Virtual Tax Forum | Tax Strategies in the COVID-19 Economic Downturn: Loss Planning and Transfer Pricing

Date: May 1, 2020
Hello, everyone. Welcome to today’s webinar entitled Tax Strategies in the COVID 19 Economic Downturn: Loss Planning and Transfer Pricing. Today’s webinar is a bit of a follow on to last week’s webinar, which hopefully many of you participated in, in which we considered some tax issues relating to the CARES Act. In that webinar we touched on some non-CARES Acts subjects, including the impact of, you know, sudden losses or sudden decreases in market valuations. And we thought that following up with a more, a somewhat deeper dive on those topics would be a good idea for today’s webinar. So that’s, that’s the, that’s the framework. My name is Dave Noren. I’m a partner in the Washington DC office at McDermott. I focus on international tax planning. I’m very pleased to be joined today by 5, 5 of my partners. First Brian Jenn, a partner in the Chicago office. He previously served as Deputy International Tax Counsel at the Treasury Department, and he was deeply involved in the issuance of proposed and final regs and other guidance implementing the TCJA. Brian has great insights on the taxation of the digital economy, transfer pricing issues, and foreign currency issues. Also joined by Brad LaBonte, a partner in our New York office. Brad advises multinational companies and investment funds on matters relating to cross border mergers and acquisitions, cash repatriation, tax treaty qualification and planning, US withholding tax, and other issues. Also joined by Enrica Ma, partner in McDermott’s Washington office. Enrica helps companies with mergers and acquisitions, internal restructuring, spinoffs, supply chain planning, as well as like-kind exchanges and leverage joint ventures for large public companies and closely held companies. Also joined by Caroline Ngo, a partner in our Washington office as well, who advises publicly traded companies on international tax planning, cross border M&A, tax treaties, and other international tax matters. Finally, joined by Tim Shuman, also a partner in our Washington office and the head of McDermott’s US and International Tax Practice. Tim focuses on corporate international tax matters, with a particular emphasis, emphasis on domestic and cross border acquisitions, dispositions, restructurings, and liquidations. Just a housekeeping note on CLE and CPE. If you’re requesting CLE credit for any jurisdiction, you have to participate by a laptop or computer. You cannot participate by phone if you’re looking for CLE or CPE. In addition, if you’re requesting CLE credit in New York, please listen for the credit code at the end of our presentation. The credit code that we’ll provide is required to obtain CLE credit, so be sure to enter that code into your evaluation at the end of the presentation in order to receive CLE. Finally, thank you very much to those who have already submitted questions during the registration process. We will do our best to address those during the Q&A portion at the end of our discussion. If you want to ask a question during the webinar, simply type it into the Q&A function in the webinar toolbar. And again, we’ll do our best to answer those during the Q&A portion at the end of our presentation. So with that, let me turn it over to my partner and good friend Enrica Ma. Take it away, Enrica. Thanks, Dave. For the next few minutes, I will be discussing different tax considerations involving IP planning under the current economic environment. Let’s go to the next slide. Since TCJA was passed in the end of 2017, companies have been considering whether they should inbound IP, outbound IP, or move the IP from one foreign jurisdiction to another. The determination of the optimal IP location is complex and involves many variables from both the tax and non-tax perspectives. Some companies have used modelling to compare the tax costs and tax benefits of having IP in one jurisdiction over the other. Other companies may have decided that moving IP just does not make sense because of the potential tax cost involved in transferring IP from one jurisdiction to the other. With the economic downturn, which is expected to bring about some changes in facts, it may worthwhile now to reconsider whether your IP is currently in the most tax efficient or tax optimal jurisdiction. Some of those changes in facts include, as shown on this slide, first, the potential to have a lower market value of the IP, which would mean a lower tax cost for moving the IP. Also, the potential changes in your projected cash, cash flow and the projected sales that will qualify as FDII income. Also, you may consider whether you are expecting to have a loss position in stores and jurisdictions, whether you could be tested loss CFCs, or NOLs in the US. Tested loss would result in the loss of foreign tax credits and QBAI return because neither the GILTI foreign tax credits or QBAI returns get carried over beyond the current year. Whereas, NOLs in the US would adversely impact section 250 deduction for GILTI and the FDII. So, when you have domestic loss but a GILTI inclusion, without a 15% deduction, your GILTI is essentially taxed at the 21% tax rate. Also, if there’s a loss in the US, many of you may have become aware that the benefit of NOL carrybacks provided by the CARES Act could be significantly … held by the increase of 8. On the other hand, due to the design of the BEAT formula, any foreign tax credit would increase BEAT dollar for dollar. So, if CFC has less income and less foreign tax credit, you could have a better BEAT result. With the potential losses, it is always good to rerun your modeling to confirm the projective foreign tax credit position in each of your 904(d) categories. Either they are excess credits or excess for limitation. The very last point on this slide is a relatively long-term question based on some prediction of the future. The consideration is how long the 21% US tax rate and the FDII benefit will remain, and whether the new section 174 R&D capitalization rule will be repealed. Each of those factors impacts the IP planning, and the determination of the optimal IP location in general. And if your company applies modeling for determining where to place your IP, each of those factors are the variables that would impact the potential outcome. Let’s go to the next slide. This slide illustrates some of the tax consequences arising from placing IP in the US, or outside the US. Each of these bullet points represent a variable in the modeling. I will start on the top row and left to right. The very top on the on the left side, from the perspective of the IP profits in order to measure your tax cost. If the IP is in the US, the profits will not be taxed at 21%, if your IP could give rise to FDII. So the tax cost from IP profits will be somewhere in between 13.125% and 21%, depending on the mixture of your FDII and FDII income based on the projection. On the right side on the top row, if the IP is held by a CFC, in a normal case, the IP profits will be taxed as GILTI. We often think of the cost for GILTI as the US tax cost, which is 10.5%. But what is the total worldwide tax cost of GILTI? If you have excess of limitation in GILTI, the total worldwide tax cost could be 10.5% plus 20% of the foreign effective tax rate in the excess of limitation situation, because the GILTI rules would allow a 50% deduction and a 80% GILTI foreign tax credits. On the other hand, if your company has excess credits in GILTI any $1 of additional IP profits will give rise to additional worldwide tax cost equal to the foreign effective tax rate. That is because any US tax, pre foreign tax credit that has imposed any additional