As widely expected, the tax reform bill released today by House Republicans provides for a one-time transition tax on untaxed accumulated earnings and profits (“E&P”) of certain non-U.S. corporations. Under the “Tax Cuts and Jobs Act,” E&P would be split between cash or cash equivalents and non-cash amounts, with cash and cash equivalents taxed at 12% and non-cash amounts taxed at 5%. The highlights:
Basic Framework. Under the bill, 10% U.S. shareholders of a non-U.S. corporation generally will include in income their pro rata share of the foreign corporation’s previously untaxed accumulated E&P, determined as of November 2, 2017 or December 31, 2017 (whichever produces more E&P). Non-U.S. corporations subject to the rules – “specified foreign corporations” – include any “controlled foreign corporation” and any foreign corporation with respect to which one or more domestic corporations is a 10% U.S. shareholder.
Rate Split. The bill differentiates between E&P that has been retained in the form of cash or cash equivalents (“cash positions,” detailed below) and other amounts of foreign E&P. The effective tax rate applicable to cash position amounts is generally 12%, and the effective tax rate applicable to foreign E&P in excess of the corporation’s cash position is generally 5%.
E&P Deficit Netting Permitted. The bill permits netting of E&P deficits and surpluses among U.S. shareholders that are members of an affiliated group.
Relevant “Cash” Determinations. The significant spread between the rates at which cash positions and non-cash E&P would be taxed makes the definition of “cash position” critical. The “cash position” of any specified foreign corporation is the sum of:
(i) cash held by such foreign corporation,
(ii) the net accounts receivable of such foreign corporation, and
(iii) the fair market value of the following assets held by such corporation: actively traded personal property for which there is an established financial market; commercial paper, certificates of deposit, the securities of the federal government and of any state or foreign government; any foreign currency; any obligation with a term of less than one year; and any asset which the IRS identifies as being economically equivalent to the previously described assets.
With respect to any U.S. shareholder, its “aggregate foreign cash position” is determined by using a 3-year averaging approach, generally taking into account the U.S. shareholder’s aggregate pro rata share of the cash position of each specified foreign corporation of such U.S. shareholder determined:
(i) as of November 2, 2017;
(ii) as of the close of the last taxable year of each such specified foreign corporation which ends before November 2, 2017; and
(iii) as of the close of the taxable year of each such specified foreign corporation which precedes the taxable year referred to immediately above.
Similar to the draft legislation released in 2014 by former Rep. Dave Camp, the bill retains a “U.S. shareholder-by-U.S. shareholder” approach for the determination of cash positions.
Installment Payments Permitted. A U.S. shareholder of a deferred foreign income corporation may elect to pay its resulting net transition tax liability over eight equal annual installments.