Firm Addresses Consolidated Group Issue Under FDII, GILTI Regs

May 3, 2019

Secretary of the Treasury
CC:PA:LPD:PR (REG-104464-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Comments on REG-104464-18

Dear Mr. Secretary:

These comments are filed with respect to the Notice of Proposed Rulemaking (REG-104464-18) ("proposed regulations or Prop. Reg. § 1.1502-50") published in the Federal Register on March 6, 2019, which provides guidance on the new deduction for foreign-derived intangible income ("FDII") and global intangible low-taxed income ("GILTI") (section 250¹) on behalf of a group of property-casualty ("P&C") and life insurance companies that file life/nonlife consolidated Federal income tax returns subject to Treas. Reg. § 1.1502-47.² 84 Fed. Reg. 8188 (Mar. 6, 2019). These comments address an issue that arises in applying the proposed regulations to a life/nonlife consolidated group.

The proposed regulations provide for consolidation of the section 250 deduction consisting of a "consolidated FDII deduction amount" and a "consolidated GILTI deduction amount." These consolidated deductions are determined on an aggregate basis for all of the relevant items of all members of the consolidated group without regard to which member owns the stock of the controlled foreign corporation ("CFC") giving rise to the GILTI or the location of the FDII. The consolidated section 250 deduction is then allocated to individual group members based on ratios relating to each member's contribution to the consolidated FDII or GILTI amount components of the consolidated section 250 deduction. Although the proposed regulations require a consolidated section 250 deduction approach, that consolidated approach could result in an inappropriate permanent disallowance of the section 250 deduction in a life/nonlife consolidated return if the allocation of the deduction to group members is made on a subgroup basis.

One possible solution for preventing the inappropriate loss of a consolidated section 250 deduction is to amend Prop. Reg. § 1.1502-50 (and make conforming amendments to Treas. Reg. §1.1502-47) to provide that the application of the consolidated section 250 deduction to a life/nonlife consolidated group occurs based on the group's consolidated taxable income. This approach is consistent with the application of the consolidated section 250(a)(2) taxable income limitation to the life/nonlife group's consolidated taxable income.

I. BACKGROUND

A. Sections 250 and 951A

Section 250 was enacted as part of Pub. L. No. 115-97 (2017) (commonly referred to as the "Tax Cuts and Jobs Act of 2017" or "TCJA") on December 22, 2017. For taxable years beginning after December 31, 2017, section 250 allows a domestic corporation a deduction equal to 37.5 percent of its FDII for that year, and a deduction equal to 50 percent of the sum of its GILTI for that year (determined under section 951A) and the amount treated as a dividend received by the corporation under section 78 that is attributable to its GILTI.³ The different deduction percentages for FDII and GILTI are the result of differences in the extent to which foreign tax credits are allowed to offset U.S. tax on FDII and GILTI. The statute is designed to ensure that both FDII and GILTI are subject to a minimum tax rate (whether U.S. or foreign) of 13.125 percent.⁴ Foreign tax credits may be available to offset some or all of the U.S. tax on FDII or GILTI so that there may be no residual U.S. tax if sufficient foreign taxes have been paid on the income. A higher deduction amount is necessary for GILTI because foreign tax credits are allowed to offset 100 percent of the U.S. tax on FDII but only 80 percent of the U.S. tax on GILTI. Considering this 80-percent limit in combination with the higher section 250 deduction percentage for GILTI, the minimum foreign tax rate with respect to GILTI at which no residual U.S. tax is owed is 13.125 percent (10.5 percent/80 percent).⁵

If the sum of a corporation's FDII and GILTI amounts exceeds the taxable income of the domestic corporation (determined without regard to section 250), then the amount of FDII and GILTI for which a deduction is allowed is reduced under section 250(a)(2) by the amount of the excess. If reduction is required, the FDII amount is reduced by an amount equal to the amount of the excess multiplied by the ratio of the FDII amount to the sum of the FDII and GILTI amounts. The GILTI amount is then reduced in an amount equal to the remainder of the excess.

