The National Multistate Tax Symposium West · • US corporations filing federal ... o Special...

The National Multistate Tax Symposium WestMove forward with confidence—State implications of tax reform

April 30-May 2, 2018

State treatment of federal deemed and actual dividends and GILTI – A deeper dive Jairaj Guleria, Deloitte Tax LLPSarah Murray, Deloitte Tax LLPShirley Wei, Deloitte Tax LLPMay 1, 2018

3

Overview

4Copyright © 2018 Deloitte Development LLC. All rights reserved.

Tax reform—Multistate considerations for multinational entities

Deemed Repatriation of Foreign E&P

Tax on Global Intangible Low-Taxed Income (GILTI)

Deduction for Foreign-Derived Intangible Income (FDII)

Tax reform legislation includes three major changes for federal taxation of multinational entities (MNEs):

It’s the end of deferral as we know it

“I don’t think ‘intangible’ means what you think it means”


Deemed repatriation of foreign E&PTax reform—Multistate considerations for multinational entities

• Applies for last tax year of controlled foreign corporation (CFC) beginning before January 1, 2018

• IRC section 965(a) provides for addition to 10(+)% shareholder of CFCs equal to pro rata share of CFC’s untaxed deferred E&P (“965 inclusion”)

o 965 inclusion based on the greater amount of post-1986 deferred income as measured on:

November, 2, 2017, or

December 31, 2017

o 965 inclusion calculation allows for netting of E&P balance against E&P deficits

• IRC section 965(c) provides for deduction for corporations to impose effective tax rate of:

o 15.5% (to extent of US shareholder’s pro rata share of CFC’s cash & cash equivalents (the “US shareholder’s aggregate foreign cash position”); and

o 8% of the US shareholder’s pro rata share of the remainder

• FTC eligible but reduced

• Election to pay tax over 8 years

• US corporations filing federal consolidated return to be treated as single US shareholder


Federal taxation of GILTI

Tax reform—Multistate considerations for multinational entities

• Annual tax calculation pursuant to IRC section 951A

• Federal taxation of net CFC tested income less its net deemed tangible income return (10% of US shareholder’s pro rata share of CFC’s qualified business asset investment (QBAI), less interest)

• 80% of foreign tax credits allowed to offset GILTI (if foreign tax rate exceeds 13.125%, no residual US tax will be owed on GILTI)

• Allows for corporate deduction under IRC section 250 for:

o GILTI (50% of GILTI before 1/1/26; 37.5% thereafter)

“Intangible” means “deemed intangible”

GILTI until proven . . . not GILTI

Get to know your (CFCs) QBAI


Federal taxation of FDII

Tax Reform—Multistate considerations for multinational entities

• New category of income for US corporations

• FDII is income of US corporation derived from:

o Sales/dispositions of property to foreign person for foreign use;

o Licenses of IP to a foreign person for foreign use; and

o Services provided to a person outside the United States

o Special rules apply for related-party transactions but can still generate FDII if property/services for use by third party outside United States

o Reduces US tax rate on the “foreign-derived” portion of the excess of certain income over “deemed tangible income return” (10% of QBAI)

• US corporations include FDII in gross income but allowed deduction under IRC section 250:

o 37.5% through 2025; 21.875% thereafter

o Deduction available for US corporations owned by non-US multinationals

o If US corporation’s GILTI and FDII exceed US corporation’s ‘other’ taxable income, then GILTI and FDII deductions reduced

This QBAI is not your CFC’s QBAI

Federal & state sourcing not identical

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Selected State Considerations


State issues raised by the 965 repatriation system

Transition Tax—Multistate considerations for multinational entities

“It doesn’t matter what I believe, it only matters what I can prove”

• Rolling versus static conformity

• Availability of state-level DRD against IRC sections 965(a) and 78 inclusions

• Deductibility of IRC section 965(c) “participation deduction”

