Structuring Private Equity for GILTI and Subpart F:...

Structuring Private Equity for GILTI and

Subpart F: Minimizing Tax for CFCs Under

Section 951A, New Regulations

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WEDNESDAY, NOVEMBER 6, 2019

Presenting a live 90-minute webinar with interactive Q&A

Scott Robins, International Tax Senior Manager, Grant Thornton, Philadelphia

Lincoln Terzian, Practice Leader, International Tax, Grant Thornton, New York

David Zaiken, Managing Director, International Tax, Grant Thornton, Washington, D.C.

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Structuring Private Equity for GILTI and Subpart F: Minimizing Tax for CFCs Under Section 951A, New Regulations

November 6, 2019

© Grant Thornton LLP. All rights reserved. 6

Today's presenters

Lincoln Terzian

Grant Thornton

Partner, International Tax

New York City Office

+1 212.542.9710

[email protected]

Scott Robins

Grant Thornton

Senior Manager, International Tax

Philadelphia Office

+1 215.376.6089

[email protected]

David Zaiken

Grant Thornton

Managing Director, International Tax

Washington National Tax Office

+1 202.521.1543

[email protected]

© 2018 Grant Thornton LLP | All rights reserved | U.S. member firm of Grant Thornton International Ltd

Agenda

7

Taxation of U.S. Shareholders of CFCs pre-2017 tax reform1

Changes to the definition of a CFC and to Subpart F income2

New Section 951A (GILTI)3

New Section 951A regs: implications for private equity investors4

Planning opportunities to minimize tax on foreign holdings5

* This webcast will not cover Passive Foreign Investment Companies (“PFICS”) and Qualified Electing Funds (“QEFS”)

and related rules in detail. However PFICs / QEFs will be briefly mentioned throughout the webcast. Any specific

questions on PFICs / QEFs can be answered during the Q&A portion of the webcast.

Taxation of U.S. Shareholder of CFCs Pre-2017 Tax Reform


Basic Tax Strategy for Investors in Private Equity Groups – Pre-TCJA

• U.S. investor would invest capital into a investment vehicle in exchange for a non-voting (or perhaps

voting) limited partnership interest in a domestic or foreign partnership (U.S. private foundation investor

would ensure the investment was not debt-financed and may invest in a foreign blocker corporation to

avoid any unrelated business taxable income taint (“UBTI”))

• Domestic or foreign partnership would acquire stock in a foreign corporation which normally held

foreign subsidiaries and possibly a U.S. subsidiary (assume none of the foreign entities were PFICs)

• U.S. individual investor would not be subject to U.S. tax on this investment until foreign corporation

paid a dividend potentially eligible for a 20% qualified dividend U.S tax rate or the domestic or foreign

partnership disposed of its stock held in foreign corporation potentially eligible for a 20% capital gains

U.S. tax rate (applicable rate is 1%-2% for private foundations)

Overall goal U.S investor goal: defer U.S. taxation on foreign corporate earnings until an exit event

and then pay 20% U.S. tax on the capital gain / dividend income (for individuals) or 1%-2% section

4940 excise tax (for private foundations)


Pre-TCJA – Worldwide System with Anti-Deferral Regime

• Prior to tax reform in 2017 (the "Tax Cuts and Jobs Act“ or “TCJA”), generally

the U.S. did not tax a shareholder of a foreign corporation on the foreign

earnings of the foreign corporation

• U.S. taxation was generally deferred until such earnings were repatriated to the

U.S. in the form of a dividend eligible for a qualified dividend rate (e.g. 20%)

• Pursuant to anti-deferral rules, U.S. shareholders were immediately taxed on

certain types of income earned by foreign corporations regardless of whether

the earnings had been distributed to the shareholders

• These rules, known as the Subpart F income regime, overrode the

general deferral rules


Pre-TCJA – U.S. Shareholder and Controlled Foreign Corporations

• Only U.S. Shareholders of Controlled Foreign Corporations (“CFCs”) were subject to the anti-deferral

rules of subpart F income

• A U.S. Shareholder was a U.S. person (domestic individual, partnership, C or S corporation, trust, or

estate) who owns (directly, indirectly, or constructively) 10% or more of the voting power of a foreign

corporation

• Modified section 318 rules of attribution apply in determining U.S. Shareholder and

ultimately CFC status under section 958(b)

• Ownership of more than 50% in a corporation under IRC §318(a)(2) is considered owning

100% of such corporation in determining U.S. Shareholder status

• Attribution could not be from a foreign person – section 958(b)(4)

• A CFC is a foreign corporation where U.S. Shareholders hold directly, indirectly, or constructively

more than 50% of the total voting power or value of the CFC


Pre-TCJA – U.S. Shareholder and Controlled Foreign Corporations, continued

• A U.S. Shareholder that owned at least 10% of the voting stock in a CFC on the last day of the CFC's tax year is

required to include in its gross income:

• It's pro rata share of the CFC's Subpart F income for the year, and

• The amount determined under section 956 (investment in U.S. property) with respect to such shareholder for

such year

• Subpart F income and section 956 income are treated as ordinary income (individual tax rate was 39.6%, now 37%)

and is ineligible for qualified dividend rate treatment and deemed-paid foreign tax credits (unless a section 962 election

is made) which can result in an effective rate of over 50% for an individual subject to subpart F income

