domesticating individually-owned controlled foreign corporations...

Domesticating Individually-Owned Controlled

Foreign Corporations Post-Tax ReformRestructuring CFCs for U.S. Taxpayers, Mitigating Tax Liability, Section 962 Election, Transition Tax

Today’s faculty features:

Presenting a live 90-minute webinar with interactive Q&A

1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

THURSDAY, JUNE 20, 2019

Paula Brunoro-Borokhov, Principal, Brunoro Law, San Diego

William R. Skinner, Partner, Fenwick & West, Mountain View, Calif.

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:

Domesticating Closely Held CFCs: Planning Strategies and Issues

Strafford Webinar – June 2019

Presented By:

Paula Brunoro-BorokhovBrunoro Law, APC

600 W. Broadway, Ste 700San Diego, CA 92101

(619) [email protected]

Paula’s practice is focused in assistingbusinesses and individuals with business and taxrelated matters, where her diverse back- ground,strong analytical and communication skills,come into play.

Paula has vast experience assisting domesticclients in all sorts of tax controversy matters andtax planning for individuals and families.

As general counsel, she assists clients with avariety of complex business and corporateissues. She also handles international businessand tax matters, including tax planning formultinational families and businesses,international tax audits, offshore voluntarydisclosures, cross border transactions, transferpricing, tax treaties, and foreign tax credit.

Paula also provides guidance and representationto US clients transacting businesses overseasand foreign clients with assets or businessrelations in the US.

6

mailto:[email protected]

I. Key Changes to CFC Rules

7

1. Elimination of Voting Control Requirement:

I.R.C. Section 951(b)❑ Expansion of the definition of “US Shareholder”: 10% or more of vote or value.❑ US person holding only non-voting preferred shares now falls under the

definition of a “US Shareholder” for CFC purposes.

Example: USShareholder

Foreign Company

5% voting + 3% value + 8% non-voting preferred

❑ Prior law: not a US Shareholder❑ T.C.J.A: US Shareholder – value of voting and non-voting >10%

8

2. 30-day Rule Repeal: I.R.C Section 951(a)(1)

❑ Pre-T.C.J.A: Foreign corporation needed to be a CFC for an uninterrupted period of at least 30 days.

❑ T.C.J.A: U.S Shareholder is subject to US tax on its prorated share of Subpart F income even if foreign corporation is only a CFC for a single day in the year, provided the US Shareholder owned the CFC on the last day of CFC’s tax year

9

3. Stock Attribution Rules: I.R.C Sections 951(b), 957(a),

958(a) and 318(a)

❑ General Rule: Take into account shares owned directly, indirectly and constructively by US persons.

❑ Repeal of I.R.C Section 958(b)(4), which generally prevented downward stock attribution from a foreign shareholder to a domestic subsidiary.

Example

US Person

ForeignSubsidiary

Foreign Parent100%

49%

51%

➢ US Person is treated as owning all of the foreign parent’s stock in the foreign subsidiary.

➢ Foreign Subsidiary is a CFC➢ US Person Subpart F inclusion is

limited to its directly held stock and stock owned indirectly through foreign entities.

10

3.1 Stock Attribution Rules: I.R.C Sections 951(b),

957(a), 958(a) and 318(a)

Foreign Investors

Foreign Parent

US Corporation

Foreign Subsidiary

100%

100%

80%

Example 2

20%

➢ USC is treated as owning all of the stock of FS (20% directly and 80% constructively) under IRC 318(a), causing FS to be a CFC

➢ USC inclusion of Subpart F income is limited to its pro rata share in respect of its directly held stock (20%)

11

3.2 Stock Attribution Rules: I.R.C Sections 951(b),

957(a), 958(a) and 318(a)

Foreign Investors

Foreign Parent

US Corporation

Foreign Subsidiary

90%

100%

100%

Example 3

➢ USC constructively owns all of FS stock

➢ USC has no direct or indirect ownership in FS and no Subpart F income

➢ FS is also a CFC as to USP➢ USP must include its pro rata share

of Subpart F income

US Person

10%

12

4. Stock Attribution Rules: Notice 2018-13

❑ Exception to the filing requirements for Form 5471 with respect to certain constructive owners of CFCs.

