Firm Comments on Allocation of Foreign Taxes Under FTC Regs

February 14, 2020

CC:PA:LPD:PR (REG-105495-19)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20024

Re: Comments on Proposed Regulations Related to the Allocation and Apportionment of Deductions and Foreign Taxes (REG-105495-19)

To Whom It May Concern:

Miller & Chevalier Chartered respectfully submits this letter in response to the Notice of Proposed Rulemaking regarding Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), and Consolidated Groups,¹ published in the Federal Register on December 17, 2019 (the “Proposed Regulations”).² Our comments relate to the rules in the Proposed Regulations related to the allocation and apportionment of foreign taxes imposed on disregarded payments within a controlled foreign corporation (“CFC”).

We respectfully request that the final regulations adopt a rule that would assign items of foreign gross income included by reason of disregarded payments, and allocate and apportion foreign taxes imposed on such disregarded payments, in a manner generally consistent with the principles of the final regulations regarding foreign branch category income issued on December 17, 2019 (the “Final Regulations”).³

In particular, we request that foreign taxes on disregarded payments by a CFC foreign branch owner to a foreign branch be allocated and apportioned based on income that is reattributed from the CFC foreign branch owner to the foreign branch under the principles of the Final Regulations regarding foreign branch category income. This treatment could be extended to, and conformed with, the treatment of disregarded payments by a foreign branch to its CFC foreign branch owner and between foreign branches owned by the same foreign branch owner.

As further discussed herein, we believe that the adoption of this recommendation would further the policies of the foreign tax credit and the proposed high tax exclusion for global intangible low-taxed income (the “GILTI high tax exclusion”)⁴ by reducing mismatches between the gross income of a qualified business unit (“QBU”) for U.S. federal tax purposes and gross income for foreign tax purposes. We believe that the rule contained in the Proposed Regulations, which generally allocates and apportions foreign taxes on disregarded payments by a foreign branch owner to a foreign branch to the “residual grouping,” will often result in an overallocation of taxes to the residual grouping and frustrate the purposes of the foreign tax credit and the GILTI high tax exclusion.

Issue

The Proposed Regulations can inappropriately deny a foreign tax credit for foreign taxes that relate to tested income and, therefore, should be creditable under section 960(d). If the approach of the Proposed Regulations were extended to the GILTI high tax exclusion, it could inappropriately understate the foreign effective tax rate on tested income.

Under the Proposed Regulations, an item of foreign gross income that a taxpayer includes by reason of a disregarded payment to a foreign branch by a CFC foreign branch owner is assigned to the residual grouping.⁵ Under Treas. Reg. § 1.960-1(d)(2)(ii)(D) and § 1.960-1(e), foreign taxes assigned to the residual grouping are not considered attributable to tested income and no foreign tax credit is available for these taxes. This would be the case even though all of the CFC's income may be tested income.

The Proposed Regulations assign foreign taxes on an item of foreign gross income that a taxpayer includes by reason of a disregarded payment to a CFC foreign branch owner from a foreign branch based on the after-tax income of the branch, which is “deemed to have arisen” in income groupings determined based on the tax book value of the assets of the branch in accordance with Treas. Reg. § 1.987-6(b)(2).⁶ In many cases, however, the tax book value of the assets of the branch does not accurately reflect the after-tax income of the branch (for example, if branch assets are minimal or if they consist primarily of disregarded receivables resulting from disregarded transactions with the foreign branch owner).

Due to regulatory constraints, U.S. taxpayers may operate in a region through a CFC with true branch operations in local countries. Many local countries impose income tax on branch operations based on branch books and records that reflect transactions with the home office or other branches. Under the Proposed Regulations, local country taxes on disregarded payments received by the foreign branch from the home office would be assigned to the residual grouping and not creditable. Furthermore, local country taxes on disregarded payments received by the CFC foreign branch owner from the foreign branch would be assigned to groupings based on branch assets, which may not accurately reflect the income of the CFC that is earned by reason of branch activities.

Recommended Guidance

We respectfully recommend that final regulations allocate and apportion foreign taxes on disregarded payments from a CFC foreign branch owner to its foreign branch, from a foreign branch to its CFC foreign branch owner, or between foreign branches owned by a single CFC foreign branch owner by treating disregarded payments as allocable and apportionable to gross income of the CFC foreign branch owner in a statutory grouping (e.g., tested income) to the extent a deduction for the disregarded payment, if regarded, would be allocated and apportioned to gross income in that statutory grouping. This rule would be similar to the rules in the Final Regulations with respect to foreign branch category income.

We further respectfully recommend that final regulations allocate and apportion foreign taxes on disregarded payments that constitute remittances from a foreign branch to its CFC foreign branch owner (and therefore, if regarded, would not be deductible because they are in the nature of distributions) based on the after-tax income of the branch, consistent with the Proposed Regulations. However, we recommend that the after-tax income of the branch be determined based on current-year branch income, including income that has been reattributed to, or from, a foreign branch under the principles described above.

Finally, we respectfully recommend that that final regulations allocate and apportion foreign taxes on disregarded payments that constitute contributions from a CFC foreign branch owner to a foreign branch to the residual grouping, consistent with the Proposed Regulations.

