International Tax UpdateDecember 7, 2020

Doug PomsBrett BloomKPMG LLPThank you to our sponsors!

• Doug Poms, Principal, International Tax, Washington National Tax, dpoms@kpmg.com

• Brett Bloom, Senior Manager, International Tax, Washington National Tax, bbloom@kpmg.com

Speakers

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• GILTI High-Tax Exclusion (“HTE”): Overview of Final and Proposed Regulations• FDII: Key Highlights of Final Regulations• BEAT: Key Highlights of 2020 Final Regulations• FTC and Expense Allocation and Apportionment: Key Highlights of Final and

Proposed Regulations

Agenda

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GILTI HTE: Overview of Final and Proposed Regulations

Specified interest expense = tested interest expense – tested interest income

GILTI Overview

Net CFC Tested Income Net DTIR GILTI Inclusion

Aggregate tested income (from all CFCs) – aggregate tested loss (from all CFCs)

(10% x QBAI) – specified interest expense

QBAI = adjusted basis of depreciable tangible property used to produce tested income

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Foreign oil and gas extraction income (“FOGEI”)

Dividends from related persons

Amounts Excluded under Subpart F High-Tax Exception Election or GILTI High-Tax Exclusion

Election

Amounts taken into account in determining the CFC’s gross subpart F income

ECI: Income from U.S. trade or business

Gross tested income includes all income except:

GILTI Overview: Gross Tested Income

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On July 23, 2020, the following final and proposed regulations were published:

• Final regulations on GILTI high-tax exclusion and subpart F high-tax exception

– Significant changes to the final GILTI high-tax exclusion rules from the 2019 proposed regulations

– Applicable for taxable years of CFCs beginning on or after July 23, 2020

– Taxpayers can choose to apply the final rules for taxable years of CFCs beginning after December 31, 2017, and before July 23, 2020, provided they consistently apply the final GILTI rules and the newly finalized subpart F high-tax exception rules

• Proposed subpart F high-tax exception rules

– Conforms the GILTI high-tax exclusion and subpart F high-tax exception rules into a single high-tax exception regime with a single election applying to all members of a CFC group.

– Significant changes to the subpart F high-tax exception rules (to mirror the GILTI high-tax exclusion rules)

– Prospective applicability date: tax years of CFCs beginning on or after the date the final regulations are filed with the Federal Register

2020 Regulations: Final and Proposed

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Proposed vs. Final Regulations: Computational Similarities and Differences

Computation Component Proposed Regulations Final Regulations

Level at which ETR test is applied

QBU by QBU basis Tested unit by tested unit basis with combination of same country tested units

Tested ETR 90% of rate under section 11 (currently 18.9%)

90% of rate under section 11 (currently 18.9%)

Special rules for fiscal year and other timing mismatches

None None

Special rules for allocating and apportioning deductions (other than taxes)

None Rule related to interest allocated and apportioned with respect to stock of lower-tier corporation

Special rules for disregarded payments

Applies principles of disregarded reattribution transaction (DRT) rules without regard to rule excluding disregarded interest payments

Applies principles of DRT rules without regard to rule excluding disregarded interest payments, with special rules for interest and multiple disregarded payments

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Step 1

Summary: GILTI High-Tax Process Flow

Identify Tested Units

• A CFC• An interest in certain pass-through entities • Certain branchesApply combination rule and “no-where” branch rule

Step 2 Determine Tentative Gross Tested Income (TGTI) items• Gross income of the CFC, as determined under U.S. tax principles, is attributed to the tested units of the

CFC• Gross income is attributable to a tested unit to the extent the income is properly reflected on the separate

set of books and records of the tested unit• Gross income attributable to a tested unit is adjusted, if necessary, to account for disregarded payments

under the principles of the DRT rules with modifications• If gross income could be attributable to multiple tested units, it is attributed to the lowest-tier tested unit

to which it could be attributable9

Summary: GILTI High-Tax Process Flow

Step 3 Determine Tentative Tested Income (TTI) items

U.S. dollar amount of foreign income taxes paid or accrued with respect to the TTI item

