ABA Members Craft Recommendations for Transition Tax Regs

October 29, 2018

Hon. Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20024

Re:Comments on the Proposed Regulations Addressing Section 965

Dear Commissioner Rettig:

Enclosed please find comments on the Proposed Regulations under and related to Section 965 of the Internal Revenue Code, other than comments that are specific to the application of the Proposed Regulations to S corporations, which will be submitted separately. These comments are submitted on behalf of the Section of Taxation and have not been approved by the House of Delegates or the Board of Governors of the American Bar Association.

The Section of Taxation would be pleased to discuss these comments with you or your staff.

Sincerely,

Eric Solomon
Chair, Section of Taxation
American Bar Association
Washignton, DC

Enclosure

cc:
Hon. David Kautter, Assistant Secretary (Tax Policy), Department of the Treasury

LaFayette “Chip” G. Harter III, Deputy Assistant Secretary (International Tax Affairs), Department of the Treasury

Douglas L. Poms, International Tax Counsel, Department of the Treasury

Brian Jenn, Deputy International Tax Counsel, Department of the Treasury

Brenda L. Zent, Special Advisor, International Tax Counsel, Department of the Treasury

William M. Paul, Acting Chief Counsel and Deputy Chief Counsel (Technical), Internal Revenue Service

Drita Tonuzi, Deputy Chief Counsel (Operations), Internal Revenue Service

Marjorie A. Rollinson, Associate Chief Counsel (International), Internal Revenue Service

Daniel M. McCall, Deputy Associate Chief Counsel (International), Internal Revenue Service

John J. Merrick, Special Counsel, Office of Associate Chief Counsel (International), Internal Revenue Service

Raymond J. Stahl, Special Counsel, Office of Associate Chief Counsel (International), Internal Revenue Service

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AMERICAN BAR ASSOCIATION
SECTION OF TAXATION

Comments on Proposed Regulations Addressing Section 965

These comments ("Comments") are submitted on behalf of the American Bar Association Section of Taxation and have not been approved by the House of Delegates or Board of Governors of the American Bar Association. Accordingly, they should not be construed as representing the position of the American Bar Association.

Principal responsibility for preparing these Comments was exercised by Devon M. Bodoh, Kimberly J. Majure, Paul J. Crispino, Carol P. Tello, Ari Berk, Morgan Hann, Magda B. Szabo, Dave Warco, John A. Karasek, Robert Kantowitz, Alexey Manasuev, and Alfonso J. Dulcey. The Comments have been reviewed by Joan Arnold of the Section's Committee on Government Submissions.

Although the members of the Section of Taxation who participated in preparing these Comments have clients who might be affected by the federal tax principles addressed by these Comments, no such member or the firm or organization to which such member belongs has been engaged by a client to make a government submission with respect to, or otherwise to influence the development or outcome of, the specific subject matter of these Comments. Additionally, while the Section's diverse membership includes government officials, no such official was involved in any part of the drafting or review of these Comments.

Contact:

Devon M. Bodoh
(202) 533-5681
dbodoh@kpmg.com

Date: October 29, 2018

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 Table of Contents

I. Executive Summary

II. Detailed Discussion

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 I. Executive Summary

b) Definitions

Proposed Regulation section 1.965-1(f) sets forth an extensive list of definitions for terms that apply for purposes of the section 965 Proposed Regulations. Generally, the definitions in the Proposed Regulations conform to those used in section 965 and the Notices, but also provide certain clarifications.

Proposed Regulation section 1.965-1(f)(45)(ii) adopts the “downward” attribution rule of Notice 2018-26, section 3.01, that, for purposes of determining whether a foreign corporation is an SFC, limits the attribution of stock owned by or for a partner (the “tested partner”) to a partnership when the tested partner owns less than five percent of the interests in the partnership's capital and profits.¹²⁷

Proposed Regulation section 1.965-1(f)(29) defines “post-1986 earnings and profits.” The definition is consistent with the “dividend reduction rule” discussed in Notice 2018-07 (i.e., the rule to prevent the double-counting of the E&P of a distributing foreign corporation), whereby a dividend from a distributing SFC to a distributee SFC made in a taxable year that begins before January 1, 2018, is not taken into account in determining the post-1986 E&P of the distributing SFC only to the extent the dividend increases the post-1986 E&P of the distributee SFC. That is, the rule, as described in Notice 2018-07 and promulgated in Proposed Regulation section 1.965-1(f)(29), limits the reduction in E&P of the distributing SFC to the amount by which the distributee SFC increases its E&P as a result of the distribution.

