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Multinational Financial Groups After the US Tax Reform

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Multinational Financial Groups After the US Tax Reform Multinational Financial Groups After the U.S. Tax Reform: Selected Inbound and Outbound Issues By Nicholas J. DeNovio, William Lu, Elena V. Romanova, and Aaron M. Bernstein* NICHOLAS J. DENOVIO is a Global Chair, International Tax Practice and Partner in the Washington D.C. office of Latham & Watkins LLP. I. Introduction and Overview WILLIAM LU is a Partner in the New York office of Latham & Watkins LLP. The Tax Cuts and Jobs Act (“TCJA”) resulted in the most sweeping changes to the Internal Revenue Code (the “Code”) in decades and will result in countless articles and commentary to address the many changes to taxpayers of all types.1 Indeed, the international tax changes alone will be the subject of many of those writings, as the framework under which the United States taxes U.S. and non- U.S. businesses on U.S. and non-U.S. income has shifted considerably. This article focuses on several of those changes and their particular, though perhaps not isolated, impact on one category of taxpayers—a multinational affiliated group of companies that includes a bank and/or a registered securities dealer ELENA V. ROMANOVA is a Partner in the (each such company, a “Financial Institution” and such group, a “Financial 2 New York office of Latham & Watkins LLP. Group”). Both U.S. parented and non-U.S. parented Financial Groups will be discussed in this article. Certain provisions apply primarily to U.S. parented Financial Groups (or to a U.S. parented subgroup of a non-U.S. parented Financial Group), while other enacted changes affect both U.S. and non-U.S. parented Financial Groups. The international tax changes impact many types of taxpayers, and their application generally can have similar results as those for Financial Groups. However, the somewhat unique footprint of Financial Groups’ global operations, the fact that the commodity they deal with is money itself, and, not least, the extensive non-tax regulatory rules by which they must AARON M. BERNSTEIN is an Associate operate combine so that the international changes discussed below may be ex- in the New York office of Latham & pected to impact Financial Groups in manners unlike any other industry, and Watkins LLP. sometimes, disproportionately unfavorably. MARCH–APRIL 2018 © 2018 N.J. DENOVIO, W. LU, E.V. ROMANOVA AND A.M. BERNSTEIN 11 MULTINATIONAL FINANCIAL GROUPS AFTER THE U.S. TAX REFORM: SELECTED INBOUND AND OUTBOUND ISSUES The key legislative changes on which this article focuses F. Continuing, and to a degree, enhanced, disparity in are: tax treatment between foreign branches and CFCs, A. The reduced corporate tax rate of 21%. and the emerging potential effect that the changes in B. The limitation on the ability of most businesses to A–E above may have on whether a Financial Group deduct interest expense under a revamped Code Sec. opts to conduct its activities through a branch (in- 163(j), and the manner in which it is expected to affect cluding a disregarded entity)5 or a subsidiary, whether Financial Institutions as taxpayers and as providers of it be of a U.S. corporation in a non-U.S. jurisdiction financing to customers. or of a non-U.S. corporation in the United States. C. The new, partial, territorial tax regime by which The article approaches the discussion of all these changes overseas profits of U.S. multinationals are taxed.3 This in a conceptual way, except in the discussion of the BEAT, topic generally falls into three subtopics, notably: where the focus shifts to transaction analysis and numeric 1. the new dividends received deduction for U.S. examples. This difference in approach is warranted because corporate shareholders on distributions from unlike in the application of GILTI and its interplay with certain foreign corporations, as provided under other tax provisions, which are primarily qualitative, the Code Sec. 245A; BEAT is heavily dependent on the analysis of particular 2. the TCJA’s retention of most of the infrastructure transactions and computational outcomes, which are more of Subpart F, which has been in the Code since readily demonstrated through examples. the Kennedy Administration; and 3. the new minimum tax on foreign earnings im- II. Summary of Key Legislative Changes6 posed under Code Sec. 951A (“global intangible low-taxed income” or “GILTI” regime). A. Reduction in the Corporate Tax Rate The corporate tax rate has been permanently reduced With increased pressure on managing to 21%, which places the United States slightly below foreign taxes and an incentive for the worldwide average corporate statutory rate of ap- proximately 23%.7 Financial Groups present in the United States to minimize payments B. New Limitations on Deductibility from the United States to foreign of Interest Expense affiliates, it is also reasonable to Through the years, the Code has applied numerous limits anticipate increased