Impacts of U.S. International Tax Reform. October 23, PDF Free Download

Impacts of U.S. International Tax Reform October 23, 2018

Christopher Jentile (Verizon), Moderator William Crowley (PwC) Anthony Sileo (KPMG) Stephen Blough (KPMG) 2

Christopher Jentile Christopher is an Executive Director of Global Tax Planning at Verizon Communications Inc. Since joining Verizon in 2008, Christopher is responsible for Federal, state and local and non-u.s. tax planning and non-u.s. tax reporting. Prior to joining Verizon, Christopher held tax leadership positions in several major multi-national corporations. Christopher received his L.L.M.-Tax from NYU School of Law, his J.D. from Rutgers School of Law and his B.S. from Fordham University. 3

William Crowley Will is a Principal in PricewaterhouseCoopers Industry Services Group where he advises his clients on the US Federal income tax aspects of domestic and international transactions. He has worked on numerous projects involving crossborder acquisitions and divestitures, transfer pricing optimization and intellectual property migration. Will helps his clients identify operational and structural tax planning opportunities while taking into account the complex and dynamic organizational implications that often result from such strategic planning opportunities. Prior to joining PwC, Will spent 15 years in senior tax leadership positions at two Fortune 50 corporations, including responsibility for leading the international tax function. In this capacity, Will drove strategic planning initiatives and partnered with senior business leaders across these companies to implement value chain transformation initiatives and other business restructurings to achieve sustainable financial and operational synergies. 4

Anthony Sileo Anthony Sileo is a Principal in KPMG s International Tax practice based in New York Metro and serves as the International Tax practice s East Region Service Leader. Anthony is responsible for a broad range of multinational clients, and has extensive experience with respect to complex cross-border transactions and international tax and transfer pricing matters relating to his client s businesses. Anthony s current and past clients include leaders in the manufacturing, consumer products, retail, technology, and communications industries. Prior to joining KPMG, Anthony was employed at a multinational law firm and advised clients on a variety of corporate legal and international, federal, and state tax matters. Anthony is a frequent speaker on international tax matters for professional organizations, including the Tax Executives Institute. 5

Stephen Blough Dr. Stephen Blough leads the transfer pricing and tax-related valuations group within the KPMG US Washington National Tax practice. As the firm s senior transfer pricing economist, Dr. Blough serves as lead transfer pricing economist for some of KPMG s largest clients, and provides technical assistance on many other projects. He is also responsible for thought leadership on US and OECD transfer pricing regulatory developments. He has authored publications on transfer pricing topics ranging from valuation of intangible property to treatment of intercompany services. Prior to joining KPMG in 1994, Dr. Blough was an economist at the Federal Reserve Bank of Boston, where he was responsible for the analysis of financial markets in their relationship to monetary and regulatory policy. He spent six years on the faculty of the department of economics at The Johns Hopkins University, where he taught graduate courses in econometric methods and macroeconomics. He has a Ph.D. in Economics and M.A. in Statistics from the University of California at Berkeley. 6

The U.S. International Tax Landscape - Overview Global Intangible Low-Taxed Income (GILTI) and Related Foreign Tax Credit (FTC) Considerations Foreign Derived Intangible Income (FDII) Base Erosion Anti-Abuse Tax (BEAT) Q&A 7

Overview 8

Overview of New International Tax Framework 9

Treasury Regulations Expected Provision Tentative release date* GILTI Proposed Regulations released on 9/13 FDII By the end of the year BEAT By the end of November PTI (GILTI and 965) By the end of the year FTC By the end of November 267A - Hybrids By the end of the year 163(j) By the end of November * Release dates are based upon recent statements by Treasury and IRS staff, but are very tentative. 10

Case Study Illustrative Structure (Pre-Tax Reform) U.S. Multinational Customers Cost Sharing Agreement U.S. Multinational Corporation IP Contract R&D Services Income earned by Non-U.S. Principal (CFC 1) not subject to U.S. tax under Subpart F and taxed only in Country A Customer Sub (Country A) CFC 1 Non-U.S. Principal (Country A) (10% tax rate) IP Royalty and/or Services fees CFC 2 (Country B) (25% tax rate) CFC 3 (Country C) (33% tax rate) Income earned by CFC 2 and CFC 3 not subject to U.S. tax under Subpart F and taxed only in Countries B and C Key: Payment Flows Services Other Customers (Country B) U.S. Multinational Corporation receives deduction (at 35%) for outbound service payments 11

Overview of CFC Income Three Categories Exempt Income Subpart F Income (Full US Taxation at 21% corporate rate) GILTI - Minimum Tax at 50% of corporate rate (10.5%, but... ) 13