Consistent with the rules of Notice 2018-26, section 3.03, Proposed Regulation section 1.965-1(f)(29) also includes a rule allowing for a reduction in post-1986 E&P for foreign taxes that accrue (i) prior to November 2, 2017, and (ii) after November 2, 2017, but on or before December 31, 2017, and that are attributable to the portion of taxable income (determined under foreign law) that accrues on or before November 2, 2017.

Finally, Proposed Regulation section 1.965-1(f)(29)(iii) provides rules that allow all deficits, including hovering deficits, to be taken into account for purposes of determining post-1986 E&P and the section 965(a) inclusion amount. These rules are consistent with the Conference Report and Notice 2018-13, section 3.03(b), and apply solely for purposes of determining post-1986 E&P. Treasury and the Service request comments on whether additional rules are needed to address the treatment of hovering deficits,(e.g., for when a hovering creates a specified E&P deficit within the meaning of section 965(b)(3)(C) and Proposed Regulation section 1.965-1(f)(44)).¹²⁸

The preamble to the Proposed Regulations (the “Preamble”) notes that Treasury and the Service received taxpayer comments requesting the ability to use an alternative measurement date for determining post-1986 E&P and cash position, given that an SFC that is not a CFC does not generally track E&P under U.S. tax principles.¹²⁹ Although appreciative of the administrative challenges, Treasury and the Service have determined that similar situations already occur in the context of minority U.S. shareholders of CFCs that are passive foreign investment corporations, as defined in section 1298 (“PFICs”) and thus decline to include such a rule in the Proposed Regulations.¹³⁰

Proposed Regulation section 1.965-1(f)(17) is consistent with the rules provided by Notice 2018-13, section 3.01, for determining whether an SFC is a DFIC or an E&P deficit foreign corporation. Specifically, the rules provide that the DFIC status of an SFC is determined first; if the SFC is a DFIC, then it is classified solely as a DFIC and not as an E&P deficit foreign corporation, even if the SFC would also qualify as such under section 965(b)(3)(B) and Proposed Regulation section 1.965-1(f)(22). If the SFC is not a DFIC, then it must be determined whether it is an E&P deficit foreign corporation. An SFC may fail to qualify as a DFIC or an E&P deficit foreign corporation despite having positive post-1986 E&P or a deficit in accumulated post-1986 deferred foreign income.¹³¹

Comments received by Treasury and the Service requested that PTI be disregarded for purposes of determining the existence of a specified E&P deficit of an E&P deficit foreign corporation. Section 965(d)(2) excludes PTI for purposes of calculating post-1986 deferred foreign income, but no express exclusion of PTI is provided for in section 965(d)(3) for purposes of determining post-1986 E&P. Accordingly, the comment was not accepted, and Proposed Regulation section 1.965-1(f)(22)(ii) does not exclude PTI for purposes of determining a deficit in post-1986 E&P. Treasury and the Service, however, are considering other rules with respect to the definitions of post-1986 E&P, accumulated post-1986 deferred foreign income, and specified E&P deficit, and welcome comments on this subject.¹³²

Proposed Regulation section 1.965-1(f)(7)(i)(C) provides that, in the case of a CFC that has shareholders that are not U.S. shareholders on the E&P measurement date¹³³, the accumulated post-1986 deferred foreign income of the CFC is reduced by amounts that would have been included by such shareholders if they had been U.S. shareholders. In this regard, Proposed Regulation section 1.965-1(f)(i)(C) is consistent with Notice 2018-07, section 3.02(c), in applying the principles of Revenue Ruling 82-16 to determine the amounts by which accumulated post-1986 deferred foreign income is reduced.¹³⁴ The Proposed Regulations, however, clarify that accumulated post-1986 deferred foreign income is reduced only to the extent such income is accrued by the SFC as of the E&P measurement date.¹³⁵

