Overview - Golden Gate University

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					The American Jobs Creation Act of 2004
- International Tax Provisions
December 9, 2004

Walter Kolligs, Principal
Ernst & Young LLP
San Francisco


 ETI Repeal
 Exploring the Implications of New §965 – The
  Repatriation Incentive
 Repatriation Planning
 Other International Provisions

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ETI Repeal

 Generally repeals ETI for transactions after December 31,
 September 17, 2003 binding contract exception
 Transition relief
     > 2005 – actual benefit under current law x 80%
     > 2006 – actual benefit under current law x 60%
 EU has concerns regarding the ETI transition rules

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Exploring the Implications of New §965
– The Repatriation Incentive

Repatriation Incentive – General Rule

 85% dividend received deduction on extraordinary cash
  dividends of a CFC received by a U.S. shareholder for
  taxable years beginning in 2004 or 2005 (but not both)
 Many provisions in the statute are vague
 Expect guidance on key terms and requirements by year-

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Repatriation Incentive – Dividend Definition

 Cash dividends are eligible for the DRD
     > The statute indicates that §78 gross up for §902/960 credits
       attributable to deductible dividends is not eligible for dividends
       received deduction. However, the Technical Corrections bill will
       correct this drafting error
     > §367 inclusions, §1248 inclusions, or §956 inclusions are not
       “dividends” but cash proceeds from a §367(b)/§332 liquidation
       are treated as dividends
     > May cherry-pick which dividends qualify

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Repatriation Incentive – Dividend Definition

 Cash dividends paid by lower tier CFCs may also qualify
  but only to the extent
     > Cash dividend to CFC recipient constitutes foreign base company
       FPHC income in year of election, and
     > Cash is ultimately distributed to U.S. shareholder in year of
     > Query: Does a CFC have sufficient cash to pay a large dividend?

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The Repatriation Incentive - Limitations

 Limitations on dividends eligible for DRD
 Greater of:
   > $500 million
   > Permanently reinvested earnings under APB 23 per applicable
     financial statements
   > Disclosed U.S. tax pursuant to APB 23 on permanently
     reinvested earnings (per applicable financial statements) divided
     by .35
 Amount in excess of prior year base period (i.e.,
    extraordinary dividend amount)
 Reduction for increased indebtedness of CFCs
 8 U.S. investment requirements
The Repatriation Incentive – Base Period

 Maximum extraordinary dividend is the dividend amount
  in excess of the base period
 All dividends, including property dividends taken into
  account in determining current amounts in excess of base
  period (“extraordinary dividends”)
 Base period amount is average dividends of 3 of the prior
  5 taxable years ending before June 30, 2003, dropping
  the highest and lowest dividend years

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The Repatriation Incentive – Base Period

 Base period dividends has expanded definition. Includes:
      > Any actual dividends, including non-cash dividends
      > PTI distributions of Subpart F income
      > Section 956 inclusions

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The Repatriation Incentive – Foreign Tax
Credit Implications (continued)

 Non-deductible dividends
      > Taxable income may not be less than the non-deductible CFC
        dividends for the year
          May be offset by any FTCs or alt. min. credits
          May not be offset with NOLs or other credits
 Expenses not deductible to the extent allocated and
  apportioned to DRD portion of dividends
 Committee reports indicate that an indirect allocation
  and apportionment method likely will not apply

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The Repatriation Incentive - Limitation

 Financial statement limitation merely serves as a cap on
  amount extraordinary dividends. Other than this cap, the
  legislation requires no correlation between actual
  repatriations for which a deduction is claimed and the
  specific amounts of the earnings of any subsidiary for
  which permanent reinvestment representations have
  been made.

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The Repatriation Incentive – Limitation

 Applicable financial statement
      > Audited financial statement certified on or before June 30, 2003
        as being prepared in accordance with GAAP; the purpose of
        which is to report to creditors, report to shareholders, or any other
        substantial non-tax purpose
      > A financial statement that is required to be filed with the SEC is
        an applicable financial statement provided it is filed on or before
        June 30, 2003

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The Repatriation Incentive – Reduction for
CFC Indebtedness

 Extraordinary dividend amount reduced by total
  increased indebtedness of all CFCs due to U.S. related
  parties during measurement period
      > Measurement period
          October 3, 2004 through year end in which DRD election is made
      > All CFCs treated as a single CFC
          Indebtedness between CFCs disregarded
      > Unclear how borrowings of split ownership CFCs are treated
      > Definition of indebtedness unclear
          Netting of payables and receivables
          Treatment of accounts payable an accrued expenses arising in the
           ordinary course of business
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The Repatriation Incentive – Reinvestment