U.S. dollar amount of the TTI item + U.S. dollar amount of foreign taxes paidor accrued with respect to the TTI item

Step 4 Determine ETR:

• TGTI items are reduced by CFC’s deductions, including current year taxes, generally allocated and apportioned under the principles of §1.960-1(d)(3)

• In the case of disregarded payments, special rules apply to allocate and apportion taxes

• Negative or undefined tax rate qualifies as high-taxed under the proposed regulations. • What result under the final regulations?

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• The principles of Treas. Reg. §1.904-4(f)(2)(vi) apply with modifications to require adjustments to the gross income of tested units of a CFC for disregarded payments, including disregarded interest payments

• The rules apply whether a disregarded payment is from a CFC to a tested unit owned by the CFC, from a tested unit owned by a CFC to the CFC or between two non-CFC tested units owned by the same CFC, even if there is no disregarded payment between the tested units and the CFC

Accordingly, under the final regulations, a disregarded payment may consist of —• Deductible payments• Payments for property (including inventory) in a disregarded sale or exchange• Disregarded section 1016(a)(1) expenditures• Deemed section 367(d) royalties upon transfers of IP

Disregarded Payment Rules

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The disregarded payments rules generally—• Increase the income of the payee of a disregarded payment, and • Decrease the income of the payor of a disregarded payment,• Without changing the character of the reattributed income, but• The adjustments are limited by the gross income of a tested unit

Special rules apply when a tested unit makes and receives multiple disregarded payments

Disregarded Payment Rules

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• Annual election• The election is made by the “controlling domestic shareholders” of a CFC by filing a statement with a tax

return– The “controlling domestic shareholders” generally are the U.S. shareholders who, in the aggregate, own directly or

indirectly (but not constructively) more than 50 percent of the voting power of the CFC

– The election is binding on all U.S. shareholders

– The controlling domestic shareholders must notify the other U.S. shareholders of the election

– Deadlines for filing or revoking by amended return

• Consistency requirements for all CFCs in a “CFC group”– A CFC group is an affiliated group as defined in section 1504(a) with certain modifications, including (i) substituting

“more than 50 percent” for “at least 80 percent” and (ii) determination based on vote or value; and (iii) including foreign corporations

– Stock ownership determined under section 318 constructive ownership rules, with certain modifications

– A CFC can be in only one CFC group

Election Rules

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• The GILTI HTE election can be made or revoked on an amended return if certain rules are satisfied− The controlling domestic shareholders must file amended returns within a 24-month period following the

unextended due date for the original tax returns− Each U.S. shareholder:

– Must file, within a six-month period during the 24-month period: » Returns for the election year reflecting the election (or revocation); and» Returns for any years in which U.S. tax liability is increased as a result of the election (or revocation)

– Must pay any tax due as a result of the election (or revocation) within a six-month period during the 24-month period

Election Rules: Amended Returns

APR 15 2019 APR 15 2021

2018 tax year end

DEC 31 2018

Unextended due date for 2018 return Due date for filing amended return with GILTI HTE

24-month period

6-month period

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GILTI HTE ConsiderationsBenefits Detriments

FTCs No reliance on FTCs because income is exempt from tax

ExpenseAllocation

Removes cost of expense allocation against high-tax GILTI

Those expenses are now subject to section 904(b)(4), which requires them to be added back to the denominator of the FTC limitation, causing the expense to potentially reduce section 904 limitation with respect to other categories

Cross-creditingFTCs

Inability to cross-credit excess taxes on high-tax CFC income against low-tax CFC income

QBAI/Tested Losses

Loss of QBAI and potential loss of tested losses subject to foreign income tax

Future Distributions

Future distributions of HTE income is exempt from US tax pursuant to section

245A.

