Looking to generate or preserve cash amid the COVID-19 pandemic? Our experts discuss how you could benefit from NOLs, transfer pricing, customs strategies, and more.
Cash repatriation and related topics
The Tax Cuts and Jobs Act (TCJA) and the Coronavirus Aid, Relief, and Economic Security (CARES) Act both made some significant changes in the tax consequences to U.S. multinationals of repatriating earnings from overseas operations. A quick overview of these changes can help businesses understand how application of the new rules can have a significant impact on cash flow.
- GILTI (global intangible low-taxed income) and PTEP (previously taxed earnings and profits): The TCJA created a process whereby certain earnings of controlled foreign corporations (CFCs) could be repatriated to U.S. corporate shareholders without being subject to U.S. income taxes. In order to discourage this process from being used to offshore intangible property to low or zero-tax countries, the TCJA also created the GILTI to impose a current tax on the net income of a CFC that exceeds 10% of the net value of its depreciable assets. Foreign taxes attributable to the GILTI are subject to different limitations than income in other categories for foreign tax credit (FTC) purposes. Additionally, allocations of expenses from the U.S. entity can unexpectedly reduce the limitation for claiming full FTCs. In the absence of proper planning, a multinational may be subject to double taxation (and a reduction in cash flow) due to certain limitations on the FTC.
- Distributions out of previously taxed earnings: In many cases, the TCJA made it simpler for companies to repatriate cash, though there are some non-U.S. tax considerations to be aware of. Under tax reform, all untaxed offshore earnings through Dec. 31, 2017, were subject to a one-time tax, and most foreign corporate current earnings will be taxed under the new GILTI regime, meaning that distributions out of these previously taxed earnings come back without any additional U.S. income tax.
- Dividends-received deduction: Additionally, Subchapter C corporations owning at least 10% of a foreign corporation are entitled to (with limited exceptions) a dividends-received deductions on distributions from these entities. Structures with tiered CFCs, hybrid dividends (such a dividend distributions expensed locally), and local fiscal year-ends should consult with an advisor to learn if any of these limited exceptions would apply.
While there are no additional U.S. income tax consequences to shareholders for above distributions, there are local jurisdiction tax consequences to consider such as local withholding taxes. Additionally, in the current pandemic environment, companies will want to consider local tax relief impacts of taking distributions out of subsidiaries, as some of these programs may limit or rescind tax relief if dividends are paid.
Debt and debt modification
In a period of economic distress, debt management is more important than ever. Multinational businesses have additional options to consider when managing debt obligations between CFCs and U.S. parents, and each of those options comes with potential tax advantages or consequences that must be considered in advance in order to maximize cash on-hand.
Multinational businesses have additional options to consider when managing debt obligations between CFCs and U.S. parents.
As always, multinationals that rely on intercompany debt obligations across international borders should make sure that these obligations are accurately and formally documented to verify the substance of the transaction in case authorities review it. Here are a few of the considerations that multinationals should keep in mind when managing intercompany debt during the pandemic:
- IRC Section 956-deemed dividends: In the past, loans from a CFC to a U.S. parent that used CFC stock and foreign assets as security were often treated as a deemed dividend. The TCJA modified this rule so that Section 956 no longer applies to arm’s-length loans from a CFC to a U.S. corporate parent. If the U.S. parent is an individual, or a pass-through entity owned by individuals, the old rules may still apply and could result in significant tax costs to the owners.
- Limits on deductibility of interest: The TCJA imposed a limit on the amount of interest a business could deduct in a year, capping the amount for most taxpayers at 30% of adjusted taxable income (ATI). That limit applies even to arm’s-length debt between related parties as discussed above. The good news is that the CARES Act raised that amount to 50% for most taxpayers in 2019 and 2020. The new law also allows businesses to elect to calculate their 2020 limit based on 2019 ATI, so those who saw significant downturns in income this year can qualify for a larger interest deduction. Businesses that count on debt as part of their pandemic survival strategy will need to plan ahead to maximize the amount of interest that qualifies for a tax deduction.
- Debt modifications and deemed payments of interest: Many businesses will seek to modify the terms of their debt in order get payments down to a level that will allow them to stay afloat through the downturn. Debt modifications between CFCs and U.S. parents can be particularly tricky, as the changes may result in cancellation of debt income or a deemed payment of interest. Any changes to the terms of a cross-border international loan should be recorded properly in the loan documents in order to support the substance of the transaction.
Debt modifications between CFCs and U.S. parents can be particularly tricky.
Net operating losses under the CARES Act
The CARES Act increased the number of years that a taxpayer can carry back a net operating loss (NOL). NOLs incurred in tax years beginning after Dec. 31, 2017, and before Jan. 1, 2021, can be carried back to each of the five years preceding the loss. In addition, the CARES Act temporarily waived a rule imposed by the TCJA that limited the amount of an NOL applied in any year to 80% of the taxpayer’s taxable income. The 80% cap is eliminated for carrybacks and carryforwards to tax years that begin before Jan. 1, 2021. Under current law, the 80% cap will be reinstated to any carryforwards applied to years beginning after that date, even if the losses were generated during years in which the cap was waived.
