TEI Submits Comments to the Treasury and IRS Regarding Proposed Regulations Under Section 965.

• Position: Tax Executives Institute

On October 9, TEI submitted comments to the Treasury and IRS regarding proposed regulations promulgated under the transition tax imposed by section 965, as amended by the Tax Cuts & Jobs Act enacted in 2017. TEI's comments were prepared under the aegis of the Institute's Tax Reform Task Force and U.S. International Tax Committee. Benjamin Shreck, TEI Tax Counsel, coordinated the preparation of TEI's submission.

On December 22, 2017, Public Law No. 115-97, colloquially known as the Tax Cuts & Jobs Act (the TCJA), was enacted into law. The TCJA represents the most sweeping change to the U.S. Internal Revenue Code (the Code) since the Tax Reform Act of 1986. The numerous additions and modifications to the Code require equally sweeping additions and modifications to the U.S. Treasury Regulations promulgated thereunder.

As part of these newly required regulations, on August 9, 2018, the U.S. Department of the Treasury (Treasury) and Internal Revenue Service (the Service) issued proposed regulations under section 965 (the Proposed Regulations). The Proposed Regulations provide additional detail regarding the computation and payment of liabilities arising under section 965 (the Transition Tax liability), which was amended by the TCJA as part of the movement toward a participation exemption system of international taxation under the Code. Treasury and the Service solicited comments on the Proposed Regulations from interested parties no later than October 9, 2018. On behalf of Tax Executives Institute, Inc. (TEI), I am pleased to respond to the government's request for comments.

TEI Background

TEI was founded in 1944 to serve the needs of business tax professionals. Today, the organization has 57 chapters in North and South America, Europe, and Asia. As the preeminent association of in-house tax professionals worldwide, TEI has a significant interest in promoting tax policy, as well as the fair and efficient administration of the tax laws, at all levels of government. Our nearly 7,000 individual members represent over 2,800 of the leading companies around the world.

Summary of TEI's Recommendations

TEI commends Treasury and the Service for their efforts in issuing the Proposed Regulations in such a short timeframe. The Proposed Regulations answer many key questions faced by taxpayers when determining their Transition Tax liability. Set forth immediately below is a summary of TEI's recommendations with respect to the Proposed Regulations, followed by detailed explanations of why the government should adopt our recommendations. The numbering of the summary follows the numbering of the detailed explanation.

1. Final regulations should provide that stock of a Specified Foreign Corporation (SFC) owned by another SFC is excluded from the definition of Cash Position, regardless of whether the stock so held is publicly-traded.

2. To prevent double counting of earnings and profits (E&P) and the inappropriate denial of a foreign tax credit in certain circumstances, Prop. Treas. Reg. [section] 1.965-1(f)(7)(B) should be rephrased as follows:

3. The term accumulated post-1986 deferred foreign income means, with respect to an SFC, the post-1986 E&P of the SFC except to the extent such E&P... would in the case of a controlled foreign corporation, be included in income of the United States shareholder under section 956, or would, if distributed, be excluded from the gross income of a United States shareholder under section 959.

   The rule of Prop. Treas. Reg. [section] 1.965-1(f)(7)(i)(C) regarding the exclusion of certain accumulated post-1986 deferred foreign income should be extended to apply to dividends paid from SFCs to a related SFC and an unrelated foreign third party.

4. Treasury and the Service should provide in final regulations that for purposes of section 965, the taxes associated with a hovering deficit are to be included in the post-1986 pool of the SFC as the hovering deficit is absorbed under section 965.

5. With respect to the basis election of Prop. Treas. Reg. [section] 1,965-2(f):

   a. Taxpayers should be given 180 days after the publication of final section 965 regulations to make the basis election, rather than the 90 days provided in Notice 2018-78;

   b. The final regulations should allow all shareholders who own SFC stock to determine gain resulting from the basis-shifting election on an aggregate, rather than share-by-share, basis; and

   c. To the extent gain is recognized under Prop. Treas. Reg. [section] 1.965-2(h)(3) because of the basis-shifting election, it should be taxed at the transition tax rate of 15.5%.

6. Final section 1.965-4 regulations should not prevent a taxpayer from changing to a permissible method of accounting from an impermissible method for purposes of calculating section 965 elements.

