ATTRIBUTES OF TAX REFORM: SHAREHOLDER AND …...CFC’s Subpart F income, which was limited to...

Moderator: Gordon Warnke, KPMG LLP

Presenters: Karen Sowell, Ernst & Young LLP

Gordon Warnke, KPMG LLP

Panelists: Bill Alexander, Skadden, Arps, Slate, Meagher & Flom LLP

Elena Romanova, Latham & Watkins LLP

Brenda Zent, U.S. Department of the Treasury (Invited)

A special thank you to James Coss from Ernst & Young LLP and Stephen Massed from KPMG LLP who were instrumental in the preparation of this presentation

ATTRIBUTES OF TAX REFORM: SHAREHOLDER AND CORPORATE LEVEL

DETERMINATIONS RECONSIDERED

University of Chicago

72nd Annual Federal Tax Conference

November 8, 2019

• The 1913 Act introduced the individual income tax, which included a tax on dividend income

• In response to constitutionality concerns regarding the taxation of corporate earnings accumulated before the

enactment of the 1913 Act (pre-1913 E&P), Congress added the E&P limitation in 1916 to distinguish

distributions of pre-1913 E&P from distributions of post-1913 E&P, only the latter of which could be taxed at the

shareholder level

• The role of E&P has grown substantially over the years and is now a component of numerous tax regimes (e.g.,

E&P is used to ensure REIT and RIC qualification and determine the scope of taxation of investments in PFICs and

distributions from Subchapter S corporations that formerly were, or succeeded to, Subchapter C corporations)

MY HOW YOU HAVE GROWN!

2

• E&P measures shareholder dividend income, but neither the Code nor the regulations expressly define the term

• Section 312

• Provides rules regarding the effect of certain transactions or items on E&P

• Rules are complicated, targeted at specific problems, and in some cases animated by policy concerns that

are no longer relevant

• E&P considerations for domestic corporations, widely held foreign corporations (WHFCs), and CFCs

• Distributions are characterized as dividends in accordance with Sections 301(c) and 316

• WHFC distributions may be subject to foreign withholding taxes, which may give rise to direct FTCs under

Sections 901 and 903

• CFC distributions take into account previously taxed E&P (PTEP) rules of Sections 959 and 961 and may

give rise to direct or indirect FTCs under Section 960 and FX gain or loss under Section 986

• PTEP also has a shareholder-level aspect because it is also tracked through shareholder accounts

• The GILTI regime increases the complexity of CFC E&P by attempting to preserve traditional E&P

determination and location notions in a multi-tax rate environment that shares attributes across CFCs

E&P: WHAT WOULD YOU SAY YOU DO HERE?

3

• The duality of E&P: dividend characterization generally is only relevant to shareholder taxation, but the

definition of “dividend” is tied solely to a corporation’s E&P

• The duality of E&P can produce counter-intuitive results, which can be taxpayer favorable or unfavorable

depending on the facts (e.g., a distribution with respect to recently purchased stock is characterized as a

dividend or return of capital based on the distributing corporation’s historical E&P profile)

• The Code and regulations limit taxpayer-favorable results from the normal application of the distribution

rules in certain circumstances to address specific policy objectives (e.g., Sections 1059 and 961(d))

• The duality of E&P is implicated by the disparate taxation of the monetization of stock investments

• Dividends are ordinary income historically subject to regular tax rates

• Stock gain attributable to E&P is generally capital gain historically subject to reduced US tax rates

(although special rules apply under Sections 964(e) and 1248 with respect to CFCs)

SERVING TWO MASTERS: THE DUALITY OF E&P

4

• The preferential treatment of capital gains motivated taxpayers to engage in various forms of “bailout”

transactions, which were intended to extract value from corporate solution at capital gains rates

• Congress has enacted a series of anti-bailout provisions, including

• Section 306 (preferred stock bailouts)

• Section 302 (redemption bailouts)

• Section 304 (related party stock sale bailouts)

• Section 356 (bailouts in acquisitive reorganizations)

• Section 355(a)(1)(B) and (C) (bailouts in divisive reorganizations)

• Sections 367(b), 964(e), and 1248 have results similar to the above anti-bailout provisions