GILTI inclusion, will be offset by the increase of 904 limitation. And what’s left will be just the foreign tax cost. And importantly, the tax cost for GILTI will be further impacted by your section 861 expense and allocation, particularly in the excess of imitation situation. Also, in calculating the tax cost for GILTI, we often assume that section 250 deduction will cut GILTI in half. However, with the potential loss position, the US and GILTI inclusion that we discussed earlier, section 250 taxable income limitation rule would reduce the 50% GILTI deduction. In that case, the tax costs from IP profits generated by CFCs would be significantly higher. Let’s go down to the next row of this slide deck. Depending on the industry and the facts of your company, the flip side of IP profits could be R&D costs. If your IP is placed in the US, the tax benefits on R&D costs are not necessarily 21%. Instead, the R&D costs that would be allocated to FDII, then the tax benefit will be 13.125%. Also, there could be additional tax costs from R&D costs if your IP is in the US. Any R&D costs incurred by US are subject to section 861 expense and allocation rule. The proposed foreign tax credit regs says R&D costs would not be allocated to GILTI. But that means the R&D costs will be pushed more into other foreign cost categories. Particularly general, if any of these categories are in excess of imitation position, any $1 R&D costs allocated to such category would reduce the 904 limitation and give rise to additional 21 cents tax cost. But don’t forget the availability of R&D credits if your IP is in the US. R&D credit, under section 41 is like a super deduction. Based on the R&D credit reward, for every $100 on R&D cost with a combination of R&D credit and the deduction, the tax benefit could go as high as $36 or 36% tax benefit. If the IP is held by CFC, R&D costs incurred by CFC would reduce the CFC’s tested income. Again, like on the income side, the tax benefit from R&D costs would vary depending on whether your GILTI has excess of limitation or excess credits. The bottom row of this slide is the BEAT consideration. If the IP is in the US, any R&D costs incurred by US would increase the denominator of the 3% threshold, which will be helpful. But if any, any of your R&D costs that are incurred by foreign affiliates, but was charged to the US, that would increase both in numerator and denominator of 3% threshold by the same amount, which would not be helpful. And if the IP is held by a CFC, as we discussed earlier, more CFC income means the more foreign taxes and potentially higher BEAT. And you can see at the bottom of this slide, and this is some other consideration that would impact the decision where to put your IP. The very first one is the potential tax cost for moving the IP to the right location. So let’s go to the next slide. This slide illustrates some of the tax consequences for inbounding IP or moving IP from CFC to a US affiliate. If the transfer is to, is to a taxable sale or distribution, the CFC transferor would generate additional tested the income, which may be helpful to avoid tested loss position in the CFC. For the US transferee in a taxable sale, it will have a stepped-up IP basis and additional amortization. The amortization would be base erosion payments. But if the IP value is reduced due to the economy downturn, with the lower step-up in basis and lower amortization, that may not be a significant concern. Compare this BEAT consequences to the fact pattern where the IP transfers to a distribution, contribution, or liquidation. Generally, there will not be any base erosion payments from the IP. Lastly, for any transfer of IP that is taxable locally, we always need to analyze the credibility of the following taxes. That would involve basket, basketing that taxes correctly and the confirming that you have access of limitation in the right basket to claim foreign in tax credit. Next slide. This last slide lists some of the similar considerations for outbounding IP or transferring IP from one foreign jurisdiction to another. Many of them are similar considerations that have been discussed previously, and they all are impacted by the changes in facts, including potential lower IP value, potential loss position in CFC, changes in projection for FDII, and changes in foreign tax credit position in GILTI or general. Before I conclude my presentation, last thing I want to note is that everything I discussed here is kind of high-level consideration. And they all need to be tailored to fit into the facts of your company and your IP. If you are reconsidering IP planning and IP location, all of us on the call are happy to support you and answer any questions you may have. Now, I will hand it over to Caroline. Thank you, Enrica. So for the next few minutes, I’ll be talking about the about preparing for the possibility of losses in your structure. One thing is certain at this time, and that is that we are living in a time of great uncertainty. We have clients who have been having operating losses and are thinking about how to utilize those losses. But we also have many clients who historically have been having income and are now thinking about the possibility that they might have losses in a few places in their structure. And they’re thinking about, what should I be thinking about now? What should I be doing now to prepare myself, in the best way possible, for now and the future? Next slide. One thing to consider is a paradigm shift that comes with the TCJA. The TCJA really focuses on the annual accounting period. Foreign tax credit pooling is gone, and so, as a result, we need to have income in the right location, the right place, and that year. Otherwise, you could have those foreign tax credits lost forever. And that’s just one example. Another major concept is that with the TCJA, there are a number of, what I call, cliff effects with the TCJA. As one example, there’s a 3% BEAT threshold. As another example, if you have a tested lost, there are certain consequences, and if you have a domestic loss, you have a certain consequences. So one concept I’ll be talking about in the next few slides is the possibility of smoothing income if you might, if you think you might have a loss in the year, smoothing income over a number of years, or smoothing income over a number of entities. Depending on the facts, moving income across legal entities or across years might be beneficial. On the flip side, depending on your facts, you might want to actually have a spike at a loss. For example, you might want to have a spike in deductions in order to carryback a loss to a pre- TCJA year where you could have the benefit of the NOL at a 35% rate. These slides focus on smoothing income, but the same concepts apply to having spikes income as well. So I talked about the TCJA’s focus on the annual counting period and various cliff effects, one example is the consequences of a tested CFC. A tested loss CFC has a number of consequences. One is that no tax are deemed paid on GILTI. And because there’s no foreign tax credit carryover on GILTI, those taxes are lost forever. Another consequence is that your QBAI return, that is otherwise available to reduce tested income, is lost because that QBAI is not available to reduce tested income of you have a tested loss. Another point is that tested loss reduces tested income of CFCs of US shareholder, but to the extent that tested losses exceed tested income, that excess is lost. So you might think to yourself well, how do I, how do I, how do I address that issue? If these attributes are significant, how can I convert my tested loss CFC to a tested income CFC and utilize these attributes? Next slide. So one way toe to think about, one