The Proposed Regulations are also consistent with Notice 2018-26, section 3.02, in the definitions of the terms “cash measurement dates” and 'pro rata share.”¹³⁶ However, the Proposed Regulations do not include rules for determining 52-53 week taxable years under Regulation section 1.441-2(c). Notice 2018-26, section 3.02, had announced forthcoming regulations would provide that a 52-53-week taxable year is deemed to begin on the first day of the calendar month closest to the first day of the 52-53-week taxable year and is deemed to end or close on the last day of the calendar month nearest to the last day of the 52-53-week taxable year, as the case may be. Instead, the Proposed Regulations use the actual dates on which such a year begins and ends.¹³⁷ Replying to taxpayer comments that requested guidance on measurement of cash when a section 381 transaction occurs during the last year of an SFC that begins before January 1, 2018, Treasury and the Service stated that the current rules provide appropriate guidance, and no additional rules are necessary.¹³⁸

Proposed Regulation sections 1.965-1(f)(13), (14), and (16) provide definitions addressing an SFC's cash position and the treatment of derivative financial instruments. Generally, the cash position of an SFC includes the fair market value of the cash-equivalent assets held by the SFC, including derivative financial instruments that are not bona fide hedging transactions. These definitions are consistent with Notice 2018-07, section 3.01(c), with the following clarifications. First, the Proposed Regulations clarify that an SFC's cash position does not include bona fide hedging transactions with respect to an asset that is not cash-equivalent assets or a liability within the meaning of Regulation section 1.1221-2(b)(2).¹³⁹ Thus, only the value of cash-equivalent assets and of hedging transactions with respect to a cash equivalent asset, subject to certain adjustments, are used to determine the SFC's cash position.¹⁴⁰ Second, Proposed Regulation section 1.965-1(f)(12) clarifies that, because the requirements to identify a bona fide hedging transaction described in Regulation section 1.954-2(a)(4)(ii) are generally relevant only to CFCs, such identification requirement will apply only to CFCs and not SFCs.

Proposed Regulation sections 1.965-1(f)(5), (6), and (43) provide definitions for the terms “account payable,” “account receivable,” and “short-term obligation,” respectively, that are consistent with the rules in Notices 2018-13, section 3.04(a) (clarified by Notice 2018-26, section 3.06) and 3.04(b)). Treasury and the Service declined to adopt regulations that define “accounts payable” to include payables related to the licensing of intellectual property, payables to employees in the ordinary course of business, and payables arising from property described in section 1221(a)(2).¹⁴¹ Treasury and the Service also declined to adopt a facts and circumstances test that would allow taxpayers to prove that a demand loan should not be treated as a short-term obligation.¹⁴²

Proposed Regulation section 1.965-1(f)(3) provides the definition for “pro rata share” consistent with the definition provided in Notice 2018-13, section 3.03(a), and clarifies that, for purposes of determining a shareholder's pro rata share of a specified E&P deficit, the value of the common stock is determined as of the last day of the last taxable year of the E&P deficit foreign corporation that begins before January 1, 2018. Treasury and the Service request comments regarding whether there are circumstances in which a specified E&P deficit should be allocated to the holders of an E&P deficit foreign corporation's preferred stock, and if so, how to allocate the specified E&P deficit between the common and preferred shareholders.¹⁴³

The definitions related to domestic passthrough entities, found in Proposed Regulation section 1.965-1(f)(19) (defining “domestic passthrough entity”), (20) (defining “domestic passthrough owner”) (21) (defining “domestic passthrough owner share”), (28) (defining “passthrough entity”), (37 (defining “section 965(a) inclusion”), and (41) (defining “section 965(c) deduction amount”) generally conform with Notice 2018-26, section 3.05(b). Proposed Regulation section 1.965-3(g), discussed below, provides rules regarding the allocation of the section 965(c) deduction in the context of domestic passthrough entities.

The definitions related to foreign currency translation are also consistent with those provided in Notice 2018-13, section 3.05(b), with Proposed Regulation section 1.965-1(f)(36) confirming that an SFCs accumulated post-1986 deferred foreign income as of each E&P measurement date must be compared in the SFC's functional currency, with any changes in functional currency between November 2, 2017, and December 31, 2017, translated into the new functional currency of the SFC using the spot rate on November 2, 2017. Proposed Regulation section 1.965-4, discussed below, may also apply to disregard certain changes in functional currency. Additionally, the Proposed Regulations use the spot rate on December 31, 2017, for translating the section 965(a) earnings amount of a DFIC into U.S. dollars for purposes of determining the section 965(a) inclusion amount of a U.S. shareholder of the DFIC, as well as for other purposes, including those described in Notice 2018-13, section 3.05(b).¹⁴⁴

2. Proposed Regulation Section 1.965-2 — Adjustments to Earnings and Profits and Basis

Generally, Proposed Regulation section 1.965-2 provides rules related to the adjustments to E&P and basis under sections 965(a), 965(b), Proposed Regulation section 1.965-1, and section 961(b). Proposed Regulation section 1.965-2 generally expands on the E&P and basis adjustments rules described in the Notices.

