Question

Company C is a US C Corporation. It builds and operates energy plants that produce electricity. Country P has significant needs for energy, but it does not have the expertise or financial capability to borrow in the public markets to fund projects of this magnitude. Country P has determined that the best way to entice foreign power investors to invest, operate, and accept the risks inherent with this market is by offering a 10-year income tax holiday on profits derived from constructing and operating the power plant. This would also include any potential withholding taxes on distributing profits. By offering a tax holiday Country P will offer to pay a reduced rate to purchase the power produced by the power plant. In this way the local citizens will benefit by having electricity at a reduced rate. Company C is interested in pursuing this project and is now asking you to determine the US tax consequences of the operating results. You learn that the expected investment is $1B and that 95% of the investment would be funded by offering debt in the public market. Company C would set up a CFC in the Netherlands and subscribe the debt offering. The coupon rate on the debt will be 7%. Company C expects that the Operating Cash Flows in Country P to be 15% of the total investment. The total investment would be the sum of public borrowings plus Company C’s contribution to equity of $50M. Company C does not desire to leave excess cash flow in Country P due to the risks associated with that market and would like the flexibility to invest elsewhere in the world for other projects (i.e. the money is not needed in the US). Consequently, the Company wishes to assert permanent reinvestment under GAAP (ASC 740). The excess cash flow would go to an intermediate holding company in the Netherlands to service the interest expense on the public borrowing. Assume that the Netherlands does not have a tax and that the loan balance is not amortizing (i.e. interest only). Thus, the structure of entities is a U.S. Parent (USP), owning as a first tier CFC (CFC1), a Netherlands Company. CFC1 would be funded with a $50M investment in equity from USP. CFC1 would borrow $950M in the public market. CFC1 would then invest $1B into CFC2 as equity. CFC2 would operate in Country P.

a) Using Pre 2017 rates and rules assume that neither Sec. 904(c) look through nor check the box is available. What, if any, is the expected annual U.S. tax and the underlaying tax rate on the investment?

b) Using Pre 2017 rates and rules assume either 904(c) look through or check the box is implemented. What, if any, is the expected annual U.S. tax and the underlying tax rate on the investment?

c) Using Post 2017 Act rates and rules what, if any, is the expected U.S. tax and tax rate on the investment (rather than guessing what year in service the asset is in assume this is year 1). Further assume that the entity holding the debt has checked open the operating entity (i.e. its one aggregate calculation)

Answer 1

[a]

This document contains proposed regulations that provide guidance relating to the determination of the foreign tax credit under the Internal Revenue Code (the “Code”). The guidance relates to changes made to the applicable law by the Tax Cuts and Jobs Act (the “Act”), which was enacted on December 22, 2017. Guidance on other foreign tax credit issues, including in relation to pre-Act statutory amendments, is also included in this document. The proposed regulations provide guidance needed to comply with statutory changes and affect individuals and corporations claiming foreign tax credits.

Send submissions to CC:PA:LPD:PR (REG-105600-18), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20224. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-105600-18), Courier's desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20044, or sent electronically, via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-105600-18).

[b]

The Act made several significant changes to the Internal Revenue Code with respect to the foreign tax credit rules and related rules for allocating and apportioning expenses for purposes of determining the foreign tax credit limitation. In particular, the Act repealed the fair market value method of asset valuation for purposes of allocating and apportioning interest expense under section 864(e)(2), added section 904(b)(4), added two foreign tax credit limitation categories in section 904(d), amended section 960(a) through (c), added section 960(d) through (f), and repealed section 902 along with making other conforming changes. The Act also added section 951A, which requires a United States shareholder of a controlled foreign corporation (“CFC”) to include certain amounts in income (a “global intangible low-taxed income inclusion” or “GILTI inclusion”).

[c]

This document contains proposed regulations (the “proposed regulations”) addressing (1) the allocation and apportionment of deductions under sections 861 through 865 and adjustments to the foreign tax credit limitation under section 904(b)(4); (2) transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under section 904(f) and (g), and for the carryover and carryback of unused foreign taxes under section 904(c); (3) the addition of separate categories under section 904(d) and other necessary updates to the regulations under section 904, including revisions to the look-through rules and other updates to reflect pre-Act statutory amendments; (4) the calculation of the exception from subpart F income for high-taxed income under section 954(b)(4); (5) the determination of deemed paid credits under section 960 and the gross up under section 78; and (6) the application of the election under section 965(n).