❑ Exception from Category 5 filing solely because that US person is considered to own the stock of the CFC owned by a foreign person by means of the downward rule.

US Person Non-US Investors

Foreign Parent

US CorporationForeign

Subsidiary

5% 95%

100%100%

13

5. Transition Tax: I.R.C 965

❑ General Rule: deemed repatriation tax on the previously untaxed E&P of certain foreign subsidiaries by causing a one-time increase in the Subpart F income of such subsidiaries.

US Person

SFCSubpart F Income

951(a)(1) inclusion

❑ Specified Foreign Corporation: CFC or any foreign corporation (other than a PFIC) in which a domestic corporation is a 10% or greater US Shareholder.

14

5.1 Transition Tax: I.R.C 965

❑ Applies to the taxable year of the CFC that begins before January 1 2018.

❑ Applies to both corporate and noncorporate US Shareholders.

❑ Existing FTC can be used to offset the transition tax.

❑ Payment can be spread over 8 years upon election.

❑ The amount of the repatriation: "higher of E&P" as at November 2, 2017 or 31 December, 2017, but the FTCs associated with that E&P may not be already fixed, or the amount of other FTCs that can be offset against the transitional tax.

15

5.2 Transition Tax: I.R.C Section 965

❑ I.R.C Section 965 allows deductions to offset a portion of the inclusion such that the repatriated earnings are effectively taxed at one of two rates.

❑ Cash and equivalents: rate of 15.5%

❑ Remaining earnings: rate of 8%

Untaxed Foreign Earnings

16

6. Territorial System: 100% Dividends Received

Deduction

❑ I.R.C 245A: 100% dividends received deduction to C Corporations who are US Shareholders of a SFC.

❑ Gain recognized by a C Corporation on the sale or exchange of stock in a foreign corporation held for more than one year that is treated as a dividend under Section 1248 is treated as a dividend for purposes of the 100% DRD.

❑ No FTC allowed.

❑ Hybrid dividends do not qualify for the DRD.

17

7. GILTI: I.R.C Sections 951A and 250

❑ GILTI is the excess of the US Shareholder’s aggregate net tested income over a routine return of 10% on its aggregate pro rata share of the depreciable tangible property of the CFC.

❑ Tested income does not include ECI, Subpart F, foreign oil and gas income, high taxed exception income if elected (18.9%) and related party dividends.

❑ 10% routine return applied to the average of the aggregate adjusted basis of depreciable tangible property used in a trade or business to produce teste income as of the end of each quarter.

❑ GILTI is included in gross income in the same manner as Subpart F and is allocated among CFCs in proportion to their share of GILTI.

18

7.1 GILTI: I.R.C Sections 951A and 250

19

7.2 GILTI: Foreign Tax Credits

❑ Deemed paid FTC under I.R.C Section 960 allowed for foreign taxes properly attributable to tested income

❑ Deemed paid credit is limited to 80% of the product of the domestic corporation’s inclusion percentage multiplied by the aggregate tested foreign income taxes

❑ GILTI is separately basketed (other than passive)

❑ No carryovers or carrybacks

❑ I.R.C. Section 78 gross-up for 100% of the deemed paid foreign income taxes

20

7.3 GILTI: Deduction for GILTI

❑ New I.R.C Section 250 provides a deduction for GILTI and Foreign-DerivedIntangible Income (FDII) of a Domestic Corporation (not a RIC, REIT or S-Corp) - It does not apply to Individuals

❑ Conceptually, provides a 10.5% minimum rate on GILTI (increased to13.125% after 2025) and a 13.125% (increased to 16.406%) rate onforeign derived income from intangibles held in the U.S

❑ Mechanics - deduction equal to the sum of 37.5% of foreign-derivedintangible income plus 50% of GILTI (limited to taxable income)

❑ For GILTI - Since 80% FTC allowed, if foreign tax rate is higher than13.125%, generally no residual U.S. tax (potentially subject to expenseallocation)

21

7.4 GILTI: Examples (no foreign tax)

Assumptions:

