Business Coalition Wants Proposed FTC Regs to Address Foreign Branch Income

February 18, 2020

CC:PA:LPD:PR (REG–105495–19)
Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington, DC 20044.

Re: Comments on proposed regulations providing guidance on foreign tax credits (NPRM REG–105495–19)

Dear Sir or Madam:

The Alliance for Competitive Taxation (“ACT”) is a coalition of leading American companies from a wide range of industries that supports a globally competitive corporate tax system that aligns the United States with other advanced economies.

Attached are ACT's comments on the proposed regulations providing guidance related to the foreign tax credit (“FTC”), including guidance implementing changes made by the Tax Cuts and Jobs Act (“TCJA”). We recognize and commend the extraordinary efforts of Treasury and IRS staff in issuing TCJA guidance in a timely and comprehensive manner.

We appreciate your consideration of these comments. ACT representatives welcome future discussion of these comments with your staff.

Yours sincerely,

Alliance for Competitive Taxation

cc:
L. G. “Chip” Harter, Deputy Assistant Secretary (International Tax Affairs), U.S. Treasury Department
Douglas Poms, International Tax Counsel, U.S. Treasury Department
Karen J. Cate, Attorney-Advisor, ACC(I) Internal Revenue Service
Jeffery Cownac, Attorney-Advisor, ACC(I) Internal Revenue Service
Jeffrey Parry, Attorney-Advisor, ACC(I) Internal Revenue Service
Larry Pounders, Attorney-Advisor, ACC(I) Internal Revenue Service

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COMMENTS BY ALLIANCE FOR COMPETITIVE TAXATION ON PROPOSED FOREIGN TAX CREDIT REGULATIONS

I. INTRODUCTION

This document sets forth ACT's comments on the second round of proposed regulations relating to the foreign tax credit (the “Proposed Regulations”), including guidance implementing the TCJA (NPRM REG–105495–19).

II. COMMENTS RELATING TO CERTAIN ASPECTS OF THE PROPOSED REGULATIONS

1. Interest expense allocated and apportioned to foreign branch income

Proposed Regulations

The Proposed Regulations do not address the allocation and apportionment of expenses to foreign branch income. However, final regulations addressing the foreign tax credit request that comments related to the allocation and apportionment of expenses to foreign branch income be submitted as part of the comment process for the Proposed Regulations.

Treasury Explanation

In the preamble to the final foreign tax credit regulations (originally proposed December 7, 2018), Treasury and IRS request comments to the allocation and apportionment of expenses to foreign branch category income. The preamble indicates that Treasury and the IRS are considering a method of allocating and apportioning interest expense to the foreign branch basket using the principles of Treas. Reg. § 1.882-5.

ACT Recommendation

ACT agrees with Treasury and the IRS that the principles of Treas. Reg. § 1.882-5 with respect to computing interest expense on a separate company basis and taking account of the terms (e.g., currency) of the debt reflected on the books of a branch should apply to apportion interest expense to foreign branch basket income in the case of regulated financial institutions.

Reasons for ACT Recommendation

While historically Treas. Reg. § 1.882-5 has not been used to determine the FTC limitation, it is appropriate to do so for foreign branch income of regulated financial institutions because Treas. Reg. § 1.882-5 is designed to deal with branches, i.e., subdivisions of regarded entities. The branch basket is the only basket in the history of section 904(d) whose content is based on the profits of a branch (i.e., a subdivision of a regarded person).

Although originally drafted to address apportionment of interest expense to U.S. branches of foreign taxpayers, Treas. Reg. § 1.882-5 has previously been applied in an outbound context, specifically, to determine interest expense apportioned to certain separate units of domestic corporations under the dual consolidated loss (“DCL”) rules.¹ Treas. Reg. § 1.882-5 has worked well for financial institutions with a minimum of controversy for decades. Historically, financial institutions have been the businesses that most commonly operate in branch form. Therefore, Treas. Reg. § 1.882-5 seems particularly well suited to apportioning interest expense to branches of U.S. regulated financial institutions. Furthermore, Treas. Reg. § 1.882-5 accounts for, among other things, the interest expense on the books and records of U.S. branches, so it is compatible with the final regulations' general reliance on foreign branches' books and records. As under the DCL rules, the principles of Treas. Reg. § 1.882-5 can be easily adapted to allow a U.S. person to allocate a portion of its interest expense to one or more foreign branches.²

The baseline for apportioning interest expense under the Adjusted U.S. Booked Liability (“AUSBL”) method of Treas. Reg. § 1.882-5 is the interest expense paid or accrued on the taxpayer's third-party liabilities which are reflected on the books of the branch and incurred in connection with its U.S. businesses. This amount is adjusted to reflect interest expense on an amount of its “U.S. connected liabilities,” which is equal to the taxpayer's U.S. assets multiplied by a fixed liability to asset ratio or to the ratio of liabilities to the assets of the entire legal entity. The purpose of this rule is to prevent possible abuses: For example, leveraging a U.S. branch more than its home office to reduce the branch's taxable income in the United States via increased interest expense deductions.

Like section 864(e), Treas. Reg. § 1.882-5 treats money as fungible. If U.S.-booked liabilities exceed U.S.-connected liabilities, the foreign corporation's U.S. interest expense deduction will be equal to the interest expense it incurs on its U.S. booked liabilities, multiplied by the ratio of its U.S.-connected liabilities to its U.S.-booked liabilities. However, if the taxpayer's U.S. booked liabilities are less than its U.S.-connected liabilities, the interest expense on the former is increased by an amount equal to the average interest rate on the U.S. dollar-denominated liabilities which are not U.S. booked liabilities, multiplied by that excess.

Thus, while the AUSBL method of Treas. Reg. § 1.882-5 takes into account the interest expense on third-party liabilities of U.S. branches that are reflected on their books, the foreign corporation adjusts that interest expense under the assumption that the leverage of its U.S. branches should be equal to either a fixed prescribed ratio or the leverage of the entire legal entity. Thus, the AUSBL method generally treats debt and interest expense as fungible, similar to section 864(e), with the fixed prescribed ratio providing a rough estimate for administrative convenience.³ However, unlike section 864(e), Treas. Reg. § 1.882-5 relies on foreign branches' books and records, making it consistent with the overall regulatory regime governing foreign branch income.

As an alternative to the AUSBL method, foreign corporations can elect to apply the separate currency pools method, whereby the U.S. interest expense deduction is based on the same U.S. leverage ratio used in the AUSBL method, but the interest rate incurred on funding of U.S. assets is determined based on the currencies in which the taxpayer holds its assets.⁴ For each such “currency pool,” the interest rate is deemed to equal the average rate on the corporation's liabilities denominated in that currency.⁵ Providing taxpayers with this election would be consistent with ACT's recommendation that the principles of Treas. Reg. § 1.882-5 be applied taking account of the terms, such as currency, of the booked debt.