7. Final regulations should reflect that, for SFC to SFC dividends between measurement dates, the between measurement dates rule of Prop. Treas. Reg. [section] 1.965-4(f), and not the principal purpose rule of Prop. Treas. Reg. [section] 1.965-4(b) (as modified by the E&P reduction transactions rule), is the exclusively applicable anti-abuse rule. Treasury and the Service should also include language in final regulations that clarifies that the between measurement dates rule applies for purposes of determining the post-1986 foreign taxes. Lastly, final regulations should provide that all SFC to SFC between measurement date dividends are in the ordinary course of business for the limited application of the E&P reduction transactions rule.

8. To prevent certain mismatches between attributes of CFCs, TEI recommends that the final regulations adopt one of the alternatives detailed in section 8. below.

9. Prop. Treas. Reg. [section] 1.965-5(c)(1)(ii) should be excluded from the final regulations as it effectively eliminates a tax asset (a foreign tax credit) granted to taxpayers by Congress.

10. Additional guidance and examples are needed when determining the proper "applicable percentage," as defined in Prop. Treas. Reg. [section] 1.965-5(d)(1), in certain circumstances (such as when CFCs have different year-ends and thus different applicable percentages, either of which may apply to withholding taxes imposed on a dividend between the two CFCs. See section 10. below).

11. Final regulations should provide that foreign currency will be translated into U.S. dollars via the average exchange rate for a taxpayer's 2017 fiscal year, not the December 31, 2017, spot rate.

12. Taxpayers should be permitted a refund or given the ability to treat as a 2018 estimated tax payment any amounts paid in excess of the taxpayer's liabilities for 2017 regular and section 965 installment tax.

13. The Service should provide penalty protection to taxpayers who make good faith efforts to compute and pay over their Transition Tax liability.

    Detailed Comments on the Proposed Regulations

1. Publicly-Traded Stock Held by a Foreign Subsidiary and the Definition of Aggregate Foreign Cash Position

   Section 965 taxes unrepatriated earnings of a U.S. shareholder at a rate of 15.5 percent, up to the amount of the taxpayer's Aggregate Foreign Cash Position. (1) Any remaining earnings are taxed at a rate of 8 percent. The Cash Position of an SFC is determined under section 965(c)(3) and generally includes cash, net accounts receivable, and, among other items, "the fair market value of... [p]ersonal property which is of a type that is actively traded and for which there is an established financial market." (2) Despite numerous taxpayer comments requesting clarification of the definition of Cash Position, particularly as it relates to actively-traded personal property, the government explicitly declined to provide additional guidance in the Proposed Regulations. (3) Instead, Treasury and the Service welcomed additional comments on the definition of Cash Position.

   Under Section 965(c)(3)(B)(iii)(I), an SFC's Cash Position includes the fair market value of "[p]ersonal property which is of a type that is actively traded and for which there is an established financial market." Section 965 does not define "actively traded" nor does it refer to definitions elsewhere in the Code. However, Congress's intended meaning of "actively traded" can easily be gleaned from the Conference Report:

   The cash position of an entity consists of all cash, net accounts receivables, and the fair market value of similarly liquid assets, specifically including personal property that is actively traded on an established financial market, government securities, certificates of deposit, foreign currency, and short-term obligations. (4)

   Congress was concerned about asset liquidity because, if liquid, an asset could easily be converted to cash and repatriated to the United States soon after a taxpayer's section 965 liability was determined. Thus, based on the policy underlying section 965's two-tier tax rate structure, liquid assets should be subject to a higher tax rate. The House Ways and Means Committee's report, dated November 13, 2017, further expands on this policy:

   The Committee believes that many domestic companies were reluctant to reinvest foreign earnings in the United States, when doing so would subject those earnings to high rates of corporate income tax.... The Committee believes that the tax on accumulated foreign earnings should apply without requiring an actual distribution of earnings, and further believes that the tax rate should take into account the liquidity of the accumulated earnings. Accordingly [Section 965] establishes a bifurcated rate, i.e., [15.5 percent] for earnings held in liquid form and [8 percent] for accumulated foreign earnings that have been reinvested in the foreign subsidiary's business. (5)

   Despite clear Congressional intent, section 965 leaves open to interpretation what it means for personal property to be actively traded, potentially subjecting illiquid investments in subsidiaries' businesses to the higher tax rate of 15.5 percent. For example...