Repatriation Tax on Derivatives: Hard on Financial Companies?

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By Alison Bennett

U.S. financial companies may feel the bite of Internal Revenue Service guidance responding to a new tax law provision requiring multinationals to bring overseas money home.

Under guidance issued in December, multinational companies will have to include derivative financial instruments in the earnings and profits they repatriate.

That could spell difficulties for the financial industry, practitioners told Bloomberg Tax.

Banks and broker-dealers routinely use derivatives as part of their business, not as a planning tool to avoid tax on the mandatory E&P return, said Lauren Lovelace, a principal in Ernst & Young LLP’s New York office. Clients view the government’s stance in its first repatriation guidance as “an overly broad stroke,” she said.

Critical Calculation

Under the 2017 tax law overhaul ( Pub. L. No. 115-97), cross-border companies have to return cash and other assets to the U.S. in a repatriation deemed to have taken place in 2017, making tax calculations key. Cash and cash equivalents face a 15.5 percent tax rate, while the rate on “illiquid assets” is only 8 percent.

That makes the definition of cash critical. With deadlines looming, it was an area where taxpayers badly needed instructions. Notice 2018-07, issued Dec. 29, 2017, was the IRS’s first guidance on repatriation and included such issues as double-counting in addition to the cash issue.

While the law itself didn’t include derivative instruments in a taxpayer’s cash position, it left the door open for Treasury to decide “economic equivalents” of cash.

In Notice 2018-07, the IRS said it will treat as cash, instruments such as notional principal contracts, options contracts, forward contracts, futures contracts, short positions in securities and commodities, and similar financial instruments.

Tough Situations

Practitioners said Notice 2018-07 could create some tough situations.

Mark H. Leeds, a tax partner with Mayer Brown LLP in New York, criticized the Treasury guidance as “a particularly onerous exercise of their statutory authority.”

Treating all financial assets as cash equivalents—subject to the 15.5 percent rate—is going too far, he said in an interview. As one example, Leeds said, “swaps by their nature are extremely illiquid.” Swaps are customized contracts traded between private parties in what is known as the “over the counter” market.

Leeds questioned whether the “entire universe of OTC derivatives” should be treated as liquid assets because there’s no ready market for them. In addition, he said, Treasury shouldn’t bring instruments into a taxpayer’s cash position simply because they reference financial assets.

Scope Too Broad?

Lovelace said in an email that the financial services industry, in particular, could feel a bite from Notice 2018-07, compared to other businesses.

Financial services firms aren’t “where you are going to find a lot of plant, property and equipment eligible for the lower 8 percent rate,” she said. While most of EY’s clients have “accepted that their unrepatriated earnings largely would be subject to the higher rate of tax,” she said the industry still views Treasury’s guidance as making a broader sweep than necessary.

Jon T. Hutchens, a tax partner in the Dentons New York office, said he isn’t surprised Treasury decided to pull in derivatives under the umbrella of cash equivalents.

“In some cases it would be relatively easy to replicate foreign currency with a derivative,” he said. “It makes sense to sweep those in.”

At the same time, Hutchens said, more guidance is needed quickly. “One of the issues they leave open is whether they’re going to exclude derivatives that aren’t actively traded or that don’t have an underlying asset that is treated as a cash equivalent,” he said. In the notice, Treasury said it’s considering regulations in this area.

Identifying Hedges

There’s another big question, he said. Under the guidance, “bona fide hedging transactions”—designed to limit risk—won’t be included as derivative instruments that are part of a multinational’s cash position.

Taxpayers have to quickly identify those hedging transactions to make the 2017 calculations in time for 2018, which could be difficult for companies that don’t have a lot of experience with the U.S. derivatives market, Hutchens said.

“I think it will be a challenge, especially for these corporations,” he said in an interview. “This is something they haven’t had to think about before. You’re indicating up front that you’re hedging a business transaction and you’re not entering the derivative for speculative purposes.”


Another complication is that the guidance says if taxpayers are hedging assets equivalent to cash, the value of the asset has to be adjusted by the fair market value of the hedge itself when the taxpayer is determining the amount of cash subject to the deemed repatriation tax.

“If a multinational has a derivatives position with some overage over whatever it was hedging, it could be an issue for them and they could wind up with significant cash equivalents,” Hutchens said.

To contact the reporter on this story: Alison Bennett in Washington at

To contact the editor responsible for this story: Meg Shreve at

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