While the Tax Cuts and Jobs Act (TCJA) has been marketed as “reform,” it is better described as an expansion of Federal tax law, with many legacy rules remaining intact but now overlaid with additional requirements. One example of this is how companies are required to recognize foreign exchange (FX) gain or loss on distributions from foreign subsidiaries.
It would be easy to assume that the new Toll Charge and participation exemption rules will allow companies to repatriate foreign earnings without any U.S. tax implications. However, the reality is that legacy FX recognition rules still apply to repatriation, and in fact have been expanded by the TCJA to more pools and larger amounts of foreign earnings. Most companies should see the impact as early as their 2017 taxable year. Companies will be challenged by the requirements for tracking the FX effect on the repatriation of their foreign earnings, but there is a silver lining in the form of a tax planning opportunity.
Under Section 986(c), which was in effect before the TCJA, when a controlled foreign corporation (CFC) distributes earnings that have already been subject to U.S. tax under subpart F (known as “previously taxed income” or “PTI”), the distribution triggers a foreign exchange gain or loss to a U.S. shareholder. In general, the Sec. 986(c) gain or loss represents the change in US dollar value of functional currency E&P between the time it was included in income and the time it is distributed.
The rules enacted in the TCJA, especially the one-time toll charge, are expected to cause most foreign earnings and profits to be taxed currently to U.S. shareholders, with the result that significant amounts of foreign earnings will be treated as previously taxed under one of several categories. For each CFC, taxpayers are now required to track as many as six categories of PTI. (These requirements also apply to some extent to other 10 percent owned foreign corporations that are not CFCs, referred to as “specified foreign corporations” or SFCs). Each category will have a different profile and may have different FX implications when repatriated.
Going forward, companies will be required to track PTI by CFC and by year in the following categories:
|Description of Income in Pool||New Category from TCJA?||Subject to Sec. 986(c)||Basis Impact (Section 961)|
|Legacy Subpart F||Foreign base company income, foreign personal holding company income, etc.||No||Yes||Yes|
|956||Investments in U.S. property||No||Yes||Yes|
|GILTI||Deemed return on intangible assets of CFCs||Yes||Yes||Yes|
|965(a)||Non-Exempt Portion of Toll Charge Inclusion generated from E&P of Income Entities||Yes||Yes||Yes|
|965(b)||E&P that is offset by deficits of other entities in the Toll Charge calculation||Yes||No||No|
|965(c)||Exempt Portion of Toll Charge Inclusion||Yes||No||Yes|
Each time a U.S. shareholder receives a distribution or is deemed to receive a distribution, the U.S. shareholder must consult the PTI categories above as a step in determining the resultant FX gain or loss.
Distributions of PTI are subject to special ordering rules. First, distributions are treated as coming from the most recent PTI, employing a last-in, first out approach in determining the source year of the distribution. Second, for each source year, the distribution is prorated across the various categories of PTI for the distributing CFC.
Considering the volume of PTI that most companies will have, especially after the Toll Charge, and as a result of the GILTI rules, applying these ordering rules has become a challenging task.
These new categories and the associated tracking rules apply beginning in the year of the Toll Charge inclusion – which, as mentioned above, is 2017 for many taxpayers. In other words, companies receiving distributions from foreign subsidiaries in their Toll Charge year will be required to calculate and report FX gains and losses with respect to those distributions.
Most organizations will find that the increased scope and complexity of these rules warrant new and improved tracking tools.
When setting up tools to track PTI, it is important to consider the various complexities that may be involved, such as:
- The number of CFCs held by a taxpayer*;
- The number of years involved;
- CFCs and U.S. shareholders with differing yearends;
- Distributions of PTI between CFCs; and
- Multiple forms of repatriation such as cash, or deemed distributions (e.g., under Sec. 956, or Sec. 304)
* Disregarded entity classification is respected for these purposes; check-the-box planning can be used to alleviate the administrative burden.
It is important to remember that the legacy FX reporting rules for foreign branches also continue to apply. Those rules, under IRC Section 987, are beyond the scope of this article. Nevertheless, companies should consider incorporating branch earnings into their FX tracking mechanisms as well.
We recommend using a reliable, automated platform for these calculations. When you consider their expanded application, increased complexity and, importantly, the number of times these calculations will be required, it will be challenging to make them accurately and efficiently without a solid platform. Consider, for example, the frequency of calculations caused by the following:
- Financial reporting;
- Tax compliance, including legacy FX reporting as well as
- Toll Charge reporting under the yet-to-be-finalized Section 965 regulations;
- Compliance with GILTI and changes in subpart F, under guidance still to be issued;
- Preparation of amended returns; and
- Forecasting cash tax liabilities
One benefit of staying on top of these calculations is that it will give taxpayers heightened visibility into where foreign exchange gains and losses reside across pools of foreign earnings. This information can be used to plan repatriation of foreign earnings in a tax-efficient manner.
For example, suppose a U.S. corporation decides to repatriate foreign earnings to meet cash needs. If PTI has been tracked properly, the company will be able to look to the PTI pools to identify the most tax-efficient source of cash – for example, to pull from PTI pools with unrealized Sec. 986 losses or minimal Sec. 986 gains.
A&M Taxand Says:
As we work with clients to tackle these calculations for both compliance and strategic planning purposes, it has become clear to us that the best approach is to employ automation. With a reliable platform, we can track multiple years of PTI simultaneously and model adjustments using both actual and forecasted data.
To provide support managing complexity and deliver efficiencies, A&M Taxand has joined forces with one of the most advanced tax technology providers, Tax Technologies, Inc. (TTI). Our joint solution is designed to produce accurate tax results by way of automating calculations, simplifying the analysis, streamlining the reporting, and centralizing tax data (such as information about attributes) for future uses. Read more on this exciting new partnership and then reach out to us to discuss how we can help with your complex computations following U.S. Tax Reform.