More reliance on section 245A (and not PTEP rules), which also limits ability to claim FTCs for withholding on future distributions

Modeling is essential!

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FDII: Key Highlights of Final 2020 Regulations

FDII Definitional FrameworkFDII = DII * (FDDEI / DEI)

FDDEI = Gross FDDEI – allocable expenses

Gross DEI = Gross income – subpart F inclusion – GILTI inclusion – foreign branch income – dividends from CFCs of which the domestic corporation is a U.S. shareholder –financial services income – domestic oil and gas extraction income

DII = DEI – DTIR

DTIR = 10% x QBAI

QBAI = basis in tangible property that produces DEI

Gross FDDEI = DEI from sales (licenses, leases) to foreign persons for foreign use, or services provided to persons or with respect to property located outside the United States

DEI = Gross DEI – allocable expenses

Gross FDDEI Gross RDEI

FDII = foreign-derived intangible incomeDII = deemed intangible incomeFDDEI = foreign-derived deduction eligible incomeDEI = deduction eligible incomeDTIR = deemed tangible income returnQBAI = qualified business asset investmentRDEI = residual deduction eligible income

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Key Highlights of Final Regulations• Substantiation

– Replace documentation requirements with substantiation requirement that are limited to specific categories of FDDEI transactions

– Increase the threshold for the small business exception

• FDDEI Services

– Retain existing categories from proposed regulations and add two new subcategories for advertising services and electronically supplied services

• FDDEI Sales– General property

• Modify foreign use rule by removing the no domestic use within 3-year rule that was in the proposed regulations and replacing it with specific rules based on the method of delivery

• New rules for digital downloads and international transportation property

– IP sales/licenses

• Retain the rule that foreign use of IP is based on revenue from exploitation outside the United States, and provide specific rules on where IP is “exploited”

• New “foreign use” rule for certain “manufacturing method or process”

• Applicability Dates

– Generally prospective applicability: the final rules generally apply to tax years beginning on or after January 1, 2021, but may have optionality for tax years beginning before January 1, 2021

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FDDEI Services Overview

Services

Transportation Services

Property Services

Proximate Services

GeneralServices

General Services to Consumers

Electronically Supplied Services

Other General Services

General Services to Business Recipient

Advertising Services

Electronically Supplied Services

Other General Services

Specific substantiation requirementsRelated party rules

New subcategories added by the final regulations

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New FDDEI Services SubcategoriesAdvertising Services Electronically Supplied Services

Definition ‒ Transmitting or displaying content to consumers with a purpose to generate revenue based on the promotion of a product or service

‒ A service, other than an advertising service, that is primarily delivered over the internet or electronic network

Location of Benefit ‒ Location where advertisements are viewed by consumers

‒ For internet advertising, location of device on which advertising is viewed

‒ IP address may be used

‒ Location where business recipient accesses the service

‒ IP address may be used if reliable

Exception ‒ If less than $50K gross receipts from all services to recipient, service deemed to benefit the billing address; otherwise deemed to benefit U.S. locations

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FDDEI Sales Overview

General Property

OR

AND

Sales of General Property to a related party are subject to the related party rules

ORFDDEI Sale

Foreign Person

Foreign Use

Specific rules based on the method of

delivery

Manufacturing assembly or processing

outside the United States

Physical and material change to

the property

Property is incorporated as a component into a second product;

< 20% FMV

Intangible Property Exploitation outside of the United States

Sales of property to end users

Sales of property for resale

Sales of digital content

Sales of international transportation

property

Final regulations add new foreign use rules for general property

Final regulations add rules for determining the location of the end user 23

FDDEI: Foreign Use of IPFinal rules retain the rule that foreign use of IP is based on revenue from exploitation outside the United States, and provide specific rules on where IP is “exploited”

• Exploitation outside the United States generally depends on the location of the end user

• End user of:

– IP embedded in general property: person that ultimately uses or consumes the property, with location based on foreign use rules

