Foreign Tax Credit Update Decem ber 16, 20 16 Brenda Zent Jason - - PDF document

GW-IRS 29 TH ANNUAL INSTITUTE ON CURRENT ISSUES IN INTERNATIONAL TAXATION

Foreign Tax Credit Update

Decem ber 16, 20 16

Brenda Zent Office of International Tax Counsel U.S. Departm ent of Treasury Jeffrey Parry Senior Counsel, Branch 3, ACCI Internal Revenue Service

• F. Scott Farm er

Morgan, Lewis & Bockius LLP Jason Yen Office of International Tax Counsel U.S. Departm ent of Treasury Patrick Brown Vice President, Tax, GE Power General Electric Com pany Michael Caballero Covington & Burling LLP

■ Tax Reform and FTC Issues ■ Section 901(m) Regulations ■ Section 704 CFTE Regulations

Agenda

2

Tax Reform and FTC Issues

■ Will it happen? ■ When? ■ Why does it matter today? ■ Revenue impact? Rate reduction v. infrastructure? ■ Scope?

Tax Reform – The Big (Trillion Dollar) Questions

Comprehensive Business Income Corporate Reform International Repatriation

Individual Pass-Throughs Corporate International Repatriation 4

■ Corporate Tax System – Divergent Options

• Destination Based Tax System – Brady/Ryan “Blueprint”
• “Current” System with Territorial Taxation – Camp Proposal
• Corporate Integration – Senate Proposal (?)

■ Tax Rate? 20%? 25%? 15%? ■ Expensing of new investment? but no deduction for “net” interest

expense

■ Structure of Subpart F

• Limited to passive income?
• Destination-based system? Dramatically limits planning
• pportunities
• Other approaches: Focus on intangibles? Minimum tax?

■ Treatment of financial services companies? Blueprint is silent ■ Who will be the winners and losers in reform? What are the dynamic

impacts (foreign exchange rates, location of business activity)?

Tax Reform – Structural (Multi-Billion Dollar) Questions?

5

■ Repatriation

• Mandatory inclusion almost certain if reform moves forward
• What rate (or rates) apply? Higher rate for “cash”? How defined?

■ Treatment of FTCs on repatriated earnings

• Section 965 approach – Ratable disallowance (85% DRD)
• Section 904(b) – Adjustment of the limitation for capital gains rates
• Does it matter how structured? DRD v. reduced rate?
• Other possibilities: flat (or two-tiered) inclusion rate, no FTCs?

■ What about deficits? Netted against earnings? Globally or within same chain? Different

treatment of hovering deficits?

■ Determination of earnings and related taxes

• JVs, complex capital structures

■ Other issues: FTC carryforwards, OFLs, ODLs, AMT

Tax Reform – Transition Issues

6

7

Section 90 1(m ) Regulations

Section 901(m) Background

8

■ Enacted on August 10, 2010 as part of the Education Jobs and Medicaid Assistance Act of 2010 (EJMAA) ■ Denies a credit for foreign taxes attributable to the basis “step-up” for U.S. tax purposes in certain transactions

• Effectively disallows a credit for the foreign income tax on the seller’s built-in

gain ■ Disqualified taxes not taken into account for purposes of section 901, 902, or 960

• Taxpayers are permitted a deduction for the disallowed taxes and no section 78

gross-up

• Treatment for other related provisions?
• Subpart F high-tax exception
• Section 904 high-tax kick-out

■ Prior guidance – Notice 2014-44

• Addresses timing of when section 901(m) disallows foreign taxes in the case of

dispositions

• Prevents avoidance of section 901(m) through successive CAAs
• Notice 2014-45 addresses retroactive check-the-box elections

Section 901(m) Base Case

9

■ Buyer acquires stock of FT from unrelated foreign Seller for $100 ■ Section 338 election made for FT ■ FT has one asset with 10-year depreciable life (for U.S. tax purposes) ■ Basis difference = 50 (100 – 50 A/B) ■ FT sells the asset for 150

• US gain = 50 (150 – 100 A/B)
• Foreign gain = 100 (150 – 50 A/B)
• 50 of gain never taxed in U.S. system

■ Foreign tax credit results

• Foreign tax (and thus credit) is 30

(30% foreign tax rate)

• U.S. tax on gain is 17.50

Stock purchase with section 338 election

FT BUYER FT SELLER

Foreign

Asset FMV = $100 AB = $100

Foreign Foreign U.S.

Asset FMV = $100 AB = $50

■ Policy of the foreign tax credit – Eliminate double taxation ■ What about U.S. tax exempt income?

• Service litigated this in the past
• Clearly the right answer in the case of broad exemptions of income such

as a shift to a territorial tax system

• But in more isolated cases, what is the right policy, and is this a move

towards an item-by-item approach to the FTC limitation?

