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I recently hosted the latest installment of our popular quarterly ‘Talking Tax’ webcast series. This episode covered a number of relevant topics, including the impact of the 2018 midterm elections and the increasing budget deficit on tax legislation, trade policy, and recently released final and proposed regulatory guidance around the 2017 tax reform act (the Act).
Scott McCandless, a principal in our Tax Policy Services practice, and Janice Mays and Mark Prater, managing directors in our Tax Policy Services practice, joined me on our first panel to discuss the impact of the midterm elections and the budget deficit on tax legislation, and trade policy.
Scott, Janice, and Mark first discussed how the results of the midterm elections and the return of divided government, with a Democratic-controlled House and a Republican-led Senate, will have a dramatic impact on the direction of tax legislation over the next two years. The prospects for significant tax legislation in the new Congress are expected to be limited, but there remains potential for bipartisan agreements to be reached to enact tax legislation, including technical corrections or other limited changes to the Act. President Trump and Congress also may find ways to work together to address the need for infrastructure improvements, IRS reforms, and promoting retirement savings.
Scott, Janice, and Mark next discussed how rising budget deficits may return as a factor in the consideration of any significant tax legislation. While revenue-raising business tax reform provisions with delayed effective dates (in 2022 and thereafter) may not be addressed during the current Congress, industrial products companies should consider communicating with policymakers well in advance of such provisions taking effect regarding their impact on business operations and investment decisions.
When we asked our webcast attendees which of the Act’s changing provisions concerned them most, 33% said the interest limitation change from EBITDA to EBIT (after 2022), 17% said the expiration of the individual provisions, including the business passthrough deduction (after 2024), 15% said the change to cost recovery ending full expensing (after 2023), and 11% said the eventual capitalization and amortization of the research credit (after 2022).
Scott then discussed President Trump’s trade agenda — a central focus of his administration’s economic policies, with a goal of rebalancing America’s global trading relationships to favor the United States. Key focus areas for the president’s trade policies have been to secure a new United States-Mexico-Canada Agreement that would replace the North American Free Trade Agreement and to address a range of issues associated with relations between the United States and China.
Trade issues, however, have increased uncertainty for businesses that operate globally, especially in terms of potential impact on business investment, supply chain management, and identification of growth opportunities. Industrial products companies should remain involved in the ongoing debate over how best to resolve global trade disputes.
When we asked our webcast attendees to what extent their tax departments are involved in the trade functions of their businesses, 33% said none — trade functions within their organizations do not reside in tax, 24% said partial —they have some touch points with tariffs, but are not involved in strategic trade decisions, and 6% said fully — they have visibility to trade functions and responsibility for tariffs.
Treavor Weeden, a partner in our International Tax Services Quantitative Solutions & Technology practice, joined Mark and me on our second panel to discuss recently released final and proposed regulatory guidance around the Act. Treasury and the IRS by the end of 2018 issued more than 1,500 pages of proposed regulatory guidance on key tax reform provisions, and this year will continue to issue additional guidance. Treasury officials have indicated that they hope to finalize as much guidance as possible by June 22, 2019, which is 18 months after the original date of enactment. Regulations filed or issued within 18 months of the date a statute is enacted can be made retroactive to the original date of enactment.
When we asked our webcast attendees what primary reaction they have to the proposed regulations issued to date, 26% said that it was too soon for them to have a reaction, 25% said that they wished that Treasury had exerted more authority to address certain tax policy issues with the Act, 11% said that they were impressed by how much guidance has been issued, and 9% said that they generally are pleased by the policy choices made in the regulation packages.
When we asked our webcast attendees which set of proposed and final regulations are the most impactful to their companies, 26% said the proposed Section 163(j) regulations, 20% said the proposed foreign tax credit (FTC) regulations, 19% said the final Section 965 regulations, and 13% said the proposed base erosion and anti-abuse (BEAT) regulations.
Final Section 965 regulations
Treavor and Mark first discussed the final Section 965 regulations issued by Treasury on January 15, 2019 to provide guidance relating to the Act’s toll charge due upon the mandatory deemed repatriation of certain deferred foreign earnings. Although the final regulations generally follow the structure and approach set forth in the proposed regulations, there are significant modifications that likely will impact a taxpayer’s toll tax calculation. Industrial products companies should carefully review the final regulations as the changes likely will impact their toll tax liability and may be a reason to consider filing amended tax returns.
Proposed FTC regulations
Treavor and Mark next discussed the proposed FTC regulations issued by Treasury on November 28, 2018 to provide guidance related to the use of FTCs in the context of the Act’s significant new international tax rules. In particular, the proposed regulations provide guidance related to the determination of the FTC limitation under Section 904 (including expense allocation and apportionment), the scope of the new foreign branch basket, and the extent of deemed-paid FTCs with respect to Subpart F and global intangible low-taxed income (GILTI) inclusions.
Industrial products companies are particularly interested in these rules given their impact on GILTI calculations and the rules provide some welcome relief to companies in the sector — even if they did not provide as much relief as some companies had hoped. These new rules, while generally helpful for companies in the sector, will require complex detailed CFC level calculations and, while helpful, will increase compliance burdens for companies across the sector.
Notice 2019-01: Previously taxed income (PTI) ordering rules
Treavor and Mark then discussed Notice 2019-01 issued by the IRS on December 14, 2018 describing regulations it intends to propose to address certain issues, including important ordering rules, from the Act regarding foreign corporations with previously taxed earnings and profits (i.e, earnings and profits of a foreign corporation attributable to amounts which are, or have been, included in a US shareholder’s gross income). Again these rules provided some welcome relief relative to guidance that generally provides for distributions of toll charge PTI first. However, they also create additional compliance burdens relative to tracking PTI accounts that will increase compliance burdens.
Proposed Section 163(j) regulations
Treavor and Mark closed out the second panel with a discussion of the proposed Section 163(j) regulations issued by Treasury on November 26, 2018. The Act revised and broadened the existing interest expense limitation rules. The proposed regulations closely follow the previous administrative guidance provided under Notice 2018-28, provide additional guidance related to the mechanics of determining the interest expense limitation, and clarify the application of Section 163(j) to consolidated groups, partnerships, and controlled foreign corporations.
Industrial products companies should assess the impact of these proposed regulations on their business operations. In particular, guidance in the regulations that suggests that certain depreciation and amortization that is capitalized to inventory cannot be added back to adjusted taxable income for purposes of calculating the Section 163(j) limitation has widespread impacts to companies in the sector.