Joe Calianno is a Tax Partner and serves as BDO’s International Technical Tax Practice Leader. He also is a former Special Counsel to the Deputy Associate Chief Counsel (International) in the office of Chief Counsel for the Internal Revenue Service (IRS). Additionally, Mr. Calianno is a member of the AICPA’s Tax Executive Committee, and previously has served as the chair of the AICPA’s International Tax Technical Resource Panel as well as the chair of the ABA’s Foreign Activities of U.S. Taxpayer’s Committee.
Mr. Calianno answered the following questions for BEPS Global Currents on April 11, 2018 regarding the U.S. Tax Cuts and Jobs Act (TCJA) and the OECD’s BEPS project:
Q: How are your clients responding to the TCJA?
A: The recently passed TCJA has dramatically changed the tax landscape, especially in the international tax area. Our clients are assessing the tax implications of the numerous provisions that were enacted and the overall impact those provisions will have on the way they do business. These provisions include the transition tax under section 965 of the Internal Revenue Code (the “Code”), changes to the subpart F and foreign tax credit rules, the global intangible low-taxed income or GILTI provision (anti-deferral type provision) under new section 951A, a participation exemption (100% dividend-received deduction (“DRD”)) under new section 245A, a deduction relating to GILTI and foreign-derived intangible income (“FDII”) under new section 250, and base erosion provisions (including the base erosion and anti-abuse tax or BEAT under new section 59A, and the new section 163(j) limitation on business interest, to name a few.
Probably the provision that has been the highest priority for most of our clients has been the transition tax under section 965 of the Code. A significant amount of time and effort has been devoted to determining the potential tax impact of this tax.
Another provision that has received a lot of attention is the new GILTI provision, a new controlled foreign corporation (“CFC”) anti-deferral provision requiring certain U.S. persons who are “U.S. shareholders” of CFCs to include in income their pro rata share of GILTI for the taxable year. Many of our clients that have CFCs are now analyzing the impact of this new provision from both a financial statement perspective and a future tax return perspective. In general, this provision was enacted to address the situation where CFCs were generating high returns primarily through foreign IP, with little or no tangible business assets. However, GILTI can be much broader in its actual application.
The test for determining whether a U.S. shareholder has a GILTI inclusion is a fairly mechanical and complex test that can result in a significant income inclusion for U.S. shareholders. This is especially true if a U.S. shareholder has CFCs producing income, where such CFCs do not have high basis tangible, depreciable business assets. At a very high level, GILTI is the excess of the U.S. shareholder’s “net CFC tested income” for the year over such shareholder’s “net deemed tangible income return” for such year. Very generally, the net deemed tangible income return with respect to a U.S. shareholder is the excess (if any) of 10 percent of the aggregate of its pro rata share of the “qualified business asset investment” of each CFC producing income with respect to which it is a U.S. shareholder, minus certain interest expense. This provision, along with the existing CFC subpart F rules, likely will result in a higher inclusion of CFC earnings for a U.S. shareholder.
However, the impact of GILTI is lessened in the case of a U.S. shareholder that is a domestic C corporation because of a deduction under new section 250 relating to the GILTI income inclusion (potentially up to 50% of the GILTI amount along with the section 78 gross up), as well as the ability to take a scaled back (80%) deemed-paid foreign tax credit relating to the income inclusion, which has certain limitations on the foreign tax credit (e.g., generally a separate GILTI foreign tax credit basket with no carryback or carryforward of the credit).
GILTI will have a higher negative impact on U.S. shareholders of CFCs that are not domestic C corporations, such as U.S. individuals. Given the benefits provided to domestic C corporations (including a new 100% DRD under section 245A), many U.S. shareholders of CFCs who are not domestic C corporations are exploring restructurings to have their CFCs owned by domestic C corporations.
From an analysis standpoint, our clients with CFCs are looking to model their projected subpart F and GILTI income (along with the potential deemed-paid foreign tax credits under section 960 in the case of a domestic C corporation), and, to the extent a CFC’s earnings are not taxed under U.S. anti-deferral rules, the potential 100% DRD that may be available in the case of a domestic C corporation that satisfies certain conditions when earnings are repatriated.
Given these new tax provisions, many of our clients with foreign subsidiaries are considering repatriating earnings back to the U.S.— which could lead to U.S. investments and acquisitions. However, some clients may need the cash offshore for expansion and/or operations, and may not have such a propensity to repatriate cash back to the U.S.
Q: Do you have clients who meet the $500 million/3 percent base erosion threshold under the BEAT, and if yes, how are you calculating the cost of goods sold (COGS)?
A: Clients that meet the BEAT threshold (an analysis in and of itself) are analyzing their transactions and calculating the tax impact that the new provision will have. Payments made to related foreign persons that are classified as COGS generally are not treated as “base erosion payments” and do not increase a company’s potential BEAT liability. In some instances, what constitutes COGS is relatively clear. There are other situations that may not be quite as clear, and guidance from the IRS and Treasury would be welcomed.
Q: What are companies doing in countries that have not implemented BEPS measures?
A: Certain countries have not yet adopted certain BEPS action items. While some companies may be restructuring proactively in anticipation of such items being adopted in the future, other companies with operations or transactions in these jurisdictions are taking a wait-and-see approach to BEPS. In general, these companies have a game plan in place, and once the jurisdiction implements the particular BEPS action item, they will take corrective action to modify their structures and/or transactions.
Q: Which BEPS type items may have the most impact on your clients following U.S. tax reform?
A: The TCJA includes a new section 267A, which, when certain conditions are satisfied, denies a deduction for certain related party interest and royalty amounts paid or accrued pursuant to certain hybrid transactions, or by, or to, hybrid entities. For instance, this provision can apply in the case of a hybrid transaction where the payor would otherwise receive a deduction for a royalty, but such amount is not included in the income of the related party recipient under the tax law of the country of which the related party is a resident for tax purposes. This provision is designed to operate in a similar fashion to BEPS Action 2. There are also provisions in new section 245A, which denies the 100% DRD in the case of hybrid dividends. Moreover, there is a new, more restrictive, limitation on business interest in new section 163(j) that can impact several taxpayers. Finally, since the U.S. signs tax treaties on a bilateral basis, it is very likely that any future U.S. tax treaties will include some BEPS-type provisions.
These comments represent the views of the author only, and do not necessarily represent the views or professional advice of BDO USA, LLP.
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.
BDO USA, LLP, a Delaware limited liability partnership, is the U.S. member of BDO International Limited, a UK company limited by guarantee, and forms part of the international BDO network of independent member firms.
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