Deloitte US - The National Multistate Tax Symposium West...US tax reform: The growing complexity of...

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The National Multistate Tax Symposium West Move forward with confidence—State implications of tax reform April 30-May 2, 2018
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  • The National Multistate Tax Symposium WestMove forward with confidence—State implications of tax reform

    April 30-May 2, 2018

  • Debt-related considerations arising from federal tax reformConrad Krol, Deloitte Tax LLPAlexis Morrison-Howe, Deloitte Tax LLP

    May 1, 2018

  • 3Copyright © 2018 Deloitte Development LLC. All rights reserved.

    • Section 163(j) Overview

    o Corporate Considerations

    o Partnership Considerations

    • State and Local Considerations

    • Effects of 2017 Tax Reform Act on Debt Issuance

    Agenda

  • 4

    Section 163(j)

  • 5Copyright © 2018 Deloitte Development LLC. All rights reserved.

    2017 Tax Reform Act ChangesSection 163(j) Interest Limitation

    • Major Changes

    o Repealed prior section 163(j) limitations on the deductibility of a corporation’s interest expense for interest paid to a related person that is not subject to U.S. tax (e.g., a foreign parent).

    o Replaced prior rules with new section 163(j), which now potentially limits deductions for all business interest – paid to related and unrelated parties

    • Applicability

    o New section 163(j) applies to limit the deduction for “business interest” of all “taxpayers” (section 163(d) separately applies to investment interest).

    o Partnerships – the limitation is applied at the partnership level with rules intended to preclude potential double counting by partners (S corporations treated similarly).

    o Corporations

    • Effective for taxable years beginning after December 31, 2017.

  • 6Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Business Interest Expense LimitationsSection 163(j) (cont.)

    • “Business interest” is defined as interest on indebtedness that is properly allocable to a trade or business.

    o Legislative history suggests that all of a corporation’s interest expense is “business interest.”

    • The deduction for “business interest” for any year is limited to the sum of:

    o “Business interest income” – not including investment interest

    o 30% of the business’s “adjusted taxable income” (“ATI”); and

    o floor plan financing interest (“FPFI”), defined in section 163(j)(9) generally as interest expense related to the acquisition of motor vehicles, including boats and farm equipment, for sale or lease.

    • “ATI” means the taxable income of the taxpayer, but excludes:

    o items of income, gain, deduction, or loss not properly allocable to a trade or business,

    o business interest expense or income,

    o net operating loss deductions under section 172,

    o deductions allowed under section 199A, and

    o only for tax years beginning before January 1, 2022, depreciation, amortization, or depletion deductions.

  • 7Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Business Interest Expense Limitations Other Considerations

    • Any disallowed interest deductions can be carried forward indefinitely, subject to the rules of Section 381

    o Carryforward would be treated as a section 381(c) attribute and as a “pre-change loss” for purposes of section 382(d).

    o Consider possible interaction between the carryforward of disallowed business interest expense and NOLs.

    • Exemptions, at the taxpayer’s election, for real estate and farming businesses and automatic exemptions for certain public utilities, retail floor planning indebtedness, small business, and for interest allocable to performing services as an employee.

    • Section 385 regulations – Treasury had indicated that they intended to re-evaluate need for Treas. Reg. §§ 1.385-3, -3T, and -4T in light of the federal 2017 Tax Reform Act (the “Act”). Query whether Treasury will remove these regulations.

  • 8Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Business Interest Expense Limitations - NOLs and Disallowed Interest Expense

    Disallowed interest expense under section 163(j) is a tax attribute similar to an NOL.

    NOLs New Section 163(j) Disallowed Interest

    C/F and C/B Periods

    Under the Act, generally indefinite carryforward and no carryback (exception for P&C insurance companies).

    Indefinite carryforward and no carryback. Acarryforward of disallowed interest treated as paid or accrued in succeeding tax year.

    Utilization Under the Act, can offset 80% of taxable income (exception for P&C insurance companies).

    Can offset 100% of taxable income.

    Treatment as attribute

    NOLs treated as attribute under section 381(c) subject to applicable limitations.

    Disallowed interest treated as section 381(c)attribute (new section 381(c)(20)).

    Section 382 Section 382 applies (and on consolidated / subgroup basis under consolidated return regulations).

    Section 163(j) disallowed interest treated as a pre-change loss under section 382(d) (new section 382(d)(3)).

    NOTE: Under prior section 163(j), it was neither explicit nor clear if and how section 382 applied to

    disallowed interest (proposed regulations simply referred to the section 382 rules on built-in

    deductions). If prior disallowed interest is carried into the new regime, it appears to be treated as paid

    or accrued in the tax year subject to new section 163(j). Query whether such an attribute is now

    subject to section 382 and the effect of prior ownership changes.

