Could Potential Tax Change Reduce Amount Altaba Shareholders Are Expecting as a Liquidating Distribution?

By Stuart E. Leblang, Michael J. Kliegman and Amy S. Elliott

The Tax Cuts and Jobs Act (TCJA) was signed into law at the end of 2017, but lawmakers may not get around to making certain technical corrections to the bill until sometime later this year.  As we have previously reported, ¹ one correction under consideration could have a direct impact on Altaba Inc. (trades over‐the‐counter as 021ESC017) (Altaba)—limiting the application of so‐called downward attribution—to the tune of a couple hundred million dollars, if not more. ² 

Stepping back a bit, TCJA removed Internal Revenue Code Section 958(b)(4), causing the constructive stock ownership attribution rule in Section 318(a)(3) to turn back on for purposes of determining whether there is a controlled foreign corporation (CFC).  The effect of the TCJA change is that foreign stock ownership of a parent is now more readily attributed down to a related U.S. subsidiary under the CFC rules, which impacts many tax provisions including the global intangible low‐taxed income (GILTI) rules of Section 951A, the Subpart F regime and information reporting requirements.

The result—which some say was inadvertent as language in the TCJA Conference Agreement ³ arguably indicates that Congress intended for the downward attribution change to only target a narrow set of circumstances, so‐called de‐control transactions ⁴ —is that there are a lot more CFCs now.  De‐control transactions were viewed as post‐inversion avoidance transactions, occurring after a U.S. multinational was acquired by a foreign corporation enabling the profits of the group’s foreign subsidiaries to escape the U.S. tax net.  If the new foreign parent acquires enough stock of the foreign subsidiaries (reducing the U.S. shareholder’s ownership), then they will no longer be considered CFCs for U.S. tax purposes, avoiding Subpart F, for example.  But turning back on downward attribution broadly creates CFCs where there was never the risk of a de‐control transaction.  This is problematic for many taxpayers, and members of Congress and their staffs are being actively lobbied to retroactively repeal the broad imposition of downward attribution—activity that we are following very closely. ⁵ 

But Altaba, as it turns out, may have actually benefitted from this broad downward attribution change and therefore may not want such retroactive repeal.  TCJA’s change to the constructive ownership rules as applied to Altaba ⁶ appears to have given rise to GILTI inclusions ⁷ related to Alibaba Group Holding Limited (NYSE:  BABA) (Alibaba) that increased the tax basis Altaba had in its Alibaba shares (reducing its taxable gain) while increasing the amount of foreign tax credits (FTCs) Altaba got to pull up from Alibaba, potentially zeroing out any actual GILTI tax. ⁸  This change meant that Altaba was effectively treated as a U.S. shareholder of a CFC even though it does not actually have control over Alibaba’s foreign subsidiaries.

How much of a benefit are we talking about?  It is possible that Altaba may have increased its basis step‐up in its Alibaba stake by nearly $1 billion (if not much more) ⁹ under the assumption that downward attribution applied and Alibaba’s foreign subsidiaries were CFCs to Altaba.  If Alibaba’s foreign subsidiaries are not CFCs to Altaba, then Altaba would not have a GILTI inclusion and it would lose the related basis step‐up, costing Altaba about $215 million ¹⁰ (although given the lack of specificity in Altaba’s disclosures on these points, this estimate could well be too conservative).

So what will Congress do about this?  While the downward attribution fix appears to have risen to the top of a sought‐after technical corrections package, along with the so‐called retail glitch, ¹¹ such a package may not get through Congress until the lame‐duck period following the elections.  Even then, Democrats will likely only go along with “addressing all the remaining TCJA corrections in one fell swoop” if they are able to secure an expansion to certain refundable tax credits (namely, the earned income tax credit and the child tax credit). ¹² 

In September, legislation was introduced by House Ways and Means Committee member John Lewis, D‐Ga., ¹³ and now‐retired Sen. Johnny Isakson, R‐Ga., ¹⁴ that would specifically address this issue on a retroactive basis, restoring Section 958(b)(4), so that downward attribution would once again be generally turned off, and adding new Section 951B to apply only in cases where the U.S. shareholder would end up actually controlling (over 50 percent) the CFC that is only a CFC by way of imposition of downward attribution (which Altaba would not satisfy).