• Only if a section 962 election is made, can an individual claimed deemed-paid foreign tax credits on subpart F income

• Pro rata share generally means the amount a shareholder would be entitled to if the CFC declared a dividend

• Subpart F Includes:

• Foreign base company income

• Certain types of insurance income

• Certain income attributable to participation in a boycott

• Illegal bribes, kickbacks, other payments

• Subpart F income is subject to current year E&P limitation, de minimis exclusion, full inclusion, and several other

statutory provided exceptions


Types of Foreign Base Company Income Generated by CFCs

• Foreign Base Company Income Executive Summary:

• Foreign personal holding company income

• Foreign base company sales income

• Foreign base company services income

• Foreign Personal Holding Company Income ("FPHCI") arises when a foreign corporation earns a material amount of

passive income (e.g. Dividends (other than PTEP), interest, royalties, etc.)

• Exceptions exists for active trade or business income as well as others

• Exit planning consideration: if foreign holding company parent sells the stock of the foreign operating companies,

any gain would be FPHCI to the U.S. shareholders (but pre-sale planning could be available to eliminate the

FPHCI character of such gain)

• Foreign Base Company Services Income is generated if a CFC performs a service on behalf of a related party for a third

party outside of the CFC's country of incorporation

• Foreign Base Company Sales Income arises when a CFC earns income from the sale of goods that are purchased from or

sold to a related party

• Generally not FBCSI if the CFC manufactures the goods or if the goods are sold within the CFC's country of

incorporation

• All of the above are eligible for numerous exceptions and limitations under the subpart F income regime

• Future repatriation of subpart F income is not subject to U.S. taxation again and is treated as previously taxed income (“PTI”

and Post-TCJA, now known as Previously Taxed Earnings and Profits (“PTEP”))


Type of Investment in U.S. Property Held by CFCs

• CFC owns tangible property in U.S. (inventory, machines)

• CFC owns shares in U.S. corporation

• CFC makes loans to U.S. person

• Direct loans

• Overdue payables

• Pledged assets / shares

• Guarantees

• CFC's use of intangible property in the U.S.


Historic U.S. International Tax RegimeWorldwide System

• Encouraged overseas operations

• Low tax planning

• Deferral (unless Subpart F applied) – would require analysis and fact gathering to determine subpart F income applicability

• Investments overseas

• Pre-TCJA Tax Rate: 39.6% / 20% (individuals); 1%-2% (private foundations); 35% (corporations)


Common Private Equity Structures – Minority 10%+ U.S. Partner and Pre-TCJA Consequences

Other investors

(<10% U.S. owners

or non-U.S. persons)

Foreign

Investment

Fund

Foreign Sub 2

Foreign Parent

Domestic Sub

U.S. Individual

12% 88%

100%

• Neither Foreign Parent nor Foreign Sub 2 are CFCs since

U.S. Shareholders did not directly or indirectly hold more

than 50% of the voting power or value of either foreign

corporation.

• Therefore U.S. Individual was not U.S. Shareholder subject

to subpart F income and section 956 income.

• Tax residence of other investors is irrelevant since they each

indirectly hold less than 10% in foreign corporations

• Any U.S. partner would still need to manage any potential

PFIC / QEF consequences

• Exit costs:

• Dividends (other than PTEP) from Foreign Parent

subject to 39.6% / 20% tax rates for individuals and

1%-2% for private foundations

• Sale of Foreign Parent subject to 20% individual

capital gains tax rate and 1%-2% for private

foundations

• Sale of Foreign Sub 2 / Domestic Corporation has no

immediate tax consequences (assuming no PFIC or

section 897 US Real Property Holding Corporation

characterization)

Although not shown, US tax

exempts may hold partnership

interests through a foreign

corporate blocker to avoid

UBTI


U.S

Investment

Fund

Foreign Sub 2

Foreign Parent

Domestic Sub

U.S. partners

50%

Common Private Equity Structures – 50% US Partnership Ownership and Pre-TCJA Consequences

Foreign Persons

50%

• Neither Foreign Parent nor Foreign Sub 2 are CFCs since

U.S. Shareholders did not hold more than 50% of the voting

power or value of either foreign corporation (only U.S.

investment Fund “counted” as a U.S. Shareholder).

• Therefore, none of the U.S. partners in the ownership chain

were subject to subpart F income and section 956 income.

• No difference if the foreign persons with the direct interest in

Foreign Parent were U.S. persons with less than 10%

ownership

• Any U.S. partner would still need to manage any potential

PFIC / QEF consequences

• Exit costs:






foundations

• Sale of Foreign Sub 2 / Domestic Corporation has no

immediate tax consequences (assuming no PFIC or

section 897 US Real Property Holding Corporation

characterization)

Single class of stock

No relationship or attribution between

foreign investors and U.S. Investment Fund

/ U.S. partners





UBTI

U.S Investment Fund

does not hold more

than 50% of the vote

or value of Foreign

parent


Foreign Sub

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

Common Private Equity Structures – Foreign Partnership and Pre-TCJA Consequences

100% of voting only

general partner

interest (may have

carried interest rights)

• Here, both Foreign Parent and Foreign Sub are CFCs since U.S.

