December 20, 2017 US House and Senate release the Conference Report on the Tax Cuts and Jobs Act (H.R. 1) Executive summary On December 15, 2017, the House and Senate released the Conference Report to the Tax Cuts and Jobs Act (H.R.1), including: (1) the legislative text (referenced in this Alert as the "Conference Agreement") and (2) a Joint Explanatory Statement of the Committee of Conference (referenced in this alert as the "Joint Explanation"). The Senate had previously released the "the Tax Cuts and Jobs Act of 2017" (the Senate Bill) on December 2, 2017, which is addressed in Tax Alert 2017-1917. Previously, the House released its version of the "Tax Cuts and Jobs Act of 2017" (the House Bill) on November 2, 2017, which is addressed in Tax Alert 2017-1845. The Conference Agreement reduces the top corporate tax rate to 21%, reduces or limits many corporate tax deductions and preferences, and substantially changes many international tax provisions. This Alert focuses on the Conference Agreement's international tax provisions. 100% deduction for certain dividends received from foreign subsidiaries The Conference Agreement would provide a 100% deduction for the foreign-source portion of dividends received by a domestic corporation from a foreign corporation (specified 10%-owned foreign corporation) with respect to which it is a US shareholder as defined in Section 951(b), as amended by the Conference Agreement. A specified 10%-owned foreign corporation would be any foreign corporation, other than a passive foreign investment company (PFIC) that is not a controlled foreign corporation (CFC), with respect to which any domestic corporation is a US shareholder. The 100% deduction would not be available to regulated investment companies or real estate investment trusts. Any gain recognized by a domestic corporation on the sale or exchange of stock in a foreign corporation held for more than one year that is treated as a dividend under Section 1248, would be treated as a dividend for purposes of the 100% deduction. Furthermore, the Joint Explanation notes that the term "dividend" is to be interpreted broadly, consistent with Sections 243 and 245. As such, dividends received by a domestic corporation from a foreign corporation through a partnership that would be eligible for the 100% deduction if the domestic corporation owned the stock of the foreign corporation directly, would also be eligible for the 100% deduction. The Joint Explanation also provides that, for computing subpart F income, a dividend received by a CFC from a specified 10%-owned foreign corporation that constitutes subpart F income may be eligible for the 100% deduction. However, see below regarding the inclusion of gain from the sale of a lower-tier CFC by an upper tier CFC that is treated as a dividend under Section 964(e)(1) as subpart F income eligible for the 100% deduction. The foreign-source portion of a dividend received from a specified 10%-owned foreign corporation would be the amount that bears the same ratio to the dividend as the undistributed foreign earnings of the specified 10%-owned foreign corporation bears to its total undistributed earnings. Undistributed earnings would be the amount of earnings and profits (E&P) of the specified 10%-owned foreign corporation as of the close of its tax year in which the dividend is distributed, and not reduced by dividends distributed during such tax year. Undistributed foreign earnings would be the portion of undistributed earnings that is attributable to neither: (1) income effectively connected with the conduct of a trade or business in the US (ECI) and subject to US federal income tax, nor (2) dividends received (directly or through a wholly-owned foreign corporation) from a domestic corporation at least 80% of whose stock (by vote and value) is owned (directly or through such wholly-owned foreign corporation) by the specified 10%-owned foreign corporation. The 100% deduction, however, would not be available for dividends received from a CFC that receives a deduction or other tax benefit under foreign tax law for the dividend (hybrid dividend). The Conference Agreement refers only to dividends received from a CFC, but, because it refers to tax benefits received by a specified 10%-owned foreign corporation, it's unclear whether hybrid dividends received from a specified 10%-owned foreign corporation that is not a CFC remain eligible for the 100% deduction. Additionally, if a CFC with respect to which a domestic corporation is a US shareholder receives a hybrid dividend from any other CFC with respect to which such domestic corporation is also a US shareholder, that hybrid dividend would be treated as subpart F income of the recipient CFC for the tax year in which the dividend is received. Credits and deductions for foreign taxes (including withholding taxes) paid or accrued with respect to any dividend benefiting from the 100% deduction would be disallowed. Additionally, for purposes of the foreign tax credit limitation under Section 904(a), the foreign-source income (and entire taxable income) of a US shareholder of a specified 10%-owned foreign corporation would be determined without regard to: 1. The foreign-source portion of any dividend received from such foreign corporation; and 2. Deductions properly allocated and apportioned to: (a) income with respect to stock of the specified 10%-owned foreign corporation (other than subpart F income and global intangible low-taxed income); and (b) stock of the specified 10% foreign owned corporation (to the extent income with respect to such stock is not subpart F income or global intangible low-taxed income). Thus, the Conference Agreement would appear to deny deductions for expenses associated with deductible dividends for purposes of the foreign tax credit limitation. To be eligible for the 100% deduction, the domestic corporation must hold stock in the specified 10%-owned foreign corporation for more than 365 