ALL HANDS TO THE PUMPS! – BAILOUTS AND LEGISLATIVE RESPONSES

5

CFC TAXATION: THE MORE THINGS CHANGE, THE MORE THEY STAY THE SAME...EXCEPT WHEN THEY DON’T

6

Pre-TCJA Post-TCJA

Subpart F

regime

• US shareholders subject to current taxation on pro rata share of

CFC’s Subpart F income, which was limited to CFC’s current E&P

• US shareholders subject to current taxation on pro rata share of

CFC’s deferred E&P invested in US property

• Generally the same, but new categories of Subpart F income for mandatory

repatriation inclusions, hybrid dividends, and Section 964(e) dividends

• New regulations coordinate US property investment rules with Section 245A DRD

• Increased number of CFCs because of Section 958(b)(4) repeal

GILTI • US shareholders generally subject to current taxation on pro rata share of CFC’s non-

Subpart F income in excess of a deemed return on depreciable tangible property

• Attribute sharing: GILTI inclusion is a US shareholder-level determination based on

CFC-level “tested items”; GILTI inclusion is pushed down to the CFC level to determine

PTEP (and, residually, Section 959(c)(3) E&P) on a CFC-by-CFC basis

• Corporate US shareholders, and individuals with Section 962 elections, allowed a

deduction equal to 50% of GILTI inclusion

PTEP • CFC E&P characterized as PTEP to the extent of current inclusions

under Subpart F regime

• PTEP excluded from income when distributed, and distributions

were sourced to PTEP before deferred E&P

• CFC stock basis increased for current inclusions under Subpart F

regime and decreased for PTEP distributions

• New categories of PTEP created

• Basis mechanics work identically for Subpart F and GILTI inclusions

CFC TAXATION: THE MORE THINGS CHANGE, THE MORE THEY STAY THE SAME...EXCEPT WHEN THEY DON’T

7

Pre-TCJA Post-TCJA

Deferred

E&P

• CFC E&P not attributable to current Subpart F inclusions were not

taxed until repatriated

• Sections 367(b), 964(e), and 1248 served as a backstop to the

Subpart F regime by ensuring inclusion of deferred E&P upon stock

disposition

• Section 245A allows corporate US shareholders (but not individuals even with a

Section 962 election) 100% DRD for dividends that meet certain requirements

• Sections 367(b), 964(e), and 1248 serve as a backstop to the Subpart F and GILTI

regimes for non-corporate US shareholders by ensuring inclusion of deferred E&P

upon stock disposition and implement the limited Section 245A territoriality regime

for corporate US shareholders

Direct

FTCs

• Domestic corporations and US individuals allowed direct FTCs for

foreign income taxes paid or accrued with respect to dividends

and PTEP distributions (e.g., foreign withholding taxes)

• Generally same as pre-TCJA, except domestic corporations not allowed direct FTCs

(or deduction) for foreign income taxes paid or accrued with respect to Section

245A DRD-eligible dividends or “hybrid dividends”

Indirect

FTCs

• Domestic corporations allowed indirect FTCs for foreign income

taxes paid or accrued by foreign corporations that were members

of a “qualified group” with respect to dividends, PTEP distributions,

or current inclusions under the Subpart F regime

• Domestic corporations only allowed indirect FTCs for foreign income taxes paid or

accrued by CFCs that are attributable to current inclusions under the Subpart F and

GILTI regimes and PTEP distributions

FX

gain/loss

• US shareholders recognized foreign currency exchange gain or loss

upon the receipt of a distribution of non-USD-denominated PTEP

• No material changes

KEY OBSERVATIONS ABOUT THE CURRENT E&P REGIME

• The current E&P regime is complex and incomplete and leads to a variety of asymmetrical results, as well as numerous

uncertainties regarding how the rules should operate

• Not all of the complexities and uncertainties are due solely to E&P considerations

• Some relate to the disparate treatment of capital gain (and loss) compared to the treatment of dividends, which is an

independent design element of the US tax system—albeit one closely related to the E&P regime

• In the following slides, we explore some of the key points to consider in potentially redesigning the taxation of shareholders

with respect to their ownership of corporate stock

• Our findings indicate that, while it may not be possible to solve for any single consideration, it does not appear to be possible

to design a single comprehensive regime that addresses all the problems of the current regime for all corporations (public,

private, domestic, and foreign) and all shareholders (individuals, corporations, and individuals making an election under Section