  • 9Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Business Interest Expense LimitationsPartnership Rules

    • The 30% Business Interest Limit is applied at the partnership level.

    • A partner’s distributive share is not included in determining such partner’s own ATI under the new rules. However, each partner’s own ATI is increased by the partner’s distributive share of the partnership’s “excess taxable income.”

    • Excess Taxable Income equals:

    • To the extent that a partnership has disallowed Business Interest Expense in a tax year, such amount is allocated among the partners and treated as a carryforward at the partner level. Such amounts, referred to as “Excess Business Interest” can only be offset by a future allocation of Excess Taxable Income of that partnership.

    • If a partner, after first offsetting all of its partnership carryforward interest expense, has remaining Excess Taxable Income, such Excess Taxable Income can be used to increase the partner’s “standalone” limit.

    Partnership ATI x

    Business Interest Expense Limitation (ATI x .3) – Net Business Interest Expense

    Business Interest Expense Limitation

  • 10Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Notice 2018-28

    Interest Expense Limitation (§163(j))

    • Carryforwards of interest under prior 163(j) are allowed for purposes of the new 163(j) provisions.

    • Moreover, carryforwards of interest from pre-2018 taxable year will be subject to the BEAT similar to

    interest arising in post-2017 taxable years.

    • Corporations only have business interest expense and business interest income (interest cannot be

    nonbusiness).

    • Section 163(j) applies to the consolidated group with forthcoming regulations allocating the deduction

    and carryforwards to various members of the group.

    • Section 163(j) will not affect the calculation of E&P of a C corporation.

  • 11

    Section 163(j)

    State and Local Considerations

  • Copyright © 2018 Deloitte Development LLC. All rights reserved. 12US tax reform: The growing complexity of multistate taxation

    Fixed date conformity states would follow the rules of former Section 163(j)

    State corporate tax code conf. to IRC – as of April 13, 2018

    Disclaimer: Slide to be used for illustrative purposes only. Not to be used as a substitute for research into application of rules.

    State conformity to IRC references specific (and/or decouples from specific) Tax Reform provisions

    ID - 12/21/17 (2017 TY) or 12/31/17 (2018 TY)

    VA – 2017 tax year conformity only

    GA – 2/9/2018. Selective nonconformity

    FL – 1/1/2018. Nonconformity to 100% bonus

    WI – 12/31/2017. Selective nonconformity

    AZ – 2017 tax year conformity only

    OR – Selective nonconformity

    *Contact a tax advisor for more information*

    Selective Conformity

    AL - Current

    AR - Varies by

    IRC section

    CA - 1/1/15

    MS - Current

    Specific Date Conformity

    AZ - 1/1/17

    FL - 1/1/18

    GA – 2/9/18

    HI - 12/31/16

    ID – 12/21/17 or

    12/31/17

    IN - 1/1/16

    IA - 1/1/15

    KY - 12/31/17

    ME - 12/31/16

    MI* - Current or

    1/1/18

    MN - 12/16/16

    NH - 12/31/16

    NC - 1/1/17

    SC - 12/31/16

    TX - 1/1/07

    VA – 2/9/2018

    VT - 12/31/16

    WI – 12/31/17

    WV - 12/31/17

    Rolling conformity to IRC currently in effect

    Selectively conforms (as noted for each affected state to ‘IRC currently in effect’, or

    to ‘IRC as of a specific date.’)

    Conforms to IRC as of a specific date (as noted for each affected state)

    Not applicable b/c state does not levy an

    entity level tax with an IRC reference point

    FL

    NM

    DE

    MD

    TX

    OK

    KS

    NE

    SD

    NDMT

    WY

    COUT

    ID

    AZ

    NV

    WA

    CA

    OR

    KY

    ME

    NY

    PA

    MI*

    VT

    NH

    MA

    RICT

    VAWV

    OHINIL

    NCTN

    SC

    ALMS

    AR

    LA

    MO

    IA

    MN

    WI

    NJ

    GA

    DC

    AK

    HI

  • Copyright © 2018 Deloitte Development LLC. All rights reserved. 13US tax reform: The growing complexity of multistate taxation

    Multistate ConsiderationsLimitation Calculation

    • Issues to be Resolved by States

    1. Should the limitation be applied at separate company level or combined group level (i.e., who is the “taxpayer”?)

    2. What happens when combined group is different than consolidated group?

    3. Is disallowed interest a tax asset of the group or a particular entity? How is it to be allocated among group members (e.g., if an entity leaves a group)?

    4. It is currently unclear whether GILTI inclusions would increase the Section 163(j) limitation – state impact if a DRD or other exclusion is available for GILTI income?