Oftentimes, interests seeking a technical correction will get language drafted and introduced as a separate bill to help generate support and momentum for whatever is ultimately included in a larger package.  But the word on the street is that retroactivity is turning out to be somewhat controversial for the very reason that some taxpayers have benefitted from the change and presumably would prefer for any reversal to be prospective.  One side argues that retroactively reinstating Section 958(b)(4) would be unconstitutional given that Congress “plainly, unambiguously repealed [it] in its entirety and without limitation, caveat, or restriction.” ¹⁵  While the other side takes the position that “[b]y its nature, a technical correction has the same effective date as the underlying provision to which it relates (i.e., retroactive as if included in the original legislation to which the correction relates)” and that “[a] taxpayer that has ignored stated Congressional intent and relied on an inappropriately broad interpretation of [TCJA] to achieve an unintended windfall would have no recourse under the Due Process Clause to preserve such windfall.” ¹⁶ 

Regardless of how this shakes out, this uncertainty is something that Altaba should likely account for as it works to wind up its affairs and ultimately dissolve.  We would expect that Congress should have made up its mind about the repeal of downward attribution—and whether any such change would be retroactive or prospective—by the time Altaba’s statutorily prescribed three‐year winding up period ¹⁷ has run (which is set to occur on or around October 4, 2022, absent an extension).  In the meantime, we expect Altaba will likely identify this as a potential liability that will have to be reserved for ¹⁸ —at a cost of hundreds of millions of dollars—and that such funds will not be available for shareholder distribution until resolution.

^{[1] The report, “Could Alibaba Be GILTI of Owning a U.S. Subsidiary?  If So, There Is a Potential Unexpected Tax Benefit for Altaba” (Jan. 31, 2019), is appended.  In that report, which used a different methodology, we estimated that Altaba could be facing a GILTI inclusion (and basis increase in its Alibaba shares) of about $1.76 billion.}

^{[2] A recent indicative market price for Altaba was about $21.85 per share (to sell, $21.90 to buy), and as Altaba has about 520 million shares outstanding, a $215 million tax hit to Altaba (explained on page 2) works out to about 41 cents per share.}

^{[3] The Senate version of the change was “not intended to cause a foreign corporation to be treated as a controlled foreign corporation with respect to a U.S. shareholder as a result of attribution of ownership under section 318(a)(3) to a U.S. person that is not a related person (within the meaning of section 954(d)(3)) to such U.S. shareholder as a result of the repeal of section 958(b)(4),” according to the TCJA Conference Report, which cites Committee Print, Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Prt. 115‐20, (December 2017), p. 378, as reprinted on the website of the Senate Budget Committee, available at https://www.budget.senate.gov/taxreform.  Further, according to the Conference Report, “In adopting this provision, the conferees intend to render ineffective certain transactions that are used . . . as a means of avoiding the subpart F provisions.  One such transaction involves effectuating ‘de‐control’ of a foreign subsidiary, by taking advantage of the section 958(b)(4) rule that effectively turns off the constructive stock ownership rules of 318(a)(3) when to do otherwise would result in a U.S. person being treated as owning stock owned by a foreign person.  Such a transaction converts former CFCs to non‐CFCs, despite continuous ownership by U.S. shareholders.”}

^{[4] Although IRS and Treasury issued guidance—Rev. Proc. 2019‐40 and REG–104223–18—that provides relief in certain cases where a U.S. shareholder only constructively owns stock of a CFC because of downward attribution, the relief is viewed as too narrow to address the concerns of many that the full repeal of Section 958(b)(4) was too broad (https://www.irs.gov/pub/irs‐ drop/rp‐19‐40.pdf; https://www.govinfo.gov/content/pkg/FR‐2019‐10‐02/pdf/2019‐20567.pdf).}

^{[5] See also the Senate’s Lobbying Disclosure Act database.}

^{[6] Before TCJA, Alibaba was not a CFC.  But now it appears that, because Alibaba may apparently own 50 percent or more of a U.S. subsidiary, downward attribution could have the effect of treating that Alibaba U.S. subsidiary as constructively owning everything Alibaba owns (including all of the stock of the other Alibaba foreign entities in the group).  The result is that Alibaba’s foreign subsidiaries may be treated as CFCs with respect to Alibaba’s 10‐percent U.S. shareholders (at one time, Altaba).}

^{[7] The GILTI provision imposes a tax (of about 10.5%) on certain so‐called intangible income earned in a foreign country (which, given the new quasi‐territorial system of taxation would otherwise generally be tax‐free) if earned by a foreign corporation that is controlled by a U.S. corporation.  If Alibaba’s foreign subsidiaries were CFCs, then Altaba (which was, at one time, a 10% U.S. shareholder of Alibaba) would be required to pick up its share of their GILTI and pay 10.5% tax on that income.  Such an income inclusion would give rise to an increase in Altaba’s tax basis in its Alibaba shares.  So, every dollar of GILTI brings about a net benefit, as an effective 10.5% GILTI tax rate is less than the 21% corporate income tax rate on capital gains (although we understand Altaba may have enough FTCs to entirely offset the tax).}

