Tax Law Update
Applicable Tax Rate
Under the Bill, in the case of a 10% U.S. shareholder that is a corporation, the rate of tax on the mandatory inclusion will be 15.5% on cash equivalent assets and 8% on non-cash property. In the case of U.S. shareholders who are individuals in the highest tax bracket, these rates would be 9.05% and 17.5%, respectively. For a further discussion of the determination of these rates, as well as the disparate impact to individual members of funds and how to identify which individuals will be subject to these provisions, see prior alert.
Cash and Cash Equivalents versus Non-Cash Property
The determination of the cash amount is based on the aggregate cash position of the U.S. shareholder, which is the greater of (i) the sum of the shareholder's pro rata share of the cash position of each specified foreign corporation with respect to which that shareholder is a U.S. shareholder as of the last day of the last taxable year beginning before January 1, 2018 (December 31, 2017, in the case of a calendar year taxpayer) or (ii) one-half of the sum of (I) the aggregate amount determined as of the close of the last taxable year of each such specified foreign corporation that ends before November 2, 2017, plus (II) the aggregate amount determined as of the close of the taxable year of each such specified foreign corporation which precedes the last taxable year that ends before November 2, 2017, (for example, December 31, 2016, and December 31, 2015, in the case of a calendar year taxpayer).
Given the large difference in the tax rates applied to the inclusion of cash versus non-cash assets, taxpayers will invariably want to know how to quantify such assets.
Specifically, the statute provides that cash assets are the following:
Actively Traded on an Established Financial Market
For purposes of the cash inclusion provision, the meaning of "actively traded" personal property on an "established financial market" is unclear. The legislative history does not provide any guidance as to how this determination is to be made. There is, however, authority in existing Treasury Regulations under section 1273 with respect to debt instruments, which provides that an "established market" exists to the extent:
To the dismay of taxpayers, these standards appear to be drawn in an extremely broad fashion.
For these purposes, a sales price exists if the price for an executed purchase or sale of the property within the 31-day period ending 15 days after the issue date is reasonably available within a reasonable period of time after the sale. The price of a debt instrument is considered reasonably available if the sales price (or information sufficient to calculate the sales price) appears in a medium that is made available to issuers of debt instruments, persons that regularly purchase or sell debt instruments (including a price provided only to certain customers or to subscribers), or persons that broker purchases or sales of debt instruments.
A firm quote is considered to exist when a price quote is available from at least one broker, dealer, or pricing service (including a price provided only to certain customers or to subscribers) for property and the quoted price is substantially the same as the price for which the person receiving the quoted price could purchase or sell the property. A price quote is considered to be available whether the quote is initiated by a person providing the quote or provided at the request of the person receiving the quote. The identity of the person receiving the quote must be reasonably ascertainable for a quote to be considered a firm quote. Moreover, a quote will be considered a firm quote if the quote is designated as a firm quote by the person providing the quote or if market participants typically purchase or sell at the quoted price.
An indicative quote is considered to exist when a price quote is available from at least one broker, dealer, or pricing service (including a price provided only to certain customers or to subscribers) for property and the price quote is not a firm quote as described above.
U.S. persons affected by the mandatory inclusion will likely want to elect to take into account the inclusion under an 8-year installment plan, with 8% of the total liability due during each of the first five years, 15% in year 6, 20% in year 7, and the final 25% in year 8. While the first five years of the schedule would allow for the most modest inclusions (i.e., 8% of the total inclusion), taxpayers will note that the first installment will be due with respect to 2017 – i.e., the cash outlay will be due by March 15, 2018, in the case of a corporation and April 15, 2018, in the case of an individual. Future year installments will also be due on the tax return due date for each applicable year. The mechanism for the election is unclear. It is also unclear who makes the election when a partnership is the U.S. shareholder.
Additionally, certain events will act as acceleration events, causing the unpaid portion of all installment payments to become immediately due as of the date of the event. These events include:
In a new development, on December 29, 2017, the Treasury Department issued Notice 2018-07 (the Notice), which outlines its intent to promulgate regulations that will serve to clarify various aspects of the inclusion, including how the amount of the inclusion will be determined. The Notice does not address any of the issues discussed above relating to actively traded personal property. However, it states that the Treasury Department and IRS intend to issue regulations that address the treatment of derivative financial instruments for purposes of measuring the cash position of a specified foreign corporation. These regulations will provide that such cash position will include the fair market value of each derivative financial instrument held by the specified foreign corporation that is not a "bona fide hedging transaction." The term "bona fide hedging transaction" means a hedging transaction that both (i) is properly identified as a hedging transaction and (ii) meets the requirements described in Treasury Regulations section 1.954-2(a)(4)(ii).
Potentially affected taxpayers will want to note the above and plan accordingly.
Mitigation Measures: Tax planning to mitigate these unintended effects is complex and affected entities and individuals are encouraged to seek professional advice.