Retain Financial Institution Definition in FTC Regs, Firm Says

February 9, 2021

The Honorable Itai Grinberg
Deputy Assistant Secretary (Multilateral Tax)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable Rebecca Kysar
Counselor to the Assistant Secretary
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable William M. Paul
Acting Chief Counsel and Deputy
Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Foreign Tax Credit Proposed Regulations (Internal Revenue Service REG–101657–20) — Definition of Financial Services Entity

Dear Ms. Kysar and Messrs. Grinberg, Rettig, and Paul:

We are writing in response to the request for comments on the proposed foreign tax credit regulations issued in November 2020 (the “2020 proposed regulations”).

In December 2019, Treasury and the IRS issued proposed regulations (the “2019 proposed regulations”) that would amend the definition of a financial services entity (“FSE”) for purposes of the foreign tax credit rules under section 904. The 2019 proposed regulations requested comments on whether additional guidance is needed with respect to the definition of a qualified financial institution (“QFI”) for purposes of the qualified deficit rules under section 952(c). The 2020 proposed regulations would make different changes to the FSE definition for purposes of section 904 than were proposed in 2019. The 2020 proposed regulations do not discuss the effect (if any) the proposed changes to the FSE definition will have on what constitutes a QFI for purposes of the qualified deficit rules.

We previously responded to the initial request for comments regarding the QFI implications of the changes to the proposed FSE definition.¹ This letter supplements those comments in light of the 2020 proposed regulations setting forth a different approach to the definition of an FSE for purposes of section 904. Our comments address only the QFI and qualified deficit issues, and not the proposed FSE definition for purpose of section 904.

We recommend that the definition of a QFI continue to be based on the definition of an FSE in the current final regulations (the “current FSE definition”), which permits related party transactions to be taken into account. Congress has confirmed that the current FSE definition appropriately implements the policy of the qualified deficit rules under section 952(c) by explicitly endorsing its use for QFI purposes, by enacting a statutory cross-references to that regulatory definition, and by specifically modifying that cross-referenced definition when it sought to exclude related party transactions in another context. Further, the reasons identified by Treasury and the IRS for proposing to modify the FSE definition have no application in the QFI context. But if the current FSE definition is nevertheless to be modified for QFI purposes, then transition relief should be provided; the rule suggested below would protect taxpayers' ability to use currently existing qualified deficits in future periods if the CFC at issue satisfies either the current FSE definition or the new FSE definition.

In the sections that follow, we first explain the relationship between the qualified deficit rules and the FSE rules. We next summarize the legislative and regulatory history that confirms the current FSE definition's consistency with the policies of section 952(c), supporting its continued use for QFI purposes. We then show the inapplicability in the QFI context of the reasons that Treasury and the IRS have identified for changing the current FSE definition in the section 904 context. We conclude by summarizing administrative law principles that advise against an approach that would render existing qualified deficits unusable, and by providing suggested drafting approaches to implement our recommendations.

I. Relationship of Qualified Deficit Rules under Section 952(c) to FSE Rules

As initially enacted in 1962, subpart F included an accumulated deficit rule that permitted a CFC with a deficit in earnings to reduce its subpart F income in later years. This ensured that taxation under subpart F, which was immediate and at the full U.S. rate, was not imposed on an amount greater than the CFC's economic income over a multi-year period. The accumulated deficit rule generally permitted any loss (even if not related to activities generating subpart F income) to offset future subpart F income. The Tax Reform Act of 1986 (the “1986 Act”) introduced the qualified deficit rules of section 952(c) in order to narrow the application of the accumulated deficit rules by limiting loss carryovers for subpart F purposes to “qualified deficits” arising from activities that generate subpart F income.²

The legislative history states that this more limited qualified deficit rule was intended to: (1) prevent taxpayers from acquiring a CFC with existing accumulated deficits and using them to offset income (as this type of attribute trafficking is not covered by section 382); (2) prevent losses from non-subpart F activities from offsetting subpart F income; (3) prevent losses in one category of subpart F income from offsetting subpart F income in another category; and (4) in the case of foreign personal holding company (“FPHC”) income and insurance income, prevent taxpayers from sheltering unrelated passive income by shifting that income into the entity with the loss.³

Section 952(c) generally protects against these concerns by providing that a qualified deficit may only offset subpart F income in the same category and limiting the available amount of the qualified deficit based on the U.S. shareholder's ownership at both the time the loss arose and the time the loss is used.⁴

