LEADING TAX DEPARTMENTS FORWARD...163(j) Interest Limitation, including: » Overview of the Rules » Status of Regulations » Valuation Allowance Considerations under ASC 740 Changes

L E A D ING TA X D E PA RT MEN TS F O RWA RD

October 29, 2019

OUR PRESENTERS

Raymond WynmanManaging DirectorInternational Tax

Jim SwanickManaging DirectorFederal Tax Practice

AGENDA

► §163(j) Interest Limitation, including:

» Overview of the Rules

» Status of Regulations

» Valuation Allowance Considerations under ASC 740

► Changes to Expense Allocation and Apportionment Under the New Foreign Tax Credit (FTC) Regime, including:

» Overview of the Rules

» Status of Regulations

» Valuation Allowances Considerations on FTC Carryforwards

► Indefinite Reinvestment Assertion under ASC 740-30 (formerly APB 23), including:

» Changes in the Assertion resulting from the TCJA

» Considerations when Earnings are not Permanently Reinvested

3

4

SECT ION 163 (J )

5

Annual Interest Expense Limitation= 30% of “adjusted taxable income” (“ATI”) (not less than zero)+ Business Interest Income+ Floor Plan Financing Interest

SECTION 163(J)

ATI = Federal Taxable Income + Net Operating Loss Deductions under Section 172;+ Business Interest Expense - Business Interest Income+ Depreciation, Amortization or Depletion (years beginning before January 1, 2022)

6

PROPOSED REGULATIONS

• Effective Date – tax years ending after they become final

• Early adoption allowed

Proposed regs under

section 163(j) were released on November 26, 2018

7

Consolidated Return Group – treated as a single entity

Sub 1 Sub 2 Elim Consol

Gross revenue 1,000 2,000 - 3,000 COGS 800 1,200 - 2,000 Gross Margin 200 800 - 1,000 SG&A Exp 250 150 - 400 Interest (Income) - Interco (100) - 100 - Interest Expense - Interco - 100 (100) - Interest Expense - 3rd Party 110 - - 110 Depreciation 100 200 - 300 Net Book Income (Loss) (160) 350 - 190 Book/Tax Differences: - Depreciation - (Fav) / Unfav (40) (100) (140)Taxable Income (Loss) (200) 250 - 50 Addback Interest - Net 10 100 - 110 Addback Depreciation 140 300 440 Adjusted Taxable Income (ATI) (50) 650 - 600 Limitation (30%) - 195 (15) 180 Plus Interest Income 100 - (100) - Net 163(j) Limitation 100 195 (115) 180 Disallowed Interest 10 - -


COGS Depreciation not added back in calculating ATI

• “Amounts incurred as depreciation, amortization, or depletion, but allocated to and capitalized with respect to inventory property under section 263A and included in cost of goods sold, is not a deduction for depreciation, amortization, or depletion for purposes of determining ATI” [Preamble to proposed regulations -REG–106089–18, November 26, 2018]

8

9


ATI of Applicable CFCs

No CFC Group Election (General Rule)> ATI and Interest Limitation determined on a CFC-by-CFC basis;> Taxable income of applicable CFC determined under principles of § 1.952-2 (as if CFC were a domestic corp.)

CFC Group Election (Alternative Method)> Interest Income/Expense of CFC Group aggregated; > Resulting net interest expense allocated to members based on relative NIE; > 163(j) limitation performed for each member from lowest to highest tier;> Upper-tier CFC member’s ATI increased by next lower-tier CFC ETI

10

PROPOSED REGS

ATI of US Shareholders of Applicable CFCs

No CFC Group Election> Subpart F or GILTI inclusions (+ Sec. 78 gross-up) are subtracted from the U.S. shareholder’s ATI

CFC Group Election•> Subpart F or GILTI inclusions (+ Sec. 78 gross-up) are subtracted from the U.S. shareholder’s ATI•> U.S. shareholder’s ATI is increased by the “Eligible CFC Group ETI” from each highest-tier CFC member

© Global Tax Management, Inc. | www.gtmtax.com 11

POLLING QUESTION #1: DID YOUR COMPANY ADOPT THE PROPOSED SECTION 163(J) REGULATIONS FOR 2018?

