International Tax Considerations Relating to Repatriation in Light of COVID-19
Volatility created by the novel coronavirus, or COVID-19, pandemic has had an immediate impact on many U.S. taxpayers conducting business abroad. Due to liquidity and cash flow needs, such U.S. taxpayers may need to repatriate cash from their foreign operations. This alert discusses some key international tax issues that taxpayers may need to consider when repatriating cash from their foreign operations.
When a controlled foreign corporation (CFC, as defined in Section 957) makes a distribution to its U.S. shareholders (as defined in Section 951(b)), the characterization of the distribution for U.S. tax purposes will depend in part on whether the CFC has any earnings and profits (E&P), and, if it does, the type of E&P being distributed.[1] Assuming the CFC has E&P,[2] such distribution will first be a distribution of previously taxed earnings and profits (PTEP)[3] followed by a distribution of non-PTEP.[4] To the extent the distribution exceeds the CFC’s E&P, the distribution is next treated as a return of basis under Section 301(c)(2) followed by gain under Section 301(c)(3).
Generally, distributions of PTEP by a CFC to its U.S. shareholder are non-taxable to the U.S. shareholder, assuming the U.S. shareholder has sufficient basis in its CFC stock,[5] but foreign currency exchange gain or loss may be recognized by the U.S. shareholder under Section 986(c).[6] Notice 2019-01 and Treas. Reg. §1.960-3(c) provide guidance regarding PTEP, including ordering rules for determining which category of PTEP is distributed first. For a summary discussion of Notice 2019-01 and Reg. §1.960-3(c), see our December 2018 and December 2019 tax alerts.
Taxpayers should determine whether the relevant foreign jurisdiction imposes any withholding taxes on the CFC to U.S. shareholder distribution. To the extent that the withholding taxes are imposed (or other foreign taxes have previously been imposed) on a distribution of PTEP, a taxpayer will need to determine whether (and to what extent) such foreign taxes may be creditable.[7] Several special rules may apply.[8] A U.S. shareholder also may be entitled to an increase in its Section 904 foreign tax credit limitation under Section 960(c).[9]
To the extent that the distribution is treated as a distribution of non-PTEP, domestic C-corporate shareholders (other than RICs and REITs) will want to consider the application of the Section 245A dividends received deduction (DRD) and confirm that they satisfy all the requirements to claim the Section 245A DRD.[10] Taxpayers should note that under Section 245A(d), no credit or deduction is allowed for any foreign taxes paid or accrued (or treated as paid or accrued) with respect to any dividend for which the Section 245A DRD is allowed. Individual shareholders will want to confirm whether they can claim qualified dividends tax rates under Section 1(h)(11) on such dividends.
If a CFC distribution exceeds the CFC’s E&P, U.S. shareholders should confirm the amount of basis in their CFC stock (if different blocks of stock exist, the basis in each block of stock) to determine the amount of the distribution that can be received tax-free under Section 301(c)(2).
If a CFC distribution exceeds the CFC’s E&P and the U.S. shareholder’s basis in CFC stock, the U.S. shareholder will have gain under Section 301(c)(3). If the CFC has lower-tier subsidiaries, U.S. shareholders should consider the possible application of Section 1248(c)(2), which could re-characterize capital gain as a dividend up to certain non-PTEP of certain lower-tier subsidiaries. Domestic C-corporate shareholders (other than RICS and REITs) will then want to consider whether a Section 245A DRD can be claimed with respect to the Section 1248 dividend via Section 1248(j), and individual shareholders that have capital gain recharacterized under Section 1248 will want to confirm whether they can claim qualified dividends tax rates on such Section 1248 dividend. Section 301(c)(3) gain could have other tax implications as well that may need to be considered (e.g., if there were a prior gain recognition agreement (GRA) filed by the U.S. shareholder pursuant to the Section 367(a) regulations dealing with GRAs, there can be implications under the GRA regulations).[11]
If cash distributions are made through tiers of CFCs, additional issues may need to be considered. Each distribution through the chain of ownership would need to be analyzed. For instance, is the distribution from the lower-tier CFC to an upper-tier CFC a distribution of PTEP, non-PTEP, a combination of PTEP and non-PTEP, a return of basis, or capital gain? Do any of the distributions trigger the CFC anti-deferral rules (e.g., Subpart F income)? Are such distributions taxed in the jurisdiction of the upper-tier CFC? Are there any withholding taxes imposed on such distributions in the lower-tier CFC’s jurisdiction? Taxes imposed on distributions of PTEP can potentially result in a foreign tax credit upon such PTEP being distributed to the U.S. shareholder. There are several special rules and provisions that may need to be considered relating to such distributions. For instance, rules under Section 960(b)(2) (providing special foreign tax credit rules when PTEP is distributed from a lower-tier CFC to an upper-tier CFC), Section 961(c) (providing for basis adjustments by an upper-tier CFC in a lower-tier CFC’s stock but only for certain limited purposes), Sections 964(e)(4) and 245A (if Section 301(c)(3) gain recognized by an upper-tier CFC is recharacterized as a dividend under Section 964(e)) may need to be considered.
