section 965 foreign deemed repatriation transition tax...

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Section 965 Foreign Deemed Repatriation

Transition Tax: Final Regulations

TUESDAY, NOVEMBER 26, 2019, 1:00-2:50 pm Eastern

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November 26, 2019

Section 965 Foreign Deemed Repatriation Transition Tax: Final Regulations

Andre Benayoun, J.D., Partner - Tax &

Business Services

Marcum

[email protected]

Patrick J. McCormick, J.D., LL.M., Partner

Culhane Meadows

[email protected]

Notice

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY

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without limitation, the tax treatment or tax structure, or both, of any transaction

described in the associated materials we provide to you, including, but not limited to,

any tax opinions, memoranda, or other tax analyses contained in those materials.

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.

marcumllp.com

IRC 965 Transition Tax Final Regs.

November 2019

Patrick McCormick, JD LLMAndre Benayoun, JD

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Introduction• Patrick J. McCormick is an attorney and

partner with Culhane Meadows, a law firm with offices across the United States. He earned his J.D. from Vanderbilt University Law School, and his LL.M. from New York University School of Law.

• Patrick exclusively practices in the area of international taxation, regularly publishing articles and giving presentations on all areas of international tax law.

• Andre Benayoun is a Principal at Marcum LLP who specializes in consulting regarding international taxation for inbound and outbound multinational corporations, S corporations, partnerships, and individuals and families.

• Mr. Benayoun is a frequent speaker at conferences and seminars on a range of international tax topics.

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Agenda1. Introduction

2. 965 Background

3. 965 Mechanics

4. Tax Rates on Deemed Dividends

5. 965 Final Regs

6. 2019 Planning for 965

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▪ 500 Pages plus Committee Reports

▪ Technical glitches

▪ Unintended and surprising results

▪ Ambiguous provisions open to interpretation

▪ US Treasury and IRS may take years to produce guidance

▪ IRS funding has been cutback

▪ Trump administrative order requires two tax regulations to be repealed for every new one added

▪ 965 Proposed Regs issued August 2018 – 250 pages

▪ 965 Final Regs issued February 2019 – 300 pages

▪ Interpretation of difficult legislative language

▪ Creates challenges but also many new planning opportunities

Section 965 background

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▪ Section 965 required United States shareholders of specified foreign corporations to include their pro rata share of accumulated earnings and profits in their U.S. taxable income (with actual repatriation from the foreign corporation unrequired for tax)

▪ Sec. 965 inclusions by U.S. shareholders were required either in 2017 or 2018 U.S. tax returns (meaning any future Sec. 965 issues will relate to missed inclusions)

▪ Based on discrete nature of Sec. 965 (one-time inclusion, only certain shareholders of SFCs affected), an alarming number of taxpayers missed timely inclusions

▪ Failure to timely include Sec. 965 amount forfeits ability to pay tax amount via installment method (or defer tax if an S corporation U.S. shareholder)

Section 965 background

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• Section 965 statutory language: in the last taxable year of a deferred foreign income corporation beginning before January 1, 2018, foreign corporation’s Subpart F income increased by post-1986 accumulated E&P

– Deferred foreign income corporation: any specified foreign corporation with accumulated post-1986 deferred foreign income which has a U.S. shareholder

• Specified foreign corporation: either (1) a controlled foreign corporation or (2) a foreign corporation with respect to which a domestic corporation is a U.S. shareholder

– Not every U.S. shareholder (for GILTI/Subpart F purposes) was subject to Sec. 965

– Once funds actually repatriated, Sec. 959 applies to avoid double taxation

• Allows effective (U.S.) tax rate on foreign earnings to be reduced from a typical dividend distribution

– Exception: Post-TCJA foreign dividends received by C corporation shareholders tax-free (if qualifying under Sec. 245A)

Section 965 Mechanics

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• Section 965 Mechanics

– Once funds actually repatriated, Sec. 959 applies to avoid double taxation

• Sec. 959 – funds previously subject to U.S. tax (based on an anti-deferral U.S. inclusion mechanism) not taxed again once actually paid out

– Exception: Sec. 962 election (Sec. 959 rules modified)

• Allows effective (U.S.) tax rate on foreign earnings to be reduced from a typical dividend distribution

– Exception: Post-TCJA foreign dividends received by C corporation shareholders tax-free (if qualifying under Sec. 245A)

Section 965 Mechanics

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• Section 965 amount classified as Subpart F income (with many mechanical aspects flowing from traditional Subpart F standards)

– Inclusion occurs by U.S. shareholder of SFC (as with Subpart F/GILTI)

• U.S. shareholder: pre-TCJA Sec. 951(b) definition used– U.S. shareholder – holder of 10% or more of the voting power of a

foreign corporation (attribution/constructive ownership rules applicable)

» Post-TCJA – U.S. shareholder expanded to voting power or value; inapplicable to Sec. 965!