Regulatory Authority for Recommendation

Section 904(d)(2)(J) does not include provisions for determining the “business profits” of a United States person that are attributable to a foreign branch. Instead, it instructs the Secretary to establish rules that make that determination. As a result of Congress's express delegation of regulatory authority, Treasury has wide latitude to write rules that determine business profits and attribute any gross income and expense items that make up those business profits to a foreign branch.

2. Other expenses allocated and apportioned to foreign branch income Proposed Regulations

The Proposed Regulations do not address the allocation and apportionment of expenses to foreign branch income. However, final regulations addressing the foreign tax credit request that comments related to the allocation and apportionment of expenses to foreign branch income be submitted as part of the comment process for the Proposed Regulations.

Treasury Explanation

N/A

ACT Recommendation

ACT recommends other expenses (i.e., other than interest and R&E expense) that are reflected on a foreign branch's books and records be allocated and apportioned to the foreign branch foreign tax credit basket (the “foreign branch basket”) in the same way that the final regulations assign gross income reflected on a branch's books and records to the foreign branch foreign tax credit basket.

Reasons for ACT Recommendation

Assigning gross income to the foreign branch foreign tax credit basket only does half the job of accurately determining the branch's business profits. As discussed above, ACT agrees with the approach taken by the final regulations with respect to gross income items — looking to those items on the branch's books and records — and believe it should be expanded to also account for expense items reflected on a foreign branch's books and records. The application of Treas. Reg. § 1.882-5 to interest expense is consistent with this approach because, as discussed above, its baseline for apportioning interest expense on regarded liabilities is those liabilities reflected on the branch's books and records.

Regulatory Authority for Recommendation

Section 904(d)(2)(J) does not include provisions for determining the “business profits” of a United States person that are attributable to a foreign branch. Instead, it instructs the Secretary to establish rules that make that determination. As a result of Congress's express delegation of regulatory authority, Treasury has wide latitude to write rules that determine business profits and attribute any gross income and expense items that make up those business profits to a foreign branch.

3. Allocation and apportionment of research and experimentation expenses for Foreign Derived Intangible Income (“FDII”) purposes (Prop. Reg. § 1.250(b)-1(d)(2)(i))

Proposed Regulations

The Proposed Regulations do not address exclusive apportionment of research and experimentation (“R&E”) expense for purposes of determining a taxpayer's FDII.

Treasury Explanation

The preamble to the Proposed Regulations provides that comments related to section 250 and Treas. Reg. § 1.861-17 were received during the comment period to the proposed section 250 regulations and will be considered when promulgating the final section 250 regulations.

ACT Recommendation

ACT recommends that for purposes of Prop. Reg. § 1.250(b)-1(d)(2)(i), if the majority of a taxpayer's R&E expense associated with a particular product category takes place in the United States, then 50 percent of the R&E expense related to such product category should be allocated and apportioned to gross non-foreign derived deduction eligible income (“non-FDDEI”)⁶, consistent with the recognition that such research is likely to bear a significant factual relationship to products sold to U.S. customers.

Reasons for ACT Recommendation

For purposes of section 904, exclusive apportionment of R&E expense is provided in the regulations because Treasury and IRS determined that R&E activity is most beneficial to the geographic location in which the R&E occurred.⁷ This rationale was further clarified by Treasury in its report, “The Impact of the Section 861-8 Regulation on U.S. Research and Development”.⁸ In this regard, it is notable that these existing regulations justify exclusive apportionment for section 904 purposes by reference to the market for sales of the resulting product. Specifically, the regulations provide “research and experimentation often benefits a broad product category, consisting of many individual products, all of which may be sold in the nearest market but only some of which may be sold in foreign markets. Second, research and experimentation often is utilized in the nearest market before it is used in other markets and, in such cases, has a lower value per unit of sales when used in foreign markets.”⁹ ACT strongly agrees with these statements, which are consistent with the experience of many ACT members in R&E-intensive businesses.

Thus, not only do the existing regulations provide a justification for exclusive apportionment in the section 904 context, they provide an equally compelling economic rationale for applying exclusive apportionment in the calculation of FDII, by recognizing that R&E activity performed in the United States will often provide its greatest economic benefits to the company in the case of products sold (or services provided) to customers in the United States. Because transactions with U.S. customers will, by definition, give rise to non-FDDEI, exclusive apportionment of 50 percent of a taxpayer's domestic R&E expense to non-FDDEI is consistent with the policy for exclusive apportionment in the section 904 context.

Moreover, exclusive apportionment reduces the potential tax incentive for U.S. companies to shift R&E abroad. Promulgating an analogous exclusive apportionment rule in the section 250 context would provide symmetry in the R&E expense apportionment rules and, as in the section 904 context, would reduce the potential tax incentive to shift R&E abroad consistent with the policy goal of TCJA to make:

. . . the United States a better place to do business by eliminating incentives for companies to shift jobs, profits and intellectual property overseas, and by creating incentives for companies to both locate in America and bring economic activity back to America.¹⁰

If taxpayers are not provided the ability to exclusively apportion R&E expense to gross non-FDDEI, a disincentive to hold intangible property (“IP”) and conduct R&E in the U.S. would exist. The FDII and Global Intangible Low-Tax Income (“GILTI”) rules currently provide similar results for U.S. companies whether IP is held in the United States or abroad.¹¹ If R&E expense is not allocated to the GILTI foreign tax credit basket (consistent with the Proposed section 904 Regulations) and exclusive apportionment to non-FDDEI is not provided, then taxpayers would be incentivized to move IP and high-paying R&E jobs offshore or to not repatriate IP.

Research activities generate high paying jobs and have spillover effects that increase U.S. productivity and competitiveness.¹² ACT's recommendations regarding the allocation and apportionment of R&E expense for FDII purposes would increase the incentive for U.S. companies to perform R&E in the United States relative to foreign locations.

Regulatory Authority for Recommendation

Adopting ACT's recommendation is within Treasury's broad authority under section 250(c) to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section [250].”

4. Apportionment of R&E expense following termination of a cost sharing arrangement; Elimination of increased exclusive apportionment of R&E expense (Treas. Reg. § 1.861-17(b)(2))

Proposed Regulations

The Proposed Regulations do not contain any special rules addressing the appropriate apportionment of R&E expense in the case of the termination of a cost sharing arrangement (“CSA”) between a U.S. group member and a controlled foreign corporation (“CFC”). Further, the Proposed Regulations remove taxpayer's ability to exclusively apportion more than fifty percent of R&E expense to a geographic location if the taxpayer can demonstrate to the satisfaction of the Commissioner that the increase in exclusive apportionment can be factually supported.

Treasury Explanation

With respect to the elimination of increased exclusive apportionment, the preamble to the Proposed Regulations provides that the increased exclusive apportionment of Treas. Reg. § 1.861-17(b)(2) has rarely been used and, when it has been used, has led to “hard-to-resolve” disagreements between the Commissioner and taxpayers.

ACT Recommendation

ACT recommends retaining the current rule in Treas. Reg. 1.861-17(b)(2), which allows for greater than fifty percent exclusive apportionment to a geographic source should the facts support such an increase. If this recommendation is not adopted, ACT recommends that taxpayers be permitted to apportion more than fifty percent of R&E expense on the basis of sales of the U.S. group in the period immediately following the termination of a CSA previously entered into between a member of the U.S. group and a CFC.

