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Taxation of Foreign Source Income Under New Tax Law

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November 19, 2019

Taxation of Foreign Source Income Under New Tax Law

Galia Antebi, Member (Partner)

Ruchelman, New York

[email protected]

Stanley C. Ruchelman, Chairman

Ruchelman, New York

[email protected]

Andreas A. Apostolides, Attorney

Ruchelman, New York

[email protected]

Notice

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

THE SPEAKERS’ FIRMS TO BE USED, AND CANNOT BE USED, BY A CLIENT OR ANY

OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT

MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING OR

RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

You (and your employees, representatives, or agents) may disclose to any and all persons,

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.

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Andreas A.Apostolides

[email protected]

GaliaAntebi

[email protected]

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Stanley C. Ruchelman

[email protected]

Ruchelman P.L.L.C.

New York, N.Y. | 212.755.3333

www.ruchelaw.com

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• U.S. Tax Reform: A (Very) Brief Overview

• Dividend Received Deduction Under Code §245A

• Hybrid Transactions

• Sales & Other Transfers of Stock in Foreign Corporations

• Expansion of Subpart F: Evolving C.F.C. Ownership Attribution Rules

• G.I.L.T.I. and F.D.I.I. Developments

• Planning Techniques

• Take-Aways

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Brief Review of Prior Law v. New Law

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• At 35%, the U.S. corporate tax rate in effect until the tax reform was one of the highest in the O.E.C.D.; this provided an incentive to shift profits outside the U.S. and defer tax

• Deferral was subject to limitations under the C.F.C. and P.F.I.C. regimes; those remain in effect

• New law introduced a partial territorial corporate system, i.e., intercompany dividends are exempt

• New law retained and expanded the C.F.C. rules to apply them to more foreign corporations and to more U.S. shareholders

• New law introduced G.I.L.T.I., a new type of global minimum tax on multinational groups’ and individuals’ foreign income which will be subject to C.F.C. regime immediate tax rules (in general, a lower U.S. tax rate for corporate taxpayers’ G.I.L.T.I. tax inclusions)

• New law also expanded the definition of intangible property under §367(d) and §482 and

I.R.S authority to challenge transfer pricing via aggregation and “realistic alternatives” theories

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• U.S. corporate tax rate permanently reduced to 21%

• New law introduced a deduction for U.S. corporations with

foreign derived intangible income (F.D.I.I.)

• Reduced corporate rate, F.D.I.I. deduction, expanded

C.rules, G.I.L.T.I., and new base erosion anti-abuse tax

(B.E.A.T., applicable only to large multinationals) →

tended to eliminate the incentive for shifting income to

foreign jurisdictions

• Certain new bonus depreciation rules encourage

locating PP&E in the U.S.

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Territorial System

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• Code §245A provides a 100% dividends received deduction for the foreign-sourceportion of a dividend paid by a “specified 10%-owned foreign corporation” (foreigncorporation that has at least one 10% U.S. shareholder that is a corporation)

• 1-year holding requirement of the vote or value

• Only C-corporations (no R.I.C.’s or R.E.I.T.’s)

• Doesn’t apply to dividends (or income treated as dividend under a Q.E.F. election) from foreign corporations which are P.F.I.C.’s (unless also C.F.C.’s, in which case the C.F.C. rules apply)

• 10% ownership requirement may be met directly, indirectly, or constructively

• I.R.S. focuses on vast grant of regulatory authority by Congress; Temp. and Prop. Regs. issued in June 2019 (with language that Temp. Regs. may have retroactive effect under Code §7805(b) as issued within 18 months of T.C.J.A.); these views are being discussed by practitioners

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• Foreign-source portion of a dividend is calculated as a formula

Undistributed Foreign Earnings

=

Total Undistributed Earnings

• For these purposes, E&P as of the close of the taxable year is not reduced by the amount of any dividend distributed during such taxable year

• The undistributed foreign earnings are earnings not attributable to

• E.C.I.

• Dividends from U.S. corporations in which the foreign corporation owns at least 80% of the outstanding shares (D.R.D. under Code§245 may be available)

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• If the D.R.D. applies, Code §956 investment in U.S. Property is

inapplicable

• No direct or indirect foreign tax credits allowed

• Withholding taxes imposed on distributions of P.T.I. from a C.F.C.

should continue to be creditable under Code §901

• Foreign income tax disallowed for credit may not be deducted

• D.R.D. disallowed for hybrid dividends received from specified foreign

corporation (more on that later)

• Under Temp. Regs., the D.R.D. is subject to limitations for any

“ineligible amount”

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• Ineligible amount includes a dividend paid either

• Out of an “extraordinary disposition account”

• In connection with an “extraordinary reduction”

• Extraordinary disposition account – applicable for

dispositions during disqualified period. Only 50% of

D.R.D. allowed for dividend portion paid out of E.D.

account

• Extraordinary reduction – 0% D.R.D. allowed, subject to

exceptions

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• Disqualified Period – the extraordinary disposition is a transaction occurring during the period before the first date G.I.L.T.I. is applicable to the C.F.C. and starting on the last date on which the E&P was measured for purposes of the transition tax

• E.g., C.F.C. with November 30 taxable year end – “disqualified period” would be January 1, 2018, through November 30, 2018

• Account may survive the closure of relevant tax year and tag along until there is an applicable distribution later

• Extraordinary disposition when

• Property disposed of would give raise to G.I.L.T.I.

