Lapsed Tax Provision Could Put Globally-Minded Midsize Firms on Q1 Diet, Says McGladrey’s Camacho

The growing offshore ambitions of midsize firms could become quickly tempered inside the new year after Congress failed to act on the year-end extension of a tax provision designed to allow U.S. firms to transfer the earnings of one foreign subsidiary to another without triggering additional federal taxes. The provision’s extension, dubbed the CFC Look-Through Rule, has been widely leveraged by the subsidiaries — or a controlled foreign corporation (CFC) of U.S. firms. Middle-Market Executive recently asked Ramon Camacho, an international tax expert from McGladrey’s Washington national tax office, about the likely impact of the lapsed rule.

MME: First, how was this provision allowed to expire? Wouldn’t Congress have been keeping a keen eye on this one?

Camacho: Well, every year there’s a group of tax provisions that are scheduled to expire — and the CFC Look-Through Rule is just one of many. What we’ve seen is that over the past few years, we’ve gotten down to the wire on this one, and each year it became more of a last minute affair to get Congress to extend the expiration date. This year they didn’t extend, and while we can say, “Wow, how did they let this one slide by?,” I think that the better question is, “How do we renew these provisions on a retroactive basis so that they can be taken advantage of at the start of the year?”

MME: Still, you would have expected law makers to have kept the expiration date for this one on their radar …

Camacho: I think that what happened here is that things may have gotten caught up in the tax reform debate, and there are certain people who view these types of extenders as taking the steam out of tax reform. They were thinking that these extenders may offer some leverage and could be held over people’s heads to try to push tax reform a little faster. This approach turned out to be rather unsuccessful as a tactic for getting tax reform done.

MME: What does this mean when it comes to the competitive footing of U.S. companies offshore?

Camacho: Basically, the provision was designed to help firms when they go offshore to defer their earnings from U.S. taxation, allowing them to keep their cash flows and grow them larger so that they can reinvest offshore. The provision allows earnings to be redeployed to other businesses or subsidiaries within their offshore operations without any current U.S. tax consequences. Now, our tax system remains a worldwide system, so unlike some of the exemption systems that exist in a number of European countries, that of the U.S. will tax those earnings when they eventually come back to the U.S. Meanwhile, certain exemption countries do not tax, so even this system of deferral doesn’t put U.S. companies on an equal footing with their foreign counterparts.

MME: Where should we expect U.S. firms to likely experience some pain?

Camacho: There’s going to be an impact on the overseas side and the domestic side as people remain conservative about things because they just don’t know what the final extenders package will look like. In fact, there’s a significant possibility that even if Congress does pass an extenders package this quarter, not everything on the extenders list is going to make it. Last time, only about 60 percent of the items on the list made it.

MME: It seems that midmarket firms have become increasingly aggressive when it comes to tapping into offshore opportunities in recent years. Are there larger implications here for the economic system?

Camacho: Well, it could diminish the value of private equity investment because as their investment companies pay more tax, there will be less capital available for redeployment. As they look to sell these companies, there will be a tax liability that potentially needs to be accounted for. The CFC Look-Through Rule remains a key feature of offshore structures, and if they can’t take advantage of it, people will look to other opportunities.

MME: So what do you expect will unfold in Congress?

Camacho: My guess is that we’ll see an extenders provision floated in the House and Senate this quarter. I would say that there is a 50/50 chance that Congress tackles this and we see an extenders provision being passed in 2 to 3 months.

MME: What steps do you recommend that midmarket firms take in the meantime?

Camacho: Well, a path of caution is always advisable, and if your firm is about to pull the trigger on a structure or redeployment of earnings offshore, I think that you may want to wait. We have a number of client firms that have decided to have their plans simmer and to wait and see where things are going to go. If we do get a provision floated, there will be an effective date included, so we’ll be able to better see if they’re intending to simply extend or even lapse the provision. Those firms that already have structures in place may want to act on a “need-to-move” basis when it comes to moving money around, and consider deferring those distributions or transfers and draw down on available credit lines at least for this quarter until we get a better read on things.