US International Taxation
Prior to the TCJA, what features historically defined the US Federal Income tax regime?
(1) Worldwide Taxation (2) High Corporate Rate (3) Tax Deferral (4) Entity Classification Regime
What are the key features of the US' new purported territorial tax system?
- Dividends received from CFCs are now exempt from US tax, and as a result, there are § 902 foreign tax credits. Note however that the exemption does not apply to hybrid dividends (where the dividend gives rise to a deduction in the country of payment) - Subpart F income remains largely intact (related party sales and services, passive income), foreign base company oil income category repealed. - New category of currently included income: Global Intangible Low-Taxed Income ("GILTI") (companion to foreign-derived intangible income ("FDII")). - § 956 retained - § 954(c)(6) extended through 2025 - Sourcing rules changed to eliminate 50/50 sourcing for exports, so that all exports are sourced to the US. - New foreign tax credit limitation basket for foreign branch income - Stock Attribution Rules are Modified by the repeal of § 958(b)(4), permitting full downward attribution, and may apply to treat stock owned by a foreign person as constructively owned by US persons owned by that foreign person. Note that this modification applies to the last taxable year of foreign corporations beginning before January 1, 2018, and each year going forward. - The 30-Day CFC Rules are modified to repeal the requirement that a corporation must be a CFC for an uninterrupted period of 30 days during the tax year before subpart F inclusions apply.
What are the important considerations for who is an owner for entity classification purposes?
- Tax concepts of beneficial ownership - Debt vs. equity - "Peppercorn" interest - Disregarded entities as owners
What code sections govern CFC dispositions?
A CFC disposition is where US sells CFC to Buyer, who holds CFC as an entity Sale of a CFC is governed by § 1248.
What is included in a CFC's gross income?
A CFC's Gross income includes: (1) Subpart F: § 952; § 954 (2) Tested Income: § 951A (3) Residual: § 245A
What are the characteristics of a disregarded entity for US tax purposes?
A DRE has an identity with its sole owner. Thus it has a "nothing status." However, this may not always be the case; consider: - § 987 - § 1503(d) - § 250(b)(3)(A)(i)(VI) (FDII export benefits not available for "foreign branch income") - Prop. Treas. Reg. § 1.904-4(f) (foreign branch basket rules "regard" certain DRE/parent transactions) - § 385 Regulations (which may be revised or withdrawn) - P.L.R 201644018 (taking into account the limited liability of a DRE owner when characterizing the DRE's debt as recourse or nonrecourse) - Preamble to Treas. Reg. § 1.108-9 (taking into account the limited liability of a DRE owner, treating the DRE's debt as nonrecourse for purposes of applying insolvency exclusion)
What code sections govern a US shareholder's inclusion of foreign income?
A US Shareholder's US inclusions include: (1) Subpart F: § 951(a) -- FTCs: § 960(a) (2) GILTI: § 951A; § 250(a) -- FTCs: § 960(d) Basis adjustments: § 961(a) CFC income from PTEP: § 959
What is the significance of the shift to a quasi territorial system of taxation in the US?
Almost all countries tax income earned by multinational corporations within their borders (i.e., territorial tax systems). In contrast, prior to the TCJA, the US additionally taxed the foreign-source income of US-based multinationals. A multinational headquartered in the US generally was required to pay federal income tax on all of its income, regardless of whether it was earned in the US or overseas. Under the new-quasi territorial system, in order to encourage the flow of capital that had been parked outside of the US by removing tax on repatriation of those funds. The reforms bringing the US closer to a territorial system include: - The transition tax under § 965 - The Participation Exemption System giving certain taxpayers the DRD under § 245A However, taxpayers must still consider the impact of the Subpart F rules and CFC reporting requirements, as well as passive foreign investment company rules. In addition to the CFC and PFIC rules, taxpayer must now be aware of new categories of foreign-source income including GILTI and FDII.
What are the tax consequences arising from a change in entity classification?
