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U.S. multinational companies that now have to bring home their accumulated overseas earnings and profits have questions about the impact of stock attribution rules that Congress expanded in its tax code overhaul.
The new law requires companies to return to the U.S. the deferred income they’ve held abroad since 1986. The repatriation, deemed to have taken place before 2018, subjects the income to a one-time “transition tax.”
The broadened stock attribution rules mean more entities could have income subject to that tax. Tax practitioners said companies aren’t sure about the interaction between the two.
The Internal Revenue Service issued Notice 2018-07 on Dec. 29 to answer some immediate questions on repatriation—including concerns about the possible double-counting of E&P—under tax code Section 965.
But the ramifications of the law’s stock attribution changes, under tax code Section 958, remain unclear, practitioners said.
A key issue: When do companies have entities with income subject to the tax?
Under the 2017 U.S. tax act (Pub. L. No. 115-97), the post-1986 deferred foreign income of “deferred foreign income corporations” (DFICs) is subject to the transition tax. That income is generally defined as foreign earnings and profits, reduced by dividends paid to other specified foreign corporations in 2017.
DFICs are defined as “specified foreign corporations,” or SFCs, which are two types of entities: controlled foreign corporations; or foreign corporations with a U.S. shareholder that owns 10 percent or more of the company.
Because an SFC’s foreign earnings and profits will be subject to a repatriation tax, the issue of whether an entity is treated as an SFC is critical.
According to both Gregory Kidder, a tax partner at Steptoe & Johnson LLP, and Dentons tax partner John Harrington, U.S. multinationals are worried that the expanded stock attribution rules could lead to entities gaining SFC status where they wouldn’t have had that treatment before.
Harrington, who chairs Bloomberg Tax’s International Advisory Board, and Paul Schmidt, tax chair at Baker & Hostetler LLP in Washington, said that previously, taxpayers couldn’t attribute stock owned by a foreign person to a U.S. person in determining whether a foreign company is treated as a CFC. Under the new rules, that’s now allowed.
In separate interviews, all three attorneys said these “downward attribution” rules could create SFCs—either controlled foreign corporations or foreign corporations with 10 percent or more domestic ownership—where they hadn’t previously existed.
Kidder said the stock attribution rules technically only apply specifically to CFCs. However, the new way stock is attributed could affect chains of foreign company ownership in ways that could lead to a foreign corporation being considered to be 10 percent or more U.S.-owned.
Kidder said the new rules could come into play in cases where the U.S. shareholder doesn’t directly own the entire 10 percent or more of the stock but has indirect ownership of some percentage of the company through foreign holdings.
If that happens, Schmidt said, it’s likely the IRS would only tax E&P from the directly owned portion of the company. He said it’s unlikely there would be a tax on the piece he described as “constructively owned.”
The expanded stock attribution rules have a business impact that goes well beyond the repatriation issue, but increasing the transition tax through treating more entities as SFCs could be one of the unwelcome results, Harrington said.
The three attorneys said there is legislative history indicating Congress didn’t intend the attribution rules to make a broad sweep that would wreck legitimate business structuring, but it isn’t clear how that might be reflected in any forthcoming IRS guidance on the issue.
The agency hasn’t said whether it plans to answer questions on the attribution rules. The question has urgency, Schmidt said, because the rules are retroactive for the last taxable year of a CFC beginning before Jan. 1, 2018. That’s generally for the 2017 calendar year, he said.
Another area where guidance is welcome, he said, is the matter of how to calculate foreign earnings and profits if a specified foreign corporation has an E&P deficit.
Schmidt said the law seems to require that the deficit be allocated among a multinational’s entities that have positive E&P. This would appear to reduce the amount of the overall inclusion, he said, because it moves the deficit across entities “without people having to restructure at all.”
While in many cases that would appear to be a good thing that “allows you the benefit of the deficit without having to plan into it,” he said, “there are some cases where a taxpayer would not necessarily want to be forced to do that.”
The IRS has said companies can expect guidance on the larger issue of the use of deficits.
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