• Disposition to related party

• Outside of the ordinary course of business – subject to facts & circumstances analysis (except for per se rules)

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• In determining portion of dividend that is from extraordinary disposition account, dividends related to such account are deemed paid last (i.e., will be treated as paid out of non-extraordinary disposition E&P first)

• Two fact patterns, per se outside regular course of business

• Disposition with the principal purpose of generating E&P during the disqualified period

• Disposition of intangible property under Code §367(d)(4)

• De minimis exception: total net gain recognized by the C.F.C. in all extraordinary dispositions does not exceed lesser of

• $50 million

• 5% of gross value of all C.F.C. property held immediately before disqualified period

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• Other rules

• Specified entities & successor rules

• Code §954(c)(6) look-thru rule turned off, partly or

wholly, to the extent of extraordinary disposition account

• Applicable to partnerships

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• U.S.P. has 11/30 year end; owns C.F.C. 1 and C.F.C. 2

• C.F.C. 1 owns assets used in an active trade or business; assets have $50x of built-in gain which is not Subpart F Income

• During disqualified period of 1/1-11/30/2018, C.F.C. 1 sells active business assets (specified property) to C.F.C. 2 for$100, and later distributes $55 cash to U.S.P.; C.F.C. 1 has

§959(c)(3) earnings of $90, without regard to distributions during the year

• Sale is an E.D. and U.S.P.’s E.D. account with respect to

C.F.C. 1 is $50 (100% pro rata share of $50x gain); the dividend of $55 is paid first out of non-E.D. E&P (or $40); U.S.P.’s ineligible amount is $15 * .5 = $7.50 (50% of the remaining dividend received, which is therefore considered paid out of the E.D. account), thus U.S.P.’s D.R.D. is limited to $47.5. Immediately after, U.S.P.’s E.D. account is reduced to $35 ($50 – $15) and accordingly, U.S.P.’s prior E.D. account is increased by $15.

• Is analysis different if asset was a patent?

C.F.C. 1 C.F.C. 2

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• The extraordinary reduction rules disallow the D.R.D. for

the “extraordinary reduction amount”

• The rules disallow the deduction to the extent a C.F.C.

dividend is attributable to current-year E&P from income

that, absent the transfer or issuance of the C.F.C.’s stock,

would have been subject to U.S. tax under the Subpart F

or G.I.L.T.I. regime

• The extraordinary reduction limitation applies to all post-

2017 distributions

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• The following transactions are treated as extraordinary reductions:

• A direct or indirect transfer, by a controlling U.S. shareholder, in the aggregate, of more than 10% (by value) of the stock of the C.F.C. owned by it as of the beginning of the taxable year, provided that the stock transferred, represents at least 5% (by value) of the outstanding stock of the C.F.C. as of the beginning of the year

• One or more other transactions that result in controlling U.S. shareholder reducing its interest in C.F.C. by more than 10% of the shareholder’s holding, provided that the change is at least 5% of the total outstanding stock (both percentages computed based on value)

• A controlling U.S. shareholder is defined as a U.S. corporation directly or indirectly owning more than 50% of the C.F.C. by vote or value

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• The extraordinary reduction amount is the lesser of• Amount of the dividend

• Sum of the controlling corporate U.S.

shareholder's pre- reduction pro rata share of the

C.F.C.'s Subpart F Income and tested income for

the taxable year, reduced by the “prior

extraordinary reduction amount” (but not below 0)

• Prior extraordinary reduction amount – includes each

prior dividend received in the same taxable year, plus

certain other amounts

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• If the C.F.C.’s taxable year closes as a result of the

transaction and the U.S. shareholder owns stock on the

last day of C.F.C. tax year (or the U.S. shareholder makes

a closing of the C.F.C.’s year election), the transaction

does not result in an extraordinary reduction

• De minimis rule – if the sum of the C.F.C.’s Subpart F

Income and tested income does not exceed the lesser of

$50 million or 5% of the C.F.C. total income for the year,

no amount will be considered an extraordinary reduction

amount

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• At the beginning of 2019, F.P. owns 100% of the equity interests in each

of two U.S. subsidiaries, U.S Sub 1 and U.S. Sub 2; in turn, U.S. Sub 1

owns 100% of the equity interests in a controlled foreigncorporation,

C.F.C. U.S. Sub 1 is a controlling section 245A shareholder with

respect to C.F.C.; on October 19, 2019, U.S. Sub 1 sells C.F.C. to U.S.

Sub 2 for $100x (the “Sale”), recognizing $50 of gain

• In consequence of the Sale, U.S. Sub 1’s ownership in C.F.C.

undergoes an Extraordinary Reduction. Thus, U.S. Sub 1 includes $50

of gain as a dividend under §1248; at the end of the year, U.S. Sub 2

takes its pro rata share of C.F.C.’s testedincome for the year, or $150;

$150 is $200 of tested income, less $50, which is the amountdescribed

in §951(a)(2)(B) (the amount described in §951(a)(2)(B) is the lesserof

(i)$50 of dividends received on account of the gain recognized by U.S.