• Expense disallowance provisions may implicate more states

• Inapplicability of foreign tax credits

• Apportionment factor representation

• Impact of unique state filing methods: separate entity reporting,

• worldwide reporting, 80/20 carve outs, tax haven inclusions

• Collateral impact of actual repatriations and/or no longer asserting APB 23

• Non-conformity to payment due date and installment election under IRC section 965(h)


Variables to quantify

state impact of

transition tax

Significant variables require analysis and integrated modeling

Transition Tax - State computation and analysis

Coordination with International Transition Tax Computation, Analysis and Conclusions

State Conformity to section 965—Fixed vs. Rolling IRC Conformity

Impact in Unitary States that Include CFCs in Group and Applicable "80/20" Exclusions

Availability of section 965(c) Deduction

State Tax Treatment of Cash Dividends—Nonconforming States

State Definition of "Subpart F Income"—section 965 Inclusion

Sales Factor Treatment of Deemed and Actual Dividends

Disallowance of deductions related to non-taxable dividends


State Treatment of Dividends Received Deduction (DRD) – as of March, 2018

For dividends paid by foreign corporations greater than 80% owned to a member of a water’s edge group, the following are states where income would NOT be eligible for a 100% DRD or exclusion:

Of these states, the ones in blue would currently conform to section 965 as enacted.

•AK

•CA

•CO

•ID

•KS

•LA (if paid or deemed paid before 6/30/18)

•NM (if filingconsolidated/combined)

•ME

•MA

•MN

•MT

•NH

•ND

•OR

•UT

•VT


Transition Tax and ASC 740—State tax considerations example

• Assumptions:

o Section 965 repatriation amount = $3B

o Blended (aggregate) state tax rate = 5%

o No cash dividends paid

• All deemed dividend is apportionable income

• Section 965 deemed inclusion is Subpart F income

• Single sales factor apportionment

• No state special rules regarding limitation on

dividends eligible for DRD, distortion tests, etc.

• Potential conclusions:

o If assume all DRD eligible, state tax = $0

o If assume all taxable, state tax = $150 million (5% x $3B)

o Based on specific state analysis below, state tax = $15.3M (before federal benefit)

State A State B State C

Conformity to 12/31/2017 IRC No Yes Yes

Deemed Dividend $0 $3B $3B

DRD% 100% 80% 80%

Dividend amount incl. in state tax base 0 $600M $600M

Dividends Statutorily Included In Sales Factor Yes No Yes

Sales Factor Numerator $20M $50M $30M

Sales Factor Denominator $100M $100M $3.1B

Sales % 20% 50% 1%

State tax rate (before federal benefit) 5% 5% 5%

Actual state tax (before federal benefit) 0 $15M $300K


Selected state issues

GILTI—Multistate considerations for multinational entities

• Rolling versus static conformity

• Will state level DRDs be as widely applicable as with transition tax?

• Section 250 deduction may be limited given it is a “special deduction” in the IRC

• Inapplicability of foreign tax credits

• State-level section 78 exclusion provisions

• Apportionment factor representation

• Impact of unique state filing methods: separate entity reporting, worldwide reporting, 80/20 carve

outs, tax haven inclusions

• Section 250 deduction is limited to taxable income which may be different for state


Statutory references

GILTI—Multistate considerations for multinational entities

• “Subpart F” income - which is defined by Section 952

o definition provided in Section 952 actually refers to “subpart F income”

o “Subpart F income” that utilizes a capital “S” refers to Subpart F of the IRC, which encompasses 951-965

o The term “subpart F income” is what 952 defines and is a type of income that gets included under 951, along with other categories of income, including 956.

o The distinction between “Subpart F income” and “subpart F income” may be critical

o States that reference “Subpart F income” could include all income under Sections 951-965, but if the state references “subpart F income,” that amount may be limited to what is defined in 952

• Is GILTI a “dividend”?

o Can we rely on a state’s deduction for “dividends”?

o What about if the state specifically references GILTI, references 951A or 951-965, or even “Subpart F income”?


