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International Tax

Publication explains how to calculate (deemed repatriation) transition tax

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

IRS has released Publication 5292 (How to Calculate Section 965 Amounts and Elections Available to Taxpayers).Code Sec. 965, which was amended by the Tax Cuts and Job Act (TCJA, P.L. 115-97, 12/22/2017), 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. The Publication provides a workbook and instructions to assist in calculating “section 965 amounts,” and also includes worksheets for taxpayers who may be able to make certain elections with respect to Code Sec. 965.

Background. Code Sec. 965, as amended by TJCA, 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) inclusion amount”).

Furthermore, under Code Sec. 965(b)(1), the Code Sec. 965(a) inclusion 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 term “aggregate foreign E&P deficit” means, with respect to any U.S. shareholder, the lesser of: (I) the aggregate of such shareholder’s pro rata shares of the specified E&P deficits of the E&P deficit foreign corporations of such shareholder; or (II) the aggregate of such shareholder’s pro rata shares of the Code Sec. 965(a)) inclusion amounts of all DFICs of such shareholder. (Code Sec. 965(b)(3)(A)(i)) The term “E&P deficit foreign corporation” means, with respect to any taxpayer, any specified foreign corporation with respect to which such taxpayer is a U.S. shareholder, if, as of Nov. 2, 2017, (i) such specified foreign corporation has a deficit in post-’86 earnings and profits, (ii) such corporation was a specified foreign corporation, and (iii) such taxpayer was a U.S. shareholder of such corporation. (Code Sec. 965(b)(3)(B)) The term “specified E&P deficit” means, with respect to an E&P deficit foreign corporation, the amount of such corporation’s deficit in post-’86 earnings and profits as of Nov. 2, 2017. (Code Sec. 965(b)(3)(C))

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.” (Code Sec. 965(c)(3)(A))

The cash position of any specified foreign corporation includes, among other things, the net accounts receivable (receivables net of payables) of such corporation and any obligation with a term of less than one year (“short-term obligation”). (Code Sec. 965(c)(3)(B))

New guidance. Publication 5292 notes that a person who is a U.S. shareholder of a DFIC may be required to report the amounts needed to compute its U.S. tax liability resulting from Code Sec. 965 (i.e., section 965 amounts). In addition, a direct or indirect partner in a domestic partnership, a shareholder in an S corporation, or an owner or beneficiary of another domestic pass-through entity that is a U.S. shareholder of a DFIC may also be required to report its section 965 amounts. For example, if a domestic partnership is a U.S. shareholder of a DFIC, its partners may be required to report their share of the partnership’s Code Sec. 965(a) inclusion amounts.

Publication 5292 provides a workbook to help taxpayers calculate the Code Sec. 965(a) inclusions, the Code Sec. 965(c) deductions, the deemed paid foreign taxes with respect to the Code Sec. 965(a) inclusions, and the portion of such deemed paid foreign taxes disallowed under Code Sec. 965(g).

All taxpayers required to include amounts in income under Code Sec. 965 should use the Section 965 Workbook. Individuals, corporations, partnerships, S corporations, and other pass-through entities that are U.S. shareholders should use the Section 965 Workbook to calculate the Code Sec. 965(a) inclusions and Code Sec. 965(c) deductions. Owners and beneficiaries of U.S. shareholder pass-through entities should receive information about their shares of the Code Sec. 965(a) inclusions and the Code Sec. 965(c) deductions of the pass-through entities from the pass-through entities to be included in the workbook. Eligible individuals making a Code Sec. 962 election (see below) and corporations should also use the Section 965 Workbook to determine the foreign taxes deemed paid with respect to the Code Sec. 965(a) inclusions and the portion of such deemed paid foreign taxes disallowed under Code Sec. 965(g). Under Code Sec. 962 and Reg 1.962-1 and Reg. 1.962-2, an individual U.S. shareholder of a controlled foreign corporation (CFC) may elect for a tax year to be taxed at corporate rates under Code Sec. 11 on amounts included in his or her gross income under Code Sec. 951(a) and to claim a foreign tax credit for foreign income taxes deemed paid with respect to such amounts under Code Sec. 902 and Code Sec. 960.

Publication 5292 includes Worksheet 1.1, the 965 Workbook (Worksheets to Calculate Inclusion of Deferred Foreign Income Upon Transition to Participation Exemption System), along with Worksheet A (U.S. Shareholder’s Section 965(a) Inclusion Amount); Worksheet B (Deferred Foreign Income Corporation’s Earnings & Profits); Worksheet C (U.S. Shareholder’s Aggregate Foreign Earnings & Profits Deficit); Worksheet D (U.S. Shareholder’s Aggregate Foreign Cash Position); Worksheet E (U.S. Shareholder’s Aggregate Cash Position – Detail); Worksheet G (Foreign Taxes Deemed Paid by Domestic Corporation for 2017 Tax Year); and Worksheet H (Section 1 Disallowance of Foreign Tax Credit and Amounts Reported on Forms 1116 and 1118).

Elections. A U.S. shareholder of a DFIC may elect to pay the Code Sec. 965 net tax liability in eight installments. In addition, owners and beneficiaries of U.S. shareholder pass-through entities may also make elections. Publication 5292also includes worksheet for taxpayers who may be able to make these elections with respect to Code Sec. 965:

(i) an election to pay the Code Sec. 965 net tax liability over eight years;

(ii) an election by S corporation shareholders to defer payment of the Code Sec. 965 net tax liability with respect to such S corporation until a triggering event;

(iii) an election by real estate investments trusts to take both Code Sec. 965(a) inclusions and the corresponding Code Sec. 965(c) deductions into account over eight years;

(iv) an election not to apply a net operating loss; and

(v) an election to use an alternative method to calculate post-’86 earnings and profits (post-’86 E&P).

Publication 5292 provides Worksheet 2.1 and 2.2, 965 Deferral Worksheet for Individuals (Calculation of Net 965 Tax Liability to be Paid in Installments); and Worksheet 3.1, 965 Deferral Worksheet for Corporations (Corporate Report of Net 965 Tax Liability, Election to Pay Net 965 Tax Liability in Installments Under Subsection 965(h) and Real Estate Investment Trust Deferral of Section 965(a) Inclusion Under Subsection 965(m)).

Not covered. Publication 5292 states that the workbook doesn’t account for Code Sec. 965 amounts to be taken into account in a 2016 tax year. However, persons that have 2016 tax year Code Sec. 965 inclusions should use the methodology of the workbook to calculate their 2016 tax year section 965 amounts. A taxpayer may need to report section 965 amounts on its 2016 tax return, a return for a tax year beginning in 2016 where, for example, a DFIC and its sole owner and U.S. shareholder were both fiscal year taxpayers with a Nov. 30 U.S. tax year end, and the DFIC dissolved on Nov. 29, 2017, the last tax year of the DFIC beginning before Jan. 1, 2018, would be its tax year beginning Dec. 1, 2016, and ending Nov. 29, 2017. A Code Sec. 965(a) inclusion amount with respect to the DFIC would be properly included on the U.S. shareholder’s return for its tax year beginning on Dec. 1, 2016, and ending on Nov. 30, 2017.

References: For the treatment of pre-2018 deferred foreign income treated as subpart F income under Code Sec. 965, see FTC 2d/FIN ¶ O-2700 et seq. Publication 5292

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