– U.S. person owning 10% or more of the voting power of a foreign corporation

Section 965 Mechanics (cont’d)

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• Year of inclusion: U.S. shareholder’s Subpart F income increased for the foreign corporation’s last tax year beginning before 1/1/18

– For fiscal year foreign corporations, U.S. shareholder inclusion year was 2018

• For calendar year foreign corporations, inclusion tax year ended in 2017

– Sec. 898 – if a U.S. shareholder owns a greater than 50% interest in a foreign corporation, the foreign corporation must adopt the shareholder’s tax year for U.S. tax purposes

» Individual majority shareholders – calendar tax year

– Subpart F inclusions occur in the taxable year of the U.S. shareholder during which the taxable year of the foreign corporation ends

• Calendar year U.S. shareholder of a fiscal year deferred foreign income corporation includes Sec. 965 amount in 2018


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Toll Charge on Unrepatriated Earnings

• Deemed repatriation of foreign earnings and profits (E&P) to U.S. shareholders on last day of tax year beginning prior to January 1, 2018. Only E&P earned while foreign entity was a CFC are considered.

• Effective tax rate on such earnings will be between 8% and 17.5% depending upon liquidity of the balance sheet and the type of U.S. taxpayer.

• Toll charge may be paid over 8 years

– If first payment was missed (due on April 17th 2018), acceleration can be avoided if payment is made by April 2019

• Planning instituted after November 1, 2017, to reduce foreign deferred E&P is ignored; dividends made during the year are also ignored

• E&P deficits from one entity may be used to reduce inclusion from another entity

• Subpart F income generated during the year is still picked up at ordinary rates (e.g., 35% or 39.6% for 2017 and 21% or 37% for 2018)

• NOLs will be used to reduce a deemed dividend unless an election is made not to do so under Sec. 965(n).

US Shareholder

Foreign Co

DeemedDividend of foreign

earnings as of 12/31/2017


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C-Corporations Trusts and Individuals Other Than S Corporation Shareholders**

Liquid Assets (i.e., cash, net account receivables, cash-equivalent assets like commercial paper, CoD, foreign currency, short-term obligations)

15.5%* 17.5%* (2017) & 27.3%* (2018)

Non-liquid Assets 8%*

* - Payable over 8 years commencing on due date of 2017 tax return. Ability to pay over 8 years is lost if first payment was not made by April of 2019.

9.05%* (2017) & 14.1%* (2018)

* - Payable over 8 years commencing on due date of 2017 tax return. Ability to pay over 8 years is lost if first payment was not made by April of 2019.

** - S Corporation can elect to defer tax to shareholders on accumulated E&P until “triggering event”

Tax Rates on Deemed Dividend (Toll Charge)

Section - 965 Final Regs

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Sec 965 Final Regs – Format

• Proposed Reg. Sec. 1.965-1 – General rules and definitions

• Proposed Reg. Sec. 1.965-2 – E&P and basis adjustments

• Proposed Reg. Sec. 1.965-3 – 965(c) deductions

• Proposed Reg. Sec. 1.965-4 – Disregarded transactions

• Proposed Reg. Sec. 1.965-5 – FTCs and allocation and apportionment of expenses

• Proposed Reg. Sec. 1.965-6 – FTCs and allocation and apportionment of expenses

• Proposed Reg. Sec. 1.965-7 – Elections and payments

• Proposed Reg. Sec. 1.965-8 – Calculations for US consolidated groups

• Proposed Reg. Sec. 1.965-9 – Applicability dates

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Final. Reg. 1.965-1 – General Rules

General Mechanics

• E&P picked up for Sec. 965 are measured at 11/2 and 12/31 (greater amount is used). If foreign taxes are paid or accrued at the end of the year, there is no pro rata carry back allowed.

• The Sec. 965 mechanism effectuates a lower tax rate to the U.S. taxpayer by deducting a portion of the 965(a) includable income pursuant to 965(c).

• For purposes of E&P deficit CFCs, PTI should be included (even though they are excluded for E&P positive CFCs). This could result in no deficit company! See. Treas. Reg. 1.965-1(f)(22)(ii).

• When E&P deficits are used by one CFC to reduce E&P of another CFC, the deficit company must increase its deficit by the amount used as an offset and reduce any qualified deficit with respect to the loss.

