The president on December 22, 2017, signed H.R. 1 (the legislation formerly known as the “Tax Cuts and Jobs Act”). The new law contains several international tax provisions that may affect insurance companies by raising new material tax exposures and reporting obligations. For calendar year taxpayers, some of these provisions are effective as of January 1, 2017 (technically, the last tax year beginning before January 1, 2018).
The IRS today issued Notice 2018-07 [PDF 151 KB] describing regulations the Treasury Department intends to issue to clarify the determination of the mandatory repatriation amounts under the new tax law.
Certain mandatory repatriation measures in the new tax law may affect insurers, as described below.
The new law includes a transition rule to effect the participation exemption regime. This transition rule provides that the subpart F income of a specified foreign corporation (SFC) for its last tax year beginning before January 1, 2018, is increased by its accumulated post-1986 deferred foreign income (deferred income) determined as of November 2 or December 31, 2017 (a measuring date), depending on which measuring date results in the greater deferred income. A taxpayer generally includes in its gross income its pro rata share of the deferred income of each SFC with respect to which the taxpayer is a U.S. shareholder. This mandatory inclusion, however, is reduced (but not below zero) by an allocable portion of the taxpayer’s share of the foreign E&P deficit of each SFC with respect to which it is a U.S. shareholder and the taxpayer’s share of its affiliated group’s aggregate unused E&P deficit.
The transition rule includes a participation exemption, the net effect of which is to tax a U.S. shareholder’s mandatory inclusion at a 15.5% rate to the extent it is attributable to the shareholder’s aggregate foreign cash position and at an 8% rate otherwise.
A specified foreign corporation (SFC) is a foreign corporation that is a controlled foreign corporation (CFC) or foreign corporation that has at least one domestic corporate U.S. shareholder. The new law revises the definition of “U.S. shareholder” in section 951(b) to include any U.S. person that owns at least 10% of the vote or value of a foreign corporation. However, this change is made effective for tax years of foreign corporations beginning after December 31, 2017, and thus, does not apply for purposes of the new law’s transition rule.
The new law repeals section 958(b)(4) for the last tax year of foreign corporations beginning before January 1, 2018, and all subsequent tax years and for the tax years of a U.S. shareholder with or within which such tax years end. Thus, “downward attribution” of stock ownership from foreign persons is taken into account for purposes of determining whether a U.S. person is a U.S. shareholder of a foreign corporation for purposes of the new law’s transition rule.
The new law’s repeal of section 958(b)(4) applies for purposes of determining whether a foreign corporation is an SFC and also for purposes of determining whether a U.S. person is a U.S. shareholder.
For example, if a domestic insurer owns 9% of a foreign affiliate, and the remaining 91% of the foreign affiliate is owned by the domestic insurer’s foreign parent, the foreign affiliate is an SFC and the domestic insurer is a U.S. shareholder of the affiliate. Therefore, the domestic corporation would have to include its pro rata share of the foreign affiliate’s deferred income, although the amount of the domestic corporation’s mandatory inclusion would be based solely on its direct and indirect ownership (in this example, 9%) of the foreign affiliate and only take into account E&P accrued during periods the foreign affiliate was an SFC.
Also, foreign income taxes paid or accrued by the foreign affiliate are not attributed to the domestic corporation’s mandatory inclusion because the domestic corporation does not own at least 10% of the foreign affiliate’s voting stock. These consequences could affect the domestic corporation’s estimated tax liability.
These attribution rules work similarly regardless of whether ownership of a foreign corporation is indirect, or whether a foreign corporation is owned in the separate accounts of an insurance company. For example, if a domestic insurer’s general account owns 5% of a foreign affiliate indirectly through a pass-through investment, the insurer’s separate account owns 4% of the foreign affiliate via direct investment, and the remaining 91% of the foreign affiliate is owned by the domestic insurer’s foreign parent, then the result is the same as described above. Likewise, the result does not change if there is no foreign parent and the domestic insurer’s general account and separate account each own 5% of the foreign corporation (resulting in 10% ownership by the insurer).
In view of the above, insurance company taxpayers may wish to consider immediately conducting an appropriate level of due diligence regarding the potential SFC status of foreign corporations in which the taxpayer invests either directly or indirectly (e.g., through a pass-through entity). When conducting such due diligence, taxpayers need to consider their constructive ownership of a given potential SFC. Therefore, ownership of a particular foreign corporation through both a taxpayer’s general and separate accounts, as well as ownership of the foreign entity by any parent or affiliate of the taxpayer, must be considered when determining whether a foreign corporation qualifies as a SFC.
If a foreign corporation is determined to be a SFC by reason of the new law but does not qualify as a CFC, taxpayers need to determine the period(s) after 1986 in which the SFC has had a 10% US corporate shareholder. Under new section 965, the earnings and profits for all such periods must be counted for purposes of mandatory repatriation. Taxpayers may elect to pay the resulting tax over an eight-year period (either straight-line or using a prescribed timeline). Tax professionals believe mandatory deemed repatriation for an SFC with the same year-end as the U.S. taxpayer creates a tax liability that is not a deferred tax liability because it no longer represents the tax effect of a basis difference. The belief is that this tax liability is to be classified as current or noncurrent based on the anticipated timing of the payment.
Since the tax associated with the repatriation of a SFC’s earnings is ultimately paid by the investor (i.e., the insurance company), the insurance company is responsible for gathering and organizing the data necessary to determine the scope of its exposure with respect to such a tax. This may be a complex and arduous process that could involve extensive data management and outreach to foreign corporations in which the taxpayer is invested (or to pass-through entities in which the taxpayer is invested, if the pass-through entities themselves invest in foreign corporations), and to other foreign affiliates that hold an interest in the taxpayer to determine potential constructive ownership of foreign corporations in which the affiliate invests.
For assistance with these matters, or more information, contact a KPMG tax professional:
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Fred Campbell-Mohn | +1 (212) 954-8316 | email@example.com
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Rob Nelson | +1 (312) 665-6457 | email@example.com
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