Prudential Financial Focuses on Foreign Tax Effective Rate

September 12, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-101828-19)
Courier's Desk
1111 Constitution Avenue, N.W.
Washington, D.C. 20224

Re: REG-101828-19 (Proposed Regulations on GILTI High-Tax Income)

Prudential Financial, Inc. (“Prudential”) appreciates the opportunity to comment on the Notice of Proposed Rulemaking (REG-101828-19) (the “Proposed Regulations”) under the global intangible low-taxed income (“GILTI”)¹ provisions regarding gross income that is subject to a high rate of foreign tax, which were published in the Federal Register on June 21, 2019. These comments address the appropriate calculation of the effective rate at which foreign taxes are imposed on tentative net tested income pursuant to the GILTI high tax exclusion election (the “HTE Election”)² when there is a mismatch between the U.S. tax year of a controlled foreign corporation (“CFC”) and the required foreign tax year of such CFC.

We commend the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) for recognizing that Congress intended that income of a CFC should be taxed as GILTI only if it is subject to a low rate of foreign tax, and for proposing regulations aimed at achieving that result. We believe that, in order to truly produce that outcome and to ensure a level playing field for CFCs subject to local regulation with respect to required tax years, final regulations should provide rules for calculating the real effective rate of foreign tax to which tentative net tested income is subject in the event a CFC is required under local law to use a different tax year than its U.S. parent.³ In particular, we request that, to the extent CFCs are required under local law to use a tax year that is different than their tax year for U.S. tax purposes, any final version of the Proposed Regulations provide that such CFCs (or the United States shareholders of such CFCs) are allowed to choose to apportion foreign taxes actually paid or accrued on a closing-of-the-books basis when calculating the effective rate at which taxes are imposed on tentative net tested income for purposes of the HTE Election. Such a rule would properly reflect taxes paid with respect to tentative net tested income.

A. Legislative History of GILTI and the Operation of the HTE Election

The legislative history of the GILTI provisions expresses the intent that the GILTI regime not apply to income subject to high foreign rates of tax. For example, the explanation provided by the Senate Finance Committee provides that “The Committee believes that certain items of income earned by CFCs should be excluded from the GILTI, either because they should be exempt from U.S. tax — as they are generally not the type of income that is the source of base erosion concerns — or are already taxed currently by the United States. Items of income excluded from GILTI because they are exempt from U.S. tax under the bill include foreign oil and gas extraction income (which is generally immobile) and income subject to high levels of foreign tax"⁴ (emphasis added). Likewise, the Joint Explanatory Statement to the Conference Committee Report provides that “the minimum foreign tax rate, with respect to GILTI, at which no U.S. residual tax is owed by a domestic corporation is 13.125 percent” and reiterates that intent that only income subject to foreign tax at low rates be included in the GILTI tax regime, stating that “at foreign tax rates greater than or equal to 13.125 percent, there is no residual U.S. tax owed on GILTI.”⁵ Treasury and the IRS, in the preamble to the Proposed Regulations, specifically identify the Congressional intent that income subject to high rates of foreign tax not be subject to GILTI as the underpinning of the proposed HTE Election.⁶

The HTE Election applies if GILTI income is subject to foreign tax at sufficiently high effective rates. The Proposed Regulations provide that, for purposes of calculating the effective rate at which taxes are imposed on tentative net tested income pursuant to the HTE Election-calculated by taking foreign taxes paid with respect to GILTI and dividing by GILTI income earned in the U.S. taxable year — taxes paid or accrued with respect to a tentative net tested income item is the U.S. dollar amount of the CFC's “current year taxes” that would be allocated and apportioned to the tentative net tested income item by treating such tentative net tested income item as being in a separate tested income group.⁷ “Current year taxes” is a concept borrowed from proposed regulations under Section 960, and is defined as foreign income taxes that are attributed to income to the extent they are paid or accrued in the U.S. taxable year of the CFC⁸ (in other words, paid or accrued by December 31^st if the United States parent corporation of the CFC has a calendar year for U.S. tax purposes).⁹

