December 21, 2017 Oil and gas sector implications of the Conference Agreement of the Tax Cuts and Jobs Act On December 20, 2017, the US House of Representatives approved the "Tax Cuts and Jobs Act" (H.R. 1) Conference Agreement (the Conference Agreement). The approval follows the Senate's passage of the Conference Agreement on December 19, 2017. The measure, which represents the first major overhaul of the US federal income tax system in more than 30 years, now goes to President Trump for signature. The President may not sign the bill until after the New Year if Congress does not approve a waiver of the Statutory Pay-As-You-Go Act of 2010 with regard to the tax bill. The Conference Agreement includes many provisions that would directly and indirectly affect the oil and gas sector. The Conference Agreement generally adheres to the framework of each of the House bill and the Senate bill and includes a number of key compromises. The provisions in the Conference Agreement aim to drive economic growth and continue to foster domestic oil and gas development and production. The provisions should be analyzed on a company-by-company basis. This Tax Alert highlights some of the key provisions for the oil and gas sector. Key tax provisions that could affect the oil and gas sector Oil and gas companies, on balance, may react somewhat favorably to the business provisions in the Conference Agreement. Perhaps most importantly for the oil and gas sector, several of its highest priorities were not addressed in the Conference Agreement. Those items not addressed include: — The deductibility of intangible drilling costs Corporate tax rate The Conference Agreement would lower the corporate tax rate to 21%, down from 35%, which today is the highest in the industrialized world. Under the Conference Agreement, the 21% tax rate would generally apply to corporate oil and gas companies, with an effective date of January 1, 2018. For oil and gas companies that are on a fiscal (as opposed to a calendar) year, detailed provisions are provided, which effectively result in the corporation having a blended rate for the fiscal tax year that includes January 1, 2018. Repeal of the corporate alternative minimum tax (AMT) The corporate AMT would be repealed under the Conference Agreement, and taxpayers with an AMT credit could use the credit to offset regular tax liability. Taxpayers would be able to claim a refund of 50% (100% for years beginning in 2021) of the remaining credits (to the extent the credits exceed regular tax for the year) in tax years beginning before 2022. The provision would apply to tax years beginning after 2017. Given the nature of drilling programs and capital spending in the sector, many oil and gas companies have been in an AMT position and have carryover AMT credits. The repeal of the corporate AMT, coupled with the ability to monetize historic AMT credits, ought to be well received by corporate oil and gas companies. Oil and gas companies should evaluate the balance sheet classification of AMT credit carryforwards after the enactment date. However, many investments in the oil and gas sector are made by individuals. The retention of the individual AMT system, and the impact of certain oil and gas cost recovery provisions (such as percentage depletion) should be carefully analyzed. Similarly, the retention of the individual AMT coupled with the repeal of the corporate AMT regime may lead to deeper entity selection discussions and analysis when evaluating oil and gas investments (including financing) or operations requiring significant capital. Dividends received deduction (DRD) modification Under the Conference Agreement, the amount of deduction allowable against the dividends received from a domestic oil and gas corporation would be reduced, applicable to tax years beginning after December 31, 2017. Specifically, the deduction for dividends received from other than certain small businesses or those treated as "qualifying dividends" would be reduced from 70% to 50%. Dividends received from 20% owned oil and gas corporations would be reduced from 80% to 65%. Expensing Under current law, taxpayers are allowed to claim additional depreciation (i.e., bonus depreciation) under Section 168(k) in the year in which qualified property (as described later) is placed in service through 2019 (with an additional year to place the property in service for qualified property with a longer production period, as well as certain aircraft). Bonus depreciation generally equals 50% of the cost of the property placed in service in 2017 and phases down to 40% in 2018 and 30% in 2019. Under current law, qualified property is defined as tangible property with a recovery period of 20 years or less under the modified accelerated cost recovery system (MACRS), as well as certain other property. To be eligible for bonus depreciation, the original use of the property must begin with the taxpayer (i.e., used property does not qualify). Additionally, under current law, taxpayers have the option of making an annual election to not claim bonus depreciation with respect to qualified property under Section 168(k)(7). Alternatively, taxpayers may elect under Section 168(k)(4) to accelerate alternative minimum tax (AMT) credits (as refundable credits) in lieu of claiming bonus depreciation with respect to qualified property. Such election comes with the added requirement to depreciate that qualified property using a straight-line recovery method. Under the Conference Agreement, the additional first year depreciation deduction would be extended through 2026 (2027 for longer production period property and certain aircraft). The provision would allow taxpayers