way to address this issue is to convert your tested loss CFC to a tested income CFC. You might be able to do that by doing things like accelerating income of the tested lost CFC or deferring deductions in order to convert your tested loss to a tested income. Another possibility is, if you think that you will have a tested loss, deferring income items that might otherwise get lost, that tested loss CFC’s, to minimize or to mitigate the impact of having a tested loss CFC. So by accelerating income or deferring deductions, you could impact the timing of income, but you’re also preventing the permanent loss of certain attributes, such as QBAI, foreign taxes and so forth. Next slide. Another one to think about is consequences of having a loss position in the US. You often think about having a loss of the US being valued at 21%. A key point is that if you have an overall domestic loss, that domestic loss could reduce income that’s eligible for GILTI or FDII, for the GILTI or FDII deduction, that is essentially taxing GILTI and FDII a 21% rate. This could impact the value of that loss for the current year. It could also impact the value that lost to any post-TCJA year to which that loss is carried. So, for example, if your losses carried, carried back five years under the CARES Act, but you don’t have sufficient income in 15, 16, and 17 to absorb that loss, it could be carried to 2018 and be impacted by this rule that I am referring to. As Enrica mentioned, losses can also result in, in BEAT liability. They could result BEAT liability for your current year, it could result in BEAT liability for a post-TCJA year to which the NOL is carried. Another important point is that as a result of deductions and your lower taxable income, you could also exceed your 3% BEAT threshold in a situation where you might otherwise not have exceeded 3% threshold. Another point is if you have insufficient income in the GILTI category for foreign tax credit purposes, your foreign taxes deemed paid on GILTI are lost. Next slide. So how could you address the situation over domestic loss? Again, another, another concept is accelerating income or defer deductions to avoid the domestic loss. Another possibility is if you, if you think you will have a domestic loss, deferring income that would otherwise be eligible for your FDII deduction or your GILTI deduction so that you don’t have that loss of a section 250 deduction. Again, these, the acceleration of income or deferred deductions impacts the timing of income, but it could also prevent the permit loss of attributes or the incurrence of tax. Another possibility is deconsolidating the US shareholder that will have the GILTI or FDII income, and so that the loss of the group does not adversely impact that particular US shareholder that has a GILTI or FDII income. So, you know, I’ve talked about a number of different concepts. As a few examples of these concepts, you could be thinking about deferring certain types of deductions, which could help your foreign tax credit limitation and would, therefore, help you utilize your foreign tax credits for GILTI purposes. I’m helping a client with that. Another possibility is accelerating certain types of income in order to get the certain types of benefits under the TCJA. Another thing to think about is a deferral of a deduction is better than the permanent waiver of a deduction. And so if you’re at a point where you’re thinking about permanently waving deductions to get under your 3% BEAT threshold, thinking about other ways of deferring deductions could be a better use of, of those deductions. There’s a number of different tools to defer deductions. For example, one commonly cited way to defer a deduction, essentially, is the R&D, defer deductions or capitalizing deductions under 59(e) for R&D expenditures. As a result of recent law changes as well, there’s also some flexibility in timing certain types of common deductions, which is something to consider. And also, there’s a number of ways to accelerate income as well if that is the better a path for you. So with that, I’ll turn over to my friend and colleague Brad LaBonte. Thanks, Caroline. So, Tim and I are going to talk about a few opportunities that taxpayers might have to recognize losses, kind of given, you know, recent market conditions and decrease in value of assets, that decrease in value might create built-in losses in property. And so, or, or, or increase an existing built-in loss. And so, that might present some opportunities for recognizing those, those losses. And if we have time, we’ll also talk about some potential rescission planning that that taxpayers might consider. Next slide, please. So, the first playing idea we’re talking about is the granite trust transactions. So, a granite trust transaction is a mechanism to recognize a built-in loss in the shares of a subsidiary triggered through a complete liquidation, including via check-the-box election under section 331. So, and, the diagram on the right-hand slide of, the slide presents the general, the general transaction. So, in the transaction, S, prior to the transaction owns 100% of foreign target, or FT stock. And without planning, if FT were to just liquidate, that liquidation would generally be tax free under section 332. But, if S contributes or sells 35% of foreign target stock to FA, a foreign acquirer, and after which FT liquidates, because neither S nor FA owns 80% of FT, when FT liquidates, the liquidation should be taxable under section 331. And because a built-in loss exists in, in the FT stock, S will currently recognize the, it’s built in loss from in the retained FT stock. The treatment of the 35% interest in the hands of FA and also S, vis-à-vis its’s transfer of stock to FA, depends really on how the transaction is implemented. And there’s a variety of ways one could implemented granite trust transaction. Either through a contribution of the minority interest, a sale of the minority interest, partnerships can potentially be used. And so those consequences really depend on the exact form of implementation, but the general idea, as depicted in the slide, is S will be able to claim a, a loss under section 331 when FT liquidates. The transactions can involve third parties, meaning, if S were to just sell that interest, that minority interest in FT to a third party, you get to the same place or, also solely internal transactions as depicted here. Generally not involving members of the consolidated group, because the consolidated return rules might defer the recognition of loss that would be recognized. And also, the loss recognizes a capital loss, meaning it could only be used offset capital gains, not ordinary income. If the loss isn’t recognized in the, isn’t taken in the in the year of recognition, it could be carried back either 3 years or forward 10 years. The CARES Act didn’t change those rules. And one, kind of, important take away from the carryback rules is, the loss could potentially be carried back to a pre-TCJA year where the, the, the corporate rate was 35%, not 21%. So there may be some additional benefit there if the capital loss would be recognized this year, it would be able to be carried back to a pre-TCJA year. Next slide, please. So a few considerations. One issue that pops up in a granite trust transaction is the size of the minority interest that’s transferred. So at a minimum, the size of the interest needs to be 20.1% to get below the 80% 332 threshold. And beyond that, the concern really is driven by whether the liquidation would result in a transfer of substantially all of the liquidating company’s assets. So, if, if, if a transfers of substantially all the assets did result, the upstream liquidation could be viewed as a, as