tax controversy to the deductibility of interest expense, which have often targeted: (1) instruments which are equity flavored and activity in other countries. (2) instruments issued by U.S. affiliates to related foreign persons (or issued to unrelated persons but guaranteed by related foreign persons). Prior to its amendment by the D. The surprise retention of Code Sec. 956 as applicable TCJA, Code Sec. 163(j) (the “earnings stripping” limita- to corporate shareholders of controlled foreign cor- tions) limited the amount of interest deductions that could porations (“CFCs”), despite the fact that the House be taken by certain corporations, if the interest was paid and Senate versions of the tax bill had both included or accrued to, or guaranteed by, certain related persons. its repeal,4 and its impact on Financial Groups under The TCJA replaced prior Code Sec. 163(j) in its entirety the new international tax rules, both as taxpayers and with a general cap on net business interest expense equal as providers of financing for clients. to 30% of net business income (i.e., “adjusted taxable in- E. The new base erosion and anti-abuse tax (“BEAT”), come” or “ATI”), regardless of who the lender or guarantor which applies in a manner to essentially reduce or is.8 Under new Code Sec. 163(j), there is no longer any deny the availability of a deduction for payments international or related party prerequisite to the applica- made by U.S. persons to their foreign affiliates and tion of the interest expense limitation, which applies to reduce or eliminate the benefit of certain tax credits, businesses regardless of whether the interest crosses borders and its unique application to Financial Groups, or whether the loan involves a related party. in the context of both U.S. parented and foreign Net business interest expense is the excess of business parented groups. interest expense over business interest income.9 Business 12 INTERNATIONAL TAX JOURNAL MARCH–APRIL 2018 interest is any interest paid or accrued on indebtedness the TCJA achieved by introducing a limited exemption properly allocable to a trade or business, and business for overseas profits of U.S.-based multinational groups. interest income is interest income properly allocable to a Subject to the important exceptions discussed below, the trade or business, excluding investment interest and invest- partial territorial system eliminates the U.S. repatria- ment income within the meaning of Code Sec. 163(d).10 tion tax on foreign earnings by allowing corporate U.S. Code Sec. 163(j) does not define interest specifically, and Shareholders18 a 100% dividends received deduction, or therefore amounts treated as interest (which would include “participation exemption” for the foreign-source portion amounts treated as “original issue discount”) under general of dividends from foreign subsidiaries.19 By eliminating U.S. federal income tax principles should be treated as the U.S. tax on a repatriation of profits from foreign sub- interest for Code Sec. 163(j) purposes.11 sidiaries, the TCJA removes the lockout effect on those ATI means a taxpayer’s taxable income, computed with- earnings.20 The participation exemption applies, however, out regard to (i) items of income, gain, deduction or loss to only a relatively narrow slice of overseas earnings of not properly allocable to a trade or business, (ii) business U.S.-based multinationals, as the framework to tax those interest or business interest expense, (iii) net operating overseas profits when earned or invested in U.S. property loss deductions, (iv) deductions under Code Sec. 199A has been maintained, and in fact expanded, through three (relating to “qualified business income”) and (v) for tax- general mechanisms. Under any of these three mecha- able years beginning before January 1, 2022, deductions nisms, a U.S. Shareholder may be subject to tax on the allowable for depreciation, amortization or depletion.12 foreign earnings of a CFC.21 First, a U.S. Shareholder may Additional adjustments to ATI may be made by future be subject to current U.S. tax under the general Subpart regulations.13 ATI includes earnings regardless of whether F rules, which for the most part remain in place and in they are earned in the United States or abroad, as long the same form taxpayers have dealt with for decades.22 For as such earnings are included in the borrower’s taxable example, foreign base company sales and services income income. To that end, Subpart F income and GILTI would rules remain unchanged. Second, a U.S. Shareholder may increase ATI, but receipt of any dividends exempt under be subject to tax, at a reduced effective rate for corporate the new participation exemption would not increase ATI. shareholders, under the GILTI regime which applies a A group filing a consolidated return appears to be treated new minimum tax as described in detail below.23 Finally, as a single taxpayer for purposes of computing the 30% by a last minute surprise retention of Code Sec.
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