The goal of preventing taxpayers from shifting passive income to a loss CFC was in part implemented through the QFI rules. Under the qualified deficit provisions, only losses generated by a QFI were permitted to be carried forward and used against the future FPHC income of that business; given that the gains and losses both arose from the same business, such a scenario did not present the articulated concern that taxpayers might shift passive income to a CFC with unrelated losses.⁵

The statutory definition of a QFI did not provide detailed guidance regarding when a CFC would be considered “predominantly engaged in the active conduct of a banking, financing, or similar business.” The legislative history to the 1986 Act did, however, recognize that the same language was used to define both an FSE under the new foreign tax credit rules creating the separate category for financial services and to define a QFI under the qualified deficit rules, and specifically noted that a QFI was a CFC that was predominantly engaged in a banking, financing, or similar business “within the meaning of new Code sec. 904(d)(2)(C)(ii).”⁶ Although Treasury and the IRS have never formally implemented this in regulations, taxpayers have generally looked to guidance under the current FSE definition to determine whether a CFC constitutes a QFI. Further, as discussed below, Congress has specifically endorsed use of the current FSE definition for QFI purposes.

We turn now to consider whether later statutory developments related to the definition of an FSE suggest any need for modification of the current FSE definition, as applied for purposes of defining a QFI.

II. Subsequent Statutory Changes Support Retaining the Current FSE Definition for QFI Purposes

While there have been significant legislative developments since the current FSE definition was promulgated, none of those changes support altering the definition of a QFI. First, the use of the current FSE definition for QFI purposes has been explicitly approved by Congress. Second, the concerns cited in the 2020 proposed regulations as motivating the most recent proposed changes to the current FSE definition do not extend to the qualified deficit rules and the definition of a QFI. We discuss each of these points in greater detail below.

A. Congress Has Approved of the Current FSE Definition for QFI Purposes

As noted above, the legislative history to the 1986 Act recognized that the same language was used in both the definition of an FSE for section 904 purposes and the definition of a QFI for section 952(c) purposes. Legislation enacted in 1988 and 2004 reflects continuing Congressional attention to the relationship between the two definitions, and reflects specific Congressional endorsement of using the current FSE definition for QFI purposes.

Four months before enactment of the Technical and Miscellaneous Revenue Act of 1988 (“TAMRA”), regulations under section 904(d) were finalized (the “1988 final regulations”). The 1988 final regulations departed from the legislative history of the 1986 Act and earlier proposed regulations by providing that active financing income that supports FSE status includes income from transactions with related persons.⁷ It is therefore notable that Congress enacted significant changes to the definition of an FSE when it passed TAMRA later that same year, yet it neither changed nor even commented on the final regulations' deviation from earlier legislative history.⁸

This fact alone should demonstrate that Congress accepted the 1988 final regulations' implementation of the FSE rules, including the regulations' inclusion of related party transactions.⁹ A second TAMRA amendment reinforces this conclusion, by reflecting further Congressional focus on the identical statutory language, this time in the context of section 952(c). In particular, TAMRA restored in modified form the “chain deficit” rule that had been repealed just two years earlier by the 1986 Act due to Congressional concerns about potential abuses of the provision. The post-TAMRA chain deficit rule adopted a similar set of safeguards as the qualified deficit rules, including limiting the use of chain deficits in FPHC income to QFIs.¹⁰ When it restored the chain deficit rule, Congress relied explicitly on QFI qualification as the means to prevent the mismatching of FPHC income and unrelated losses, thus adopting the QFI definition for the same purpose as under the qualified deficit rules, and doing so shortly after the revised FSE definition was adopted in the 1988 final regulation.¹¹

The only other change since 1988 to the FSE rules occurred sixteen years later when Congress reduced the number of foreign tax credit baskets under section 904(d) from nine to two. The import of the 2004 legislation is addressed immediately below, in connection with our comments on the reference to the same legislation in the preamble to the final regulations under section 904 that were issued in November 2020 (the “2020 final regulations”).¹²

B. The Reasons Articulated for Changing the Current FSE Definition Do Not Support Changing the QFI Definition

The 2020 proposed regulations retain the rule proposed in 2019 requiring that 70 percent of qualifying income be from transactions with unrelated persons, meaning that many treasury centers of U.S. multinationals will not qualify as an FSE.¹³

In response to comments criticizing the changes to the FSE definition that were proposed in 2019, the preamble to the 2020 final regulations states that:

The Treasury Department and the IRS have determined that revisions to the financial services entity rules in § 1.904–4(e) continue to be necessary in light of statutory changes made in 2004 (under the American Jobs Creation Act of 2004, Pub. L. 108–357) and the changes to the look-through rules in § 1.904–5 in the 2019 FTC final regulations, which were precipitated by the revisions to section 904(d) under the TCJA.¹⁴

Although the preamble does not explain why the cited statutory changes make it necessary to revise the current FSE definition for foreign tax credit purposes, for the following reasons those changes do not in any event support altering the longstanding definition for QFI purposes.

