US House and Senate release the Conference Report on the Tax Cuts and Jobs Act

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21 December 2017 Global Tax Alert US House and Senate release the Conference Report on the Tax Cuts and Jobs Act EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts.
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21 December 2017 Global Tax Alert US House and Senate release the Conference Report on the Tax Cuts and Jobs Act EY Global Tax Alert Library Access both online and pdf versions of all EY Global Tax Alerts. Copy into your web browser: Executive summary On 15 December 2017, the United States (US) House and Senate released the Conference Report to the Tax Cuts and Jobs Act (H.R.1), including: (1) the legislative text (referenced in this Alert as the Conference Agreement ) and (2) a Joint Explanatory Statement of the Committee of Conference (referenced in this alert as the Joint Explanation ). The Senate had previously released the Tax Cuts and Jobs Act of 2017 (the Senate Bill) on 2 December 2017, which is addressed in EY Global Tax Alert, US Congress JCT releases explanation of international provisions of Senate tax reform proposal, dated 14 November Previously, the House released its version of the Tax Cuts and Jobs Act of 2017 (the House Bill) on 2 November 2017, which is addressed in EY Global Tax Alert, US international tax provisions and implications of the Tax and Jobs Act, dated 6 November The Conference Agreement reduces the top corporate tax rate to 21%, reduces or limits many corporate tax deductions and preferences, and substantially changes many international tax provisions. This Alert focuses on the Conference Agreement s international tax provisions. 2 Global Tax Alert Detailed discussion 100% deduction for certain dividends received from foreign subsidiaries The Conference Agreement would provide a 100% deduction for the foreign-source portion of dividends received by a domestic corporation from a foreign corporation (specified 10%-owned foreign corporation) with respect to which it is a US shareholder as defined in Internal Revenue Code 1 Section 951(b), as amended by the Conference Agreement. A specified 10%-owned foreign corporation would be any foreign corporation, other than a passive foreign investment company (PFIC) that is not a controlled foreign corporation (CFC), with respect to which any domestic corporation is a US shareholder. The 100% deduction would not be available to regulated investment companies or real estate investment trusts. Any gain recognized by a domestic corporation on the sale or exchange of stock in a foreign corporation held for more than one year that is treated as a dividend under Section 1248, would be treated as a dividend for purposes of the 100% deduction. Furthermore, the Joint Explanation notes that the term dividend is to be interpreted broadly, consistent with Sections 243 and 245. As such, dividends received by a domestic corporation from a foreign corporation through a partnership that would be eligible for the 100% deduction if the domestic corporation owned the stock of the foreign corporation directly, would also be eligible for the 100% deduction. The Joint Explanation also provides that, for computing subpart F income, a dividend received by a CFC from a specified 10%-owned foreign corporation that constitutes subpart F income may be eligible for the 100% deduction. However, see below regarding the inclusion of gain from the sale of a lower-tier CFC by an upper tier CFC that is treated as a dividend under Section 964(e)(1) as subpart F income eligible for the 100% deduction. The foreign-source portion of a dividend received from a specified 10%-owned foreign corporation would be the amount that bears the same ratio to the dividend as the undistributed foreign earnings of the specified 10%-owned foreign corporation bears to its total undistributed earnings. Undistributed earnings would be the amount of earnings and profits (E&P) of the specified 10%-owned foreign corporation as of the close of its tax year in which the dividend is distributed, and not reduced by dividends distributed during such tax year. Undistributed foreign earnings would be the portion of undistributed earnings that is attributable to neither: (1) income effectively connected with the conduct of a trade or business in the US (ECI) and subject to US federal income tax, nor (2) dividends received (directly or through a wholly-owned foreign corporation) from a domestic corporation at least 80% of whose stock (by vote and value) is owned (directly or through such wholly-owned foreign corporation) by the specified 10%-owned foreign corporation. The 100% deduction, however, would not be available for dividends received from a CFC that receives a deduction or other tax benefit under foreign tax law for the dividend (hybrid dividend). The Conference Agreement refers only to dividends received from a CFC, but, because it refers to tax benefits received by a specified 10%-owned foreign corporation, it s unclear whether hybrid dividends