FDII equals the company's "deemed intangible income" multiplied by the percentage of its "deduction eligible income" that is derived by serving foreign markets. For this purpose, deemed intangible income equals the excess (if any) of the company's deduction eligible income over a 10-percent return on its qualified business asset investment ("QBAI"). The percentage of the company's deduction eligible income derived from serving foreign markets equals the amount of its "foreign-derived deduction eligible income" over its deduction eligible income.

Deduction eligible income means the excess (if any) of the gross income of the corporation determined without regard to any subpart F income inclusion under section 951(a)(1), any GILTI inclusion under section 951A, any financial services income (as defined in section 904(d)(2)(D)), any dividends received from a CFC, any domestic oil and gas extraction income, and any foreign branch income (as defined in section 904(d)(2)(J)), over the deductions (including taxes) properly allocable to such gross income. Foreign-derived deduction eligible income means the deduction eligible income derived in connection with property sold by the taxpayer to any non-U.S. person that the taxpayer establishes to the satisfaction of the Secretary is for a "foreign use," or services provided by the taxpayer that the taxpayer establishes to the satisfaction of the Secretary are provided to any person, or with respect to property, located outside the United States. Foreign use means any use, consumption, or disposition outside the United States. Special rules apply to property or services provided to domestic intermediaries and with respect to related party transactions.

Section 951A requires a U.S. shareholder of a CFC to include in gross income its GILTI in a manner generally similar to inclusions of subpart F income. GILTI means, with respect to any U.S. shareholder for the shareholder's taxable year, the excess (if any) of the shareholder's "net CFC tested income" over the shareholder's "net deemed tangible income return." Net CFC tested income is the excess (if any) of the aggregate of the shareholder's pro rata share of the "tested income" of each CFC with respect to which it is a U.S. shareholder over the aggregate of its pro rata share of the "tested loss" of each CFC with respect to which it is a U.S. shareholder. The tested income of a CFC is the excess (if any) of the gross income of the CFC determined without regard to certain amounts (the "gross tested income") over deductions properly allocable to such income. The tested loss of a CFC is the excess (if any) of deductions properly allocable to the CFC's gross tested income over the amount of such gross income. The U.S. shareholder's net deemed tangible income return is the excess (if any) of 10 percent of the aggregate of its pro rata share of the QBAI of each CFC with respect to which it is a U.S. shareholder over certain interest expense. QBAI means the average of the aggregate of a CFC's adjusted bases, determined at the close of each quarter of the taxable year, in specified tangible property used in the CFC's trade or business and of a type with respect to which a deduction is generally allowable under section 167.

The Secretary is authorized to prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of section 250.

B. Proposed Regulations on the Deduction for GILTI/FDII

The Preamble to the proposed regulations explains that the "result of the section 250 deduction for both GILTI and FDII is to help neutralize the role that tax considerations play when a domestic corporation chooses the location of intangible income attributable to foreign-market activity." 84 Fed. Reg. 8189. The proposed regulations provide guidance for determining the amount of the section 250 deduction, including rules for applying the taxable income limitation of section 250(a)(2). The proposed regulations provide an ordering rule for applying sections 163(j) (limitation on business interest) and 172 (net operating loss ("NOL") deduction) in conjunction with section 250. (The proposed regulations under section 163(j) provide a single limitation for a consolidated group.) Specifically, for purposes of applying the section 250(a)(2) taxable income limitation, a domestic corporation's taxable income is determined after all of the corporation's other deductions are taken into account. The Preamble explains there are five steps a corporation must take to determine its allowable business interest under section 163(j), its net operating loss deduction under section 172(a), and its section 250 deduction.

