Mandatory deemed repatriation income – IRC Section 965 amount

As part of the transition to a new territorial tax regime, the new IRC Section 965 enacted by the Tax Cuts and Jobs Act of 2017 requires certain U.S. shareholders of controlled foreign corporations (CFCs) to recognize mandatory deemed repatriation income as Subpart F income. In general, the net IRC Section 965 amount is the post-1986 accumulated earnings and profits and deficits recognized under IRC Section 965(a) and (b) (together referred to as IRC Section 965(a) inclusion amount) less the deduction under IRC Section 965(c). 

At the federal level, U.S. shareholders may elect to defer payment of the federal tax liability with respect to the mandatory deemed repatriation income. New York State, however, disallows the deferral of any New York State tax associated with mandatory deemed repatriation income. 

New York City follows suit in similar respects. For New York City’s business corporation tax purposes, the IRC Section 965(a) inclusion amount received from both unitary and nonunitary corporations not included in a combined return with the taxpayer is to be treated as gross exempt CFC income – not gross investment income, effective for tax years beginning on or after Jan. 1, 2017, and as such, the federal deduction under IRC Section 965(c) is not allowed. 

The computation of the net IRC Section 965 amount for New York City purposes, however, is more complex. The IRC Section 965(a) inclusion amount received from both unitary and nonunitary corporations not included in a combined return with the taxpayer, less any interest deductions directly or indirectly attributable to the income (or less 40 percent of IRC Section 965(a) inclusion amount if the safe harbor election is made) is to be treated as exempt CFC income, and this exempt CFC income must be deducted from entire net income (ENI) when computing business income. In determining the amount of interest deductions directly or indirectly attributable to the IRC Section 965(a) inclusion amount, taxpayers must follow the guidance provided in Finance Memorandum 16-2, Direct and Indirect Attribution of Interest Deductions Under the Business Corporation Tax; Finance Memorandum 18-11, Impact of IRC Section 163(j) Limitation on Interest Attribution; and Finance Memorandum 18-9. For purposes of Finance Memorandum 16-2, if the stock of a foreign corporation that generates the IRC Section 965(a) inclusion amount is business capital, then the stock is exempt CFC stock; if the stock of a foreign corporation that generates the IRC Section 965(a) inclusion amount is investment capital, then the stock is not exempt CFC stock. 

Compared to prior law, this new approach to mandatory deemed repatriation income inclusion is not generally favorable to New York City taxpayers, as it will drastically reduce the amount of exempt CFC income to be deducted from ENI in computing the New York City business corporation tax – previously, exempt CFC income encompasses the IRC Section 965(a) inclusion amount plus the interest deductions attributable to IRC Section 965(a) inclusion amount; the new law, however, requires the interest  deductions attributable to IRC Section 965(a) inclusion amount to be subtracted from the IRC Section 965(a) inclusion amount to arrive at exempt CFC income. 

Taxpayers who have an underpayment of estimated tax penalty related to the addback of interest deduction attributable to the IRC Section 965(a) inclusion amount (or the 40 percent safe harbor election attributable to the IRC Section 965(a) inclusion amount) on their 2017 New York City Business Corporation Tax return may request a penalty abatement. This penalty relief is not available for tax years after 2017.

Finally, the IRC Section 965(a) inclusion amount is not included in the numerator or denominator of the business allocation percentage (BAP).

Global intangible low-taxed income

For federal tax purposes, IRC Section 951A requires certain U.S. shareholders of CFCs to include in gross income the CFC’s global intangible low-taxed income, which is the excess of a U.S. shareholder’s net CFC tested income for the tax year over the U.S. shareholder’s net deemed tangible income return for the tax year. The GILTI amount also includes amounts earned directly by the U.S. shareholder, as well as distributive shares of GILTI from flow-through entities. 

At the state level, 95 percent of GILTI (without regard to the FDII and the GILTI deductions under IRC Section 250) is excluded from New York taxation as exempt CFC income for tax years beginning on or after Jan. 1, 2019. New York City has amended its treatment of GILTI and will not follow New York State’s GILTI exemption. For New York City business corporation tax purposes, eligible C corporations must include the net GILTI income (which is GILTI recognized under IRC Section 951A less the IRC Section 250(a)(1)(B)(i) deduction) in ENI when computing business income. Taxpayers must attach a copy of their federal or pro-forma Form 8992, Form 8993, and Schedule I-1 of Form 5471, along with accompanying worksheets used to compute GILTI and, where applicable, FDII amounts, to their New York City tax return.

Since most of GILTI is now being taxed by New York City, receipts from controlled foreign corporations generating GILTI must be included in calculating the allocation percentage to properly reflect the taxpayer’s business income and capital in the city. As the memorandum further indicates, if the stock of a foreign corporation that generates GILTI is business capital, the net GILTI income must be included in the denominator but not the numerator of the business allocation percentage (BAP). Taxpayers must report this amount in the Everywhere column of Form NYC-2.5 or Form NYC-2.5A, Line 53 Discretionary Adjustments, and attach a statement to the return indicating the GILTI amounts included on this line. Alternatively, if the stock of a foreign corporation that generates GILTI is investment capital, only the net GILTI income may be deducted as investment income in the computation of business income, and such GILTI amount is not included in the numerator or denominator of the BAP. 

Foreign-derived intangible income deduction

For federal tax purposes, a U.S. domestic corporation taxed as a C corporation can deduct a portion of its income derived from serving foreign markets.

New York State, however, disallows the federal FDII deduction for tax years beginning on or after Jan. 1, 2017, for purposes of Article 9-A and Article 33.

For purposes of Subchapter 3-A, New York City similarly decouples from the federal FDII deduction for tax years beginning on or after Jan. 1, 2017. In other words, the FDII deduction under IRC Section 250(a)(1)(A) will not be taken into account in calculating the GILTI amount includible for New York City tax purposes.

What does CohnReznick think?

Notably, New York City will now decouple from New York State on the treatment of GILTI. This change not only complicates compliance – because the city and the state will have different sets of rules with respect to the GILTI provisions, it also increases the tax burden for corporations operating in the city – the city now requires its corporations to include the amount of GILTI income in the computation of city taxes even though the state has adopted a 95% exemption on that income.

Contact

John Morhart, Director, National Tax, State & Local Tax

646-762-3460

Corey Rosenthal, Partner, Practice Leader, State & Local Tax

646-625-5729

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