962) that any distribution regime must accommodate

8


• Complexity and uncertainties

• Section 312 is a patchwork of legislative responses to specific problems and perceived abuses, and provides detailed

rules for making certain adjustments to E&P

• Many unresolved questions remain, including the impact of certain redemptions, reorganizations, and spin-offs on E&P

determinations

• Character (and potentially rate) differences

• Significantly different results can ensue depending on whether a disposition is preceded by a distribution or the

underlying E&P is recognized as part of the disposition proceeds

• This problem is exacerbated where ordinary income and capital gain are taxed at different rates

9


• Duality of E&P

• Because a dividend is defined by reference to the distributing corporation’s E&P, the corporate decision to declare a

distribution to its shareholders determines when and, in many cases, how its shareholders are subject to US tax with

respect to the distribution (e.g., “nimble” dividend out of current E&P despite overall deficit)

• Timing

• The timing of corporate-level BIG/BIL recognition affects dividend characterization

• A distribution of unrealized appreciation (e.g., through leverage) can be treated as a return of capital even though

the distribution would have been a dividend if appreciation was realized

• Acquisitions

• Attribute “acquisitions” affect dividend characterization

• Subject to certain exceptions (e.g., Section 338 elections), the system generally preserves corporate attributes

between shareholders (e.g., stock sales) and corporations (e.g., reorganizations and Section 332 liquidations)

• Rules prevent certain dividends from creating usable capital losses (Sections 961(d) and 1059), but generally there are

no rules that “correct” for dividends creating unusable capital losses

10

NEP AND TEP – DOMESTIC EXAMPLES

11

IT’S A WONDERFUL LIFE? A WORLD WITH NO E&P OR WITH SHAREHOLDER-LEVEL TRACKING

• To fully appreciate the role of E&P in taxing shareholder distributions, we explored a model where E&P is no

longer relevant and not tracked at the shareholder level (the NEP Model)

• Two alternative approaches were explored in connection with the NEP Model:

• NEP (All): Treat all distributions as dividends

• NEP (Gain): Treat distributions as dividends only to the extent of shareholder gain (i.e., if the post-distribution

stock value is less than the shareholder’s pre-distribution stock basis, the distribution is characterized as a

return of stock basis to the extent of shortfall and the remainder, if any, is taxed as a dividend)

• For ease of illustration, we assumed a 100% DRD would be available for distributions between corporations

• Various design choices have been made to permit the model to be illustrated, but different choices could be

made to achieve different policy results

12

NEP MODEL: DOMESTIC CORPORATION

X

(US)

A B

60% 40%

Background

• A’s X stock has an AB of $18 and FMV of $24

• B’s X stock has an AB of $12 and FMV of $16

• X holds Asset 1, which has an AB of $0 and FMV of$40

Year 1

• X has taxable income of $30 and pays tax of $10

• X’s FMV is $60

• Analysis

• Current system: $20 of E&P created

• NEP (All) and NEP (Gain): E&P is not computed, tracked, or relevant

Year 2

• Asset 1’s FMV declines from $40 to $30


• B sells all its X stock to C for $20

• Analysis

• Current system: B recognizes $8 of capital gain

• NEP (All) and NEP (Gain): B recognizes $8 of gain (character?)

C

40%

Yr. 2: sale

Yr. 1: $30 income

$10 taxes

Asset

1

13

NEP MODEL: DOMESTIC CORPORATION

X

(US)

A

60% 40%

Year 3

• X borrows $10 against Asset 1 and makes a pro rata distribution of $30 to A and C

• X’s post-distribution FMV is $20

• Analysis

• Current system: A recognizes $12 of dividend income and has $6 return of basis; C

recognizes $8 of dividend income and $4 return of basis.

• NEP (All): A recognizes $18 of dividend income and has a $6 BIL, and C recognizes $12

of dividend income and has a $12 BIL

• NEP (Gain): A recognizes $12 of dividend income and has $6 return of basis, and C has

$12 return of basis

• Post-distribution value of A’s X stock, $12, is $6 less than pre-distribution AB of

$18

• Post-distribution value of C’s X stock, $8, is $12 less than pre-distribution AB of

$20

C

Yr. 3: $18

distribution

Yr. 3: $12

distribution

Asset

1

14

Bank

Yr. 3: $10

What if, instead, X had sold Asset 1 and distributed $30 cash (i.e., non

leveraged distribution)?