Proposed Regulation section 1.965-2(b) provides rules clarifying the interaction between sections 959 and 965. These rules are consistent with and follow the sequence of the rules laid out in Notice 2018-07, section 3.02(d).

Generally, Proposed Regulation section 1.965-2(c) provides that the E&P of a DFIC that is described under section 959(c)(2) with respect to a section 958(a) U.S. shareholder is increased by the amount equal to the section 965(a) inclusion of such U.S. shareholder. Because section 965(a) previously taxed E&P is tracked in functional currency but the section 965(a) inclusion amount is in U.S. dollars, such previously taxed E&P is translated, if necessary, into the foreign currency of the DFIC using the spot rate on December 31, 2017, provided the section 965(a) inclusion amount is included in income by the section 958(a) U.S. shareholder.¹⁴⁵ Proposed Regulation section 1.965-2(c) also provides that the E&P (including a deficit) of a DFIC described in section 959(c)(3) is reduced (or in the case of a deficit, increased) by an amount equal to the section 965(c) previously taxed E&P of the DFIC.

Proposed Regulation section 1.965-2(d) provides rules relating to the E&P of DFICs and E&P deficit foreign corporations by reason of a reduction under section 965(b)(1) or (5) (the “reduction rules”). Proposed Regulation section 1.965-2(d)(1) provides that a DFIC increases its E&P described in section 959(c)(2) by an amount equal to the reduction in the section 965(a) inclusion amount taken by a DFICs section 958(a) U.S. shareholder under the reduction rules. Such increase in section 959(c)(2) is defined under Proposed Regulation section 1.965-2(d)(1) as “section 965(b) previously taxed E&P”. Section 965(b) previously taxed E&P must be translated to the DFIC's functional currency, if necessary, using the spot rate of December 31, 2017, are included in the gross income of the section 958(a) U.S. shareholder under section 951(a)(1)(A), and reduce the DFIC's E&P (including a deficit) described in section 959(c)(3).¹⁴⁶

Proposed Regulation section 1.965-2(d)(2)(i)(A) provides that the section 959(c)(3) E&P of an E&P deficit foreign corporation is increased by an amount equal to the section 958(a) U.S. shareholder's pro rata share of the specified E&P deficit taken into account under the reduction rules.¹⁴⁷ For purposes of the above-mentioned rule, increased E&P is not treated as E&P of the taxable year described in section 316(a)(2). Proposed Regulation section 1.965-2(d)(2)(i)(B) provides that, for purposes of determining the reduction in a qualified deficit under section 952, a section 958(a) U.S. shareholder pro rata share of the E&P of an E&P deficit foreign corporation is increased by an amount equal to the portion of the U.S. shareholder's pro rata share of the specified E&P taken into account under the reduction rules, and such increase is attributable to the same activity to which the deficit so taken into account was attributable. Proposed Regulation section 1.965-2(d)(2)(ii) provides rules for determining the portion of a section 958(a) U.S. shareholder's pro rata share of a specified E&P deficit taken into account for purposes of the reduction rules. Such portion is 100 percent if (i) the section 958(a) U.S. shareholder (or the consolidated group of which such shareholder is a member) does not have an excess aggregate foreign E&P deficit, or (ii) for an affiliated group of which not all section 958(a) U.S. shareholders are members of the same consolidated group, the aggregate of the section 965(a) inclusion amounts of the group's E&P net surplus shareholders (to the extent of group ownership) is equal to or greater than the sum of the excess aggregate foreign E&P deficits of the group's E&P net deficit shareholders.¹⁴⁸ In any other case, the section 958(a) U.S. shareholder must designate the portion of the specified E&P deficit of each E&P deficit foreign corporation to be taken into account, including the portion attributable to a qualified deficit.¹⁴⁹

Proposed Regulation section 1.965-2(e)(1) provides that, pursuant to section 961(a), a section 958(a) U.S. shareholder must increase its basis in the stock of the DFIC by the U.S. shareholder's section 965(a) inclusion amount with respect to such DFIC. Proposed Regulation section 1.965-2(e)(2), relating to rules regarding basis adjustments in the case of section 962 election, is reserved; Treasury and the Service requested comments as to the appropriate amount of the basis adjustments in such situations.¹⁵⁰