■ Why didn’t Congress simply require foreign taxes from these transactions separately basketed? or another alternative?

• Would have allowed higher effective rate on income from assets but much

easier to administer

• Reverse the trend of reducing the number of baskets

Policy of the Foreign Tax Credit

10

■ Concern is U.S. tax exempt income

• Rules apply to the U.S. basis differences before and after the transaction
• Not about disparity between U.S. and foreign tax basis (though correlated)
• Foreign tax basis is not relevant under the statute (except for an election

under the regulations)

• Not just about the resulting “hyped” foreign taxes

■ Concern is also about assuming the foreign tax liability of another person – the seller ■ Should it matter whose liability is assumed?

• Unrelated foreign seller
• Unrelated U.S. seller
• Related person

Policy of Section 901(m)

11

Policy Issues on Scope of CAAs

12

• Case 1: Unrelated U.S. seller

■ Sale of foreign DE from one U.S. taxpayer to another ■ US1 may be subject to U.S. tax on the asset gain; US2 obtains a basis step-up ■ Should section 901(m) apply if the basis step-up has been purchased with exposure

• f gain to U.S. tax?

■ Concern about trafficking of attributes – similar to section 382 ■ But this approach encourages buyers to trigger foreign tax immediately, e.g., through as asset transfer, or value is lost in the sale

• U.S. seller often indifferent from tax standpoint

because it can claim a credit

• U.S. buyer gets step up and no denial of credit
• U.S. fisc almost always worse off from credit

claimed by Seller and no denial of FTC for buyer

US1 US2 FDE FDE Case 1

Policy Issues on Scope of CAAs

13

■ Case 2: Related Seller

• Policy issue in the case of a 901(m)

between related persons

• Policy would suggest that this should be

treated as a section 909 splitter

• Gain from sale in CFC 1
• Tax on gain incurred by CFC 2
• Regulations under section 909 and

preamble made clear that related CAAs would be under Section 901(m)

■ Case 2A: Related U.S. Seller

• Compare if directly under U.S. members
• f the consolidated group
• Exemption from section 901(m) more

compelling where tax and basis effects are in the same return

• And the policy concerns of section 909

should be satisfied as gain is income to the same U.S. taxpayer

US1 US2 FDE FDE USP Case 2 Case 2A CFC 1 CFC 2 FDE FDE USP

Gain or Income Foreign Tax Gain or Income Foreign Tax

■ Not like section 909, or the PFIC rules (where possible to avoid) ■ Section 338 elections are still advantageous

• May provide a better after-tax return than no election/step-up
• Provides administrative simplicity because section 338 election

eliminates prior tax history

• No need to compute taxes and earnings for prior years
• But section 901(m) requires computation of historical U.S. basis (even if
• nly to compare with foreign basis)
• Increased amortization reduces E&P
• May reduce subpart F income
• Mandatory repatriation

■ Need to also analyze many factors

• Look-through on pre-acquisition earnings
• No more separate 10/50 baskets
• Tax rate and magnitude of earnings (or deficits)
• Existence of PTI, built-in losses, U.S. property
• Impact on seller if a U.S. taxpayer(subpart F passive income creating

gain limitation, dilution of FTC (CCA 200103031))

Why does it matter?

14

§338 Election (no §901(m)) §338 Election (with§901(m)) No §338 Election Year 1 E&P $4 ($15 ‐ $5 ‐ $6) $4 ($15 ‐ $5 ‐ $6) $9 ($15 ‐ $6) Year 1 Foreign Tax $6 $6 $6 Disallowed Portion N/A $2

$ $

N/A Pre‐§904 Creditable Foreign Tax $6 $4 $6 E&P $4 $4 $9 Foreign Tax Credit $6 $4 $6 Hypothetical §78 Gross‐up $6 $4 $6 Foreign ETR 60%

$ $

50%

$ $

40%

$ $

After‐Tax Return Excess Foreign Tax Credit $11.50 $2.50 $10.20 $1.20 $9.75 $0.75

Costs/ Benefits of Section 338 Election

15

Stock purchase with section 338 election FT BUYER FT SELLER

Foreign

FMV = $100 AB = $100

Foreign Foreign U.S.

