Treasury Provides Welcome Relief Under Section 965

As amended by the Tax Cuts and Jobs Act (P.L. 115-97), section 965 requires some taxpayers to include in income an amount based on the accumulated post-1986 deferred foreign income of specified foreign corporations that they own either directly or indirectly through other entities. Given the immediacy of those amendments (for 2017 financial statements and tax returns), soon after year-end (and in rapid succession), Treasury and the IRS issued interim guidance under section 965: Notice 2018-07, 2018-4 IRB 317; Notice 2018-13, 2018-6 IRB 341; Rev. Proc. 2018-17, 2018-9 IRB 384; and Notice 2018-26, 2018-16 IRB 480.

On August 9 Treasury and the IRS published proposed regulations (REG-104226-18) under section 965.¹ In large part, the proposed regulations confirm and adopt the guidance in the section 965 notices.²

On October 1 the IRS issued Notice 2018-78, 2018-42 IRB 604, which provides welcome relief to taxpayers under section 965 regarding:

• the basis election as it applies to some taxpayers under the transition rule;

• the treatment of members of a consolidated group as one U.S. shareholder for determining the aggregate cash position of a specified foreign corporation (SFC); and

• section 965 elections and transfer agreements made by taxpayers affected by Hurricane Florence.

Background — Amended Section 965

As amended, section 965 provides that for the last tax year of a deferred foreign income corporation (DFIC) that begins before January 1, 2018 (such year of the DFIC, the inclusion year), the subpart F income of the corporation (as otherwise determined for that tax year under section 952) is to be increased by the greater of the corporation’s accumulated post-1986 deferred foreign income determined as of November 2, 2017, or accumulated post-1986 deferred foreign income determined as of December 31, 2017 (each date being an earnings and profits measurement date). The greater is the section 965(a) earnings amount.

For this purpose:

• A DFIC is any specified foreign corporation of a U.S. shareholder that has accumulated post-1986 deferred foreign income as of November 2, 2017, or December 31, 2017, that is greater than zero.

• For tax years of foreign corporations beginning before January 1, 2018, a U.S. shareholder is a U.S. person who directly, indirectly, or constructively owns at least 10 percent of the total combined voting power of all classes of the foreign corporation’s stock.

• An SFC is any controlled foreign corporation, as well as any foreign corporation, having as a U.S. shareholder at least one domestic corporation. However, a corporation that is a passive foreign investment company (as defined in section 1297) with respect to the shareholder and is not a CFC, is not considered an SFC.

• The term “accumulated post-1986 deferred foreign income” includes all post-1986 E&P reduced by both post-1986 E&P that if distributed, would be excluded from the gross income of a U.S. shareholder under section 959 (previously taxed income, or PTI); and post-1986 E&P attributable to income that is effectively connected with the conduct of a U.S. trade or business and subject to U.S. income tax.

Notice 2018-78

The Basis Election Under the Transition Rule

The proposed regulations allow U.S. shareholders to elect to make specific basis adjustments for each DFIC and each E&P deficit foreign corporation (the basis election). The general rule provides that the basis election must be made no later than the due date (taking into account extensions, if any) for the U.S. shareholder’s return for the tax year that includes the last day of the last tax year of a DFIC or E&P deficit foreign corporation that begins before January 1. If that due date occurred before September 10, the proposed regulations provide that the basis election must be made by October 9 (the transition rule).

In Notice 2018-78, Treasury and the IRS announced that they have determined that requiring taxpayers to make a binding basis election before the proposed regulations are finalized would be too onerous. Accordingly, when finalized, under the transition rule, the basis election will need to be made no later than 90 days after the regulations have been published in the Federal Register. Also, the final regulations will provide that if a basis election was made on or before the date they are published, the basis election may be revoked no later than that same date.

Consolidated Groups

The proposed regulations provide rules allowing a U.S. shareholder to disregard specific assets in determining its aggregate foreign cash position. They state that all members of a consolidated group that are U.S. shareholders of an SFC are treated as a single U.S. shareholder for specified enumerated purposes, but not for disregarding some assets when determining an SFC’s aggregate foreign cash position.

In Notice 2018-78, Treasury and the IRS announced that to prevent the overstatement of the aggregate foreign cash position, the final regulations will provide that all members of a consolidated group that are U.S. shareholders of an SFC will be treated as a single U.S. shareholder for determining that SFC’s aggregate cash position.

Hurricane Florence Relief

In response to Hurricane Florence, the IRS announced in September that some individual and business taxpayers will have until January 31, 2019, to file specific tax returns and make specific tax payments.³ Questions have arisen regarding whether those announcements apply to section 965 elections and to transfer agreements required to be filed under the proposed regulations.

Notice 2018-78 provides a postponement for affected taxpayers⁴ to make those elections and file those agreements. Affected taxpayers for whom section 965 elections or transfer agreements are due on or after September 7 and before January 31, 2019, now have until January 31, 2019, to file those elections or transfer agreements.

Taxpayers who believe they are entitled to that relief should mark “Hurricane Florence” on the top of the relevant section 965 election statement or transfer agreement, and for a transfer agreement, should include a notation as to which party to the agreement is an affected taxpayer.