to claim 100% bonus depreciation with respect to qualified property acquired and placed in service after September 27, 2017, and before January 1, 2023 (January 1, 2024, for certain qualified property with a longer production period, as well as certain aircraft). The provision would phase down bonus depreciation to 80% for qualified property placed in service before January 1, 2024; 60% for qualified property placed in service before January 1, 2025; 40% for qualified property placed in service before January 1, 2026; and 20% for qualified property placed in service before January 1, 2027 (with an additional year to place in service available for long production period property and certain aircraft associated with each phase-down percentage). The expensing provisions in the Conference Agreement would also expand the current law definition of qualified property by repealing the requirement that the original use of the property begin with the taxpayer; instead, property would generally be eligible for 100% bonus depreciation if it is the taxpayer's first use of such property (provided that such "used" property is not acquired from a related party or in a carryover basis transaction). While the provision would generally expand the definition of qualified property, it specifically states that qualified property would not include property used by a regulated public utility company in the trade or business of the furnishing or sale of: (1) electrical energy, water or sewage disposal services; (2) gas or steam through a local distribution system; or (3) transportation of gas or steam pipeline, if the rates for the furnishing or sale of such services have been established or approved by a state or political subdivision thereof, by an agency or instrumentality of the United States or by a public service or utility commission or other similar body of any state or political subdivision thereof. Additionally, the provision states that qualified property would not include any property used in a trade or business that has had floor plan financing indebtedness (as defined in paragraph (9) of Section 163(j)), if the floor plan financing interest related to such indebtedness was taken into account in computing the interest limitation under Section 163(j). Further, a real property trade or business that elects not to be subject to certain interest provisions of Section 163(j) would have to depreciate qualified improvement property under the alternative depreciation system (and thus, such property would not be eligible for bonus depreciation). Lastly, specific provisions exist with respect to certain electing farming businesses. The Conference Agreement's expensing provisions would generally apply to property acquired and placed in service after September 27, 2017, as well as specified plants planted or grafted after that date. Property would not be treated as acquired after the date on which a written binding contract is entered into for its acquisition. For property acquired prior to September 27, 2017, (e.g., property for which a binding written contract was entered into prior to September 27, 2017, to purchase the property), such property would be subject to the bonus depreciation rules in place prior to the enactment of the provision (as previously described). A transition rule would allow a taxpayer to elect to utilize 50% bonus depreciation, instead of 100%, for qualified property placed in service during the first tax year ending after September 27, 2017. As the oil and gas sector is very capital intensive, and often takes many years to recoup necessary investments, expanding the 100% expensing provisions ought to have a significant effect on the deployment of capital and development of new projects, providing oil and gas companies with an immediate cash-tax benefit. The inclusion of a five-year period for 100% expensing (for many assets), followed by a five-year phase down of such provisions (as described above), should provide some level of certainty for short- and long-term planning and encourage capital investments. Importantly for oil and gas companies, the relaxation of the "original use" rules should make 100% expensing available to a wider base of assets. The oil and gas sector has a history of reinvestment and developing large-scale operations that can provide both economic growth and employment, and the 100% expensing provisions would appear to further that purpose. Further, oil and gas companies that are in a loss position and that would not otherwise benefit from immediate expensing would have the flexibility to elect not to apply the provisions of Section 168(k) and, instead, utilize the depreciation provisions as set forth in Section 168 generally. Such election, along with other Section 168 elections to "slow down" depreciation (e.g., annual election to use the alternative depreciation system), will become more relevant in tax years beginning on or after January 1, 2022, when depreciation deductions will reduce "adjusted taxable income" for purposes of the 30% interest deduction limitation under Section 163(j). Oil and gas companies will want to carefully model out the impact that depreciation elections will have on interest deductibility. Interest limitation Under current law, business interest is generally allowed as a deduction in the tax year in which the interest is paid or accrued, subject to limitation rules, as applicable. Section 163(j) limits a corporation's ability to deduct disqualified interest (i.e., interest paid or accrued to a related party when no federal income tax is imposed on the interest) paid or accrued in a tax year if: (1) the payor's debt-to-equity ratio exceeds 1.5 to 1.0 (safe