided If the anti-avoidance test is met, the transaction will be disregarded for purposes of determining a US shareholder s section 965 tax liability. 3 prong test: 1. The transaction occurred after 11/2/17, 2. A principal purpose is to reduce the 965 liability of the US Shareholder, and 3. Section 965 liability is reduced. Transactions Presumed to meet Principal Purpose: Cash Reduction E&P Reduction Pro Rata Share Reduction Rebuttal statement required. 13
Notice 2018 26 (cont d.) Anti-Avoidance Rule Provided (cont d.) Ordinary Course of Business Exception - The presumption that a cash reduction transaction or an E&P reduction transaction satisfies the principal purpose prong does not apply if the transaction occurs in the normal course of business. Per Se Transactions The regulations will provide rules that treat certain forms of these three transaction types as per se satisfying the principal purpose prong of the anti-avoidance rule. No rebuttal is permitted. 14
Notice 2018 26 (cont d.) Anti-Avoidance Rule Provided (cont d.) Cash Reduction Transactions Examples Transfers of cash, accounts receivable, or cash equivalent assets from an SFC to a US shareholder Certain assumptions of accounts payable of a US shareholder by an SFC Specified Distributions are Per Se Transactions Distribution by an SFC to a US shareholder if: At the time of the distribution, there was a plan or intention for the distributee to transfer cash, A/R, or cash equivalent assets to any SFC of the US shareholder, or The distribution is non-pro rata to a foreign person that is related to the US shareholder. 15
Notice 2018 26 (cont d.) Anti-Avoidance Rule Provided (cont d.) E&P Reduction Transactions Defined: a transaction between an SFC and any (1) US shareholder of such SFC, (2) another SFC of a US shareholder of such SFC, or (3) any person related to a US shareholder of such SFC, if such transaction would reduce the accumulated post-1986 deferred foreign income or post-1986 undistributed earnings. Per Se Transactions E&P reduction transactions that involve: 1) a complete liquidation of an SFC to which section 331 applies, 2) a sale or other disposition of stock by an SFC, or 3) a distribution by an SFC that reduces the E&P of such SFC pursuant to section 312(a)(3). 16
Notice 2018 26 (cont d.) Anti-Avoidance Rule Provided (cont d.) Pro Rata Share Reduction Transactions Defined: a transfer of the stock of an SFC to a US shareholder of the SFC or a person related to a US shareholder of such SFC if such transfer would: 1) reduce such US shareholder s pro rata share of the Section 965(a) earnings amount of such SFC, 2) increase such SH Shareholder s pro rata share of the specified E&P deficit of such SFC, or 3) reduce such US shareholder s pro rata share of the cash position of such SFC. Per Se Internal Group Transactions A pro rata share transaction if, immediately before or after the transfer, the transferor of the SFC s stock and the transferee of such stock are members of an affiliated group in which the US shareholder is a member. 17
Notice 2018 26 (cont d.) Other Guidance Provided Accrued Foreign Income Taxes Addresses allocation of foreign income tax that accrues: (1) within the SFC s US tax year that includes 11/2/2017 and (2) after 11/2/2017 and on or before 12/31/2017. Aggregate Foreign Cash position Only includes AR and AP with an initial term of less than one year. Domestic Pass-Through Entities Must allocate the Section 965(c) deduction to their domestic pass-through owners in the same proportion as the toll tax inclusion required by Section 965(a). Current Net Operating Loss A taxpayer making an election under Section 965(n) should disregard both the NOL for the taxable year and the NOL carried into the inclusion year. Penalties The IRS will waive penalties related to a taxpayer s net liability under the toll charge. 18
Publication 5292 Overview Released on April 6, 2018 Guidance Provided Who May be Required to Report Section 965 Amounts Workbook to Assist in Calculating Section 965 Amounts Elections What elections can be made Who can make an election When must an election be made How are elections made Workbook to Calculate: Section 965(a) Inclusion DFIC E&P Aggregate Foreign E&P Deficit Section 965(c) Deduction Aggregate Foreign Cash Position 19
Discussion Topics Overview If a Section 965(n) election is made with regard to CY loss, is the taxpayer required to apportion expenses for FTC purposes? Should restricted cash (e.g., capital reserves required by local law) be included in Aggregate Foreign Cash Position even though the taxpayer is not permitted to distribute the cash? Section 986(c) for unrealized foreign currency gain or loss on the distribution of PTI. (Consider Notice 88-71) 20
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