^{[8] In various discussions with Altaba’s investor relations, it was communicated that any GILTI inclusion might not result in a tax hit to Altaba because it may have enough FTCs to fully offset the inclusion and that the related GILTI inclusion (causing a basis step‐up) could end up being fairly large in Altaba’s case (between $500 million and over $1 billion).  (For our estimates, see the next footnote.) In a prior report, before new figures were released in May, we estimated that the annual inclusion (and associated step‐up) could be as high as $1.76 billion (“Could Alibaba Be GILTI of Owning a U.S. Subsidiary?  If So, There Is a Potential Unexpected Tax Benefit for Altaba” (Jan. 31, 2019)).}

^{[9] Altaba effectively reported a $943 million basis increase in its Alibaba stake between the reporting period that ended Sept. 30, 2018 as compared to the reporting period that ended March 31, 2019 (at both times, Altaba owned 283,315,416 shares of Alibaba, in some combination of ordinary shares and American depositary shares).  As of Sept. 30, 2018, Altaba reported “Deferred tax liabilities on unrealized appreciation” of about $9.939 billion, which, based on Altaba’s historical assumptions regarding the effective federal and state taxes (a combined rate of 22.8%) estimated to be due on the gain in those shares, reflects taxable gain of $43.592 billion.  At that time, Altaba reported that the value of its affiliated investments (its Alibaba stake) was about $46.682 billion, reflecting an assumed tax basis in the shares of $3.09 billion.  (https://www.sec.gov/Archives/edgar/data/1011006/000119312518313038/d639883dex991.htm)}

^{However, as of March 31, 2019, Altaba reported “Deferred tax liabilities on unrealized appreciation” of about $10.866 billion, which reflects taxable gain of $47.658 billion.  At that time, Altaba reported that the value of its affiliated investments was about $51.691 billion, reflecting an assumed tax basis in the shares of $4.033 billion.  The increase in tax basis over this period was therefore $943 million.  As this is an imperfect methodology for estimating Altaba’s GILTI inclusions, it is very possible that they exceeded $1 billion.  (https://www.sec.gov/Archives/edgar/data/1011006/000119312519136948/d738500dex991.htm)}

^{[10] $943 million x 22.8% = $215 million.}

^{[11] Congress wanted to incentivize businesses (including retail and restaurants) to make improvements to their property.  To do that, it intended for improvements to the interior of a nonresidential building to be eligible for immediate expensing under the Section 168(k) bonus depreciation provision.  However, there was a glitch whereby the statute as currently written provides that such improvements should be depreciated over 39 years and therefore are ineligible for bonus depreciation.  Legislation is required to fix this glitch.}

^{[12] See Politico’s Morning Tax from Feb. 6, 2020 (https://www.politico.com/newsletters/morning‐tax/2020/02/06/cloudy‐ forecast‐for‐tax‐law‐fixes‐785113).}

^{[13] H.R. 4509 (https://www.congress.gov/bill/116th‐congress/house‐bill/4509), which, like its companion bill in the Senate (S. 2589), would “amend the Internal Revenue Code of 1986 to restore the limitation on downward attribution of stock ownership in applying the constructive ownership rules to controlled foreign corporations.”}

^{[14] S. 2589 (https://www.congress.gov/bill/116th‐congress/senate‐bill/2589).}

^{[15] Kies, Kenneth J., Nov. 5, 2019, letter to the editor of Tax Notes entitled “Article Misrepresents Congressional Intent on Section 958 Changes,” Tax Notes Today International.}

^{[16] Femia, Rocco V. and Marc J. Gerson, Dec. 31, 2018, letter to leaders of the Senate Finance Committee and House Ways and Means Committee as published in Tax Notes Today Federal.}

^{[17] The dissolution period will last at least three years from the time the certificate of dissolution is filed (as required by Delaware General Corporate Law (DGCL)), but the period can be extended either at the direction of the judge or automatically for the resolution of pending claims.}

^{[18] A proposed retroactive change in the tax law adverse to Altaba might constitute a future/uncertain claim (DGCL Section 280(c)(3)), a claim that has not yet arisen but is likely to become known to the corporation or successor entity within 5 years after the date of dissolution.  Altaba would likely have an obligation to account for such a liability in its Section 280 report and the assigned judge would then generally decide whether to allow Altaba to release it for distribution to shareholders or continue to hold it in reserve until it is resolved.}