harbor ratio); and (2) the payor's net interest expense exceeds 50% of its adjusted taxable income. In general, adjusted taxable income is the corporation's taxable income calculated without taking into account deductions for net interest expense, net operating losses (NOLs), domestic production activities under Section 199, depreciation, amortization and depletion. Disallowed interest amounts may be carried forward indefinitely and any excess limitation may be carried forward for three years. Under the Conference Agreement, Section 163(j) would be modified such that the net interest expense deduction would be limited for every business, regardless of form, to 30% of adjusted taxable income (ATI). The provision would be effective for tax years beginning after December 31, 2017. Further, the provision would require the interest expense disallowance to be determined at the tax filer level. ATI for purposes of this provision is modified from the Senate bill and would be a business's taxable income calculated without taking into account: (i) any item of income, gain, deduction, or loss which is not properly allocable to a trade or business; (ii) any business interest or business interest income; (iii) NOLs; (iv) the amount of any deduction allowed under Section 199A; (v) in the case of tax years beginning before January 1, 2022, any deduction allowable for depreciation, amortization or depletion; and (vi) such other adjustments as provided by the Secretary. ATI also would not include the Section 199 deduction, as it would be repealed. Further, the interest limitation rules under the Conference Agreement would exempt certain taxpayers, including, but not limited to, certain regulated public utilities. Additionally, under the Conference Agreement, businesses would generally be allowed to carry forward interest amounts disallowed under the provision to succeeding tax years indefinitely. Any carryforward of disallowed interest is an item taken into account in the case of certain corporate acquisitions described in Section 381 and is treated as a "pre-change loss" subject to limitation under Section 382. The provision would include special rules to allow a pass-through entity's owners to use unused interest limitation for the tax year and to ensure that net income from pass-through entities would not be double-counted at the partner level. The limitation on the deductibility of interest (which would generally not apply to regulated utilities) could negatively affect the after-tax cost of capital for investment decisions. As previously described above, ATI would be computed without regard to depreciation, amortization, or depletion until 2022, and, for years beginning in 2022, ATI would be decreased by those items. The net result is that oil and gas companies (which generally have depreciation, amortization, and depletion) may have a lower interest expense deduction in years beginning in 2022. Importantly, under the Conference Agreement, a grandfathering rule for existing debt obligations is not included. Additionally, by limiting net interest expense that exceeds 30% of ATI, the advantage of financing merger and acquisition transactions with debt would be reduced. To the extent the acquirer cannot deduct interest on acquisition debt, the economic cost of a debt-financed acquisition would be greater than under current law. Oil and gas companies facing deferral or disallowance of interest deductions generally would have incentives to increase their net interest income, either by converting interest into another type of deductible expense or by converting another type of income into effectively tax-free interest income. Additionally, for multi-national oil and gas companies, the removal of the additional worldwide interest limitation (which was proposed to be Section 163(n), but was not adopted in the Conference Agreement) should be well received. NOLs Under current law, Section 172 allows taxpayers to carry back an NOL arising in a tax year for two years and carry forward the NOL for 20 years to offset taxable income. Generally, an NOL is the excess of the taxpayer's business deductions over its gross income. Section 172 also provides special provisions modifying the carryback period for specific types of losses or losses arising in particular years. Included in these special provisions is Section 172(f), which allows a 10-year carryback of losses arising from specified liabilities. The AMT rules do not allow a taxpayer's NOL deduction to reduce the taxpayer's alternative minimum taxable income by more than 90%. Under the Conference Agreement, an indefinite carry forward of NOLs arising in tax years ending after December 31, 2017 would be allowed. The provision also would repeal all carrybacks for losses generated in tax years ending after December 31, 2017, but would provide a special two-year carryback for certain losses incurred in the trade or business of farming. For losses arising in tax years beginning after December 31, 2017, the provision would limit the amount of NOLs that a taxpayer could use to offset taxable income to 80% of the taxpayer's taxable income. Further, as part of the repeal of NOL carrybacks, the provision would repeal Section 172(f), the special rule allowing a 10-year carryback of specified liability losses. Under the Conference Agreement, the indefinite NOL carry forward, general repeal of NOL carrybacks (including the repeal of Section 172(f)), and certain other measures would be effective for losses arising in tax years ending after December 31, 2017. The 80% NOL limitation rule would be effective for losses arising in tax years beginning after December 31, 2017. The loss limitation provision