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Congress told the Treasury Department to look back at what multinational companies may have done to minimize their overseas earnings and profits in anticipation of a new repatriation tax. Companies now are wondering how far Treasury will go.
Many U.S. multinationals had long expected a Republican push for tax overhaul that would include “deemed repatriation,” or the requirement that they bring back offshore E&P for a one-time tax, according to Alexandra Minkovich, of counsel at Baker McKenzie.
The new tax law does that, and it hands Treasury specific authority—and directions—to write retroactive regulations to address moves companies may have made before the law was enacted to avoid the repatriation tax.
Some companies may have done things to minimize their E&P before enactment of tax reform legislation, she said. But “others may have engaged in regular business activities that were not influenced by the prospect of tax reform, yet had the result of reducing earnings and profits.”
Where will Treasury draw the line?
The new law (Pub. L. No. 115-97) requires multinationals to ship home all the E&P accumulated offshore since 1986, at a tax rate of 15.5 percent for cash and 8 percent for “illiquid” assets.
The accompanying conference report gives Treasury the authority to write guidance addressing E&P-shrinking strategies that it sees as potentially problematic. Questions remain, however, about the scope of a crackdown, Minkovich said.
Some big issues are the breadth of Treasury’s authority, the activities that could be considered abusive, and whether it’s appropriate to issue retroactive guidance, she said.
“It would be interesting to watch them issue regulations on past behavior in an administration that has a deregulatory perspective,” Minkovich said. “I wouldn’t expect a lot of guidance that would change the characterization of transactions taxpayers have already engaged in.”
Robert J. Kovacev, a partner with Steptoe & Johnson LLP, said Treasury is likely to act on its authority, given the highly specific language in the lawmakers’ conference report.
“I think they will because Congress was so explicit,” Kovacev said.
The conference report says lawmakers were aware of efforts by companies to change their entity classifications, accounting methods, and taxable years—and to undertake distributions and liquidations—to avoid a repatriation tax.
“The conferees expect the Secretary to prescribe rules to adjust the amount of post-1986 earnings and profits in such cases in order to prevent the avoidance” of the tax, the report says.
Kovacev said tax code Section 7805 does somewhat limit the capacity of tax regulations to go backward. But “if Congress authorizes retroactive regulations, then that’s OK,” he said. “I think Congress wanted to make sure Treasury knew that they had the authority to go back in time.”
The question of what Treasury will target is a sharp one for a lot of multinationals, especially because the language in the report is somewhat open-ended, Kovacev said.
Eric Solomon, co-director of National Tax at Ernst & Young LLP, said Treasury and the Internal Revenue Service have “a challenging task.”
It might be easier to identify deals that don’t work under current law, he said. It’s a lot tougher to write a retroactive rule to target specific deals that are legal but designed to reduce offshore E&P, and likely some would be captured and others overlooked, Solomon said.
Another option—a rule based on intent—is uncertain in scope and would need to be administered through audits, he said.
Kovacev predicts a good deal of lobbying.
“Congress has spoken,” he said. “Clearly they have heard of strategies that they consider to be avoiding the purposes of repatriation but they’re leaving the door open so Treasury can act.
“Now we start round two, which is taxpayers going to Treasury and attempting to inform Treasury’s policy-making in this area,” he said. “The ball’s in Treasury’s court.”
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