days during the 731-day period that begins on the date that is 365 days before the ex-dividend date. For this purpose, a taxpayer would be treated as holding stock for any period only if the specified 10%-owned foreign corporation is a specified 10%-owned foreign corporation for such period, and the taxpayer is a US shareholder with respect to such specified 10%-owned foreign corporation for such period. As proposed, the 100% deduction would not apply to either foreign income directly earned by a domestic corporation through foreign branches or to capital gains recognized from the sale or exchange of stock in a specified 10%-owned foreign corporation. Effective date The 100% deduction would apply to distributions made, including amounts received on the sale or exchange of stock of a foreign corporation treated as a dividend under Section 1248 (and for purposes of determining a taxpayer's foreign tax credit limitation under Section 904, deductions in tax years beginning), after December 31, 2017. Reduced transition tax on deferred foreign earnings The Conference Agreement would require a mandatory inclusion of the accumulated foreign earnings of a controlled foreign corporation (CFC) and other foreign corporations with a 10% domestic corporate shareholder (a 10/50 company), collectively referred to as specified foreign corporations, or SFCs. Whether a foreign corporation is a SFC is determined without the application of Section 958(b)(4) (preventing downward attribution from a foreign person to a US person), which is repealed for the foreign corporation's last year beginning before January 1, 2018. The mandatory inclusion would be implemented by increasing the subpart F income of the SFC (treating a 10/50 company as a CFC solely for this purpose) in its last tax year beginning before January 1, 2018 (transition year), by the greater of its "accumulated post-1986 deferred foreign income" determined on November 2, 2017 or December 31, 2017. The mandatory inclusion would be subject to tax at reduced rates: 15.5% for earnings held in cash or other specified assets, and 8% for the remainder. The two rates are achieved by allowing a deduction against the required inclusion, based on the US shareholder's top marginal income tax rate in the inclusion year. However, there is a claw-back provision that would subject the entire mandatory inclusion amount to a 35% tax rate if a domestic corporation, which was subject to the transition tax, inverts within 10 years of the Conference Agreement's enactment. The Conference Agreement would allow a US shareholder to elect to pay the transition tax over eight years at 8% for the first five years, 15% in the sixth year, 20% in the seventh and 25% in the eighth. However, in the case of a subchapter S corporation that has a mandatory inclusion, the Conference Agreement would permit each shareholder of the S corporation to elect to defer payment of its net tax liability with respect to the S corporation by reason of the mandatory inclusion until the tax year in which any of the following occurs first: 1. The corporation ceases to be an S corporation. 2. The S corporation liquidates or sells substantially all of its assets. 3. The S corporation ceases its business, ceases to exist or any similar circumstance. 4. The shareholder transfers shares in the S corporation; transfers of less than all of the stock in an S corporation are a triggering event only with respect to the transferred shares. Accumulated post-1986 deferred foreign income The accumulated post-1986 deferred foreign income of a SFC means its E&P (i) accumulated in tax years ending after December 31, 1986, but only during periods in which the foreign corporation was a SFC, and determined as of November 2, 2017 or December 31, 2017 (measurement dates), whichever is greater, (ii) without diminution by reason of any dividends distributed during the SFC's transition year other than dividend distributions made to another SFC, and (iii) reduced by any E&P previously subject to US tax as effectively connected income or, in the case of a CFC, E&P which, if distributed, would be excluded from gross income of the US shareholder under Section 959 (e.g., income previously taxed under subpart F of the Code). The US shareholder's mandatory inclusion would be determined after taking into account any E&P deficits of its SFCs, thus effectively requiring inclusion of the net positive amount of deferred foreign income. Further, a net deficit of one US shareholder (i.e., E&P deficits of its SFCs that exceed the accumulated post-1986 deferred foreign income of its SFCs) would be allowed to offset the aggregate net positive amount of accumulated post-1986 deferred foreign income (i.e., the net amount remaining after taking into account E&P deficits of the US shareholder's SFCs) of another US shareholder if both US shareholders are members of the same affiliated group. In either instance, when a deficit of one foreign corporation is used to offset positive deferred foreign income of another corporation, foreign tax credits would be stranded and unusable in a future year with the repeal of Section 902 in both the deficit corporation and the corporations to which a deficit is allocated. Regardless of the amount of deferred foreign income included in the mandatory inclusion, all accumulated post-1986 deferred foreign income (i.e., untaxed post-1986 E&P) would be treated in the transition year (and until distributed) as though it were previously taxed subpart F income. Also, the E&P from an E&P deficit corporation would be increased in the transition year by the amount of deficit allocated to another SFC. Cash and other specified assets The 15.5% transition tax rate would apply to an amount of the mandatory inclusion equal to a US shareholder's aggregate foreign cash position, which means the greater of the US shareholder's pro rata share of the aggregate cash position of its SFCs determined on the last day of the