PwC Cites ‘Anomalies’ in Transition Tax Under TCJA

Dana Trier, Esq.
Deputy Assistant Secretary — Tax Policy
U.S. Treasury Department
1500 Pennsylvania Ave. N.W.
Washington DC 20224

5 February, 2018

Determination of cash position under section 965

Dear Dana:

Jim McCabe, John Rauber, and I thank you and your Treasury colleagues for taking the time to meet with us to discuss two of the anomalies that have occurred in measuring the cash position under section 965, enacted as part of the Tax Cuts and Jobs Act of 2017. Below, I have briefly summarized the facts we discussed with you regarding the first of the anomalies, involving cash contributed or lent by the U.S. parent to its foreign subsidiaries for the purpose of completing an acquisition, and Treasury's authority to promulgate regulations carrying out the purposes of section 965. I have also included examples that may aid in your consideration of the formation of guidance under section 965. We plan to follow up with you shortly with an analysis of the other factual situation.

Fact Summary

The U.S. parent company (“USP”) operates on a fiscal year-end of October 31. In June 2017, USP announced it had entered into a definitive agreement to purchase a foreign target corporation (“FT”) for USD 5.2 billion/EUR 4.4 billion. At the behest of the seller, the acquisition transaction was structured as purchases by USP's foreign subsidiaries of FT's subsidiaries around the globe. The receipt of regulatory approvals from approximately 20 jurisdictions was a condition to closing pursuant to the terms of the purchase agreement. While USP originally anticipated closing on or before September 15, 2017, delays in receiving the required regulatory approvals postponed the closing date initially to November 1, 2017, and ultimately to December 1, 2017. USP funded its planned acquisition with a combination of U.S. cash that was transferred to its foreign subsidiaries, third-party debt raised in foreign markets, and cash generated through overseas earnings. To ensure its foreign subsidiaries had the funds necessary to close on the acquisition and to reduce the risk of foreign currency exposure, USP provided the U.S. funds to its foreign subsidiaries in advance of the original anticipated closing date of September 15, 2017. As a result of the delays in receiving regulatory approvals, which delayed the acquisition closing date, USP's October 31, 2017, balance sheet contained an extra USD 5.2 billion of cash for purposes of closing the FT acquisition transaction on November 1, 2017. Of that amount, approximately USD 2.5 billion originated in the U.S. and USD 1.0 originated through debt issued in foreign markets.

Applicable Law: New Section 965

New Section 965 taxes U.S. companies on all of their previously tax-deferred post-1986 earnings and profits at rates that differ depending on whether the earnings and profits are held in cash and cash equivalents or other assets. The rate for earnings held in cash or liquid form is 15.5%, and the rate for the remainder is 8%. Per the House Committee Report accompanying the Tax Cuts and Jobs Act (TCJA),

“[t]he Committee believe[d] that many domestic companies were reluctant to reinvest foreign earnings in the United States, when doing so would subject these earnings to high rates of corporate income tax rates. Accordingly, the Committee is aware that such companies have accumulated significant untaxed and undistributed foreign earnings as a result.” Further, the Committee “believe[d] that the tax rate should take into account the liquidity of [such] accumulated earnings.” With respect to the computation of a U.S. shareholder's aggregate cash position, the Committee Report states that by using a three-year average as the aggregate cash position for a U.S. shareholder, the effect of unusual or anomalous transactions is muted.”

Taken together, the quoted language demonstrates that Congress's intent in enacting Section 965 was to tax deferred earnings at higher rates where the earnings are in liquid form and thus not reinvested in hard assets overseas, while also mitigating situations in which a cash position on a single measurement date may not fairly represent the taxpayer's true liquidity position.

The TCJA provides a broad grant of authority to the Treasury Secretary in Section 965(o) to prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of section 965. Pursuant to the Conference Report, this provision is intended to be a “specific grant of regulatory authority to carry out the intent of this provision.

Issue: Overstated Aggregate Cash Position Due to Impending Acquisition

In the factual situation described above, USP's foreign subsidiaries held cash of approximately USD 3.5 billion on October 31, 2017, solely in anticipation of the FT acquisition. This cash either originated in the United States or was obtained through newly issued debt in the foreign markets; none of the USD 3.5 billion came from, nor did it represent, tax-deferred foreign earnings held in liquid form. Further, this cash would not have been on USP's balance sheet at the end of FY2017 (nor in the prior year) if the FT transaction had closed by September 15^th as originally contemplated. Therefore, the inclusion of this cash in the aggregate foreign cash position of USP would materially overstate the amount of USP s tax-deferred earning and profits held in liquid form.¹

To remedy the overstatement of cash position that would otherwise occur, USP requests that Treasury, through the regulatory authority granted to it by Congress under Section 965, issue guidance that would exclude from the definition of “aggregate foreign cash position” on a measurement date excess cash held on the balance sheet of a specified foreign corporation that was to be used solely for the purposes of funding a foreign acquisition pursuant to a binding contract entered into before November 2, 2017.