Foreign Co

$100 965(a) amount - $50 965(c) amount = $50

inclusion

US ShareholderC Corporation

$50 965 inclusion

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Partnership Look-Through Rule

• A USP is treated as a foreign partnership for 965 purposes similar to the later GILTI rules. Note that Prop. Regs. have requested the same treatment for Subpart F, but such Prop. Regs. are not yet final. Subpart originally had different treatment pursuant to abuses under the Subpart F rules (see Notice 2010-41).

US Individuals

Purported 965 taxpayer

US Corp

CFC3 CFC4

USP

Treas. Reg. 1.965-1 – General Rules

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PTI Gives Rise to Basis

• Under traditional Subpart F rules, the generation of previously taxed income (“PTI”) gives rise to basis (see Sec. 961)

• What about 965 inclusions? What if no amount was picked up due to deficits?

– Sec. 965(a) PTI is defined under Treas. Reg. 1.965-2(c) and 965(b) PTI is defined under Treas. Reg. 1.965-2(d)

• Treas. Reg. 1.965-2(g) states in pertinent part that gain is not recognized on 965(a) PTI in the inclusion year. The same is true for 965(b) PTI, but only if a basis adjustment election is made pursuant to 1.965-2(f)(2).

CFC 1

$100 Subpart F Deemed Inclusion


$100 Subpart F IncomeIncreases basis in CFC1 by $100

Treas. Reg. 1.965-2(f) – Basis Election

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So many kinds of PTI

• In short, 965(a) PTI refers to PTI generated from the payment of tax in the US under 965(a). A step up in basis is given for 965(a) PTI.

• 965(b) PTI refers to the PTI generated on E&P that was not picked-up in the US, but instead was sheltered by E&P deficits of another CFC pursuant to 965(b). No step up in basis is given for 965(b) PTI unless a basis election is made.

• All of this has required new ordering rules between different 959(c)(2) types of PTI which now include Subpart F PTI, 965(a) PTI, 965(b) PTI, and GILTI PTI. The ordering rules state that 965(a) and (b) PTI will come out first, then a pro rata basis from other 959(c)(2) PTI.

• Note that distributions of 965(a) PTI are subject to foreign exchange gain or loss to the U.S. taxpayer (net of 965(c) deductions) on the same pro rata basis as the 965(c) deduction, while 965(b) PTI distributions are not subject to foreign exchange gain or loss to the taxpayer.

Foreign Co

$100 965(a) Deemed Inclusion


$100 965(a) inclusionIncreases basis in Foreign Co by

$100

965(a) PTI

Foreign Co 2


$0 965(a) inclusionNo increase in basis without

election

965(b) PTI

Foreign Co 1

$100 of E&P @ 12/31/17 ($100) of E&P @ 12/31/17

$100 of E&P @ 12/31/17

965(a) PTI vs. 965(b) PTI

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The Election

• The Prop. Regs. were not kept in the final Regs. Mostly because they did not work as intended under the original drafting (the language made it such that the election only applied to first-tier CFCs).

• With the Final Regs., the basis election applies to all CFCs regardless of which tier they are. In short, the basis election allows the taxpayer to step the basis in CFCs with 965(b) PTI. This also requires that the taxpayer reduce basis in deficit CFCs’ outside basis for the same amount. A nice feature of the Final Regs. is that the basis amount may be chosen by the taxpayer to avoid immediate gain on a step down in basis of a deficit CFC.

• Election must be made with the 2017 return (including extensions). For some tax payers with a return due date prior to September 10th (30 days after this was published in the federal register, they may have until October 9th of 2017 to make such election). No 9100 relief currently available for missing the election.

Mechanics of Election

Foreign Co

$100 965(a) Deemed Inclusion


$100 965(a) inclusionIncreases basis in Foreign Co by

$100

965(a) PTI

Foreign Co 2


$0 965(a) inclusionNo increase in basis without

election

965(b) PTI

Foreign Co 1

$100 of E&P @ 12/31/17 ($100) of E&P @ 12/31/17

$100 of E&P @ 12/31/17

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Foreign Co 2


Foreign Co 1

$600 of E&P BOY Basis: $200

($200) of E&PBOY Basis: 1$50

Foreign Co 1 is allocated $200 of deficit and picked up $400 of 965(a) inclusion

No Election Election

Sec. 965(a) inclusion $400 $400

EOY Basis in F1 $600 $800*

EOY Basis in F2 $150 $0

Gain Recognized $0 $50**

* BOY Basis: $200 + Sec. 965(a) inclusion of $400 + 1.965-2(f) basis of $200** Deficit of $200 allocated against $150 of basis. Note that under the FinalRegs., the taxpayer may choose to only apply the $150 of basis to avoid $50 of gain recognition.