SFCs' year in which the mandatory inclusion occurs, or, the average of the US shareholder's aggregate pro rata share of the cash position of its SFCs determined in the two years ending immediately before November 2, 2017. So, the cash positions of a US shareholder with one SFC with a calendar tax year would be determined as of December 31, 2017 or the average of December 31, 2016 and December 31, 2015, whichever is greater. For purposes of this calculation, the cash position of an SFC would include the following: cash; net accounts receivable of the foreign corporation; and the fair market value of actively traded personal property, commercial paper, certificates of deposits, government securities, foreign currency, obligations with a term of less than a year, and any asset economically equivalent to the these assets. To prevent double inclusions, the provision would specifically exclude all or part of three items to the extent the US shareholder can demonstrate such cash amount is taken into account by the US shareholder's pro rata share of cash from another SFC. Such cash items include: (i) net accounts receivable, (ii) actively traded personal property (e.g., stock in an SFC), and (iii) obligations with a term of less than a year. For the foregoing calculations, the determination of whether a person is a US shareholder, whether a foreign corporation is subject to the transition tax, and the amount of a shareholder's pro rata share of a foreign corporation are all determined as of the end of the last tax year of a foreign corporation, which begins before January 1, 2018. Transactions with the principal purpose of reducing the aggregate cash position of a foreign corporation subject to the transition tax would be disregarded. Use of tax attributes to reduce the transition tax Any foreign income taxes deemed paid by the US shareholder under Section 960 would be reduced based on the same ratios applied to determine the allowable deduction against the mandatory inclusion. A gross-up under Section 78 would be required only for the foreign income taxes remaining after the reduction ratios are applied, and this amount may be claimed as a credit against the transition tax liability (or other foreign source income), subject to the normal limitations under Section 904. The Conference Agreement also would not limit the use of a foreign tax credit carryforward of the US shareholder to offset the transition tax. The recapture of foreign losses under Sections 904(f) and 907(c)(4) was not turned off for the mandatory inclusion. However, US shareholders may elect to forgo the use of their net operating loss deduction to reduce US taxable income on the mandatory inclusion. Limitation on losses with respect to specified 10%-owned foreign corporations The Conference Agreement would provide that, solely for purposes of determining loss on a disposition of stock of a specified 10%-owned foreign corporation, a domestic corporate shareholder must reduce (not below zero) its adjusted basis in such stock by the amount of any 100% deduction claimed for dividends received with respect to such stock. A reduction would not be required to the extent the adjusted basis of the stock was reduced under Section 1059. Effective date This provision would apply to distributions made after December 31, 2017. Sale by an upper-tier CFC of stock of a lower-tier CFC The Conference Agreement would provide that the foreign-source portion, if any, of gain recognized by an upper-tier CFC on the sale or exchange of stock of a lower-tier CFC held for at least one year that is treated as a dividend under Section 964(e) would be treated as a subpart F income for purposes of Section 951(a)(1)(A). The Conference Agreement appears to treat the entire amount of such gain as offset, thus potentially denying any expense under Section 954(b)(5) expense offset. However, a domestic corporation shareholder of the selling CFC would be allowed a 100% deduction against its pro rata share of the subpart F income in the same manner as if the subpart F income were a dividend received from the selling CFC. For purposes of determining loss from a sale or exchange of stock of a foreign corporation by a CFC, rules similar to the loss limitation with respect to specified 10%-owned foreign corporations described above apply. Effective date This provision would apply to sales or exchanges after December 31, 2017. Recapture of foreign branch losses The Conference Agreement would require a domestic corporation that transfers, after December 31, 2017, substantially all of the assets of a foreign branch (within the meaning of Section 367(a)(3)(C)) to a specified 10%-owned foreign corporation with respect to which the domestic corporation is a US shareholder after the transfer, to include in gross income the "transferred loss amount," subject to certain limitations. The transferred loss amount would be the excess (if any) of: (i) losses incurred by the foreign branch after December 31, 2017, and before the transfer, for which a deduction was allowed to the domestic corporation; over (ii) the sum of taxable income earned by the foreign branch and gain recognized due to overall foreign loss (OFL) recapture as a result of the transfer. For this purpose, only taxable income of the foreign branch earned in tax years after the loss is incurred through the close of the tax year of the transfer is included in gross income. The transferred loss amount would be reduced (not below zero) by the amount of gain recognized by the taxpayer (other than gain recognized by reason of OFL recapture) on account of the transfer. However, this gain amount would be reduced by the amount of gain that would be recognized under Section 367(a)(3)(C) as in effect before these changes with respect to losses incurred before January 1, 2018. Amounts included in gross income under this provision would be treated as US-source. The Conference Agreement would also repeal the active trade or