Changes in classification have real tax consequences. Deemed transactions occur during the following entity classification changes: - Corporation to disregarded entity - Corporation to partnership - Disregarded entity to corporation - Partnership to corporation - Partnership that goes from two owners to one (no election filed) - Disregarded entity that goes from one owner to two owners (no election filed)
What impact did the TCJA have on choice of entity elections?
Considerations when making a choice of entity election under the new TCJA rules include: - Corporate rate reduction - Foreign source dividends received deduction - New anti-deferral rules (e.g., GILTI) - Accelerated expensing - Limitation on business interest deduction - New foreign branch rules
What code sections govern CFC distributions?
Distributions from CFC to US include: (1) PTEP: § 959 -- FTCs: § 960(b) and (c) (2) Untaxed earnings: § 245A Basis adjustment: § 961(b)
What is the purpose of the anti-deferral rules under Subpart F?
Due to the structure of the US federal income tax regime, US-based multinationals historically found it advantageous to conduct business abroad through foreign subsidiaries. In response to domestic entities increasing their business activities abroad, Congress, during the Kennedy administration, introduced the anti-deferral rules under Subpart F. While taxpayers previously could defer federal tax liability on foreign earnings until such earnings were repatriated to the US, Subpart F created carve-outs from this general rule for certain types of income earned by CFCs. The anti-deferral rules are typically applied to entities located in low-tax jurisdictions.
What is default classification and the effect of this determination on different entities?
Eligible entities include everything that is not a per se corporation. Default Classification is made for eligible entities even if check-the-box election is never filed. See Treas. Reg. § 301.7701-3(b) Eligible entities Include: - Domestic eligible entities (e.g., LLCs and L.P.s) -- Two or more owners = default to partnership -- Single owner = disregarded - Foreign Entities -- Where all owners have limited liability = default is corporation -- Where not all owners have limited liability = default is partnership (two or more owners) or disregarded (single owner)
What is included in a CFC's expenditures and taxes?
Expenditures (including foreign income taxes) of a CFC include: (1) Subpart F: -- Allocation to determine net subpart F: § 954 -- Allocation of FTCs: § 960 (2) Tested Income: § 951A -- Allocation to determine net CFC tested income: § 951A, § 954 -- Allocation of FTCs: § 960 (3) Residual: § 245A
Where US sits at the top of a structure and is 100% owner of US LLC1, which owns 30% of a US LLC2 as a limited partner, with US being the general partner owning 70%, what is the classification of US LLC2? Where US LLC2 owns 40% of France LP as a 40% limited partner, with US being the 50% general partner, and Mexico Srl (DRE), another entity owned 99% by US and 1% US DRE (owned by US), what is the classification of France LP?
Here, every intermediate itself is disregarded in the ownership chain. US LLC2 is disregarded for US tax purposes. France LP is disregarded for US tax purposes.
What is the BEPS initiative?
In response to discourse questioning whether multinational corporations pay their "fair share" of taxes, the Organization for Economic Cooperation and Development (OECD) created the BEPS initiative, which targets companies that allegedly avoid taxation or reduce the tax burden in their home country by engaging in tax inversions or by migrating intangibles to lower tax jurisdictions. The objective of BEPS is to ensure that profits of multinational corporations are taxed where economic activities generating the profits are performed and where value is created. With global coordination seen as essential, the OECD worked to develop a package of 15 actions (i.e., guidelines) to equip governments with the domestic and international instruments needed to execute BEPS recommendations. Nearly 100 countries are participating, as well as several non-State jurisdictions and international organizations participating as Observers.
How have governments around the world responded to the dramatic financial and economic developments occurring over the past several decades?
Regarding treatment of corporate multinationals, governments around the world responded to the dramatic financial and economic developments by: (1) Continuing to court capital and business through reduced corporate tax rates, special repatriation regimes, and various tax incentives (i.e., offensive measures). (2) Enacting new tax laws designed to protect the revenue base created by domestic corporations and subsidiaries of foreign-parented multinationals doing business within their borders (i.e., defensive measures). For example, the Base Erosion and Profit Shifting ("BEPS") initiative of the Organization for Economic Cooperation and Development ("OECD") attempts to tax what is colloquially referred to as "nowhere income."