FMV = $100 AB = $50

• Buyer purchases stock of FT

and makes section 338(g) election

• In post-acquisition Year 1
• FT has $15 income
• Foreign taxes of $6 (40% rate)
• $5 additional amortization deduction

for US tax purposes (10-year recovery period)

• Also need to consider factors on prior

slide

Is a Section 338 election still advisable? ■ Temporary Regulations

• Address the disposition guidance in Notice 2014-44, including adding successor rules
• Exclude foreign withholding taxes
• Effective back to the issue date of Notice 2014-44

■ Proposed Regulations

• Expand categories of CAAs (from 3 to 6)
• Provide de minimis exceptions
• Permits an election to use foreign basis in computing basis differences
• Include foreign withholding taxes that are creditable under foreign law against potentially

disqualified taxes

• Comprehensive guidance on operational issues
• Effective when finalized
• Elective back to 2011
• But must apply all proposed regulations on a consistent basis, except expanded CAA list

New Proposed and Temporary Regulations

16

Disposition Rules – Original Concern and Notice 2014-14

17

■ FDE has assets with $100 FMV, and $0 Adjusted Basis for US and foreign tax purposes ■ CFC 1 acquires FDE stock from Seller for $100 in a CAA

• U.S. basis step-up
• section 901(m) applies
• $100 basis difference

■ CFC 2 acquires FDE stock from CFC 1

• “Disposition” cleanses the original

CAA (statute accelerates remaining basis difference)

• section 901(m) applies to new CAA
• $0 basis difference, so no effect

■ Notice 2014-44 provides no acceleration of the basis difference which is carried over to CFC 2 CFC 1 CFC 2 FDE FDE US3 Seller FDE

Assets FMV = $100 US A/B = $0

• For. A/B = $0

Assets FMV = $100 US A/B = $100

• For. A/B = $0

Basis Diff. $100 ($100-$0) Assets FMV = $100 US A/B = $100

• For. A/B = $0

Basis Diff. $0 ($100-$100)

■ The abuse concern of Notice 2014-44 is a subset of broader issue ■ Intersection of the two tax systems creates multiple possibilities

• Can be taxable, partially taxable, or tax-free in each jurisdiction
• So 9 possible combinations (or more if multiple countries involved)

■ Temporary regulations adopt Notice 2014-44 four categories

• Taxable in both jurisdictions – section 901(m) disposition rule
• Tax-free in both jurisdictions – section 901(m) taint is “transferred” to acquiror
• Other cases look to the reduction in the basis difference
• Positive basis difference reduced if US loss or foreign gain is recognized
• Negative basis difference reduced if US gain or foreign loss is recognized

■ Temporary Regulations also includes successor rules: Result – the section 901(m) taint is an asset level attribute that carries with asset to transferee

• Including unrelated persons – transfer to a p-ship that is 20% owned
• No de minimis or other exceptions apply
• Note, section 901(m) itself contains no carryover attribute provision

Temp Regs and Complexity from Successive Transfers

18

■ Three categories of transactions identified in the statute

• Qualified Stock Purchase (QSP) with a section 338 election
• Purchase of a partnership interest with a section 754 election
• Hybrid acquisition – asset acquisition for U.S. tax purposes, and stock acquisition (or disregarded)

for foreign tax purposes

• Section 336(e)

■ Scope of transactions can be unexpectedly broad

• Can include a U.S. corporation acquiring another U.S. corporation with section 338(h)(10) election,

e.g., if the target has a foreign branch

• Related party transfers of DEs (section 901(m) applies, not section 909)

Scope of Covered Transactions

19

■ Regulatory Authority

• To apply section 901(m) to “similar transactions”
• To exempt (1) certain CAAs and (2) relevant foreign assets with respect to which the basis

difference is de minimis

■ Temporary Regulations adopt the three statutory CAA categories

• Track the statutory language exactly

■ Proposed Regulations add three new categories

• “Partnership CAA”
• “Partnership Distribution CAA”
• “Busted Transaction CAA”

■ “Similar” interpreted as providing a U.S. basis step-up

• Not intent based

Scope of Covered Transactions

20

■ Any transaction (or series of transactions occurring pursuant to a plan) to the extent it is treated as:

• an acquisition of assets for U.S. income tax purposes
• the acquisition of an interest in a fiscally transparent entity for

foreign income tax purposes

Partnership CAA

21

FC 1 USP FC 2 DE

• FC 1 sells to USP
• FC 2 sells to DE
• P-Ship becomes a DE for

U.S. purposes as a result

• f the sale
• Rev. Rul. 99-6 treats as an

asset acquisition by USP

• A sale of a partnership

interest by FC 1 and 2

P-ship

Country Z

P-ship

Country Z

■ Any transaction (or series of transactions occurring pursuant to a plan) to the extent

• it is treated as a partnership distribution of one or more assets
• either:

 the U.S. basis of the distributed assets is determined by section 732(b) or 732(d), or  the U.S. basis of the partnership’s remaining assets is adjusted under section 734(b)

• transaction results in an increase in the U.S. basis of one or more of the assets distributed
• r retained by the partnership

 Includes full or partial gain recognition

• there is no corresponding increase in the foreign basis of such assets

 “Corresponding” – does this mean equivalent amount?