business exception of Section 367(a)(3) for outbound transfers of certain appreciated property to foreign corporations in connection with any exchange provided in Sections 332, 251, 354, or 361. Effective date These provisions would be effective for transfers after December 31, 2017. New current-year inclusion to US shareholders for global intangible low-taxed income The Conference Agreement would require a US shareholder of any CFC to include in gross income for a tax year its "global intangible low-taxed income" (GILTI) in a manner similar to current subpart F income inclusions. A US shareholder's GILTI for any tax year would mean the excess, if any, of the US shareholder's "net CFC tested income" over its "net deemed tangible income return." In this manner, GILTI would represent an amount deemed in excess of a specified return. Net CFC tested income. A US shareholder's net CFC tested income for a tax year would equal the excess, if any, of: (i) the shareholder's aggregate pro rata share of the "tested income" of each of its CFCs for the tax year, over (ii) the shareholder's aggregate pro rata share of the "tested loss" of each of its CFCs for the tax year. Tested income of a CFC for a tax year would mean the excess, if any, of: (i) the CFC's gross income for that year — but not including ECI, subpart F gross income, gross income excluded from "foreign base company income" or "insurance income" under the high-tax exception of Section 954(b)(4), dividends received from related persons within the meaning Section 954(d)(3), and any foreign oil and gas extraction income within the meaning of Section 907(c)(1) (tested gross income) — over (ii) the deductions (including taxes) properly allocable (under rules similar to those of Section 954(b)(5)) to such tested gross income. Tested loss of a CFC would be the excess, if any, of: (i) deductions properly allocable to its tested gross income, over (ii) its tested gross income. Accordingly, for any tax year, a CFC could have tested income or tested loss, but not both. Net deemed tangible income return. A US shareholder's net deemed tangible income return for a tax year would equal the excess, if any, of: (i) 10% of the US shareholder's aggregate pro rata share of the "qualified business asset investment" (QBAI) of its CFCs over (ii) the amount of interest expense taken into account in determining the US shareholder's net CFC tested income to the extent that the interest income attributable to the expense is not taken into account in determining the US shareholder's net CFC tested income (e.g., interest payable to an unrelated lender). A CFC's QBAI for any tax year would mean the average of its aggregate adjusted bases, measured as of the close of each quarter of the tax year, in tangible property used by the CFC in a trade or business for the production of tested income and for which a deduction is generally allowable under Section 167. The Treasury would be authorized to issue anti-avoidance regulations (and other appropriate guidance) with respect to QBAI. Deemed-paid foreign income taxes. The Conference Agreement would amend current Section 960 such that a US corporation with a GILTI inclusion would be treated as having paid foreign income taxes equal to 80% of the product of: (i) its "inclusion percentage" and (ii) the aggregate "tested foreign income taxes" paid or accrued by its CFCs. A US corporation's inclusion percentage for a tax year would mean the ratio (expressed as a percentage) of: (i) its GILTI inclusion to (ii) the aggregate of its pro rata shares of the tested income of its CFCs. Tested foreign income taxes of a CFC would mean the foreign income taxes paid or accrued by the CFC that are properly attributable to the tested income of the CFC that is taken into account by the US corporation under Section 951A. Notwithstanding that the US corporation would be treated as having paid only 80% of the product determined above, the Conference Agreement would amend Section 78 generally to treat the US corporation as having received dividends from the relevant CFCs equal in the aggregate to 100% of that product. (The deemed dividends would not, however, be treated as dividends for purposes of calculating dividend received deductions under Section 245 or 245A.) The Conference Agreement would also create a new foreign tax credit limitation category under Section 904(d) for GILTI that does not constitute passive category income (passive GILTI would continue to be treated as income in the passive limitation category). Excess foreign tax credits in the non-passive GILTI limitation category for a tax year could not be carried back or forward to another tax year. Effective date The new GILTI provision would be effective for tax years of foreign corporations beginning after December 31, 2017, and for tax years of US shareholders with or within which such tax years of foreign corporations end. Deduction allowable for foreign-derived intangible income and GILTI inclusions The Conference Agreement would allow a US corporation a new deduction in respect of its "foreign-derived intangible income" (FDII) and GILTI inclusion (including any corresponding Section 78 dividends). For tax years of the US corporation beginning after December 31, 2017 but on or before December 31, 2025, the deduction generally would be equal to the sum of: (i) 37.5% of the US corporation's FDII and (ii) 50% of the sum of (a) its GILTI inclusion and (b) corresponding Section 78 dividends. If, however, the sum of the US corporation's FDII, GILTI, and Section 78 dividends exceeded its taxable income (determined without regard to the new deduction), the amount of FDII (on the one hand) and GILTI and Section 78 dividends (on the other) would be reduced proportionately to eliminate the excess. For tax years beginning after December 31, 2025, the percentages described above would be reduced to 21.875% and 37.5%, respectively. Foreign-derived intangible income. A US corporation's