CARES Act NOL Modifications and International Tax Considerations

| 4/23/2020
CARES Act NOL Modifications and International Tax Considerations

This is the second in a series of Tax News Highlights articles covering international taxes and what companies need to consider during and after the current global pandemic.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) enacted on March 27 provides economic relief and helps generate liquidity for companies negatively affected by the COVID-19 pandemic. A key provision of the act involves Section 172(b)(1) net operating loss (NOL) carrybacks and carryforwards. The CARES Act modifies the NOL rule to allow for a five-year carryback period for NOLs incurred for tax years beginning after Dec. 31, 2017, but before Jan. 1, 2021.

This change potentially allows taxpayers to use NOLs generated in years with a 21% tax rate to offset taxable income from years that had a 35% tax rate. The interaction of these NOL carrybacks with provisions of the Tax Cuts and Jobs Act of 2017 (TCJA) – such as the Section 965 transition tax, Section 250 foreign derived intangible income (FDII) deduction, global intangible low-taxed income (GILTI) calculation, and Section 59(A) base erosion and anti-abuse tax (BEAT) – should be carefully analyzed to avoid unintended consequences. Taxpayers with post-2017 NOLs can waive NOL carrybacks entirely or elect to waive the carryback solely with respect to amounts that would go back to a year with a Section 965 inclusion amount.

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Section 965 transition tax considerations

Under the TCJA, the Section 965 transition tax taxed deferred foreign income in an effort to transition the U.S. to a territorial system of taxation for corporations. Under the applicable TCJA provisions, taxpayers subject to the transition tax were permitted to exclude NOLs in determining their transition tax inclusion under Section 965(n). Taxpayers also could elect to pay the transition tax over a back-loaded eight-year period by making installment payments each year under Section 965(h).

The transition tax generally is not affected by an NOL carryback to the year in which the transition tax was imposed. The CARES Act provides that taxpayers are deemed to make the election under Section 965(n) with respect to the NOL carryback. However, the carryback might have an indirect impact on other tax attributes, such as freeing up foreign tax credits to be carried forward or creating an overall domestic loss carryforward. Although changes to these attributes do not change the calculation of the transition tax, they can affect the unpaid transition tax liability remaining after the application of foreign tax credits. For taxpayers that made the election under Section 965(h) to pay the tax over eight years, any overpayment caused by a change in these tax attributes or by a reduction in regular tax liability as a result of the carryback will be applied against any deferred transition tax liability and will not result in a refund under current IRS procedures.

FDII and GILTI considerations

Section 250 allows U.S. corporate taxpayers a deduction equal to 37.5% of their FDII. FDII was implemented to be the carrot to the GILTI stick. The purpose of GILTI is to tax currently deemed intangible income of controlled foreign corporations. In addition to the FDII deduction, Section 250 allows corporations a deduction equal to 50% of a corporation’s GILTI inclusion. However, under Section 250(a)(2), if the sum of FDII and GILTI income exceeds the taxable income of the domestic corporation, the deduction can be fully reduced to zero and the taxpayer no longer will qualify for a Section 250 deduction. The NOL deduction may effectively reduce or eliminate the Section 250 deduction for FDII or GILTI in certain circumstances.

BEAT considerations

BEAT is a newly enacted provision under the TCJA that affects U.S. corporations with average gross receipts of $500 million or more and base erosion percentage, as defined under the TCJA, greater than 3%. BEAT’s main objective is to deter corporations from reducing their tax liability through foreign related-party transactions by assessing a minimum tax on the taxpayers’ modified taxable income without the benefit of certain related-party deductions. While an NOL reduces a taxpayer’s regular tax liability, it does not reduce modified taxable income, thus reducing the benefit of an NOL carryback. Therefore, taxpayers need to forecast if an NOL carryback to 2018 or later years will create a BEAT liability or if electing to forgo certain related-party deductions as permitted under the proposed regulations maximizes their NOLs.

Now what?

While the CARES Act NOL modifications appear beneficial on many fronts and allow access to refunds of previously inaccessible tax payments, taxpayers with international transactions must carefully model how the options available interact with the international tax provisions enacted by the TCJA to maximize all of their tax attributes.

Want more insights on addressing coronavirus-related challenges?
Go to the Crowe COVID-19 resource center for more analysis and updates.

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John Kelleher - Large
John Kelleher
Partner, Tax