Sub 1, and (ii) $160, which is determined as $200 * (292/365), or annual

tested income multiplied by the ratio of the number of days in 2019 that

U.S. Sub 2 did not own C.F.C. out of the total number of days in2019)

• U.S. Sub 1’s E.R. amount is $50, or U.S. Sub 1’s pre-reduction pro rata

share of C.F.C.’s 2019 tested income ($200) reduced by tested income

taken into account by U.S. Sub 2, a U.S. tax resident ($150). Without

the Temporary regulations, U.S. Sub 1 would expect to qualify fora

§245A deduction with regard to full distribution, or $50; thus, U.S. Sub

1’s ineligible amount is $50, meaning no portion of the dividend is

eligible for a §245A D.R.D., unless U.S. Sub 1 makes election to close

C.F.C.’s tax year on date of transfer, or files a C.T.B. election

immediately prior to the Sale (in either case, U.S. Sub 1 will account for

any tested income arising as of the date that the short year closes and

get the benefit of a 50% §250 deduction on any tested income included

through the transfer date)

F.P.

C.F.C. C.F.C.

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• Ineligible amounts (including tiered amounts from lower-

tier C.F.C.’s) will be tracked on Form 5471

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Sales of C.F.C. Stock

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• Gain on the sale of C.F.C. stock by a U.S. Shareholder is subject to tax

• Code §1248 remains in effect and recharacterizes all or portion of the gain as dividend income to the extent of the E&P of the C.F.C. attributable to the selling shareholder

• Under Code §1248(j) such dividend amount qualifies for the 100% D.R.D. under Code§245A for a corporation that is a U.S. Shareholder

• The balance of the gain is subject to the 21% corporate tax rate

• D.R.D. dividends reduce basis for purposes of determining losses

• Tiered C.F.C.’s

• Gain recognized by C.F.C. on the sale of stock in a lower tier C.F.C. is treated under Code§964(e) in whole or in part as a dividend, under similar principles

• Such dividend is treated as Subpart F Income notwithstanding any other provision

• Any U.S. Shareholder with respect to the selling C.F.C. must include in gross income its pro rata share of such Subpart F Income

• Corporate U.S. Shareholders are entitled to a Code §245A deduction as if the Subpart F Income was dividend

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• Planning to reduce U.S. tax from 21% to 10.5%

• A lower-tier C.F.C. makes a C.T.B. election to be disregarded as to its sole C.F.C. shareholder

• C.T.B. election is made prior to a sale of shares. This causes actual sale of shares to be treated as sale of assets used in trade or business

• As a result, U.S. Shareholder to be subject to tax under G.I.L.T.I. rules rather than Subpart F rules

• Under Code §250, it is entitled to a 50% deduction for the G.I.L.T.I. inclusion in income resulting in a 10.5% tax

F Sub 1

F Sub 2• Extraordinary Reduction Limitation?

• By their terms the Temp. Regs. do not apply to a transfer (e.g., under Code §337 by F Sub 2 of all its assets to F Sub 1 in exchange for all F Sub 2’s stock in a tax-free “§332” liquidation) if the C.F.C.’s tax year closes as a result of the transfer while it is held by a controlling Code §245A shareholder

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• Code §1059 provides that if a corporation receives any “extraordinary dividend” (as defined in §1059(c)) with respect to a share of stock and has not held the stock for more than 2 years before the dividend announcement date, the corporation’s basis in the distributing’s stock shall be reduced by the nontaxed portion of such dividends (but not below 0)

• Before disposing of low-basis C.F.C. stock, consider possible taxable gain triggered upon distribution of an “extraordinary dividend” under §1248; gain recognized might also be increased by virtue of theD.R.D. (which could lead to circular adjustments)

• Between related parties, Code §1059 could potentially be mitigated via a C.T.B. election, with transaction recharacterized as a tax-free all-cash “D” reorganization

C.F.C.

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Hybrid Transactions

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• Hybrid Dividends paid to U.S. shareholder

• No Code §245A deduction allowed

• Do not carry F.T.C.'s

• C.F.C.-to-C.F.C. Hybrid Dividends

• Treated as Subpart F Income – cannot be reduced by other expenses or the Code §952(c) limitations

• Do not carry F.T.C.'s

• Hybrid Dividend

• Dividend from a C.F.C. that otherwise would generate a Code §245A deduction

• For which the payor C.F.C. received a deduction (or other tax benefit) with respect to any foreign income tax

• What is an example of an "other tax benefit"?