1. The 2004 Act

The changes to section 904(d) enacted in the 2004 Act do not suggest a need for a change in the QFI context, and instead, the accompanying legislative history is clear that the definition of an FSE was intended to continue unchanged, including specifically for purposes of section 952(c). In particular, the legislative history states:

The provision does not alter the present law interpretation of what it means to be a “person predominantly engaged in the active conduct of a banking, insurance, financing, or similar business.” [Citing Treas. Reg. § 1.904-4(e).] Thus, other provisions of the Code that rely on this same concept of a “person predominantly engaged in the active conduct of a banking, insurance, financing, or similar business” are not affected by the provision. For example, under the “accumulated deficit rule” of section 952(c)(1)(B), subpart F income inclusions of a U.S. shareholder attributable to a “qualified activity” of a controlled foreign corporation may be reduced by the amount of the U.S. shareholder's pro rata share of certain prior year deficits attributable to the same qualified activity. . . . The present-law meaning of 'predominantly engaged' for purposes of section 952(c)(1)(B) remains unchanged under the provision.¹⁵

The 2004 changes were focused on reducing the number of separate categories for foreign tax credit limitation purposes, and did not modify the qualified deficit rules at all.¹⁶ Moreover, as noted above, the changes to the foreign tax credit limitation rules for financial services companies were intended to expand such companies' ability to cross-credit, by allowing them to combine general income and credits with financial services income and credits.¹⁷ Indeed, the 2004 change to permit more cross-crediting by financial services companies was taxpayer favorable and therefore it is unclear why a legislative provision that was intended to expand the ability of FSEs to cross credit a broader range of their income should justify narrowing the application of the rule now. But even if this change were somehow warranted in light of the 2004 amendment (and notwithstanding the accompanying legislative history disavowing any such change), nothing about this legislation supports a modification of the operation of the QFI rules. The 2004 Act did not modify the section 952(c) rules in any way, and to the contrary, the legislative history was clear that the “[t]he present-law meaning of 'predominantly engaged' for purposes of section 952(c)(1)(B) remains unchanged under the provision.”

Even more telling than the 2004 legislative history's explicit endorsement of the current FSE definition is the fact that the same legislation enacted a new Code provision confirming that the definition of an FSE does not exclude related party transactions. In particular, the 2004 Act enacted section 864(f), which provides a one-time election to allocate interest expense using a worldwide fungibility approach.¹⁸ Section 864(f), as enacted, also included rules that alter the general interest allocation rules for financial companies, which allow taxpayers to subdivide their group into financial and non-financial companies. Newly enacted section 864(f) defined a financial corporation for this purpose, providing that:

For purposes of this paragraph, the term 'financial corporation' means any corporation if at least 80 percent of its gross income is income described in section 904(d)(2)(D)(ii) and the regulations thereunder which is derived from transactions with persons who are not related (within the meaning of section 267(b) or 707(b)(1)) to the corporation.¹⁹

Thus, Congress defined a financial company for purposes of section 864(f) by statutory cross-reference to the FSE definition set forth in section 904(d) and its implementing regulations.²⁰ But rather than simply cross-referencing that definition for section 864(f) purposes, Congress specifically modified it to exclude income from related party transactions. Through this combination of provisions the 2004 legislation shows that Congress sought to continue taking related-party transactions into account for FSE purposes (as provided by the current FSE definition in the regulations implementing section 904(d)), while simultaneously choosing to modify that definition by excluding related-party transactions solely for purposes of section 864(f). Accordingly, Congress could hardly have made it clearer that the FSE definition itself incorporates related-party transactions, and a regulatory change to the contrary would thus be inconsistent with the 2004 legislation.

Accordingly, nothing in the 2004 Act supports altering the current FSE definition when used in the context of the QFI and qualified deficit rules, and instead, the statute and the legislative history confirm the Congressional decision to adopt the current FSE definition in that context.

