Taking the Sting out of Mandatory Repatriation: Consider OFLs, NOLs, and FTCs
By Raymond Wynman and Andrew Wai
As we approach the final stages in the tax reform process, the details and what-if scenarios are swarming. One detail everyone should be aware of is that the House and Senate bills impose a tax on the deferred foreign income of U.S. shareholders of CFCs as part of the transition to a territorial system of taxation. In short, the amount of non-previously taxed E&P of a U.S. shareholder’s CFCs is included in the shareholder’s 2017 Subpart F income. This Subpart F inclusion is paired with a dividend received deduction which results in a tax of 14% (House) – 14.5% (Senate) to the extent of cash and cash equivalents and 7%–7.5% on other assets. Any available foreign tax credits (“FTC”) can be used to offset this repatriation tax subject to a haircut which disallows the portion of the FTC attributable to the dividend received deduction (e.g. in the House bill, 60% haircut to the extent of cash and 80% on other assets assuming a 35% tax rate).
Scenario 1: Deducting foreign tax in the past
Taxpayers in a chronic excess FTC position who have chosen to benefit from deducting their current foreign income taxes under § 164(a)(3), may benefit from an election to claim FTCs under § 901 by filing amended returns. The mandatory one-time repatriation inclusion provides a one-time opportunity to claim FTCs and use them to offset the repatriation tax. By amending the prior year returns, foreign taxes will be credited instead of being deducted; this is likely to increase the U.S. tax liability since the benefit of crediting will be less than the benefit of the deduction. However, this is likely to generate excess credit carryforwards available to offset the US tax liability on the one-time repatriation. Taxpayers should expect that the reduction in US tax liability on the one-time repatriation will be much larger than the deduction lost on the amended returns. This may be a time-consuming process as it may require reviewing the prior ten years of foreign source income on the US tax returns and foreign tax returns for each CFC. Remember that the open period is extended from the normal three years to ten years in the case of a claim for credit or refund related to an overpayment attributable to foreign taxes.[1] Also keep in mind that the switch from deduction to FTC may not increase the NOL amount outside the § 6511(d)(2) three-year period from when the NOL amount was incurred.[2]
Scenario 2: Currently in an OFL position
Important technical differences remain between the House and Senate versions of the repatriation tax which produce dramatically different estimates of the final tax liability. Consider, for example, the interaction of the repatriation tax with the overall foreign loss (OFL) recapture rules. In the House bill, Sec. 4004(k) appears to turn off OFL recapture on the income inclusion from the deemed repatriation:[3]
“For purposes of sections 904(f)(1) and 907(c)(4), in the case of a United States shareholder of a deferred foreign income corporation, such United States shareholder’s taxable income from sources without the United States and combined foreign oil and gas income shall be determined without regard to this section.”
If this language remains in the final bill, the full amount of the mandatory inclusion would then be foreign source income (“FSI”) (instead of a portion being recaptured as domestic source) and available to be offset by any available FTCs, including carryforwards. As above, Taxpayers in an OFL position, who have been deducting foreign taxes under the expectation that their FTC carryforwards would go unused within the ten-year window, may benefit from filing amended returns and claiming the FTCs.
The Senate’s bill is silent on OFL recapture. Instead, Sec. 14103(n) of the Senate bill allows for an election to avoid applying NOLs against the mandatory inclusion. Similar to the House proposal, this election allows taxpayers to maximize their FSI resulting from the deemed repatriation, make full use of FTCs, and preserve NOLs for later use. Keep an eye on the evolution of these provisions as we speed through the conference committee.
We hope this post was helpful as you assess the impact of tax reform on your business. GTM will be publishing regular posts highlighting key features of tax reform as the move toward final passage and the need to be ready for action escalates.
Visit www.gtmtax.com/tax-reform for U. S. tax reform updates.
[1] I.R.C. § 6511(d)(3)(A)
[2] Chief Counsel Advice Memorandum 201136021 (December 8, 2010)
[3] Treatment of SLLs is not clear.
Illustration by Michelle Kondrich, www.michellekondrich.com all rights reserved