GILTI Essentials and Mechanics Current Inclusion US Shareholders are subject to current US taxation on their portion of a CFC s global intangible low-taxed income (GILTI) Netting US Shareholders net positive GILTI and negative GILTI from their CFCs Tax Rate Lower tax rate is achieved through a deduction: 50% for tax years beginning before 12/31/25, and 37.5% thereafter Total GILTI and foreign-derived intangible income (FDII) deduction is limited by taxable income (without regard to GILTI and FDII) Effective Date Effective for CFC tax years beginning after December 31, 2017 Computation done on a USSH-by-USSH basis but under the Proposed Regulations, USSHs in same consolidated group treated as one shareholder Impact of expense allocations! No QBAI from tested loss CFCs QBAI determined on a quarterly average method, using basis determined under ADS principles 14

GILTI Mechanics Definitionally Driven 15

GILTI Basket: Haircuts and Limitations Deemed paid tax credits under new Section 960(d) available to offset the US tax cost associated with GILTI inclusions with several haircuts and limitations: No FTCs for foreign income tax paid or accrued by tested loss CFCs Inclusion percentage reduces FTCs when there is QBAI or tested loss CFCs Limited to 80% of foreign taxes attributable to Tested Income (after previously noted reductions) Separate FTC category for GILTI inclusions Impact of expense allocations to GILTI basket FTCs in GILTI basket cannot be carried forward or back Use It or Lose It! Section 78 gross up based on full amount of foreign taxes (reduced by inclusion percentage) Query: What basket? Preamble to proposed regulations clarifies to expect GILTI basket. 16

Approach to GILTI: Fight or Flight? Approach Flight Description Away from GILTI and into Subpart F Opportunities Structuring into high-taxed Subpart F income through operational or structural changes FTCs can be claimed currently, or deferred and selectively claimed through Section 956 Fight Limit Tested Losses Restructure legal entities so that tested loss entities are combined with tested income entities to avoid elimination of QBAI and FTCs from calculations Fight FTC Limitations Changing allocation formulas and inputs: Reduce expenses allocated to GILTI income to increase FTC capacity 17

Other GILTI Planning Opportunities - Transfer Pricing Considerations Stability/Control: FTC planning in a GILTI world requires stable, predictable income streams; this will demand a robust and defensible world-wide transfer pricing policy Un-trapping QBAI and FTCs: Revised transfer pricing may be able to turn loss CFCs profitable Revisit transfer pricing in connection with related party payments into US: Royalties Product Sales Services 18

USMN Customers Case Study: Illustrative Structure GILTI Implications CSA U.S. Multinational Corporation IP Contract R&D Services GILTI of CFC1, CFC2, and CFC3 subject to U.S. tax at effective rate of 10.5% Ability to credit foreign taxes paid. Revisit/minimize expense allocation (e.g., interest expense stewardship) to GILTI basket Customer Sub (Country A) CFC 1 Non-U.S. Principal (Country A) (10% tax rate) IP Royalty and/or Services fees CFC 2 (Country B) (25% tax rate) Customers (Country B) CFC 3 (Country C) (33% tax rate) Consider structuring into subpart F for high-tax CFCs Consider on-shoring IP if substance at CFC Principal is not aligned with business (especially if CFC Principal has risk of not meeting DEMPE) and cost is not high to effect change management 19

Foreign Derived Intangible Income (FDII) In order to minimize incentives to move and hold intangible assets outside the U.S., new Section 250 allows a deduction for Eligible C Corporations that reduces the effective U.S. tax rate on foreign-derived income treated as attributable to intellectual property and other intangible assets. FDII is generally the portion of the U.S. corporation s net income (other than GILTI and certain other income exclusions) that Exceeds a deemed rate of return of the U.S. corporation s tangible depreciable business assets and Is attributable to certain sales of property to foreign persons or to the provision of certain services to any person, or with respect to any property, located outside the U.S. 21

Foreign Derived Intangible Income (FDII) Overview Section 250(a) allows a domestic corporation to deduct an amount which is the lesser of (1) the sum of 37.5% of its foreign-derived intangible income (FDII) plus 50% of its GILTI; or (2) taxable income Legislative history indicates that the deduction is only available to domestic C corporations which are not RICs or REITS. The allowable deduction percentages decrease to 21.875% for FDII and 37.5% for GILTI for tax years beginning after December 31, 2025. 22

