Second Installment: Advising International Business Ventures: Tax Reform’s “Transition” Tax
Freeman Law frequently advises international business ventures. International operations often give rise to unique (and sometimes unanticipated) compliance obligations and complex reporting requirements. Recent tax reform rules and regulations have imposed a number of new requirements. The IRS and Treasury Department have elaborated on these new rules through proposed regulations and other guidance. This post focuses on, and provides a second installment to, the new “transition” tax under section 965.
Freeman Law’s prior Insight post on the section 965 “transition” tax provides a general overview of the new provision, which impacts taxpayers with international operations. As described in that Insight post, the Tax Cuts and Jobs Act, P.L. 115-97 (2017) (the “Act”) enacted new section 965 of the Internal Revenue Code. Section 965 imposes the new “transition” tax, which applies to the last taxable year of a “deferred foreign income corporation” (“DFIC”) that begins before January 1, 2018.
Under Section 965(a), the subpart F income of a DFIC for the last taxable year that begins before January 1, 2018 (known as the “inclusion year”), is increased by the greater of (i) the “accumulated post-1986 deferred foreign income” of the DFIC determined as of November 2, 2017, or (ii) the “accumulated post-1986 deferred foreign income” of such corporation determined as of December 31, 2017. Whichever amount is greater is referred to as the “section 965(a) earnings amount.”
A United States shareholder must include, in its gross income, its pro rata share of this subpart F income, subject to certain reductions. This is known as the U.S. shareholder’s Section 965 inclusion amount.
This post covers some additional section 965 concepts:
Post-1986 Earnings and Profits and The Section 965(c) Deduction
The TCJA allows a deduction—against a section 965(a) inclusion amount—equal to the sum of:
- the United States shareholder’s 8 percent rate equivalent percentage of the excess (if any) of:
- the section 965(a) inclusion amount, over
- the amount of such United States shareholder’s aggregate foreign cash position, plus
- the United States shareholder’s 15.5 percent rate equivalent percentage of so much of the United States shareholder’s aggregate foreign cash position as does not exceed the section 965(a) inclusion amount.
The amount of the deduction allowed to a United States shareholder is referred to as the “section 965(c) deduction amount.”
The term “aggregate foreign cash position” means, with respect to any United States shareholder, the greater of:
- the aggregate of the United States shareholder’s pro rata share of the cash position of each specified foreign corporation of the United States shareholder determined as of the close of the last taxable year of the specified foreign corporation that begins before January 1, 2018, or
- one half of the sum of:
- the aggregate described in clause (i) determined as of the close of the last taxable year of each specified foreign corporation that ends before November 2, 2017, plus
- the aggregate described in clause (i) determined as of the close of the taxable year of each specified foreign corporation which precedes the taxable year referred to in subclause (a).
The cash position of any specified foreign corporation is the sum of:
- cash held by the corporation,
- the net accounts receivable of the corporation, and
- the fair market value of the following assets held by the corporation (each asset, a “cash- equivalent asset”):
- personal property which is of a type that is actively traded and for which there is an established financial market (“actively traded property”);
- commercial paper, certificates of deposit, the securities of the Federal government and of any State or foreign government;
- any foreign currency;
- any obligation with a term of less than one year (“short-term obligation”); and
- any asset which the Secretary identifies as being economically equivalent to any asset described in section 965(c)(3)(B).
For these purposes, the term “net accounts receivable” means, with respect to any specified foreign corporation, the excess (if any) of (i) the corporation’s accounts receivable, over (ii) the corporation’s accounts payable (determined consistent with the rules of section 461). Section 965(c)(3)(C).
Notably, an entity (other than a corporation) is treated as a specified foreign corporation of a United States shareholder for purposes of determining the United States shareholder’s aggregate foreign cash position if any interest in the entity is held by a specified foreign corporation of the United States shareholder and the entity, if it were a foreign corporation, would be a specified foreign corporation of the United States shareholder.
Tax Credit Implications
The TCJA provides that no credit is allowed under section 901 for the “applicable percentage” of any taxes paid or accrued (or treated as paid or accrued) with respect to any amount for which a section 965(c) deduction is allowed.
The term “applicable percentage” is defined as the percentage equal to the sum of the following two amounts:
(i) 0.771 multiplied by the ratio of (a) the section 965(a) inclusion amount in excess of the United States shareholder’s aggregate foreign cash position divided by (b) the section 965(a) inclusion amount, and
(ii) 0.557 multiplied by the ratio of (a) the amount of the section 965(a) inclusion amount equal to the United States shareholder’s aggregate cash position, divided by (b) the section 965(a) inclusion amount.
With respect to the taxes treated as paid or accrued by a domestic corporation with respect to the section 965(a) inclusion amount, section 78 applies only to the portion of such taxes that bears the same proportion to the amount of the taxes as (i) the excess of (a) the section 965(a) inclusion amount, over (b) the section 965(c) deduction amount with respect to such amount, bears to (ii) the section 965(a) inclusion amount.
Paying in Installments
The TCJA allows a United States shareholder to elect to pay the section 965 net tax liability in eight installments. If a taxpayer makes this election, the first installment is due on the due date (without regard to extensions) for the taxpayer’s tax return for the inclusion year. Each successive installment is due on the due date (without regard to extensions) for the taxpayer’s tax return for the following tax years.
If there is an addition to tax for failure to timely pay an installment, a liquidation or sale of substantially all the assets of the taxpayer (including in a title 11 or similar case), a cessation of business by the taxpayer, or any similar circumstance, the unpaid portion of the remaining installments is treated as due on the date of such event (or in the case of a title 11 or similar case, the day before the petition is filed). However, this rules does not apply in the case of the sale of substantially all the assets of a taxpayer if the purchaser enters into an agreement with the Secretary under which the purchaser is liable for the remaining installments due under section 965(h) in the same manner as if the buyer were the taxpayer.
If a taxpayer has made an installment payment election and a deficiency is later assessed with respect to the taxpayer’s net tax liability, the amount of the deficiency is prorated among the installments. The taxpayer is required to pay the part of the deficiency that prorated to any installment that has already come due upon notice and demand from the IRS. However, this proration rule does not apply if the deficiency is due to negligence, intentional disregard of rules and regulations, or fraud with intent to evade tax.