Reasons for ACT Recommendation

ACT understands that rules governing the allocation and apportionment of R&E expense cannot be tailored to fit every conceivable taxpayer fact pattern. In some common fact patterns, however, a mechanical application of the rules may be inconsistent with the geographic location that benefits from the expense.

For example, a CFC may enter into a CSA with its U.S. parent to develop and license IP that the CFC holds directly and uses to support its sales to foreign customers. The preamble to the Proposed Regulations explains that, in this fact pattern, the sales or services gross receipts of the CFC are “excluded from the apportionment formula because the controlled [corporation] is not expected to benefit from the taxpayer's remaining R&E expenditures.” However, should the CSA be terminated (for example, due to the taxpayer restructuring in order to repatriate IP), all sales and services gross receipts from the CFC would be included in the apportionment fraction in the first year after the CSA is terminated. Upon termination of the CSA, the CFC generally would keep its pre-termination interests in cost-shared intangibles and provide products and services using a combination of those frozen-in-time intangibles and newly developed intangibles it licenses from the U.S. participant.

Under the Proposed Regulations, in the first year following the termination of the CSA, all of the foreign corporation's sales and services gross receipts would be included in the apportionment base. In virtually all cases, however, most of the sales and services income would be attributable to the use of IP owned by the CFC that was developed during the period the CSA existed Although the CFC may benefit from the U.S. corporation's post-termination R&E expenditures, it likely does so only to a very limited extent in the period immediately following the CSA termination.

Given the likelihood that taxpayers with existing CSAs may wish to restructure as a result of the TCJA, Treasury should consider addressing this and other similar fact patterns. Treasury could provide a specific rule applicable to CSA terminations. Alternatively, Treasury could retain an approach similar to Treas. Reg. § 1.861-17(b)(2), which allows taxpayers to exclusively apportion greater than fifty percent of R&E expense to the geographic location where the R&E took place, should the taxpayers' facts support such an increase. Under this approach, taxpayers that terminate a CSA could reduce the amount of R&E expense that is apportioned to foreign source income based on CFC sales in the years immediately following termination. As time passes, the taxpayer would be expected to reduce the percentage of R&E expense exclusively apportioned, ultimately getting back to the general fifty percent exclusive apportionment provided in the regulations. This rule would have the added benefit of applying to other similar fact patterns (e.g., where a CFC has purchased IP from a third party). The economic rationale for increased exclusive apportionment in the case of CSA terminations and other similar fact patterns is compelling, and ACT believes it is important to provide taxpayers the opportunity to apply increased exclusive apportionment where appropriate based on taxpayers' facts.

Based on the preamble, we understand Treasury's primary concern with existing Treas. Reg. 1.861-17(b)(2) is that the rule has led to “hard-to-resolve disputes” between taxpayers and the IRS. However, because Treasury also noted in the preamble that the rule is only rarely invoked, ACT presumes that the frequency of such disputes must also be rare. Accordingly, we believe that any administrative burden on taxpayers or the IRS is outweighed by the benefit of permitting taxpayers to utilize an alternative approach when the facts warrant it.

Regulatory Authority for Recommendation

Either approach outlined above is consistent with Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

5. R&E apportionment to the foreign branch foreign tax credit basket

Proposed Regulations

The Proposed Regulations apportion R&E expense on the basis of a taxpayers sales or services gross receipts that are assigned to the grouping to which the taxpayer's “gross intangible income” attributable to the sale or service is assigned.¹³

Treasury Explanation

The preamble to the Proposed Regulations states that R&E expenditures ordinarily give rise to deductions that are definitely related to gross intangible income and thus R&E expense should be apportioned against such income. Gross intangible income is defined as all gross income attributable, in whole or in part, to IP. However, gross intangible income does not include dividends or any amounts included under section 951, 951A, or 1293.¹⁴

ACT Recommendation

In circumstances where a foreign branch pays a royalty to its U.S. owner that is assigned to the general foreign tax credit basket (the “general basket”), ACT recommends that a portion of the sales earned by the branch should be attributed to the general basket for purposes of apportioning R&E expense.

Reasons for ACT Recommendation

When a foreign branch utilizes IP that is attributable to its U.S. owner in order to sell products, the royalty paid by the foreign branch to the U.S. owner, although generally disregarded, will nevertheless result in the reallocation of income from the branch basket to the general basket equal to the amount of the royalty.¹⁵ The sales or services gross receipts earned by the foreign branch, by contrast, would be assigned to the foreign branch basket. After application of the exclusive apportionment rule of Prop. Reg. § 1.861-17(c), taxpayers must apportion the remaining R&E expense based on the ratio of the gross receipts from the sale or leases of property.¹⁶ In this fact pattern, the Proposed Regulations do not provide a mechanism to allocate a portion of the foreign branch's sales to the gross intangible income (i.e., the royalty payment) in the general basket for purposes of apportioning R&E. As a result, all of the R&E expense associated with the branch's activities would be apportioned to the foreign branch basket. If the branch were, instead, a CFC, the (regarded) royalty payment would similarly be treated as gross intangible income, however, the CFC would have sales allocated to the general basket that gave rise to the gross intangible income, with the result that the foreign apportioned R&E expense would be apportioned to the general basket.

ACT recommends that Treasury permit taxpayers in the branch fact pattern described above to treat a portion of the branch sales as giving rise to gross intangible income in the general basket. The taxpayer's past experience with R&E should be considered in determining the amount of sales allocable to the general basket. If Treasury believes a mechanical rule is required in making this determination, ACT would be happy to work with the IRS and Treasury on developing such a rule.

Regulatory Authority for Recommendation

The allocation and apportionment of R&E currently is governed solely by regulation, namely, Treas. Reg. § 1.861-17. Treasury and the IRS can modify this regulation as they wish.

6. Definition of financial services entity (Treas. Reg. § 1.904-4(e)(1)(ii))

Proposed Regulations

The Proposed Regulations provide a definition of “financial services entity” (“FSE”) for section 904 purposes that is generally consistent with sections 954(h), 1297(b)(2)(B), and 953(e). Thus, any entity that is “predominantly engaged in the active conduct of a banking, insurance, financing, or similar business” and earns “income derived in the active conduct of a banking, insurance, financing, or similar business” will generally qualify as a financial services entity.

Treasury Explanation

The preamble to the Proposed Regulation explains the change in definition of FSE was provided to “promote simplification and greater consistency with other Code provisions that have complementary policy objectives.”

ACT Recommendation

ACT recommends that the existing definition of FSE for section 904 purposes, as defined in Treas. Reg. § 1.904-4(e), remain unchanged. If, contrary to this recommendation, Treasury decides to change Treas. Reg. § 1.904-4(e) to align more closely with the provisions of subpart F, then ACT believes the financial services entity group test should be expanded and other conforming changes must be made to ensure that entities or groups that are primarily engaged in insurance, lending, financing or similar activities are not inappropriately excluded from the definition. Although we have noted below some specific changes that we believe would be needed, we wish to emphasize that, even if these specific recommendations are adopted, the changes to Treas. Reg. § 1.904-4(e) contemplated by the proposed regulations are very likely to result in significant uncertainty with little or no simplification benefit for taxpayers or the IRS.