1. YES

2. NO

3. Not Sure

12

SECT ION 163 (J )ASC 740 CONS IDERAT IONS

13

VALUATION ALLOWANCE EXAMPLE – SECTION 163(J)

VA Analysis Temps 2019 2020 2021 2022-2029

Indef. Lived

Unused balance

Accrued Expenses 300 (300)Indefinite lived intangible (200) 200 Fixed Assets-NBV (1,000) 100 100 100 700 - Fixed Assets-NTV 900 (90) (90) (90) (630) - Net TI before NOLs/163j (290) 10 10 70 200 Addback depreciation 90 90 90 - - ATI - 100 100 70 200 163(j) Limitation - 30 30 21 60

Sec 163j Interest c/f * 150 - (30) (30) (21) (60) 9 Net TI before NOLs (290) (20) (20) 49 140 US federal NOLs – pre-18 275 - - - (49) - 226 US federal NOLs – post-17 - 290 20 20 - (112) 218

- - - - 28 453 Net DTA/(DTL) before VA - pretax 425 Valuation Allowance - pretax (453)Net DTA/(DTL) - pretax (28)


E X P E N S E A P P O RT I O N M E N T A N D A L L O C AT I O N F O R F T C P U R P O S E S


General

EXPENSE APPORTIONMENT AND ALLOCATION

► Expense apportionment to GILTI will result in US tax even if foreign rate is in excess of 13.125%» Prop. Regs confirm expense apportionment to GILTI» Key to minimize expense apportionment to GILTI

► Treas. Reg. 1.861-8 thru -17 provide for expense apportionment and allocation► Other than interest expense under Treas. Reg.1.861-13, expense apportionment

rules have not changed but questions arises:» R&D expense apportioned to GILTI when using sales method?» How are Stewardship and SG&A expense apportioned to GILTI?» Review management fee charge out» Specific interest expense rules


Interest Expense

EXPENSE APPORTIONMENT AND ALLOCATION

► Interest expense apportioned between US and foreign using existing methodology but either TBV or ATBV but FMV is not available

►New §1.861-13 requires characterization of CFC stock (Investment + E&P) in various grouping that include but are not limited to:»General limitation, passive, GILTI, and §245A»Using either the asset method or modified gross income method

►§ 864(e)(3): Assets characterized as GILTI are reduced by a portion equal to the §250 deduction percentage (generally 50% but could be lower)

►§ 904(b)(4): Interest expense apportioned to §245A is not taken into account into taxable income for FTC limitation purposes


POLLING QUESTION #2: HOW DID YOUR COMPANY ALLOCATE/APPORTION EXPENSES TO GILTI INCOME UNDER REG. SEC. 1.861-8?

1. Used a general method (e.g., sales, gross income method, etc.)

2. Performed detailed Reg. Sec. 1.861-8 study

3. Did not apportion any expenses (other than interest expense)

4. Not Sure


Example

INTEREST EXPENSE APPORTIONMENT

► US uses modified gross income to characterize CFC stock► Determine category of gross foreign source income:

» GILTI is $800 ($1,000 less $2,000 of QBAI x 10%). 64% of total MGI

» SubF is $250. 20% of total MGI» Sec. 245A is $200. 16% of total MGI

► CFC stock of $2,000 is characterized as follows:» GILTI = $1,280 (2,000 x 64%)» Sub F = $400 (2,000 x 20%)» §245A = $320 (2,000 x 16%)

► GILTI asset is further reduced by §250 deduction» Assume 50% §250» GILTI = $640 (1,280 x 50%)

► Apportionment of interest expense» US = $170 (1,000 / (1,000+2,000-640) x 400)» GILTI = $108 (640/(1,000+2,000-640) x 400)» GL (Sub F) = $68(400/(1,000+2,000-640) x 400)» §245A = $54(320/(1,000+2,000-640) x 400)

US$1,000 US assets

CFC

Inv + E&P = $2000

Modified Gross Income (“MGI”):- Gross Tested Income $1,000- Sub F 250- QBAI 2,000

Int Exp = $400

19

FTC CARRYFORWARDSASC 740 CONS IDERAT IONS


VALUATION ALLOWANCE – CONSIDERATIONS RELATED TO FTCS

►ODL - An overall domestic loss (ODL) is created when a domestic loss offsets foreign-source income during a year in which the taxpayer claims the foreign tax credit» Under prior law, future U.S.-source income was recaptured as FSI by the

lesser of the ODL account or 50% of the US source income. » The TCJA amended Section 904(g) to allow a taxpayer to elect a recapture

percentage between 50% and 100% of the US source income (but not greater than the ODL account) for ODLs that arose prior to January 1, 2018.