2. The TCJA

The changes to the foreign tax credit rules made by the TCJA were perhaps the most dramatic changes since the enactment of those rules over 100 years ago, and, at the very least were the most significant changes to the separate categories and foreign tax credit limitation rules since the 1986 Act. Despite the magnitude of these changes, however, nothing in the TCJA altered or was directed at the FSE definition. Similarly, nothing in the TCJA changed the operation of the qualified deficit rules in section 952(c), although Congress did adopt a rule coordinating the operation of section 952(c) with the section 965 transition tax rules.²¹

Moreover, nothing in the TCJA changed the statutory provisions in section 904(d)(3) regarding the application of look-through, as referenced in the preamble to the 2020 proposed regulations. Treasury and the IRS, in the absence of direction from Congress but in light of other changes made to section 904(d), issued guidance limiting the operation of the look-through rules to passive income. As a result of these regulatory changes to the look-through rules, certain conforming changes were needed to the current FSE definition, which was written at a time when look-through applied to all separate categories of income, and when there was a separate category for financial services income. Thus, as the preamble to the 2020 final regulations noted, conforming changes may need to be made to update the current FSE definition to account for the revised operation of the look-through rules. However, the proposed modifications to the current FSE definition are more than conforming changes and instead directly reverse the treatment of related party transactions reflected in the regulations for the past 32 years, which has been repeatedly endorsed by subsequent legislative activity. Further, we are not aware of any other provision in the TCJA that would support altering the underlying provisions that define an FSE (such as the definition of active financing income); this is particularly clear with regard to the definition of a QFI, as subpart F was retained in its entirety by the TCJA (other than a few small changes that are not relevant to section 952(c) or qualified deficits).

Finally, rather than supporting a change to the QFI definition, the overall changes to the international tax system made by the TCJA suggest retaining the current scope of a QFI, as narrowing the definition will increase the distortions that would result if losses generated by a financing business do not offset its later FPHC income. When a subpart F loss is not treated as a qualified deficit, the result is necessarily an overstatement of subpart F income across a multiple year period, because the disqualified subpart F loss will not offset later subpart F income.²² For a non-QFI CFC that has only FPHC income, the result is that subpart F tax can be imposed on an amount greater than the CFC's economic income over the period, potentially offset in the future if the CFC stock is sold, as the over-taxation results in a basis increase in the CFC's stock.

However, if a CFC also earns non-subpart F income, the restriction of QFI treatment will yield particularly anomalous results. Prior to the TCJA the effect would have been to accelerate U.S. taxation of active earnings otherwise eligible for deferral from U.S. tax; but after TCJA the effect would be considerably more adverse. For example, post-TCJA, the overstatement of subpart F income can effectively subject what would otherwise be exempt income to U.S. tax at a 21 percent rate. For example:

Assume that a CFC has a deficit of 100 in year one that is attributable to FPHC income, and then in year two earns 100 of FPHC income. Assume that in addition to its subpart F producing activities the CFC also earns 100 of exempt income (e.g., tested income that has been offset by tested losses from another CFC). Although the CFC will have no net subpart F income across the two years, and 100 of exempt income, absent QFI treatment it will pay tax at 21 percent on 100 of net income, effectively taxing its exempt earnings at 21 percent. While the increase in its stock basis from the subpart F inclusion in year two will eliminate the gain attributable to the exempt income upon a future sale of the CFC stock, any such gain would in any event have been converted to an exempt dividend under section 1248.

Therefore, the consequences of restricting qualified deficit treatment are considerably more distortive post-TCJA than before, and heighten the importance of ensuring that the QFI definition operates in the manner that Congress intended, by permitting a deficit generated by a financing business to offset future FPHC income from that business.²³

Accordingly, the reasons cited in the preamble to the 2020 final regulations for altering the current FSE definition, regardless of their merits in the FSE context, should not be relevant for purposes of the definition of a QFI. If changes are made to the current FSE definition (beyond what may be necessary to accommodate the change to the look-through rules), a QFI should continue to be defined with reference to the current FSE definition, consistent with the specific direction in the legislative history to the 2004 Act that the changes to section 904 should not alter the QFI definition.

