Tax Data Management - Third Issue 2004

This is a newsletter from J.D. Choi of Tax Technologies, Inc. to tax professionals whose interests are improving the tax management processes.

Table of Contents

1. Christmas in October?
2. International Tax Compliance Training

1. Web based tax data warehouse?

When signing the the "American Jobs Creation Act of 2004" last Friday, President Bush signed into law the most sweeping changes to the corporate tax code in eighteen years. The law is filled with special interest giveaways. There are substantive changes once you look past the special interest giveaways. Of course one of the most anticipated provisions such as repeal of extraterritorial income exclusion is in the new bill. Its substitute provision - domestic production activities deduction - is in the bill as well.

These changes will have a significant impact on corporate tax management from the planning, provision and compliance perspectives. This article examines the impact of selected international tax rule changes on international tax computations by examining the interaction of the provisions.

Summary of new tax rules examined:

• Repatriation of permanently invested foreign earnings (Effective date - first taxable year beginning on or after the date of enactment or taxpayer’s last taxable year beginning before the date of enactment at the taxpayer’s election. The deduction is not applicable to dividends received one or more year after the date of enactment)
• FTC carry forward to 10 years (Effective date - taxable year ending after the date of enactment)
• Worldwide interest allocation election (Effective date - taxable years beginning after 12/31/2008)
• Recharacterization of overall domestic losses (Effective date - taxable years beginning after 12/31/2006)
• Reduction of foreign tax credit categories (Effective date - taxable years beginning after 12/31/2006)
• Apply look-through rules for 10/50 dividends (Effective date - taxable years beginning after 12/31/2002)
• Attribution of stock ownership through partnerships for 902 and 960 credits (Effective date - taxable years beginning after the date of enactment)
• Repeal of AMT limitation on the use of FTC (Effective date - taxable years beginning after 12/31/2004)

Analysis

I would venture to guess the most eagerly anticipated provision among tax executives is the repatriation provision. This provision allows an 85 percent deduction from the dividend repatriated in the amount greater of $500 million or permanently invested earnings in foreign countries. This is a one-time event with a potentially very significant impact on a number of international tax computations. Companies with low-tax earnings (most of the high-tech companies) or the companies that have been splitting E&P and taxes are in a great position to benefit from this provision.

Further, as the taxpayer can designate the dividend subject to deduction, it may provide an effective mechanism to reduce the OFL attributes. It may also have long lasting impact on the foreign tax credit calculations, as it would reduce the foreign E&P that would be part of foreign assets for the purpose of interest expense apportionment. Companies should also take into account the possibility of worldwide interest expense apportionment by taxpayer election that would be effective for the tax years beginning after December 31, 2008 as the repatriation may increase the interest expense of foreign subsidiaries to the extent it has to fund the one-time repatriation through local financing.

The amount of dividend repatriated under this incentive can be enormous as most companies have been taking the exception under APB 23 and took a position that foreign earnings are permanently reinvested. As the foreign tax credit is not available for the dividend subject to deductions, it is predictable that the companies will repatriate the low-tax earnings with little additional US tax liability on the distribution. As companies will be modeling the impact of this repatriation, it should take into account the withholding taxes since it would not be creditable to the extent the withholding tax is attributable to the dividend subject to the deduction.

This repatriation may also have significant impact on the foreign tax credit limitations calculation by way of interest expense apportionment. The repatriation may significantly reduce the accumulated earnings and profits of foreign subsidiaries. This reduction of E&P would reduce the interest expense apportionment basis for the foreign asset of the companies using tax book basis of assets. It would have less impact on the companies using the fair market value method since the fair market value of the assets may not be reduced as much as the E&P repatriated to the extent the repatriation is funded by local debt financing.

Also, it is conceivable that if the company has OFL from prior years, it may decide to repatriate as much dividend as possible, including high tax earnings, since the impact on the foreign tax credit would be as low as 50 percent of 15 percent of total distribution subject to dividend received deduction, presumably low-taxed earnings, while reducing the OFL. To the extent a taxpayer designates the high-taxed earnings as dividend not subject to dividend received deduction, it would also be able to reduce the OFL attributes even though it may create foreign tax credit carry forward.

Since the foreign tax credit carry forward is extended to 10 years, companies will have a longer window to plan and deal with the foreign tax credit carry forward. This means that the foreign tax credit carry forward created due to this one-time distribution may not have to carry valuation allowance for financial reporting purpose.

The opportunity to exhaust the OFL is also getting better as the new law provides the recharacterization of overall domestic loss (“ODL”). Up until now, the ODL was not subject to recharacterization and created permanent reduction of foreign source income, thereby, reducing the possibility of using the foreign tax credit. With the new provision allowing the ODL to restore the foreign source income, coupled with large repatriation to the US, it is conceivable that there will be an increase in US source income in the future years that may increase the possibility of restoring what would have been lost foreign source income.