Partnership Distribution CAA

22

■ Any transaction (or series of transactions occurring pursuant to a plan) to the extent:

• Treated as an asset acquisition for both U.S. and foreign income tax

purposes

• The transaction results in an increase in the U.S. basis in one or more

assets

• There is no corresponding increase in the foreign basis of one or more

assets

■ Basically a (full or partially) taxable transaction for U.S. purposes and a (full or partially) nonrecognition transaction for foreign tax purposes

• Very broad – potential trap for the unwary
• Flips the approach of section 909
• Section 909 – general statue limited by regs to a list of identified transactions
• Section 901(m) – statutory list that regulations expand with a catchall provision
• De minimis exception

Busted Transaction CAA

23 ■ “Busted” corporate transactions

• “Busted” section 351 transaction, reorganization, liquidation
• “Busted” is a misnomer

■ Other corporate transactions

• Section 301 distribution of appreciated assets by a reverse hybrid
• Section 351(g) stock
• Transactions with boot
• Section 367(a) taxable asset transfers
• What happens if tax free due to gain recognition agreement but gain is later triggered?

■ Other transactions

• Unagreed section 482 adjustment on sale of property
• Section 475 assets
• Taxable asset transfers to non-section 475 taxpayer in otherwise nontaxable transaction
• Different result if transfer on Dec. 30 or January 1
• Section 704(c)(1)(B) distribution of contributed property to another partner within 7 years
• Section 737 distribution of other property to partner that contributed property within 7 years
• Section 707 disguised sales of assets
• assumption of disqualified liabilities on contribution of appreciated asset
• contribution followed by distribution of cash or marketable securities pursuant to a plan
• Section 721 taxable asset transfers under Notice 2015-54
• Section 904(f) taxable asset transfers

■ Examples listed only apply if the transaction under foreign law is ■ treated as an “asset acquisition” ■ resulted in a corresponding basis increase in one or more of the assets acquired ■ Argument that section 301 or partnership distributions in Examples listed are not “asset acquisitions” even under U.S. law?

Busted Transaction CAA – Examples

24

■ Proposed regs exclude certain CAAs where there is a de minimis basis difference ■ General rule – section 901(m) does not apply if the basis difference for all RFAs is less than the greater of:

• $10 million, or
• 10% of the U.S. basis of all RFAs immediately before the CAA

■ Example:

• Total U.S. basis before of $1 billion, then threshold is $100 million

■ Related party transactions

• Threshold is cut in half
• Necessary to address internal transactions that are covered by section 901(m) and not section 909
• Anti-abuse rule if the CAA was entered into between related parties with a principal purpose of

avoiding application of 901(m)

 De minimis rule applied separately for RFA owner under U.S. law with respect to each

foreign income tax

And then the Good News . . . De Minimis Exceptions

25

■ De minimis exception for classes of assets – if the absolute value of the basis difference for all RFAs in a class is less than the greater of:

• $2 million, or
• 10% of the U.S. basis of all RFAs in a class immediately before the CAA

■ Asset classes are the seven classes in Treas. Reg. § 1.338-6(b)

• Class I – cash & deposits
• Class II – publicly traded property
• Class III – MTM assets
• Class IV – inventory
• Class V – residual category
• Class VI – section 197 intangible other than goodwill and GCV
• Class VII – goodwill and GCV

■ Significantly reduces the administrative burden if step-up is primarily goodwill and GCV – basically a single asset with single depreciable life ■ Special rules for related CAAs

• Reduce thresholds to $1 million and 5%

De Minimis Exceptions – Asset Classes

26

Asset Class US Basis Pre Post Basis Diff. De Minimis Thresh. 901(m) Applies? Class I – Cash 100 100 10 NO Class II – Publicly traded property 100 115 15 10 YES Class III – MTM assets 100 100 10 NO Class IV – Inventory 100 85

• 15

10 YES Class Vl 3 yr Residual 5 yr 7 yr 15 yr Total 20 20 20 40 100 10 30 25 35 100

• 10

10 5

• 5

10 NO Class VI –197 intangible

• ther than GW / GCV

NO Class VII – GW / GCV 1500 1500 150 YES TOTALS 500 2000 1500

De Minimis Exceptions – Asset Classes

27

■ De minimis exception only excludes a CAA that is part of an “Aggregated CCA Transaction” if:

• the CAA individually is below the de minimis threshold
• the Aggregated CAA Transaction is below the threshold

■ Aggregated CAA Transaction is a “series of related CAAs occurring as part of a plan” (Prop. Reg. § 1.901(m)-1(a)(3)) ■ Almost all transactions will be included in the aggregate rules

• For example, an acquisition of a target with a subsidiary where a section 338 election is made for

both entities ■ Also separate anti-abuse rule that excludes transfers of built-in loss assets in certain circumstances

De Minimis Exception – Aggregation Rule

28

 USP acquires CFC 1 and CFC 2 in

a single transaction, makes a section 338 election for both

 Both located in Country X

 Application of De Minimis to CFC 1

 Satisfies Aggregate CAA test  Fails individual CAA test  (12 > greater of 10 or 6)  Section 901(m) applies

 Application of De Minimis to CFC 2

 Satisfies Aggregate CAA test  Satisfies Individual CAA test  Section 901(m) does not apply  Not necessarily a good answer

 Can you merge both CFCs before

the sale?