G.P. indirectly owns 100% of the voting power of both.

• However, since the U.S. LPs have no voting rights, they are not

U.S. Shareholders subject to subpart F income and section 956

income.

• If U.S. GP has carried interest rights, then it could be subject to

subpart F income and section 956 income.

• If GP was foreign, then the foreign corps would not be CFCs and

the U.S. LP would also not be subject to the subpart F income and

section 956 income.

• Any U.S. partner would still need to manage any potential PFIC /

QEF consequences

• Exit costs:

• Dividends (other than PTEP) from Foreign Parent subject to

39.6% / 20% tax rates for individuals and 1%-2% for private

foundations

• Sale of Foreign Parent subject to 20% individual capital

gains tax rate and 1%-2% for private foundations

• Sale of Foreign Sub 2 / Domestic Corporation could

generate subpart F income to the GP and no other US tax

consequences US LPS (assuming no PFIC or section 897

US Real Property Holding Corporation characterization)

Foreign

Investment

Fund

U.S. G.P.

100%

LPs have not authority to control,

remove, or elect GP and can’t

otherwise override GP decision




corporate blocker to avoid UBTI


Common Private Equity Structures – Traditional U.S. Partnership and Pre-TCJA Consequences

• Here, both Foreign Parent and Foreign Sub are CFCs since

U.S. Investment Fund directly and indirectly owns 100% of

the voting power of both. Subpart F income is aggregated at

the U.S. Investment Fund level.

• The U.S. LPs will be allocated their partner share of subpart

F income and section 956 income from U.S. Investment

Fund regardless of their ownership percentage in U.S.

Investment Fund.

• Individuals: 39.6% tax rate (no FTC)

• Private foundations: 1%-2% excise tax

• However, since U.S. GP has no distribution rights, it is not

allocated any subpart F income or section 956 income.

• Exit costs:






foundations

• Sale of Foreign Sub 2 / Domestic generates subpart

F income to U.S LPs (taxed at 39.6% with no FTC)

Foreign Sub

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

100% of voting

only general

partner interest

US

Investment

Fund

U.S. G.P.

100%








Changes to the definition of a CFC and to Subpart F income


Summary of Key Changes of TCJA

• Repeal of section 958(b)(4) – foreign attribution

• Expansion of U.S. Shareholder to include both voting

and non-voting stock

• Section 951A GILTI Income (discussed in subsequent

section)

• Partnerships treated as an aggregate of investors not

an entity for subpart F income / GILTI purposes

(discussed in subsequent section)


Sec. 958(b)(4) Repeal

• Sec. 958(b) applies, with some modifications, the rules of Sec. 318(a) (the

constructive ownership rules), to determine if a foreign corporation is a CFC

or if a U.S. person is a U.S. shareholder, among other things

• Prior to TCJA, Sec. 958(b)(4) provided that in applying downward attribution

rules, stock owned by a foreign shareholder/partner would not be attributed to

a domestic entity

• Repeal of Sec. 958(b)(4) "turns on" the downward attribution rules of Sec.

318(a)(2)(C) for purposes of determining if a foreign corporation is a CFC or if

a U.S. person is a U.S. shareholder

Insight: This provision is effective retroactively to January 1, 2017


Foreign

Investment

Fund

• TCJA renders the use of a foreign partnership to avoid CFC status

ineffective

• As a result of Sec. 958(b)(4) repeal, Foreign Sub 2 becomes a CFC,

subjecting the U.S. Individual to GILTI, Sub F, etc.

• The U.S. individual will be allocated his / her partner share of subpart F

income and section 956 income from U.S. Investment Fund regardless

of their ownership percentage in U.S. Investment Fund taxed at 37%

with no FTC, subject to section 962 election (if it was a US private

foundation, then 1%-2% excise tax)

• Foreign parent does not become a CFC because of Treas. Reg. Section

1.318-1(b)(1) (a corporation can't be deemed to own its own stock)

• Domestic Sub also must file Forms 5471, and does not satisfy the new

reporting exception (because of U.S. Shareholder owner)

• Exit costs:


37% / 20% tax rates for individuals and 1%-2% for private

foundations

• Sale of Foreign Parent subject to 20% individual capital gains

tax rate and 1%-2% for private foundations

• Sale of Foreign Sub 2 / Domestic generates subpart F income

to U.S LPs (taxed at 37% with no FTC)

• Fund should consider check-the-box election on Foreign Sub 2, or U.S.

Individual may consider section 962 election

Post-TCJA Consequences – Minority 10%+ U.S. Partner

Foreign Sub 2

Foreign Parent

Domestic Sub

U.S. Individual

12% 88%

100%

Other investors

(<10% U.S. owners

or non-U.S. persons)





UBTI

No relationship or

attribution between

foreign investors and

U.S. Investment Fund /

U.S. partners


• Prior to TCJA, private equity funds could often invest up to 50% in

companies without concern of the CFC regime

• Some of these investments may have been PFICs (and mark to

market/qualified electing fund elections may have been made)

• As a result of Sec. 958(b)(4) repeal, Foreign Sub 2 becomes a CFC,

subjecting the partners of U.S. Investment Fund to GILTI, Sub F, etc.