– IP used to provide a service

Generally: recipient of the service, with location based on FDDEI services rules

Property service or transportation service that involves transportation of property: owner of the property

– IP used in development of secondary IP: end user of the secondary IP

– Manufacturing method or process sold to unrelated foreign person: unrelated foreign person

FDDEI: Foreign Use of IP

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BEAT: Key Highlights of 2020 Final Regulations

Deduction Waiver Election

Election to waive deductions

Deduction Waiver Election2019 Proposed Regulations – In General• The 2019 proposed regulations allowed taxpayers to elect to waive deductions that otherwise would be base erosion

tax benefits

– Deductions could be waived in whole or part

• All deductions that are not waived were considered “allowed” and, therefore, BEAT-able, even if not claimed

• Election was made on an annual basis and taxpayers could choose not to make the election for a subsequent year (but may not reverse an election)

• Waiver could be elected on an original return, an amended return, or during exam

• Taxpayers could increase waived deductions on an amended return or during exam, but could not decrease deductions or revoke an election

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Election to waive deductions

Deduction Waiver Election2020 Final Regulations • Generally retain the waiver election, but limit availability of the election to taxpayers that could be an applicable

taxpayer but for the election

– E.g., a CFC that does not have any ECI could not make the election because a foreign corporation with no ECI cannot be an applicable taxpayer

• New rule generally allows corporate partner in a partnership to make a waiver election with respect to its allocable share of partnership deductions

– Partner generally must decrease basis in partnership interest by amount of waived deductions

• Treasury rejected comments requesting that taxpayers be permitted to decrease the amount of waived deductions by amended return or during an exam

• Treasury also rejected comments requesting automatic relief to revoke prior elections under section 59(e)(4) (to capitalize certain R&D expenses) or 168(k)(7) (to not claim additional bonus depreciation)

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Anti-Abuse Rule -Nonrecognition Transactions

Election to waive deductions

Anti-Abuse Rule – Nonrecognition Transactions2019 Final Regulations • The 2019 final regulations provided an exception from base erosion payment treatment for amounts transferred to, or exchanged with,

a foreign related party in a transaction to which sections 332, 351, 355, or 368 apply (“specified nonrecognition transactions”)

• Anti-abuse rule: If a transaction (or series of transactions), plan, or arrangement has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a specified nonrecognition transaction, the specified nonrecognition transaction exception does not apply

– Per se principal purpose if basis step-up transaction between related parties within 6 months prior to specified nonrecognition transaction

2020 Final Regulations • The 2020 final regulations retain the general approach but provide two helpful clarifications/limitations:

– The anti-abuse rule will not apply unless a principal purpose of the basis step-up transaction was to increase depreciation/amortization deductions without increasing base erosion tax benefits.

NOTE: no change to per se rule for related party transactions

– If the anti-abuse rule applies, only the increase in basis due to the step-up transaction is disqualified from the specified nonrecognition transaction exception/is treated as a BE payment

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FTC and Expense Allocation and Apportionment: Key Highlights of Final and Proposed Regulations

Allocation and Apportionment of Stewardship Expense –Final Rules

Stewardship Expense Allocation and Apportionment

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Final Regulations

In General— Can be incurred with respect to corporations, partnerships,

and DREs, but not true branches— Clarify that stewardship deductions may be related to

particular entities— Apply to TYBA December 31, 2019 Allocation— Retain expanded allocation (dividends and shareholder-level

inclusions) Apportionment— Retain apportionment based on characterization of interest in

entity as determined for interest expense apportionment purposes

— Special rules for domestic affiliates— Exempt income and asset rules do not apply

In General— Can be incurred with respect to partnerships as well

as corporationsAllocation— Allocable to a class of gross income that includes not

only dividends, but also inclusions of a shareholder under section 951, section 951A, the related section 78 gross-up, and PFIC inclusions

Apportionment— Apportioned based on the stock characterization rules

provided in the interest allocation and apportionment rules (Reg. § 1.861-13)

