The Repatriation Tax – 7 Takeaways

Do you have a 10% or more interest in a foreign corporation?  If so, then you may have a repatriation tax issue on your 2017 (not 2018!) tax return.

Under the new tax legislation, the United States is shifting international corporate taxation from worldwide taxation to a system resembling territorial taxation.  The new system has been designated as Participation Exemption System Taxation (P.E.S.T.), and it began on January 1, 2018.

To transition from the old system to the new, a repatriation tax may be due with the 2017 tax return.  While extensions can be filed to extend the filing deadlines for U.S. corporate (Form 1120) and individual tax returns (Form 1040) until October 15, 2018,[1] the new law requires that 90% of the repatriation tax be paid on or before April 17, 2018 (assuming that no changes or adjustments are made to the new legislation).

Understanding the Repatriation Tax

To understand the how the repatriation tax works, one must look to the Conference Committee Report.[2]  The conference committee starts discussion of the repatriation tax on PDF page 1000 (of 1097) of the report (or page 477 (of 560) of the bill).  It references the repatriation tax as “deemed repatriation at two-tier rate…”  On page 1012, it explains the treatment of the repatriation tax will follow the Senate amendment with several modifications.  It then goes on to call the tax a “transition tax.”  This is important because, as previously indicated, this is a one-time tax that transitions taxpayers from the old system to the new system.  After we deal with the transition or repatriation tax, it will be crucial to understand how foreign corporations will be taxed in 2018 and future years.

Here are the seven takeaways in the conference committee agreement:

1. The provision applies to any U.S. shareholder of a “controlled foreign corporation,” not just multinational companies.[3]
2. The provision also applies to all foreign corporations in which a U.S. person owns a 10% voting interest, but at least one of the U.S. shareholders must be a domestic corporation.[4]
3. The repatriation tax will be based on the following tax rates:[5]
   15. 5% on cash or cash equivalents
   16. 8% on all other earnings
4. “Earnings and profits” (E&P) will be measured based on the greater value as of either November 2, 2017, or December 31, 2017. It is important to note that the E&P will not be reduced by distributions made during 2017.[6]
5. The conference committee has anticipated that taxpayers may engage in tax strategies to try to reduce E&P for measurement purposes. They have instructed the IRS to prescribe rules to prevent improper strategies from adjusting E&P for measurement purposes.[7]
6. One can elect to pay the repatriation tax final determined liability in eight installments that break down as follows:
   1. Years 1 through 5 – 8% of the net tax liability
   2. Year 6 – 15% of the net tax liability
   3. Year 7 – 20% of the net tax liability
   4. Year 8 – 25% of the net tax liability

The election to pay installments must be made by the due date for the tax return.  The first installment payment must be paid with the 2017 tax return (90% paid by April 17, 2018).  Succeeding installments must be paid annually no later than the due dates (without extensions) for the tax return.

The timely payment of an installment does not incur interest, but if a deficiency is later determined under audit or examination, then the deficiency will be payable along with underpayment interest.

Finally, there is an acceleration payment rule if one ceases business, fails to make timely payments, liquidates or sells the company, and/or goes into bankruptcy.[8]

7. The provision is effective for the last taxable year of a foreign corporation that begins before January 1, 2018, (i.e., 2017).

What has not been determined?

The new tax provisions need significant clarifications.  For example, it is unclear as to how the IRS will define “cash or cash equivalents.”  It is equally unclear what “all other earnings” will encapsulate.  In addition, there are perceived issues related to the double counting of E&P for measurement purposes if distributions made during the 2017 year are not counted.  Finally, the measurement or “testing date” will be significant for many.

Some commentators have indicated that the language does not make fully clear how foreign tax credits can and cannot be used for measurement purposes.[9]  Furthermore, the interaction of Subpart F and the rules on Previously Tax Income (PTI) come into play for this analysis.

We expect the IRS to issue copious notices and guidance related to this topic.

What next?

We strongly urge our clients who perceive that they have or may have repatriation tax issues to begin planning steps on how to address the repatriation tax.  Please feel free to direct any questions to International Tax Director Mishkin Santa at msanta@thewolfgroup.com.