Deduction for foreign-derived intangible income (FDII) Overview Deduction eligible income: the excess (if any) of: The gross income of a domestic corporation, excluding: Subpart F income GILTI any financial services income (as defined in Section 904(d)(2)(D)) any dividend received from a CFC by its US shareholder any domestic oil and gas income of the corporation, and any foreign branch income (as defined in Section 904(d)(2)(J)) Over the deductions (including taxes) properly allocable to such gross income. Eligible Gross Income - Allocable Deductions (including taxes) = Deduction Eligible Income 23

Foreign Derived Intangible Income (FDII) Additional Detail Foreign-derived deduction eligible income: any deduction eligible income of the taxpayer that is derived in connection with: property sold by the taxpayer to any person who is not a US person and that the taxpayer establishes to the satisfaction of the Secretary is for a foreign use, or services provided by the taxpayer that it establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, not located within the United States. Foreign use: The sale of property to a foreign related party is not treated as for foreign use unless: Such property is ultimately sold by a related party, or used by a related party in connection with property which is sold or the provision of services, to another person who is an unrelated party who is not a United States person, and the taxpayer establishes to the satisfaction of the Secretary that such property is for foreign use. The TCJA further provides that a sale of property is treated as sale of its component parts. 24

Foreign Derived Intangible Income (FDII) Deemed tangible income return: with respect to any corporation, an amount equal to 10% of the corporation s qualified business asset investment (QBAI) as defined in Section 951A(d) without regard to whether the corporation is a CFC. Deemed intangible income: the excess (if any) of its deduction eligible income over its deemed tangible income return. Foreign-derived intangible income: with respect to a domestic corporation, is the amount which bears the same ratio to the corporation s deemed intangible income as its foreign-derived deduction eligible income (FDDEI) bears to its deduction eligible income (DEI). Foreign-Derived Intangible Income = Deemed Intangible Income x FDDEI / DEI 25

Deduction for foreign-derived intangible income (FDII) 26

FDII Global Structuring Considerations What actions should taxpayers consider taking and when? Taxpayers should model their existing operations to determine which income streams could immediately qualify for the preferential FDII US tax rate Taxpayers should consider whether onshoring foreign IP to the United States to the lower, preferential FDII US tax rate State and local corporate income taxes must also be considered when comparing to the effective tax rate applicable to the IP income if it remains offshore What does this mean for taxpayers? Taxpayers will need to calculate the impact of preferential rate and the corresponding GILTI impacts Taxpayers will need to determine whether US income may qualify as FDII 27

Case Study: Illustrative Structure (Post-Tax Reform) U.S. Multinational Key: Customer Customer Subs (Country A) Payment Flows Services Other Services Contract U.S. Multinational Corporation CFC 2 (Country B) (20% tax rate) Customer (Country B) Royalty IP U.S. MNC purchases IP from Non-U.S. Principal With all IP now owned directly in the U.S., royalties from CFCs for non-u.s. IP used to provide services to local customers (e.g., CFC 2) now paid to the U.S., reducing GILTI exposure and increasing potential FDII benefit Consider BEAT implications of outbound payment for the IP, which could be considered a deductible payment due to future U.S. tax amortization U.S. MNC contracts directly with some Non-U.S. Customers Income earned from services to Non-U.S. Customers may benefit from FDII Eliminates outbound payments to CFCs for I/C services performed that could be characterized as Base Erosion Payments for BEAT purposes 28

What is BEAT? The base erosion and anti-abuse tax ( BEAT ) is essentially a minimum tax calculated on a base equal to the taxpayer s income determined without tax benefits arising from base erosion payments. Broadly, base erosion payments are any amounts paid or accrued by a US taxpayer to a foreign related party and which have the effect of reducing the gross receipts of the US taxpayer. The main types of payments that could trigger the BEAT are service fees, interest, and royalties. Base eroding payments also include payments to acquire tangible or intangible property if acquired property generates amortization or depreciation deductions. The following are generally not base erosion payments: Reductions to gross receipts for costs required to be capitalized to inventory and recovered as COGS under Sections 471 and 263A Pass-through amounts that are not gross income and deductions for US Federal income tax purposes Amounts paid or accrued for certain types of services ('service cost method exception') refer to Section 59A(d)(5) Certain qualified derivative payments - see Section 59A(h) 30

BEAT Minimum Tax BEAT Minimum Tax rates increase over time: Note: Base erosion minimum tax amount considers other applicable tax credits No carryforwards or carrybacks (like GILTI) 31

When does BEAT Apply? BEAT The BEAT applies to any U.S. corporation other than a Regulated Investment Company (RIC), a REIT, or an S corporation (whether U.S.-parented or foreign-parented) that makes significant deductible payments to foreign related parties. Thresholds to determine applicable taxpayer - Taxpayer has: (1) Average annual gross receipts of at least $500 million for the 3 taxable-year period ending with the preceding taxable year; and (2) A base erosion percentage of 3% or higher (2% for banks or registered securities dealers) for the taxable year. 32

