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IRS issues guidance on Tax Act’s deemed repatriation rules

IRS has issued a Notice and accompanying News Release that provide guidance regarding Code Sec. 965, which was enacted into law by the Tax Cuts and Jobs Act and which requires certain foreign corporations to increase their subpart F income, for their last tax year that begins before Jan. 1, 2018, by the amount of their deferred foreign income.

Background. Code Sec. 965, as newly enacted by the Tax Cuts and Jobs Act, imposes a transition tax on untaxed foreign earnings of foreign subsidiaries of U.S. companies by deeming those earnings to be repatriated.

More specifically, Code Sec. 965(a) provides that, for the last tax year of a deferred foreign income corporation (“DFIC”) that begins before Jan. 1, 2018 (such year of the DFIC, the “inclusion year”), the subpart F income of the corporation (as otherwise determined for such tax year under Code Sec. 952) is increased by the greater of (1) the accumulated post-’86 deferred foreign income of such corporation determined as of Nov. 2, 2017, or (2) the accumulated post-’86 deferred foreign income of such corporation determined as of Dec. 31, 2017 (each such date, a “measurement date,” and the greater of the accumulated post-’86 deferred foreign income of the corporation as of the measurement dates, the “Code Sec. 965(a) earnings amount”). Furthermore, under Code Sec. 965(b)(1), the Code Sec. 965(a) earnings amount which would otherwise be taken into account under Code Sec. 951(a)(1) by a U.S. shareholder with respect to a DFIC is reduced by the amount of such U.S. shareholder’s aggregate foreign earnings and profits (E&P) deficit which is allocated to such DFIC under Code Sec. 965(b)(2). The Code Sec. 965(a) earnings amount reduced as described in the preceding sentence is referred to in this notice as the “Code Sec. 965(a) inclusion amount.”

For purposes of Code Sec. 965, a DFIC is, with respect to any U.S. shareholder, any specified foreign corporation of such U.S. shareholder that has accumulated post-’86 deferred foreign income (as of a measurement date) greater than zero.Code Sec. 965(e)(1) provides that the term “specified foreign corporation” means (A) any controlled foreign corporation (CFC), and (B) any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder.

A U.S. shareholder of a DFIC is allowed a deduction for the tax year in which the above rules apply in an amount equal to the sum of: (i) the U.S. shareholder’s 8% rate equivalent percentage of the excess (if any) of: (a) the amount so included as gross income, over (b) the amount of the U.S. shareholder’s aggregate foreign cash position, plus (ii) the U.S. shareholder’s 15.5% rate equivalent percentage of so much of the amount described in item (i)(b) (above) as does not exceed the amount described in item (i)(a) (above). (Code Sec. 965(c)(1))

The 8% rate equivalent percentage is, as to any U.S. shareholder for any tax year, the percentage which would result in the amount to which that percentage applies being subject to a 8% rate of tax determined by only taking into account a deduction equal to that percentage of the amount and the highest rate of tax specified in Code Sec. 11 for the tax year. (Code Sec. 965(c)(2)(A)) The 15.5% rate equivalent percentage is, with respect to any U.S. shareholder for any tax year, the percentage determined under the 8% equivalent percentage definition applied by substituting a 15.5% rate of tax for the 8% rate of tax. (Code Sec. 965(c)(2)(B))

The term “aggregate foreign cash position” means, with respect to any U.S. shareholder, the greater of (i) the aggregate of such U.S. shareholder’s pro rata share of the cash position of each specified foreign corporation of such U.S. shareholder determined as of the close of the inclusion year or (ii) a somewhat similar calculation involving earlier tax years. Each date used in this calculation is a “cash measurement date.”

Notice provides guidance in several areas. The Notice announces that IRS intends to issue regs in the following areas with respect to determining amounts included in gross income by a U.S. shareholder by reason of Code Sec. 965: (1) determination of aggregate foreign cash position; (2) determination of accumulated post–’86 deferred foreign income; (3) application of Code Sec. 961 to amounts treated as Subpart F income under Code Sec. 965; and (4) treatment of affiliated groups making a consolidated return for purposes of Code Sec. 965; determination of foreign currency gain or loss under Code Sec. 986(c).