Given this change allowing the restoration of foreign source income, what is interesting is the lack of one provision that I expected to be in this bill – restoration of E&P due to deficit carry back and carry forward. This has been the issue that impacted the companies significantly as the deficit carry back and carry forward locked away the taxes in the pre-87 tax years and had significant impact on financial reporting for some of the large companies. For some reason, this is conspicuously absent.

With the reduction of foreign tax credit baskets, starting the tax year beginning after December 31, 2006, it is likely that all the separate limitation loss (“SLL”) recharacterization potential will be lost. In many cases, it was the 10/50 baskets that created SLL. With the application of look-through to the 10/50 distributions coupled with the reduced number of baskets, companies will expect easier administration of tax attributes and better use of foreign source income.

I personally found the attribution of ownership through partnerships particularly interesting as there are plenty of structures that include foreign partnerships as part of post check-the-box era planning. Up to this point, I believe most of the practitioners were relying on the REV. RUL. 71-141 to flow the deemed paid credits through the foreign partnerships although the ruling never addressed the issue of dividend to foreign partnership and accompanying foreign tax credit. Although the issue of deemed paid credit through foreign partnership was mentioned in 1997 as part of changes to the 902 regulations, the issue of deemed paid credit through foreign partnership was not resolved at the time (TD 8708). The new provision removes this ambiguity and clarifies the allowance of foreign tax credit under §§ 902 and 960 when a foreign partnership is the recipient of the dividend from controlled foreign corporations. This will provide a certainty to the international tax planning using foreign partnerships.

Companies subject to alternative minimum tax (“AMT”) will also find it helpful that the new law provides the repeal of foreign tax credit usage limitation under AMT. Based on this change, companies may no longer have to keep two separate FTC carry forwards – one for the excess FTC carry forward computed on 20 percent tax rate and the other for the 90 percent limitation for the AMT. Again, due to the extension of the carry forward period to 10 years, companies may no longer have to take the valuation allowance for the AMT either.

This repatriation rule may have a significant impact on global economy depending on how the US tax executives take their positions. If a large portion of US tax executives decide to repatriate large portions of the foreign earnings, it may have a devastating impact on the foreign economy. At a minimum, I would expect that low-taxed earnings will be repatriated. That may also have a significant impact on the countries provided various tax incentives to bring the US corporations to their country.

Taken all together, I would consider this as a Christmas gift in October to many international tax planners.

2. International Tax Compliance Training  » Return top

TTI will be hosting International Tax Compliance Training in Teaneck, New Jersey on November 10th and 11th. This course will cover the compliance issues, including the new provisions and possible ramifications on the international tax compliance going forward. For the first time, we are offering an international tax compliance course that would include not only tax technical aspects of compliance, but also a practical approach by including hands on, on-line exercises.

Here are the details of the international tax compliance training:

• US Income Tax System
  • Worldwide versus Territorial System
  • Entity Classification – Branches, CFC’s, Hybrids
• Foreign Earnings and Profits
  • Determining E&P
  • GAAP and Tax Adjustments
  • Basketing of E&P
  • Distributions
  • Anti-Deferral Rules
    • Subpart F Income
    • Section 956 Investment in US Property
  • Form 5471 Preparation
    • Schedule H – Current E&P
    • Schedule J – Accumulated E&P
    • Schedule M- Transactions
    • Schedule O- Organization/Reorganization
  • Income Sourcing
    • IRC Section 61 Income Classes
    • Sourcing Dividends
    • Section 863(b) and Section 862
    • Sourcing Other Income
  • Expense Allocation & Apportionment
    • A&A of R&D Expense
    • A&A of Interest
    • Other Expenses
  • Foreign Tax Credit
    • Foreign Taxes and Creditability Test
    • Direct and Indirect Credits
    • Foreign Tax Credit Limitation Calculation
    • Section 904(d) Categories
    • Special Rules
  • Form 1118 Preparation
    • Schedule A - Income
    • Schedule B - Foreign Tax Credit
    • Schedules C, D, E - Taxes Deemed Paid
    • Schedule H – Apportionment of Deductions
  • New Legislation
    • Compliance and Planning Opportunity
  • Foreign Data Collection
    • Information Systems
    • Reporting Packages
    • Compliance versus Provision
  • Compliance Systems and Process
    • Training
    • Considerations
  • Form 8858 Preparation
    • Announcement 2004-4
    • Foreign Disregarded Entities
  • Form 8865 Preparation
    • Foreign Partnerships
  • Form 1120, Schedule M-3
    • Impact On International Tax Compliance
  • Form 1120, Schedule N
    • Considerations

Course Level: Beginner to Intermediate
No pre-requisites or advanced preparation required
Recommended CPE Credit: Up to 14 Hours
Cost: $1,195

If you are interested in attending this training session, please visit our training site to register for the course. For more information regarding administrative policies such as complaint and refund, please contact our offices toll-free at 866-239-4884.

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Regards,

J.D. Choi
CEO, Tax Technologies, Inc.
201-387-9451