De Minimis Exception – Aggregation Rule

29

Asset Basis Before 48 After 60 Basis Difference 12

USP CFC 1 CFC 2

Asset Basis Before 100 After 96 Basis Difference (4) Aggregated CAA Transaction Asset Basis Before 148 After 156 Basis Difference 8 * All amounts in millions of USD

Country X Country X

Relevant Foreign Assets

30

■ What is a relevant foreign asset?

• General concept is an asset that has been acquired in a CAA
• An asset is relevant only if income, deduction, gain or loss

attributable to the asset is taken into account in determining the foreign income tax

• May have either built-in gain or built-in loss
• Most significant asset by value often is goodwill and other section

197 intangibles

• Anti-abuse rule also includes assets that was not relevant at the

time of the CAA if later become relevant

• Per se rule if asset becomes relevant within one year period

 Basis difference is computed using U.S. basis

 U.S. tax basis immediately after the CAA, over  U.S. tax basis immediately before the CAA  Built-in losses can be used as an offset (i.e., a negative basis

difference)

 U.S. basis comparison administratively difficult to implement

 Foreign targets are unlikely to have computed historical U.S. tax

basis

Election to Use Foreign Tax Basis – More Good News

31

 Foreign Basis Election

 U.S. basis immediately after CAA minus  Foreign basis immediately after CAA

 But foreign basis may be lower due to accelerated depreciation for

foreign tax purposes

 Election is irrevocable once made  Flexibility in making election

 U.S. owners of relevant foreign assets make the election  Except for p-ship, which is made by each partner  Separate elections with respect to each CAA, each foreign income tax,

and each foreign payor (person or entity (including DE) liable for tax), but

 “Aggregate CAAs” treated as one CAA for this purpose  If foreign payors report on combined basis they are treat as one for this

purpose

Election to Use Foreign Tax Basis – More Good News

32

 Allocation Questions

 Foreign taxes subject to the haircut are those that are “determined

with respect to the income attributable to the relevant foreign assets”

 Raises a question of whether section 901(m) and disqualified taxes

should be determined by tracing the taxes to the step-up in specific assets

 Difficult questions arise if tracing to each assets is required  Particularly where additional assets are later acquired  Which asset gets the benefit of the lower rate brackets?  What if different rates on income from different assets?  Statute determines the disallowance of foreign taxes using a formula  Aggregate basis and divided by all of the allocable foreign income

 Proposed regulations implement formula in a practical way

 Regs use all foreign income and all foreign taxes on the return of

each foreign payor (person or entity (including a DE)) that include income from RFAs and subject to foreign tax

Income from RFA and Tax Imposed on Such Income

33

■ What is the disqualified portion of the tax?

• Basically equal to the total basis step-up in relevant foreign

assets (generally those relevant in determining foreign income) multiplied by the effective foreign tax rate

• Statute adopts a formula:
• But the statute implements this in a complicated manner to

ensure that the foreign tax disallowance corresponds to the timing of utilization of the basis difference

Disqualified Portion of the Taxes

34

General allocation rule ■ Use the “applicable cost recovery method” using U.S. methods ■ Done on an annual basis Difficulties occur where:

 More than one person subject to section 901(m)

 Apply the disallowance formula so that basis differences and any disposition amounts must be

allocated among the these parties

 Owner of relevant foreign assets is a partnership

 Must also account for amounts under successor rules

Proposed regulations provide detailed rules to address these issues

Allocation of Basis Differences

35

Basis difference is effectively “tax-exempt” income for which foreign taxes credits are

disallowed under section 901(m)

Statute’s use of a formula can present issues in a specific year:

 If the aggregate basis difference exceeds foreign taxable income in a given year (e.g., where a

CFC has a foreign loss) then there may be insufficient FTCs to disallow under section 901(m)

 If the aggregate basis difference is negative in a given year (i.e., the allocable basis difference in

that year is a net U.S. basis step-down) the statute does not allow a taxpayer to claim more FTCs than the amount actually paid Proposed regulations address this issue with carryover rules

 Bad News: If basis difference exceeds foreign taxable income, the excess carries forwards and

disallows foreign tax credits in a future year

 Good news: If the aggregate basis difference for a year is negative, it carries forward and offsets

positive basis differences in future years (and thus more foreign tax credits) Entity-level attribute

 Section 901(m) can still apply to an entity even though it has disposed of all of its RFAs, and

• therwise taken into account all of total basis difference in earlier years

Not provided for in the statute, but may have simplified the rules?