a reorganization. And so, generally, the safe harbor ruling threshold for, for reorganizations is 90% of net assets and 70% of gross assets will constitute substantially all. So, as a general safe harbor of 30%, if 30% of the target’s stock is transferred, then the liquidation would fall within the safe harbor there for substantially all of the assets being transferred to any one transferee. But it also depends on the nature of the assets as well. So if, in our previous example, if S were to receive 100% of foreign target’s operating assets, there may be a concern that the liquidation will be an upstream C reorganization into, into S. There’s a few impacts on, or, taxpayers should consider impacts of liquidation on some related transactions. So, for if, for example, there were recent 351 contributions to the foreign target or if the foreign target was the transferor in any recent 351 transactions, the taxable liquidation of foreign target might raise some control issues with respect to that earlier 351 transaction. If foreign target sold stock before the granite trust transaction, in a 304 transaction, there may be some concerns around whether that the stock deemed received by foreign target in the 304 transaction, when redeemed, would be dividend equivalent or, or exchange equivalent. Can get fairly complicated there, but I think the general idea is just to consider any transactions surrounding the granite trust transaction and in any following impacts. And also, just in general, there’s a concern around whether the economic substance doctrine might apply to the loss recognition or whether a business purpose would be required for the transfer of the minority interest followed by the liquidation. Generally, granite trust transactions are respected. There’s firmly established case law that is, is generally respected. There’s been IRS rulings addressing granite trust transactions that have been approved. Also, the transactions at issue are generally the transactions that aren’t, to which the economic substance doctrine is not relevant, generally involving 1001 exchanges, 351 transactions, liquidations. And so, it’s always a concern, kind of, particularly in whatever context the transaction is executed. But as a general principle, granite trust transactions are a tried and tested planning strategy. Next slide, please. And just a few takeaways from the international side. So, section 961(d) says that if 245 cap A dividends have been paid on foreign stock, then for purposes of recognizing loss in that stock, basis is reduced. So if, in our example, foreign target had paid to 245 cap A dividends in the past, 961(d) might reduce the loss recognized by the amount of those 245 cap A dividends. The loss is generally treated as US source. So there’s a benefit there from a foreign tax credit limitation perspective. There’s some exceptions. Again, if some 245 cap A dividends have been paid on the stock within the past 24 months, there may be potential resourcing of that loss to a 904(b4) subgroup. So, it can get complicated there, but the general rule is that the law should be US sourced, and also subject to certain anti abuse rules around, more getting towards sourcing aspects of this rather than the loss, per se. Expense apportionment benefits, to the extent that FT was a, the FT stock was a GILTI asset, attracted expenses that would reduce your GILTI FTC limitation. By eliminating that stock, that basis is no longer taken into account. Similarly, in a 331 liquidation, the liquidated company’s attributes disappear. So any PTEP in the liquidated CFC would also disappear, and it would just not be, be taken into account for expense apportionment purposes. And, last note is also, its taxable to the liquidating corporation as well under section 336. And so, if you’re liquidating a CFC, that CFC will recognize any built-in gain or loss in its assets, which might generate Subpart F income, or, or loss or tested income, or tested loss. And a particular complication here is if the liquidated CFC owns appreciated CFC stock, that 336 game would generally be treated as Subpart F income, subject to dividend recharacterization under 964(e), including new 964(e4), which treats that Subpart F income as, or requires an inclusion that income at the US shareholder level. And that inclusion can be eligible for a 245 cap A deduction, but the mechanics there can get, get pretty tricky. And with that, I think I’ll turn it over to Tim. Okay, thanks, Brad. So we’re going to continue our high-level survey through a few of these, sort of, opportunistic loss recognition type transactions. We know a lot of these things can be bread and butter planning, including granite trust transactions. A lot of companies have experience with looking at granite trust transactions. But we certainly think that the present moment gives reason to reexamine your group and look at these sort of opportunities. So we thought on that front we would also talk, very briefly, in high level about worthless stock deductions and bad debt deductions. Again, we know that these, these are relatively common phenomena in groups with the 20% drop in market values and other movements in the economy. For example, perhaps there’s a timing opportunity here, an interesting COVID-related aspect from timing that we’ll talk about as well. So on slide 17, the main concept of worthless stock deduction is to take a loss under Section 165, which is the provision that allows deductions for bona fide losses. They have to be evidenced by closed and completed transactions, which we’ll come back to in the, so called, identifiable event requirement. And they can’t be reimbursed or compensated for by insurance or otherwise. The key provision for worthless stock deductions is in Section 165(g), which generally provides a capital loss for worthless securities, which includes stock and long-term debt that qualifies as securities, but not partnership interest for this purpose. What it means to be worthless, of course, is two value requirements. You have to conclude that both the stock has no current liquidation value, and that it has no potential future value, which the case law identifies as whether a reasonable businessperson would view the stock is having value. So if there is a foreseeable uptick in fortunes coming, for example, that might color your view as to whether the stock has potential value. And then the key requirement to crystallize the loss is that there has to be an identifiable event with regard to the securities. And that includes some obvious things, like declaring bankruptcy or disposing all the company’s assets. But the key one from an internal tax planning perspective tends to be, can you check the box on subsidiary? And it tends to be a foreign subsidiary. If at the time of the check-the-box election, resulting in a deemed liquidation, if the stock does not have a positive value, then you can claim the worthless stock deduction. A brief watch out. If you try to claim a worthless stock deduction on a domestic subsidiary that’s a member of the consolidated group, you have to also pay attention to the consolidated group rules that are related the recognition of losses. In particular, the rule 1.1502-36, the horrible unified loss rule, the beta plot of plan’s existence. You have to carefully study that one if you’re trying to take a production on domestic subsidiary stock. And most importantly is section 165(g)(3), which permits, not a capital loss, but an ordinary loss for worthless securities. If the shareholder and subsidiary are affiliated in the 80% ownership by vote/value, and the subsidiary meets inactive gross receipts test of 90% for its entire history, in essence. And so, what this leads to is many difficult