• The U.S. LPs will be allocated their partner share of subpart F

income and section 956 income from U.S. Investment Fund

regardless of their ownership percentage in U.S. Investment Fund.

• Individuals: 37% tax rate (no FTC)

• Private foundations: 1%-2% excise tax

• U.S. Investment Fund and Domestic Sub also must file Forms 5471, and

do not satisfy the new reporting exception (because of U.S. Shareholder

owner)

• Foreign parent does not because of Treas. Reg. Section 1.318-1(b)(1) (a

corporation can't be deemed to own its own stock)

• Exit costs:



foundations

• Sale of Foreign Parent subject to 20% individual capital gains

tax rate and 1%-2% for private foundations

• Sale of Foreign Sub 2 / Domestic generates subpart F income

to U.S LPs (taxed at 37% with no FTC)

• Fund should consider check-the-box election on Foreign Sub 2, or U.S.

Individual may consider section 962 election

Post-TCJA Consequences – 50% US Partnership Ownership

U.S

Investment

Fund

Foreign Sub 2

Foreign Parent

Domestic Sub

U.S. partners

50%

Foreign Persons

50%

Single class of stock

No relationship or attribution between

foreign investors and U.S. Investment Fund

/ U.S. partners





UBTI

U.S Investment Fund

does not hold more

than 50% of the vote

or value of Foreign

parent


Se

ctio

nS

um

ma

ry

• Eliminates the "uninterrupted

period of 30 days"

requirement for SubpartF

Elimination of

requirement that

CFC must be

controlled for 30

days before subF

applies

Other Key Modifications Subpart F

Rules

• Expanded definitionto

include any U.S. person

who owns 10% or more of

the total vote or value of a

foreign corporation

(previously vote only)

Modification of

definition of U.S.

shareholder

Effective date − Taxable years of foreign corporations beginning

after December 31, 2017, and for taxable years of U.S.

shareholders with or within which such taxable years of foreign

corporationsend


Foreign Sub 2

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

Post-TCJA Consequences – Foreign Partnership

100% of voting

only general

partner interest

• Now since the definition of U.S. Shareholder has been expanded to

include U.S. persons with no voting rights, certain U.S. LPs are U.S

Shareholders while pre-TCJA none of the U.S. LPs were U.S.

Shareholders

• As will be discussed in the following slides, certain U.S. LPs owning

at least a 10% non-voting preferred interest in Foreign Investment

Fund are subject to subpart F income, section 956 income, and

GILTI generated by Foreign Parent and Foreign Sub

• If the GP was foreign, then Foreign Parent and Foreign Sub would

be CFCs if more than 50% of the non-voting preferred interests

were held by U.S. persons each holding at least 10% of such

interests and then certain of those US LPs would be subject to

subpart F income, section 956 income, and GILTI generated by

Foreign Parent and Foreign Sub as CFCs

• Exit costs:



foundations

• Sale of Foreign Parent subject to 20% individual capital

gains tax rate and 1%-2% for private foundations

• Sale of Foreign Sub 2 / Domestic generates subpart F

income to U.S LPs (taxed at 37% with no FTC)

• >10% U.S. individuals should consider section 962 election

Foreign

Investment

Fund

U.S. G.P.

100%









Foreign Sub 2

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

Post-TCJA Consequences – US Partnership

100% of voting

only general

partner interest

• Same outcome as previous slide with

Foreign Investment Fund

• As discussed in the next slides, the less

than 10% U.S. LPs will no longer be

subject to subpart F income and section

956 income and will not be subject to the

new GILTI regime under the aggregate

approach.

• This is welcomed news for such minority

U.S. partners as normally such partners

would’ve been allocate their partnership

share of such income items regardless of

their ownership in US Investment Fund

US

Investment

Fund

U.S. G.P.

100%








GILTISection 951A


New U.S. International Tax RegimeQuasi-Territorial System

• Location of operations and associated tax rate may determine incremental U.S. tax

• Tax law change may impact location of cash/investments

• GILTI tax rate at 10.5% rate for corporations and 37% for individuals (1%-2% for private foundations)

Exempt Exempt

GILTI


• Sec. 951A – Global Intangible Low-Taxed Income Included In Gross Income Of U. S. Shareholders

• Imposes a minimum tax on certain foreign income described as "global intangible low-taxed income" (GILTI)

• Discourages income shifting incentives by subjecting income to current U.S. tax

• U.S. Shareholders of one or more CFCs are subject to current U.S. tax on its GILTI

• Domestic corps can obtain a deduction equal to 50% of the GILTI inclusion (subject to taxable income limits) with ability

to claim foreign tax credits

• GILTI is taxed at 37% tax rate for individuals and 1%-2% section 4940 for U.S. private foundations without the ability to

claim FTCs

• Section 962 is available for U.S. individuals, trusts, and estates to be taxed at a 10.5% effective tax rate with the ability

to utilize foreign tax credits

• Effective date – Taxable years of foreign corporations beginning after Dec. 31, 17, and for taxable years of U.S.

shareholders in which or with which such taxable years of foreign corporations end

Impact to Private Equity: GILTI disrupts the general goal of deferral until an exit event as U.S. persons are taxed

currently on the earnings of their CFCs. Individuals are hit particularly hard given the 37% tax rate without the

ability to claim FTCs. Section 962 should be considered by U.S. individual shareholders who hold GILTI

generating CFCs.

