Corporate tax reform was a major victory for treasury and finance in 2018. Even so, more guidance was needed to help practitioners apply the changes. Now, the IRS has issued new regulations clarifying corporate tax reform.
The Internal Revenue Service is finalizing a bevy of regulations in anticipation of the 2018 filing season that will clarify and tighten up ambiguous language in the recent Republican tax reform bill, potentially impacting corporate cash.
The rushed passage of the Tax Cuts and Jobs Act on Dec. 22, 2017, and the resulting sparse or fuzzy language on important provisions has left corporate taxpayers and their advisors flustered about how precisely to apply the law. With the 2018 tax-filing season starting in earnest in March, regulators are seeking to provide more detailed guidance on several fronts. Much of that recently issued or proposed guidance may impact companies’ available cash, whether that cash remains overseas or is brought back to the United States, and the amount of debt or existing capital the company uses to pursue acquisitions or capital-intensive projects.
“If treasury hasn’t talked to the tax department lately about the impact of these regulations, it needs to be able to engage them,” said Kathleen Dale, principal, international tax, at KPMG. “We had the law we were working from, and now we have a lot more guidance out there which may present upside and often downside, or things that need to be addressed.”
She said that a common regulatory theme has been anti-abuse provisions that give the government “significant discretion in disregarding or re-characterizing transactions entered into with—and this is the term [the IRS uses]—‘a principal purpose of avoiding the application of the provision.’”
The new law, for example, lowers the corporate tax rate to 21 percent and eliminates corporates’ ability to defer overseas earnings, although its global intangible low-taxed income (GILTI) provision provides a route to cut the rate on those earnings in half. Still, 10.5 percent is more than if the taxes were deferred indefinitely under the old regime, and there are other unfavorable aspects, Dale noted. She added that some corporates have consequently restructured their operations to limit the earnings subject to GILTI, to minimize the impact of that tax.
The proposed regulations, for which comments were due Dec. 9, 2018, and have yet to be finalized, essentially disregard those types of transactions.
“To the extent companies planned to delay the effective application of the GILTI regime, they need to be aware of the ‘anti-abuse provisions’ in the proposed regulations that disregard many of those transactions,” she said.
GLOBAL-INTANGIBLE LOW-TAXED INCOME (GILTI)
Since the introduction of GILTI, it is more likely that American companies’ overseas earnings will be taxed in the United States, in some instances at the lower rate, creating more of an incentive for them to bring cash home. Joseph Calianno, tax partner and international technical tax practice leader in BDO’s national tax office, noted several factors U.S. companies should consider when making that decision. They include: whether the foreign subsidiaries actually have the cash and whether it’s needed to fund their operations; and whether the cash is needed in the U.S. to make an acquisition or expand their facilities. In addition, the foreign jurisdiction may impose legal restrictions on distributing the cash to the U.S. parent, or a withholding tax.
Another factor in whether to repatriate cash, Calianno said, will be the so-called “participation exemption” in Section 245A, permitting certain U.S. corporations to receive a 100 percent dividend-received deduction on the distribution of dividends from their foreign subsidiaries. The earnings that will generally qualify for the participation exemption are those of the foreign subsidiaries that have not already been taxed under certain anti-deferral rules. The new provision could enable a company to return overseas earnings in the form of a dividend, without being taxed.
American-based multinationals have been issuing record volumes of debt especially in Europe, to take advantage of ultra-low rates. In late November, the IRS issued a proposed rule under Section 163J that may limit a US company’s ability to deduct interest expense.
“Depending on the company’s makeup, it will have to analyze the rules to determine whether it will be able to deduct the interest on the debt it issues,” Calianno said. “After doing the necessary modeling, it could affect the company’s decision whether to incur debt to fund an acquisition or expand operations.”
Dale noted that companies will have to reconsider the assumptions underlying their business decisions. “If there’s incremental debt in the system that’s going to disallow interest expenses under 163J, then the company might decide it doesn’t want to deal with that and make a capital contribution instead of funding through debt,” she said. “The company won’t get any deduction from a capital contribution, but if [the interest-expense deduction] is already limited, it may just be simpler that way.”
New regulations published Jan. 22, after being issued in proposal form last August, clarify how U.S. companies must pay repatriation taxes under Section 965 of the tax code. Dale said that companies made best efforts to calculate their mandatory repatriation tax liability for the 2017 tax year, based on guidance at that time. There are differences in the final regulations, however, and companies may have to recalculate that liability. There’s no materiality standard in tax, so accuracy is paramount to avoid triggering an “accelerated event” that could result in significant financial consequences, she added.
“If you elected to pay your tax liability over seven years, and a company doesn’t do it the correct way, its taxes could become due all that year,” Dale said. “That would be a bad day for a lot of companies.”
Interested in more regulatory guidance? Download AFP's Libor transition guide.