Taxpayers that plan to have their CFCs make loans rather than actual distributions will need to consider the rules under Section 956 and other related provisions to determine the tax consequences of such loans. Like actual distributions, taxpayers will need to analyze and calculate the relevant E&P in the CFC to determine the tax implications of the CFC loans. To the extent the CFC has PTEP that is not being distributed, such PTEP may be able to insulate the U.S. shareholder from an income inclusion under Section 951(a).[12] To the extent that there would be non-PTEP in the CFC that would be treated under the Section 956 rules as being deemed distributed, domestic C-corporate shareholders (other than RICs and REITs) should review whether they qualify for the Section 245A DRD (as provided in the Section 956 regulations) relating to such E&P to reduce their Section 956 amount. Similar issues under Section 956 may need to be considered if a U.S. shareholder does not pay down trade payables due to its CFC in a timely manner or has a CFC directly or indirectly guarantee a third-party loan.
Besides Section 956, taxpayers will need to consider various other items relating to a CFC to U.S. shareholder loan including the terms of the loan (e.g., how long will the loan be outstanding, interest rate, currency denomination for purposes of Section 988, etc.) and the U.S. tax implications on the payment of interest. Unless an exception applies (e.g., the de minimis exception under Section 954(b)(3), the high taxed exception under Section 954(b)(4), etc.), interest received by the CFC should generally be Subpart F income and includible into gross income by the U.S. shareholder. The U.S. shareholder also could be subject to an interest deduction limitation under Section 163(j). Interest paid to the CFC should generally be subject to a 30% U.S. withholding tax unless reduced by an income tax treaty. If the U.S. shareholder is an applicable taxpayer (as defined in IRC Section 59A(e)) for BEAT purposes and the CFC is entitled to treaty benefits, the interest payment could also be a base erosion payment and the BEAT implications also would have to be considered.
Taxpayers that plan to repatriate cash from their foreign branches or fiscally transparent entities (e.g., foreign disregarded entities) will need to consider the tax implications of such distributions. For instance, are there any foreign withholding taxes on such distributions?[13] To the extent that the distribution is from a “qualified business unit” that is on a different functional currency than the U.S. taxpayer, foreign currency exchange gain or loss may be recognized under Section 987.
While distributions received by U.S taxpayers from their foreign operations in many instances may not be subject to U.S. income tax, as detailed above, several correlative tax implications to such distributions will still need to be considered. Finally, the financial statement and state and local tax impacts of any repatriation should be considered.
[2] See Notice 2019-01, which provides that the forthcoming regulations will clarify that a distribution will be a distribution of PTEP only to the extent it would have otherwise been a dividend under Section 316.
[3] These amounts include Section 965 E&P and amounts that are or have been included under Sections 951(a)(1) and 951A. See Section 951A(f)(1)(A), which provides that any global intangible low-taxed income included in gross income under Section 951A(a) is treated in the same manner as an amount included under Section 951(a)(1)(A) for purposes of applying certain sections of the Internal Revenue Code (IRC), including Section 959.
[4] See generally Section 959.
[5] See Section 961 and the regulations thereunder relating to adjustments to basis when there are certain inclusions under the CFC anti-deferral rules and distributions of PTEP. Special rules apply as it relates to U.S. individual shareholders that make a Section 962 election. U.S. individual shareholders that have made a Section 962 election for Section 965, Subpart F, or GILTI inclusions in prior years however may be subject to tax on all or a portion of the distribution of PTEP under Section 962(d). In addition, a distribution of PTEP may be included in net investment income for Section 1411 purposes assuming the taxpayer has not made a Reg. §1.1411-10(g) election and the amount is not derived from a trade or business described in Reg. §1.1411-5.
[6] Taxpayers should note that foreign currency exchange gain or loss recognized under Section 986(c) is scaled back on distributions of Section 965(a) PTEP (as defined in Reg. §§ 1.965-1(f)(39) and 1.965-2(c)) and Section 986(c) does not apply with respect to distributions of Section 965(b) PTEP (as defined in Reg. §§ 1.965-1(f)(40) and 1.965-2(d)). See Reg. §1.986(c)-1(b) and (c).
[7] See generally, Sections 901, 960(b) and 904 and Treas. Reg. §1.960-1 and -3. There can be limitations on the ability to claim foreign tax credits relating to distributions of PTEP. For example, no deduction or credit is allowed for the applicable percentage of any withholding taxes imposed on a U.S. shareholder by the jurisdiction of residence of the distributing foreign corporation with respect to a distribution of Section 965(a) PTEP or Section 965(b) PTEP. Treas. Reg. §1.965-5.
[8] For instance, for foreign tax credit purposes, because PTEP was included in U.S. taxable income in a prior year, the tax imposed on the distribution is treated as attributable to a timing difference and is allocated to the separate category to which the E&P from which the distribution was paid are attributable. See Treas. Reg. §1.904-6(a)(1)(iv).
[9] See generally, Section 960(c).
[10] As it relates to Section 245A, see also certain requirements in Section 246. Other rules relating to Section 245A include rules dealing with basis under Sections 961(d) and 1059.
[11] See e.g., Treas. Reg. §§ 1.367(a)-8(b)(1)(iii) and 1.367(a)-8(n).
[12] See Sections 959(a)(2) and 959(f)(2).
[13] Certain foreign tax credit rules may need to be considered. For instance, in the case of a disregarded payment from a foreign branch to the U.S. owner, see Treas. Reg. §1.904-6(a)(2).
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