evidentiary issues. We see some multinational companies that claim worthless stock deductions and low and behold … a subsidiary since 1930, they have to prove the 90% gross receipts test was satisfied, which would be quite difficult. There are some historical analyses you can go down and some assumptions you can make, reasonable assumptions you can make under various case law. But it requires a close study, in particular, if there’s been prior restructuring transactions, such as mergers or acquisitions that were section 381 transactions. Next slide, please. And so the mirror concept for debt that’s not security is Section 166, which permits a bad debt deduction for partially or wholly worthless debt. The debt has to, of course, be bona fide debt. You would treat it as debt for tax purposes not as equity. And similar to the worthless stock deduction, you have to prove that in the year you’re attempting to claim the deduction, the loss actually occurs. So you have to prove that you inspect a bad debt, that the debt had value at the beginning of the year, and then an identifiable event occurs that shows that the debt does not have value during the year. And unlike the worthless stock deduction law where you have to show entire worthlessness, the good news here is that bad debt deductions also allow partial worthlessness deductions. You have to have an identifiable event that demonstrates that the debtors are unable to pay a portion of the debt that’s charged off. This charge-off rule is one of the requirements for the creditor to claim the bad debt deduction. And you also have to show the identifiable event shows reasonable grounds for abandoning future hope of repayment, which is sort of similar to that 165(g) requirement of no potential future value. And the, sort of, key watch out we want to mention, because this comes up with some frequency, is that a mere temporary shrinkage of value is generally not sufficient under the case law to show entitlement to a bad debt deduction. This includes, if you have, for example, a foreign currency denominated debt, that the foreign currency has fluctuated in a manner that shows it’s worth less. Or even if a country imposes blocks on repatriating cash or paying off the debt, the general thought in the case law is that you have to assume that that blocked income rule will be only temporary. And at some point, we relax, you’ll be able to get currency back. That’s just a watch out to look out for. You, of course, have to show, to crystallize your loss, the uncollectible amount is determinable with reasonable certainly. And you have to charge it off, remove the debt from your balance sheet. And the key here is sort of similar to 165(g)(3), if you can claim a bad debt deduction, where this probably makes the most sense is debt of a US company owed by a foreign subsidiary, that the debt deduction is ordinary, which can then cause it to, perhaps, enter and NOL, or even be claimed in the different years, we’ll show in the next slide if you turn there, please. So how does COVID and the recent developments law change all this? As we know, under TCJA, NOLs are not permitted to be carried back anymore. And carryforwards were subject to a limited that only offset 80% of taxable income in a year. The CARES Act changed that for 2018-2020 NOLs, which can now be carried back five years. That’s very similar to Brad’s point about capital losses, you can carryback those losses into pre-TCJA years. There’s a potential to monetize these losses at a 35% tax rate, given this is a five-year carryback and it includes 2018,2019 losses. Pretty substantial possibilities of going into 35% tax years. CARES Act also removes the 80% taxable income limitation. And then there’s various procedures to waive or reduce the carryback period for some cases. One key provision, which is not often thought about, but COVID raises really interesting issues on. We did mention this briefly in our last webinar, section 165(i). This is a provision that allows casualty losses from presidentially declared disasters, which right now includes the entirety of the US, allows those losses to be claimed in a prior year’s, the prior year’s tax return. So if you if you take a casualty loss right now, you can claim it on your 2019 tax return and potentially claim a refund very quickly as a matter of, of cash flow monetizing loss quickly. Importantly, this has to, the loss has to occur, quote in a disaster area, and it has to be quote attributable to a federally declared disaster. So the interesting issue that comes up is, well what about worthless stock deduction and the bad debt deduction that I took because the market values declined? Can I claim that that is a loss in a disaster area that’s attributable to a federally declared disaster? I don’t have great answers to give you at this point on those questions. There are things we’re still considering. Of course, one question might come up is, do you have, I am assuming you can squirrel your way into 165(i), would it apply to the entirety of the loss, or perhaps only, only the diminution of value that’s occurred since the declaration of disaster. All interesting issues that I think are worthy of further study. Next slide, please. So lastly, just a high level, the sort of summary for the opportunistic loss planning here is, what should you do now? One point that’s not mentioned here, the easiest point. Develop your full year model. Use your crystal ball that figure out what your full year looks like. I’m just kidding, it’s not that easy, but the idea is to look through your structure and consider what the fact panel will look like over the course of the year. Are there opportunities right now to recognize losses? And, you know, might you regret that later? Which we’ll, we’ll come to, time permitting, on the decision front. One interesting point, given the declining market values question, and this ties into Brian’s upcoming presentation on transfer pricing. It’s how does this rapid decline of value in the market change or alter your view of valuation methodologies? Can you support a significant diminution value that supports taking this loss right now? Because we know modernization is on a lot of people’s minds, look back at prior losses. Obviously, look at that carryback and carryforward possibilities that arise from those prior years. And then, the watch out here, which we also touched on in our last webinar is, are rules are so much more complicated now, as Enrica and Caroline both talked about, in terms of the interaction between our loss rules and the international tax rules, in particular. And loss carryback now, may have a significant impact on your GILTI income or GILTI inclusion, the availability of a Section 250 deduction, for example, in the year to which that loss is carried. If you carryback the loss in a 965 year, there’s some favorable rules. You can choose not to do that. If you do, it may impact your 965 transition tax and then also in there could be some significant BEAT consequences. So the theme with all things that are post-TCJA is there’s that key modeling exercise in any of these analyses and equations. And let me turn it over back to Brad to talk about rescission. Thanks, Tim. So, just, we just wanted to, kind of, briefly touch on the idea of rescission. And so the idea, so if there’s a situation where, earlier in the year property was sold and US shareholders sold IP to a CFC, and there’s a FDII benefit anticipated from that sale, but due to market developments, that benefit might not be available. Or, if a transaction is undertaken now, and later circumstances would, kind of, warrant revisiting that transaction, the rescission doctrine might be, might be available. So, the rescission