US Corp holds 100% of one CFC

Tax Year 2019FTC Credit CalcSec. 960 Credit

Tax Rate in Effect 21% Inclusion Percentage (900/1000) 0.90

QBAINet CFC Tested Income

1000.001000.00

904 Limitation

900.00Tested Foreign Income Taxes (0%) 0.00

FSI

GILTI

78 Gross Up (100%)Deductions (ignoring other allocations)

0.00-450.00

Net CFC Tested Income 1000.00

Tax Rate (21%)

450.00

Less: 10% of QBAI -100.00 94.50

GILTI InclusionSection 78 Gross Up

900.000.00 Tentative Tax 94.50

Deduction Allowed (50%) -450.00 FTC Allowed 0.00

Net TaxableTentative Tax (21 %)

450.0094.50

Net Tax 94.50 10

22

7.5 GILTI: Examples (foreign tax)

23

8. Foreign Derived Intangible Income

❑ FDII is the portion of a domestic corporation’s deemed intangible income, which is derived from non-US sources.

❑ Rate is lower than domestic corporate tax rate.

❑ The income of the US company that exceeds the 10% return on the depreciable tangible assets of the company and which is "foreign" in nature is taxed at an effective rate of 13.125% (16.406% starting 2026).

❑ Available only to US Corporations.

US Parent

Foreign Subsidiary

Non-US Investors

24

8.1 Foreign Derived Intangible Income

Example

US Parent

Foreign Manufacturer

Foreign Service Co

Foreign Distributor

GI: $110Taxes: $0QBAI: $0

➢ FDII: $110➢ Deemed Deduction: 37.5% x 110 = $41.45➢ FDII Tax: (110-41.45) x 21% = $14.44➢ FTC: $0➢ FDII taxation after FTC: $14.44➢ Effective tax rate on FDII: 14.44/110 = 13.125%

25

9. Section 367(a)(3) Repeal

❑ Transfers of property used in an active trade or business no longer qualify as a non-recognition transfer.

26

Domesticating Closely Held CFCs:

Planning Strategies and Issues

Presented as part of Strafford Webinar

June 2019

By William Skinner

29

William R. Skinner, Esq. is a tax partner

with Fenwick & West LLP, in Mountain

View, CA. He graduated from Stanford

Law School and was recognized as a Rising

Star in Tax by California Super Lawyers.

He focuses his practice on U.S.

international corporate taxation, M&A

taxation and tax controversies.

William R. Skinner

Partner, Tax Group

Phone: 650.335.7669

Fax: 650.938.5200

E-mail:

[email protected]

Emphasis:

International Tax

Tax Planning

Tax Controversy

TAX GROUP

II. The Section 962 Election

30

TAX GROUP

The Section 962 Election – Why May it Now Be Necessary

▪ GILTI has harsh effects on US individuals and other non-C corporation shareholders of CFCs for several reasons:

• Treatment of GILTI as ordinary income rather than qualified dividend income – See Rodriguez v. Commissioner, 137 T.C. 174 (2013) and SIH Partners LLP v. Commissioner, 150 TC No. 3 (2018).

• Broad scope of GILTI as including most if not all CFC income

• Inability of an individual to claim an indirect credit under section 960(a) for entity-level foreign taxes

▪ An individual with a CFC generating significant income will need to consider Section 962 as one of the possible planning alternatives for these harsh results.

31

TAX GROUP

GILTI – Impact of a Section 962 Election

▪ Section 962 allows an election to be made by a United States shareholder

that is an individual to be taxed at corporate rates on subpart F income

and GILTI.

▪ Where the Section 962 election is made, the United States shareholder’s

tax on subpart F income / GILTI is limited to the following:

• The maximum rate of tax that would apply to the amount of subpart F income under Section 11 of the Code if it were received by a domestic corporation, less

• Any indirect credit that would be allowed to such a domestic corporation with respect to the subpart F income under Section 960.

▪ For calculating the hypothetical corporate tax on GILTI, the proposed

Section 250 regulations make the 50% deduction available.

32

TAX GROUP

GILTI – Impact of a Section 962 Election

▪ Section 962(d). Actual dividends by a CFC out of its earnings that were taxed under Section 962 are tax-free PTI distributions only to the extent of the amount of tax paid under Section 962(a).

▪ Any amounts in excess of the Section 962(d) PTI are not excluded from gross income under Section 959(a) and hence constitute taxable dividends.