received from a specified 10%-owned foreign corporation that is not a CFC remain eligible for the 100% deduction. Additionally, if a CFC with respect to which a domestic corporation is a US shareholder receives a hybrid dividend from any other CFC with respect to which such domestic corporation is also a US shareholder, that hybrid dividend would be treated as subpart F income of the recipient CFC for the tax year in which the dividend is received. Credits and deductions for foreign taxes (including withholding taxes) paid or accrued with respect to any dividend benefiting from the 100% deduction would be disallowed. Additionally, for purposes of the foreign tax credit limitation under Section 904(a), the foreign-source income (and entire taxable income) of a US shareholder of a specified 10%-owned foreign corporation would be determined without regard to: 1. The foreign-source portion of any dividend received from such foreign corporation. 2. Deductions properly allocated and apportioned to: (a) income with respect to stock of the specified 10%-owned foreign corporation (other than subpart F income and global intangible low-taxed income); and (b) stock of the specified 10% foreign owned corporation (to the extent income with respect to such stock is not subpart F income or global intangible low-taxed income). Thus, the Conference Agreement would appear to deny deductions for expenses associated with deductible dividends for purposes of the foreign tax credit limitation. Global Tax Alert 3 To be eligible for the 100% deduction, the domestic corporation must hold stock in the specified 10%-owned foreign corporation for more than 365 days during the 731- day period that begins on the date that is 365 days before the ex-dividend date. For this purpose, a taxpayer would be treated as holding stock for any period only if the specified 10%-owned foreign corporation is a specified 10%-owned foreign corporation for such period, and the taxpayer is a US shareholder with respect to such specified 10%-owned foreign corporation for such period. As proposed, the 100% deduction would not apply to either foreign income directly earned by a domestic corporation through foreign branches or to capital gains recognized from the sale or exchange of stock in a specified 10%-owned foreign corporation. The 100% deduction would apply to distributions made, including amounts received on the sale or exchange of stock of a foreign corporation treated as a dividend under Section 1248 (and for purposes of determining a taxpayer s foreign tax credit limitation under Section 904, deductions in tax years beginning), after 31 December Reduced transition tax on deferred foreign earnings The Conference Agreement would require a mandatory inclusion of the accumulated foreign earnings of a CFC and other foreign corporations with a 10% domestic corporate shareholder (a 10/50 company), collectively referred to as specified foreign corporations, or SFCs. Whether a foreign corporation is an SFC is determined without the application of Section 958(b)(4) (preventing downward attribution from a foreign person to a US person), which is repealed for the foreign corporation s last year beginning before 1 January The mandatory inclusion would be implemented by increasing the subpart F income of the SFC (treating a 10/50 company as a CFC solely for this purpose) in its last tax year beginning before 1 January 2018 (transition year), by the greater of its accumulated post-1986 deferred foreign income determined on 2 November 2017 or 31 December The mandatory inclusion would be subject to tax at reduced rates: 15.5% for earnings held in cash or other specified assets, and 8% for the remainder. The two rates are achieved by allowing a deduction against the required inclusion, based on the US shareholder s top marginal income tax rate in the inclusion year. However, there is a claw-back provision that would subject the entire mandatory inclusion amount to a 35% tax rate if a domestic corporation, which was subject to the transition tax, inverts within 10 years of the Conference Agreement s enactment. The Conference Agreement would allow a US shareholder to elect to pay the transition tax over eight years at 8% for the first five years, 15% in the sixth year, 20% in the seventh and 25% in the eighth. However, in the case of a subchapter S corporation that has a mandatory inclusion, the Conference Agreement would permit each shareholder of the S corporation to elect to defer payment of its net tax liability with respect to the S corporation by reason of the mandatory inclusion until the tax year in which any of the following occurs first: 1. The corporation ceases to be an S corporation. 2. The S corporation liquidates or sells substantially all of its assets. 3. The S corporation ceases its business, ceases to exist or any similar circumstance. 