Shareholder Current System NEP (All) NEP (Gain)

A $18 dividend

$0 return of basis

$6 BIL

$18 dividend

$0 return of basis

$6 BIL

$12 dividend

$6 return of basis

$0 BIL

C $12 dividend

$0 return of basis

$12 BIL

$12 dividend

$0 return of basis

$12 BIL

$0 dividend

$12 return of basis

$0 BIL

NEP MODEL: COMPARISON OF RESULTSShareholder Current System NEP (All) NEP (Gain)

A $12 dividend

$6 return of basis

$0 BIL

$18 dividend

$0 return of basis

$6 BIL

$12 dividend

$6 return of basis

$0 BIL

C $8 dividend

$4 return of basis

$8 BIL

$12 dividend

$0 return of basis

$12 BIL

$0 dividend

$12 return of basis

$0 BIL

NEP (All) results

in increased

dividend with

offsetting capital

loss; results

similar to current

law whenever

corporation has

distributed E&P

> gain in stock

Shareholder

not taxed on

pre-ownership

earnings

Leveraged

distributions

may impact

results under

current system;

NEP results are

not impacted

15

SHAREHOLDER-LEVEL TRACKING – TEP MODEL

• The tracking E&P model (TEP Model) tracks E&P at the shareholder level

• A corporation’s E&P and deficits terminate as a corporate-level attribute at the end of each annual

accounting period and E&P and deficits flow through to its shareholders who maintain their own

shareholder-level accounts

• Certain design choices depart from current law

• If a shareholder disposes of its investment in the corporation, the shareholder’s accounts terminate and the

new shareholder starts its own accounts

• Section 1248 approach could be extended to sales of domestic corporate stock if it was desirable to

equalize sale vs. distribution consequences

16

TEP MODEL: DOMESTIC CORPORATION

X

(US)

A B

60% 40%

C

40%

Yr. 2: sale

Yr. 1: $30 income, $10

taxes

17

Background

• A’s X stock has an AB of $18 and FMV of $24

• B’s X stock has an AB of $12 and FMV of $16

• X holds Asset 1, which has an AB of $0 and FMV of$40

Year 1

• X has taxable income of $30 and pays tax of $10


• Analysis

• Current system: X has $20 of E&P

• TEP: X’s E&P is allocated pro rata (A has $12 and B has $8)

Year 2

• Asset 1’s FMV declines from $40 to $30


• B sells all its X stock to C for $20

• Analysis

• Current system: B recognizes $8 of capital gain, and B’s share of X’s E&P remains intact

• TEP: B recognizes $8 of gain that, depending on design choice, may be treated as capital

gain or recharacterized as an $8 dividend and B’s $8 TEP account with respect to X is

eliminated and does not carry over to C

Asset

1

TEP MODEL: DOMESTIC CORPORATION

X

(US)

A

60% 40%

C

Yr. 3: $18

distribution

Yr. 3: $12

distribution

18

Year 3

• X borrows $10 against Asset 1 and makes a pro rata distribution of $30 to A and C

• X’s post-distribution FMV is $20

• Analysis:

• Current system: A recognizes $12 of dividend income and has $6 return of basis; C

recognizes $8 of dividend income and $4 return of basis

• TEP: A has $12 of dividend income and $6 return of basis; C has $12 return of basis

Bank

Yr 3: $10

Asset

1

TEP MODEL: COMPARISON OF RESULTSShareholder Current System NEP (All) NEP (Gain) TEP

A $12 dividend

$6 return of basis

$0 BIL

$18 dividend

$0 return of basis

$6 BIL

$12 dividend

$6 return of basis

$0 BIL

$12 dividend

$6 return of basis

$0 BIL

C $8 dividend

$4 return of basis

$8 BIL

$12 dividend

$0 return of basis

$12 BIL

$0 dividend

$12 return of basis

$0 BIL

$0 dividend

$12 return of basis

$0 BIL

What if, instead, X had sold Asset 1 and distributed $30 cash (i.e., non

leveraged distribution)?