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• Under the proposed regulations, each “specified owner” of a share of

C.stock must maintain a “hybrid deduction account” with respect to such share

• A specified owner is any U.S. corporation or upper-tier C.F.C. that owns shares in a C.F.C. directly or indirectly through a partnership, trust, or estate

• A hybrid deduction is any deduction or other tax benefit allowed to the

C.F.C. under a relevant foreign tax law and is related to or results from anamount paid, accrued, or distributed with respect to an instrument issuedby the C.F.C. and treated as stock for U.S. tax purposes

• Under proposed regulations, the amount of a hybrid dividend is limited tothe sum of a U.S. shareholder's “hybrid deduction accounts” with respectto each share of C.F.C. stock

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• Disallowance of deductions for certain related-party interest and royalty expense payments by U.S. taxpayers and C.F.C.'s

• No deduction allowed for any disqualified related-party amount paid or accrued pursuant to a hybrid transaction or by, or to, a hybrid entity

• Disqualified related-party amount = interest or royalties paid or accrued to related party if

• Such amount is not included in the income of the related party under the tax law of its country of tax residence, or

• Such related party is allowed a deduction with respect to such amount under its local country tax law

• A hybrid transaction is any transaction, instrument, or agreement for which one or more payments is treated as interest or royalties for U.S. tax purposes but not so treated for purposes of the tax law of the recipient's country of residence

• A hybrid entity is an entity treated as fiscally transparent in one jurisdiction but not the other, where one of the jurisdictions is the U.S.

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• Broad regulatory authority to expand the scope of Code §267A to

• Deny deductions for conduit arrangements that involve a hybrid transaction or hybrid entity

• Apply the provision to foreign branches

• Apply the provision to “certain structured transactions”

• Treat as an exclusion a tax preference that has the effect of reducing the headline rate by 25% or more

• Deny all or a portion of a deduction claimed for interest or royalties paid that are subject to certain preferential tax regimes or a participation exemption

• Determine the tax residence of a foreign entity

• Identify exceptions to the general rule

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• A foreign corporation is a C.F.C. if more than 50% is owed by U.S.

Shareholders, by vote or value

• U.S. Shareholder

• U.S. Person (includes U.S. formed entities)

• Owning shares having 10% of the voting power

• For taxable years beginning after December 31, 2017, owning

shares having 10% or more of the value

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• For purposes of determining C.F.C. status, direct, indirect, and constructive ownership counts

• Constructive ownership from:

• U.S. family members (spouse + lineal; not siblings)

• Corporations in proportion to ownership, once 10% of value is owned

• Partnerships in proportion to ownership, with no threshold

• Special rule for chains of 3 or more levels of ownership

• Once a corporation or a partnership own more than 50% of the vote in a lower tier corporation – directly or indirectly – it is deemed to own all of the vote in the lower-tier corporation

• Downward attribution

• For purposes of income inclusion, only Code §958(a) ownership counts

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• Downward attribution:

• A partnership is treated as owning all of the shares owned by its partners. No threshold applies

• A trust is treated as owning all of the shares owned by its beneficiaries, unless a beneficiary's interest is a remote contingent interest

• A corporation is treated as owning all of the shares owned by a shareholder who owns 50% or more of the stock of the corporation

• Under prior law, Code §958(b)(4) provided that downward attribution to entities would not apply to attribute ownership from a foreign person to aU.S. person

• Under the new law, this rule was eliminated resulting in more U.S. persons treated as U.S. Shareholders and more foreign corporations treated as C.F.C.’s

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• Because F.P. owns “50% or more” of U.S. Sub, U.S. Sub is attributed all of F.P.’s holdings, i.e., 100% of the interests in F Sub

• F Sub will be treated as a C.F.C.

• U.S. Sub will not have Subpart F / G.I.L.T.I. income inclusion (no Code §958(a) ownership)

• Relief from Form 5471 filing under Notice 2018-13 and 2018-26?

F.P.

F Sub

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• U.S. Sub is attributed all of F.P.’s holdings, i.e., 90% of F Sub; therefore F Sub is a C.F.C.

• The U.S. Individual will be treated as a U.S. Shareholder of a C.F.C., and under Code§958(a) will therefore face Subpart F / G.I.L.T.I. inclusions together with informational reporting

• U.S. Sub may have reporting obligation but no income inclusion as not a Code §958(a) U.S. shareholder

• Relief under Rev Proc 2019-40?

F Sub

F.P.

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• Final regulations under Code §965 expand the relief announced in Notice 2018-26 and effectively turns off downward attribution for partnerships in the partner from whom attribution is to occur owns less than 10% percent of the interest in the partnership’s capital and profits. Similar relief applies for beneficiaries of trust:

• Up from the 5% relief announced in the Notice

• Only applies for purposes of the transition tax

• Notices 2018-13 and 2018-26 provide relief from filing for Category 1 and 5 if no U.S. shareholder (including the filer) owns interest within Code §958(a) meaning and the Foreign corporation is a C.F.C due to downward attribution from a foreign person

• The repeal of Code §958(b)(4) affected many provision beyond Subpart F; Proposed regulations under several code provisions modify how Code §958(b) apply to them in light of the repeal of Code §958(b)(4)

• Not all code sections covered; specifically, portfolio interest not addressed

• Rev. Proc. 2019-40 addresses difficulties faced by taxpayers who are required to file information reports as a result of the downward attribution but who have no access to the required information

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• Rev. Proc. 2019-40 provides three safe harbors:

• Deemed not C.F.C. – the I.R.S. will accept the determination that the Code

§957 ownership requirements are not satisfied if conditions are met

• Alternative Information – when information is not readily available, an

unrelated Code §958(a) U.S shareholder may use alternative information

in determining income inclusion and other amounts reported on Form 5471

(subject to priority list), provided that the C.F.C. has no related Code

§958(a) U.S. shareholder

• Transition tax may be determined on the basis of alternative information

• The safe harbors are not available to “U.S. controlled” C.F.C.