4. The shareholder transfers shares in the S corporation; transfers of less than all of the stock in an S corporation are a triggering event only with respect to the transferred shares. Accumulated post-1986 deferred foreign income The accumulated post-1986 deferred foreign income of an SFC means its E&P (i) accumulated in tax years ending after 31 December 1986, but only during periods in which the foreign corporation was a SFC, and determined as of 2 November 2017 or 31 December 2017 (measurement dates), whichever is greater, (ii) without diminution by reason of any dividends distributed during the SFC s transition year other than dividend distributions made to another SFC, and (iii) reduced by any E&P previously subject to US tax as ECI or, in the case of a CFC, E&P which, if distributed, would be excluded from gross income of the US shareholder under Section 959 (e.g., income previously taxed under subpart F of the Code). The US shareholder s mandatory inclusion would be determined after taking into account any E&P deficits of its SFCs, thus effectively requiring inclusion of the net positive amount of deferred foreign income. Further, a net deficit of one US shareholder (i.e., E&P deficits of its SFCs that exceed the accumulated post-1986 deferred foreign income of its SFCs) would be allowed to offset the aggregate net positive amount of accumulated post-1986 deferred foreign income (i.e., the net amount remaining after taking into account E&P deficits of the US shareholder s SFCs) of another US 4 Global Tax Alert shareholder if both US shareholders are members of the same affiliated group. In either instance, when a deficit of one foreign corporation is used to offset positive deferred foreign income of another corporation, foreign tax credits would be stranded and unusable in a future year with the repeal of Section 902 in both the deficit corporation and the corporations to which a deficit is allocated. Regardless of the amount of deferred foreign income included in the mandatory inclusion, all accumulated post-1986 deferred foreign income (i.e., untaxed post-1986 E&P) would be treated in the transition year (and until distributed) as though it were previously taxed subpart F income. Also, the E&P from an E&P deficit corporation would be increased in the transition year by the amount of deficit allocated to another SFC. Cash and other specified assets The 15.5% transition tax rate would apply to an amount of the mandatory inclusion equal to a US shareholder s aggregate foreign cash position, which means the greater of the US shareholder s pro rata share of the aggregate cash position of its SFCs determined on the last day of the SFCs year in which the mandatory inclusion occurs, or, the average of the US shareholder s aggregate pro rata share of the cash position of its SFCs determined in the two years ending immediately before 2 November So, the cash positions of a US shareholder with one SFC with a calendar tax year would be determined as of 31 December 2017 or the average of 31 December 2016 and 31 December 2015, whichever is greater. For purposes of this calculation, the cash position of an SFC would include the following: cash; net accounts receivable of the foreign corporation; and the fair market value of actively traded personal property, commercial paper, certificates of deposits, government securities, foreign currency, obligations with a term of less than a year, and any asset economically equivalent to the these assets. To prevent double inclusions, the provision would specifically exclude all or part of three items to the extent the US shareholder can demonstrate such cash amount is taken into account by the US shareholder s pro rata share of cash from another SFC. Such cash items include: (i) net accounts receivable, (ii) actively traded personal property (e.g., stock in an SFC), and (iii) obligations with a term of less than a year. For the foregoing calculations, the determination of whether a person is a US shareholder, whether a foreign corporation is subject to the transition tax, and the amount of a shareholder s pro rata share of a foreign corporation are all determined as of the end of the last tax year of a foreign corporation, which begins before 1 January Transactions with the principal purpose of reducing the aggregate cash position of a foreign corporation subject to the transition tax would be disregarded. Use of tax attributes to reduce the transition tax Any foreign income taxes deemed paid by the US shareholder under Section 960 would be reduced based on the same ratios applied to determine the allowable deduction against the mandatory inclusion. A gross-up under Section 78 would be required only for the foreign income taxes remaining after the reduction ratios are applied, and this amount may be claimed as a credit against the transition tax liability (or other foreign source income), subject to the normal limitations under Section 904. The Conference Agreement also would not limit the use of a foreign tax credit carryforward of the US shareholder to offset the transition tax. The recapture of foreign losses under Sections 904(f) and 907(c)(4) was not turned off for the mandatory inclusion. However, US shareholders may elect to forgo the use of their net operating loss deduction to