C. Any Changes to the Definition of a QFI Should Implement the Policies of Section 952(c)

As explained above, neither the 2004 legislation nor the TCJA modified the operation of section 952(c). Thus, neither enactment requires an abandonment of the clear direction that Congress has provided, on multiple occasions, endorsing use of the current FSE definition for QFI purposes. Further, although Congress used the same language to define an FSE and a QFI, the underlying statutory provisions are distinct. One is a foreign tax credit rule that governs permissible cross-crediting between foreign tax credit limitation categories, while the other is a subpart F rule that determines whether economic losses may be taken into account in determining a CFC's subpart F income. Given that the two provisions serve different policy goals, any policies that may support disregarding repeated Congressional direction regarding the intended scope of an FSE should not compel a similar deviation from Congressional intent regarding the definition of a QFI.

Instead, if changes are to be made to the definition of a QFI, notwithstanding Congressional direction to the contrary, those changes should be tailored to the policies and operational structure of section 952(c), rather than being imposed by implicit cross-reference. The current FSE definition, as applied for QFI purposes, fully addresses the statutory purpose of section 952(c) to prevent passive income from being offset by unrelated losses, by ensuring that the same qualified financial activity gives rise to both the qualified deficit and the later income that it offsets. Together with the requirement that a CFC be a QFI in both the year the loss arose and the year in the which the loss is used, these rules address the incentive to move unrelated passive income into the entity to utilize the loss, which was the main concern Congress sought to guard against.²⁴

Accordingly, because the concerns Congress expressed in creating the qualified deficit rules are adequately addressed by the current FSE definition, there is no need to amend the definition for purposes of applying the qualified deficit rules. And if Treasury and the IRS determine that guidance under the QFI rules is needed to address any QFI-specific concerns, such guidance should be issued after notice and comment.

III. Existing Qualified Deficits Should Not Be Rendered Unusable

As noted above, in order to use an existing qualified deficit to offset income in the current year, a CFC must have been a QFI in the year the deficit occurred, and in the year the deficit is to be used. Subject to that, however, the rules impose no time limit on a taxpayer's ability to use a qualified deficit, and the legislative history is clear that Congress intended that such deficits be preserved indefinitely for future use.²⁵

If the proposed changes to the current FSE definition are extended to the QFI definition, such an extension would limit taxpayers' ability to apply existing qualified deficits, altering the tax consequences of transactions entered into in prior years. For example, taxpayers with significant hedging losses faced operational decisions about when to close out offsetting gain positions. While business considerations might counsel otherwise, in the absence of the ability to offset future income with accumulated deficits, closing out offsetting gains in the same taxable year would have avoided overstating subpart F income over a multiple year period. But given the operation of the QFI rules under the 1988 final regulations, treasury centers did not historically operate under such constraints, and instead permitted business considerations to dictate the closing out of their positions, knowing that net losses realized in one year would offset net gains in a subsequent year.

At the time these operational decisions were being made by existing treasury centers, taxpayers were entitled to carry forward a net loss recognized in a particular year as a qualified deficit under rules enacted in the 1986 Act, and in accordance with the interpretation of the statutory language in the current FSE definition. Adopting a new interpretation of those rules now will deny such taxpayers the ability to use existing qualified deficits, producing an unanticipated and uneconomic result, and one that could have been avoided in some cases if taxpayers were aware that this change to the QFI definition would be made on a retroactive basis. Moreover, we understand that this change could require some taxpayers to adjust their financial statements to account for the loss of an existing tax attribute.

General principles of sound tax administration weigh against altering a taxpayer's ability to use existing attributes that fully reflect economic reality. For example, Treasury and the IRS have only limited authority to issue rules with retroactive effect.²⁶ Moreover, in those areas where Treasury and the IRS have broader authority to issue retroactive guidance, such as revenue rulings,²⁷ when altering prior guidance Treasury and the IRS have generally applied the modified rule only on a go forward basis.²⁸ While the proposed changes to the FSE definition would not have a retroactive effective date, because an entity must be a QFI both in the year of the loss and the year the loss is used, the change would have a practical effect in the context of the qualified deficit rules that is identical to a retroactive rule change. Thus, similar consideration should be given here to maintaining the usability of existing qualified deficits.

Additionally, avoiding adverse changes to taxpayers' reliance interests is consistent with broad principles of administrative law. When agencies alter previous policies, principles of administrative law require that those agencies consider any significant reliance interests implicated by the change in policies, take into account those interests in making their decisions, and provide a considered justification for the changes that affect those reliance interests.²⁹ Unlike FSE status, a determination that is made in the context of section 904 on a year-by-year basis, the definition of a QFI is relevant to the recognition and use of a qualified deficit in two separate years. Given taxpayers' reasonable reliance on the current FSE definition for qualified deficit purposes, and the risk that the proposed changes would render existing qualified deficits unusable in future years, as well as the potential financial effects of the loss of the attribute, Treasury and the IRS should recognize taxpayers' significant reliance interest in the current FSE definition as applied for qualified deficit purposes. The preamble to the 2020 final regulations does not address the potential effect of the changes to the FSE definition on the QFI or qualified deficit rules, and for the reasons noted above, the justifications provided for the changes do not apply to the QFI definition or the qualified deficit rules.