The five-year window for NOL carrybacks will include some years in which affected U.S. multinationals will have paid taxes on repatriated income under the TCJA’s repatriation rules. Taxpayers in this situation can elect to not apply their NOLs in years when they paid the repatriation tax. If they don’t elect to this treatment, the amount of the repatriation tax paid in the applicable year isn’t eligible for reduction by the NOL.
On top of the interaction with the repatriation rules, any reduction in a multinational’s prior year income will have a cascading effect on income-based calculations like GILTI, the foreign-derived intangible income (FDII) deduction, and the foreign tax credit (FTC). The impact on calculations like these should be factored into any discussion about use of an NOL carryback by a multinational business.
The havoc wrought upon the world economy by the COVID-19 pandemic has almost certainly caused changes at any global business that has an intercompany transfer pricing policy. Here are a few additional considerations:
- Documentation is critical: Any changes a business makes to its transfer pricing policy must be supported by proper documentation. Taxing authorities will certainly be aware of what has happened in the global economy, but that doesn’t mean they will be willing to accept everybody’s worst-case scenario on faith.
- Be prepared to defend losses: In normal times, most businesses are operated with the goal of turning a profit. During an economic crisis, many businesses are taking drastic measures to minimize short-term losses and survive until a turnaround. Taxing authorities, however, are likely to remain inherently suspicious of operating losses that are allocated into their jurisdictions. Affected businesses need to be documenting global operations as well as operations in each country in a manner that justifies the allocation of losses a particular jurisdiction.
- Adapt transfer pricing strategies for COVID-19 logistics: The pandemic has caused the relocation of many workers who had been deployed to various countries on overseas assignments. It has disrupted supply chains throughout the world, possibly resulting in changes to where a business sources its supplies or assembles its products. These changes should be reflected throughout the transfer pricing documentation.
Any changes a business makes to its transfer pricing policy must be supported by proper documentation.
There are a number of COVID-19 tax considerations for global mobility professionals. For example, posting U.S. employees into foreign countries and hosting foreign nationals for work inside the United States require careful tracking of time spent and money earned in relevant locations. Employers need to know each employee’s location, the duration of the stay and the amount of money earned, and the reporting and payment obligations that may be triggered by the person’s presence in the jurisdiction. Businesses also need to track potential law changes in those countries that may grant relief to international employees whose time within the boundaries has been extended due to COVID-19. Strategies in this area focus primarily on protecting against unexpected tax obligations that could drain cash at a critical moment.
- Inadvertent permanent establishment: One of the earliest and most long-lasting effects of the pandemic has been sudden unexpected changes in the locations where globally mobile employees are working. Some employees who had been located physically outside their country of residence were called back much sooner than expected. Others who didn’t return early in the pandemic may have spent much more time in the country where they were posted due to travel restrictions. (Employees in these situations may also need cash for short-term housing assistance.) Employers need to be clear on where each overseas employee is located at all times. Once you have a clear picture of the jurisdictions that are involved it’s important to consult with a tax advisor familiar with the local rules that define “permanent establishment” for a business in each country. Wherever possible, employers need to take steps to minimize the likelihood of a permanent establishment that could create an unanticipated and costly compliance requirement.
- Employee residence and payroll obligations: While an inadvertent permanent establishment might be one of the worst-case scenario consequences of COVID-19 travel changes, it’s not the only complication businesses need to guard against. Depending on the length of an employee’s stay in a jurisdiction, local rules could raise questions about residency for the individual and/or potential payroll tax obligations for the employer. IRS guidance has offered some relief on this front for non-U.S. employees who have been stuck in the United States longer than expected due to travel restrictions, but each country will likely have its own take on a relief policy. If a U.S.-based employee winds up spending enough days in a country that doesn’t have a similar relief provision or treaty exception, the person could unknowingly establish residency in the jurisdiction. If the long-term solution for an employee’s overseas assignment is to replace it with a virtual telework presence, the company will need to evaluate that person’s residency and determine what impact it will have on income and payroll tax filing requirements. Benefits like housing allowances and schooling stipends for dependents may no longer be needed.
- Future considerations: As the workplace becomes more accustomed to virtual team meetings from home offices around the world, it’s possible that physical relocation of human resources may decline somewhat. In the short term, increased barriers to international travel may cause an outsized impact in this area. If and when a vaccine or effective treatment becomes available, employee postings to foreign countries may begin to increase again. However, it seems likely that the cost/benefit analysis of global mobility postings will forever be changed by lessons learned from the virtual work connections made during the pandemic.
It’s important to consult with a tax advisor familiar with the local rules that define “permanent establishment” for a business in each country.
We can help
If your multinational business is affected by any of these issues and would like to learn more about potential cash generating strategies that can help you weather the COVID-19 pandemic, please contact your Plante Moran advisor to learn more about how we can help.