FDII for a tax year would be the amount that bears the same ratio to its "deemed intangible income" as its "foreign-derived deduction eligible income" bears to its "deduction eligible income." Deduction eligible income. A US corporation's deduction eligible income for any tax year would mean the excess, if any, of: (i) its gross income, without regard to any amount included in gross income under Section 951(a)(1), its GILTI inclusion, any financial services income (as defined under Section 904(d)(2)(D)), any dividend received from a CFC in respect of which it is a US shareholder, any domestic oil and gas extraction income, and any foreign branch income (as defined under new Section 904(d)(2)(J)), over (ii) the deductions, including taxes, properly allocable to such gross income. Foreign-derived deduction eligible income. A US corporation's foreign-derived deduction eligible income for a tax year would mean any deduction eligible income that the corporation derived in that year in connection with: (i) property sold (for these purposes, including a lease, license, exchange, or other disposition) to any non-US person that the US corporation "establishes to the satisfaction of the [Treasury] Secretary" (establishes) is for a "foreign use"; or (ii) services that the US corporation establishes that it provided to a person or, with respect to property, located outside of the US. Foreign use means any use, consumption, or disposition that is not within the US. Special rules would apply to property sold or services provided to: (i) an unrelated intermediary within the US and (ii) a related party (generally defined as greater than 50% common ownership). Deemed intangible income. A US corporation's deemed intangible income for a tax year is the excess, if any, of its deduction eligible income over its "deemed tangible income return" for the year. A US corporation's deemed tangible income return for a tax year would be 10% of the corporation's QBAI for the year. QBAI would be determined with reference to tangible property (or portion thereof) that a US corporation used in a trade or business for the production of deduction eligible income and for which a deduction is generally allowable under Section 167. A US corporation's QBAI for a tax year would be the average of the aggregate-adjusted bases in such property, measured as of the close of each quarter of the year. Effective date The new deduction would be allowable for tax years beginning after December 31, 2017. Changes to the foreign tax credit regime Repeal of Section 902. The Conference Agreement would repeal current Section 902. Amendments to Section 960. The Conference Agreement would amend Section 960 to deem a US corporation that has a subpart F income inclusion with respect to a CFC as paying only the CFC's foreign income taxes "properly attributable" to the subpart F income. The Conference Agreement would also provide rules (apparently similar to current Section 960(a)(3)) that would deem a US corporation as paying foreign income taxes attributable to PTI distributions, including distributions through tiered CFCs (e.g., withholding taxed paid by an upper-tier CFC on the receipt of PTI from a lower-tier CFC). Amendments to Section 1293(f) would ensure that these rules apply to an amount included in the gross income of a domestic corporation with respect to a PFIC treated as a qualified electing fund, but only to the extent that the ownership requirements of current Section 902(a) or (b) are satisfied. New limitation category for non-passive foreign branch income. The Conference Agreement would create a new Section 904(d) limitation category for foreign branch income (defined as business profits attributable to one or more qualified business units in one or more foreign countries). Foreign branch income that constitutes passive income, however, would continue to be included in the passive limitation category. Effective date The changes to Sections 902 and 960 would be effective for tax years of foreign corporations beginning after December 31, 2017 and for tax years of US shareholders with or within which such tax years of foreign corporations end. The new Section 904(d) limitation category would be effective for tax years beginning after December 31, 2017. Source of income from inventory sales Current Section 863(b) provides special rules that source income derived from the sale of inventory produced within the United States and sold outside of the United States (or vice versa) (a Section 863(b) Sale) as partly from US sources and partly from foreign sources. The Conference Agreement would require income from a Section 863(b) sale to be apportioned between US and foreign sources solely on the basis of the production activities with respect to the inventory sold. Effective date The amendment would apply to tax years beginning after December 31, 2017. Other changes to the current subpart F provisions of the Code Expanded stock attribution rules. The Conference Agreement would repeal current Section 958(b)(4), which generally prevents stock owned by a foreign shareholder from being attributed downward to a domestic subsidiary. For foreign-parented groups, the current-law rule could prevent CFC status for any foreign subsidiaries jointly-owned by the foreign parent corporation and US subsidiary. For example, if the foreign parent owned 55% of the foreign subsidiary and the US subsidiary owned the remaining 45%, the foreign subsidiary would not be a CFC under current law because Section 958(b)(4) prevents the US subsidiary from being treated as owning any portion of the foreign parent's 55% interest. The Conference Agreement would repeal this limitation. Thus, under these assumed facts, the US subsidiary would, for purposes of determining US shareholder and CFC status, be treated as owning all of the stock of the foreign subsidiary, causing it to be a US shareholder of the foreign subsidiary, which would now be a CFC. The US subsidiary's