The proposed regulations also provide rules for purposes of applying section 250 to consolidated groups. The Preamble explains that the section 250 deduction "is available to a member of a consolidated group ('member') in the same manner as the deduction is available to any domestic corporation." 84 Fed. Reg. 8200. It further explains that computing a member's section 250 deduction based solely on its items of income and QBAI may not result in a clear reflection of the consolidated group's income tax liability. The Preamble notes that using a strict separate-entity approach to the application of section 250 could lead to inappropriate increases or decreases in a consolidated group's aggregate amount of section 250 deductions. The proposed regulations avoid those issues by "ensur[ing] that the aggregate amount of deductions allowed under section 250 to members appropriately reflects the income, expenses, gains, losses, and property of all members." Prop. Reg. § 1.1502-50(a)(2). Definitions in the proposed regulations provide for the aggregation of certain amounts, including deduction eligible income, foreign-derived deduction eligible income, and GILTI, which are used along with the consolidated group's consolidated taxable income to calculate an overall section 250 deduction for the group. Prop. Reg. § 1.1502-50(e). The proposed regulations then allocate the consolidated group's overall section 250 deduction to individual members based on the member's contribution to the consolidated FDII and GILTI amounts. Prop. Reg. § 1.1502-50(b).

C. Section 172

Section 172 provides the rules for determining an NOL deduction. Section 172(b)(2) provides rules for determining the amount of any NOL carryback or carryover. Section 172(b)(2)(A) requires taxable income for prior years to be determined with certain modifications in section 172(d). Section 172(d)(9) provides that no deduction under section 250 shall be allowed for this purpose.

Section 172 provides that, unlike other types of taxpayers, P&C companies can carry back NOLs to two prior taxable years and offset 100 percent of certain taxable income.

D. Life/Nonlife Regulations Under Treas. Reg. § 1.1502-47

Special rules apply under Treas. Reg. § 1.1502-47 to taxpayers that elect to file a life/nonlife consolidated return. These rules require the use of a subgroup method to determine consolidated tax liability, with one subgroup consisting of the group's nonlife companies and the other subgroup consisting of the group's life insurance companies. Treas. Reg. § 1.1502-47(a)(2)(i). In general, and except to the extent the life/nonlife consolidated rules provide otherwise, all of the other consolidated return provisions apply. Treas. Reg. § 1.1502-47(a)(4).

Initially, each subgroup computes its consolidated taxable income by applying the rules in Treas. Reg. § 1.1502-11. The nonlife subgroup computes nonlife consolidated taxable income and the life subgroup computes consolidated partial life insurance company taxable income. Treas. Reg. § 1.1502-47(a)(2)(i). As part of that calculation, each subgroup is required to use its own NOL carryforward or carryback (if a carryback is available) determined as if the subgroup was the consolidated group. See Treas. Reg. § 1.1502-47(h)(2)(iv), (k)(5), (1)(3). This treatment is required even if the other subgroup has a current year loss. See, e.g., Treas. Reg. § 1.1502-47(h)(2)(iii) and (v), (k)(5)(i) and (ii). If a subgroup's NOL carryforward is insufficient to absorb that subgroup's taxable income, a current year loss from the other subgroup may generally be utilized. If the current-year loss does not fully absorb the other subgroup's taxable income, an NOL carryforward may be used. However, losses (both current-year losses and NOL carryovers) from the nonlife subgroup are limited in absorbing life subgroup income under section 1503(c)(1) and (2). Section 1503(c) does not contain limitations on the use of life subgroup losses against nonlife subgroup taxable income.

Consequently, even though under Treas. Reg. § 1.1502-47 one subgroup's taxable income before consolidation may generally be netted against another subgroup's taxable loss, in whole or in part, in computing overall consolidated taxable income, the life/nonlife consolidated return regulations adopt unique rules that treat this sharing as an offset by a loss of the other subgroup, rather than a pure consolidated taxable income calculation of a consolidated group that is treated as a single taxpayer. (The life/nonlife regulations prevent the offset from creating negative taxable income of either subgroup for purposes of the consolidated taxable income computation.) Unlike the rules for other consolidated return filers, in the case of a life/nonlife group filing, the deductions and income of a subgroup with a taxable loss do not actually affect the computation of nonlife consolidated taxable income or consolidated partial life insurance company taxable income (if the taxable loss is in the other subgroup). Treas. Reg. § 1.1502-47(a)(2)(ii). Rather, they constitute a bottom-line adjustment in reaching consolidated taxable income. Because of these unique rules and the treatment of losses as offsets rather than part of a single consolidated taxable income calculation, consolidated taxable income as defined in Treas. Reg. § 1.1502-47(g) also cannot be negative.