Global Intangible Low Taxed Income


GILTI – Overview and Mechanics

Qualified Business asset

investment

Gross Income of CFC

Allocable Deductions

Gross income of CFC

Exceptions

(e.g., Subpart F, related party

Dividends (other than PTEP), etc.)

Allocable deductions

U.S. Shareholder's net tested

income or loss

Qualified Business Asset

Investment

10% return

U.S. Shareholder's Net Deemed

Tangible Income Return

Allocable DeductionsCFC tested income or loss

Global Intangible

Low-taxed Income

_

_

=

∑ of CFC tested income and loss =

_

X

_ =

CFC-level items

U.S. shareholder-level items


investment Tested interest expense


investment Tested interest income

_

Specified Interest Expense


• Tested income is gross income without regard to certain exceptions

• Net tested income is the excess of tested income over deductions

• Net tested losses occur when deductions exceed gross income

• Under Treas. Reg. Sec. 1.952-2(a)(1) and Prop. Treas. Reg. Sec. 1.951A-2(c)(2), tested

income or tested loss of a CFC is determined by treating the CFC as a domestic corporation

taxable under Section 11 and by applying the principles of Section 61 and the regulations

thereunder

Tested Income or Loss

Exceptions

from gross

tested

income

Effectively connected income

Subpart F Income

Income excluded under the high-tax exception

Dividends (other than PTEP) received from certain related parties

Foreign oil and gas extraction income, over deductions allocable to such

gross income


Net Deemed Tangible Income Return

• Net deemed tangible income return (NDTIR) equals 10%

times the CFCs’ aggregate adjusted basis in "qualified

business asset investment" ("QBAI") over specified interest

expense

• QBAI is the quarterly average of the aggregate of CFCs’

adjusted bases in specified tangible property (STP)

• STP means tangible property used in the production of gross

tested income

• None of the tangible property of a tested loss CFC is specified

tangible property (annual determination)

• Tangible property means property for which a deduction under

section 167(a) is eligible to be determined under section 168

• Specific rules for dual use property

10 percent

CFC basis in

depreciable

propertyX

NDTIR

Less Specified interest expense

New Section 951 regs: implications for private equity investors


Content best practices

Limit the # of bullets and

amount of text

•

•

•

•

•

• Treasury concurrently released three separate regulation packages on Friday, June 14th

• Final regulations under Section 951A (i.e., Global Intangible Low-taxed Income or "GILTI")

• Proposed regulations under Sections 951, 951A and 958

• Temporary regulations under Section 245A (i.e., the Dividends (other than PTEP) received deduction or "DRD") – not covered in this presentation

• The regulations are a significant development, and are certain to impact nearly all private equity investors with interests in controlled foreign corporations

• The three packages contain nearly 500 pages of regulations in total

TCJA regulations issued

35


Final GILTI Regs – At a glance

• Final and temporary regulations released on

June 14

• Issued under Sections 78, 861, 951, 951A, 965,

6038, and 6038A

• Primarily provide guidance relating to the

calculation of GILTI, but also finalize a few

proposed FTC regulations

What is the development?

When do the rules apply?

Effective date – Generally, the GILTI regulations apply to taxable years of foreign corporations

beginning after Dec. 31, 2017, and for taxable years of U.S. shareholders in which or with which such

taxable years of foreign corporations end (Consistent with Sec. 951A). The other FTC regulations have

varying "special applicability dates."

• Largely retained structure and approach from

proposed regulations released in 2018

• Adopt aggregate approach to partnerships (key

point)

• Provide certainty to taxpayers working on 2018

calculations

• Several taxpayer favorable modifications

What are the highlights?




amount of text

•

•

•

•

•

• For purposes of Section 951A (and certain related provisions), a domestic partnership is generally

not treated as owning stock of a foreign corporation within the meaning of Section 958(a).

• The partners of a domestic partnership are treated as owning proportionately the stock of CFCs

owned by the partnership in the same manner as if the partnership were a foreign partnership under

Section 958(a)(2).

• As a result, the domestic partners, not the domestic partnership, pick-up the GILTI inclusion.

• However, for purposes of determining U.S. shareholder status, CFC status and whether a U.S.

shareholder is a “controlling domestic shareholder” for purposes of making certain elections, a

domestic partnership is not treated as foreign partnership.

• The aggregate approach also applies to S corporations and their shareholders, which are treated as

partnerships and partners for purposes of Section 951 through Section 965.

Partnership rules

37


Partnerships under final regs

USP

(U.S.)

PRS

(U.S.)

FC

(Non-U.S.)

5%

100%

Individual A

(U.S.)

95%

Application of Section 951A

• For purposes of sections 951A, PRS is not treated as owning the FC stock; instead,

PRS is treated in the same manner as a foreign partnership.

• USP is treated as owning 95% of the FC stock under section 958(a), and Individual

A is treated as owning 5% of the FC stock under section 958(a).

• USP is a United States shareholder of FC, and therefore USP determines its income

inclusions under section 951A based on its ownership of FC stock under section

958(a).

• Individual A is not a United States shareholder of FC, Individual A does not have a

pro rata share of any amount of FC for purposes of section 951A.