Thus, apart from the request for comments that was included in the 2019 proposed regulations, Treasury and the IRS have not yet addressed the QFI implications of the currently proposed changes to the current FSE definition. When the agencies do turn to consider those QFI implications, giving appropriate weight to the reliance interests of taxpayers with existing qualified deficits would counsel against any change to the standard for qualification as a QFI, and would instead support retaining the current FSE definition for purposes of the qualified deficit rules.

IV. Recommendations and Drafting Suggestions

If changes to the current FSE definition are finally adopted, for the reasons stated above those changes should not be extended to restrict the scope of the QFI definition for qualified deficit purposes. If such an extension is nevertheless adopted, in light of taxpayers' substantial reliance interests in relation to existing qualified deficits we recommend that the regulations provide a transition rule that permits the appropriate use of existing qualified deficits. Such an approach would recognize the previously settled rules for qualified deficits, and the fact that taxpayers reasonably arranged their business operations in reliance on those rules. Drafting approaches to implement these recommendations are suggested below.

A. Retain the Current FSE Definition for Purposes of Defining a QFI

For all the reasons noted above, we recommend that any changes to the FSE definition apply only for section 904 purposes and that the final regulations retain the same definition of a QFI as under the current FSE definition. This approach would reflect the policy goals of Congress in enacting the qualified deficit rules, and the continued expression by Congress that the current FSE definition is an appropriate way to determine whether a CFC qualifies as a QFI. It would also recognize the significant reliance interest that taxpayers with existing qualified deficits have in the operation of the rules.

If the final regulations modify the FSE definition for purposes of section 904(d), the existing QFI definition could be continued by adopting a new regulation that simply cross references Treasury regulation section 1.904-4(e) as in effect prior to its amendment, or that contains a definition of QFI that reflects the same elements as the definition of FSE under the existing section 904 regulations.³⁰

If this recommendation is not adopted, we would alternatively recommend adoption of a transition rule recognizing that the changes to the current FSE definition for QFI purposes would depart from settled expectations based on longstanding congressional and administrative guidance.

B. Preserve Existing Qualified Deficits Under a Transition Rule

Any constriction of the scope of the definition of a QFI, at a minimum should not affect the use of existing qualified deficits. If the QFI definition is modified in a way that restricts the ability of existing QFIs to maintain their QFI status, and to continue using their existing qualified deficits, then appropriate transition relief should be provided.

Transition relief permitting taxpayers to use their existing qualified deficits could be accomplished by a rule such as the following:

For taxable years beginning on or after [the date of the final FSE regulations], and solely for purposes of taking into account a qualified deficit attributable to a taxable year beginning before such date, a CFC is a QFI if it meets the definition of financial services entity by applying the principles of either 26 CFR 1.904-4(e) (revised as of April 1, 2019) or §1.904-4(e).

This approach would permit the taxpayer to use an existing qualified deficit if it meets either the current FSE definition, or the new FSE definition as modified when finalized. Additionally, in order to limit the time period for which this rule is applicable, an ordering rule could be provided that would require taxpayers to reduce qualified deficits arising before the change to the FSE definition first. Once these legacy qualified deficits are utilized, the transition rule would become moot, and taxpayers could rely solely on the altered FSE definition going forward.

* * * * *

We appreciate the opportunity to submit these comments for your consideration and would welcome the opportunity to discuss this submission at your convenience.

Sincerely,

Michael J. Caballe
Robert E. Culbertson

cc: Department of the Treasury
Kevin Nichols, Acting International Tax Counsel
Jason Yen, Associate International Tax Counsel Internal Revenue Service

Drita Tonuzi, Deputy Chief Counsel (Operations)
Peter Blessing, Associate Chief Counsel (International)
Daniel M. McCall, Deputy Associate Chief Counsel (International — Technical)
Barbara A. Felker, Branch Chief, Office of Associate Chief Counsel (International)
Melinda E. Harvey, Branch Chief, Office of Associate Chief Counsel (International)
Jeffrey L. Parry, Office of Associate Chief Counsel (International)