A&M Tax Advisor Weekly
While the Tax Cuts and Jobs Act (TCJA) has been marketed as “reform,” it is better described as an expansion of Federal tax law, with many legacy rules remaining intact but now overlaid with additional requirements. One example of this is how companies are required to recognize foreign exchange (FX) gain or loss on distributions from foreign subsidiaries.
It would be easy to assume that the new Toll Charge and participation exemption rules will allow companies to repatriate foreign earnings without any U.S. tax implications. However, the reality is that legacy FX recognition rules still apply to repatriation, and in fact have been expanded by the TCJA to more pools and larger amounts of foreign earnings. Most companies should see the impact as early as their 2017 taxable year. Companies will be challenged by the requirements for tracking the FX effect on the repatriation of their foreign earnings, but there is a silver lining in the form of a tax planning opportunity.
Under Section 986(c), which was in effect before the TCJA, when a controlled foreign corporation (CFC) distributes earnings that have already been subject to U.S. tax under subpart F (known as “previously taxed income” or “PTI”), the distribution triggers a foreign exchange gain or loss to a U.S. shareholder. In general, the Sec. 986(c) gain or loss represents the change in US dollar value of functional currency E&P between the time it was included in income and the time it is distributed.
The rules enacted in the TCJA, especially the one-time toll charge, are expected to cause most foreign earnings and profits to be taxed currently to U.S. shareholders, with the result that significant amounts of foreign earnings will be treated as previously taxed under one of several categories. For each CFC, taxpayers are now required to track as many as six categories of PTI. (These requirements also apply to some extent to other 10 percent owned foreign corporations that are not CFCs, referred to as “specified foreign corporations” or SFCs). Each category will have a different profile and may have different FX implications when repatriated.