inclusion of any subpart F income, however, would still be limited to its directly held stock, along with any stock indirectly held through foreign entities as determined under Section 958(a). The repeal of Section 958(b)(4) would greatly expand the application of subpart F, including the incidence of the US tax on GILTI and on the mandatory inclusion, each as previously described. Expanded definition of US shareholder. The Conference Agreement would expand the definition of a US shareholder under Section 951(b) to include a US person that owns at least 10% of the value of shares of all classes of stock in a foreign corporation. Elimination of the 30-day rule. Under current law, a US shareholder of a CFC is required to recognize a subpart F inclusion under Section 951(a) with respect to a foreign corporation only if that foreign corporation was a CFC for at least 30 consecutive days during its tax year. The Conference Agreement would eliminate this 30-day rule. Therefore, under the Conference Agreement, a US shareholder would be required to recognize a subpart F inclusion under Section 951(a) with respect to a foreign corporation if the foreign corporation was a CFC at any time during the tax year. Repeal of foreign base company oil-related income rules. The Conference Agreement would repeal Section 954(g), which treats as subpart F income certain foreign oil-related income earned by a CFC. Repeal of inclusion based on withdrawal of qualified shipping investment. Foreign shipping income earned by a CFC between 1976 and 1986 was not treated as Subpart F income to the extent reinvested in certain qualified shipping investments. Under current law, such income is subject to US tax to the extent there is a net decrease to a CFC's qualified shipping investments in any tax year. The Conference Agreement would repeal this income inclusion requirement. Effective dates The Conference Agreement's expansions of the stock attribution rules would apply to the last tax year of foreign corporations beginning before January 1, 2018, and all subsequent years, and to tax years of the US shareholders in which or with which such tax years of foreign corporations end. The other changes to the current Subpart F rules would apply to tax years of foreign corporations beginning after December 31, 2017, and to tax years of the US shareholders in which or with which such tax years of foreign corporations end. Limitations on net interest expense deductions The Conference Agreement would amend Section 163(j) to limit the deduction of any taxpayer for any tax year for net business interest expense to 30% of the taxpayer's adjusted taxable income (as defined) for that year. This limitation would apply to all taxpayers, regardless of their form (special rules would apply with respect to partnerships and S-Corporations) and regardless of whether interest is paid to related or unrelated parties (foreign or domestic). For this purpose, adjusted taxable income (ATI) is defined as taxable income determined without regard to any items not properly allocable to a trade or business, any business interest or business interest income, any net operating loss (NOL) deduction, and in the case of tax years beginning before 1 January 2022 any deduction for depreciation, depletion, and amortization (DD&A), and other adjustments as may be provided by regulations. Because the Conference Agreement repeals Section 199 for tax years after December 31, 2017, adjusted taxable income is computed without regard to such deduction. Thus, for tax years beginning on or after January 1, 2022, ATI would take into account DD&A deductions and generally result in lower ATI and a correspondingly greater limitation on net business interest expense deductions. The Conference Agreement would provide an exception for taxpayers with average annual gross receipts of US $25 million or less during the prior three-year period. The Conference Agreement also exempts from the limitation interest from floor plan financing (as defined to generally mean indebtedness used to finance the acquisition of motor vehicles held for sale or lease), and interest expense of an electing real property trade or business, electing farming business, and certain regulated power and utility businesses. The Conference Agreement would allow for the indefinite carryforward of interest expense disallowed by the provision. Amended Section 163(j) would be effective for tax years beginning after December 31, 2017. New base erosion and anti-abuse tax (BEAT) The Conference Agreement would introduce a base erosion minimum tax (generally referred to as a BEAT). In general, the BEAT would apply to an applicable taxpayer (i.e., corporations, other than RICs, REITs, or S-corporations) that is subject to US net income tax with average annual gross receipts of at least $500 million for the three-year period ending with the preceding tax year, and that has made certain related party deductible payments, determined by reference to a base erosion percentage of at least 3% (2% in the case of banks and certain security dealers) of the corporation's total deductions for the year. An applicable taxpayer would be required to pay a base erosion minimum tax amount equal to the excess of 10% (5% rate applies for tax years beginning in calendar year 2018) of its modified taxable income for a tax year over its regular tax liability for the tax year reduced, but not below zero, by the excess, if any, of credits allowed under Chapter 1 against the regular tax liability over the sum of: (1) the credit allowed under Section 38 (general business credit) for the tax year properly allocable to the research credit (Section 41(a)), plus (2) the portion of the applicable Section 38 credits not in excess of 80% of the lesser of the amount of such credits or the base erosion minimum tax amount (determined without regard to this clause (2)). "Applicable Section 38 credits" would mean credits properly allocable