Example of Election

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965(c) does not apply to everything

• If an election has been made pursuant to 1.1411-10(g), the 3.8% NIIT is due in 2017 on the full 965(a) amount. Note that once made, this election is irrevocable.

• For expense allocation and apportionment that would be based on gross income, no 965(c) deduction is allowed. This may result in reduced ability to take FTCs under 904 limit calculations!

• Furthermore, for interest expense allocation and apportionment, 965 PTI generated, is an includable asset! Note that interest expense is allocated and apportioned based on assets. Again, this would likely result in reduced ability to take an FTC.

Foreign Co


965(a) – 965(c) = includable amount to US Taxpayer

Treas. Reg. 1.965-3 – 965(c) Deductions

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• Regs. Sec. 1.965-4: anti-abuse rules, dictating that specified transactions are disregarded

– Transactions disregarded for Sec. 965 purposes – can still have other tax effect!

– Targeted transactions: ones which were undertaken with a principal purpose of reducing a Section 965 element, accounting method/entity classification changes, and E&P changes

• Exceptions to Sec. 1.965-4 rules exist for incorporation transactions (U.S. shareholder inserting corporation into ownership structure)

Treas. Reg. 1.965-4 – Anti-Abuse Rule

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• Regs. Sec. 1.965-4: anti-abuse rules dictating that specified transactions are disregarded

– Overarching regulatory focus: whether a “Section 965 element” modified by a subsequent transaction

• Section 965 element – primarily a U.S. shareholder’s Section 965 inclusion amount with respect to a SFC (though also U.S. shareholder’s foreign cash position or certain tax credit transactions)

• Regulations provide presumption for certain transactions undertaken with a principal purpose of avoiding Sec. 965

– Presumption rebutted only where facts and circumstances clearly establish transaction not undertaken to avoid Sec. 965

– Presumptions applicable for specified cash reduction transactions, E&P reduction transactions, and pro rata share transactions

Treas. Reg. 1.965-4 – Anti-Abuse Rule

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FTCs

• For direct taxes paid by the U.S. taxpayer, such as withholding taxes from a first-tier CFC, a U.S. FTC is “haircutted” by the “applicable percentage.” This percentage is a function of cash position and ranges from 55.7% haircut to 77.1% haircut for 2017 and the same amount for 2018 even though the Sec. 965(c) deduction amounts are only 26.2% to 61.9% for 2018. It applies to both, 965(a) and (b) PTI.

• For deemed paid taxes, no credit is allowed for the applicable percentage of any foreign tax associated with income for which a 965(c) deduction was allowed. Deemed paid credits include 960 credits to U.S. C corps and lower-tier withholding tax on dividend distributions up the chain of ownership to the U.S. taxpayer. Note that former 902 credits could be trapped as former 960(a)(3) will not apply.

Foreign Co

Withholding tax on dividends


FTC allowed subject to haircut

2018 Distribution of PTI

Treas. Reg. 1.965-5 & 6 – FTCs and Withholding Taxes

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• Regs. Sec. 1.965-7: rules regarding Sec. 965 elections

– Contains provisions re: acceleration events under Sec. 965(h) and triggering events under Sec. 965(i)

• Acceleration events expanded under regulatory guidance: inclusion of alterations to consolidated groups

• Transfer agreements available to allow transferee to assume transferor’s Sec. 965 liability without immediate acceleration

• Regs. Sec. 1.965-8: affiliated/consolidated group rules re: Sec. 965

– All members of a consolidated group who are U.S. shareholders of a SFC are treated as a single shareholder for specified purposes

Treas. Reg. 1.965-7 & 8 – Elections and Payments & US Consolidated Rules

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• Retroactive Sec. 965 Issues

– Sec. 965(h) allowed taxpayers to pay Sec. 965 amount in (back-weighted) installments, cushioning the blow of its imposition

• For retroactive inclusions, Sec. 1.965-7 provides Sec. 965(h) election unavailable

– Special relief for S corporation shareholders available under Sec. 965(i) also unavailable for retroactive failures

– Sec. 965 inclusions were large amounts – meaning that interest and penalties also are high where failures have occurred

• Failures have dual impact – mitigation mechanisms become unavailable, and interest/penalties become an added blow

2019 Planning for Sec. 965

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• What to do now?

– Sec. 965 mitigation options minimal; analysis requires creativity in exploring options

• Is the taxpayer a true U.S. taxpayer? Could they be reclassified?

– Treaty provisions allow reclassification (and often are not explored, given foreign-based U.S. shareholder’s foreign tax rates)

» Need to ensure no triggering of exit tax by virtue of a reclassification!

• Exit tax – application where a long-term resident has net worth over $2 million

2019 Planning for Sec. 965

section 965 foreign deemed repatriation transition tax...

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