On December 22, 2017, the Tax Cuts and Jobs Act introduced a one-time mandatory repatriation tax under Internal Revenue Code Section 965 (“the Section 965 tax”). The Section 965 tax requires U.S. shareholders of certain ‘specified foreign corporations’ to increase their gross income, for the last tax year that begins before January 1, 2018, by an amount equal to their pro rata share of post-1986 accumulated deferred foreign income, that is, foreign earnings and profits (“E&P”).
This income is treated as subpart F income and subject to reduced tax rates which, in effect, operates as a U.S. tax holiday. This is an extremely timely and relevant issue for taxpayers whose tax returns are due by March 15th or April 15th and have significant offshore investments.
For purposes of the Section 965 tax, a specified foreign corporation is any controlled foreign corporation (i.e., a foreign corporation whose vote and value is owned greater than 50% by U.S. shareholders), or any foreign corporation with respect to which one or more domestic corporations is a U.S. shareholder. A specified foreign corporation does not include passive foreign investment companies (“PFICs”), as long as they are not also treated as controlled foreign corporations.
If you are a U.S. shareholder with an interest in a specified foreign corporation and believe you are subject to the Section 965 tax, then you must determine your E&P subject to tax. Under Section 965, E&P is determined at two measurement dates, November 2, 2017 or December 31, 2017, whichever amount is greater.
Although the calculation is quite intricate mathematically, the ultimate result is to tax E&P attributable to cash or liquid assets at a rate of 15.5%, and non-cash or illiquid assets at a rate of 8%. The above reduced rates are arrived at by applying a participation exemption to the regular corporate or individual tax rates depending on which is applicable.
A U.S. shareholder must determine the aggregate foreign cash position reported as the specified foreign corporation’s balance sheet in order to calculate how much of the E&P relates to cash versus non-cash. For example, if a U.S. shareholder has $100 of E&P and $90 of cash or cash-like items on the balance sheet, then $90 of the $100 will be taxed at the cash rate of 15.5% and the remaining $10 will be taxed at the non-cash rate of 8%.
Deficits of specified foreign corporations may offset E&P in arriving at the net taxable E&P, subject to special allocation rules under the statute.
Additionally, foreign taxes paid with respect to E&P are also permitted pursuant to the same participation exemption rule described above.
Once calculated, a U.S. shareholder may pay the section 965 tax immediately or via eight installment payments. There are special rules for S-corporations, RICs and REITs. For example, U.S. shareholders of S-corporations, in particular, have the ability to elect deferral on payment of their 965 tax liability indefinitely until a triggering event at the corporate level occurs (i.e., the S-corporation ceases to exist or operate its business).
It is important to note that the 965 tax is imposed on deferred foreign income regardless of whether the E&P is actually repatriated. If repatriated after December 31, 2017, then the E&P is treated as previously taxed income, and is not again subject to tax.
Lastly, on March 13th the IRS released IR-2018-53 which provides clearer guidance on how to report the 965 tax on U.S. shareholder returns. Further, guidance is prescribed with respect to payment of the 965 tax due without regard to return extensions.
The guidance also provides examples of statements to attach to U.S. shareholder returns with respect to the 965 tax. Strict adherence to the guidance is recommended as interest and penalties do attach to inaccurate filings. Return submission errors could also arise for failure to submit returns according to the newly released instructions.
Please consult your local Mazars USA tax advisor for more information.