B. Tax Year Mismatch Causes Distortions in Effective Tax Rates for HTE Election

Using this definition of “current year taxes” for purposes of the HTE Election can lead to distortions in effective tax rate calculations if a CFC has different U.S. and foreign tax years, as in such cases “current year taxes” are divorced from the income with respect to which such taxes are due if the income is earned in the calendar year and foreign income tax is not accrued until the close of the foreign tax year (i.e., the foreign tax is accrued after the close of that calendar year, in which case the foreign taxes of the CFC will be attributable to two different U.S. tax years). The preamble to the proposed regulations under Section 960 makes this divergence clear: “Current year taxes of a CFC that are imposed on an amount under foreign law that would be income under US law in a different taxable year are eligible to be deemed paid in the year in which the foreign tax accrues, and not in the earlier or later year when the related income is recognized for US tax purposes.”¹⁰ As a result, if a CFC has a tax year mismatch, then under the Proposed Regulations the amount of foreign income taxes that are attributed to tentative net tested income for purposes of the HTE Election will not properly reflect the actual effective foreign tax rate applicable to such income earned by such CFC, and could result in the inability of a United States shareholder of that CFC to exclude such tentative net tested income for purposes of calculating GILTI tax liability.

A fact pattern where GILTI income is increasing over time can illustrate the impact of this potential mismatch on the ability of a taxpayer to benefit from the HTE Election. For example, assume the following income and tax payment profile for a CFC paying foreign income taxes at a 30% rate, with a required March 31 tax year end for foreign purposes, but whose U.S. taxable year is the calendar year:

Year Mismatch Effective Tax Rate Calculation Under Proposed Regulations

	Year 1				Year 2				Year 3
	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1
GILTI Income	5	12	13	25	25	25	35	35	35
Taxes (30% rate, 3/31-year end)	6*				22.5				39
HTE numerator	6				22.5
HTE denominator	55				120
ETR on GILTI	10.91%				18.75%
* Year 1, Q1 assumes that the CFC earned 5 of income for each quarter previously, so that taxes dues on 3/31/Year 1 are 30% of 20 = 6.

Under the Proposed Regulations as currently drafted, the reference to “current year taxes” means that for Year 1 only 6 of tax would be taken into account in calculating the effective rate at which taxes are imposed on tentative net tested income pursuant to the HTE Election. For Year 2, only 22.5 of tax would be taken into account, and in each of Year 1 and Year 2 the effective rate of foreign tax for purposes of the HTE Election would be below the 18.9% threshold for the HTE Election provided in the Proposed Regulations, notwithstanding that foreign tax paid and attributable to that income is imposed at a 30% rate. This divergence of effective tax rates is a direct consequence of the different tax years and the nine-month mismatch between “current year taxes” (the numerator in the HTE Election effective tax rate calculation) and tentative net tested income (the denominator in the HTE Election effective tax rate calculation).

This mismatch is of particular concern to Prudential, and may lead to its inability to utilize the HTE Election to exclude from GILTI income earned in high-tax foreign jurisdictions. Prudential and its U.S. subsidiaries join in filing a consolidated tax return that uses the calendar year as the annual accounting period for U.S. tax purposes. However, certain CFCs owned by members of Prudential's consolidated group are required by foreign regulators to use non-calendar years for tax purposes. For example, Prudential's insurance company CFCs in Japan — which imposes income taxes on large enterprises at an approximately 30% rate — are required under insurance regulatory law to use a March 31 fiscal year end,¹¹ and the tax law in Japan requires a corporation to use the same accounting period for tax purposes as it is required to use under the non-tax laws governing that type of corporation.¹² However, the U.S. taxable year of those CFCs is the calendar year,¹³ leading to the fact pattern (illustrated in the above example) where, under the Proposed Regulations as currently drafted, only a single quarter's worth of income will be reflected in the calculation of “current year taxes” used as the basis for the CFC's eligibility for the HTE Election, with the remainder of “current year taxes” corresponding to income earned in the latter three quarters of the prior calendar year.¹⁴

