1. Identifying stewardship expenses
The final FTC regulations continue to use the definition of stewardship expenses provided in the Section 482 regulations. Under this definition, stewardship expenses are U.S. expenses that duplicate expenses incurred by a related entity and that are incurred primarily to protect a taxpayer’s investment in another entity or facilitate the taxpayer’s compliance with its own reporting, legal, or regulatory requirements.
It can be difficult to distinguish between related-party transaction expenses that are properly classified as stewardship expenses and other related-party transaction expenses, such as controlled expenses or supportive expenses. The main difference is that stewardship expenses generally do not provide a benefit to the related party, but determining when and if a benefit is provided to a related party is a fairly subjective exercise.
2. Impact on foreign tax credit usage
U.S. expenses are allocated to various categories or “baskets” of income to determine the limitation, if any, on the amount of FTC a taxpayer can claim. The Tax Cuts and Jobs Act of 2017 (TCJA) created a new global intangible low-taxed income (GILTI) basket to compute the FTC limitation related to GILTI inclusions. Under the final FTC regulations, stewardship expenses are allocated and apportioned to the GILTI basket. As a result, the FTCs available to reduce the U.S. tax on the GILTI inclusion may be limited and the incremental U.S. tax cost of a taxpayer’s GILTI inclusion may increase, even where the local effective tax rate is more than the theoretical breakeven point of 13.125%, the point at which U.S. taxes are entirely offset by FTCs. The incremental U.S. tax on GILTI created by allocation and apportionment of stewardship expenses to the GILTI FTC limitation could be material to many taxpayers.
Additionally, the preamble to the final FTC regulations clarifies that stewardship expenses can be incurred with respect to all entities, including disregarded entities. Because U.S. expenses related to disregarded entities are allocated to the foreign branch basket, the same apportionment principles similarly could affect the limitation of FTCs applied to the foreign branch basket.
3. New prescribed method
The final FTC regulations not only expand the types of income to which stewardship expenses are allocated and apportioned, they also provide a new apportionment method for those expenses. Taxpayers now are required to apportion stewardship expenses based on assets. For controlled foreign corporations (CFCs), the relative values of CFC stock held by a taxpayer serve as the basis for apportionment. However, for branches and other subsidiaries included in the taxpayer’s consolidated return, the values of the subsidiaries’ assets serve as the basis for apportionment rather than the value of their stock. Consequently, the apportionment of stewardship expenses will mirror, with some potential adjustments, the apportionment of interest expense many taxpayers already perform. Computing the tax basis of stock under the new regulations likely will be difficult and time-consuming, so taxpayers should begin the process now to understand what adjustments to their apportionment factor will be required.
4. Applicability date
Though originally proposed to be applicable to tax years beginning on or after Dec. 17, 2019, the final FTC regulations generally are applicable to tax years beginning on or after Dec. 31, 2019. While the additional time generally was good news for taxpayers, many already had moved down the path of assessing the impact or even filing consistent with the proposed rules for their 2019 tax year. Taxpayers that did not analyze how 2019 expenses would be allocated under the stewardship provisions of the proposed regulations should consider working with their tax advisers now to determine how the final FTC regulations affect 2020 stewardship expenses to avoid the inevitable rush that comes later in the filing season.
5. Ancillary benefits
Working through the exercise of identifying, allocating, and apportioning stewardship expenses under the final FTC regulations can yield potentially positive ancillary benefits. Planning proactively for FTC usage can provide important insights for transfer pricing and cash flow planning. FTC planning also can lead to positive foreign-derived intangible income (FDII) planning opportunities. The interconnection of these rules should not be ignored. Taxpayers proactively should use the expense identification exercise to comply with the final FTC regulations as an opportunity to drive benefit through a more holistic approach to international tax planning.