CFC and U.S. shareholder determinations

• For CFC/U.S. shareholder determinations PRS is treated as a domestic partnership.

• PRS owns 100% of the total combined voting power or value of the FC stock within

the meaning of section 958(a).

• PRS is a United States shareholder under section 951(b), and FC is a controlled

foreign corporation under section 957(a).

• USP is a United States shareholder of FC because it owns 95% of the total

combined voting power or value of the FC stock under sections 958 and 318.

• Individual A, however, is not a United States shareholder of FC because Individual A

owns only 5% of the total combined voting power or value of the FC stock under

sections 958 and 318.

What about subpart F?


Partnerships under final regs

USP

(U.S.)

PRS 1

(U.S.)

FC

(Non-U.S.)

10%

100%

Individual A

(U.S.)

90%

PRS 2

(U.S.)

Individual B

(NRA)

90%10%

CFC and U.S. shareholder determinations

• Under section 958(b)(2), PRS1 is treated as owning 100% of the FC stock for

purposes of determining the FC stock treated as owned by USP and Individual A

under section 318(a)(2)(A).

• Therefore, USP is treated as owning 90% of the FC stock under section 958(b)

(100% x 100% x 90%), and Individual A is treated as owning 10% of the FC stock

under section 958(b) (100% x 100% x 10%).

• Accordingly, both USP and Individual A are United States shareholders of FC under

section 951(b).

Application of Section 951A

• USP is treated as owning 81% (100% x 90% x 90%) of the FC stock under section

958(a), and Individual A is treated as owning 9% (100% x 90% x 10%) of the FC

stock under section 958(a).

• Because USP and Individual A are both United States shareholders of FC, USP and

Individual A determine their respective pro rata shares of any tested item of FC

based on their ownership of section 958(a) stock of FC.


Prop. GILTI Regs – At a glance

• Proposed regulations released on June 14

• Issued under Sections 951, 951A, and 958

• Provide proposed guidance relating to elective

"GILTI High-tax Exclusion" ("GILTI HTE") and

modify the taxation of partners in domestic

partnerships for purposes of subpart F

What is the development?

When do the rules apply?

Effective date – Generally, the regulations apply to taxable years of foreign corporations beginning on or after publication

of the final regulations

• Taxpayers may NOT rely on the GILTI HTE prior to finalization of the regulations

• A domestic partnership may rely on proposed aggregate treatment rules with respect to taxable years of foreign

corporations beginning after December 31, 2017, provided the rules are consistently applied Key Takeaway : Private equity partnerships should consider amending Schedule K-1s to present subpart F income consistent with

the proposed regulations (i.e. reporting subpart F income as footnote disclosure item rather an income item on page 1)

• Adopt pure aggregate approach to domestic

partnerships for purposes of subpart F

(expanding on the GILTI the final regulations)

• Framework for a GILTI HTE

• Excludes tested income when effective tax rate

exceeds 90% of 21% (high tax exception- key

point)

What are the highlights?




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Prop. vs. final regulations

41

Gross tested income does not

include gross income excluded from

foreign base company income (as

defined in section 954) or insurance

income (as defined in section 953) of

the corporation solely by reason of

an election made under section

954(b)(4) and §1.954-1(d)(5).

Final regulations Prop. regulations

Expand GILTI HTE to include

certain high-taxed income if that

income would not otherwise be

FBCI or insurance income.

Excludes gross income subject to

foreign income tax at an effective

rate that is greater than 90 percent

of the rate that would apply if the

income were subject to the

maximum rate of 21% (i.e., 18.9%).


GILTI high-tax exclusion highlights

Elective

Effective rate test is 90% of the max corporate rate

(i.e. 18.9%)

Effective rate is based on deemed paid amount

under Section 960How does

it work?

Consistency rule within groups of CFCs

Election applies for current and future years

unless revoked (subject to a 60-month rule)

The GILTI HTE would exclude certain high-taxed income even if it’s not FBCI or insurance (in other words, GILTI)




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•

• The treatment of domestic partnerships as foreign partnerships in the final GILTI regulations is solely for purposes of section 951A

• The final rule does not affect the determination of ownership under section 958(a) for any other provision of the Code, nor does it change whether such partner has a distributive share of a domestic partnership’s subpart F inclusion under section 951(a)

• Proposed regulations would apply a similar aggregate treatment to domestic partnerships for purposes of section 951 – aligning GILTI with other deemed income regimes

• The rules in the proposed regulations are proposed to apply to taxable years of foreign corporations beginning on or after the date of publication

• However, a domestic partnership may rely on the rules for tax years of a foreign corporation beginning after Dec. 31, 2017, and for tax years of a domestic partnership in which or with which such tax years of the foreign corporation end (must be consistently applied)

Partnerships under proposed regs

43



• For purposes of determining the stock owned under section 958(a) by a partner of a domestic partnership, a domestic partnership is treated in the same manner as a foreign partnership

• Partnership is treated as an aggregate of its partners for purposes of determining whether, and to what extent, its partners have inclusions under section 951 and 951A and for purposes of any other provision that applies by reference to sections 951 and 951A

• Domestic partnerships are still treated as entities for purposes of determining whether a foreign corporation is a CFC, and for determining U.S. shareholder status

• Aggregate treatment does not apply for any other purposes of the Code (e.g. section 1248 and PFICs)

• Key Takeaway : Private equity partnerships should consider amending Schedule K-1s to present subpart F income consistent with the proposed regulations (i.e. reporting subpart F income as footnote disclosure item rather an income item on page 1)



• Under the proposed regulations, all U.S.