Reasons for ACT Recommendation

Existing Treas. Reg. § 1.904-4(e) generally defines a FSE as an entity for which at least 80 percent of its gross income qualifies as active financing income as defined in Treas. Reg. § 1.904-4(e)(2)(i) (which consists of a list of 25 different types of income). The Proposed Regulations, by contrast, define financial services income, in part, to include income derived in the active conduct of a banking, financing, or similar business under section 954(h)(2)(B).

This proposed change to the definition of FSE raises numerous concerns for ACT members and is highly unlikely to achieve Treasury's stated goal of promoting simplification and consistency. As noted above, the existing regulations under Treas. Reg. § 1.904-4(e) provide a detailed list of the types of activities that give rise to qualifying income for purposes of defining an FSE. Further, this regulatory scheme has been virtually unchanged for over 30 years, with the result that taxpayers, advisors, and the IRS have a thorough understanding of the rules and their application to a taxpayer's particular facts. The statutory provisions in section 954(h) provide no such detail, however, and no regulations have ever been promulgated to provide further explanation of the intended meaning of these concepts. In the absence of detailed regulations describing the statutory concepts in section 954(h), taxpayers and the IRS will face significant uncertainty in applying the rules and will likely need (in the absence of further guidance) to refer to the legislative history to section 954(h) (which does not, by its terms, address the appropriate treatment of income for purposes of section 904), the legislative history to section 904(d)(2)(D), and the currently applicable 1.904-4(e) regulations for further explanation.

For example, many of the activities described in the existing Treas. Reg. § 1.904-4(e) do not appear to fit within the relevant definition of a “lending or finance business” provided in section 954(h)(4). Further, section 954(h)(2)(B) also requires certain indicia (e.g., in the case of an unregulated finance business, transactions must be with “customers which are not related persons”) that do not appear within the existing Treas. Reg. § 1.904-4(e) rules. As an additional example, the statutory provisions of section 954(h)(2)(B) do not literally apply to banks or securities dealers that are licensed or registered under foreign law (rather than U.S. law), except to the extent “specified by the Secretary in regulations.” As noted, no regulations under section 954(h) have ever been promulgated. Accordingly, if Treasury and the IRS choose to apply the relevant provisions of section 954(h) in the section 904 context, they will need to determine how to address this comparative lack of detail and the apparent differences in the relevant standards. Failure to address these issues could easily result in many entities that have consistently been treated as FSEs for 30 years suddenly failing to meet the definition, despite the fact that Congress has offered no indication (in the TCJA or otherwise) that the existing standards should be fundamentally changed.¹⁷

Despite the similarity between the language used in section 904(d)(2)(D) and sections 954(h) and 954(i), sections 954(h) and 954(i) (part of the so-called “active financing exception,” originally enacted on a temporary basis in 1997 and subsequently made permanent) do not share the same policy goals as section 904(d)(2)(D). Sections 954(h) and 954(i) incorporate strict standards intended to ensure that income of a financial nature is subject to current U.S. tax (at the full U.S. rate) unless it meets a rigorous standard of activity and lack of mobility. By contrast, section 904(d)(2)(D) and the existing Treas. Reg. § 1.904-4(e) regulations serve a different purpose — ensuring that the income of companies predominantly engaged in financial services activities is not inappropriately characterized as arising in the passive basket. In effect, section 904(d)(2)(D) represents a recognition by Congress that the income of entities predominantly engaged in financial activities (without regard to whether they would satisfy the strict standard needed to avoid current U.S. tax on this income) is appropriately treated as arising in the general basket (previously the financial services basket).

Accordingly, ACT recommends that the existing regulations in Treas. Reg. § 1.904-4(e), which have provided objective and administrable rules for taxpayers and the IRS for over 30 years, be retained. If Treasury and the IRS wish to revise specific portions of the existing regulations, ACT would welcome the opportunity to provide comments on any such proposals. In addition, ACT would welcome the opportunity to provide comments to Treasury and the IRS on regulations to implement the active financing exception rules. ACT believes that any attempt to provide greater consistency between the rules of sections 954(h) and (i) and the existing regulations under section 904(d)(2)(D) should not be undertaken before Treasury and the IRS have provided appropriate regulatory guidance under sections 954(h) and (i).

ACT also notes that the proposed regulations appear to have inadvertently altered the substantive rules for analyzing affiliated groups engaged in financial services businesses in several respects. Specifically, under Prop. Reg. § 1.904-4(e)(2)(ii), a corporation that is a member of a financial services group is deemed to be a financial services entity regardless of whether it is a financial services entity on its own accord. For this purpose, if the affiliated group as a whole meets the requirements of section 954(h)(2)(B)(i), then all members of the affiliated group will qualify as a financial services entity. However, section 954(h)(2)(B)(i) only contemplates income earned through a lending or finance business and fails to reference insurance income or income derived by a licensed bank or securities dealer. Consequently, affiliated groups in the insurance industry, as well as affiliated groups that include banks and securities dealers, that qualify as a financial services group under the existing regulations may no longer qualify under the Proposed Regulations. If the existing regulations are not retained, contrary to ACT's recommendation, then ACT believes that a business predominantly engaged in the insurance industry, as well as licensed banks and securities dealers, should be included for purposes of determining whether an affiliated group qualifies as a financial services group.

Regulatory Authority for Recommendation

ACT recommends that the Treas. Reg. § 1.904-4(e) regulations should be retained, consistent with Treasury's prior exercise of its authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

7. Allocation and apportionment of stewardship expense (Treas. Reg. § 1.861-8(e)(4)(ii))

Proposed Regulations

Under the Proposed Regulations, stewardship expenses would be allocable to dividends and inclusions received or accrued, or to be received or accrued, under sections 78, 951, 951A, 1291, 1293, and 1296 from related corporations. The Proposed Regulations provide that stewardship expenses are then apportioned based on the value of a taxpayer's stock assets which would be characterized in the same manner as for interest expense apportionment (i.e., the tax book value or adjusted tax book value of the taxpayer's stock assets other than stock of affiliated corporations).

Treasury Explanation

As detailed in the Preamble to the Proposed Regulations, the current rules for allocating and apportioning stewardship expense do not provide an explicit rule; rather they provide examples of permissible methods. In order to provide certainty to taxpayers, Treasury and IRS have promulgated a specific rule addressing the allocation and apportionment of stewardship expenses.

