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Final Transition Tax Regs: An Analysis of Important Changes

David Stewart: Welcome to the podcast, I'm David Stewart, editor in chief of Worldwide Tax Daily. This week: A look at the transition tax. I'm joined in the studio by Worldwide Tax Daily senior legal reporter Andrew Velarde, who's been following this issue and recently sat down with a practitioner to talk about it. Andrew, welcome to the podcast.

Andrew Velarde: Thank you for having me here, Dave.

David Stewart: So who did you talk to?

Andrew Velarde: I chatted with Raymond Wynman from Global Tax Management. He's in charge of the firm's international practice.

David Stewart: All right, so what did you talk about?

Andrew Velarde: We were talking about the final rules related to the transition tax paid on an SFC's
or specified foreign corporation’s accumulated deferred foreign income. More specifically, we talked about two provisions that were two of the more notable changes between the proposed rules and the final rules. These were the basis-shifting election and the specified payment rule. Hi, Raymond, thank you for being with us here today.

Raymond Wynman: Thank you, Andrew, for having me.

Andrew Velarde: So, Raymond, let's talk about the first issue you've identified here
the basis-shifting election. Can you give us a little background on this election, as it was laid in the proposed regs? What did it do? What were its shortcomings that needed to be addressed?

Raymond Wynman: Sure, Andrew, let me dive into it with giving an example to better illustrate the issue here. So let's just assume that we have a US that owns CFC 1 and a CFC 2 brother, sister company. CFC 1 has $100 of deferred income and CFC 2 has a deficit of $20 in this example. So, under 965, on the total tax, we know that the amount of inclusion that we would have would be a net of $80. That $80 will create PTI at CFC 1, and this is referred to as section 965(a) PTI. However, remember that CFC 1 has $100 of EMP and presumably it still has $100 of cash to be distributed. So the IRS gave the benefit of that $20 deficit from CFC 2 also as PTI, and they referred it in the regs as 965(b) PTI. The problem is that for section 965(a) PTI, taxpayers get basis on the section 961, but you do not get basis for the 965(b) PTI. So why is that a problem? Let's take my example one step farther. Assume that in my example, US has basis in CFC of $10. The 965(a) PTI increases the basis to $90
we had $10 plus the $80 of PTI created on the 965(a), and it increased it to $90. The problem is that on the 961(b), if a taxpayer distributes the PTI in access of basis, it must recognize gain of 40 access. The proposed regulations offer a solution in the form of basis-shifting election, which would shift the U.S. shareholder basis in its deficit corporation to the corporation that has the earnings in the amount of the deficit that has allocated on the section 965(b). The amounts of basis shifted was an all-or-nothing election and could immediately produce capital gain. So if, for example, in this case, CFC 2 had no basis and we shifted that $20 over to CFC 1, it would create a $20 capital gain. Some taxpayers did not think that we’ll ever get to that problem because future PTI from GILTI should be able to provide additional means of distribution before getting to the section 965 PTI. However, the IRS issued [Notice 2019-1], which basically required that any PTI distributions are coming out first from 965 PTI before coming out from GILTI PTI, so eventually taxpayers will always access this 965(b) PTI. And it could create potentially a recognition of a capital gain.

Andrew Velarde: So then it sounds like there could be a forced gained recognition that could discourage repatriation. I remember the final regs made reference to this. So, how did the final regs change this rule to potentially address that?

Raymond Wynman: Yes, Andrew, the final 965 regs provide an alternative to this all-or-nothing approach. Under the final regulations, U.S. shareholders may designate the amount of basis to be shifted from each deficit corporation to each DFIC subject to the following rules. First of all, it limits the increase in stock basis of each CFC with income amount to the 965(b) E&P. Second, it limits the total basis increase at the DFIC so that the total basis reduction at the deficit corporation is limited. Third and finally, it prevents the reduction in deficit corporation basis below zero (“to the extent rule”). In other words, that will prevent U.S. shareholders from recognizing capital gain to the extent that there is no basis. The alternative basis-shifting election may allow for increased future cash repatriation before capital gain would be triggered in 2017 or in ’18 for fiscal years.

Andrew Velarde: All right, so what are the next steps for companies that might consider making this election? Is there a deadline they need to pay attention to? And what about companies have already filed their return, what should they do?

Raymond Wynman: So for companies that have already filed their tax return, they would need to amend the return and make an affirmative election by May 6, 2019, so that they have the ability of applying the new final regulations instead. For fiscal years that still have to file the tax return, they would have to include the election using the tax return
filing it by the deadline.