Key Definitions A base erosion tax benefit means any deduction allowed (other than cost of goods sold) with respect to a base erosion payment for the taxable year. Base erosion percentage: determined by dividing the aggregate amount of base erosion tax benefits by the aggregate amount of the deductions allowable under Chapter 1, taking into account base erosion tax benefit for which a deduction is allowed under Chapter 1 and by not taking into account any deduction allowed under sections 172, 245A or 250. Modified taxable income: taxable income computed under Chapter 1 for the taxable year, determined without regard to any base erosion tax benefit with respect to any base erosion payment, or the base erosion percentage of any NOL deduction allowed under section 172 for the taxable year. 33

Several Common Trends Effects across industry sectors: Inbound and outbound businesses Services companies Leasing and licensing companies Financial institutions Impact on common operating models: Global R&D footprint Intra-group transaction 'hubs' Global contracting models Service centers Character of items for Federal tax accounting purposes: COGS determination Agency, conduit, reimbursements Open regulatory and policy questions Computational issues and interplay with other provisions: Interplay with GILTI, FTC, taxable income, Sec. 163(j), etc. 34

Cost of Goods Sold and Related Issues Tax character of intercompany payments is critical Payments giving rise to deductions vs. reductions in gross receipts to arrive at gross income (i.e., amounts capitalized into inventory for US Federal tax purposes) Scope of Section 263A: Producers and resellers Treatment of sales based royalties Manufacturing service (tolling) and other direct and indirect costs Consideration of accounting method change Interplay with transfer pricing and customs valuation provisions 35

Characterization of transaction is critical If the payment gives rise to a deduction for the U.S. taxpayer, then the payment could be a base erosion payment. If, however, the payment is not a deduction, but a pass through amount, then there is no base erosion payment Generally, a taxpayer who receives income under a claim of right that is free of restrictions must include that item into gross income in the current year However, some amounts received on behalf of another as an agent, a conduit, a reimbursement, or pursuant to a revenue sharing agreement may not give rise to income and deductions and be instead reported net Generally, the character of a payment for US Federal income tax purposes is determined based on the economic substance of the underlying contractual relationship between the relevant parties 36

Service Cost Method Exception Exception for services eligible under the Services Cost Method (Treas. Reg. sec. 1.482-9) Specified covered services (Rev. Proc. 2007-13) Low-margin services Excluded services Top of mind issues: What if a markup on eligible service costs is charged? What if a foreign tax authority requires certain markup? How is markup charged / booked / invoiced? 37

Impact of NOLs In calculating modified taxable income, taxpayer adds back 'the base erosion percentage of any net operating loss deduction allowed under Section 172 for the taxable year. Is the base erosion percentage calculated based on the year the NOL is utilized or the year the NOL arose? How is the calculation impacted if NOL carryforwards exceed current year taxable income? Is the starting point for calculating modified taxable income zero? What if the NOL relates to years prior to the effective date of BEAT? What if the NOL relates to a year when the company was not an applicable taxpayer? 39

Case Study: Illustrative Structure BEAT Implications CFC 1 Non-U.S. Principal (Country A) (10% tax rate) CSA IP U.S. Multinational Corporation IP Contract R&D Services CFC 3 (Country C) (33% tax rate) Outbound payments to CFC1 (for I/C services performed by Non-U.S. Principal) and CFC3 (for contract R&D Services) would be considered Base Erosion Payments BEAT only applies if a taxpayer s total Base Erosion Tax Benefits (including a taxpayer s Base Erosion Payments) exceed 3% of all deductions for the year 40

Adapting to the Evolving Global Tax Environment US Tax Reform State Aid Increasing Global Transparency (e.g. DAC6) Unilateral Actions Global Tax Environment EU GAAR ATAD I&II Increased Pressure on Debt Planning Increased Information Reporting & Transparency BEPS Expansion of Hybrid Rules 41

Case Study Revisited U.S. Multinational Corporation IP Contract R&D Services U.S. Multinational Customers Cost Sharing Agreement Customer Sub (Country A) CFC 1 Non-U.S. Principal (Country A) (10% tax rate) IP Royalty and/or Services fees CFC 2 (Country B) (25% tax rate) CFC 3 (Country C) (33% tax rate) Key: Payment Flows Services Other Customers (Country B) 42

Impacts of U.S. International Tax Reform. October 23, 2018