Sample guidance language and examples are included below. USP's view is that both the U.S. cash and the cash borrowed in foreign markets should be excluded from the “aggregate foreign cash position” definition because neither bucket of cash represents tax-deferred earnings of the foreign subsidiaries. The proposal below offers for your consideration examples of two different fact scenarios: one that involves cash raised through foreign-issued debt and one that does not.

Proposed Solution: Sample Regulatory Guidance Language and Examples

Cash held by a specified foreign corporation on a measurement date, which is not earnings and profits of the specified foreign corporation and is held solely for the purpose of closing on the acquisition of a foreign target after such measurement date pursuant to a binding written contract, may inflate the aggregate foreign cash position of a United States shareholder. Where such cash was obtained by the specified foreign corporation through cash infusions or loans from a United States shareholder, it does not represent tax-deferred earnings of the specified foreign corporation being held in liquid form because it originated in the U.S. and was not generated through the business activities of the specified foreign corporation. Where such cash was obtained through third party debt raised in the foreign markets, such cash does not represent tax-deferred earnings of the specified foreign corporation being held in liquid form because it was not generated through the regular business activities of the specified foreign corporation, but instead was raised solely for the purpose of a one-time acquisition. Accordingly, for purposes of determining the cash position of a specified foreign corporation, the Treasury Department and the 1RS intend to issue regulations providing that any cash obtained by a specified foreign corporation, where such specified foreign corporation is legally obligated to transfer such cash to a third party to acquire a foreign target corporation pursuant to a binding contract entered into prior to November 2, 2017, shall be excluded from the aggregate foreign cash position of the United States shareholder. However, for purposes of determining the aggregate foreign cash position of the United States shareholder, any cash held by the foreign target corporation as of the acquisition date shall be treated as if it were held by the specified foreign corporation on the measurement date.

Example #1 — No Foreign Issued Debt. (i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP, CFC1 and CFC2 all have an October 31 fiscal year end. Prior to October 31, 2017, USP had entered into a binding commitment pursuant to which CFC2 was legally obligated to purchase foreign target corporation (FT) for $1,000, with an expected closing date of November 1, 2017 or shortly thereafter. To provide CFC2 with sufficient funds to complete the FT acquisition, USP issued $900 of debt in the United States and then used that cash to make a capital contribution and/or loan to CFC1 totaling $900. CFC1 then lent the $900 of cash to CFC2 pursuant to a long-term note. CFC1 held no other cash. On October 31, 2017, CFC2 held (i) the $900 of U.S. cash; and (ii) $100 of its own cash. On December 15, 2017, CFC2 purchased FT for $1,000 with the $900 of U.S. cash and the $100 of its own foreign cash. On the acquisition date, FT had $25 of cash and no other liquid assets on its balance sheet.

(ii) Analysis. USP's aggregate foreign cash position taken into account with respect to its fiscal year ended October 31, 2017, is $125. USP's aggregate foreign cash position includes the $100 of CFC2's foreign cash, and the $25 of FT's foreign cash.

Example #2 — Foreign Issued Debt. (i) Facts. USP, a domestic corporation, owns all of the stock of CFC1, a foreign corporation, which owns all of the stock of CFC2, also a foreign corporation. USP, CFC 1 and CFC2 have an October 31 fiscal year end. Prior to October 31, 2017, USP had entered into a binding commitment pursuant to which CFC2 was legally obligated to purchase foreign target corporation (FT) for $1000, with an expected closing date of November 1,2017 or shortly thereafter. To provide CFC2 with sufficient funds to complete the FT acquisition, USP issued S600 of debt in the U.S. and then used that cash to make a capital contribution and/or loan to CFC1 totalling $600. CFC1 then lent the U.S. cash of $600 to CFC2 pursuant to a long-term note. Additionally, CFC1 borrowed $300 from third party lenders in foreign markets and lent this $300 of borrowed cash to CFC2 pursuant to a long-term note. CFC1 held no other cash. On October 31, 2017, CFC2 held (i) the $600 of U.S. cash; (ii) the $300 of borrowed foreign cash; and (iii) $100 of its own cash. On December 15, 2017, CFC2 purchased FT for $1,000 with the $600 of U.S. cash, the $300 of borrowed foreign cash and $100 of its own foreign cash. On the acquisition date, FT had $25 of cash and no other liquid assets on its balance sheet.

(ii) Analysis. USP's aggregate foreign cash position taken into account with respect to its fiscal year ended October 31, 2017, is $125. USP's aggregate foreign cash position includes the $100 of CFC2's foreign cash, and the $25 of FTs foreign cash.

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I hope the foregoing is useful to you. Please let us know if you have questions, need additional information, or if a follow up discussion would be helpful.

Thank you for your consideration.

Very truly yours,

Pamela Olson
pam.olson@pwc.com
T: (202) 414 1401
PwC

Cc:
Jim McCabe
John Rauber
Douglas Poms
Jason Yen
Brenda Zent
Lindsay Kitzinger
Gary Scanlon