Untangling tax reform: repatriation tax and further guidance

Authored by Jim Alajbegu

On Dec. 29, 2017, the Treasury Department and Internal Revenue Service issued Notice 2018-07, its first major guidance under the Tax Cuts and Jobs Act (the Act). This guidance addresses calls from U.S. shareholders for help with the one-time tax on certain accumulated offshore earnings and profits (repatriation tax).

In general

Newly enacted section 965 imposes a repatriation tax on certain previously untaxed earnings of specified foreign corporations (SFCs) of U.S. shareholders by deeming those earnings to be repatriated. Foreign earnings held in the form of cash and cash equivalents are taxed at a 15.5 percent rate, and the remaining earnings are taxed at an 8 percent rate. The repatriation tax generally may be paid in installments over an eight-year period.

Notice 2018-07 discusses regulations the Treasury and IRS intend to issue, including rules for determining the amount of cash and cash equivalents for purposes of applying the 15.5 percent rate and rules for determining the amount of foreign earnings subject to the repatriation tax. These rules will assist taxpayers by providing certain additional information needed for computing their repatriation tax.

Comments are requested on the rules described in the notice and on what additional guidance is needed to assist taxpayers in computing the repatriation tax. The Treasury and IRS expect to issue additional guidance in the future. Notice 2018-07 will be published in IRB 2018-04 on Jan. 22, 2018.

U.S. individuals who are U.S. shareholders of SFCs affected by repatriation tax

Since we issued our tax alert “U.S. international tax reform: the new global tax landscape,” discussions continued on the application of the new law and the international tax ramifications. Specifically, under the Act, any U.S. shareholder of an SFC must include in its income the pro rata share of the accumulated post-1986 deferred foreign income of the corporation for the last taxable year beginning before Jan. 1, 2018. We anticipated further guidance on whether U.S. individuals would be included as “U.S. shareholders of an SFC” under the repatriation tax imposed under newly enacted section 965. While Notice 2018-07 does not specifically address the issue, based on our current understanding of the new tax law), we believe that the repatriation tax on deferred foreign income is applicable to all U.S. shareholders (including individuals, LLCs, partnerships and corporations) who own a 10 percent or more voting interest in SFCs. SFCs include controlled foreign corporations (CFCs) and 10/50 companies,[1] but not passive foreign investment companies (PFICs) that are not CFCs. This is in contrast to the participation exemption shift to a territorial tax regime which is relevant for C corporations only.

The repatriation tax is assessed on deferred foreign income of such SFCs (generally, deferred earnings and profits related to post-1986 accumulated foreign earnings accumulating during period(s) when an SFC), as of Nov. 2, 2017, or Dec. 31, 2017, whichever date reflects the greatest amount of deferred E&P. We note that with respect to income inclusion, individual U.S. shareholders and investors in U.S. shareholders that are pass-through entities generally can elect application of corporate rates for the year of inclusion pursuant to section 962.

A special rule permits deferral of the repatriation tax liability for shareholders of an S corporation; however, S corporations are required to report the includible repatriation amount as well as the amount of deduction that would be allowable, and provide a copy of such information to its shareholders. Any shareholder of the S corporation may elect to defer his (her) portion of the net tax liability at transition to the participation exemption system until the shareholder’s taxable year in which a triggering event occurs.

Payment of the repatriation tax can be undertaken in one payment or by way of eight installment payments. If the installment election is chosen, 8 percent of the net tax liability is made in each of the first five of such installments, 15 percent of the net tax liability in the sixth such installment, 10 percent of the net tax liability in the seventh such installment and 25 percent of the net tax liability in the final or eighth such installment.

Relevant E&P and tax pools must be determined, pro rata shares of inclusions must be calculated for relevant U.S. shareholders, elections for installments (or S corporation deferrals) and initial net tax liability installment payments must be made by the due date of the tax return for the year of inclusion.

Treatment of accumulated post-1986 deferred foreign income as subpart F income

Notice 2018-07 explains that under section 965, the subpart F income of a deferred foreign income corporation (DFIC) for the last taxable year that begins before Jan. 1, 2018, will be increased to include the greater amount of accumulated post-1986 untaxed foreign income determined as of Nov. 2, 2017, or Dec. 31, 2017. Section 965(b) allows for the reduction of the earnings amount (which would be taken into account by a U.S. shareholder with respect to a DFIC) by the amount of such U.S. shareholder’s aggregate foreign earnings and profits deficit which is allocated to such DFIC, resulting in the inclusion amount. Note that limitations under section 952 would not apply to the earnings amount or inclusion amount.

Application of the participation exemption

Notice 2018-07 provides that section 965(c) allows a deduction from the inclusion amount, which is equal to the sum of 8 percent rate equivalent percentage of the excess, if any, of the inclusion amount over aggregate foreign cash position, plus 15.5 percent rate equivalent percentage of so much of the aggregate foreign cash position as does not exceed the inclusion amount.

The “aggregate foreign cash position” means with respect to any U.S. shareholder, the greater amount of

  1. the aggregate of the U.S. shareholder’s pro rata share of the cash position of each SFC, or
  2. one half of the sum of
    1. the inclusion amount described in paragraph (i) determined as of the close of the last taxable year that ends before Nov. 2, 2017, plus
    2. the aggregate described in paragraph (i) determined as of the close of the last taxable year that precedes the year described in paragraph i. 

The following items should be taken into account in determination of the cash position of any SFC:

  1. cash,
  2. net accounts receivables (excess of accounts receivable over accounts payable determined under section 461), and
  3. fair market value of
    1. personal property (actively traded property);
    2. commercial paper, certificates of deposit, securities of the federal government and of any state of foreign government;
    3. any foreign currency;
    4. short-term obligations; and
    5. any asset which the Treasury Secretary identifies as equivalent to any assets described in section 965(c)(3)(B).

“DFIC” is, with respect to any U.S. shareholder, any SFC of such U.S. shareholder that has accumulated post-1986 deferred foreign income greater than zero.

“Accumulated post-1986 deferred foreign income” means the post-1986 earnings and profits of the SFC except for earnings attributable to the effectively connected with the U.S. trade or business income or the income of a CFC that was previously taxed.

In the case of any CFC that has non-U.S. shareholders, the accumulated post-1986 earnings and profits will be reduced by the amount which would be previously taxed if such shareholders were U.S. shareholders. In other words, the earnings and profits would be reduced by the amount attributable to non-U.S. shareholders.

Regulations and further guidance

The Treasury and IRS are aware that section 965 could result in double counting the shareholder’s aggregate foreign cash position as a result of multiple inclusion years of SFCs and U.S. shareholders as well as certain transactions between SFCs.

To avoid double counting and double non-counting, the law authorizes the Treasury Secretary to provide regulations and other guidance to make appropriate adjustments to the amount of post-1986 earnings and profits of an SFC to ensure that a single item will be taken into account only once in determination of the includible income.

For related insights and in-depth analysis, see our tax reform resource center.

For more information on these topics, or to learn how Baker Tilly tax specialists can help, contact our team.

The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely.  The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

[1] 10/50 companies must have at least one U.S. shareholder that is a domestic corporation in order for the repatriation tax to be applicable.