ACT Recommendation

ACT recommends that:

Reasons for ACT Recommendation

Under the asset method described in the Proposed Regulations, stewardship expense related to overseeing a U.S. taxpayer's domestic subsidiaries would be allocated solely to foreign income (a result of the fact that the stock of a taxpayer's wholly owned domestic subsidiaries would not be taken into account). However, these expenses are not incurred as a result of, or incident to, the oversight of a taxpayer's foreign investments and, therefore, ACT believes it is unreasonable to allocate such expenses against foreign source income. Rather, ACT believes that a taxpayer's first step in allocating and apportioning stewardship expenses should be to determine, wherever possible, whether the stewardship expenses, or a portion of the expenses, were incurred as a result of, or incident to, the oversight of either its related domestic corporations or related foreign corporations. If the expense factually relates to a taxpayer's domestic investments, it should be allocated based on the classes of gross income produced by the domestic investments. Conversely, if a taxpayer is able to factually relate at least a portion of its stewardship expense that was incurred as a result of, or incident to its related foreign corporations, ACT believes that that portion of the expense should be allocated and apportioned based on the relative tax book value, or adjusted tax book value, of the foreign corporations' stock, as characterized under Treas. Reg. § 1.861-13 (treating the section 250 deduction as giving rise to exempt assets).

ACT further believes that, if a taxpayer is not able to determine whether the stewardship expenses were incurred as a result of, or incident to, either its related domestic or foreign subsidiaries or are allocable to more than one category, the expenses should be apportioned based on the gross income from such investments (treating the section 250 deduction as giving rise to exempt income), rather than applying an asset-based apportionment approach. This is consistent with the methodology of Treas. Reg. 1.861-8(a)(2), which apportions expenses that are not definitely related to any particular class of gross income using a gross income basis. As stewardship expense is incurred to protect taxpayers' capital investments and protect the income generated from such investments, ACT believes, consistent with Treas. Reg. § 1.861-8(a)(2), that when taxpayers are not able to factually relate stewardship expenses to a particular investment or subset of investments, gross income generated from these investments should be the apportionment base for stewardship expenses.¹⁸

Using gross income as the apportionment base for stewardship expenses would be easy for taxpayers and the IRS to administer and, with the introduction of section 951A, is not subject to manipulation (by deferring repatriation of foreign earnings). Thus, when taxpayers are not able to factually relate the expense to a particular investment or subset of investments, the amount of gross income from both domestic and foreign subsidiaries should be a good proxy for the time and expense incurred relating to oversight of both foreign and domestic subsidiaries. As deductions which are supportive in nature (overheard, general and administrative, and supervisory expenses) are also ordinarily apportioned on the basis of gross income,¹⁹ taxpayers who are not able to factually allocate stewardship expense to a particular investment or subset of investments would be able to utilize the same apportionment method for both types of expenses. Because the existing regulations contemplate a bifurcation between expenses that are supportive in nature and expenses that represent stewardship of a taxpayer's investments, the ability to apportion these expenses (assuming both of the expenses are not factually related to a particular class of gross income or investment) utilizing the same apportionment base will provide welcome administrative relief to some taxpayers. Further, unlike the asset-based approach in the proposed regulations, which effectively eliminates any apportionment of these expenses to a taxpayer's domestic business activities, this gross income-based approach recognizes that stewardship and other oversight expenses support both a taxpayer's domestic and foreign operations.

For the avoidance of doubt, ACT believes that existing Treas. Reg. § 1.861-8(b)(3), relating to the allocation and apportionment of supportive expenses, provides the appropriate framework for treatment of these expenses. ACT understands that some taxpayers are able to factually relate supportive expenses to a particular class of gross income. Consistent with Treas. Reg. §§ 1.861-8(a)(2) and (b)(3), ACT believes that the existing rules for allocating and apportioning the expense on the basis of a factual relationship of the expense to a particular class of gross income is appropriate. The recommendation described in detail above is applicable to fact patterns where taxpayers are not able without undue administrative burden to factually relate the expense to a particular class of gross income.

Regulatory Authority for Recommendation

As the statute is silent, the allocation and apportionment of stewardship expense is governed solely by regulation.

8. Allocation and apportionment of damage awards, prejudgment interest and settlement payments (Treas. Reg. § 1.861-8(e)(5))

Proposed Regulations

The proposed regulations provide that, in the case of claims made by investors that arise from corporate negligence, fraud, or other malfeasance, prejudgment interest, and settlement payments paid by a taxpayer, expenses are allocated and apportioned based on the value of all the corporation's assets.

Treasury Explanation

In the preamble to the Proposed Regulations, Treasury and IRS explained that under prior law there was no clear rule for allocating and apportioning prejudgment interest and settlement payments arising due to claims made by investors related to corporate malfeasance. The preamble notes that disputes have arisen as to how these relatively rare expenses should be allocated and apportioned and thus the proposed regulations were promulgated.

ACT Recommendation

ACT recommends that in the case of claims made by investors that arise from corporate malfeasance, prejudgment interest and settlement payments paid by the taxpayer, expenses should be allocated and apportioned based on the geographic location where the malfeasance is alleged to have taken place.

Reasons for ACT Recommendation

By allocating and apportioning prejudgment interest and settlement payments by reference to the value of all assets held by the corporation, the expenses may be allocated and apportioned, in some part, to classes of gross income that did not give rise to the litigation.

For example, if a taxpayer is sued based on alleged malfeasance that occurred in the United States, there is limited, if any, factual connection between the alleged place of malfeasance (i.e., the U.S.) and the taxpayer's assets that are held abroad. While ACT understands Treasury's desire to provide a special rule for these rare expenses, ACT believes allocation and apportionment should be based on the geographic location where the malfeasance is alleged to have taken place, as this approach ties more closely to the general approach in Treas. Reg. § 1.861-8 of allocating expenses based on the factual relationship between the expense and the activity to which it relates.

Regulatory Authority for Recommendation

The recommendations above are within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

9. Allocation of foreign gross income resulting from the receipt of a disregarded payment by a foreign branch (Prop. Reg. §§ 1.861-20(d)(3)(ii)(B) and 1.960-1(d)(3)(ii))

Proposed Regulations

The Proposed Regulations contain general rules that assign foreign gross income to statutory and residual groupings in order to allocate and apportion foreign income taxes imposed on a tax base that includes such foreign gross income. See Prop. Reg. § 1.861-20. The Proposed Regulations also contain specific rules that apply Prop. Reg. § 1.861-20 to specific operative sections.

Under Prop. Reg. § 1.861-20(d)(3)(ii)(B), foreign gross income that arises “by reason of the receipt of a disregarded payment made to a foreign branch by a foreign branch owner” is assigned to the residual grouping. Where section 960 is the operative section, Treas. Reg. § 1.960-1(e) provides that foreign tax imposed on foreign gross income of a CFC that is assigned to the residual grouping cannot be deemed paid by a corporate U.S. shareholder. Further, although not entirely clear, Prop. Reg. § 1.960-1(d)(3)(ii)(A) can be read to indicate that the same result occurs whether the disregarded payment is made by the foreign branch owner or another foreign branch.