 Extraordinary dividend must be reinvested in U.S.
  pursuant to a domestic reinvestment plan
   >   Funding worker hiring and training
   >   Infrastructure
   >   Research and development
   >   Capital investment
   >   Financial stabilization of the corporation for purposes of job
       creation or retention
 No time limitation placed on reinvestment requirement
 No incremental investments requirement (e.g., spending
    repatriated funds on recurring R&D or capital spending
15 Guidance expected before year-end!
The Repatriation Incentive – Reinvestment
Requirement (continued)

 Cannot be used for payment of executive compensation
 The domestic reinvestment plan must be:
    > Approved by the president, CEO or comparable officer of the U.S.
      shareholder before the payment of the dividend
    > Subsequently approved by the board of directors, management
      committee, executive committee or similar body
 How to track the reinvestment
    > Taxpayers may want to use dedicated bank accounts to fund
      qualified investments and/or establish annual reports to board of
      directors on use of repatriated extraordinary dividends for which
      DRD was claimed
    > However, senior IRS officials have stated publicly that dedicated
 16   bank accounts likely would not be required
Repatriation Incentive – Other

 How will pre-enactment dividends be treated?
 Whether a stock repurchase program qualifies as
  “financial stabilization”
 Whether debt repayment qualifies as “financial
   > Different treatment for AAA and AA rated issuers as compared
     with issuers below investment grade
 Proceeds likely could be used for corporate acquisitions
  and joint ventures where the entity holds U.S. qualifying
   > IRS considering an allocation rule for qualifying and non
     qualifying assets
17 How will goodwill in an acquisition be treated?
Repatriation Planning

Leveraging Foreign Operations

 Many companies may have low-taxed E&P outside the
  U.S., but not have cash sufficient to pay significant
 Consider leveraging foreign operations with debt in order
  to generate cash.
 Consider sale and leaseback transactions of business
 U.S. parent company guarantee may be required to
  ensure lowest cost financing possible
      > Parent company guarantee must be documented
      > Risk of recharacterization by the IRS as a U.S. borrowing

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Leveraging Foreign Operations (continued)

     Guarantee                                              Guarantee

                        1.                           2.
     Financial    Business Assets                US$/Euro
                                    CFC                        Market
                    Leaseback                        Note
  Common methods of generating cash
  USP guarantee ensures best pricing and general market
   acceptability of offering
 Sale and leaseback (if respected as a lease) may generate more low-
   taxed E&P
 USP guarantee places some pressure on risk of recharcterizing the
20 transaction as a U.S. borrowing 20
The Repatriation Incentive – Planning:
E&P Bumps

 Used to dilute pools of taxes while generating deductions
  going forward, and used to create E&P in entities that
  have cash, but no earnings to pay a dividend
      > Busted §351
      > §59(e) and other E&P elections
      > Deferred inter-company transaction in foreign countries with
        consolidation regimes (UK and Australia)
      > §737 disguised sale

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FTC Reform

 10-year FTC carryforward; one-year carryback
     > Carryover rule applies to excess FTCs that may be carried over
       to any taxable year ending after the date of enactment
     > Carryback provision applies to excess foreign taxes arising in
       taxable years beginning after the date of enactment
 Consolidation of FTC baskets
     > Two baskets remain: passive category and general income
     > Generally effective for taxable years beginning after December
       31, 2006
     > Transitional rule for pre-January 1, 2007 taxes carried over to
       post-January 1, 2007 years

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FTC Reform (continued)

 OFL Recapture on Sale of CFC Stock
      > Effective for dispositions after the date of enactment
      > Also can apply to tax-free transactions if receive back a smaller
        percentage of stock than transferred
 Look-thru for dividends from non-controlled §902s
      > Effective for taxable years beginning after December 31, 2002
 Repeal 90% limit on AMT FTC
      > Effective for taxable years beginning after December 31, 2004

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FTC Reform (continued)

 Exchange Rate for Foreign Taxes
      > Most taxpayers may elect to use the exchange rate in effect on
        the date the taxes were paid
      > RICs, however, must instead use the exchange rate on the date
        the income accrues
 §902 Stock Attribution Through Partnerships
      > Effective for taxes of foreign corporations for taxable years
        beginning after the date of enactment