In the context of qualifying for the HTE Election when income is subject to statutory rates of foreign tax above the 18.9% threshold (like income earned by an insurance company CFC in Japan), this mismatch is likely to cause only negative consequences for United States shareholders, given that qualification for the HTE Election is an all-or-nothing test based on effective tax rates. For example, if the mismatch results in a calculation whereby “current year taxes” reflect less income than was earned in the calendar year, then under the Proposed Regulations the income of the CFC would be viewed as being subject to an effective rate of foreign tax that is below the 30% rate imposed by Japan, and possibly below the rate required for eligibility for the HTE Election. However, if the mismatch results in a calculation whereby “current year taxes” reflect more income than was earned in the calendar year, there is no added benefit for HTE Election eligibility purposes; the income of the CFC would be considered to be subject to an effective rate of foreign tax that is above the 30% rate imposed by Japan, but even under the statutory rate the income of the CFC would have qualified for exclusion under the HTE Election. In other words, when the statutory rate is above the 18.9% threshold for the HTE Election provided in the Proposed Regulations, a mismatch would likely only ever result in a detriment to a United States shareholder hoping to take advantage of the HTE Election by causing the effective tax rate to fall below the threshold for eligibility, but would not provide a benefit since, absent a mismatch, the GILTI income of the CFC would have been eligible for exclusion under the HTE Election based on the statutory rate.

C. Recommended Solution: Closing-of-the-Books Election

We would request that the Proposed Regulations be revised to provide that, to the extent CFCs are required under local law to use a tax year that is different than their tax year for U.S. tax purposes, such CFCs (or the United States shareholders of such CFCs) are allowed to choose to apportion foreign taxes actually paid in respect of tentative net tested income on a closing-of-the-books basis for purposes of calculating the effective rate at which taxes are imposed pursuant to the HTE Election.¹⁵ To the extent such closing-of-the-books election is made, final regulations could provide that the closing-of-the-books method must be applied consistently thereafter and cannot be revoked without IRS permission.

The closing-of-the-books method would produce a result that would properly align foreign taxes paid with the tentative net tested income to which those taxes relate, and would accordingly be consistent with both the statutory text¹⁶ and the legislative history¹⁷ of Section 960, which state that foreign taxes paid should be “properly attributable” to income. The table below illustrates how the method would apply to the facts of the above example:

Year Mismatch Effective Tax Rate Calculation: Closing-of-the-Books Recommendation

	Year 1				Year 2				Year 3
	Q1	Q2	Q3	Q4	Q1	Q2	Q3	Q4	Q1
GILTI Income	5	12	13	25	25	25	35	35	35
Closing of Books Taxes Attributed	1.5	3.6	3.9	7.5	7.5	7.5	10.5	10.5	10.5
Taxes (30% rate, 3/31-year end)	6*				22.5				39
HTE numerator	16.5				36
HTE denominator	55				120
ETR on GILTI	30%				30%
* Year 1, Q1 assumes that the CFC earned 5 of income for each quarter previously, so that taxes dues on 3/31/Year 1 are 30% of 20 = 6

As shown in the above table, the proposed revision would result in a matching of tentative net tested income determined for U.S. tax purposes and the foreign income taxes ultimately due with respect to such income, as the taxpayer would be permitted to apportion foreign taxes for the foreign fiscal years ending March 31 to the income in the preceding calendar year to which such taxes are properly attributed. For Year 1, taxes of 16.5 would be taken into account in calculating the effective rate at which taxes are imposed on tentative net tested income pursuant to the HTE Election, and for Year 2 taxes of 36 would be taken into account in calculating the effective rate for purposes of the HTE Election. As a result, in each of Year 1 and Year 2 the effective rate of foreign tax for purposes of the HTE Election would be 30% — appropriately reflecting that foreign tax is paid at a 30% rate — and the GILTI income of the CFC would be eligible for exclusion under the HTE Election.

The closing-of-the-books method would also properly align foreign taxes paid with the income to which those taxes relate in the event of extraordinary transactions which, if there is a significant mismatch between U.S. and foreign tax years, could cause distortions when calculating the effective rate of foreign tax for purposes of the HTE Election. For example, in the context of a CFC with a foreign tax year that ends on March 31 but a calendar year for U.S. tax purposes, the closing-of-the-books method would match foreign taxes paid to the income to which such taxes relate for purposes of the HTE Election if there is an extraordinary transaction — like a sale of assets giving rise to a significant gain or loss — in the period between April 1 and December 31, where under the Proposed Regulations (as currently drafted) the numerator used in the calculation of the effective rate of foreign tax for purposes of the HTE Election would in such a case not properly reflect the extraordinary event.