Treasury Explanation

The preamble to the Proposed Regulations provides:

As a result of changes made by the TCJA, the accurate allocation and apportionment of foreign income taxes to the gross income to which they relate has taken on increased importance. . . . Therefore, taxpayers will benefit from increased certainty on how to match foreign income taxes with income, particularly in the case of differences in how a U.S. taxable base and foreign taxable base are computed with respect to the same transaction.

ACT Recommendations

ACT makes two recommendations:

Reasons for ACT Recommendation

The scope of the rules for allocating and apportioning foreign gross income attributable to a disregarded payment received by a foreign branch are unclear. Prop. Reg. § 1.860-20(d)(3)(ii) contains separate rules for disregarded payments made by a foreign branch and disregarded payments made by a foreign branch owner. As a result, the Proposed Regulations appear to contemplate payments from a foreign branch to its foreign branch owner and payments from a foreign branch owner to its branch. However, it is unclear how the Proposed Regulations would apply to disregarded payments from one foreign branch to another.

When section 960 is the operative section, Prop. Reg. § 1.960-1(d)(3))(ii)(A) exacerbates this uncertainty, because it does not explicitly distinguish between disregarded payments from a foreign branch owner to a foreign branch (“downstream disregarded payments”) and payments made by one foreign branch to another. In fact, it can be read to suggest that all foreign gross income arising from disregarded payments received by a foreign branch are allocated to the residual category. ACT recommends that Treasury and the IRS resolve the uncertainty in both sections of the Proposed Regulations by more closely matching foreign income taxes with income, rather than by mechanically allocating foreign taxes to residual income.

Many U.S. taxpayers use single entities to operate distinct but related businesses. Like with all businesses, numerous payments arise between business operated through a single entity. And when foreign law imposes tax separately on each such business, these payments from one business to another are often treated as disregarded payments between foreign branches for U.S. tax purposes. U.S. taxpayers are free to choose the form of entity through which they operate businesses — corporations, partnerships, or unincorporated businesses. There is no compelling rationale for denying foreign tax credits paid or accrued by a CFC that chooses to operate various businesses as mere divisions for U.S. tax purposes. Accordingly, ACT recommends that Treasury and the IRS narrow the application of Prop. Reg. § 1.960-1(d)(3)(ii)(A) to apply only to foreign gross income attributable to a downstream disregarded payment received from a foreign branch owner in its capacity as a foreign branch owner.

Additionally, ACT recommends that Prop. Reg. § 1.861-20(d)(3)(ii)(B) similarly be clarified to confirm that it is limited to payments from a foreign branch owner in its capacity as such. In circumstances where a corporate taxpayer operates businesses both through a home office juridical entity and also through one or more separate foreign branches, ACT is unaware of any rationale for conditioning the treatment of foreign tax imposed on a foreign branch on whether it is related to foreign gross income received from the home office business or from another foreign branch.

If Treasury and the IRS believe that foreign tax attributable to downstream disregarded payments should be allocated to the residual category because they resemble contributions to capital, Prop. Reg. § 1.861-20(d)(3)(ii)(B) should be limited to downstream disregarded payments that resemble payments on equity, and should not apply to payments reflected on the foreign branch owner's books and records as expenses.

This would mirror the approach of the recently issued regulations determining the income attributable to a foreign branch. Under Treas. Reg. § 1.904-4(f)(2)(vi), most downstream disregarded payments increase foreign branch income; however, contributions of money or other property in a downstream disregarded payment generally do not cause income to be reattributed between foreign tax credit baskets. Applying this approach in the section 960 context would assign foreign gross income arising from bona fide capital contributions to the residual grouping, but would assign foreign gross income attributable to downstream disregarded payments to the same grouping as the income represented by the disregarded payment.

Finally, assigning all foreign tax imposed on downstream disregarded payments to the residual category would also significantly undermine the proposed regulations expanding the high-tax exception to tested income. Prop. Reg. § 1.951A-2(c)(6) would apply to a “tentative net tested income item” — an item of gross income attributable to a qualified business unit (“QBU”) of a CFC, determined by generally giving effect to disregarded payments under the principles of Treas. Reg. § 1.904-4(f)(2)(vi).²⁰ The foreign income taxes paid or accrued with respect to a tentative net tested income item would be determined by reference to the regulations under section 960. Calculating income by giving effect to downstream disregarded payments while ignoring the foreign tax imposed on such payments is likely to create unintended consequences, while making the high-tax exception difficult to apply and administer.

Regulatory Authority for Recommendation

The recommendations above are within Treasury's authority under section 960(f) to prescribe regulations as may be necessary or appropriate to carry out the provisions of section 960 and under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

10. Foreign tax imposed on disregarded payments other than disregarded reattribution transactions (Prop. Reg. § 1.904-6(b)(2)(ii))

Proposed Regulations

Prop. Reg. § 1.904-6(b)(2)(ii) assigns foreign tax imposed on a “downstream” disregarded payment from a foreign branch owner to a foreign branch to the foreign branch basket, or a specified separate category (such as the category associated with a bilateral income tax treaty) associated with the foreign branch basket, irrespective of whether the downstream disregarded payment gives rise to foreign branch income under Treas. Reg. § 1.904-4(f)(2)(vi).

Treasury Explanation

N/A

ACT Recommendation

The Proposed Regulations will create mismatches with respect to the basketing of foreign taxes and associated foreign income in the case of certain downstream disregarded payments received by foreign branches of U.S. persons. To prevent this mismatch, ACT recommends that the rule that assigns foreign tax imposed on a downstream disregarded payment to the branch basket only applies where the associated payment is also assigned to the foreign branch basket.

Reasons for ACT Recommendation

Under Treas. Reg. § 1.904-4(f)(2)(vi), downstream disregarded payments from a foreign branch owner to a foreign branch of a U.S. person generally result in the reattribution of income to the foreign branch basket, or a specified separate category (such as the category associated with a bilateral income tax treaty) associated with the foreign branch basket. Treas. Reg. § 1.904-4(f)(2)(vi)(C) provides an exception, under which certain disregarded payments (such as interest payments) do not cause this reattribution of gross income. In all cases involving downstream disregarded payments to foreign branches of a U.S. person, however, Prop. Reg. § 1.904-6(b)(2)(ii) provides that foreign taxes imposed on such payments are assigned to the foreign branch basket. This will, in common fact patterns, result in foreign tax being assigned to a different foreign tax credit basket than the income on which it is imposed.²¹

ACT believes this mismatch of foreign tax and associated foreign income is an inappropriate policy result. Further, when applied in the treaty context, this result contravenes the text and policy of the United States' bilateral income tax treaties. Regardless of whether a downstream disregarded payment increases foreign branch basket income, if the payment causes an item treated as U.S. source income to be subject to foreign tax, such U.S. source income may be eligible to be resourced under a treaty to facilitate the treaty's relief from double taxation. However, if the foreign tax is assigned to the treaty category associated with the foreign branch basket, while the income on which the tax is imposed is assigned to the treaty category associated with the general basket, the Proposed Regulations would effectively prevent taxpayers from claiming a credit to which they are entitled under a treaty.²²

Regulatory Authority for Recommendation

Section 904(d)(2)(J) does not include provisions for determining the “business profits” of a United States person that are attributable to a foreign branch. Instead, it instructs the Secretary to establish rules that make that determination. As a result of Congress's express delegation of regulatory authority, Treasury has authority to provide appropriate rules for the determination of foreign taxes attributable to a foreign branch.