reduce US taxable income on the mandatory inclusion. Limitation on losses with respect to specified 10%-owned foreign corporations The Conference Agreement would provide that, solely for purposes of determining loss on a disposition of stock of a specified 10%-owned foreign corporation, a domestic corporate shareholder must reduce (not below zero) its adjusted basis in such stock by the amount of any 100% deduction claimed for dividends received with respect to such stock. A reduction would not be required to the extent the adjusted basis of the stock was reduced under Section This provision would apply to distributions made after 31 December Sale by an upper-tier CFC of stock of a lower-tier CFC The Conference Agreement would provide that the foreignsource portion, if any, of gain recognized by an upper-tier CFC on the sale or exchange of stock of a lower-tier CFC held for at least one year that is treated as a dividend under Section 964(e) would be treated as a subpart F income for purposes of Section 951(a)(1)(A). The Conference Agreement appears to treat the entire amount of such gain as offset, thus potentially denying any expense under Section 954(b)(5) expense offset. However, a domestic corporation shareholder Global Tax Alert 5 of the selling CFC would be allowed a 100% deduction against its pro rata share of the subpart F income in the same manner as if the subpart F income were a dividend received from the selling CFC. For purposes of determining loss from a sale or exchange of stock of a foreign corporation by a CFC, rules similar to the loss limitation with respect to specified 10%-owned foreign corporations described above apply. This provision would apply to sales or exchanges after 31 December Recapture of foreign branch losses The Conference Agreement would require a domestic corporation that transfers, after 31 December 2017, substantially all of the assets of a foreign branch (within the meaning of Section 367(a)(3)(C)) to a specified 10%-owned foreign corporation with respect to which the domestic corporation is a US shareholder after the transfer, to include in gross income the transferred loss amount, subject to certain limitations. The transferred loss amount would be the excess (if any) of: (i) losses incurred by the foreign branch after 31 December 2017, and before the transfer, for which a deduction was allowed to the domestic corporation; over (ii) the sum of taxable income earned by the foreign branch and gain recognized due to overall foreign loss (OFL) recapture as a result of the transfer. For this purpose, only taxable income of the foreign branch earned in tax years after the loss is incurred through the close of the tax year of the transfer is included in gross income. The transferred loss amount would be reduced (not below zero) by the amount of gain recognized by the taxpayer (other than gain recognized by reason of OFL recapture) on account of the transfer. However, this gain amount would be reduced by the amount of gain that would be recognized under Section 367(a)(3)(C) as in effect before these changes with respect to losses incurred before 1 January Amounts included in gross income under this provision would be treated as US-source. The Conference Agreement would also repeal the active trade or business exception of Section 367(a)(3) for outbound transfers of certain appreciated property to foreign corporations in connection with any exchange provided in Sections 332, 251, 354, or 361. These provisions would be effective for transfers after 31 December New current-year inclusion to US shareholders for global intangible low-taxed income The Conference Agreement would require a US shareholder of any CFC to include in gross income for a tax year its global intangible low-taxed income (GILTI) in a manner similar to current subpart F income inclusions. A US shareholder s GILTI for any tax year would mean the excess, if any, of the US shareholder s net CFC tested income over its net deemed tangible income return. In this manner, GILTI would represent an amount deemed in excess of a specified return. Net CFC tested income. A US shareholder s net CFC tested income for a tax year would equal the excess, if any, of: (i) the shareholder s aggregate pro rata share of the tested income of each of its CFCs for the tax year, over (ii) the shareholder s aggregate pro rata share of the tested loss of each of its CFCs for the tax year. Tested income of a CFC for a tax year would mean the excess, if any, of: (i) the CFC s gross income for that year but not including ECI, subpart F gross income, gross income excluded from foreign base company income or insurance income under the high-tax exception of Section 954(b)(4), dividends received from related persons within the meaning Section 954(d)(3), and any foreign oil and gas extraction income within the meaning of Section 907(c) (1) (tested gross income) over (ii) the deductions (including taxes) properly allocable (under rules similar to those of Section 954(b)(5)) to such tested gross i
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