Basis Difference Carryovers

36

 Section 901(m) applied separately for each section 901(m) taxpayer (or section 902 foreign

corporation) with respect to each foreign income tax imposed on relevant foreign asset acquired in a CAA and a foreign payor (individual or entity (including a DE) subject to foreign tax)

 An acquisition of a European group involves multiple CAAs  Could have multiple section 901(m) computations in the same jurisdiction if multiple creditable

income taxes

 Foreign consolidated groups

 Election to apply foreign basis is made separately for each CCA with respect to each foreign

tax and each foreign payor

Every CAA Likely Includes Multiple CAAs

37

Acquisition Involving Multiple Jurisdictions

CFC 1

Netherlands

CFC 2

France

CFC 3

Switzerland

CFC 4

Spain

CFC 5

France

DE 1

France

DE 2

German CAA Comp. 1 CAA Comp. 2 CAA Comp. 4 CAA Comp. 5 CAA Comp. 6

French consol. group

CAA Comp. 7 Industry Specific Tax

38

Business 1 Business 2

• Every entity (including DE 1 and 2) has a separate CAA and is a separate foreign payor
• Spain has one CCA and is a single foreign payor but with respect to two foreign income taxes
• France has three entities but as one return is filed for all entities, taxes and income are allocated

between CFC 2 and CFC 5

• CFC 2 and DE 1 are a single foreign payor because CFC 2 and DE 1 file on a combined basis
• Each ringed group is a separate 901(m) computation
• FP is acquired in a QSP
• Section 338 Elections made

for all entities CAA Comp. 3

 Third-country withholding taxes (WHT) excluded from section 901(m)

 But affect computation of disallowed income taxes if creditable against what

would otherwise be potentially disqualified taxes

 Base case example

 50 basis difference, 100 foreign income, and 40 foreign tax (40% rate)

20 40 50 100

 Base Case with 20 WHT – only 20 of foreign tax (20% ETR)

10 20 50 100

• Proposed regulations add-back the withholding taxes:

20 20 20 50 100

Creditable Withholding Taxes – Good News / Bad News

39

Add back of WHT restores base case result

CAA defined without regard to whether transaction occurs when relevant for U.S. tax Disqualified tax denied for section 901, 902 and 960, implying that at time the tax is

paid or accrued must be relevant for U.S. tax purposes under those sections

 Proposed regulations confirm that denial only occurs when a U.S. person or section 902

foreign corporation pays or accrues a disqualified tax

 BUT clarify that section 901(m) applies even if CAA occurs prior to U.S. ownership solely

between foreign persons (e.g., among non-section 902 foreign corporations)

Due diligence is required on any acquisition of foreign stock to determine if prior CAAs

that reduced foreign taxes or have remaining basis differences

Busted Transaction CAA most problematic (most other require U.S. nexus) Section 338 election doesn’t cure a prior CAA unless there is a foreign basis election  Deemed sale not recognized under foreign law; thus not a disposition, so remaining

aggregate basis carries over under old CAA with assets

 Foreign basis election combines impact of prior transactions

Look Back to pre-U.S. Ownership and Prior CAAs

40

 Temporary Regulations

 Notices 2014-44 and -45 – Disposition rules retroactive to the date of the

Notice (generally CAAs on or after July 21, 2014)

 Also covers remaining basis differences from prior CAAs back to 2011  Exclude foreign withholding taxes  Also retroactive to July 2014

 Proposed Regulations

 Generally apply to CAAs after regs are finalized  Taxpayers can rely on the proposed regulations if:

 They apply all of the regs consistently to all CAAs on or after Jan. 1, 2011  Except expanded list, which must be applied on or after Dec. 7, 2016

 Consistency requirement – all related parties treated as one taxpayer  Retroactive reliance – Proposed regs have favorable rules

 De minimis exception  Exception for withholding taxes  Foreign basis election (especially for foreign basis step-up transactions)

Effective Dates

41

 Simple Case – CAA in 2012

 Favorable to apply proposed regs for the de minimis rule  Timing of making foreign basis election  3 year v. 10 year statute of limitation for foreign tax credits

 Complicated Case –

 CAA in 2017 that is included in one of the new CAA categories  No section 901(m) because no need to apply the proposed regulations  But then a second CAA takes place in 2018 that includes an equivalent

foreign basis step-up

 Need to make the foreign basis election and de minimis rules to avoid

section 901(m), but this means pulling the first CAA into the rules

 What is if there is also a 2011 CAA that would be affected by the

proposed regs (e.g., the carryover rule)

 But 2011 is a closed year  Do you only lose the credits if they are carried forward to an open year?