11. Base differences (Prop. Reg. § 1.861-20(d)(2)(ii)(B))

Proposed Regulations

The Proposed Regulations treat certain transactions that give rise to foreign tax as per se base differences. Where foreign law imposes tax on a distribution to a partner described in section 733, the Proposed Regulations would treat the transaction as a base difference.

Treasury Explanation

According to the Preamble to the Proposed Regulations, “The Treasury Department and the IRS have determined that foreign tax on these items, which are excluded from U.S. gross income, is particularly difficult to associate with a particular type of U.S. gross income.” The preamble requests comments on whether a different assignment of any of these types of foreign gross income would be more appropriate.

ACT Recommendation

ACT recommends that foreign tax imposed on a distribution by a partnership to a partner that is allocable to the partner's distributive share of partnership income is treated as attributable to a timing difference. That is, the foreign taxes would be allocated and apportioned to the appropriate foreign tax credit basket or baskets to which the tax would be allocated and apportioned if the partner's distributive share of partnership income were recognized under Federal income tax principles in the year in which the tax was imposed.

Reasons for ACT Recommendation

Distributions by a partnership to a partner represent a return of a partner's investment in the partnership. However, unlike in the case of corporate stock, a portion of the partner's outside basis in its partnership interest may be attributable to its distributive share of partnership income. To the extent that foreign tax is imposed on a distribution to a partner that reduces the partner's outside basis, the foreign tax may be attributable to the partner's share of the partnership income that gave rise to such basis. Although there are no rules under current law for identifying the particular tranche of basis of a partnership interest to which a distribution to a partner is attributable, it would be unreasonable to treat all distributions by a partnership to a partner as base differences. ACT's recommendation would provide parity in taxation as between investment in a partnership and investment in a corporation, as distributions described under sections 301(c)(1) and (c)(3) are treated as timing differences.

Corporate distributions pose similar issues in connecting the distribution of particular earnings and profits to the underlying U.S. gross income that gave rise to such earnings and profits. Statutorily, sections 316 and 959 do not contain rules to allocate foreign tax imposed on corporate distributions to particular statutory and residual groupings of U.S. gross income. Nonetheless, the foreign law distribution rules under the Proposed Regulations, when applied in conjunction with Notice 2019-01, allocate and apportion foreign taxes on foreign gross income to statutory and residual groupings by reference to groupings of the distributing corporation's E&P.

Similar principles should be applied to distributions by a partnership to a partner such that the foreign tax imposed on distributions to partners is associated with the underlying partnership income that has been allocated to the partners. For example, a rule may require that a distribution by a partnership be first allocated to the partner's share of the partnership income (and only after such share is exhausted, allocated to other sources, such as partnership contributions). For this purpose, a partner's share of the partnership income would include any distribution of PTEP by a lower-tier CFC to the partnership, which distribution is then allocated among the partners. To the extent that a distribution is allocable to a partner's share of the partnership income, such distribution is treated as a timing difference. Any foreign taxes imposed on the distribution by a partnership to a partner would then be allocated to the appropriate foreign tax credit basket or baskets to which the tax would be allocated and apportioned if the partner's distributive share of partnership income were recognized under federal income tax principles in the year in which the foreign tax was imposed. This “earnings first” convention would be similar to the approach already adopted with respect to corporate distributions.²³

Regulatory Authority for Recommendation

The recommendation above is within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

12. Foreign tax redeterminations (Treas. Reg. § 1.905-4(b))

Proposed Regulations

The Proposed Regulations provide that if U.S. tax liability increases as a result of a foreign tax redetermination, then taxpayers must notify the IRS of the change in U.S. tax liability by the due date (including extensions) of the original return for the taxpayer's taxable year in which the foreign tax redetermination occurs.

Treasury Explanation

N/A

ACT Recommendation

ACT recommends that when a foreign tax redetermination increases U.S. tax liability for a taxable year, notification to the IRS be permitted within three years of the end of the taxpayer's taxable year in which the redetermination occurred.

Reasons for ACT Recommendation

The requirement to notify the IRS of a foreign tax redetermination by the due date of the original return for a taxpayer's taxable year in which the redetermination occurred would place undue burden on taxpayers. For example, assume a calendar year taxpayer receives notification of a foreign tax redetermination in December of 2019 that decreases the amount of foreign tax credits available in a given tax year, and thus increases the amount of U.S. tax due in such tax year or a subsequent tax year. Under the Proposed Regulations, the taxpayer would be required, by the due date (including extensions) of the calendar year 2019 tax return, to file an amended return, Form 1118 Foreign Tax Credit — Corporations or Form 1116 Foreign Tax Credit (Individual, Estate, or Trust), and a statement providing:

By requiring notification by the due date (including extensions) of the original return for the taxpayer's taxable year in which the foreign tax redetermination occurred, taxpayers will need to complete both the annual return for the year and an amended return related to the foreign tax redetermination in expedited fashion. To lessen this burden ACT recommends that taxpayers be given three years to notify the IRS should a foreign tax redetermination increase U.S. taxable income. For the avoidance of doubt, the additional time given to taxpayers to notify the IRS of an increase in U.S. taxable income by reason of a foreign tax redetermination will not impact the accrual of interest on the additional tax due.

Regulatory Authority for Recommendation

The recommendation above is within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

13. Payments to a foreign tax jurisdiction to prevent additional interest and penalties from accruing

Proposed Regulations

The Proposed Regulations do not address payments made to foreign tax jurisdiction in order to prevent the accrual of future interest and penalties.

Treasury Explanation

N/A

ACT Recommendation

ACT recommends that payments made to foreign tax authorities during the course of a foreign tax dispute, in order to prevent future interest and penalties from accruing (should the foreign tax authority prevail in the dispute), not give rise to a foreign tax redetermination.

Reasons for ACT Recommendation

In some cases, taxpayers may make payments to a foreign tax jurisdiction that should be viewed as deposits rather than payments related to an additional assessment of foreign tax. For example, taxpayers may make payments to prevent the accrual of interest and penalties related to an alleged foreign tax deficiency that the taxpayer is currently litigating.²⁴ Such a payment does not represent a concession on the technical issues of the litigation and does not affect the ability of the taxpayer to litigate the issue. Further, the payment is not made with respect to an additional tax assessment by the foreign tax jurisdiction. Rather, the payment is made solely for the purpose of reducing the amount of interest and penalties that would be due should the foreign taxing authority prevail in litigation.

In many cases foreign tax disputes can take years to resolve. Thus, the payments made to prevent interest and penalties from accruing can have a material impact on the amount ultimately remitted to a foreign taxing jurisdiction should the local authorities prevail in litigation. Should the taxpayer prevail in litigation, in general, the amount paid to stop the accrual of interest and penalties would be refunded to the taxpayer (or be credited as payment towards the current year tax liability), with interest. Therefore, the prudent thing for many taxpayers, is to pay the needed amount to stop the accrual of interest and penalties with the understanding that the amount, plus interest, would be refunded upon successful litigation of the dispute.