19

Shareholder Current System NEP (All) NEP (Gain) TEP

A $18 dividend

$0 return of basis

$6 BIL

$18 dividend

$0 return of basis

$6 BIL

$12 dividend

$6 return of basis

$0 BIL

$18 dividend

$0 return of basis

$6 BIL

C $12 dividend

$0 return of basis

$12 BIL

$12 dividend

$0 return of basis

$12 BIL

$0 dividend

$12 return of basis

$0 BIL

$12 dividend

$0 return of basis

$12 BIL

Unlike NEP, and

similar to

current system,

timing of

BIG/BIL

recognition

impacts results

Similar to NEP (Gain),

TEP does not tax

shareholder on pre-

ownership earnings

Similar to

current law,

leveraged

distributions

impact

results

under TEP

NEP AND TEP – CFC EXAMPLES

20

NEP MODEL: CFCS• Current income consequences

• Individual and corporate US shareholders would be given positive basis adjustments to the extent of their inclusions under

Subpart F and GILTI regimes

• Corporate US shareholders would increase CFC stock basis for all income that is not currently taxed (Exempt Income)

• Individual US shareholders would not increase CFC stock basis for any income that is not currently taxed (Deferred Income)

• Current loss consequences

• Corporate US shareholders (but not individual US shareholders) would decrease basis in loss CFCs to extent of loss offset

amounts that gave rise to positive basis adjustments in income CFCs

• Distribution consequences

• A distribution would be characterized as tax-free return of basis to the extent of prior net positive investment adjustments

of that shareholder

• Thereafter, a distribution would be characterized as a dividend

21

NEP MODEL: CFCS• Observations

• In light of valuation difficulties in closely held context, NEP (Gain) is not explored in connection with CFC distributions

• Limiting return of basis to prior increases results in dividend income and stock BIL for distributions by newly acquired

corporations (design choice could be considered to allow full basis recovery prior to dividend income)

• E&P is irrelevant, so shareholders would have to forego FTCs or another FTC attribution method would have to be

adopted, and FX gain or loss (if retained) would have to be measured using another method

• Other design choices are possible and, even under the above design choices, further choices would need to be made

where tested loss CFC’s utilized losses exceed shareholder’s basis in the tested loss CFC or the tested loss CFC has losses in

excess of aggregate CFC tested income in any year

22

NEP MODEL: INDIVIDUAL VS. CORPORATE US SHAREHOLDERS

CFC1TI = $30

QBAI = $100

A

Summary

• Net positive adjustments are unique to shareholder; exceptions could be made where

appropriate (e.g., reorganizations)

• Corporate US shareholders receive basis increases for Exempt Income, but individual US

shareholders do not receive basis increases for Deferred Income

• E&P is eliminated, but shareholders must track their net-positive basis adjustments to

basis; tracked basis could be utilized under modified FX gain/loss and FTC regimes if

desired

Facts

• A owns 100% of CFC1; A’s CFC1 stock has an AB of $20

• In Year 1, CFC has tested income of $30 and QBAI of $100

• At the end of Year 1, CFC1 distributes $30 to A

Analysis

• A has net CFC tested income of $30 and NDTIR of $10, which results in a GILTI inclusion

amount to A of $20

• A is an individual: A’s CFC1 stock basis is increased by $20; the first $20 of the

distribution is a return of basis and the next $10 is a dividend

• A is a corporation: A’s CFC1 stock basis is increased by $30; entire $30

distribution is a return of basis

Yr. 1: $30 tested income

$30

CFC1TI = $30

QBAI = $100


$30 A

(US)

$20 basis increase $30 basis increase

Individual Sh. Corporate Sh.

23

NEP MODEL: TESTED LOSS CFC

CFC1TI = $40

QBAI = $100

Summary

• An individual US shareholder does not receive a basis increase for Deferred Income, so it is not necessary to

adjust the basis of a tested loss CFC held by an individual

• The basis in a tested loss CFC held by a corporate shareholder must be adjusted downward if it gives rise to a

positive increase to basis in another CFC

Facts

• A owns 100% of CFC1 and CFC2; A’s CFC1 stock has an AB of $20 and CFC2 stock has an AB of $10

• In Year 1, CFC1 has tested income of $40 and QBAI of $100; CFC2 has a tested loss of $10


Analysis

• A has net CFC tested income of $30 and NDTIR of $10, which results in a GILTI inclusion amount to A of $20

• If A is an individual:

• A’s CFC1 stock basis is increased by $20; no downward adjustment to CFC2 stock is necessary because

tested loss did not give rise to basis increase in CFC1

• The first $20 of the distribution is a return of basis and the next $20 is a dividend

• Recognition of $10 loss in CFC2 stock necessary to get to “correct” amount of tax

• If A is a corporation

• A’s CFC1 stock basis is increased by $40 and CFC2 stock basis must be reduced by $10 since tested loss

resulted in $10 basis increase to CFC1


$40

Individual vs. Corporate Sh.