• Generally limited to U.S. Shareholders of foreign corporations that would

not be C.F.C.’s without downward attribution from a foreign entity

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• If the following safe harbor conditions are met, a foreign corporation will not be treated as a C.F.C. with respect to a U.S. person:

• The U.S. person does not have actual knowledge or statements received that the entity is a C.F.C.

• There is no reliable publicly available information sufficient to determine that the entity is a C.F.C. and

• If the U.S. person directly owns an interest in a foreign entity, the

S.person must engage in further due diligence with the foreign entity to determine if it may be a C.F.C., if it owns directly or indirectly stock in another foreign corporation, or in a domestic entity

• No requirement to inquire with foreign person from whom shares are attributed

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• Rev. Proc. 2019-40 also provides for

• Penalty relief for failure to file a Form 5471 and accuracy related

penalties for those who relied on the safe harbors

• Viewed as part of the reasonable cause exception

• No express relief provide from the extended statute of limitation

• Treasury’s intention to further revise Form 5471 instructions to

relieve certain Category 5 filers from additional filing requirements

• Category 5 filer who is unrelated constructive owner of a C.F.C. will be

granted a “free pass” from filing

• The relief offered in the Rev. Proc. can be applied for taxable years

beginning before January 1, 2018, and in all subsequent years

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• F Sub 2 is a C.F.C. under downward

attribution

• U.S. Individuals is an unrelated Code §958(a)

U.S. shareholder

• U.S. Sub is not a Code §958(a) U.S.

shareholder; U.S. Sub is a related

shareholder

• Because U.S. Individual is a 958(a)

shareholder U.S. Sub doesn’t get a free pass

under the 2018 Notices but can utilize safe

harbor is lack of knowledge

• For U.S. Individual lack of knowledge isn’t

enough; must inquire; can use alternative

information as unrelated and there is no

related 958(a) shareholder

F.P.

F Sub 2

Nonresident alien

U.S. Individual

F Sub 1

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F.P.

• F Sub 2 is a C.F.C. under downward

attribution

• U.S. Individuals is an unrelated Code

§958(a) U.S. shareholder

• U.S. Sub is a related Code §958(a)

U.S. shareholder

• U.S. Sub must also inquire to eliminate

filing requirement

• Because there is a related Code

§958(a) U.S. shareholder, U.S.

Individual may NOT use alternative

information

F Sub 2

F Sub 1

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N o v e m b e r 1 9 , 2 0 1 9

• Partnership downward attribution with no threshold

• F.J.V. will be a C.F.C.

• D.S.P. is not a Code §958(a) shareholder;D.S.P. is a constructive related owner

• U.S.P. is unrelated Code §958(a) shareholder

• D.S.P. doesn’t get a free pass under the 2018 Notices because there is a 958(a)U.S. shareholder but may utilize safe harbor if lack of knowledge

• U.S.P. must inquire with F.J.V. for safe harbor to apply

• Because no related Code §958(a) shareholder, U.S.P. may use alternative information if filing requirements apply

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• For purposes of determining C.F.C. status, entity view prevails

• Domestic partnership-owned foreign corporation is a C.F.C. even if no partner is a U.S. person

• Under current law, entity treatment applies also with respect to Subpart F Income inclusion

• The inclusion amount is determined at the partnership level

• The owners of the pass-thru entity are subject to tax on their share of the amount determined at the level of the pass-through entity

• Less than 10% owners still pick up distributive share of income

• Under Prop. Regs., for income inclusion purposes, aggregate view will prevail

• Domestic partnership will be treated as a foreign entity – looked through for purposes of determining the person that owns stock in the foreign corporation within the meaning of Code §958(a)

N o v e m b e r 1 9 , 2 0 1 9

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N o v e m b e r 1 9 , 2 0 1 9

• For purposes of determining the status of any U.S. person asU.S. Shareholder or controlling domestic shareholder, and for

purposes of determining the status of a foreign corporation as a

C.F.C., the change will not apply, i.e., entity view will continue

• Proposed regulations will be effective for taxable years

beginning after the date of publication

• Domestic partnership may apply the rules described in the

proposed regulations for taxable years beginning after

December 31, 2017 if the partnership and its U.S.

