US Tax Reform Set To Increase Number Of CFCs And Transparency Risk

22 January 2018

The US tax reform introduces changes to Subpart F stock attribution rules that are expected to result in the formation of many new controlled foreign corporations. However, the amendments leave room for interpretation with tax professionals mooting whether the new repatriation and GILTI taxes could also be triggered.

Several tax and transfer pricing directors told TP Week they expect considerable impact from the new US tax reform, specifically from a rule that will increase the number of controlled foreign corporations (CFC) and potentially lead to increased documentation requirements, disputes and business restructurings for multinationals.

The Tax Cuts and Jobs Act removed a rule that blocked downward attribution of stock from a foreign parent to a US subsidiary.

For example, if a foreign parent company has a 100% share in a US subsidiary and a 100% share in a foreign subsidiary, the US subsidiary is under the new rules considered to own 100% of the foreign subsidiary, thereby creating a CFC.

“The foreign subsidiary will become a CFC of the US group, and the US group will become a 10% or more shareholder of the CFC, even where the US group owns no stock in the subsidiary, so long as the foreign parent owns more than 50%. This change could significantly increase the number of CFCs for a foreign-parented MNE,” Gary Wilcox, tax controversy and transfer pricing partner at Mayer Brown in Washington DC, told TP Week.

Tom Humphreys, co-chair of Morrison & Foerster’s federal tax group and tax department in New York, told TP Week that the rule was designed to ensure the foreign subsidiary, in a chain with a foreign parent, a US subsidiary and a foreign subsidiary, is treated as a CFC, but the provision as it was enacted, is broader than that.

“The number of such ‘new’ CFCs could be substantial. The Senate legislative history attempts to narrow the rule, however, there still exists uncertainty over this issue,” Humphreys added.

Tax consequences

Advisers disagreed on what these ‘new’ CFCs could lead to in terms of tax consequences, but many are hopeful that this will be cleared up in the explanatory ‘blue book’ which is usually released after tax legislation changes.

Wilcox said it could cause the new mandatory repatriation tax to apply where the US group owns less than 10% of a foreign subsidiary, but is considered to own at least 10% by virtue of the foreign parent’s stock interest. Secondly, a US group that has previously avoided Subpart F income by owning a minority interest in a foreign subsidiary could now be taxed on Subpart F income due to the foreign parent’s stock interest, and thirdly, the new GILTI tax could be imposed on the US group by virtue of its minority interest in a former non-CFC becoming a 10% or more US shareholder interest in a CFC, Wilcox explained.

GILTI is a new minimum tax on global intangible low-taxed income.

“For example, if a US group owns 9% of a foreign subsidiary and its foreign parent owns the other 91%, under the new law it will be considered a 10% or more US shareholder of a CFC for purposes of triggering the applicability of mandatory repatriation, Subpart F and GILTI. Because the law change applies retroactively to 2017, the US group will be subjected to the mandatory repatriation tax to the extent of its 9% interest. Going forward, it will be taxed on the CFC’s Subpart F income at a 21% rate and GILTI at a current effective rate of 10.5%, again to the extent of its 9% interest,” he said.

Wilcox added that if the foreign parent owns 100% of a foreign subsidiary, the subsidiary could still become a CFC of the US group by virtue of the expanded stock attribution rule.

“However, that has no meaningful tax consequences to the US group as a practical matter, since the US group is taxable under mandatory repatriation, Subpart F or GILTI only to the extent of its actual stock interest held directly or indirectly through other foreign subsidiaries. It could, however, cause a US person holding 10% or more of the foreign parent’s stock to become subject to mandatory repatriation, Subpart F and GILTI,” he said.

Essentially, multinationals will have work to do in figuring out which CFCs a US shareholder has an interest in.

Jessica Tien, principal economist at DLA Piper in Silicon Valley, said tax attributes of MNEs in connection with Subpart F or GILTI or transfer pricing would not be directly impacted. However, the new rules may add to the list of concerns for foreign headquarters to establish a US presence, and MNEs should prioritise strengthening of their transfer pricing and Subpart F positions anticipating full transparency, Tien told TP Week.

Potential documentation requirements

Advisers disagreed on whether documentation requirements could change with the new rules. Wilcox said the expansion of the stock attribution rules should not impact reporting obligations of US groups under Section 6038 to file Form 5471s for foreign subsidiaries, as those rules still define CFCs under the old law, while Tien said this could be a possible requirement.

“We could all benefit from clarifications by the IRS,” Tien said. “This is an evolving issue. If Form 5471s is required, such an expansion of disclosure of business and financial facts may enable the IRS to see more details than what would have been required by country-by-country reporting or transfer pricing documentation. Furthermore, since the 5471s are part of the US tax returns, these forms can be made available to foreign jurisdictions through the information exchange provisions per tax treaty. MNEs are faced with the risk of more tax disputes resulting from another vehicle for scrutinising their financial results by country,” Tien said.

The new provision is retroactive and applies to the last taxable year of the CFC beginning before January 1 2018. As the provision is already in effect, taxpayers and advisers are eagerly awaiting more guidance on the issue.

The above article was published on on January 22 2018 and has been republished with the approval of the Publisher.