We anticipate that certain amendments will be proposed to the subgroup approach in Treas. Reg. § 1.1502-47 as a result of the amendments to section 172 and other TCJA amendments. At this time, there is no guidance as to what changes may be made to life/nonlife consolidation.

II. DISCUSSION

The Preamble states that the section 250 deduction "is available to a member of a consolidated group ('member') in the same manner as the deduction is available to any domestic corporation." 84 Fed. Reg. 8200. It also states the rules in the proposed regulations are intended to avoid inappropriate increases or decreases in the amount of a consolidated group's aggregate section 250 deductions that could result from a strict, separate-entity approach to applying section 250. Further, the Preamble notes that the consolidated approach to the section 250 deduction is necessary to ensure a clear reflection of income and that the aggregate deduction does not depend on which member contributed the GILTI or FDII income. In the case of a consolidated group, the proposed regulations provide for the calculation of a consolidated section 250 deduction that reflects the income, expenses, gains, losses, and property of all members, which is then allocated to individual group members. The proposed regulations fail, however, to address how the rules would apply to members of a life/nonlife consolidated group. Because of the unique rules that apply to life/nonlife groups, clarification of how to calculate the section 250 deduction for members of such groups is necessary to properly implement all of the tax policy goals identified in the Preamble.

Without clarification, and contrary to the tax policy reflected in the Preamble, it is possible the proposed regulations would be applied in a manner that results in the permanent denial of a section 250 deduction to members of a life/nonlife group, even where the group has positive amounts of FDII, GILTI, and consolidated taxable income. As one example, consider a life/nonlife group that has a consolidated GILTI deduction amount, a loss in the nonlife subgroup, income in the life subgroup, and overall consolidated taxable income. The section 250 deduction may or may not be available to the life/nonlife consolidated taxpayer, depending on which member (and which subgroup) owns the stock of the CFC. As indicated in the Preamble, to clearly reflect income, the availability of the section 250 deduction should not depend on which member of the group owns the stock of a particular CFC.

III. RECOMMENDATION

To ensure that the aggregate section 250 deduction allowed to members of a life/nonlife consolidated group remains consistent regardless of the consolidated group composition, one possible solution is to clarify Prop. Reg. § 1.1502-50 (and make conforming amendments to Treas. Reg. § 1.1502-47) to apply the section 250 deduction based on consolidated taxable income of a life/nonlife group rather than take it into account in a subgroup calculation. Even though the proposed regulations generally allocate the section 250 deduction to the member with GILTI (or FDII) income, in a life/nonlife group, it could be considered a consolidated deduction first to determine whether it can be used against consolidated taxable income, and only thereafter allocated to a member. This approach would implement the tax policy goals reflected in the Preamble, and, in particular, lessen the importance of the subgroup location of the CFC stock in computing the section 250 deduction.

Section 250(a)(2) contains a taxable income limitation on the amount of the section 250 deduction. Under the proposed regulations for consolidated groups, the consolidated section 250(a)(2) limitation looks to the excess of the sum of FDII and GILTI over consolidated taxable income of the consolidated group. For this purpose, the proposed regulations provide that the section 250(a)(2) limitation is determined after taking into account the application of sections 163(j) and 172(a). Therefore, for a life/nonlife consolidated group, the section 250(a)(2) limitation is determined based on consolidated taxable income for the life/nonlife group. To be consistent, the section 250 deduction could be applied based on overall consolidated taxable income. This is in effect the same approach available to "regular" consolidated return taxpayers. This approach would still allow for effect to be given to the section 250(a)(2) limitation should FDII and GILTI be more than consolidated taxable income.

Sincerely yours,

Peter H. Winslow

Lori J. Jones

Brion D. Graber

Scribner, Hall & Thompson, LLP
Washington, DC