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

GW-IRS 29 TH A NNUAL I NSTITUTE ON C URRENT I SSUES IN I NTERNATIONAL T AXATION Foreign Tax Credit Update Decem ber 16, 20 16 Brenda Zent Jason Yen Office of International Tax Counsel Office of International Tax Counsel U.S. Departm ent of Treasury U.S. Departm ent of Treasury Jeffrey Parry Patrick Brown Senior Counsel, Branch 3, ACCI Vice President, Tax, GE Power Internal Revenue Service General Electric Com pany F. Scott Farm er Michael Caballero Morgan, Lewis & Bockius LLP Covington & Burling LLP Agenda ■ Tax Reform and FTC Issues ■ Section 901(m) Regulations ■ Section 704 CFTE Regulations 2

Tax Reform and FTC Issues Tax Reform – The Big (Trillion Dollar) Questions ■ Will it happen? ■ When? ■ Why does it matter today? ■ Revenue impact? Rate reduction v. infrastructure? ■ Scope? Individual Comprehensive Pass-Throughs Business Income Corporate Corporate Reform International International Repatriation Repatriation 4

Tax Reform – Structural (Multi-Billion Dollar) Questions? ■ 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 ● opportunities 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)? 5 Tax Reform – Transition Issues ■ 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 6

Section 90 1(m ) Regulations 7 Section 901(m) Background ■ 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? o Subpart F high-tax exception o 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 8

Section 901(m) Base Case ■ Buyer acquires stock of FT from unrelated foreign Seller for $100 BUYER SELLER ■ Section 338 election made for FT U.S. Foreign ■ FT has one asset with 10-year Stock purchase with depreciable life (for U.S. tax section 338 election purposes) ■ Basis difference = 50 (100 – 50 A/B) FT FT ■ FT sells the asset for 150 Foreign Foreign • US gain = 50 (150 – 100 A/B) Asset Asset • Foreign gain = 100 (150 – 50 A/B) • FMV = $100 FMV = $100 50 of gain never taxed in U.S. system AB = $100 AB = $50 ■ Foreign tax credit results • Foreign tax (and thus credit) is 30 (30% foreign tax rate) • U.S. tax on gain is 17.50 9 Policy of the Foreign Tax Credit ■ 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 10

Policy of Section 901(m) ■ 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) o 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 11 Policy Issues on Scope of CAAs  Case 1: Unrelated U.S. seller ■ Sale of foreign DE from one U.S. taxpayer to Case 1 another ■ US1 may be subject to U.S. tax on the asset US1 US2 gain; US2 obtains a basis step-up ■ Should section 901(m) apply if the basis step-up has been purchased with exposure of gain to U.S. tax? FDE FDE ■ 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 12

Policy Issues on Scope of CAAs Case 2 USP ■ Case 2: Related Seller • Policy issue in the case of a 901(m) between related persons • Policy would suggest that this should be CFC 1 CFC 2 treated as a section 909 splitter Foreign Gain from sale in CFC 1 Gain or o Tax Tax on gain incurred by CFC 2 Income o • Regulations under section 909 and FDE FDE 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 Case 2A USP of the consolidated group • Exemption from section 901(m) more compelling where tax and basis effects are in the same return US1 US2 • And the policy concerns of section 909 Gain or Foreign should be satisfied as gain is income to Income Tax the same U.S. taxpayer FDE FDE 13 Why does it matter? ■ 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 o No need to compute taxes and earnings for prior years o But section 901(m) requires computation of historical U.S. basis (even if only to compare with foreign basis) ● Increased amortization reduces E&P o May reduce subpart F income o Mandatory repatriation ■ Need to also analyze many factors ● Look-through on pre-acquisition earnings o No more separate 10/50 baskets o 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)) 14