would apply to tax years beginning after December 31, 2017. As many oil and gas companies often have years in which NOLs result, the limitation on the NOL deduction to 80% of taxable income may have a significant impact, and may result in a form of a minimum tax to certain taxpayers in certain years. Separately, the indefinite carryforward for certain NOLs should be well received by the sector. The modification of Section 172 related to carryover and carryback changes applies to NOLs arising in tax years ending after December 31, 2017. Therefore, a fiscal-year oil and gas taxpayer with a tax year ending after December 31, 2017, would not be allowed to carryback NOLs arising in the February 1, 2017-January 31, 2018, period and would not be allowed to carryback NOLs arising in that period that are specified liability losses for the 10-year period currently allowed. A calendar year oil and gas taxpayer, however, with a tax year ending December 31, 2017 would be able to use the current carryback and specified liability loss provisions for losses arising in the January 1, 2017-December 31, 2017 period. The 80% limitation applies to losses arising in tax years beginning after December 31, 2017. Therefore, carryover losses from tax years beginning before December 31, 2017 are not subject to the 80% limitation. Specified liability losses are limited deductible expenditures for product liability, land reclamation, nuclear power plant decommissioning, dismantlement of drilling platforms, remediation of environmental contamination, and workers' compensation payments. Although the Conference Agreement would preserve a majority of the NOL provisions under the Code, the repeal of Section 172(f) is expected to have the greatest impact on oil and gas companies, which incur the types of liabilities eligible for the extended carryback benefit under Section 172(f). Taxpayers will not be able to rely on specified liability losses as a source of cash tax savings for eligible liabilities that generate losses in tax years ending after December 31, 2017. Repeal of Section 199 Under current law, Section 199 allows a taxpayer to claim a deduction equal to 9% (6% for certain oil and gas activities) of the lesser of the taxpayer's taxable or qualified production activities income subject to a limitation of 50% of W-2 wages paid by the taxpayer during the calendar year that are allocable to the taxpayer's domestic production gross receipts. Qualified production activities income is derived from certain production activities and services performed in the United States and, for tax years beginning before January 1, 2017, in Puerto Rico. Under the Conference Agreement, Section 199 would be repealed effective for tax years beginning after December 31, 2017. The elimination of the Section 199 deduction for certain domestic production activities may negatively affect certain oil and gas companies, particularly those in the downstream space. Energy credits The Conference Agreement would not repeal any conventional energy tax credits (the House bill would have repealed the enhanced oil recovery tax credit (Section 43) and the credit for producing oil and gas from marginal wells (Section 45I)). Like-kind exchanges Under current law, generally no gain or loss is recognized to the extent that property held for productive use in the taxpayer's trade or business or for investment purposes is exchanged for property of a like-kind that is also held for productive use in a trade or business or for investment. The taxpayer then utilizes a carryover basis in the property acquired in the exchange equal to the basis of the property exchanged, decreased by the amount of any money received by the taxpayer and increased by the amount of gain or decreased by the amount of loss to the taxpayer that was recognized on such exchange, if any. The like-kind exchange rules under Section 1031 generally apply to tangible property (both real and personal), as well as certain intangible property. Under the Conference Agreement, Section 1031 would be modified so that its provisions would only apply to like-kind exchanges of real property that is not held primarily for sale. The provision would be effective for like-kind exchanges completed after December 31, 2017, although the provision would not apply to any like-kind exchange if the taxpayer has either: (1) disposed of the relinquished property; or (2) acquired the replacement property on or before December 31, 2017. The Conference Agreement would retain qualifying like-kind exchange treatment for real property only. As operating and non-operating interests in oil and gas reserves ought to be considered real property for this purpose, like-kind exchange treatment should continue to apply to such assets. However, top-side well equipment and other non-real property assets would generally be ineligible for Section 1031 treatment. Contributions to capital Under current law, a corporation's gross income does not include any contributions to its capital (i.e., transfers of money or property to the corporation by a shareholder or non-shareholder). Instead, the taxpayer excludes such amount from its income with the basis in property contributed (or acquired with contributed money) being modified in accordance with Section 362 and the regulations promulgated thereunder. Under Section 118, a contribution to capital does not include any contribution in aid of construction or any other contribution as a customer or potential customer. Under the Conference Agreement, the language in Section 118 would be retained specifying that a contribution to capital does not include any contribution in aid of construction or any other contribution