— Uncertainty as to ability to specifically relate items of stewardship to specific CFCs

2019 Proposed Regulations

Stewardship – Example R

Reg. 1.861-13 Characterization Summary

USP1

CFC3

Facts – USP’s Expense Summary

‒ Expense 1: $900 expenses directly benefit CFC2 and for which CFC2 pays USP a service fee of $1,000

‒ Expense 2: $60 expenses relate to services performed by USP to maintain licenses with CFC1 and CFC2 that produce royalty income

‒ Expense 3: $540 expenses for shareholder oversight (e.g. audit, accounting, treasury) related to all of USP’s subsidiaries

Analysis of USP’s Expenses

‒ Characterization Only Expense 3 is considered a stewardship expense because it is undertaken by USP to

protect its investment in and duplicates activities of its subsidiaries

‒ Allocation Expense 3 is allocated against dividends, subpart F, and GILTI inclusions from USP’s

subsidiaries.

‒ Apportionment Based on Reg. 1.861-13 characterization of the stock of US Sub, CFC1, CFC2, and CFC3:

$180 ($540 x $15K/$45K) to § 951A category

$72 ($540 x $6K/$45K) to general category

$108 ($540 x $$9K/$45K) to passive category

$180 ($540 x $15K/$45K) to residual U.S. source income

Compare to the example in the 2019 proposed FTC regulations that treated the stock of US Sub as an exempt assets and did not allocate the stewardship expense against U.S. source income.

CFC2CFC1US Sub2

TBV: $15K TBV: $5K TBV: $10K TBV: $15K

§951A / Non-245A

$15K

General/ 245A

$6K

Passive / Non-245A

$9K

1 USP has no other assets than the investments shown above.

Reg. 1.861-8(g)(18), Example 18

Stewardship Example

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Poll Question 3Question: Which of the following do the allocation and apportionment of stewardship rules not apply to?

Answers:a. DREs.b. Unincorporated branches.c. Affiliated group members.d. All of the above.

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Allocation and Apportionment of R&E Expense – Final Rules

R&E Expense Allocation and Apportionment

Step 2Step 1 Step 3 Step 4

Determine section 174 deductions.

Allocate to “gross intangible income,” which does not include dividends, subpart F inclusions, or GILTI inclusions.

Reduce by R&E percentage exclusively apportioned to a specific geographic source.

Apportion balance using the sales method.

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R&E Expense – Changes in Final Regulations

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The 2020 FTC Regulations retain the significant aspects of the proposed rules, with notable changes: – For R&E activities that relate to more than one SIC code, limit the ability to aggregate categories to those that are

within the same Major Group (i.e., the two digit SIC code category).

– Allocation

• Finalize rules limiting R&E allocation to “gross intangible income”, which excludes dividends and subpart F/GILTI inclusions.

• Eliminate ability to directly allocate legally mandated R&E.

– Apportionment

• Eliminate increased exclusive apportionment and gross income method.

• Clarify that only R&E activities undertaken during the tax year (without regard to whether the related expenditures are capitalized) are considered in determining whether 50% of R&E expenditures are exclusively apportioned.

• If section 250 or section 904 is the operative section, DRT rules apply to reallocate sales to the general and foreign branch categories. A new Example 6 illustrates this requirement.

• Do not address whether expenses incurred under a contract research arrangement are eligible for deduction under section 162 or section 174.

R&E Expense – Changes in Final Regulations

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– Apportionment (cont.)

• Expand the scope of sales of related and unrelated parties included for apportionment. Sales of related and unrelated parties are included if the other entity is reasonably expected to

• acquire products in which the IP is either embedded or used in connection with the manufacture or sale, or

• receive services that directly or indirectly benefit from the IP.

• Therefore, the gross receipts taken into account for apportionment generally will reflect the sales made to end users.

Applicability date: Tax years beginning after December 31, 2019. Ability to early adopt.