doctrine, as developed in case law and IRS rulings primarily says that a transaction can be disregarded, essentially never existed, if the following two requirements are met. First is the status quo ante requirement, which requires that the parties to the transaction, the original transaction, be restored to the same position they would have occupied if the transaction had not occurred. So, generally it has to be the same parties involved, the same property that was subject to the original transaction. Sometimes this is framed in terms of the materiality threshold, where the parties must be materially restored to the same position they were in at the time of the original transaction. And the second requirement is the taxable year requirement. So, the rescission of the original transaction has to be affected in the same taxable year as the original transaction. This could get complicated where both parties to the transaction might have different tax years. For example, if a property were sold to a fiscal year CFC but the US shareholder is calendar year. It’s not really clear how the rescission rules work in that context, if the rescission occurs in a, you know, in different tax year for one of the parties. But, in general, the same tax year requirement exists. Next slide, please. So just some, rescission analyses are really, kind of, driven by the specific facts of the transaction that the taxpayer is seeking to rescind. So, just a few general considerations that pop up in any in any rescission analysis, what happens, kind of, in the period between the original sale and the purported rescission transactions? And can that affect the ability to treat the trans, the original transaction, as if it as if it never existed? General principle, so long as you can restore the parties to the same position they were in as if the transaction never happened in the first place, a rescission might be available. Example is if stock were sold and then dividends were paid on that stock to the new buyer, and then the party sought to rescind that transaction. If the stock has returned and the dividends are also returned, there might be a good argument for rescinding that that stock sale. Whereas if the buyer had kept the dividends, rescission might be more challenging. Unilateral actions, generally more challenging to actually rescind. So just dividends are paid, hard to rescind dividends just because of interactions with constructive receipt issues, and also a contract didn’t exist that, kind of, you know, triggered that dividend payment. Tax elections also are somewhat challenging to rescind. Non-tax business purpose for the rescission, there’s no authority, kind of, limiting rescission solely to transactions that have non-tax purposes. And there’s IRS rulings permitting rescissions that were, that appeared to be solely tax driven. There could be concerns if the original transaction was, really, kind of motivated for tax reasons, whether you can rescind that transaction. But, in general, there’s, you know, good authority for not requiring a business purpose for a given rescission. The ability to do over the rescinded transaction can be complicated. So, if you were to rescind the original sale and then sell the property again to the same buyer just at a lower valuation, kind of, step transaction principle scan come into play there. And you might treat this, really, as just one sale that happened at the beginning of the year, but really, kind of, facts and circumstances that just need to be considered. The form of rescission, so, also unclear, but in general, experts will advise to structure the rescission as a rescission agreement of the original transaction, as compared to original sale property, and then the buyer were to just sell the property back without, kind of, styling that as a rescission. There’s a real risk that those transactions would be treated as two separate transactions rather than a rescission of, of the original transaction. And this, one, one take away point is, this is just kind of a US tax doctrine that permits the transaction could be disregarded. But both transactions might be respected from, for non-US tax purposes. And so there can be follow on, you know, foreign law or state law implications of the, of the rescission transaction. Great. Well, thank you very much, Brad and Tim and Caroline and Enrica. Now we’re going to shift gears slightly and go to Brian Jenn for a discussion of transfer pricing planning in these highly unusual and challenging times. Brian? Thank you, Dave. So, many businesses are facing a challenge today where their transfer pricing arrangements that they have in place, with respect to existing transactions, really no longer reflect their business reality. And there are also questions about an uncertainty about how you price and structure transactions, new transactions, going forward. So we’re going to talk about that here. Next slide, please. So, the reality of many business operations today is that operations in countries around the world are partially or fully shut down, either by government order, or out of precaution to avoid spreading a virus, or simply because of a falloff in demand for products or services. There might also be a need to reallocate functions within a group in a, in a way that could create … challenges or, or maybe to reallocate assets, either as part of a pre-existing plan before the cris—onset of the crisis. Or, as part of supply chain changes in response to a need to diversify supply chains going forward. Also, we’re certainly seeing a need for companies to reallocate cash, either on an intercompany basis or borrowing externally. These are the business realities. The transfer pricing situation may be that existing intercompany agreements are providing a limited risk return with respect to activities. The comparables that you had for either, ongoing transactions or for perspective transactions are no longer effectively comparables because your situation has changed relative to what the baseline was. You could have valuations that are based on prior market conditions, or, also advance pricing agreements that are affecting your ability to change and respond in your transfer pricing policies. So, we’ll talk about these issues. But, just at a high level I would say, an important take away is that it doesn’t necessarily make sense to continue applying your transfer pricing policy in a mechanical way, as if this is business as usual. There might be a justification for changing that policy going forward. Next slide, please. I’m going to talk now about the allocation of losses in existing arrangements. And the unfortunate reality of taxpayer experience with transfer pricing audits is that while tax administrations often seek a return that implies that a local entity bears risk, and as a theoretical matter might acknowledge, the downside risk as part of the deal. In reality, as many companies know, auditors fight against accepting low returns and losses for your affiliates. And, this is this is something that I saw working in the transfer pricing guidelines and developing those at the OECD. Countries were willing, as a theoretical matter, to acknowledge the upside means that they need to bear downside to, but in practice that was, that was never the experience. So, many affiliates around the world might be compensated under their existing arrangements under a, so called, limited risk basis, particularly for distribution or manufacturing activities or other services. But limited risk doesn’t mean one thing. It’s not, it doesn’t mean risk free. It really depends on what your inter, your intercompany agreements say, and what is the transfer pricing method you’re using. If an entity is compensated under a