to: (1) the low-income housing credit (Section 42(a)), (2) the renewable electricity production credit (Section 45(a)), and (3) the investment credit (Section 46), but only to the extent properly allocable to the energy credit determined under Section 48. For tax years beginning after December 31, 2025, the 10% rate would be increased to 12.5%, and the regular tax liability would be reduced by the aggregate amount of Chapter 1 credits. In the case of a taxpayer that is a member of an affiliated group that includes a bank (Section 581) or a registered securities dealer (Section 15(a) of the Securities Exchange Act of 1934), the rates would be 1% higher than the rates described above. An applicable taxpayer's modified taxable income would equal its taxable income determined under Chapter 1 without regard to a deduction or reduction, as applicable, (a base erosion tax benefit) allowable for the tax year with respect to any base erosion payment, and without regard to any "base erosion percentage" of any NOL deduction allowed under Section 172. Base erosion tax benefits attributable to base erosion payments that are taxed under Sections 871 or 881, in proportion to the actual rate of tax imposed under those Sections to 30%, would be excluded from the computation of modified taxable income. A "base erosion payment" generally would mean: (i) any amount paid or accrued by the corporation to a foreign related party and with respect to which a deduction is allowable, including amounts paid or accrued to acquire depreciable or amortizable property, (ii) any premium or other consideration paid or accrued by the taxpayer to a foreign person which is a related party of the taxpayer for any reinsurance payments taken into account under Sections 803(a)(1)(B) or 832(b)(4)(A), and (iii) any amount that constitutes reductions in gross receipts of the taxpayer that is paid to or accrued by the taxpayer with respect to (1) a surrogate foreign corporation (as defined in Section 7874(a)(2)) which is a related party of the taxpayer (but only if such person first became a surrogate foreign corporation after November 9, 2017), and (2) a foreign person that is a member of the same expanded affiliated group as the surrogate foreign corporation. Base erosion payments would not include: (i) any amount that constitutes reductions in gross receipts including payments for costs of goods sold (except as noted above with respect to surrogate foreign corporations), (ii) any amount paid or accrued by a taxpayer for services if such services meet the requirements for eligibility for use of the services cost method described in Treas. Reg. Sec. 1.482-9, without regard to the requirement that the services not contribute significantly to fundamental risks of business success or failure and only if the payments are made for services that have no markup component, and (iii) any qualified derivative payment, if certain requirements are met. A "base erosion tax benefit" would mean: (i) any deduction allowed under Chapter 1 for the tax year with respect to a base erosion payment, (ii) in the case of a base erosion payment with respect to the purchase of property of a character subject to the allowance for depreciation or amortization, any deduction allowed in Chapter 1 for depreciation or amortization with respect to the property acquired with such payment, (iii) any reduction under Section 803(a)(1)(B) in the gross amount of premiums and other consideration on insurance and annuity contracts for premiums and other consideration arising out of indemnity insurance, and any deduction under Section 832(b)(4)(A) from the amount of gross premiums written on insurance contracts during the tax year for premiums paid for reinsurance, or (iv) any reduction in gross receipts with respect to a payment described above with respect to a surrogate foreign corporation in computing gross income of the taxpayer for the tax year. The "base erosion percentage" for any tax year would be the aggregate amount of base erosion tax benefits for the year divided by the aggregate deductions allowable under Chapter 1 for the year including base erosion payments, though the denominator would exclude deductions allowed under Sections 172, 245A or 250, and deductions for qualified derivative payments and payments for certain services outside the scope of a base erosion payment (as described above). For purposes of the provision, all persons treated as a single employer under Section 52(a) would be treated as one person. However, the exception for foreign corporations under Section 1563(b)(2)(C) would be disregarded in applying Section 1563 within Section 52 for these purposes. In the case of a foreign person, the gross receipts that are taken into account for purposes of the provision are those taken into account in determining income of that foreign person that is effectively connected with the conduct of a US trade or business. Related party for purposes of this provision would mean: (i) any 25% owner of the taxpayer, (ii) any person who is related to the taxpayer or any 25% owner of the taxpayer, within the meaning of Sections 267(b) or 707(b)(1), and (iii) any other person related to the taxpayer within the meaning of Section 482. Section 318 regarding constructive ownership of stock applies to the definition of related party with the exception that "10%" is substituted for "50%" in Section 318(a)(2)(C), and, for these purposes, Section 318(a)(3)(A), (B) and (C) do not cause a US person to own stock owned by a person who is not a US person. The Conference Agreement would grant the Treasury Department broad authority to prescribe such regulations or other guidance necessary or appropriate, including regulations providing for such adjustments to the application of this Section necessary to prevent avoidance of the provision, including through: (1) the use of unrelated persons, conduit transactions, or other intermediaries, or (2) transactions or arrangements