  • Determination of aggregate foreign cash position. The Notice provides guidance regarding the determination of aggregate foreign cash position:

… Allocation between multiple inclusion years. IRS is aware that in cases where specified foreign corporations have inclusion years that end in or with different tax years of the same U.S. shareholder, Code Sec. 965 could result in double-counting such shareholder’s aggregate foreign cash position for purposes of determining the shareholder’s deduction under Code Sec. 965(c).

IRS intends to issue regs providing that, in the case of a U.S. shareholder that has a Code Sec. 965(a) inclusion amount in more than one tax year, the aggregate foreign cash position taken into account in the first tax year will equal the lesser of the U.S. shareholder’s aggregate foreign cash position or the aggregate of the Code Sec. 965(a) inclusion amounts taken into account by the U.S. shareholder in that tax year. Furthermore, the amount of the U.S. shareholder’s aggregate foreign cash position taken into account in any succeeding tax year will be its aggregate foreign cash position reduced by the amount of its aggregate foreign cash position taken into account in any preceding tax year.

In addition, in cases in which, for example, a calendar year U.S. shareholder owns specified foreign corporations with inclusion years that end in or with different tax years of the U.S. shareholder, at least one specified foreign corporation of such U.S. shareholder will have a final cash measurement date in 2017 (for example, Dec. 31, 2017), and at least one other such specified foreign corporation will have a final cash measurement date in 2018 (for example, Nov. 30, 2018). IRS is aware that a U.S. shareholder in this situation may not be able to determine its aggregate foreign cash position for purposes of calculating its deduction under Code Sec. 965(c) for its 2017 tax year by the date that its return for such taxable year must be filed (including extensions).

For purposes of determining the aggregate foreign cash position of a U.S. shareholder for a tax year in which it takes into account a Code Sec. 965(a) inclusion amount, future regs will provide that the U.S. shareholder can assume that its pro rata share of the cash position of any specified foreign corporation with an inclusion year ending after the date the return for such tax year of such U.S. shareholder is timely filed (including extensions, if any) will be zero as of the cash measurement date with which the inclusion year ends.

… Treatment of related party transactions for purposes of determination of cash position. Net accounts receivables and short-term obligations between related specified foreign corporations may inflate the aggregate foreign cash position of a U.S. shareholder relative to the actual aggregate amount of liquid assets (other than the intercompany receivables) owned by the specified foreign corporations of the U.S. shareholder. For example, if a U.S. shareholder wholly owns two specified foreign corporations and one specified foreign corporation makes a short-term loan to the other specified foreign corporation, the borrowing corporation may invest the proceeds of such financing in illiquid assets or may spend the cash on operating expenses.

Accordingly, for purposes of determining the cash position of a specified foreign corporation with respect to net accounts receivable and short-term obligations, IRS intends to issue regs providing that, with respect to a U.S. shareholder, any receivable or payable of a specified foreign corporation from or to a related specified foreign corporation will be disregarded to the extent of the common ownership of such specified foreign corporations by the U.S. shareholder.

… Treatment of derivative financial instruments and hedging transactions for purposes of determination of cash position. IRS intends to issue regs that address the treatment of derivative financial instruments for purposes of measuring the cash position of a specified foreign corporation. Derivative financial instruments include notional principal contracts, options contracts, forward contracts, futures contracts, short positions in securities and commodities, and any similar financial instruments.

The regs will provide that the cash position of any specified foreign corporation will include the fair market value of each derivative financial instrument held by the specified foreign corporation that is not a “bona fide hedging transaction.” A bona fide hedging transaction means a hedging transaction that meets the requirements of a bona fide hedging transaction described in Reg. § 1.954-2(a)(4)(ii) and that is properly identified as such in accordance with the requirements of that subparagraph.

  • Determination of accumulated post-’86 deferred foreign income. The Notice provides guidance regarding the determination of accumulated post-’86 deferred foreign income:

… Adjustments to post-’86 E&P to account for certain amounts paid or incurred between specified foreign corporations between measurement dates. Certain transactions between specified foreign corporations may result in E&P of a specified foreign corporation being taken into account more than once or not at all by a U.S. shareholder under Code Sec. 965(a).

IRS intends to issue regs to address the possibility of double-counting or double non-counting in the computation of post-’86 E&P arising from amounts paid or incurred (including certain dividends) between related specified foreign corporations of a U.S. shareholder that occur between measurement dates and that would otherwise reduce the post-’86 E&P as of Dec. 31, 2017, of the specified foreign corporation that paid or incurred such amounts.