In general, what is the effect of the Subpart F rules?
Subpart F provides that any income earned by a CFC that is not distributed or otherwise taxed for the tax year in which it was earned is considered constructively repatriated. US shareholders must include the pro rata share of their CFC's Subpart F income in their gross income. For example, where US parent sells goods to Cayman CFC at a cost, and Cayman CFC then sells to Sister Spain CFC (owned by US co), and Spain sells to consumers, US co will have subpart F income. With some notable exceptions, the rules of Subpart F remained consistent and operate in a manner similar to when they were first introduced in the 1960s. Note however that by contrast, the global economy has changed dramatically since then: - Declining rates of corporate taxation outside the US - Increased "tax competition" from havens, emerging economies, and major trading partners - Globalization of capital and sources of wealth - Greater interaction, integration, and exposure of intellectual property - Implementation of sophisticated tax planning strategies - Evolution of transfer pricing methodologies
How is the classification regime applied to business entities?
The classification regime applies to "business entities" by first asking "is it an "entity"?" "Whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law." See Treas. Reg. § 301.7701-1(a)(1).
What is the classification of Nova Scotia Unlimited Liability Company owned by a US corporation?
The default classification is a DRE, because this is a foreign entity, and not all owners have limited liability. This is a real entity type in Canada, where Canada does not have any limited liability companies. So when dealing with Canadian corporations, will see NSULCs and the like.
What is the classification of Nova Scotia Unlimited Liability Company owned 90% by a US corporation, and 10% by Germany GmbH (which is 100% owned by US)?
The default classification is a DRE, because this is a foreign entity, and the owner (Germany GmbH) is itself disregarded. Thus, NSULC only has one owner and is still disregarded. See Rev. Rul. 2004-77.
What is the classification of an Ireland LLC owned by a US corporation and a US individual?
The default classification is a corporation, assuming limited liability for all owners Ireland LLC may be a CFC (if all owners are US persons).
What is the classification of a US LLC owned by a US corporation and a US individual?
The default classification is a partnership, even though it provides limited liability to all owners.
What rules are used to establish whether a CFC exists?
To determine whether a taxpayer is a US Shareholder: § 951(b); § 951A(e)(2) - To determine the type of US Shareholder: § 958 To determine whether a taxpayer is a CFC: § 957(a); § 951A(e)(3)
How is the classification of dually chartered entities determined?
Under Treas. Reg. § 301.7701-5, whether an entity is domestic vs. foreign is determined separately from default classification/eligible entity status. An entity has domestic status if a "business entity" is created or organized in the US (even if also chartered or organized in a foreign jurisdiction). An entity has foreign status if it's not domestic. In determining whether an entity is a per se corporation or an eligible entity: - If per se in any jurisdiction, an entity is a corporation. - If an entity is not a per se corporation in any jurisdiction, it is an eligible entity. The default status of eligible dually chartered entities is determined under the rules of Treas. Reg. § 301.7701-2 and -3. If the laws of any jurisdiction of organization would treat it as a corporation by default, it defaults to corporate classification. See Treas. Reg. § 301.7701-2(b)(9) Thus, consider: Is it organized in the United States? Is it a "per se" corporation in any jurisdiction of organization? If not per se, does it meet the requirements for default corporate treatment?
What is considered to be a "business entity?"
· Companies · Cooperatives · Partnerships · Joint ventures · Agreements · Trusts
What is a per se corporation and the effect of this determination?
·"Per se" corporations are never eligible to elect classification Includes: - US corporations (Corp., Inc., etc.) (IncludesS corporations) - Foreign entities listed in Treas. Reg. § 301.7701-2(b)(8)(i) - Insurance companies and banks - Exempt organizations (§ 501) and government entities - REITs and RICs - Certain publicly traded partnerships