▪ Treatment of dividends as ordinary income or qualified dividend income appears to depend on whether the foreign corporation is or is not a Qualified Foreign Corporation under Section 1(h)(11)(C). See Barry Smith v. Commissioner, 151 TC No. 5 (2018).

33

TAX GROUP

Section 962 Election – Example 1

▪ US Shareholder owns stock of a Singapore CFC that generates $100 of tested income taxed at 15%.

▪ What are the effects of electing Section 962?

34

CFC

Singapore

CFC has no QBAI = $0

Net Income $100

Foreign Tax <$15>

E&P $85

US

Shareholder

Assume CFC Earns Solely Tested Income

100%

US Shareholder Owns Only One CFC

TAX GROUP

Example of a Section 962 Election –

Sing CFC with 15% Tax Rate

35

Without Section 962(a) With Section 962 Election

GILTI $100 GILTI $100

Foreign Tax ($15.00) Foreign Tax ($15.00)

Net GILTI $85.00 Net GILTI $85.00

Shareholder Tax at 37% ($31.45)

After Tax Income $53.55 Hypothetical Corporate Tax $10.50

Tax Rate 46% Less Indirect Credit ($12.00)

Net Tax under Sec. 962(a) $0.00

Initial Tax Rate 15%

Additional Tax on Dividend

Distribution $85.00

Less Section 962(d) PTI $0.00

Net Dividend $85.00

Tax at Ordinary Rates ($31.45)

After Tax Income $53.55

Tax Rate - On Repatriation 46%

TAX GROUP


With Qualified Dividend income

▪ US Shareholder owns stock of a UK CFC that generates $100 of tested income taxed at 15%. Assume UK CFC is qualified foreign corporation for purposes of Section 1(h)(11)(C).


36

CFC

UK


Net Income $100

Foreign Tax <$15>

E&P $85

US

Shareholder


100%


TAX GROUP


UK CFC with 15% Tax Rate & 1(h)(11)

37











Distribution $85.00


Net Dividend $85.00

Tax at 1(h)(11) Rates ($17.00)



TAX GROUP


Low-Taxed CFC

▪ US Shareholder owns stock of a Bermuda CFC that generates $100 of tested income taxed at 2%.


38

CFC

Bermuda


Net Income $100

Foreign Tax <$2>

E&P $98

US

Shareholder


100%


TAX GROUP


Bermuda CFC with 2% Tax Rate

39











Distribution $98.00

Less Section 962(d) PTI ($8.90)

Net Dividend $89.10

Tax at Ordinary Rates ($32.97)



TAX GROUP

Other Relevant Issues in Actual Repatriation

▪ In addition to federal income taxes of actual dividends, several other taxes may be triggered by an actual repatriation of earnings from a closely CFC:

• Foreign withholding taxes (which may or may not be creditable)

• State income taxes

• 3.8% Medicare contribution tax

▪ Accumulated Earnings Tax should also be considered (note – PHC cannot apply to a foreign corporation).

40

TAX GROUP

Example 1 with SALT and Foreign Taxes

▪ In addition to basic facts, assume that Singapore imposes a 10% dividend withholding tax. Shareholder resides in the state of California (13.3% top rate) and is subject to Medicare contribution tax.

41

CFC

Singapore


Net Income $100

Foreign Tax <$15>

E&P $85

US

Shareholder


100%


TAX GROUP

Example 1 with Additional Taxes – No Section 962

42

Without Section 962(a)

GILTI $100

Foreign Tax ($15.00)

Net GILTI $85.00




Distribution of Cash $85.00

Less Sing WHT at 10% ($8.50)

Net Cash $76.50

Less Cal Tax at 13.3% ($10.17)

Less NIIT at 3.8% ($2.91)

Plus Sec. 960(b) Credit against GILTI $8.50

After Tax Cash $40.47

Shareholder Taxes ($13.08)

Total Tax Rate on Repatriation 60%

TAX GROUP

Example 1 with Additional Taxes – Section 962

Election

43

With Section 962 Election

GILTI $100

Foreign Tax ($15.00)

Net GILTI $85.00

Hypothetical Corporate Tax $10.50

Less Indirect Credit ($12.00)




Distribution $85.00


Net Dividend $85.00

Less Sing WHT at 10% ($8.50)

Net Cash $76.50

Less Cal tax at 13.3% ($10.17)

Less NIIT at 3.8% ($2.91)

Fed Tax at Ordinary Rates ($31.45)

FTC For Sing Taxes $8.50

After tax cash $40.47

Total Tax Rate on Repatriation 60%

TAX GROUP

GILTI – Election Mechanics

▪ Only an individual, estate or trust that is a United States shareholder as defined in Section 951(b) is permitted to make the Section 962 election.

