On Dec. 4, the U.S. Department of the Treasury and the IRS released proposed regulations that provide computational rules for the foreign tax credit (FTC). The regulations include much-anticipated guidance on changes made by the Tax Cuts and Jobs Act (TCJA) – most notably the global intangible low-taxed income (GILTI) calculation and FTC application.
The proposed regulations do not make an exception for GILTI from the allocation and apportionment of expenses when calculating the FTC available to offset U.S. tax on a GILTI inclusion. Consequently, many U.S. taxpayers will find they have significant liability related to GILTI notwithstanding relatively high tax rates outside the United States.
Following are highlights of the proposed regulations.
The proposed regulations do not make an exception for GILTI from the allocation and apportionment of expenses when calculating the FTC available to offset U.S. tax on a GILTI inclusion. Consequently, many U.S. taxpayers will find they have significant liability related to GILTI notwithstanding relatively high tax rates outside the United States.
Following are highlights of the proposed regulations.
Allocation and apportionment of deductions and the calculation of taxable income for purposes of Section 904(a)
- A 50 percent GILTI deduction is treated as exempt income for purposes of allocating and apportioning expenses to GILTI and will have a similar impact on the basis of controlled foreign corporation (CFC) stock for the purpose of apportioning interest expense.
- The definitions of “exempt income” and “exempt assets” are revised to clarify that income or assets are treated as exempt (or partially exempt) only to the extent that the income or the income from the assets is, or is treated as, exempt, excluded, or eliminated on a taxpayer’s tax return for a given year.
- A one-time exception to the five-year lock on research and experimentation (R&E) deduction apportionment is available to taxpayers for their first taxable year beginning after Dec. 31, 2017.
- Treasury and IRS expect to re-examine the existing approaches for allocating and apportioning expenses, including interest, R&E, stewardship, and general and administrative expenses, as well as to re-examine the CFC netting rule.
FTC limitation under Section 904
- Two new separate foreign credit limitation categories are added: foreign branch category income and Section 951A (GILTI) category income.
- An exception permits taxpayers to assign unused foreign taxes in the pre-2018 separate category for general category income to the post-2017 separate category for foreign branch category income to the extent they would have been assigned to that separate category if the taxes had been paid or accrued in a post-2017 taxable year.
- Transition rules are provided for recapturing overall foreign loss (OFL) or separate limitation loss (SLL) across the effective date of, and additional separate limitation categories added by, the TCJA.
Treatment of subsequent reductions in tax in applying Subpart F high-tax exception
- When foreign income taxes paid or accrued by a CFC are reasonably certain to be returned to a shareholder upon a subsequent distribution to the shareholder, the foreign income taxes are not treated as paid or accrued for purposes of the high-tax exception under Section 954(b)(4).
Deemed paid taxes under new Sections 960 and 78
- Generally, current year taxes are allocated and apportioned to income groups at the CFC level based on a CFCs contribution to aggregate in that income group.
- Each CFC is required to establish a separate annual previously taxed earnings and profits account (annual PTEP account) for earnings and profits attributable to Subpart F or GILTI inclusions for the taxable year. The account serves as a mechanism for tracking the different categories of Subpart F income through ownership chains and associating foreign taxes paid, accrued, or deemed paid by a CFC with distributions of previously taxed earnings and profits.
- Section 959 guidance on distributions of previously taxed earnings and profits will be issued in the future.
Effect of Section 965(n) election not to apply net operating losses to inclusion under Section 965
- Ordering rules are provided to coordinate the election’s effect on Section 172 with the computation of the FTC limitations under Section 904.
Conforming amendments
- Temporary regulations for allocation and apportionment of deductions are being re-proposed. Treasury and the IRS will remove the corresponding temporary regulations upon finalization of the proposed regulations.
- Treasury and the IRS intend to make conforming amendments to the examples throughout the FTC regulations upon finalization of the proposed regulations.