Shareholder partners, all consistently apply such rules

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• Foreign Co is a C.F.C. because its 100%

owned by a domestic partnership, a

“U.S. person”

• Under current rules, Subpart F Income

inclusion is at P.R.S. level and Mr. X

picks up 5%, his distributive share

• Under Prop. Regs., for purposes of

determining Code §958(a) shareholders,

S. will be looked-through:

• U.S.P. will be a U.S. Shareholder and

will directly pick up Subpart F Income

• Mr. X will not be a U.S. Shareholder

because he owns less than 10%

• Mr. X may face P.F.I.C. issues

95%

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5%

100%

N o v e m b e r 1 9 , 2 0 1 9

• Two individuals are not related

• P.R.S. 2 is U.S. person; thus Foreign Co is a C.F.C.

• Under current law, P.R.S. 2 is a §958(a) U.S.

Shareholder and both U.S.P. and Mr. X pick up

distributive share of Subpart F Income through P.R.S.

2 and P.R.S. 1 (81% and 9%, respectively)

• Under Prop. Regs., for purposes of determining status

of U.S.P. and Mr. X as U.S. Shareholders, P.R.S. 1

and P.R.S. 2 are viewed as entities

• P.R.S. 1 constructively owns 100% of Foreign Co

(special attribution rule) and therefore U.S.P. is

treated as owning 90%, and Mr. X is treated as

owning 10%, of Foreign Co

• Under Prop. Regs., for purposes of determining

income inclusion as §958(a) U.S. Shareholder, both

P.R.S. 2 and P.R.S. 1 are looked through so that

U.S.P. owns 81% and Mr. X owns 9% of Foreign Co

and will pick up income inclusion in that proportion

90% 10%

100%

10%90%

N o v e m b e r 1 9 , 2 0 1 9

Nonresident alien

U.S. Individual

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N o v e m b e r 1 9 , 2 0 1 9

• Under prior law, the foreign corporation needed to be a C.F.C. for an

uninterrupted period of 30 days or more to trigger Subpart F inclusion

for a U.S. Shareholder

• Under new law, Subpart F applies if the corporation is a C.F.C. at any

time during the taxable year

• Intergenerational planning that resulted in avoidance of Subpart F for

structures involving a foreign parent, U.S.-resident child and a grantor

trust are no longer effective

• Structure should be examined for available restructure steps prior

to death

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N o v e m b e r 1 9 , 2 0 1 9

• C.T.B. for the foreign corporations solved the problem of the U.S. beneficiaries who inherited this structure post death

• Consider multi-tier structures

Foreign Co 1Foreign Co 2

Grantor BeneficiaryForeign

Grantor

Trust

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Nonresident alien

• With the elimination of the 30-day rule, post-death C.T.B. would trigger Subpart F Income on the deemed liquidation

U.S. Individual

N o v e m b e r 1 9 , 2 0 1 9

Rules Related to Passive & Mobile

Income (Otherwise Known as G.I.L.T.I.)

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N o v e m b e r 1 9 , 2 0 1 9

• New Code §951A is a Subpart F-type inclusion for a U.S. Shareholder's "G.I.L.T.I." pleasures

– a C.F.C. generating low-taxed income, not taxed under Subpart F, and deemed to be attributable to high-value intangibles

• A U.S. shareholder’s G.I.L.T.I. inclusion is allocated based on their pro rata share (in same manner as Subpart F regarding basis, P.T.I., etc.) and determined as the U.S. shareholder's aggregate net tested income attributable to all C.F.C.’s, less a routine return of 10% on its aggregate pro rata share of the depreciable tangible property of eligible C.F.C.'s

• Tested income does not include E.C.I., Subpart F Income, income that escapes Subpart Fcharacter under high tax (18.9%) exception, foreign oil and gas income, and related-partydividends

• 10% routine return is applied to the average of the aggregate adjusted basis of depreciable tangible property (under S.L. method) used in a trade or business to produce tested income as of the end of each quarter

• Tax imposed on corporations at reduced rate, achieved through 50% deduction. Foreign taxes paid on G.I.L.T.I. are determined by multiplying the total C.F.C. foreign taxes by the proportion of the G.I.L.T.I. compared to the C.F.C. tested income & limited in deductibility to 80% (the “haircut”). Excess F.T.C. attributable to G.I.L.T.I. not allowed for carryover

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N o v e m b e r 1 9 , 2 0 1 9

• New Code §250 provides a deduction for G.I.L.T.I. and Foreign-Derived

Intangible Income (F.D.I.I.) of a Domestic Corporation (not a R.I.C., R.E.I.T.,

or S-corporation) – does not apply to individuals

• For corporations G.I.L.T.I. is viewed as a minimum residual tax on low

taxed foreign income

• For individuals, G.I.L.T.I. is more akin a new Subpart F category

• Conceptually, provides a 10.5% minimum rate on G.I.L.T.I.

• Mechanics – deduction equal 50% of G.I.L.T.I. (limited to taxable income –

thus, corporate groups in overall loss position also do not benefit)

• On simple basis, if foreign tax rate is higher than 13.125%, theoretically no

residual U.S. tax would result

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N o v e m b e r 1 9 , 2 0 1 9

• U.S. Shareholder level calculation:

• Aggregate allocable tested income from all C.F.C.’s

• Aggregate allocable tested loss

• Reduce the net result by the allocable deemed tangible income return (D.T.I.R.)

