E&P

Question 1

Calculating E&P for a US corporation

Answer 1

1) E&P starts with taxable income
2) Adjustments are made for differences between taxable income and E&P, i.e., E&P adjustments

Question 2

Calculating E&P for a foreign corporation

Answer 2

1) E&P starts with book income under local country generally accepted accounting principles (GAAP)
2) Local GAAP is adjusted to conform to US GAAP principles as required by Reg. §1.964-1(b)
3) US tax and E&P adjustments are then made to arrive at E&P as required by Reg. §1.964-1(c)
4) In determining foreign entity E&P, temporary or timing adjustments are made, but permanent adjustments are not

Question 3

Calculating E&P for a CFC

Answer 3

1) Start with local GAAP
2) Adjust to get to US GAAP
3) Make E&P adjustments

Question 4

Total tax on US and foreign source income =

Answer 4

Taxable income (TI)
1) dividends, and inclusions (GILTI, Sub F, gross-up, other)
2) less deductions (incl. NOL, 245A DRD, 250 deduction)
Regular Income Tax Liability (RTL)
3) times 21%
Foreign Source
4) plus BEAT liability (base erosion minimum tax amount)
5) less FTCs and other credits

Question 5

E&P

Answer 5

In concept, E&P should measure the “economic viability” of a corporation at a point in time to distribute assets. E&P represents an increase or decrease in the amount of net assets of the corporation that are not the result of:
* Assets received from its shareholders as contributions to capital
* Distributions of assets to its shareholders
When in doubt look at items of income (or expense) for inclusion (or exclusion) from E&P from an economic or business perspective rather than an accounting or
tax perspective.

Question 6

Examples of irrelevant tax adjustments (i.e., those that do not impact economic position of the corporation and as such are not included in an E&P calculation) include:

Answer 6

‒ Tax exempt interest income;
‒ Limitations of interest expense deductions due to §163(j)
‒ Dividends received deduction;
‒ Disallowance for meals and entertainment;
‒ Non-deductibility of fines, penalties, lobbying expense, business gifts, political contributions and club dues; and
‒ Discharge of indebtedness excluded from gross income under §108

Question 7

Typical E&P adjustments—Reserves

Answer 7

Reserves are generally non-deductible for E&P purposes because they do not meet the economic performance rules of §461 or the recurring item exception of §461(h). Each year the change in the reserve account balance must be reversed.

Question 8

Examples of non-deductible reserve accounts include:

Answer 8

• Bad debt reserve
• Inventory reserves
• Vacation pay reserve
• Accrued bonus
• Deferred compensation
• Accrued severance
• Other compensation type reserves
• Accrued self-insurance reserve
• Pension/profit-sharing reserves unless § 404A election is made
• Warranty reserve
• Contingency reserves
• Restructuring reserves

Question 9

5 Typical E&P adjustments

Answer 9

1) UNICAP — US Ratio Method
2) Depreciation under allowable §§ 312(k) or 168(g) methods only:
* Generally straight-line over ADR mid-point life, or
* Straight-line over MACRS/ADS life
3) Amortization — pre- vs. post-§ 197 rules
4) Unrealized exchange gains and losses
5) Foreign Income Taxes

Question 10

Foreign taxes deductible for E&P purposes

Answer 10

• Foreign income taxes (federal, local, state, municipal, cantonal, provincial)
• Withholding taxes
• Capital income taxes
• Real property taxes
• Personal property taxes
• Payroll taxes
• VAT, GST, Sales and Use taxes
• Corporate stock taxes

No deduction for deferred taxes is allowed!

Question 11

Earnings and profits does not track contributions, only __________.

Answer 11

activity

Question 12

Distributions

Answer 12

A “distribution” is a payment from a corporation to its shareholder that is not in exchange for value provided by the shareholder to the corporation

Question 13

Taxability of Distributions

Answer 13

Whether a distribution is taxable to its shareholder is dependent on how the distribution is characterized. Generally, a distribution can be characterized in one of three categories:
‒ Dividend -> Taxable to Shareholder (§959)
‒ Return of Capital -> Non-Taxable to Shareholder
‒ Return of Capital in excess of basis -> Taxable to Shareholder

Question 14

3 Step Distribution Taxability Analysis

Answer 14

1) §301(c) (1) — Amount constituting a dividend
* That portion of the distribution which is a dividend (as defined in §316) shall be included in gross income
‒ Further break it down based on §959
2) §301(c) (2)—Amount applied against basis
* That portion of the distribution which is not a dividend shall be applied against and reduce the adjusted basis of the stock
3) §301(c) (3)—Amount in excess of basis
* That portion of the distribution which is not a dividend, to the extent that it exceeds the adjusted basis of the stock, shall be treated as gain from the sale or exchange of property

Question 15

Distributions out of PTEP
(Section 959(c)(1) or (c)(2))

Answer 15

• Amount not included in US shareholder’s gross income under §959(a)
• FTC for any withholding tax under §960(b)?
• Foreign currency gain/loss under §986(c)?
  (Depends on whether the functional currency of the PTEP is USD)
• Sufficient basis in CFC Stock? (§961 requires downward basis adjustment)

Question 16

Distributions out of Untaxed E&P
(Section 959(c)(3))

Answer 16

• Amount included in taxable income under §301 …
• … but deduction under §245A might apply, in which case:
  ‒ No FTC for withholding tax
  ‒ No foreign currency gain/loss under §986(c)
  ‒ Basis reduction only required for purposes of determining loss on disposition of stock (§961(d)) or if distribution is an extraordinary dividend under §1059

Question 17

§959 categories of PTEP

Answer 17

E&P of a CFC is divided into separate pools referred to as §959 pools:
‒ §959(c)(1)(A): PTEP related to investments in US property (§956 Inclusion)
‒ §959(c)(2): PTEP related to Subpart F income, GILTI and deemed dividends under §1248 ‒ §959(c)(3): E&P that has not been taxed

Question 18

E&P in Liquidation

Answer 18

• Generally, when a CFC is liquidated, it either sells off all its assets and distributes cash up to the parent or distributes all its assets up to the parent
• May qualify for nonrecognition of gain/loss under §332 if at least 80% of the liquidating subsidiary’s stock is received in a complete cancellation or redemption of all the subsidiary’s stock which is completed within 3 years under a plan of liquidation

Question 19

E&P in Sale

Answer 19

• US Parent may choose to sell its CFC, rather than liquidate it
• Gain from the sale of stock of a CFC is covered under §1248: the gain recognized on the sale should be included in the gross income of such person as a dividend, to the extent of the earnings and profits of the target CFC

Question 20

When planning a distribution, nuanced tax analysis may be required in the following areas:

Answer 20

A) Gain or loss under §§ 301 or 961
* E&P and basis studies for source of distributions* (earnings vs. capital)
* Stock basis in relevant shares*
* Type of (and USD basis in) PTEP distributed**
B) Tax on untaxed earnings
* Qualification for §245A and non-applicability of §1059(e)
C) FX gain/loss under §986(c)
* Type of PTEP distributed
* USD basis in PTEP distributed
* Application of haircut to §965(a), GILTI PTEP
D) FTC
* Withholding and local income tax on distributions; basketing; foreign tax credits (including the haircuts) under Section 960

• Consider recent adjustments under Sections 965, 961, etc.
  ** Consider recent Notice 2019-1 providing new categories of PTEP and clarifying ordering.