as a customer or potential customer. Further, the provision would modify Section 118 to specify that a contribution to capital does not include any contribution by any governmental entity or civic group, other than a contribution made by a shareholder operating in its capacity as a shareholder. The provision would apply for contributions made, and transactions entered into, after the date of enactment. Pass-through provisions Under the Conference Agreement, numerous pass-through related provisions have been proposed, including, but not limited to, the following: Special 20% deduction for pass-through income — The Conference Agreement would add a new Section 199A, which grants individuals, trusts and estates a 20% deduction on certain pass-through income. Special limitations would apply to income from "specified service businesses" and businesses that do not pay a certain amount of W-2 wages. As a general rule, an individual taxpayer may deduct 20% of domestic "qualified business income" (QBI) from a partnership, S corporation, or sole proprietorship ("qualified businesses"), subject to certain limitations and thresholds. At the top tax rate of 37%, provided in the Conference Agreement, if a taxpayer's sole income source is domestic QBI and the application of the deduction is not limited, then the effective tax rate on the domestic QBI would be 29.6%. The deduction is not allowed against adjusted gross income, but rather is a deduction to reduce taxable income. With the reduction of the C corporation income tax rate to 21% and the presence of a significantly higher top individual income tax rate of 37%, the application of the 20% deduction will be an important factor in determining whether individuals should conduct business through a pass-through (where the entity does not pay federal income taxes but the owners do) or through a C corporation (where the entity pays federal income tax and the owners also pay tax on dividends or stock sales). The provision would be effective for tax years beginning after December 31, 2017, and before January 1, 2026. As many individuals invest in US oil and gas assets through partnerships, the availability (and effect) of the 20% deduction (subject to certain limitations) for certain flow-through income ought to be carefully analyzed and modeled. Further, for individual investors in PTPs, it is noteworthy that the Conference Agreement retained a limited wage limitation exemption — which ought to result in PTP individual unitholders being able to receive the 20% deduction (off individual rates), without the application of the wage limitation. For more information on the provisions, including information on QBI, limitations, special rules for specified service businesses and other pass-through items (including loss limitation rules applicable to individuals, mandatory basis adjustments for sales of partnership interests with built-in losses, among others), please see Tax Alert 2017-2141. Repeal of partnership technical terminations — Under Section 708(b)(1)(B) of current law, a sale or exchange of 50% or more of interests in partnership capital and profits within a 12-month period causes a "technical termination" of the partnership. The Conference Agreement would repeal Section 708(b)(1)(B) for partnership tax years beginning after December 31, 2017. On balance, such repeal ought to remove some barriers to transfers of partnership interests; however, further analysis would be needed to the extent that a technical termination may be desirable to effect a change in partnership elections or methods. Sale of partnership interests by foreign partners — In Grecian Magnesite (Grecian Magnesite Mining, Industrial & Shipping Co., SA vs. Comm'r, 149 T.C. No. 3 (Jul. 13, 2017)), the Tax Court declined to follow Revenue Ruling 91-32 (1991-1 C.B. 107.) holding that the gain recognized by a foreign person on its redemption from a partnership engaged in a US trade or business did not result in effectively connected income (ECI). The Conference Agreement would reverse this decision, reestablishing, by statute, a provision similar to the Revenue Ruling 91-32 holding to treat gain or loss from the sale of a partnership interest by a foreign partner as ECI that is taxable in the United States if the gain or loss from the sale of the underlying assets held by the partnership would be treated as ECI. In addition, the Conference Agreement would require the purchaser of a partnership interest from a partner 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 a foreign corporation (similar to the operation of the Foreign Investment in Real Property Tax Act (FIRPTA) rules applicable to sales of US real estate by foreign owners). The provision regarding the treatment of gain or loss from the sale of a partnership interest by a foreign partner as ECI would be effective for sales or exchanges occurring on or after November 27, 2017, while the effective date for required withholding on sales of partnership interests would be for sales or exchanges occurring after December 31, 2017. If enacted, the provision could negatively affect investments in US oil and gas by non-US investors. Carried interest — For certain partnership interests held in connection with the performance of certain services, the Conference Agreement would impose a three-year holding period to treat capital gain as long-term capital gain. The provision is effective for tax years beginning after December 31, 2017. International The Conference Agreement contains many, complex international tax related provisions, many of which would directly and indirectly impact multi-national oil and gas companies, as well as multi-national companies in