▪ Partnerships and S corporations are not eligible. However, individuals owning through a pass-through entity that are themselves United States shareholders are permitted to make the Section 962 election.

▪ The election is made annually.

▪ The election applies to all controlled foreign corporations owned by the individual; you cannot select particular CFCs for the election.

44

TAX GROUP

Section 962 Election Mechanics

▪ S Corp cannot elect Section 962 because it is not an individual.

▪ Father can elect as a 958(b) shareholder of >10%. Son can also elect as a 958(b)

shareholder of >10%.

▪ Cousin cannot elect because not a 10% United States shareholder in own right

45

S Corp

Son

5%

Father Cousin

CFC

90% 5%

GILTI/Subpart F Income

TAX GROUP

Interaction of Section 962 with Section 956 Investments

▪ What is the impact of Section 956 in the post-TCJA environment? How does Section 956 interact with Section 962 election?

46

CFC

Shareholder

$125 Loan

$100 GILTI PTI (§962)

$50 Untaxed E&P

TAX GROUP

Interaction of Section 956 & Section 962

▪ As to the $100 of Section 962 PTI, it appears that the full $100 is available to exclude the Section 956 investment from gross income. See Section 962(d) (referring to Section 959(a)(1), not Section 959(a)(2)).

▪ As to the $25 section 956 investment in excess of PTI, Section 956 continues to apply because Shareholder is not a C corporation eligible for Section 245A.

▪ Questions:

• If Shareholder elects Section 962 with respect to the $25 Section 956 inclusion, is the hypothetical C Corporation tax under Section 962(a)(1) zero because of Section 245A?

• Note FTC regulations turn off the indirect credit on Section 956 amounts.

47

III. Domestication and restructuring

strategies of CFCs for U.S. taxpayers

49

1. Check the box: treat FC as US Partnership

❑ File Form 8832 to treat the foreign company as a partnership for US tax purposes to avoid CFC status.

❑ US shareholders would be taxed on the underlying income on a flow-through basis.

❑ US shareholders would be able to claim foreign tax credits.

❑ Drawbacks?

❑ Election could trigger a deemed liquidation of the company.

❑ US owners could recognize taxable gain on the deemed sale of their shares.

❑ Not all foreign business entities are eligible.

50

1.1 Check the box: turning subs into branches

❑ Regs. Sec. 1.318-1(b)(1): a corporation cannot be considered to own its own stock by virtue of the attribution rules.

❑ Turn FS into a branch.

❑ FP can’t own its own stock. USCo cannotbe considered as owning FP’s stock.

❑ Formerly deemed CFC are one entity from US perspective.

❑ Option 2: turn US sub into a branch.

51

2. Contribute Foreign stock to US Corporation

❑ If US Corporation owns at least 10% of the foreign company, the US tax rate on GILTI is reduced from 37% to 10.5% and possibly down to 2-3% or less after the 80% FTC is taken into account.

❑ Subsequent distributions of foreign income is potentially eligible for the 100% DRD under Section 245A.

❑ Drawbacks?

❑ Two levels of tax on subsequent sale at a gain.

❑ Accumulated earnings and personal holding company taxes.

❑ Taxation in foreign country.

52

3. Contribute Foreign stock to PPLI

❑ Assets go into a life insurance policy that allows owner to borrow from the death benefits while alive.

❑ Drawbacks?

❑ Complicated

❑ Relinquish of control

❑ Costs

53

4. Estate Planning Options

❑ Check the box: Obsolete with the repeal of the 30-day rule.

❑ Harvesting Gains

❑ Segregating non-US assets

❑ Avoiding or minimizing US situs assets

❑ Two tier blocker structure

54

4.1 Two tier Blocker Structure

50%

❑ Avoid US estate tax, provide step-up in basis and avoid substantial Subpart F income to US beneficiaries.