comparable profits method or a TNMM method, it’s exposure to risk under that method will vary depending, depending on the profit little level indicator that is being targeted. Some profit level indicators effectively give a return on non-costs or a return on assets. Think of just a PLI, like a return on capital employed, or a berry ratio, which is the ratio of gross profits to operating expenses. In those kinds of fact patterns, where you’re operating expenses or your capital employed are not significantly changing despite a slowdown of operations, those, those kinds of ratios as the basis for applying a TNMM can result in significant continuing remuneration to an affiliate that is effectively not doing anything, or not doing anything close to what it was in the past. And the question is whether, whether that is appropriate? And, kind of, in any case, unless benchmarks are showing negative returns, these methods won’t allow you to, in general, to claim a loss. Same issue arises with a cost-plus transaction, where if you’re providing a simple, kind of, mark up on costs, then that could be very mechanically applied going forward in a way that gives the return that might not be justified in light of the circumstances. Regarding comparables, they typically lag by a year or two, the year that is being benchmarked. And this can create a significant challenge in that the comparables don’t directly support a lower benchmark return for this year, but maybe in a few years they will show a lower return. But at that point, if the economy has recovered, a tax administration may be reluctant to accept that comparable as a benchmark. And so, effectively, you never get to take into account a reduced return. That’s the, that’s the bad outcome, but, but with some proactive approach to, to your benchmarking and your transfer pricing, generally, you don’t necessarily need to make that the outcome. But it does put pressure on companies to make adjustments now if they have any hope of showing a lower return that reflects the actual economics of their situation. Unfortunately, there might be a good basis for making current year adjustments, notwithstanding the reported results of comparables. You can consider, you know, making an adjustment when there is a situation where you have idle capacity or unusual expenses. Those, those kinds of fact patterns, which wouldn’t obviously be reflected in your comparables, could be appropriate adjustments to comparables for this year. That would allow you to report a lower return and affiliate in that year. Another approach would be to consider using the lower end of an arm’s length range. And check your filters for your comparable determination and determine that, make sure that you’re not explicitly excluding loss making entities as being potential comparables. Whereas they might be good comparables in the current environment. So, an important starting point for determining whether you do have a good basis for making an adjustment in your particular circumstances is to examine your intercompany agreements to see what flexibility they can provide you. Do they presume or do they explicitly provide a certain level of services that is not currently being provided? And would that shortfall in services justify lower compensation? And does that intercompany agree that explicitly recognize any risks like inventory risk, like inventory risks, FX risks, acts of God in the agreement? Or is there, or is there any kind of a force majeure clause? All of these things could be a basis in an agreement for potentially making an adjustment downward to your comparables to arrive it at the return that your targeting. But even in the absence of a specific provision and your intercompany agreements, there may be a basis to renegotiating an agreement among affiliates. The Tax Court recognized the renegotiation might be arm’s length. In a case, going back to 1963, involving Nestle, where they allowed related parties to renegotiate a royalty agreement in a way that effectively increased the royalty rate. And the Tax Court reasoned there that unrelated parties would have renegotiated the agreement under similar circumstances. The OECD transfer pricing guidelines also permit renegotiation. Although, you have to, you have to consider whether it was part of that renegotiation, you have essentially a fair benefit that you would see at arm’s length. And so there is a basis in the law for, for allowing adjustments downward, even to potentially limited risk entities, even potentially in the absence of provisions of your intercompany agreements. But the key to successfully defending, ultimately, this kind of an adjustment will be to have contemporaneous documentation of your own circumstances, in terms of dealing with unrelated parties and renegotiations in that context of the overall economic environment. And documenting that upfront, why you are making changes to the intercompany agreement effectively that you had previously agreed. Next slide, please. I’m going to talk a little bit about pricing in an uncertain environment for going forward transactions. Even in the current environment and in some cases, because of it, companies are continuing plans for internal restructurings, which may involve transfers of intangible property. Now, if that property had been acquired recently in a transaction involving a third party, you might have thought an acquisition cost method would be appropriate for say, an outbound transfer of IP. For better or worse, depending on your facts, that might not be true anymore, or at least that might not be as good a benchmark as it was. Or even a comparable uncontrolled transaction that you thought was a good transaction, might no longer be as reliable. In these circumstances, if you have to think about other kinds of transfer pricing methods for valuing assets, whether, maybe an income method or a cash flow basis valuation method might make more sense. And, in that context, you can, you can project lower income or lower cash flows for some period and that might be supported by your own internal forecasts, thereby resulting in a lower transfer price for, say, intangible property. Thinking kind of more generally about intercompany transactions and arrangements going forward, you can think about the term and termination provisions in your agreements, but take into account that while it might be more attractive to provide greater flexibility on termination and adjustment of agreements, that would have to be priced into the agreement. Also, you know, just think about when you’re benchmarking, potentially using multi-year averages or thinking about where you end up in a range of other tools for providing you flexibilities. Next slide, please. I’m going to talk now about, just briefly mention advance pricing agreements. You might already be in in a APA or in the process of negotiating one. If you’re already in an APA, they could be hard to get out of, but it is possible to have a basis to renegotiation, and a tax administration might entertain that. Certainly, if you can argue that a critical assumption has been violated, but even a material change in facts could be a basis to renegotiation and something that you should present to competent authorities. If you’re in the process of negotiating an APA, it could be possible to request an amendment to your APA request. That could, that kind of a request, a reamended request could accommodate alternative pricing for normal years and for down years, respectively, and could accommodate things like extraordinary expenses. Next slide, please. Intercompany financing. I would just say that this particular form of external borrowing or internal borrowing, in any case, you should take account of the