Allocation and Apportionment of Foreign Income Taxes – Final and Proposed Rules

Allocation and Apportionment of Foreign Taxes

Reg. § 1.904-6 and Reg. § 1.861-20– Final Regulations are applicable to tax years beginning after December 31, 2019

– Notable changes from 2019 FTC Proposed Regulations:

• Removed § 301(c)(2) and § 733 distributions from exclusive list of base differences

• Final regulations reserve on the allocation and apportionment of foreign tax on disregarded payments

The rule in 2019 proposed Reg. § 1.904-6(b)(3) relating to dispositions of property resulting in certain disregarded reallocation transactions was removed and reproposed as part of proposed Reg § 1.861-20 as contained in the 2020 FTC proposed regulations.

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Foreign Taxes – General Allocation and Apportionment Rules

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A foreign income tax is allocated and apportioned to the statutory and residual groupings that include the items of foreign gross income included in the base on which the tax is imposed based on the following three-step process:

Step 1Assign items of

foreign gross income to statutory and

residual groupings based on the

grouping of the corresponding US item under Reg. §

1.861-20(d)

Step 2Allocate and

apportion deductions allowed under foreign law to foreign gross income

in statutory and residual groupings

under Reg. § 1.861-20(e)**

Step 3Allocate and

apportion foreign income tax by

reference to foreign taxable income in the statutory and residual groupings

under Reg. § 1.861-20(f)

**Reg. § 1.904-6 modifies Step 2 by first applying the “cream skimming” rule when allocating and apportioning deductions for purposes of section 904

Many exceptions to general rules . . .

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Exceptions in Final Regulations• Special rules where there is no corresponding US item (i.e., a timing or base difference)

• Distributions from a foreign corporation

• Special rule for “foreign law distribution”

• Special rule for reverse hybrids

• FGI arising from gain on the disposition of a disregarded entity (i.e., disposition of assets for U.S. tax purposes)

• Foreign law inclusion regime income (e.g., foreign rules similar to subpart F)

Exceptions in Proposed Regulations• Foreign gross income arising from a disposition” of stock

• Foreign taxes arising on a disregarded reattribution payment

• Foreign taxes arising on a disregarded contribution

• Foreign taxes arising on a disregarded remittance

Definition of Creditable Taxes – Proposed Rules

Creditable Foreign Taxes –Jurisdictional Nexus Requirement

Existing regulations focus on ensuring that a foreign levy is applied to the appropriate base, but did not include a jurisdictional connection

The jurisdictional nexus requirement is proposed to address the rise of extra-territorial taxes being introduced by other countries by ensuring there exists sufficient nexus between the income that is being taxed and the jurisdiction asserting tax

Key elements:

• Applies to “foreign taxes” including in lieu of taxes under section 903

• Contains separate standards for foreign taxes imposed on foreign country residents vs. non-residents

• The proposed rule would look at the relationship between the taxpayer’s activities/capital/assets generating income and the foreign country asserting tax

– The test would inherently be a facts and circumstances inquiry

– The preamble includes examples of relevant factors: in-country operations, employees in country, management in country

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Creditable Foreign Taxes –Jurisdictional Nexus Requirement

Key elements (cont’d):

• Foreign tax imposed on a nonresident would need to be tied to the nonresident’s activities in the foreign country; essentially, requires the tax be based on ECI-type or PE-type treaty principles OR source of income OR situs of property

– Destination-based criteria (e.g., location of customers or users) flunk the requirement

– Taxes based on source of income must use principles similar to the sourcing rules of the U.S.

o A specific rule applies for services income and gains of nonresidents

• Foreign tax imposed on a resident may be on worldwide income but must incorporate arm’s length transfer pricing principles for income of a related party allocated to the taxpayer

– Section 482 and/or OECD transfer pricing guidelines

– Destination-based criteria with respect to taxation of residents similarly flunk the requirement48

Questions