LPs (regardless of ownership % held in US

Investment fund) would be subject to the

subpart F income generated by the CFCs.

• However, if US Investment Fund chose to

apply the proposed regulations (i.e.

provide subpart F income as a footnote

disclosure as opposed to an item of

income on page 1 of the Schedule K-1),

then U.S. LPs with less than a 10%

interest in US Investment Fund could

exclude the subpart F income

Foreign Sub 2

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

100% of voting

only general

partner interest

US

Investment

Fund

U.S. G.P.

100%

Planning opportunities to minimize tax on foreign holdings


Summary of Planning Strategies for Private Equity with CFC investments

1. Application of final and proposed regs to minimize / eliminate number of U.S. partners subject to

subpart F income and/or GILTI

2. If above doesn’t apply or doesn’t cover enough US partners, then one or more of the following could

be implemented

a. Let individual partners know about the sec 962 election

b. Contribute interest in FC to US Holding Corp (could create US withholding tax issues for

non-US investors – maybe only have US investors hold thru US Holding corp)

c. File CTB elections on foreign subs on FP to eliminate 958(b)(4) issue

d. File CTB elections on CFCs to reduce GILTI by freeing up QBAI

e. File CTB elections on CFCs to convert GILTI to high-tax subpart F income which is exclude

from GILTI and is not taxable to the US investors

f. Wait to see if proposed HTE GILTI regs are passed and apply to CFCs to reduce /

eliminate GILTI


Strategy #1 – Partnership apply proposed regulations

• Until the proposed regulations become effective (which is for

taxable years of foreign corporations beginning on or after

publication of the final regulations), partnerships should

consider reporting all subpart F income inclusions as a K-1

footnote disclosure rather than item of income on page 1 of

Schedule K-1 (typically reported on line 11)

• Partnerships should also be reporting GILTI items in a similar

fashion (i.e. in K-1 footnote disclosures rather than as items of

income on page 1 of the K-1)

• By adopting this reporting methodology, US partnerships would

be relying on the proposed regulations as provided in the

preamble and would allow less than 10% U.S. partners to

exclude subpart F income from U.S .taxable income

• This strategy achieves deferral on CFC earnings for <10% U.S.

partners and preserves eligibility for qualified dividend tax rates

and capital gains tax rates for individuals

Foreign Sub 2

Foreign Parent

U.S. LPs

100% of non-

voting preferred

limited partner

interest

100% of voting

only general

partner interest

US

Investment

Fund

U.S. G.P.

100%


Strategy #2a – Section 962

• Section 962 allows individuals to be taxed at Corporate rates for subpart F income

(21%) and GILTI (10.5%) rather than 37% and also provides the ability to reduce

such U.S. tax liability with deem-paid foreign tax credits from the CFC.

• Partnerships should consider putting a footnote disclosure regarding an individual

partner’s ability to make a section 962 election which could result in a reduction or

even elimination of his / her U.S. Federal income tax liability on GILTI and subpart F

income

• Of course, each individual’s tax profile and the tax attributes of each CFC subject to

this election will determine whether such election should in fact be made by such

partner and would require the partner to consult with his / he tax advisor on whether

such election should be made.


Strategy #2b – Use US Holding Company

• Consider the use of a US Holding

Company either to directly hold

the shares of Foreign Parent (see

US Holdco Structure 1) or as an

investment vehicle for 10%+ U.S.

LPs

• Structure 1 allocates all GILTI /

subpart F income at US HoldCo

which benefits 10%+ U.S. LPs but

could result in double taxation for

other partners

• Structure 2 only impacts 10% U.S.

LPs in a beneficial way by

allocating their share of GILTI to

the US Hold Co

Foreign Sub 2

Foreign Parent

10% + U.S. LPs

100% of non-

voting preferred

limited partner

interest

100% of

voting only

general

partner

interestUS

Investment

Fund

U.S. G.P.

100%

US Hold Co

US Hold Co Structure 1

Foreign Sub 2

Foreign Parent

10%+ U.S. LPs

Non-voting

preferred limited

partner interests100% of

voting only

general

partner

interest

US

Investment

Fund

U.S. G.P.

US Hold Co

US Hold Co Structure 2

Other US LPs and

non-US investors

Other US LPs and

non-US investors




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•

• Allows the taxpayer to access QBAI and tested foreign income taxes that

would otherwise be excluded due to tested loss entities

• May not be necessary if inclusion is already shielded by excess FTC

• Consider other ancillary issues of the disregarded entity status (e.g., subpart

F, exit planning, etc.).

Check-the-box planning –Considerations for Strategies 2c to 2e

51


Strategy #2c – CTB elections to eliminate “downward attribution” problem

• Due to the repeal of section 958(b)(4), U.S. Individual

would be subject to the subpart F income and GILTI

generated by Foreign Sub 2.