CFC2TL = $<10>

QBAI = $0

A

(US)A

Yr. 1: $10 tested loss

Downward basis

adjustment only necessary

when tested loss CFC is

held by a corporate

shareholder

24

TEP MODEL: CFCS• In the CFC context, TEP Model tracks E&P (and CFC income/loss) at the shareholder level

• CFC deficits reduce shareholder’s E&P, which eliminates “extra” E&P in the current system that results when a

tested loss of one CFC offsets tested income of another CFC

• Preservation of shareholder-level accounts accommodates existing FTC and FX gain/loss rules

• Termination of shareholder account upon stock disposition means new shareholder cannot access indirect FTCs

from historic inclusions

• Model assumes basis adjustments are made for both individual and corporate shareholders to account for

absorbed tested loss

• As with NEP, other design choices possible and further choices necessary (e.g., where utilized losses exceed

shareholder’s basis or tested losses exceed aggregate tested income in any year)

25

TEP MODEL: INDIVIDUAL VS. CORPORATE US SHAREHOLDERS

Summary

• Current ordering rules apply to distributions

• New shareholders do not inherit accounts, meaning that they don’t have access to indirect FTCs attributable to

historic inclusions; shareholder account could survive in certain circumstances (e.g., reorganizations)

• Model works identically for corporate and individual shareholders, although, consistent with current law,

dividends to corporate shareholders are eligible for Section 245A DRD

Facts

• A owns 100% of CFC1; A’s CFC1 stock has an AB of $20

• In Year 1, CFC has tested income of $30 and QBAI of $100


Analysis

• A has net CFC tested income of $30 and NDTIR of $10, which results in a GILTI inclusion amount of $20

• A increases its PTEP account and CFC1 stock basis by $20, and increases its Section 959(c)(3) account by $10

• The first $20 is a PTEP distribution, which reduces A’s PTEP account and CFC1 stock basis by $20

• The next $10 is a dividend, which reduces A’s Section 959(c)(3) account by $10

• If A is a corporation, the dividend is eligible for a Section 245A DRD

• If A is a corporation or an individual with a Section 962 election, the PTEP distribution may be

attributed foreign taxes under Section 960(b)

• Purchaser would not have a PTEP or Section 959(c)(3) account and distribution of pre-acquisition income

would be a return of basis under Section 301(c)(2) without attributed foreign taxes under Section 960(b)

CFC1TI = $30

QBAI = $100


$30

A

(US)A

26


TEP MODEL: TESTED LOSS CFC

CFC1TI = $40

QBAI = $100

Summary

• If a US shareholder owns a tested income CFC and a tested loss CFC, the tested income CFC’s excess

income would be offset by the tested loss CFC’s excess loss, helping to address the “excess E&P”

conundrum in current system

• The tested loss CFC stock basis shifted to the tested income CFC prevents permanent elimination of gain

through application of Section 245A for corporate shareholders and prevents corporate and individual

shareholders from selectively recognizing BIL in tested loss CFC

Facts

• A owns 100% of CFC1 and CFC2; A’s CFC1 stock has an AB of $20, and A’s CFC2 stock has an AB of

$10

• In Year 1, CFC1 has tested income of $40 and QBAI of $100, and CFC2 has a tested loss of $10


Analysis

• A has net CFC tested income of $30 and NDTIR of $10, which results in a GILTI inclusion of $20

• A increases its PTEP account and CFC1 stock basis by $20, and A increases its Section 959(c)(3) account

by $10 (i.e., $20 increase to reflect CFC1’s tested income and $10 decrease to reflect CFC2’s tested

loss)