Foreign Grantor

Trust

Top Tier –Foreign Entity 1

Top Tier –Foreign Entity 2

Lower Tier –Foreign Entity 1

US Investment Portfolio

100%100%

50%

55

TAX GROUP

IV. Additional Practical Issues

in Domestication Transactions

56

TAX GROUP

Section 962 PTI Ordering Rules

▪ Section 962(d) is subject to the same ordering rules as other PTI –i.e., LIFO ordering of Section 959(c)(1), followed by LIFO ordering Section 959(c)(2) accounts.

▪ Where shareholder has both Section 962(d) PTI and other PTI, the source of the distribution will be critical.

▪ There is no priority for fully taxed PTI in advance of Section 962 PTI.

▪ However, Notice 2019-1’s priority rule for all Section 965 PTI can be helpful in allowing Section 965 PTI to be distributed before Section 962(d) amounts.

57

TAX GROUP


▪ Unlike normal LIFO ordering rule, Section 965 PTI of $400 is distributed first

and results in an exclusion of $300 from gross income.

▪ Next $100 can also be distributed tax-free before Sec. 962(d) amounts are

distributed.

58

CFC

Shareholder

Distributes $300

2017 $400 Section 965 PTI

2018-2019 $200 GILTI / §962 PTI

TAX GROUP


▪ C Corporation as a successor in interest under Section 959(d) has $400 of Section 965

PTI. C Corporation also has $200 of GITLI PTI. CFC can distribute $600 to C

Corporation tax-free as a PTI distribution.

▪ However, under normal Section 301(c) rules, C Corporation appears to have $200 of

E&P due to the GILTI. See GLAM 2015-3. This comes out of C Corporation first.

59

CFC

Shareholder

$400 §965

InclusionContributes

on 1/1/2018C Corp

Blocker

CFC

$200 GILTI

$400 965 PTI

$200 GILTI PTI

TAX GROUP

Ownership of a Foreign Branch / Flow-through Entity

▪ Direct foreign business activities remain subject to worldwide

taxation subject to a foreign tax credit, as under pre-2018 law.

▪ A new FTC basket applies to income “attributable to” foreign

branches, as provided under regulations. Sec. 904(d)(2)(J).

▪ Foreign business income generally is not eligible for the 20%

deduction for pass-through income because of limitation to income

effectively connected with a US trade or business. Section

199A(c)(3)(A)(i).

• However, income from providing sales and services to foreign

customers as part of a US trade or business may qualify for the

reduced rate of tax on pass-through income.

60

TAX GROUP

S Corporation – Flow-Through Structure

▪ Through F Reorganization, shareholder domesticates CFC into a branch of an S corporation.

▪ What are the pros and cons of S Corporation structure?

61

Shareholder

S Corp

F DRE

10% WHT on Distributors

20% Tax Rate

TAX GROUP

Considerations in S Corporation / Flow-Through

Pros:

▪Allows direct credit for foreign entity level taxes. No second level US federal income tax

on actual distribution of profits.

▪No AET / PHC issues.

▪No Medicare contribution tax if individual actively participates.

▪Consider whether Section 199A applies to foreign income that is effectively connected

income with a QTOB.

Cons:

▪No deferral of residual US tax

▪No deferral of state tax

▪Gives up benefit of tax-free repatriation of Section 965 PTI

62

TAX GROUP

New High-Taxed Exception for GILTI

▪ New proposed regulations (REG 101828-19) allow the taxpayer to elect

to exclude from GILTI tested income subject to a rate of at least 90% of

the C Corporation rate (18.9%).

▪ In the case of high-taxed CFCs, this new rule may considered in lieu of

Section 962. Does it yield a better result?

63

Shareholder

UK CFCTested Income

20% Foreign Tax

TAX GROUP

Any Questions

William R. Skinner

Partner, Tax Group

Fenwick & West LLP

(650) 335-7669

[email protected]

64

65

Thank You

William R. Skinner, Partner, Tax Group

Fenwick & West LLP

(650) 335-7669

[email protected]

Paula Brunoro-Borokhov, Principal

Brunoro Law, APC

(619) 394-8681

[email protected]

65

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