D. Closing-of-the-Books Approach is Used to Allocate Taxes in Other Contexts

This closing-of-the-books approach is consistent with the approach used to allocate taxes in other contexts; for example, Treasury regulations which detail rules for allocating tax items of a subsidiary that enters or leaves a consolidated group during the tax year state that: “Federal, state, local, and foreign taxes are allocated under [ ] this section on the basis of the items or activities to which the taxes relate.”¹⁸ If the above closing-of-the-books election recommendation is incorporated when the Proposed Regulations are finalized, those final regulations could reference that allocation principle, similar to the way that rule is applied by reference to allocate foreign taxes of a target corporation between pre- and post-transaction periods in a Section 338 transaction,¹⁹ as well as for purposes of closing a CFC's taxable year under the recently promulgated temporary regulations governing the section 245A deduction for certain earnings distributed in the same year as reductions in ownership of CFC stock by a controlling shareholder.^{20, 21}

E. Closing-of-the-Books Election Would Have Appropriate Safeguards and Be Easily Implemented

We believe the above recommended rule could be made available only to CFCs which are required under local law to use a tax year that is different than their U.S. tax year and could be predicated upon the requirement that the closing-of-the-books method be applied consistently once elected. Accordingly, the proposed rule would not give rise to a potential for abuse given the narrow scope of applicability to CFCs required by foreign law to use a specific tax year and the condition that the closing-of-the-books method, once elected, be applied in a uniform manner on a going-forward basis. In addition, the closing-of-the-books method described above would only apply to apportion foreign taxes paid or accrued as of the end of the foreign fiscal year to tentative net tested income to which such taxes relate, so no foreign taxes could be considered for purposes of the effective rate calculation unless and until such taxes are actually incurred.²² If Treasury and the IRS believe the revision suggested in this letter has the potential for abuse notwithstanding those safeguards, we would welcome an opportunity to discuss additional limitations on the proposed rule.

The proposed rule's narrow scope should minimize any burden that Treasury and the IRS face in administering the provision. The suggested revision could be administered by including a closing-of-the-books election and supporting calculations and declarations in the statement the Proposed Regulations require to be attached to an original or amended income tax return in order to elect to apply the HTE Election.

When we met to discuss this closing-of-the-books proposal with respect to the tax year mismatch issue with representatives from Treasury, a question was asked about how this may apply to CFCs with a foreign tax year that ends after October 15 (the U.S. filing deadline after extension for a U.S. calendar year taxpayer). Currently, United States shareholders that have CFCs that file tax returns after October 15 may be required to file an amended U.S. tax return to the extent foreign taxes used for U.S. tax determinations differ from the actual foreign taxes paid or accrued. Therefore, we believe that in such a case the closing-of-the-books method does not result in any administrative burden beyond that which may already exist.

Prudential appreciates your consideration of these comments and would welcome the opportunity to discuss them with you at your convenience. Please contact us at (973) 802-5703 or james.shea@prudential.com and (973) 802-4437 or eric.lopata@prudential.com if you have any questions.

James J. Shea
Senior Vice President and Chief Tax Officer
Prudential Financial, Inc.
Newark, NJ

Eric M. Lopata
Vice President and Corporate Counsel
Prudential Financial, Inc.
Newark, NJ

cc:
Hon. David J. Kautter, Assistant Secretary of the Treasury (Tax Policy), U.S. Department of the Treasury
Hon. Charles P. Rettig, Commissioner, Internal Revenue Service
Lafayette G. “Chip” Harter III, Deputy Assistant Secretary (International Tax Affairs), U.S. Department of the Treasury
Michael J. Desmond, Chief Counsel, Internal Revenue Service
William M. Paul, Deputy Chief Counsel (Technical), Internal Revenue Service
Douglas L. Poms, International Tax Counsel, U.S. Department of the Treasury
Wade Sutton, Senior Counsel, U.S. Department of the Treasury
Jason Yen, Attorney-Advisor, U.S. Department of the Treasury