• A increases its CFC1 stock basis by $10 and reduces its CFC2 stock basis by $10 to account for the

tested loss

• Absent this adjustment, following the distribution, CFC1 would have $10 BIG and CFC2 would

have $10 BIL, permitting A to selectively dispose of CFC2 to lower its overall tax burden or result

in A having gain upon further distributions from CFC2 or upon a sale of CFC1 stock


$40


CFC2TL = $<10>

QBAI = $0

A

(US)A


27

TEP MODEL: TESTED LOSS CFC

CFC1TI = $40

QBAI = $100

Analysis (continued)

• Distribution characterization

• First $20 is a distribution of PTEP, which reduces A’s PTEP account and CFC1 stock basis by $20

• Next $10 is a dividend, which reduces A’s Section 959(c)(3) account by $10

• Final $10 is a return of A’s CFC1 stock basis (A’s CFC1 stock basis is ultimately reduced to $20)

• Results are the same if A is a corporation or an individual, but A is eligible for a Section 245A DRD if it is

a corporation


$40


CFC2TL = $<10>

QBAI = $0

A

(US)A


28

IS THE JUICE WORTH THE SQUEEZE?

29

LOTS OF LEMONS, BUT IS THERE ANY LEMONADE?

30

Current system NEP Model* TEP Model*

Complexity • Considerable complexity at

corporate level to compute E&P

on an annual basis and track

historical E&P

• Complexity associated with computing

and tracking E&P is eliminated

• Considerable complexity at shareholder

level to track income, loss, and Deferred

Income/Exempt Income accounts

Valuation • None, other than divisive

reorganizations

• NEP (All): None

• NEP (Gain): Considerable valuation

considerations for closely held

corporations

• None, other than divisive reorganizations

Distributions from

E&P vs.

Stock gain

attributable to E&P

• Domestic corporations and

WHFCs: Disparate character

treatment, but same rates

• CFCs: Generally same

character treatment and rates;

PTEP successor concepts

• NEP (All): Disparate character

treatment, but same rates; no basis

recovery until sale

• NEP (Gain): Disparate character

treatment, but same rates

• Domestic corporations and WHFCs:

Disparate character treatment, but same

rates

• CFCs: Generally same character treatment

and rates; no PTEP successor concepts

*design choices can be made that change observed results under both models

LOTS OF LEMONS, BUT IS THERE ANY LEMONADE?

31

Current system NEP Model* TEP Model*

Potential for

capital losses

from pre-sale

dividends

• Pre-sale dividends can create capital

losses for shareholders

• In some cases this can be advantageous

if pre-sale dividend eligible for DRD

and disadvantageous if it is not

• NEP (All): Same as current system

• NEP (Gain): Issue eliminated

• Same as current system, except issue is

mitigated to some extent because

shareholder exchanges to do indirectly

transfer corporate E&P

Pre-existing

attributes

• Shareholder exchanges generally do not

affect E&P and unrealized BIG/BIL

• Shareholder exchanges generally

do not affect unrealized BIG/BIL

but generally not relevant in the

domestic context

• Shareholder exchanges terminate accounts,

but do not affect unrealized BIG/BIL

FTCs • Domestic corporations: Direct and

indirect FTCs for taxes attributable to

current inclusions and PTEP distributions

• US Individuals: Direct FTCs for taxes

attributable to dividends and PTEP

distributions

• Either direct and indirect FTCs for

PTEP distributions are eliminated, or

attribution method must be

developed

• Similar to current system, but “attributable

to” standard is applied at shareholder

level

FX gain/loss • FX gain/loss measured on PTEP

distributions

• Either FX gain/loss is eliminated or

a new method must be developed

• Similar to current system, but applied at

shareholder level

*design choices can be made that change observed results under both models

OTHER REGIMES TO EXPLORE (AND WORLDS TO CONQUER)?

32

• The Full Schnabel (all non-publicly traded corporations, or at least all non-publicly traded CFCs,

taxed as partnerships)

• The Full Canadian (all distributions treated as returns of capital first)

• Other

• Consent dividends

• Various TCJA comment letter proposals

• Targeted simplification (e.g., nimble dividend rule, PTEP)

ATTRIBUTES OF TAX REFORM: SHAREHOLDER AND …...CFC’s Subpart F income, which was limited to...

Documents

Transcript of ATTRIBUTES OF TAX REFORM: SHAREHOLDER AND …...CFC’s Subpart F income, which was limited to...