    5. What if the interest expense is treated as a non-business expense for state tax purposes?

  • 14Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Multistate ConsiderationsIntercompany Interest Addback Rules

    • State interest addback rules would generally apply after determination of deductible interest amount pursuant to Section 163(j)

    • Issues to be Resolved by States

    1. If the entity has both intercompany and third-party interest expense, what portion of the post-limitation deduction is subject to addback?

    2. Many states offer exceptions to the addback requirements for “interest paid during the tax year” to a specified recipient (e.g., treaty country resident). If interest is deducted in a different year than the interest was paid – would the exception still apply?

    • Example of Allocation between different sources of interest expense and considerations:

    • Third party interest expense $100,000• Related party interest expense $100,000• Total $200,000

    • Federal 163(j) limit (assumed) $150,000• Carry forward: $50,000

    • How much of the $150,000 current deduction is related party?

    • Need to determine what the state add-back applied to (Total $200,000 or Allowed $150,000)

    • Need to determine how the safe harbors apply:

    ◦ If the safe harbors apply to the amount currently deducted, there may be significant timing issues for provisions such as the conduit exceptions.

  • 15Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Interaction of Section 163(j) and State Intercompany Addback Rules

    Is interest limited under

    Section 163(j)?

    • Section 163(j) limitation calculation

    • Proper calculation level

    YES NO

    Is any deductible interest

    paid to a related party in

    a state with an addback

    requirement?YES

    Does an full addback

    exception apply?

    Deduct Federal

    Interest

    • Amount of post limitation deduction that is intercompany vs 3rd party

    NO

    YES• If applicable, was the interest “paid in the taxable year”?

    Deduct Partially Allowed

    Interest or No Interest

    NO

  • 16Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Section 163(j) Calculation Example

    State A State B State C State D

    Combined/Consolidated/Separate

    Combined Combined Consolidated Separate

    (Sub only)

    Conformity to 2018 IRC No Yes Yes Yes

    Section 163(j) applies? Only to $30M I/C interest

    Yes Yes Yes

    Limitation at group or separate entity level

    Group Separate Group Separate

    Section 163(j) limitation 50% x $2B = $1B 30% x ($1B) = ($300M) –cannot be less than zero

    30% x $2B = $600M N/A

    Disallowed Deduction $0 $100M $0 N/A

    Assumptions

    • No business interest income

    • Consolidated groups will calculate limitation on a consolidated basis

    • Prior debt/equity safe harbor does not apply

    Facts• Two entities in group – Parent and Subsidiary• Interest Paid Parent = $100M - $70M to Bank, $30M

    to Lux Affiliate | Subsidiary = $0• ATI Parent = ($1B) | Subsidiary $3B

  • 17

    Effects of Tax Reform on Debt IssuancePotential for a Sea Change?

  • 18Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Effects of Tax Reform on Debt Issuance

    • Post Tax Reform, there will be less incentive to have “repatriation notes” where interest and principal paid

    by foreign subsidiaries was seen as an effective way to repatriate cash to the US without a dividend

    o Transition tax will create large amounts of federal previously taxed income (“PTI”)

    o GILTI inclusion effectively ends most offshore deferral

    o Section 245A would potentially provide a 100% DRD for certain repatriated cash

    • If companies begin to repatriate more via dividend, potential beneficial effect on the state tax rate due to

    availability of foreign DRDs

    • Section 163(j) limitation may cause companies to re-evaluate their debt profile, including the level of debt

    borne by each member of the group

  • 19Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Additional analysis necessary for state purposes

    • State specific calculation at each separate legal entity

    o Conformity

    o Separate entity vs consolidated or combined group

    o State adjusted taxable income (ATI)

    o State modifications (including bonus depreciation/100% expensing, etc)

    o ATI excludes depreciation, amortization, or depletion deductions only for tax years beginning before January 1, 2022.

    • Consider interplay with other "pre-tax reform" state modifications affecting interest, such as related party addbacks and interest disallowance attributable to foreign dividends

    • Analysis to align interest expense and income

    o Consider structural changes

  • 20

    Questions

  • 21Copyright © 2018 Deloitte Development LLC. All rights reserved.

    Contact information

    Conrad Krol

    Deloitte Tax LLP

    [email protected]

    Alexis Morrison-Howe

    Deloitte Tax LLP

    [email protected]

    mailto:[email protected]:[email protected]

  • 22Copyright © 2018 Deloitte Development LLC. All rights reserved.

    This presentation contains general information only and Deloitte is not, by means of this presentation, rendering accounting, business, financial, investment, legal, tax, or other professional advice or services. This presentation is not a substitute for such professional advice or services, nor should it be used as a basis for any decision or action that may affect your business. Before making any decision or taking any action that may affect your business, you should consult a qualified professional advisor.

    Deloitte shall not be responsible for any loss sustained by any person who relies on this presentation.

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