Mandatory Repatriation Provisions in Tax Bills Will Require Immediate Action for US Shareholders
The mandatory repatriation provisions in both the House and Senate Tax bills will require US shareholders of Controlled Foreign Corporations (“CFCs”) to include in their 2017 taxable income their pro rata share of the post-1986 previously untaxed accumulated earnings and profits (“E&P”) of such CFCs. Much of the media coverage around these provisions has focused on the impact for US multinationals such as Apple and Google with billions of dollars of foreign earned cash previously kept outside the US tax net. However, a lesser known but clearly important aspect of these provisions is that, if enacted, the rules will apply to all US shareholders of CFCs. As defined, the term US shareholder means US individuals, domestic partnerships, domestic trusts, and domestic corporations that own 10% or more of the voting power of the shares of a CFC.
Given that the mandatory repatriation provisions will apply for the 2017 tax year (or the first tax year ending after December 31, 2017 for fiscal year taxpayers), it is critical that impacted US shareholders determine the amount of unrepatriated E&P in their CFCs as soon as possible. In the case of US shareholders that are C corporations, they will also have to determine the accumulated taxes (commonly referred to as tax pools) paid by such CFCs to determine the amount of foreign tax credits that may (partially or fully) shelter the US tax cost on the mandatory repatriation of accumulated E&P.
For US shareholders that have previously asserted in their US GAAP financial statements that they intend to permanently reinvest their earnings outside the US for purposes of their income tax provision, such assertions will no longer be valid. The tax cost of the mandatory repatriation provisions will have to be accounted for in their 2017 (or first applicable FYE thereafter) US GAAP financial statements.
This alert provides an overview of key aspects of the mandatory repatriation provisions in both the House and Senate bills and recommended action for affected taxpayers.
The Mechanics (Simplified)
The mandatory repatriation provisions require any US shareholder to include in income the US shareholder’s pro rata share of the net post-1986 accumulated E&P of the CFCs it holds shares in. Such amounts will be treated as subpart F income, and taxed at the rates applicable to subpart F income (but adjusted as described below). Unlike the current subpart F regime that looks at each CFC on a stand-alone basis, and generally only requires inclusions in income of current year earnings of each CFC, the proposed rules allow positive accumulated E&P in one CFC to be offset by negative accumulated E&P in other CFCs in which the same US shareholders owns voting shares. The net amount required to be included in income will be the accumulated E&P through December 31, 2017 (or the first fiscal year ending thereafter for fiscal year taxpayers).
Both bills allow for a partial dividend received deduction (“DRD”) against the net accumulated E&P that must be included in the US shareholder’s income. The DRD percentage is higher for net accumulated E&P that is held in non-cash assets versus cash assets. The Senate version of this provision provides for a DRD such that US shareholders that are C corporations would be taxed at a 14.49% rate on cash assets and a 7.49% rate on non-cash assets (the rates would generally be slightly higher for individuals and trusts that are US shareholders). The House bill, by contrast, simply imposes a 14% rate on cash assets and a 7% rate on non-cash assets.
Both bills allow the tax to be paid in installments over 8 years. A special deferral rule is allowed for individual shareholders of S corporations when the S corporation is a US shareholder in a CFC. The bill provides triggering rules for S corporations, whereby the individual shareholders of an S corporation would only owe tax on the subpart F inclusion upon the occurrence of certain triggering events (such as the sale of the shares of the S corporation). It is not clear why a special rule was provided for S corporations and not partnerships or LLCs that are US shareholders.
Given the lower effective rates of tax that will be paid on the subpart F inclusions under the mandatory repatriation rules, a scaled back foreign tax credit will be allowed for C corporations that otherwise would have been allowed to take a foreign tax credit on actual or deemed distributions from CFCs under current law.
What Does CohnReznick Think?
The impact of the mandatory repatriation rules will be significant for US shareholders of CFCs. Given that the rules will apply for the 2017 tax year, it is important that those impacted begin now to assess the impact.
The only way to determine the impact of the new rules will be to determine the post-1986 E&P of each of the CFCs in which the US shareholder owns shares. E&P is the net profit of the CFC determined under US tax principles. Unfortunately, many US shareholders do not accurately track E&P annually because such calculations only mattered for purposes of calculating US tax liability if an actual distribution was made from a CFC, or there was a deemed income inclusion from the CFC under subpart F, or other deemed inclusion provisions. Furthermore, many US shareholders typically pay little attention to E&P calculations for CFCs with losses because tracking such amounts made little to no difference for US tax purposes. Given that the mandatory repatriation provisions allow for netting of negative E&P CFCs against positive E&P CFCs owned by the same US shareholders, calculating the negative accumulated E&P in loss making CFCs will be critical.
For impacted C corporations, calculating the tax pools in all of their CFCs will be equally critical in order to determine the actual tax cost of the mandatory repatriation provisions.
For taxpayers that are impacted by the mandatory repatriation provisions, and who issue audited GAAP financial statements, they will no longer be able to assert that they are permanently reinvesting non-US earnings for purposes of their income tax provision.
CohnReznick has a dedicated team of specialists that can assist taxpayers in assessing what the impact of the mandatory repatriations provisions will be, and how to plan going forward in light of such provisions.
For more information, please contact James Wall, Principal, International Tax Services, at James.Wall@CohnReznick.com or at 646-254-7460 or Christina Lee, Partner, National Tax – International Tax Services, at Christina.Lee@CohnReznick.com or at 646-254-7450 or James Robbins, Partner, International Tax Services, at James.Robbins@CohnReznick.com or at 646-762-3033.
Any advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues. Nor is it sufficient to avoid tax-related penalties. This has been prepared for information purposes and general guidance only and does not constitute legal or professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice specific to, among other things, your individual facts, circumstances and jurisdiction. No representation or warranty (express or implied) is made as to the accuracy or completeness of the information contained in this publication, and CohnReznick LLP, its partners, employees and agents accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it.