designed in whole or in part: (A) to characterize payments otherwise subject to this provision as payments not subject to this provision, or (B) to substitute payments not subject to this provision for payments otherwise subject to this provision. The provision would add new information reporting requirements under Sections 6038A and 6038C to require the reporting of information relating to payments subject to the provision. Further, the provision would also increase the failure to furnish information or maintain records penalties under Section 6038A(d)(1) and (2) to $25,000. Effective date The BEAT would apply to base erosion payments paid or accrued in tax years beginning after December 31, 2017. Denial of deduction for certain hybrid payments The Conference Agreement would deny a deduction for any disqualified related party amount paid or accrued with respect to a hybrid transaction or by, or to, a hybrid entity. A disqualified related party amount would be any interest or royalty paid or accrued to a related party (within the meaning of Section 954(b)(3)) to the extent: (1) there is no corresponding inclusion to the related party under the tax law of the country in which the party is a resident for tax purposes or is subject to tax, or (2) the related party is allowed a deduction with respect to such amount under the tax law of such country. However, the provision would not apply to interest or royalties included in the gross income of a US shareholder as subpart F income under Section 951(a). A hybrid transaction would be any transaction, series of transactions, agreement, or instrument in which one or more payments are treated as interest or royalties for US tax purposes but not so treated under the tax law of the country of which the recipient of the payment is resident for tax purposes or is subject to tax. A hybrid entity would be any entity that is fiscally transparent for US tax purposes but not so treated for purposes of the tax law of the country of which the entity is resident for tax purposes or is subject to tax, or vice-versa. The Conference Agreement would grant the Treasury broad authority to issue regulations or other guidance as may be necessary or appropriate to carry out the purposes of the provision, including regulations or other guidance providing rules for: 1. Denying deductions for conduit arrangements that involve a hybrid transaction or a hybrid entity 2. Applying the provision to branches or domestic entities 3. Applying the provision to certain structured transactions 4. Treating a tax preference as an exclusion from income (if such preference has the effect of reducing the country's generally applicable statutory tax rate by at least 25%) for purposes of determining whether a payment of interest or a royalty is treated as a disqualified related party amount 5. Denying all of a deduction claimed for an interest or a royalty payment if such amount is subject to a participation exemption system or other system which provides for the exclusion or deduction of a substantial portion of such amount 6. Determining the tax residence of a foreign entity if the foreign entity is otherwise considered a resident of more than one country or of no country 7. Creating exceptions to the general rule set forth in the provision 8. Setting forth requirements for record keeping and information in addition to any requirements imposed by section 6038A The Joint Explanation states that Treasury may issue regulations or other guidance as may be necessary to carry out the purposes of this provision for branches (domestic or foreign) and domestic entities, even if such branches or entities do not meet the statutory definition of a hybrid entity. Effective date The provision would be effective for tax years beginning after December 31, 2017. Qualified dividend income (QDI) treatment denied for dividends paid by a surrogate foreign corporation In general, under Section 1(h)(11), a US individual taxpayer who receives a dividend from a qualified foreign corporation is subject to income tax on such dividend at the preferential capital gains rate. The Conference Agreement would deny this preferential treatment for dividends received from a corporation which first becomes a surrogate foreign corporation, within the meaning of Section 7874(a)(2)(B) (other than a foreign corporation that is treated as a domestic corporation under Section 7874(b)), after the date of the enactment of the Conference Agreement. Effective date The provision would be effective for dividends received after date of enactment. Fair market value method of interest expense apportionment Effective for tax years beginning after December 31, 2017, the Conference Agreement would repeal the fair market method of interest expense apportionment under Section 864(e). Treatment of gain or loss of foreign persons from sale or exchange of interests in partnerships engaged in a US trade or business The Conference Agreement would enact Section 864(c)(8) to treat the portion of gain (or loss) from the sale or exchange of an interest in a partnership that is engaged in a US trade or business as effectively connected income (ECI) to the extent the gain (or loss) from the sale or exchange of the underlying assets held by the partnership would be treated as ECI allocable to such partner. The Conference Agreement would also require the purchaser of a partnership interest to withhold 10% of the amount realized on the sale or exchange of the partnership interest, unless the transferor certifies that the transferor is not a nonresident alien individual or foreign corporation. This provision would be effective for sales, exchanges, and dispositions on or after November 27, 2017. The portion of the provision requiring withholding on sales or exchanges of partnership interests would be effective for sales, exchanges, and dispositions after December 31, 2017. ———————————————
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