In the above situation ACT believes that a foreign tax redetermination should not be deemed to occur as the payment is not related to an additional assessment of foreign tax, rather it is a payment made to protect the taxpayer from an additional amount being due should the foreign tax authority prevail in litigation. Thus, ACT recommends that payments made to prevent future amounts being due (i.e., interest and penalties) not be treated as a foreign tax redetermination in the final regulations.²⁵

Regulatory Authority for Recommendation

The recommendation above is within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

14. Upward adjustments to foreign income taxes paid or accrued (Prop. Reg. § 1.905-3(b)(4))

Proposed Regulations

The Proposed Regulations provide that if a taxpayer is under examination within the jurisdiction of the IRS's Large Business and International Division and, among other requirements, incurs a foreign tax redetermination that results in a downward adjustment to the amount of foreign income taxes paid or accrued by a taxpayer or foreign corporation for which the taxpayer computes a deemed paid credit, the general notification requirements with respect to foreign tax redeterminations do not apply.²⁶ Instead, depending on the timing of the foreign tax redetermination (e.g., filing an amended return), the taxpayer is generally able to notify the IRS with a statement, signed under the penalties of perjury, detailing the foreign tax redetermination.

Treasury Explanation

The Proposed Regulations (Prop. Reg. § 1.905-3(b)(4)) are largely based on the 2007 temporary regulations. The preamble to the 2007 temporary regulations state that the rule was added because taxpayers requested that they be able to notify the IRS of a foreign tax determination during the course of an examination in lieu of filing an amended return at the conclusion of an IRS examination.

ACT Recommendation

Similar to the proposed rule for downward adjustments, ACT recommends that taxpayer's be permitted to notify the IRS of a foreign tax redetermination during the course of an examination where there is an upward adjustment to the amount of foreign tax paid or accrued or included in the computation of foreign taxes deemed paid.

Reasons for ACT Recommendation

ACT applauds Treasury and the IRS for providing a rule that simplifies the notification requirements of a downward foreign tax redetermination, when the redetermination occurs during the course of an IRS examination. However, ACT believes there is no policy reason to limit the alternative notification requirements only to situations where the taxpayer experiences a downward adjustment to the amount of foreign income taxes paid or accrued. Rather, ACT believes the alternative notification requirements should be available to taxpayers that experience an upward adjustment to the amount of foreign income taxes paid or accrued. Otherwise taxpayers may need to file, and the IRS examine, an amended return to a taxable year for which an initial examination has already concluded. ACT believes it is more efficient for both the taxpayer and the IRS to address all foreign tax redeterminations (downward and upward) during the course of an ongoing examination.

Regulatory Authority for Recommendation

The recommendation above is within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

15. Foreign tax redeterminations related to pre-2018 tax years

Proposed Regulations

The Proposed Regulations provide that a foreign corporations taxable income, earnings and profits, and current year taxes must be adjusted in the year to which the redetermined tax relates.²⁷

Treasury Explanation

In the preamble to the Proposed Regulations, Treasury and IRS request comments as to whether alternative adjustments should be made for post-2017 foreign tax redeterminations with respect to pre-2018 taxable years, including adjusting taxable income, earnings and profits, and post-1986 undistributed earnings and post-1986 foreign income taxes in the foreign corporations last taxable year beginning before January 1, 2018.

ACT Recommendation

ACT recommends, consistent with the language in the preamble to the Proposed Regulations, that taxpayers may elect to account for post-2017 foreign tax redeterminations with respect to pre-2018 taxable years in the foreign corporations last taxable year beginning before January 1, 2018.

Reasons for ACT Recommendation

As noted in the preamble to the Proposed Regulations, post-2017 foreign tax redeterminations that relate to pre-2018 taxable years will cause taxpayers to account for the effect of the foreign tax redetermination on foreign taxes deemed paid by domestic corporate shareholders of the foreign corporation in the relation-back year and any subsequent pre-2018 year in which the domestic corporate shareholder computed a deemed-paid credit under section 902 or 960 with respect to the foreign corporation, as well as any year to which unused foreign taxes from any such year were carried. Thus, a single foreign tax credit redetermination could require multiple federal tax returns to be amended (potential amended state returns will add to this burden). To lessen this burden on both taxpayers and the IRS, ACT believes that, at the election of the taxpayer, post-2017 foreign tax redeterminations related to foreign corporations pre-2018 tax years, may be accounted for in the foreign corporations last taxable year beginning before January 1, 2018.

Regulatory Authority for Recommendation

The recommendation above is within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code.

16. Effective dates

Proposed Regulations

The Proposed Regulations have various applicability dates; however, a majority of the regulations are proposed to apply to taxable years that end on or after December 16, 2019.²⁸

Treasury Explanation

N/A

ACT Recommendation

ACT recommends that the Proposed Regulations, upon finalization, apply for tax years ending on or after the date the final regulations are posted in the Federal Register. ACT also recommends that taxpayers be provided the ability to rely on the final regulations for tax years ending prior to the applicability date.

Reasons for ACT Recommendation

As the Proposed Regulations were not published in the Federal Register until December 17, 2019, many calendar year companies will have an increased compliance burden with respect to the tax year ended December 31, 2019. Such taxpayers will need to take into account, in their return due October 15, 2020 (assuming the Proposed Regulations are finalized prior to this date), the impact the regulations have on their foreign tax credit calculation. As the rules provided in the Proposed Regulations are complex and, in some cases, a material departure from prior law (e.g., the allocation and apportionment of stewardship expense), taxpayers will be under severe time pressure to update existing compliance processes. In addition, the Proposed Regulations are subject to change until finalized, and the preamble to the Proposed Regulations explicitly states that Treasury Department and the IRS are considering whether additional changes to certain rules in the Proposed Regulations are appropriate.

Given the limited amount of time to analyze and apply the Proposed Regulations (especially in the case of calendar year taxpayers) and the possibility of further changes as the regulations are finalized, ACT believes it is appropriate to apply the regulations only to tax years ending after final regulations are posted in the Federal Register. Treasury and the IRS may also grant taxpayers the ability to apply the Proposed Regulations to tax years ending prior to the date of finalization.

Regulatory Authority for Recommendation

The recommendations above are within Treasury's authority under section 7805(a) to prescribe all needful regulations for the enforcement of the Code. Further, Treasury has the authority under section 7805(b)(7) to allow taxpayers to rely on the Proposed Regulations prior to finalization.

III. CONCLUSION

We understand that a number of details would need to be addressed if Treasury and the IRS accept the recommendations set forth above. ACT member companies and their advisors have identified a number of these detailed drafting issues and have given some thought as to how they might be addressed. ACT representatives would welcome the opportunity to meet with Treasury and the IRS to discuss any of the above recommendations.