Deemed Dividends Under Proposed Tax Reform

Miles & Stockbridge P.C.
Contact

2017 tax reform efforts may alleviate adverse deemed dividend tax treatment of foreign subsidiary support for the obligations of U.S. parent companies.  Present support is limited to the pledge of 66 ⅔rds of the stock in foreign subsidiaries, but that may change depending on the final Senate bill and the outcome of the conference committee deliberations.

Current Law

U.S. shareholders owning 10% or more of a controlled foreign corporation (CFC) are required to include in current income for U.S. tax purposes their pro rata shares of the corporation’s untaxed earnings invested in certain items of U.S. property.  U.S. property generally includes tangible property located in the United States, stock of a U.S. corporation, and certain intangible assets, such as patents and copyrights, acquired or developed by the CFC for use in the United States.  U.S. property also includes any obligation of a U.S. person, including any obligation that the CFC is deemed to hold by reason of its being a pledgor or guarantor of such obligation.  The inclusion rule for investment of earnings in U.S. property is intended to prevent taxpayers from circumventing U.S. tax on dividend repatriations by making loans to, or guaranteeing the obligations of, a U.S. person (both of which are treated as a “deemed dividend”).

Related Proposed Tax Reform

Both the U.S. House of Representatives and the Senate have passed tax reform which would affect deemed dividend tax treatment. The Senate plan, for the most part, follows the House bill in modifying the treatment of foreign income that is subject to U.S. tax.   The proposed rules establish a “participation exemption system” for foreign income, pursuant to which 100% of active foreign business income is exempted from U.S. taxation when paid by dividend to domestic corporations and attributable to U.S. shareholders.

In order to transition to the participation exemption system of taxation, the Senate plan, like the House bill, provides for a “deemed repatriation” one-time, reduced tax on accumulated foreign earnings.  U.S. companies would owe the tax regardless of whether they actually repatriate the income.  Foreign deferred earnings would be subject to tax at the rate of 14.5% for cash (12% in the House bill) and 7.5% for reinvested earnings. The tax on the foreign deferred earnings is payable over 8 years, but unlike the House bill's equal installments, the bulk of the Senate plan's payments are deferred into the future (8% for 5 years, 15% in year 6, 20% in year 7, and 25% in year 8).

With the deemed repatriation and the reduction of tax on offshore earnings, the foreign tax credits on those dividends would likely be eliminated.  A company that has spent time and money planning with respect to foreign tax credits may want to consider repatriating its cash back into the U.S. at the current higher tax rate in order to take advantage of its existing foreign tax-credit planning and to avoid losing its credits.

The House bill would eliminate the rule that a U.S. shareholder must include in its current income for U.S. tax purposes its share of a foreign subsidiary's untaxed earnings invested in U.S. property.  The elimination of this requirement, coupled with the 100% exemption for dividends received from a foreign subsidiary by a U.S. shareholder, means that retained earnings would not be subject to deemed repatriation tax–whether a U.S. parent corporation reinvests its foreign subsidiary's earnings in U.S. property (i.e. by the foreign subsidiary pledging or guaranteeing an obligation of its U.S. parent corporation) or elects to distribute them.  This would have the effect of enabling foreign subsidiaries to guarantee the obligations of, and provide security for, indebtedness of their U.S. parent company without adverse U.S. tax treatment.

As of this writing, it is too early to determine the likely outcome of the debate in Congress on incentives for U.S.-based multi-nationals to repatriate earnings at reduced tax rates.  If tax reform results in the reduction or elimination of U.S. tax disadvantages for U.S. parent companies to use the value of foreign assets to secure U.S. debt obligations, it will be easier for U.S.-based multinationals to obtain financing without concern over some of the existing barriers.

Opinions and conclusions in this post are solely those of the author unless otherwise indicated. The information contained in this blog is general in nature and is not offered and cannot be considered as legal advice for any particular situation. Any federal tax advice provided in this communication is not intended or written by the author to be used, and cannot be used by the recipient, for the purpose of avoiding penalties which may be imposed on the recipient by the IRS. Please contact the author if you would like to receive written advice in a format which complies with IRS rules and may be relied upon to avoid penalties.

[View source.]

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Miles & Stockbridge P.C. | Attorney Advertising

Written by:

Miles & Stockbridge P.C.
Contact
more
less

Miles & Stockbridge P.C. on:

Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
- hide
- hide