VA ANALYSIS - REVERSING TEMPORARY DIFFERENCES VA Analysis 2017 2018 Temps 2019 2020 2021 2022-

2029Indef. Lived

Unused balance

Domestic source loss (1,000) (1,000)Foreign source income 500 500 ODL (500) (500)

Accrued Expenses 300 (300)Indefinite lived intangible (400) 400 Fixed Assets-NBV (2,600) 100 100 100 2,300 - Fixed Assets-NTV 500 (90) (90) (90) (230) - Net TI before NOLs/163j (290) 10 10 2,070 400 Sec 163j Interest c/f * 100 - (30) (30) (40) - - Net TI before NOLs (290) (20) (20) 2,030 400 US federal NOLs – pre-18 500 - - - (500) - - US federal NOLs – post-17 500 290 20 20 (830) - - Net temporary items (1,100) 700 Net DTA/(DTL) at 21% (231) 147 FTC c/f ** 300 (126) 174

- - - 21 84 174 Net DTA/(DTL) before VA 69 Valuation Allowance (174)Net DTA/(DTL) (105)

** ODL recapture = 2017 ODL recapture- lesser of ODL or 100% of US source income 500 2018 ODL recapture- lesser of ODL or 50% of US source income 100

600 FTC benefit at 21% 126


C O N S I D E R AT I O N S W H E N E A R N I N G S A R E N O T P E R M A N E N T LY

R E I N V E S T E D


OVERVIEW

► ASC 740-30-25 generally requires entities to record deferred taxes on outside basis difference in investments in subsidiaries

» Exception applies if can assert indefinite reinvestment under ASC 740-30-25-17

» Still commonly referred to as APB 23

► Outside-basis difference

» Differences between financial statement carrying amounts and tax basis of the parent’s investment in another entity’s stock

» Can be more than just retained earnings

© Global Tax Management, Inc. | www.gtmtax.com

OVERVIEW

24

►Outside differences may result from

»Undistributed earnings

»Foreign currency translation gain or losses included in equity

»Purchase accounting

»Impairments

»Book versus tax difference in capitalizing cost

»Others

►Reversal of outside basis differences occur when

»Dividends from the subsidiary

»Sale of subsidiary’s stock by the parent

»Liquidation of the subsidiary

»Merger of subsidiary into the parent


OUTSIDE-BASIS DIFFERENCES: BOT TOM-UP APPROACH

25

►Start from the bottom of the organizational chart and move-up

»Bottom-up approach►Determine legal form of subsidiary

»Corporation v. Partnership v. Flow-Thru v. Joint Venture►Determine domestic versus foreign relationship

»Domestic relationship cannot be permanently reinvested►Determine tax and book basis of investment parent has in subsidiary

»Determine whether basis difference results in a deferred tax asset or liability• DTA: tax basis > book basis• DTL: book basis > tax basis

►Review whether exception applies to recognize DTA or DTL»No DTA unless basis difference will reverse in foreseeable future»No DTL recognized if permanently reinvested or tax law provides means to recover

investment tax free


POLLING QUESTION #3: DID YOUR COMPANY CHANGE ITS INDEFINITE REINVESTMENT ASSERTION AS A RESULT OF THE TCJA?

1. Yes

2. No

3. Not Sure


TAX CUTS AND JOBS ACT IMPLICATIONS

27

►TCJA does not change APB 23 but:»Most foreign earnings have been taxed under the one-time mandatory

tax»US Multinationals may be pressured to bring these earnings back to the

US►Assuming that the earnings cannot be permanently reinvested, consider:

»Whether there is outside basis difference•Earnings included under Sec 965(a) provide for tax basis under Sec. 961


TAX CUTS AND JOBS ACT IMPLICATIONS (CONT ’D)

28

►Items to be considered to calculate deferred taxes» Foreign withholding taxes•Change in FTC regime could result in actual tax deferred (i.e., not offset

with FTC)»Foreign income taxes when distributed from one country to another»US Federal taxes•Dividends that do not qualify for 245A•Dividends from 965(b) PTI when distribution in excess of basis–Note ordering rules for PTI distribution

•Distributions in excess of capital»State taxes»Foreign currency gain or loss on PTI


EXAMPLE – CHANGE IN ASSERTION IN INTERIM PERIOD

29

Facts: » USP has asserted that the undistributed earnings of FS are indefinitely reinvested,

meeting the indefinite reversal criteria in ASC 740-30-25-17. » In Q3 2019, USP changes its intent to indefinitely reinvest the unremitted earnings

of FS, requiring recognition of a DTL for the outside basis difference.

Results:» An acceptable approach would be to recognize the DTL as a discrete item in Q3 2019

for the portion of the DTL associated with its outside basis difference at the beginning of the year, and as an adjustment to the estimated ETR for the portion of the liability associated with earnings in the current year. In such case, the amount related to the first three quarters’ translation adjustment would be allocated to OCI and the portion existing at the beginning of the year (including CTA) would be recognized as a discrete charge to income tax expense.

30

QUESTIONS?

Documents

LEADING TAX DEPARTMENTS FORWARD...163(j) Interest Limitation, including: » Overview of the Rules » Status of Regulations » Valuation Allowance Considerations under ASC 740 Changes