other sectors. For a detailed description of the Conference Agreement's international tax provisions, please see Tax Alert 2017-2166. Highlights of the proposed changes are as follows: 100% exemption for foreign-source dividends — Effective (generally) for distributions made after December 31, 2017, the Conference Agreement would exempt 100% of the foreign-source portion of dividends received by a US corporation from a foreign corporation (other than a passive foreign investment company (PFIC) that is not also a controlled foreign corporation (CFC)) in which the US corporation owns at least a 10% stake. For details with respect to certain specific provisions, please see Tax Alert 2017-2166. Mandatory toll charge on tax-deferred foreign earnings — The Conference Agreement would provide a one-time transitional tax on a US 10%-shareholder's pro rata share of the foreign corporation's post-1986 tax-deferred earnings, at the rate of either 15.5% (in the case of accumulated earnings held in cash, cash equivalents or certain other short-term assets) or 8% (in the case of accumulated earnings invested in illiquid assets (e.g., property, plant and equipment)). A foreign corporation's post-1986 tax-deferred earnings would be the greater of the earnings as of November 2, 2017 or December 31, 2017. The portion of post-1986 earnings and profits subject to the transition tax would not include earnings and profits that were accumulated by a foreign company prior to attaining its status as a specified foreign corporation. The Conference Agreement would allow post-1986 accumulated earnings deficits of any foreign corporations to offset tax-deferred earnings of other foreign corporations. Additionally, the Conference Agreement would allow the netting to generally be done among all affiliated group members. The US shareholder may elect to pay the transitional tax over a period of up to eight years. For other related provisions, please see Tax Alert 2017-2166. Overall domestic loss — The Conference Agreement would provide an election to increase the percentage (but not greater than 100%) of domestic taxable income that may be offset by any pre-2018 unused overall domestic loss and recharacterized as foreign source. Anti-base erosion rules for intangible income — The Conference Agreement would impose a tax on a US shareholder's aggregate net CFC income that is treated as global intangible low-taxed income (GILTI). GILTI is gross income in excess of extraordinary returns from tangible depreciable assets excluding ECI, subpart F income, high-taxed income, dividends from related parties, and foreign oil and gas extraction income. The extraordinary return base would be equal to 10% of the CFCs' aggregate adjusted basis in depreciable tangible property. Only 80% of the foreign taxes paid on the income would be allowed as a foreign tax credit. All CFCs would be aggregated for purposes of the computation. For tax years beginning after December 31, 2017, and before January 1, 2026, the highest effective tax rate on GILTI would be 10.5%. For tax years beginning after December 31, 2025, the effective tax rate on GILTI would be 13.125%. The Conference Agreement would maintain the tax incentive in the Senate bill for US companies to earn intangible income from exploiting US intangibles abroad. Income from foreign derived intangible income (FDII) for tax years beginning after December 31, 2017, and before January 1, 2026 would be provided an effective tax rate of 13.125%. For tax years beginning after December 31, 2025, the effective tax rate on FDII would be 16.406%. Eligible income would not include, among other items, financial services income under Section 904(d)(2)(D). Transfers of intangible property to the United States — A Senate bill provision would have allowed US companies to repatriate their intangible property tax-free over a three-year period. The Conference Agreement did not adopt this provision. Subpart F modifications — The Conference Agreement would make the following modifications: (a) repeal of foreign base company oil related income (FBCORI) as subpart F income; and (b) repeal of the inclusion based on withdrawal of previously excluded subpart F income from a qualified investment in foreign base company shipping operations. Definition of US shareholder — The definition of a US shareholder would be changed to include any US person who owns 10% or more of the total value (as well as vote) of shares of all classes of stock of a foreign corporation. Modification of stock attribution rules for CFC status — The Conference Agreement would change the stock attribution rules. Under this provision, US corporations would be deemed to own the foreign stock that is owned by the US corporation's foreign parent for purposes of determining CFC status. The Conference Agreement would clarify that the provision is intended to target transactions that avoid subpart F by "de-controlling" a foreign subsidiary so that it is no longer a CFC. Repeal of 30-day CFC rules — Under the Conference Agreement, foreign corporations would be considered CFCs as soon as the ownership requirements are met and subject to the subpart F and base erosion rules. CFC look-through rules — The look-through rule for related CFC dividend, interest and royalties was not made permanent. Thus, the rules expire after 2019. Maintains Section 956 investment in US property rules — Both the House bill and the Senate bill repealed or modified current law Section 956. However, the Conference Agreement adopted neither change. Foreign tax credit changes — Under the Conference Agreement, indirect foreign tax credits would only be available for Subpart F income. No credits would be