The U.S. Treasury released final Code Section 965 regulations on January 15, 2019, known as transition/repatriation tax, which clarify many unanswered questions and concerns. The clarifications are mixed with good and bad news. One of the clarifications, related to section 965(h) acceleration events, is very time sensitive.

Background

2017 Tax Reform enacted a one-time “Transition Tax” (under section 965) for U.S. shareholders who own specified foreign corporations which have deferred foreign earnings. Basically, calendar year U.S. shareholders are required to include the deferred foreign earnings as 2017 taxable income as if those foreign earnings had been repatriated to the U.S. To avoid an imposition of a significant tax burden on those U.S. taxpayers who own foreign corporations with deferred foreign earnings, Congress provided a few mitigation rules. For instance, the effective rate of Transition Tax is between 8 percent to 15.5 percent for U.S. corporate taxpayers and 9.1 percent to 17.5 percent for individual taxpayers (depending on the cash position of the specified foreign corporations). In addition, Transition Tax rules provide that the U.S. taxpayers can make an election under section 965(h) to pay the Transition Tax over an eight-year period by making annual installments without an interest charge.

Section 965(h)(3) also provides that if a “Acceleration Event”[1] occurs (e.g., a liquidation or sale of substantially all the assets of the taxpayer), the taxpayer who made section 965(h) election may have to pay all of the remaining installments at the time of the Acceleration Event – “Acceleration of payment”. However, such acceleration payment rule shall not apply to “Covered Acceleration Events” where buyer and seller of specified foreign corporations enter into a transfer Agreement under section 965(h)(3) – “Transfer Agreement”. Examples of Covered Acceleration Events are sale, exchange or other disposition of substantially all of the assets of a U.S. taxpayer to another U.S. taxpayer, a domestic corporation taxpayer becomes a member of a consolidated group, or a consolidated group ceases to exist. An example of not Covered Acceleration Event is that a U.S. individual taxpayer ceases to be a U.S. tax resident.

Additionally, a shareholder of an S Corporation can make an election under section 965(i) to defer the Transition Tax indefinitely until a “Triggering Event”[2], upon which the S corporation shareholder’s Transition Tax liability could be due immediately. Similar to Covered Acceleration Events, the regulations also provided certain types of “Covered Triggering Event”, where the remaining Transition Tax liability could be further deferred if a Transfer Agreement under section 965(i)(2) is timely filed. An example of Covered Triggering Event is a transfer of any share of the S corporation stock by the shareholder that results in a change of ownership for federal income tax purposes.

Treasury and the IRS provided proposed section 965 regulations and certain guidance (IRS Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns Q18~Q20) regarding Transfer Agreements. But certain detailed rules and procedures were not clear until the release of the final section 965 regulations. Below are some bullet points we observed which should be noted by taxpayers who made section 965(h) or 965(i) elections.

  1. Certain tax-free reorganization transactions or exchanges described in section 351 or 721 may be treated as Acceleration Events. The proposed section 965 regulations (issued on August 1, 2018) were not clear as to whether a disposition of substantially all of the assets resulting from a downstream tax-free reorganizations (e.g., exchanges done according to section 351 or 721) should constitutes an Acceleration Event. For example, an individual U.S. taxpayer Bob who contributed his wholly owned controlled foreign corporation (CFC, which gave rise of Transition Tax to Bob in 2017 tax year and he made section 965(h) election) into a newly formed C corporation in late 2018[3]. Bob still indirectly owns 100 percent of the CFC, which does not seem to be a “disposition” transaction. However, the final section 965 regulations clarify that such transactions should be treated as Acceleration Events. The good news is that such transactions should be qualified as a Covered Acceleration Event. Therefore, the remaining installments can still be deferred as long as Bob and the new C-corporation enter into a Transfer Agreement. The Transfer Agreement has a very short due date, which could easily be overlooked. Failure of filing the Transfer Agreement could result in an Acceleration of Payment.
  2. Transfer Agreement, along with its attachments, has to be filed within 30 days after the date of Acceleration Event occurs. The final section 965 regulations further provided an extended due date of January 31, 2019 for the Acceleration Events which occurred before December 31, 2018.
  3. Summary of Transfer Agreement filing procedure.

Requirement to enter into a Transfer Agreement under section 965(h)(3)

(i) A statement that the document constitutes an agreement by the eligible section 965(h) transferee to assume the liability of the eligible section 965(h) transferor for any unpaid installment payments of the eligible section 965(h) transferor under section 965(h);

(ii) A statement that the eligible section 965(h) transferee (and, if the eligible section 965(h) transferor continues in existence immediately after the acceleration event, the eligible section 965(h) transferor) agrees to comply with all of the conditions and requirements of section 965(h) and paragraph (b) of this section, as well as any other applicable requirements in the section 965 regulations;

(iii) The name, address, and taxpayer identification number of the eligible section 965(h) transferor and the eligible section 965(h) transferee;

(iv) The amount of the eligible section 965(h) transferor’s section 965(h) net tax liability remaining unpaid, as determined by the eligible section 965(h) transferor, which amount is subject to adjustment by the Commissioner;