• However, if a CTB election was made on Foreign Sub

2, then Foreign Sub 2’s status as a CFC would

terminate on that date.

• U.S. Individual would be required to include into

income his / her/ its pro-rata share of Foreign Sub 2’s

subpart F income earned in the year of CTB election

but then would no longer subject to it.

Other investors

(<10% owners)

Foreign

Investment

Fund

Foreign Sub 2

Foreign Parent

Domestic Sub

U.S. Individual

12% 88%

100%




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53

This example assumes no tested interest expense, tested interest income or tested foreign

income taxes exists at either CFC 1 or CFC 2

USP

CFC 1

CFC 2Tested Loss: (200)

QBAI: 2000

USP

CFC 1

CFC 2

Pre CTB Post-CTB

Tested Income: 500

QBAI: 1,000

GILTI Inclusion: 200

Tested Income - NDTIR

(500-200) - (1000 x 10%)

GILTI Inclusion: 0

Tested Income – NDTIR

(300) - ((3000 x 10%))

Tested Income: 300

QBAI: 3,000

Strategy #2d – CTB election to reduce GILTI by freeing up QBAI




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•

54

CFC 3

20% Rate

Pre-Tax E&P: 0

Tax: 0

USP

CFC 1

CFC 2

20% Rate

3rd Party

Debt

Pre-Tax E&P: 100

Tax: 20

Pre-Tax E&P: 100

Tax: 20

Interest: 500

Taxable Income: 600

Asset Basis (US): 100

Existing Stock Basis in Subs: 200

Increase in Basis Due to GILTI: 200

This example assumes no interest expense limitations

Interest Apportionment under Treas. Reg. Sec. 1.861-10

Assets producing U.S. source income 100.00

Assets producing foreign source income (Average of BOY and EOY) 300.00 (a) = ((200+400)/2)

Total Assets 400.00 (b)

Percentage of total assets producing FSI 75% (c) = (a/b)

Interest Expense 500.00 (d)

Interest Expense to be apportioned against FSI 375.00 (e) = (c) x d

Computation of FSI resulting from GILTI (Claiming FTC)

CFC 2 Tested Income 80.00


Section 78 Gross Up 40.00

GILTI Inclusion 200.00

Section 250 deduction 100.00

Gross FSI 100.00

Interest to be allocated against FSI 375.00 (e)

Overall Foreign Loss -275.00 Unable to claim FTC

Incremental U.S. Tax Paid 21.00 (100 x 21%)

Computation of FSI resulting from GILTI (Deducting foreign taxes)



GILTI Income 160.00

Section 250 deduction 80.00

FSI 80.00

Incremental U.S. Tax Paid 16.80 (80 x 21%)

Strategy #2e – CTB election to convert GILTI to high-taxed subpart F income




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55

FC 3

20% Rate

Pre-Tax E&P: 0

Tax: 0

USP

CFC 1

FC 2

20% Rate

3rd Party

Debt

Pre-Tax E&P: 100

Tax: 20

Pre-Tax E&P: 100

Tax: 20

Interest: 500

Taxable Income: 600

Asset Basis (US): 100

Existing Stock Basis in Subs: 200

Increase in Basis Due to GILTI: 200

Analysis

• Assume that Check-the-box planning results in the

income of FC 2 and FC 3 being treated as FBCSI

• As a result, the Subpart F income would qualify for the

high tax exception. ((ETR is greater than 18.9% (90%of

21%))

• Income qualifying for the high tax exceptions is excluded

from the computation of tested income

• The income of FC 2 and FC 3 excluded from GILTI may

qualify for the participation exemption under Sec. 245A

• As a result, no incremental U.S. tax is due

• The benefit in this example is a result of the highly

leveraged U.S. Parent

• Consider the following:

• What if the foreign corporate rate changes in the

future?

• What if the entities do not qualify for high-tax as a

result of timing differences in a year?

• What if FC 2 and FC 3 face a downturn in

business, resulting in NOLs?

Strategy #2e – CTB election to convert GILTI to high-taxed subpart F income, continued


Strategy #2f – Wait and see if GILTI HTE proposed regulation is final

• Although the proposed regulations regarding the High-Tax Election (“HTE”) for GILTI

won’t be available to US Shareholder until for taxable years of foreign corporations

beginning on or after publication of the final regulations, analysis can be conducted

now to see if how the GILTI HTE could held reduce the GILTI tax burden (or possibly

eliminate it) for certain U.S. partners.


Key Takeaways

• Original tax strategy in a Pre-TCJA world was to defer U.S. taxation until an exit /

liquidity event and then monetize the investment at lower qualified dividend / capital

gains tax rates (for individuals)

• Now Post-TCJA, the new rules might interfere with the original strategy by expanding

the scope of CFCs and U.S. Shareholders and imposing current year taxation of CFC

earnings via GITI.

• In light of tax reform changes, historical private equity structures with foreign

corporations need to be reviewed for potential adverse impact


Any final questions?

58

Q&A


Disclaimer

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to be considered to arrive at conclusions that comply with matters

addressed in this presentation. The views and interpretations expressed

in the presentation are those of the presenters and the presentation is

not intended to provide accounting or other advice or guidance with

respect to the matters covered

For additional information on matters covered in this presentation,

contact your Grant Thornton LLP adviser

59


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