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FTC Reform (continued)

 FTC Minimum Holding Period for Property
      > 15 days within a 30-day testing period
      > Exclusive of periods where there is no risk of loss
      > Effective for amounts that are paid or accrued more than 30 days
        after the date of enactment
 Domestic Loss Recapture (OFL Corollary)
      > Effective for overall domestic loses incurred for taxable years
        beginning after December 31, 2006

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FTC Reform (continued)

 Income Tax Base Differences
      > Treated as “general limitation income”
      > Effective for taxable years after December 31, 2006
      > For taxable years beginning before January 1, 2007, a taxpayer
        may elect to treat such taxes as taxes imposed on either general
        limitation income or financial services income

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FTC Reform (continued)

 Worldwide Interest Expense Apportionment
      >   Elective for tax year beginning after 2008
      >   Apportion interest of w/w affiliate group on w/w assets
      >   Separate group treatment for financial institutions
      >   Who Benefits?
            MNCs with significant CFC debt
      > Treatment of related party loans?

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FTC Reform (continued)

     JOBS Act (S. 1637) §661
      > “The Secretary may prescribe regulations disallowing a credit
        under subsection (a) for all or a portion of any foreign tax, or
        allocating a foreign tax among 2 or more persons, in cases
        where the foreign tax is imposed on any person in respect of
        income of another person or in other cases involving the
        inappropriate separation of the foreign tax from the related
        foreign income.”
     This provision not included in final bill

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Subpart F Reform

 No look-through for interest, dividends, rents and
  royalties from related CFCs
 Look-through Treatment for CFC Sale of Partnership
      > Might also apply to §904 (but remember the look-through

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Subpart F Reform - §956 Changes

 The Limited overturned
      > Exception limited to deposits with specified banks or corporations
        held by “bank holding companies” or “financial holding
 Exclusion of Assets from Definition of U.S. Property
      > Securities acquired and held by a CFC that is a dealer in
      > Expanded exception for obligations to those issued by an
        unrelated U.S. person other than a domestic corporation

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Subpart F Reform

 Expansion of Active Financing Exception
      > Allows the use of employees of a related CFC organized in the
        same home country as tested
 Repeal of Foreign Personal Holding Company and
  Foreign Investment Company Rules
      > Effective 2005
          Defer income to next year, if possible
      > FPHCI now includes personal services contract income
 Expansion of Definition of Excluded Income from
  Commodities Transactions
      > Exception covers certain transactions in the normal course of a
        CFC’s trade or business
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Section 956: New Exceptions to Section

 The American Jobs Creation Act of 2004 adds a new
  exception to the definition of U.S. property:
     > The acquisition by a CFC of obligations issued by a U.S.
       person that is not a domestic corporation and that is not:
         a U.S. 10-percent shareholder of the controlled foreign
          corporation, or
         A partnership, estate or trust in which the controlled foreign
          corporation or any related person is a partner, beneficiary or
          trustee immediately after the acquisition by the controlled
          foreign corporation of such obligation
     > Enables CFCs to invest in wide variety of U.S. issued asset-
       backed securities with greater pre-tax yields

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Section 956: REMICS

    Is a Real Estate Mortgage Investment Conduit (“REMIC”) a
     U.S. Person for purposes of §956?
     > The term “United States person” for purposes of §956 is defined
       in the regulations as having the same meaning that it has in
     > Section 957(c) incorporates the general definition of the term as
       it appears in §7701(a)(30); i.e., to include a U.S. citizen or
       resident alien, domestic partnership domestic corporation,
       domestic trust, or domestic estate, but not certain individuals
       who are resident in the U.S. possessions
     > Under §860A(a), a REMIC is not subject to tax and is not treated
       as a corporation, partnership, or trust for purposes of subtitle A
     > If the REMIC is a U.S. person, would it qualify for the new
33   > If the REMIC is not a U.S. person, would its regular interests be
       excepted from the scope of §956?
RIC and REIT Provisions

    RICs may designate “interest-related” and “short-term capital
     gain” dividends
    Interest-related and short-term capital gain dividends
     received by a foreign shareholder are exempt from 30% U.S.
     tax on FDAP income
    Estate tax exemption
    REIT capital gain distributions exempt from tax under
     FIRPTA where REIT is publicly traded in the U.S. and
     shareholder holds less than 5% of stock in the REIT

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