(v) A copy of the eligible section 965(h) transferor’s most recent Form 965-A or Form 965-B, as applicable, if the eligible section 965(h) transferor has been required to file a Form 965-A or Form 965-B;

(vi) A detailed description of the acceleration event that led to the transfer agreement;

(vii) A representation that the eligible section 965(h) transferee is able to make the remaining payments required under section 965(h) and paragraph (b) of this section with respect to the section 965(h) net tax liability being assumed;

(viii) If the eligible section 965(h) transferor continues to exist immediately after the acceleration event, an acknowledgement that the eligible section 965(h) transferor and any successor to the eligible section 965(h) transferor will remain jointly and severally liable for any unpaid installment payments of the eligible section 965(h) transferor under section 965(h), including, if applicable, under §1.1502-6;

(ix) A statement as to whether the leverage ratio of the eligible section 965(h) transferee and all subsidiary members of its affiliated group immediately after the acceleration event exceeds three to one, which ratio may be modified as provided in publications, forms, instructions, or other guidance;

(x) A certification by the eligible section 965(h) transferee stating that the eligible section 965(h) transferee waives the right to a notice of liability and consents to the immediate assessment of the portion of the section 965(h) net tax liability remaining unpaid; and

(xi) Any additional information, representation, or certification required by the Commissioner in publications, forms, instructions, or other guidance.

Requirement to enter into a Transfer Agreement under section 965(i)(2)

(i) A statement that the document constitutes an agreement by the eligible section 965(i) transferee to assume the liability of the eligible section 965(i) transferor for the unpaid portion of the section 965(i) net tax liability, or, in the case of a partial transfer, for the unpaid portion of the section 965(i) net tax liability attributable to the transferred stock;

(ii) A statement that the eligible section 965(i) transferee agrees to comply with all of the conditions and requirements of section 965(i) and paragraph (c) of this section, including the annual reporting requirement, as well as any other applicable requirements in the section 965 regulations;

(iii) The name, address, and taxpayer identification number of the eligible section 965(i) transferor and the eligible section 965(i) transferee;

(iv) The amount of the eligible section 965(i) transferor’s unpaid section 965(i) net tax liability or, in the case of a partial transfer, the unpaid portion of the section 965(i) net tax liability attributable to the transferred stock, each as determined by the eligible section 965(i) transferor, which amount is subject to adjustment by the Commissioner;

(v) A copy of the eligible section 965(i) transferor’s most recent Form 965-A, if the eligible section 965(i) transferor has been required to file a Form 965-A;

(vi) A detailed description of the triggering event that led to the transfer agreement, including the name and taxpayer identification number of the S Corporation with respect to which the section 965(i) election was effective;

(vii) A representation that the eligible section 965(i) transferee is able to pay the section 965(i) net tax liability being assumed;

 (viii) An acknowledgement that the eligible section 965(i) transferor and any successor to the eligible section 965(i) transferor will remain jointly and severally liable for the section 965(i) net tax liability being assumed by the eligible section 965(i) transferee

(ix) A statement as to whether the leverage ratio of the eligible section 965(i) transferee immediately after the triggering event exceeds three to one, which ratio may be modified as provided in publications, forms, instructions, or other guidance;

(x) Any additional information, representation, or certification required by the Commissioner in publications, forms, instructions, or other guidance.

Where to file:

Memphis CSCO 

5333 Getwell Road MS 81 Memphis, TN 38118

Please contact to Polina Chapiro or Yan Jiang in our International Tax Service practice if you have any questions on the final section 965 regulations.

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[1] There are seven types of Acceleration Events listed under final Reg. section 1.965-7(b)(3)(ii), which include 

  • An addition to tax is assessed for the failure to timely pay an installment;
  • A liquidation, sale, exchange, or other disposition of substantially all of the assets of the person (including in a title 11 or similar case, or, in the case of an individual, by reason of death);
  • In the case of a person that is not an individual, a cessation of business by the person;
  • Any event that results in the person no longer being a United States person, including a resident alien (as defined in section 7701(b)(1)(A)) becoming a nonresident alien (as defined in section 7701(b)(1)(B));
  • In the case of a person that was not a member of any consolidated group, the person becoming a member of a consolidated group
  • In the case of a consolidated group, the group ceasing to exist (including by reason of the acquisition of a consolidated group within the meaning of Reg. section 1.1502-13(j)(5)) or the group otherwise discontinuing in the filing of a consolidated return; or
  • A determination by the Commissioner.

[2] Provided under final Reg. section 1.965-7(c)(3), the following events are considered triggering events

  • The corporation ceases to be an S corporation (determined as of the first day of the first taxable year that the corporation is not an S corporation);
  • A liquidation, sale, exchange, or other disposition of substantially all of the assets of the S corporation (including in a title 11 or similar case), a cessation of business by the S corporation, or the S corporation ceasing to exist;
  • The transfer of any share of stock of the S corporation by the shareholder (including by reason of death or otherwise) that results in a change of ownership for federal income tax purposes; or
  • A determination by the Commissioner.

[3] Such reorganization transaction is common for taxpayers who want to take advantage of lower corporate tax rate or to mitigate global intangible low-taxed income (GILTI) tax impacts.