Discussion

Disregarded Reattribution Transactions

In our view, foreign taxes paid on a disregarded payment received by a foreign branch from its CFC foreign branch owner or from another foreign branch, and foreign taxes paid on a disregarded payment received by a CFC foreign branch owner from its foreign branch, are better regarded for U.S. federal tax purposes as taxes on the gross income of the CFC foreign branch owner or foreign branch to which the disregarded payment is allocable. In the simplest case (and by no means an uncommon situation), if all gross income of the CFC foreign branch owner is tested income, the tax on the disregarded payment should be considered a tax attributable to tested income. To the extent there may be multiple disregarded payments between a CFC foreign branch owner and its foreign branches, or between foreign branches owned by the same CFC foreign branch owner, an ordering rule similar to the rule adopted in the Final Regulations relating to foreign branch category income should apply.⁷

This recommended guidance would be more consistent with the approach taken in the Final Regulations with respect to foreign branch category income.⁸ The recommended guidance would eliminate the disparity in the treatment of foreign taxes on disregarded payments between foreign branches owned by a U.S. person that earns income in the foreign branch category and foreign branches owned by a CFC whose U.S. shareholder has a GILTI inclusion. The recommended guidance would also be consistent with the proposed rule applicable to foreign gross income attributable to disregarded sales of property, which allocates and apportions foreign taxes in a way that takes into account the disregarded transaction, and would extend that treatment to disregarded services and other transactions.⁹ The result would be more consistent with the purpose of the foreign tax credit, which is to mitigate double taxation of the same income.

The approach of the recommended guidance also would be consistent with the approach taken in proposed regulations regarding the GILTI high tax exclusion, which would apply on a QBU-by-QBU basis and would, therefore, require U.S. shareholders to determine the effective tax rate on foreign branches of CFCs.¹⁰ The effective tax rate on foreign branches is most accurately determined by giving effect to all items that are taken into account in determining income for foreign tax purposes, including disregarded payments received from the CFC foreign branch owner or other foreign branches owned by the same CFC foreign branch owner.

Remittances and Contributions

If a disregarded payment from a foreign branch to a CFC foreign branch owner is a remittance, we respectfully recommend that foreign taxes be allocated and apportioned based on current-year income of the foreign branch. In such a case, the disregarded payment would, if regarded, be a distribution and would not result in a reattribution of gross income under the principles of Treas. Reg. § 1.904-4(f)(2)(vi). The Proposed Regulations assign foreign taxes on disregarded distributions based on the after-tax income of the branch in the statutory and residual income groupings, but it deems such after-tax income to be determined based on the tax book value of the branch assets. In order to better reflect the character of branch income, after-tax income should instead be determined based on the current-year income of the branch in the statutory and residual income groupings (measured after giving effect to disregarded transactions that result in reattribution of income as described above). This rule would produce more appropriate results given that branch assets may not correspond to income, and it would be administrable because it would be limited to current-year income and would not require maintaining separate earnings and profits accounts for a branch.

If a disregarded payment from a CFC foreign branch owner is a contribution, we respectfully recommend that foreign taxes be allocated and apportioned to the residual income grouping. The Proposed Regulations assign foreign taxes on all disregarded payments by a CFC foreign branch owner to a foreign branch to the residual income grouping. We agree that this result is appropriate in the limited case of foreign taxes on disregarded payments that, if regarded, would be contributions to capital.

Conclusion

We recognize that complexity may result from a rule that “regards” disregarded payments, but as the preamble to the Final Regulations regarding foreign branch category income observes, rules that reattribute gross income as a result of disregarded payments can be “designed to utilize information that is already available to taxpayers, making the rule more administrable.”¹¹ Perhaps even more importantly, in this case the alternative would be to disallow a foreign tax credit for foreign income taxes incurred by a CFC that earns solely tested income. Such a result would be contrary to the policies of the GILTI foreign tax credit and the GILTI high tax exclusion, which are to ensure that taxpayers with high foreign effective tax rates are not subject to additional U.S. tax on GILTI. It would also be contrary to the general and longstanding policies underlying the foreign tax credit, which is to mitigate double taxation.

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We hope that you find this letter helpful and would be happy to answer any questions that you may have.

Respectfully submitted,

Layla J. Asali
lasali@milchev.com
(202) 626-5866

Rocco V. Femia
rfemia@milchev.com
(202) 626-5823

Marc J. Gerson
mgerson@milchev.com
(202) 626-1475

Miller & Chevalier Chartered
Washington, DC

cc:
The Honorable David Kautter, Assistant Secretary (Tax Policy), Department of the Treasury
Lafayette Harter III, Deputy Assistant Secretary — International Tax Affairs, Department of the Treasury
Douglas Poms, International Tax Counsel, Department of the Treasury
The Honorable Charles Rettig, Commissioner, Internal Revenue Service
The Honorable Michael Desmond, Chief Counsel, Internal Revenue Service
Peter Blessing, Associate Chief Counsel (International), Internal Revenue Service