GILTI and ASC 740 – state tax considerations example

Performing a GILTI Specific State Analysis – Illustrative Example

Federal Context:

• GILTI Inclusion Amount: $1B

• GILTI Deduction Amount = ($500M)

• FDII Deduction Amount = ($100M)

State Tax Assumptions:

• Blended State Tax Rate: 6%

• All GILTI is apportionable income but is not included in the receipts apportionment factor

• Entity recognizing GILTI income is considered an 80/20 company that may be excludable from certain combined groups, as applicable

• States would not allow a “double benefit” for GILTI deduction, if GILTI income is not included in state taxable income


Tax Reform and ASC 740 – state tax considerations (cont.)

Performing a GILTI Specific State Analysis – Illustrative Example

Potential Conclusions:

• If assume all GILTI income is DRD eligible, state tax = $0

• If, however, assume all taxable, state tax = $24M ($400M * 6%)

• Based on specific state analysis, however (see below) state tax = $13.6M (before federal tax benefit)

State A State B State C State D

Conformity to 2018 IRC No Yes Yes Yes

§ 951A GILTI Income $0 $1B $1B $1B

DRD Applicable N/A No No 100%

US Shareholder Files as part of group? Yes Yes No Yes

Includable Income $0 $1B $0 $0

Section 250 Deduction Allowed? N/A No No Yes

Allowable Deduction N/A $0 $0 ($100M)

Taxable Income $0 $1B $0 ($100M)

Group Apportionment % 10% 20% 15% 30%

Tax Rate 8% 8% 8% 8%

Actual State Tax $0 $16M $0 ($2.4M)

17

California Considerations


Transition Tax—California Considerations

• Currently, California conforms to the Internal Revenue Code as of January 1, 2015 and thus has not adopted IRC Section 965. The FTB confirmed this in a preliminary report on the TCJA issued on February 12.

• Despite non-conformity, California is a relevant transition tax consideration in at least two situations

o To the extent of actual dividends

o To the extent that a company’s indefinite reinvestment (APB 23) position is modified

• The California impact differs for water’s-edge versus worldwide filers

Overview



• Actual future dividends may be taxable in California:

o Water’s Edge Filers:

Elimination or deductibility of dividends is determined with respect to each annual “layer” of E&P on a LIFO basis, working back from current year E&P.

In each layer, dividends are eliminated to the extent paid from previously included E&P (Cal. Rev. & Tax. Code §25106).

Dividends between tiers of CFC have to be accounted for based on the paying CFC’s inclusion ratio.

75% DRD available on the remaining amount (CRTC § 24411).

o This LIFO method was litigated in Fujitsu IT Holdings, Inc. & Franchise Tax Board, 120 Cal. App. 4th 459 (2004) and Apple, Inc. v. Franchise Tax Board, 199 Cal. App. 4th 1 (2011).

In Fujitsu, the court applied a preferential ordering to current year earnings—dividends are treated as (1) first paid from earnings eligible for elimination under CRTC 25106 and (2) then any excess paid from earnings eligible for partial DRD under CRTC 24411.

In Apple, Inc., however, the court applied the LIFO method to multiple year earnings and profits—dividends are deemed paid first from current year’s earnings until exhausted and then from the most recent prior years’ earnings on a year-by-year basis until each year’s earnings are exhausted. Under the LIFO method, taxpayers must take into account untaxed earnings in the current year before getting the benefit of previously taxed earnings generated in prior years.

Interest expense related to foreign investment is added back (only with respect to the deducted portion of the dividend) (CRTC § 24344).

Water’s-Edge Filers


Transition Tax—California ConsiderationsWater’s-Edge Filers – Foreign Investment Interest Offset (FIIO)

• General – Interest expense incurred for purposes of foreign investment may be offset against the foreign DRD. (CRTC §24344(c))

• Computation (Form 2424)

• Specifically Assign Interest Expense to Domestic or Foreign

• Unassigned Interest Expense (gets allocated based upon percentage)

• Allocation Percentage:

− Foreign Investment – Foreign investment is generally stock or other equity investment, which is included in total assets.