• D.T.I.R. is not available for C.F.C.’s with tested loss

• G.I.L.T.I. is computed at the level of the U.S. Shareholder and is a “top down” computation

• If a C.F.C. with tested loss has interest expense taken into account in calculating the net loss, the interest may reduce the D.T.I.R. from anotherC.F.C. with tested income

• To mitigate the result, regulations reduce the interest expense of a tested lossC.F.C. by the disallowed D.T.I.R. of the tested loss C.F.C.

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N o v e m b e r 1 9 , 2 0 1 9

Foreign Co 2

• $149 Gross Tested Income

• $150 Specified Interest

• (-1) Tested Loss

• $1000 Q.B.A.I.

• Potential D.T.I.R. $100

Foreign Co 1 Foreign Co 2

Foreign Co 1

• $500 Net Tested Income

• $2000 Q.B.A.I.

• Potential D.T.I.R. $200

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N o v e m b e r 1 9 , 2 0 1 9

• If net income of a C.F.C. is taxed by a foreign country at an effective rate of at least 90% of the U.S. corporate tax rate, currently 18.9% (90% x 21%), it is excluded from G.I.L.T.I.

• The effective rate is not blended, and is calculated by reference to each qualified business unit (Q.B.U.)

• Exclusion may apply to some Q.B.U.’s and not others

• No foreign tax credit for local income taxes imposed on income that is excluded under the high-tax exception

• Election

• Election to exclude made by controlling U.S. shareholder and is binding for all

• An election for one C.F.C. applies to all C.F.C.’s of the shareholder

• Applies for subsequent tax years until revoked

• Once election is revoked, new election isn’t available for 60 months

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N o v e m b e r 1 9 , 2 0 1 9

• De minimis rule – Subpart F Income not taxed to U.S. Shareholder if

• Amounts to less than of 5% of gross income of the C.F.C. and

• Does not exceed $1 million

• Income excluded from Subpart F under the de minimis rule is

included in G.I.L.T.I.

• Income included in Subpart F under the full inclusion rule is excluded

from G.I.L.T.I.

• The rule requires 100% inclusion in Subpart F Income if the

C.F.C.’s Subpart F Income for the year exceeds 70% of total gross

income

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N o v e m b e r 1 9 , 2 0 1 9

• A C.F.C.’s Subpart F Income is limited to current year’s E&P

• If Subpart F Income is reduced under this rule in any year, excess

E&P in a subsequent year is recharacterized as Subpart F

• Gross income that is excluded from tax under the E&P limitation is

still treated as Subpart F Income and is therefore excluded from

G.I.L.T.I. in Year 1

• Income giving rise to the recapture in Subpart F in a subsequent year

is not otherwise Subpart F Income and therefore is also included in

G.I.L.T.I. in that year notwithstanding the recapture taxation

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N o v e m b e r 1 9 , 2 0 1 9

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N o v e m b e r 1 9 , 2 0 1 9

• Provided under new Code §250

• Available only to a U.S. C-corporation that exploits foreign markets with goods and services that will be used or consumed abroad

• F.D.I.I. deduction not available to a U.S. C-corporation that is a R.I.C. or R.E.I.T.

• Capped at taxable income so that it cannot create a loss

• Applies to income derived from property sold to foreign persons or for foreign use or from services provided to any person or with respect to property not located in the U.S., excluding Subpart F Income, G.I.L.TI., financial services income, dividends from C.F.C., domestic O.G.E.I., and foreign branch income

• Eligible income reduced by 10% routine return on qualified business assets

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N o v e m b e r 1 9 , 2 0 1 9

• Conceptually – 13.125% rate on foreign-derived income from intangibles held in U.S.

• Mechanics – deduction of 37.5% (until 1/1/2026) of foreign-derived intangible income

• F.D.I.I. is part of an array of financial reasons to locate PP&E in the U.S.

• 21% tax rate

• Bonus depreciation allowing an immediate write-off for property having a ≤ 20-year

recovery period, computer software, water utility, a film or television production, or a

qualified live theatrical production

• Expensing of up to $1.0 million for equipment each year, phasing out when total property

placed in service exceeds $2.5 million

• Single factor apportionment rules based on place of delivery can yield intentional double

no-taxation result at state level

• State industrial development programs for major facilities are extensive – New Jersey,

Florida, Nevada, Massachusetts have exceeded $100 million in benefits over time

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N o v e m b e r 1 9 , 2 0 1 9

Planning Techniques

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N o v e m b e r 1 9 , 2 0 1 9

• Code §962 election allows individuals to treat C.F.C. inclusion

amounts as if received by a domestic corporation

• Election available only to individual U.S. Shareholder (owning 10% or

more, including constructive ownership)

• Code §962 election results in

• Electing shareholder is taxed on income inclusion from a C.F.C. at

the highest corporate rate in effect for the taxable year

• Electing shareholder is entitled to a deemed paid credit for foreign

income taxes paid by the C.F.C. under Code §960

• The amount of the income inclusion is increased to include the amount of

the creditable foreign corporate income tax under Code §78

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N o v e m b e r 1 9 , 2 0 1 9