Effective Dates – Examples

42

Section 70 4(b) Regulations on the Allocation of Foreign Incom e Taxes

 Regulations addressing the allocation of “creditable foreign

tax expenditures” or CFTEs were first issued in April of 2004

 Temporary regulations issued in February maintain the

approach, but modify the regulations to address certain specific issues



Apply to partnership taxable years that begin on or after Jan. 1, 2016 and end after Feb. 4, 2016

 CFTEs do not have substantial economic effect



Allocated in accordance with the partners’ interests in the partnership



CFTEs are generally allocated consistent with the “related” income as determined using foreign tax principles

 The temporary regulations primarily address 3 issues

• Section 743 adjustments
• Guaranteed payments and preferential allocations involving differing

treatment in different jurisdictions

• Multiple disregarded payments
• Sec. 704 Temp Regs – Allocations of CFTEs

44

ABC Section 743 Adjustments – Base Case Example

45

Partner A Partner B

Property 200 FMV 0 US A/B 0 Foreign A/B Sale of Property 200 U.S. gain 200 Foreign gain 40 Foreign tax 50% interest 100 FMV 0 A/B

■ ABC is a hybrid partnership (partnership for U.S. purposes but a corporation, and thus a taxpayer, for foreign tax purposes) ■ A and B are 50 / 50 partners of ABC ■ ABC sells the property and has 200 of gain ■ Foreign tax of 40 (20% rate) ■ There is a single CFTE category of income with all 200 of gain ■ Because the 40 of foreign tax is related to the gain, it is allocated to that category ■ 200 of net income in the CFTE category is allocated 50 / 50, or 100 to each of A and B ■ 20 of foreign tax is allocated to each

50% interest 100 FMV 0 A/B

Section 743 Adjustments – Temp Regs

46

Partner A Partner C Partner B

ABC

Property 200 FMV 0 US A/B 0 Foreign A/B Sale of Property 200 U.S. gain 200 Foreign gain 40 Foreign tax 50% interest 100 FMV 0 A/B

■ ABC makes a section 754 election ■ Partner B sells its interest to Partner C for 100 on Jan 1, 2009 (section 901(m) does not apply) ■ ABC sells the property and has 200

• f gain

■ Foreign tax of 40 (20% rate)

100 FMV 100 A/B 50% interest 100 FMV 0 A/B

■ 704/743 Analysis: 200 of gain is allocated 50 / 50 to A and C, and then C’s gain is reduced from 100 to 0 from the section 743 adjustment ■ CFTE Allocation: Net income in the CFTE category is 200 (section 743 adjustment is not included) and is allocated 50 / 50, or 100 to each of A and C ■ Foreign tax is allocated 50 / 50 (and not only to A), or 20 to each of A and C ■ End result: C has 0 income but 20 of foreign tax

Section 743 Adjustments – Section 901(m)

47

Partner A Partner C Partner B

ABC

Property 200 FMV 0 US A/B 0 Foreign A/B Sale of Property 200 U.S. gain 200 Foreign gain 40 Foreign tax 50% interest 100 FMV 0 A/B

■ Same as prior example, except sale of partnership interest is post-2010 ■ Section 901(m) applies; 20 of the foreign tax is not creditable

50% interest 100 FMV 0 A/B 100 FMV 100 A/B

■ 704/743 Analysis: 200 of gain is allocated 50 / 50 to A and C, and then C’s gain is reduced from 100 to 0 from the section 743 adjustment ■ CFTE Allocation: 200 net income in the CFTE category is 200 (section 743 adjustment is not included) and is allocated 50 / 50, or 100 to each of A and C ■ Foreign tax is allocated 50 / 50 (and not only to A),

• r 20 to each of A and C

■ Section 901(m): 20 of foreign tax allocated to C is disallowed under 901(m) (Notice 2014-44)

Value / Cash Distribution 80 Less US Tax Gain Allocated 100 Section 743 Adj. (100) Foreign tax (20) Net income (20) Tax Cost / Benefit 7 Total Return from Sale 87 Investment 100 Net return (13)

Section 743 Adj. – Section 901(m) Example

48

Gain on Sale 100 Less US Tax Gain 100 Foreign tax Net income 100 Tax Cost / Benefit (35) Total Return from Sale 65 Investment Net return 65 US Consequences to Partner C US Consequences to Partner B Total Return to C and B = 52

Value / Cash Distribution 80 Less US Tax Gain Allocated 100 Section 743 Adj. (80) Foreign tax (20) Net income Tax Cost / Benefit Total Return from Sale 80 Investment 80 Net return

Section 743 Adj. – Section 901(m) Example (cont’d)