… Determination of amount of diminution by reason of distributions to specified foreign corporations. The post-’86 E&P of a specified foreign corporation are reduced to reflect dividends distributed during the corporation’s inclusion year to another specified foreign corporation. (Code Sec. 965(d)(3)(B)) As a result, a dividend paid by a specified foreign corporation to another specified foreign corporation (whether in an inclusion year or a prior tax year, including a prior tax year that includes a measurement date) generally reduces the corporation’s post-’86 E&P with respect to any measurement date that such dividend precedes.

IRS intends to issue regs to clarify that the amount by which the post-’86 E&P of a specified foreign corporation is reduced under Code Sec. 965(d)(3)(B) as a result of a distribution made to a specified foreign corporation in the inclusion year may not exceed the amount by which the post-’86 E&P of the distributee corporation is increased as a result of the distribution.

… Determination of accumulated post–’86 deferred foreign income in the case of a CFC with non-U.S. shareholders. In the case of a CFC that has shareholders that are not U.S. shareholders on a measurement date, IRS intends to issue regs providing that the accumulated post-’86 deferred foreign income of the CFC on such measurement date will be reduced by amounts that would be described in Code Sec. 965(d)(2)(B) if such shareholders were U.S. shareholders. In such cases, the regs will follow the principles of Rev Rul 82-16, 1982-1 CB 106—which covers exclusions from CFC subpart F income—in order to determine the amounts by which accumulated post-’86 deferred foreign income is reduced.

… Coordination between Code Sec. 959 and Code Sec. 965 in the inclusion year. IRS intends to issue regs to clarify the interaction between the rules under sections Code Sec. 959 (Exclusion from gross income of previously taxed E&P) and Code Sec. 965 in the inclusion year of a DFIC and the tax year of a U.S. shareholder of the DFIC in which or with which such inclusion year ends.

  • Application of Code Sec. 961 to amounts treated as Subpart F income under Code Sec. 965. In order to provide certainty regarding the application of the rules described in Code Sec. 961 (Adjustments to basis of stock in CFCs and other property) with respect to amounts included under Code Sec. 965, IRS intends to issue regs providing that if a U.S. shareholder receives distributions from a DFIC during the inclusion year, that are attributable to previously taxed income described in Code Sec. 959(c)(2) by reason of Code Sec. 965(a), the amount of gain recognized by the U.S. shareholder with respect to the stock of the DFIC under Code Sec. 961(b)(2) will be reduced (but not below zero) by the Code Sec. 965(a) inclusion amount.
  • Treatment of affiliated group making a consolidated return for purposes of Code Sec. 965. IRS intends to issue regs providing that, solely with respect to the calculation of the amount included in gross income by a consolidated group (as defined in Reg. § 1.1502-1(h)) by reason of Code Sec. 965(a), all of the members of a consolidated group that are U.S. shareholders of one or more specified foreign corporations will be treated as a single U.S. shareholder. Thus, for example, all members of a consolidated group that are U.S. shareholders will be treated as a single U.S. shareholder for purposes of determining the aggregate foreign cash position of the consolidated group and for purposes of taking such aggregate foreign cash position into account under Code Sec. 965(c)(1).
  • Determination of foreign currency gain or loss under Code Sec. 986(c). IRS intends to issue regs providing that any gain or loss recognized under Code Sec. 986(c) (foreign currency gain or loss) with respect to distributions of previously taxed income described in Code Sec. 959(c)(2) by reason of Code Sec. 965(a) will be diminished proportionately to the diminution of the taxable income resulting from Code Sec. 965(a) by reason of the deduction allowed under Code Sec. 965(c).

IRS says that it expects to issue additional guidance in the future.

Effective date. Code Sec. 965 is effective for the last tax years of foreign corporations that begin before Jan. 1, 2018, and with respect to U.S. shareholders, for the tax years in which or with which such tax years of the foreign corporations end. IRS intends to provide that the regs described above are effective beginning the first tax year of a foreign corporation (and with respect to U.S. shareholders, the tax years in which or with which such tax years of the foreign corporations end) to which Code Sec. 965 applies. Before the issuance of the regs described in this notice, taxpayers may rely on the rules described in the Notice.

Notice 2018-7, 2018-4 IRB; IR 2017-212

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