• If the election is applicable to G.I.L.T.I. inclusion:

• Deduction under Code §250 is available under final regulations –

currently G.I.L.T.I. deduction is 50%

• F.T.C. is limited to 80%

• F.T.C. limitations under Code §904 continue to apply

• If foreign tax rate is 13.125% or higher, in principle no additional U.S.

tax will be due for electing shareholders

• Election is annual

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N o v e m b e r 1 9 , 2 0 1 9

• Actual distribution of E&P previously taxed under Subpart F and

I. are taxed again as a distribution from a foreign corporation

• P.T.I. rules are limited to the net U.S. tax that was paid on the

income inclusion

• If qualified, dividend subject to U.S. income tax at 20% (otherwise

37%)

• Direct F.T.C. is allowed for dividend withholding tax

- 69 -

N o v e m b e r 1 9 , 2 0 1 9

Facts

• Foreign gross income – $100

• Foreign tested income – $100

• No Q.B.A.I.

• Inclusion percentage for Individual U.S. Shareholder –100%

• Foreign Corporate tax rate –13.125%

• No Withholding tax on dividend distribution

C.F.C.

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N o v e m b e r 1 9 , 2 0 1 9

Income Inclusion without Code §962 Election

• Foreign corporate income tax paid =

$13.125

• G.I.L.T.I. inclusion = $86.875 [100% x

(100-13.125)]

• G.I.L.T.I. tax due = $32.143 [37% x

86.875]

Income Inclusion with Code §962 Election

• Foreign corporate income tax paid = $13.125

• G.I.L.T.I. inclusion = $86.875 [100% x (100-

13.125)]

• Section 78 gross up 100% x $13.125 = $13.125

• Total gross income = $100 [86.875+13.125]

• §250 deduction = 50% → taxable income -

$50

• Tentative U.S. tax (21%) = $10.5

• 80% F.T.C. available = $10.5 [80% x 13.125]

• G.I.L.T.I. tax due $0 [10.5 – 10.5]

- 71 -

N o v e m b e r 1 9 , 2 0 1 9

At Distribution

• Distribution amount – $86.875

• All is P.T.I.

• No additional U.S. tax is due

At Distribution

• Distribution amount – $86.875

• P.T.I. limited to U.S. tax paid

• Taxable dividend – $86.875

[86.875 - 0]

• Assuming dividend is not

qualified (37%) – $32.143

additional U.S. tax

• Assuming dividend is qualified

(20%) – $17.375 additional tax

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N o v e m b e r 1 9 , 2 0 1 9

• Mitigates U.S. tax on individual when

• A C.F.C. generates G.I.L.T.I. tested income

• Pays foreign tax

• But does not pay dividend

• Eligible for qualified dividend treatment

• If dividend does not qualify for preferential long-term capital gains

rate, Code §962 election would result in greater total tax liability

• But the election allows deferral at a relatively low cost, specifically

for G.I.L.T.I. income

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N o v e m b e r 1 9 , 2 0 1 9

And Unanswered Questions

- 74 -

N o v e m b e r 1 9 , 2 0 1 9

• More foreign corporations will be treated as C.F.C.’s resulting in more U.S. tax under Subpart F, and more informational reporting for Code §958(a) and constructive U.S. Shareholders

• U.S. Shareholder status for C.F.C. purposes tested by vote or value, not just vote

• Downward attribution rule from a foreign person to a U.S. person

• 30-day rule eliminated; reduces possibilities to plan to avoid C.F.C. rules

• All inbound plans involving grantor trusts established by foreign parent must be re-examined to address wind-up of structure once foreign parent dies

• Individual taxpayers or L.L.C.’s that own C.F.C.’s directly should consider making relevant Code §962 tax elections or using a domestic holding company

• G.I.L.T.I. tax may be reduced to 10.5%

• Dividends received from 10% subsidiary benefit from D.R.D. – subject to Temp. Regs.

• Cumulative corporate and individual U.S. Federal tax reduced to about 28%

• F.D.I.I. for income derived from servicing foreign markets is taxed at 13.125%

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N o v e m b e r 1 9 , 2 0 1 9

• Check-the-box and other hybrid tax plans severely curtailed in cross-border tax planning

• Outbound tax planning

• No D.R.D. for U.S. corporation if foreign payor deducts or receives a benefit resulting from dividend

• Subpart F inclusion for U.S. Shareholder if a lower-tier C.F.C. paying a dividend to itsC.F.C. parent deducts the payment or obtains a tax benefit for the payment

• General exceptions to Subpart F – blocked income, high tax, same country, payment from active business E&P – will not apply to shield the U.S. Shareholder from G.I.L.T.I. tax

• Inbound tax planning

• U.S. corporation denied a deduction for interest and royalties paid to a related party that is not fully taxed upon receipt

• Same treatment for U.S. corporation if foreign corporation receives a notional deduction

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N o v e m b e r 1 9 , 2 0 1 9

Important Notice

This presentation is not intended to be legal advice. Reading these materials does not

create an attorney-client relationship. The outcome of each case stands on its own merits.