allowed with respect to any dividends associated with exempt dividends. Foreign tax credits would be used on a current year basis and would not be allowed to be carried forward or back. Separate branch FTC basket — The Conference Agreement would establish a separate foreign tax credit basket for branches. This will minimize a corporation's ability to cross-credit between branches and CFCs. Worldwide interest allocation — The Senate bill accelerated the effective date of the worldwide interest allocation rules to tax years beginning after December 31, 2017. The Conference Agreement does not adopt this provision. Export sales source rule — The Conference Agreement would amend the source of income rules from sales of inventory determined solely on basis of production activities. Inbound base erosion rule — The Conference Agreement contains a base erosion anti-abuse tax (BEAT) provision. The BEAT would apply to corporations (other than RICs, REITs, or S corporations) that are subject to US net income tax with average annual gross receipts of at least $500 million and that have made related party deductible payments totaling 3% (2% in the case of banks and certain security dealers) or more of the corporation's total deductions for the year. A corporation subject to the tax generally would determine the amount of tax owed under the provision (if any) by adding back to its adjusted taxable income for the year all deductible payments made to a foreign affiliate (base erosion payments) for the year (the modified taxable income). Base erosion payments would not include cost of goods sold, certain amounts paid with respect to services, and certain qualified derivative payments. The excess of 10% (5% in the case of one tax year for base erosion payments paid or accrued in tax years beginning after December 31, 2017) of the corporation's modified taxable income over its regular tax liability for the year (net of an adjusted amount of tax credits allowed) would be the base erosion minimum tax amount that is owed. For tax years beginning after December 31, 2025, the rate would increase from 10% to 12.5%. The rate for certain banks and security dealers would be one percentage point higher than the rates described above. Premiums related to reinsurance of life and property and casualty contracts would be specifically included as base erosion payments. The exception for costs of goods sold would not apply to base erosion payments made to a surrogate foreign corporation that first became a surrogate foreign corporation after November 9, 2017. The Conference Agreement would include a modification to the Senate provision that mostly eliminates the penalty in the BEAT calculation for companies that take advantage of certain business tax credits, including the low income housing tax credit and certain renewable electricity production tax credits. Importantly, for certain multi-national oil and gas companies, the Conference Agreement would repeal the FBCORI rules. This proposal would be effective for tax years of foreign corporations beginning after December 31, 2017, and for tax years of US shareholders in which or with which such tax years of foreign subsidiaries end. Additionally, the Conference Agreement does not appear to address the issue of foreign oil and gas loss recapture in the context of repatriation. The other international tax changes contained in the Conference Agreement and described above appear to apply equally to all companies in all industries, such as the repatriation tax (although the rates in the Conference Agreement are higher than those proposed in either the House bill or the Senate bill), the new category of subpart F income for GILTI amounts, and the BEAT provisions. The international provisions of the Conference Agreement are detailed and expansive, and they ought to be analyzed on a company-by-company basis. Multi-national oil and gas companies ought to quickly quantify the effect of the provisions on global operations and global payments. Finally, the Conference Agreement does not alter the FIRPTA rules. Conclusion While the potential effects of the Conference Agreement will vary across the domestic oil and gas sector on a company-by-company basis, at first glance, the Conference Agreement could drive economic growth and foster oil and gas development. The oil and gas sector is very capital intensive and has a history of re-deploying capital and earnings into new projects, driving economic activity and employment, and the Conference Agreement appears to support and encourage oil and gas companies to continue investing significantly in the United States. That being said, a number of provisions, including those related to expensing, those affecting inbound energy investments, and those related to the taxation of foreign income and foreign persons will require further analysis. All-in-all, the Trump Administration appears to be closing in on the first major overhaul of the US federal income tax in more than 30 years. Key actions to take now are as follows: — Model the Conference Agreement — Model the effect of tax reform legislation to understand how it impacts your tax liability and business — Identify any provisions that may require additional legislation or regulatory guidance to achieve congressional intent or to allow taxpayers to comply with enacted legislation Separately, Chairman Hatch introduced, on December 20, 2017, a bill to extend and amend a number of energy and other tax provisions, with the objective being to pass legislation either later this month or in January. For details on the extender provisions, please see Tax Alert 2017-2165. ———————————————
| |||||||||||||||||
| |||||||||||||||||