− Total Assets – Assets and stock or other equity investments (if less than 50% ownership – value taken into account at the federal tax book value (original cost for federal tax purposes less depreciation, amortization, or depletion) (if more than a 50% ownership – value taken into account at the adjusted basis for federal tax purposes with certain adjustments).

• Apply Ratio to Unassigned Interest Expense [smaller of this amount or the DRD, then multiply by 75%] (CRTC §24344(c)(2)).

• In Apple, Inc. v. Franchise Tax Board, 199 Cal. App. 4th 1 (2011) a California Court of Appeal held that the Taxpayer had met its burden in proving that its interest expense was attributable to domestic operations by providing evidence that the primary purpose of its borrowing was to fund domestic operations.



• General treatment of foreign dividends

o Elimination available to the extent dividend is from worldwide, unitary E&P layers

• But situations exist where there may be no elimination

o Prior water’s-edge tax years

o Acquired or non-unitary CFCs

Worldwide Filers



• Entities Generally Included in the Water’s Edge Group

o Fully Included

20% US Factors

US Corporations

o Partially Included

ECI

Subpart F inclusion ratio (next slide)

CFC Inclusion



• Subpart F inclusion ratio - CFC income & factors are includible in the California return based on a ratio of Subpart F income over current year E&P

• Subpart F – IRC Section 952 (does not include all federal Subpart F)

• Current Year E&P – E&P as defined in IRC Section 964

• Net Income – Total Net Income as reflected on the CFC’s books and records, adjusted to conform to California tax law

CFC Inclusion


• Computation of PTI Amounts

o Close analysis of previously included income in each historic layer of E&P.

o CFC income & factors are includible in the California return based on a ratio of Subpart F income over current year E&P (“Subpart F inclusion ratio”)

o Inter-CFC dividends from lower tier CFCs and prior year dividends into the domestic group further complicates computation.

• Computation of FIIO

o Trace interest to domestic activities to limit amounts subject to standard allocation formula.

• Identify Other Offsets:

o Treatment of dividends in the sales factor.

• Worldwide v. Water’s Edge Calculation:

o Taxpayers may benefit from electing to file on a worldwide methodology.

Transition Tax—California ConsiderationsAreas of Focus

25

Action Steps


Action StepsIssues for Immediate Consideration

• State E&P and the Transition Tax

o Tracking of “untaxed” E&P in states that do not conform to Section 965(a)

o If “untaxed” E&P exists in states, consider the companies policy with respect whether or not they are indefinitely reinvested or if deferred tax liabilities are required

o Federal/state filing group differences

o Applicability of Section 965(c) deduction for state tax purposes

Special deduction?

Impact if inclusion is already eligible for deduction or exclusion?

o Previously taxed income

o Understand the amount of income included in each historic layer of E&P

Determine how CFC income and factors are included in the return

o Worldwide vs. Water’s Edge

o Apportionment effect


Action Steps

Issues for Immediate Consideration

• GILTI

o Because there are no federal tax credits for state tax, GILTI may result in additional state tax even if no additional federal income tax

o GILTI inclusion is computed on a shareholder by shareholder basis

Identify which entity will be deemed to recognize GILTI income

Determine whether it will be eligible for a state subtraction or DRD

How will GILTI income be sourced for apportionment purposes?

o Applicability of GILTI deduction for state tax purposes

• FDII

o Federal rules for determining “foreign deduction eligible income” may be different than state apportionment rules

o Deduction is still available for entities with no GILTI inclusion as long as it has foreign derived income

Evaluate restructuring alternatives in the context of international, federal and state

implications of GILTI, FDII and the related issues

28

Final observations, takeawaysand questions


Contact information

Sarah MurrayDeloitte Tax [email protected]

Jairaj GuleriaDeloitte Tax [email protected]

Shirley WeiDeloitte Tax [email protected]

mailto:[email protected]




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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