Andrew Velarde: It sounds like for some companies the way this is rapidly approaching, what factors should they consider when weighing whether to make this election?

Raymond Wynman: Well, Andrew, that are a couple of things that need to be considered here. The first thing is that if you have sufficient stock basis, then you might not trigger a capital gain. So it's going to be a question of reviewing your stock basis, whether you are comfortable with that. And obviously that may involve some stock basis study to a certain extent, given the close deadline that might be occurring here. The second thing is really that if you do find that you don't have enough stock basis to cover 965(b) PTI, then you might want to consider the shifting. But by shifting basis, we are taking basis away from other companies. And you really want to look at it from a strategic planning perspective or divestiture perspective, whether or not that is the right answer or not. And the third option is really, are you ever going to distribute cash from your companies with where you have this 965(b) PTI problem with low basis? And therefore you need to really review strategically whether you're gonna distribute cash from those companies or not.

Andrew Velarde: Let's shift gears now to another provision in the 965 rules: the specified payment rule. Can you tell us a little about what is the specified payment rule? What was it under proposed regs? And what was problematic with it under those proposed rules?

Raymond Wynman: Yeah, so under the proposed regs, specified payments rule required that deductible payments made between specified foreign corporations, which occurred between the 965 measurement days to be disregarded in determining E&P at 12/31/2017. If the payer and the payee had different tentative 965 measurement dates before the application of the specified payment rule, applying these rules sometimes increased the 965 inclusion, and that was the problem. It can go both ways
it can reduce, so you were trying to avoid the double counting of E&P. But it also could result in certain circumstances in the additional income.

Andrew Velarde: So, I recall seeing the final regs mention how the request for relief had been made following the proposed rules because of the complexity and the potential for inappropriate results. Can you tell us how the final regs changed the rule to adapt to these criticisms?

Raymond Wynman: The final regs basically addressed the issue from two perspectives. It first eliminated the requirement that the SFCs have different tentative measurement dates for the specified payment rule to apply. And so if a taxpayer wanted to apply these rules, it wasn't only if you have two different measurements of dates or not. But then the second issue of how it has been addressed by the IRS was to allow taxpayer to disregard the specified payments rule in its entirety. So this way, taxpayers, if it was creating additional E&P inclusion, then it would be able to ignore this rule and not have to include that additional E&P. The rule must be applied consistently across all SFCs and be made by the U.S. shareholder and all U.S. persons related within the meaning of the related-party rules on the section 267(b).

Andrew Velarde: I've talked with practitioners who have said that the expansionist rule is going to require a substantial number of recalculations. What do taxpayers need to do to take action on these changes?

Raymond Wynman: Well, calendar-year taxpayers who already have filed their return with 965 should have applied specified payment rules on their return already. So they will have to revisit and look at the calculation, whether it makes sense to amend the return. For those taxpayers, where there is an additional inclusion, it would probably make sense to recalculate what your 965 inclusion needs to be. And file an amended return in order to not apply the specified payment rule. An amended 2017 return is likely to be needed in these circumstances. Currently the choice not to apply the specified payment rule in itself does not require filing a separate election. But because we are having different amounts of inclusion, we suggest that the taxpayers file amended tax returns to show this revised number.

Andrew Velarde: All right, well, Raymond, I want to thank you for taking the time to speak about these two important changes to these provisions. And thank you for being here.

Raymond Wynman: Thank you, Andrew.

David Stewart: And now, Coming Attractions. Each week we preview commentary that will be appearing in the next issue of the Tax Notes magazines. We're joined by executive editor for commentary Jasper Smith. Jasper, what will you have for us?

Jasper Smith: In Tax Notes, Theodore Seto compares pre- and post-TCJA incentives for multinational corporations to shift capital to U.S. and foreign parents, while Donald Williamson considers how the TCJA's revised tax rates, brackets, and qualified business income deduction apply to estates and trusts.

In State Tax Notes, Billy Hamilton looks at Wisconsin's municipal financing framework and its cities' fiscal partnership with the state. Also, in the latest edition of Raising the Bar, practitioners discuss states' inclusion of a greater share of GILTI in their corporate tax bases. 

And in Tax Notes International, Julia Ushakova-Stein discusses the proposed FDII regulations and members of DLA Piper examine the challenges that multinational entities might face during the post-acquisition integration process.

David Stewart: You can read all that and a lot more in the April 8th editions of Tax Notes, State Tax Notes, and Tax Notes International.

That's it for this week. You can follow me on Twitter @Taxstew, that's S-T-E-W. If you have any comments, questions, or suggestions for a future episode, you can email us at And as always, if you like what we're doing here, please leave a rating or a review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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