2023 Year-End Guide – International Tax

Legal Entity Rationalization

As global tax developments take center stage, multinational enterprises (MNEs) are at risk of evolving into more complex tax profiles and incurring increased total tax liability. Additionally, with rising interest rates and significant inflation taking hold, MNEs are preparing for a reduced growth environment. As a result, tax planning and cash savings are becoming priorities. The current economic and global tax environments have renewed the interest of many MNEs in considering consolidating and simplifying organizational profiles to reduce tax and business challenges, among other opportunities.

A number of MNEs with large and complex legal and operating structures that have been built up through acquisitions and organic growth have found that the original purposes of the structures are no longer relevant; for example, historic deferral or repatriation strategies may no longer be relevant given global tax reform. As a result, those MNEs face many challenges, including:

• Increased substance scrutiny (local country requirements, EU/OECD grey and blacklists, treaty abuse scrutiny, ATAD 3 shell company directive);
• Enhanced disclosure requirements (country-by-country reporting, mandatory disclosure rules, ATAD 3 shell company directive, Pillar Two, and potentially U.S. CbC GILTI rules); and
• Significant costs incurred to maintaining certain legal entities and structures (internal costs, such as salaries, operational, and administrative costs, as well as external costs, such as audit and tax compliance).

Those challenges can potentially be reduced or mitigated through proper legal entity rationalization (LER) planning.

LER Planning and Considerations

Many options can be considered when contemplating LER planning for an MNE, including:

• Elimination of tiered foreign holding companies;
• Consolidation of foreign subsidiaries under a single foreign holding company;
• Consolidation of foreign subsidiaries directly under the U.S. parent; and
• Consolidation of foreign subsidiaries to reduce legal entities to one per jurisdiction.

When contemplating an LER planning strategy, it is important to keep in mind both tax and non-tax considerations. Tax considerations include the impact on tax attributes, future repatriation mechanisms and the impact on dividend withholding tax, the impact on the U.S. tax profile, and the U.S. tax costs of restructuring. Non-tax considerations include the future divestment or commercial and legal need to keep businesses separate, historic liabilities and claims (such as pension liabilities), human resources, and union requirements and approvals needed.

Benefits of LER Planning

Post-implementation, the benefits of proper LER planning can be significant. With a future state that significantly reduces redundancy, MNEs can align their legal and capital structure with strategic priorities, effectively evaluate the performance of underlying assets, align the corporate structure with its core business functions, effectively circulate working capital and repatriation, and significantly reduce costs.

How a Tax Advisor Can Help

A tax advisor can help MNEs assess their organizational structures, as well as tax and business needs, to consider opportunities for LER planning and, as a result, help MNEs reduce costs and align their corporate structure with future global goals.

International Tax Planning in a Distressed Economy

A distressed economy can have major tax implications for U.S. companies with foreign operations. In a distressed economy, U.S. companies can utilize planning opportunities to access cash and/or claim certain tax benefits. Some of these planning opportunities include:

• Accessing CFC cash by borrowing from a controlled foreign corporation (CFC) (or pledging CFC stock to secure third-party debt) without causing an inclusion under Section 956.
• Claiming an ordinary worthless stock loss on an insolvent CFC under Internal Revenue Code Section 165(g)(3).
• Importing built-in loss property through an inbound liquidation or reorganization of a CFC.
• Preserving net operating losses, foreign tax credits, and Section 250 deductions by deconsolidating.
• Repatriating previously taxed earnings and profits to trigger Section 986(c) foreign exchange losses.
• Restructuring so that CFCs are no longer directly or indirectly owned by U.S. entities.
• Accelerating foreign-source income to utilize foreign tax credits.
• Capitalizing interest expense into cost of goods sold to minimize the base erosion and anti-avoidance tax (BEAT).
• Increasing adjusted taxable income for Section 163(j).

This list identifies only some of the opportunities available to a company operating in a distressed economy. Each opportunity needs to be evaluated based on a taxpayer’s specific facts and circumstances.

How a Tax Advisor Can Help

A tax advisor can help multinational companies by assisting in reviewing their international operations to identify opportunities, model potential tax benefits, analyze tax positions and risks, and assist in the preparation of supporting documentation.

Sec. 965(b) PTEP: Foreign Tax Credit Considerations

On March 31, the U.S. District Court for the Western District of Tennessee, in the case of FedEx Corp. v. United States, granted FedEx’s motion for partial summary judgment over the denial of foreign tax credits (FTCs) related to earnings from profitable related foreign corporations offset by losses from other foreign corporations (“offset earnings”). With this ruling, the court invalidated the Treasury Department’s transition tax regulation provision limiting the FTC on offset earning distributions from Internal Revenue Code Section 965(b) previously taxed earnings and profits (965(b) PTEP). 

While Section 965(g), among other provisions, placed limitations on FTCs associated with income taxed under the transition tax, neither Section 965(g) nor any other section under the Tax Cuts and Jobs Act explicitly eliminated FTCs on offset earnings. The IRS and Treasury, however, issued a regulation denying FTCs for foreign taxes paid on those offset earnings.

FedEx argued that Section 960(a)(3) unambiguously provided an FTC for offset earnings because those earnings were never included in income under Section 951 and, therefore, the taxes remained available for use on a future distribution of previously taxed income.

The court ruled that under the plain language of the tax code, which is not ambiguous, FedEx is entitled to an FTC for foreign taxes paid on the offset earnings that were distributed as PTEP in 2018 and set aside the regulation.

Actions Taxpayers Can Take

• Review position on potential foreign tax credit claims. Determine if the company may be entitled to a refund of foreign taxes paid on offset earnings under Section 965.
• Evaluate the impact of the ruling on the company’s tax positions. Determine if there is sufficient foreign-source income to access additional FTCs available from the ruling.
• Consider the potential impact of Moore v. United States on the ability to claim additional FTCs.

How a Tax Advisor Can Help

• Assist in assessing the impact of the FedEx case and associated tax positions taken regarding the FTC implications.
• Model various “what if” scenarios to validate analysis and better position taxpayers to utilize FTCs.

How Smith + Howard Supports Year-End Tax Planning

A trusted advisor can help businesses determine which strategies would be effective in helping them lower their total tax liability for the year ahead.

At Smith + Howard, we are committed to comprehensively understanding your circumstances and long-term objectives, striving to earn your trust through our dedication and expertise.

For more information, please call us at 404-874-6244 or contact a Smith + Howard advisor today.

This article outlines some — but not all — considerations for year-end tax planning. To learn more about additional tax strategies and to consider how they may be influenced by recent administrative guidance and potential legislative changes that remain under consideration, please see the following articles:

1. Accounting Methods
2. Business Incentives + Tax Credits
3. Corporate and M+A
4. Financial Transactions
5. Partnership Tax
6. Real Estate
7. State and Local Tax
8. Transfer Pricing
9. International Tax
10. Global Employer Services