Energy Group Seeks Changes to Proposed FTC Regs

February 14, 2020

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

To Whom It May Concern:

On behalf of the American Petroleum Institute (“API”) and its members I am submitting comments pertaining to the Department of Treasury and Internal Revenue Service's (“Treasury and the IRS”) proposed regulations concerning “Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, the Definition of Financial Services Income, Foreign Tax Redeterminations Under Section 905(c), the Disallowance of Certain Foreign Tax Credits Under Section 965(g), and the Application of the Foreign Tax Credit Limitation to Consolidated Groups.”

Section 905(c) Foreign Tax Redeterminations

The natural gas and oil industry operates worldwide, with some API members operating in over a hundred different countries. Prop. Treas. Reg. § 1.905‐3(b)(2)(i) requires a United States tax redetermination be done in all cases to reflect for a foreign corporation's foreign tax redetermination. A foreign tax redetermination is inclusive of changes in foreign tax liability and other changes which would affect taxpayer's foreign tax credit balance such as tax amounts determined under section 1291, deemed foreign taxes paid under section 960, or the high‐tax exception to subpart F. Problematic for API members is the method chosen to enforce this proposed change to the foreign tax redetermination to the IRS.

Historically, taxpayers were permitted to report foreign tax redeterminations by prospectively adjusting a foreign corporation's pool of post‐1986 undistributed earnings and post‐1986 foreign income taxes. Under the proposed regulations, Treasury and the IRS make the argument that, with the elimination of section 902 pooling, this method is no longer feasible and that a new method of notification is required. The method of notification deemed necessary is the filing of amended returns for the year of the foreign tax redetermination. Under most circumstances, a taxpayer incurring a foreign tax redetermination would be required to file an amended Form 1118 for the affected tax year.¹

Controlled foreign corporations (“CFCs”) use accrual method accounting and foreign income tax returns are typically filed after the end of the United States tax year for the same period. These foreign returns typically have a foreign tax liability which is different, even if only marginally, from the foreign income taxes accrued for U.S. income tax. Even these minor, marginal differences, would constitute a foreign tax redetermination and require that amended returns be filed. The compliance costs for these foreign tax redeterminations, and associated compliance burden, would be dramatic. API and its members suggest that in lieu of a blanket rule that foreign tax redetermination require a filing of an amended return, a de minimis rule be adopted. A de minimis rule stating that differences between the foreign tax actually paid and the amounts reported on the U.S. tax forms must be at least $5 million to require an amended return would eliminate mere minor differences and greatly reduce the compliance burden. For those returns with foreign tax redeterminations, but under the de minimis threshold, a mere statement on the current year return could demonstrate the updated accrual of foreign taxes paid including the redetermined amounts.

Sourcing of Damage/Award Expenses on Consolidated Basis

Proposed Reg. §1.861‐8(e)(5) provides that the allocation and apportionment of legal and accounting fees and expenses is tied to the factual relationship between such expenses and the activities to which they relate. For example, accounting fees incurred for the preparation of a study of the costs involved in manufacturing a specific product will ordinarily be allocated to the class of gross income derived from that specific product. Moreover, in alignment with this general principle, Prop. Treas. Reg. § 1.861‐8(e)(5) provides that deductions for damages awards, prejudgment interest and settlement payments arising from product liability or similar claims are allocated to the class of gross income produced by the specific sales of products or services related to the claims for damage or injury.

In the case of claims made by investors that arise from corporate negligence, fraud, or malfeasance, the same proposed regulations provide that damages, prejudgment interest, and settlement payments are allocated and apportioned based on the value of all the corporation's assets. Here, Treasury and the IRS depart from the general approach because there are few, if any, instances where a distinct factual link exists between investor related claims and all the taxpayer's assets. API and its members recommend that the allocation of expenses related to shareholder suits should more closely tie to the factual relationship between the expenses and the activities to which they relate. Our members believe that this is best accomplished by allocating such expenses to the class of gross income produced by the assets located in the jurisdiction where the investor related claim is filed.

R&E Deductions Should be a Deduction Under Section 174

The preamble to the proposed regulations requested comments whether research and experimentation (“R&E”) costs performed in the United States, but reimbursed by foreign affiliates per research agreements, should still be a qualifying expense under section 174. Treas. Reg. § 1.174‐3 permits R&E expenses to be deducted during the taxable year provided they are in connection with the taxpayer's trade or business. Natural gas and oil companies and their foreign affiliates commonly engage in contract research arrangements which describe the terms under which R&E is performed by one party and is ultimately reimbursed by the other, in this case by the foreign affiliate. These R&E expenditures are associated with the development of products, techniques, and general knowledge related to the trade or business of the domestic corporation which are qualifying R&E expenses described by Treas. Reg. § 1.174‐ 2.

Costs incurred by a taxpayer, which are subsequently reimbursed by a foreign affiliate, and qualify as R&E expenditures under section 174 research agreements should still be deductible as an R&E expense. Section 174 does not provide any suggestion that since a cost is to be reimbursed by a separate party, a taxpayer should be deprived of a deductible expense which qualifies under § 174. Furthermore, Treasury and IRS have also previously considered situations in which R&E may be performed pursuant a contract between two parties, and have still determined that the R&E costs still qualify under § 174.²

Clarification of Prop. Treas. Reg. § 1.960‐1(d)(3)(ii)(A)

The proposed regulations provide guidance related to the allocation and apportionment of foreign taxes, as applied to both foreign taxes recognized by branches and controlled foreign corporations. Prop. Reg. 1.960‐1 provides specific guidance on the allocation and apportionment of foreign taxes by controlled foreign corporations. Proposed Regulation 1.960‐1(d)(3)(ii)(A) states that foreign taxes attributable to base differences or “resulting from the receipt of a disregarded payment made to a foreign branch” are assigned to the residual income grouping, which results in any foreign taxes attributable to the income to be disallowed. A reasonable interpretation of the preamble to the proposed tax credit regulations as well as the cross‐reference cited in Prop. Treas. Reg. § 1.960‐1(d)(3)(ii)(A) would suggest that the proposed language is intended to apply only to foreign taxes attributable to a payment from a branch owner to the branch itself. However, the current language is ambiguous. API and its members request Treasury and IRS amend the language of Prop. Treas. Reg. § 1.960‐1(d)(3)(ii)(A) in order to clarify the scope of its applicability.

The final sentence of the proposed regulation currently includes the following language:

“Foreign gross income attributable to a base difference, or resulting from the receipt of a disregarded payment made to a foreign branch, is assigned to the residual income grouping under Sec. 1.861‐20(d)(2)(ii)(B) . . .” (emphasis added)

A reasonable interpretation of this language would seem to conflict with the preamble's and included suggested interpretation that this rule should only apply to payments from branch owners to the foreign branch. The current language is broad enough to cover payments not just from the branch owner to the foreign branch. API and its member suggest the following language to help further refine the regulation language and bring it within the scope as defined by the preamble.

“Foreign gross income attributable to a base difference, or resulting from the receipt of a disregarded payment made by a foreign branch owner to a foreign branch, is assigned to the residual income grouping under Sec. 1.861‐20(d)(2)(ii)(B) . . .”

We welcome the opportunity to discuss these comments at your convenience. You can reach me at (202) 682‐8455 or at comstocks@api.org.

Sincerely,

Stephen Comstock
Director — Tax & Accounting Policy
American Petroleum Institute
Washington, DC