Attorney Proposes Guidance to Encourage Repatriation of PTEP

March 5, 2020

The Honorable Lafayette G “Chip” Harter
Deputy Assistant Secretary, International Tax Affairs
United States Treasury Department
1500 Pennsylvania Avenue NW, Room 3058
Washington, DC 20220

Peter H. Blessing
Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Avenue NW
Washington, DC 20224

Subject: Proposal re section 961(b)(2) issue

Dear Chip and Peter:

The purpose of this note is to remind you of an issue that is gating repatriation of PTEP (formerly, PTI) from CFCs, propose relatively simple options for addressing this issue, and request that you provide early guidance on this matter, separate from the work being undertaken with respect to the post-TCJA PTEP rules.

The basics are well known but, to summarize, under Treas. Reg. §1.961-2(a), distributions from PTEP which are excluded from income under section 959(a) reduce tax basis in the shares of the distributing CFC at the time of distribution, whereas under section 961(a) any increase in basis from PTEP occurs only at the end of the tax year. The result is exposure to gain under section 961(b)(2) for mid-year PTEP distributions in excess of basis at the time of the distribution, even though no gain would exist based on results for the full tax year.

This has of course been an issue since 1962 with respect to distributions of PTEP from subpart F income reported under section 951(a)(1)(A). However, this issue has not generated any significant controversy to date, probably given the relatively small amount of subpart F PTEP compared to overall tax basis.

Following the Tax Cuts and Jobs Act and enactment of the GILTI rules, the preponderance of PTEP of most CFCs in a tax year will arise under new section 951A, but still with no increase in tax basis under section 961(a) until the end of the tax year. As a result, U.S. shareholders of CFCs with significant GILTI PTEP are faced with the difficult choice of 1) waiting until after the end of the tax year to distribute the PTEP accumulated under section 951A, 2) making a mid-year distribution and risking creating taxable capital gains under 961(b)(2), or 3) lending the PTEP-related cash to the US and relying on section 959(a) to avoid additional US tax (but creating ancillary issues related to interest paid by the U.S. borrower on the loan with related BEAT and U.S withholding tax consequences).

I know that you have many smart people working on PTEP guidance, including this issue. I will nonetheless suggest several approaches for you to consider:

1) Gain Reduction Approach

Adopt the gain reduction approach of Treas. Reg. §1.965-2(g). This can be accomplished by renumbering Treas. Reg. §1.961-2(c) as Treas. Reg. §1.961-2(c)(i) and adding a new Treas. Reg. §1.961-2(c)(ii) to read as follows:

Treas. Reg. §1.961-2(c)(ii) Reduction in gain recognized under section 961(b)(2) by reason of distributions attributable to section 951A previously taxed earnings and profits in the inclusion year — If a section 958(a) U.S. shareholder receives a distribution from a controlled foreign corporation (including through a chain of ownership described under section 958(a)) during the inclusion year of the controlled foreign corporation that is attributable to section 951A previously taxed earnings and profits of the controlled foreign corporation, then the amount of gain that otherwise would be recognized under section 961(b)(2) by the section 958(a) U.S. shareholder with respect to the section 958(a) U.S. shareholder's section 958(a) stock of the controlled foreign corporation is reduced (but not below zero) by an amount equal to the section 951A previously taxed earnings and profits of the controlled foreign corporation with respect to the section 958(a) U.S. shareholder.

2) Section 1248 Recharacterization Approach

Adopt the approach of Treas. Reg. §1.1248-1(b) whereby gain recognized by a shareholder under section 301(c)(3) in connection with a distribution of property by a corporation with respect to its stock shall be treated as gain from the sale or exchange of stock of such corporation. This can be accomplished by adding the italicized language below to the second sentence of Treas. Reg. §1.1248-1(b) so that it reads as follows:

For purposes of section 1248(a), gain recognized by a shareholder under section 301(c)(3) in connection with a distribution of property by a corporation with respect to its stock and amounts treated under section 961(b)(2) as gain from the sale or exchange of property shall be treated as gain from the sale of exchange of stock of such corporation.

Since section 961 by its terms only applies to section 958(a) U.S. shareholders, this modification would permit shareholders recognizing gain under section 961(b)(2) to benefit from section 959(a) to the extent of any GILTI-related section 959(c)(1) or (c)(2) PTEP at the end of the tax year and be entitled to the dividend received deduction under section 245A for any remaining section 959(c)(3) E&P for the CFC at the end of the tax year.

3) Gain Recharacterization Approach

Similar to recommendation 2, provide that section 962(b)(2) gain shall be treated as gain from the sale or exchange of stock of such corporation. This can be accomplished by adding the italicized language below to Treas. Reg. §1.961-2(c) so that it reads as follows:

To the extent that the amount of the reduction in the adjusted basis of property provided by paragraph (a) of this section exceeds such adjusted basis, the amount shall be treated as gain from the sale or exchange of property. To the extent that the reduction in excess of adjusted basis under paragraph (a) arises directly or indirectly with respect to stock in a foreign corporation, the amount of gain under the preceding sentence shall be treated as gain from the sale or exchange of stock of such foreign corporation.

Taking a cue from the comments of Commissioner Rettig at the annual meeting of the International Fiscal Association in Boston last week, in my view you can provide a useful service to your taxpayer customers by issuing early and discrete guidance on this important matter.

For the record, I am a tax lawyer in private practice and a member of the faculty of the Boston University School of Law.

Respectfully submitted

Brainard L. Patton
Counselor at Law
Duxbury, MA