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CARES Act Has Negative ‘Knock-On' Effects for International Tax

Posted on Mar. 30, 2020

Practitioners are discovering that business-friendly changes to net operating losses and interest deduction limitations in legislation responding to the coronavirus economic crisis could hurt multinationals because of interactions with other international provisions.

“Unfortunately, it seems that the knock-on effects are mainly negative,” Jose Murillo of EY said on a firm webcast March 27. “Many would say [that’s] part of the system that was designed as part of the Tax Cuts and Jobs Act, but now with this downturn, there are many more taxpayers that are going to be subject to these negative rules and there’s a lot of focus being placed on it.”

Changes made to the TCJA's limitations on NOLs and section 163(j) interest deductions in the Coronavirus Aid, Relief, and Economic Security (CARES) Act (H.R. 748) are designed to increase liquidity for businesses during the pandemic. The bill was passed unanimously by the Senate March 25 and by voice vote in the House March 27 before being signed by President Trump.

The bill relaxes NOL limitations to allow for losses in tax years 2018 through 2020 to be carried back up to five years while temporarily repealing the 80 percent NOL limitation and instead allowing a full income offset.

But companies examining the carrybacks in post-TCJA years 2019 and 2020 will have to consider the provision’s impact on the section 250 deduction, according to Murillo.

“That statute was designed with a taxable income limitation, so where there is a taxable income limitation, the deduction is reduced. So if the carryback is wiping out entirely the taxable income in the carryback year, then there is no section 250 deduction,” Murillo said. “In effect, the statute forces you to use a very valuable attribute, an NOL deduction, and takes away a deduction that would have resulted in a much lower amount of tax being paid on that income. There’s negative tax rate arbitrage.”

Section 250 gives a deduction to reduce the tax rate on global intangible low-taxed income and foreign-derived intangible income. But the GILTI inclusion amount and FDII eligible for the deduction are reduced proportionately if a taxpayer doesn’t have U.S. taxable income, resulting in a higher tax rate.

Future Fix? Don’t Count on It

Addressing whether the interaction may be rectified in future expected coronavirus legislation, Marjorie Rollinson of EY said she doesn't think the Senate is sympathetic to changing the NOL rules to avoid the negative impact with section 250.

“My understanding is that they . . . think that it is just how the [bill] works, that the choice was made back in [the] TCJA,” Rollinson said.

Gary Gasper of EY added that the issue may be viewed through a partisan lens by Democrats, who might not be willing to help businesses when they are more focused on individuals.

Murillo also flagged a potential liability under the base erosion and antiabuse tax that could result from the NOL changes, because a lower regular tax liability increases the likelihood of a BEAT liability.

The BEAT operates as a minimum tax — 5 percent for 2018, 10 percent for 2019-2025, and 12.5 percent thereafter — on related-party payments. It is calculated on the excess of modified taxable income over a taxpayer’s regular tax liability, reduced by some types of credits. It applies to corporations with annual gross receipts exceeding $500 million whose base erosion percentage is 3 percent or higher. Base erosion percentage is calculated as the base erosion tax benefits divided by most deductions.

The legislation also modifies the net business interest deduction limit from 30 percent of adjusted taxable income to 50 percent for tax years beginning in 2019 or 2020. This change will result in negative interactions similar to those seen with the NOL changes, Murillo said, because greater interest expense being deducted will make it more likely that taxable income limitations “become relevant.”

As to whether the government might be willing to offer relief on any of the interactions, Murillo noted that many of the issues were brought to Treasury’s attention when it was drafting BEAT and GILTI rules. Rollinson, who until last year served as IRS associate chief counsel (international), said she doesn't think Treasury is likely to address the issues.

“I think that they might be very hesitant to take time away from trying to get the remaining TCJA regs they need to get out to do that because it would just be for a temporary measure,” Rollinson said. “They would be hoping that if Congress wanted to grant some relief, that Congress would do that.”

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