49

Gain on Sale 80 Less US Tax Gain 80 Foreign tax Net income 80 Tax Cost / Benefit (28) Total Return from Sale 52 Investment Net return 52 Total Return to C and B 52 US Consequences to Partner C US Consequences to Partner B Section 901(m) loss to aggregate return (65% of 20 foreign tax) or 13

• Partner C acquires the partnership interest for 80 instead of 100

■ Regulations address guaranteed payments and preferential

allocation

• Deductibility in foreign jurisdiction is the key
• If deductible, then not part of the foreign tax base

■ Deductible guaranteed payment – no adjustments necessary

because deductible for U.S. and foreign tax purposes

■ Non-deductible guaranteed payment

• Include the income in the CFTE category
• Treat the payment as distributive share of partnership income

■ Deductible preferred allocations

• Reduce the net income in the CFTE category
• Do not treat as an allocation of partnership income

■ Multiple jurisdictions

Guaranteed Payments and Preferential Allocations

50

Preferential Allocations

51

■ A and B form ABC by contributing

7500 and 2500 respectively

■ AB is a hybrid partnership ■ A has a 1000 preferred return for

excess capital, deductible in Country X, but not Y

■ AB has 3000 of net income ■ Foreign tax of 400 (20% rate) in

Country X, because 1000 allocation is deductible

■ There is a single CFTE category of

income

■ Include the deduction when allocating

Country X taxes – so 200 to A and B Partner A Partner B

AB

Country X

2500 Contribution 50% Residual 3000 Net income 1000 Deduction 400 Foreign tax 7500 Contribution 1000 Preference 50% Residual

Preferential Allocations (cont’d)

52

Partner A Partner B

AB

Country X

■

Same facts as above, except that the income is also subject to a withholding tax imposed by Country Y

■

AB has 3000 of net income

■

Foreign tax of 400 (20% rate) in Country X

■

Additional Foreign tax of 300 (10% rate) in Country Y , because 1000 allocation is not deductible

■

Still a single CFTE category of income

■

Include the deduction when allocating Country X taxes – so 200 to A and B

■

Ignore the deduction when allocating Country Y taxes – so 200 to A and 100 to B

■

What if Country Y taxes are creditable so that AB only owes 100 in Country X? Does A get 0 or 50 of Country X taxes?

7500 Contribution 1000 Preference 50% Residual 2500 Contribution 50% Residual 3000 Net income 1000 Deduction 400 Foreign tax 300 Additional foreign withholding tax from Country Y

Multiple Disregarded Payments -- Example 36

53

Partner A Partner C Partner B

ABC

DEZ

Country Z

DEY

Country Y

DEX

Country X Unrelated Customers

900 Royalty 90 W/H Tax 1000 Royalty 0 W/H Tax 800 Royalty 0 W/H Tax 100 Net Income 30 Income Tax 100 Net Income 0 Income Tax 800 Net Income 0 Income Tax Agreement provides all partnership items allocated as follows A B C DEX 80% 10% 10% DEY 10% 80% 10% DEZ 10% 10% 80% ■ What happens to the cash? is this

effectively just 80 / 10 / 10?

■ 120 of tax related to DEX business ■ Tax allocated to 80 / 10 /10 ■ What happens if the W/H tax is

imposed by Country Y?

Multiple Disregarded Payments -- Example 36 (cont’d)

54

Allocations of Income and Tax A B C Income Tax Income Tax Income Tax DEX 1000 income 120 tax 800 96 100 12 100 12 DEY 0 income 0 tax DEZ 0 income 0 tax TOTAL 800 96 100 12 100 12

Multiple Disregarded Payments -- Example 37

Partner A Partner C Partner B

ABC

DEZ DEY DEX

Unrelated Customers

900 Royalty 90 W/H Tax 1000 Royalty 0 W/H Tax 800 Royalty 0 W/H Tax 100 Net Income 30 Income Tax 100 Net Income 0 Income Tax 800 Net Income 0 Income Tax Agreement provides all partnership items allocated as follows A B C DEX 80% 10% 10% DEY 10% 80% 10% DEZ 10% 10% 80% ■ Disregarded payments affect

cash distributions

■ 30 tax allocated to 80 / 10 / 10 ■ 10 tax allocated to 10 / 80 / 10

• 90 of tax x (100 / 900)

■ 80 tax allocated to 10 / 10 / 80

• 90 of tax x (800 / 900)

55

Multiple Disregarded Payments -- Example 37 (cont’d)

56

Allocations of Income and Tax A B C Income Tax Income Tax Income Tax DEX 100 income 30 tax 80 24 10 3 10 3 DEY 100 income 10 tax 10 1 80 8 10 1 DEZ 800 income 80 tax 80 8 80 8 640 64 TOTAL 190 33 170 19 660 68

Questions?

57