possibility of implicit support that a subsidiary might have with respect to its parent. And that is not something that needs to be paid for under the transfer pricing guidelines. So if, if knowing that your parent brings you up to higher credit level than you otherwise would, just by virtue of your affiliation, that’s something that doesn’t need to be explicitly compensated if you have a guarantee arrangement over direct borrowing between the parent and the subsidiary. I’m going to moved quickly to pillar one of the OECDs project, and talk about how losses are taken into account under pillar one. You’ll recall the, you know, pillar one involves an amount A, which is an amount, new amount that would be reallocated to market jurisdictions. And it could be some measure of premium returns. And what happens when you have a loss? How does that get taken into account in calculating your amount? The OECD has hinted at this, hasn’t developed detailed rules yet. But the thinking that we have been talked about so far is that, potentially, there would be a carryforward, even with respect to prior year losses before any kind of new regime is implemented. Losses could be carried forward and could offset the amount that is reallocated under amount A in the future. Similarly, amounts B and C. Amount B is a fixed return for activities, non-risky activities that you, that you have in a particular market jurisdiction. So that is subject to the same discussion we had earlier about whether a loss could be appropriate in a limited risk environment. Amount C, though, is a return to risks and intangibles. And so, because that is a return to risks, that should also reflect the possibility of a downside risk. So you should be able, potentially, to have a loss with respect to amount C that could offset your amount B. On pillar two, I would just say, this is the inclusion rule in under tax payment rule, which we’re trying to get to a minimum tax. And with respect to that, I would just say, while GILTI might be grandfathered with respective pillar two, these issues could still matter, depending on the interaction of the grandfathering with the regimes that other countries adopt. And the key issue with respect to losses in pillar two is how they’re taken into account in determining whether you have met the effective tax rate threshold in a particular jurisdiction, which might be, say, 12.5%. And that, that is something that the OECD is working on, and will be something to pay attention to and potentially provide feedback on. Great thank you very much, Brian. We have a few questions that have been submitted, and we will cover those in a moment. In the meantime, I’d like to give everybody a last opportunity to type any remaining questions into the Q&A box. And then, for those of you requesting CLE credit in New York, the credit code for our webinar is BLUE1. BLUE1. So that’s B L U E and the number one. BLUE1. So be sure to enter that code when completing your evaluation. And for all attendees requesting CLE or CPE credit, a certificate will be emailed to you directly. Okay, so to the questions that we’ve gotten, a few on transfer pricing that that came in ahead of the webinar, I think Brian covered pretty much all of them in the course of his presentation. The one that I would put to him, though, is how do you, how do you think about the impact of government subsidies on the pricing of your intercompany transactions? So, the so-called PPP program, you know, that has, may involve loan forgiveness, how does that affect the way that taxpayers think through the pricing of their intercompany transactions going forward? Right. And the question there might be whether, if you’re getting some form of assistance from the government, whether that is effectively credited against the return that the entity would otherwise get or not. Is it essentially just a bonus that the entity gets? And, you know, that, I think, would depend on considering the circumstances of the comparables you’re facing and whether you’re making other adjustments to that, that entity’s return in respective losses. If you are making other adjustments, then maybe you don’t take into account that kind of support in determining what, what is on an intercompany basis is the compensation to that entity. But, if you aren’t making other adjustments, does it really make sense that the entity gets, you know, paid twice? Paid on an intercompany basis and without diminishment for losses, essentially, and from the government. And so I think those are the considerations you would think about. Great. Thanks, Brian. And then, we got a couple of questions on rescission. One of them was, concerned the ability of a taxpayer to rescind an election, and then the other one concerned, should we, when we think about the potential problems in rescinding a dividend, should we think differently about an intercompany dividend from the way that we might think about dividends more generally? So I put those to Brad and Tim for their thoughts. Sure. So on, on the, the election question, I think there’s a there’s a couple obstacles to rescinding an election. The first is that the relevant statute or regulations providing for the election might set forth a specific procedure for revoking that election. So it might either say the election is irrevocable or is only a revocable with the, with IRS consent. So, in those circumstances, I think relying on rescission would be, would be pretty challenging. And so once you kind of get past, if the election is in specific—if revocation the election is specifically addressed by the regulations or the statute, there’s also a common law doctrine of election, where a taxpayer may not be able to, kind of, unilaterally revoke an election made in an earlier tax year without consent of the service. So, and also just the general kind of rescission authorities around there being an agreement, a bilateral agreement that’s being rescinded rather than a unilateral action. So, I think, you know, if, if, if it’s, if the right election is in place, there may be stronger arguments for rescinding it. But, yeah, really, there’s really kind of, a lot of circumstances surrounding elections that way might make rescission impractical. I’ll handle the second question on intercompany dividends. As you can imagine, one of the requirements for rescission, in the government’s view, is that there be a contract or an agreement between the parties. And the question that comes up with dividends is, there are the unilateral actions. So the question on rescinding dividends is whether is it, sort of, meets the contract rule? I think it depends heavily on which country you’re talking about. There’s different positions based on how different countries’ laws that are given in declarations apply. And then also, the extent of the question is, do you have to focus on the payor or the payee in restoring their original position? I think this, the rescission case law focuses on the status quo of the parties ex ante? So, ideally, the answer should be both. But of course, would reserve on particular facts and circumstances in different countries involved. Okay, thanks Tim, and thank you to all my fellow panelists. I’d like to thank everybody for attending the webinar. There were a couple of questions that we didn’t have time to get to. We will do our best to follow up with you after the webinar on that. As a reminder, please complete the program evaluation that will be emailed to you after the program. And again, for those of you seeking CLE credit in New York, please be sure to answer, to enter the BLUE1 credit code in your evaluation. BLUE, the number one. Thanks again, and this concludes our webinar.

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