Proposed Regulation section 1.965-2(f)(1) clarifies the general rule that, except as provided in Proposed Regulation section 1.965-2(f)(2), no adjustments to basis of stock or property are made under section 961 (or any other provision of the Code) to take into account the reduction in the section 965(a) earnings amount of a section 958(a) U.S. shareholder under section 965(b). Treasury and the Service believe an increase in the basis of DFICs is appropriate only if there is a corollary reduction to the basis of the E&P deficit foreign corporations.¹⁵¹ Additionally, Treasury and the Service believe that such a reduction may give rise to gain in certain cases and prove to be overly burdensome for taxpayers.¹⁵²

Accordingly, Proposed Regulation section 1.965-2(f)(2) provides rules that allow section 958(a) U.S. shareholders to make an election to make basis adjustments to account for the application of section 965(b). Generally, these adjustments allow the section 958(a) U.S. shareholder to (i) increase the basis of the stock of the DFIC by an amount equal to the section 965(b) previously taxed E&P of the DFIC, and (ii) decrease the basis of the stock of an E&P deficit foreign corporation (or the U.S. shareholder's basis in applicable property with respect to an E&P deficit foreign corporation) by an amount equal to its pro rata share of the specified E&P deficit taken into account under section 965(b) and Proposed Regulation sections 1.965-2(b)(2) and 1.965-8(b) (discussed below), as the case may be.¹⁵³ The adjustments must be consistently made by the section 958(a) U.S. shareholder with respect to all section 958(a) stock of SFCs owned by such U.S. shareholder and related persons.¹⁵⁴ The basis adjustment election must be made no later than the due date (taking into account extensions) for the section 958(a) U.S. shareholder's return for the first taxable year that includes the last day of the last taxable year of the DFIC or E&P deficit foreign corporation that begins before January 1, 2018; relief is not available under Regulations sections 301.9100-2 or 301.9100-3.¹⁵⁵ As final regulations have not yet been issued, Treasury has stated that with respect to tax returns that are due (determined with regard to any extension) before the date that is 90 days after the date that the final regulations are published in the Federal Register (the “Federal Register Publication Date”), the basis election must be made no later than 90 days after the Federal Register Publication Date.¹⁵⁶ In addition, the final regulations will provide that if a basis election was made on or before the Federal Register Publication Date, the basis election may be revoked no later than 90 days after the Federal Register Publication Date.¹⁵⁷

Proposed Regulation section 1.965-2(g) provides a “gain-reduction” rule pursuant to which a section 958(a) U.S. shareholder would reduce the amount of gain that would otherwise be recognized under section 961(b)(2) as the result of a distribution of section 965 previously taxed E&P. The rules are consistent with those provided under Notice 2018-7, section 3.03, and Notice 2018-13, section 4. Furthermore, the rules would apply to distributions of section 965(b) previously taxed E&P where the taxpayer makes a basis adjustment election under Proposed Regulation section 1.965-2(f). Proposed Regulation section 1.965-2(g)(2) requires the taxpayer to reduce the basis in section 958(a) stock or applicable property by the amount that would be recognized as gain but for the rule.

Proposed Regulation section 1.965-2(h) provides the rules of application for all basis adjustments under Proposed Regulation sections 1.965-2(e), (f)(2), and (g)(2). Generally, the rules require the adjustments to be made as of the close of the last day of the last taxable year of the SFC that begins before January 1, 2018, and are made to each share of section 958(a) stock (or in a manner consistent with such allocation to stock in the case of applicable property).¹⁵⁸ Additionally, the rules require netting of the specified basis adjustments and gain recognition to the extent that a net downward adjustment would exceed basis.¹⁵⁹ Finally, the specified basis adjustments are limited to property held by a section 958(a) U.S. shareholder, unless the section 958(a) stock or applicable property is owned through a foreign passthrough entity, in which case the adjustment is made to the section 958(a) stock or applicable property held by the foreign passthrough entity as if it was directly held by the section 958(a) U.S. shareholder.¹⁶⁰

Proposed Regulation section 1.965-2(i) provides definitions that apply for purposes of Proposed Regulation section 1.965-2(i). Proposed Regulation section 1.965-2(i)(1) defines “applicable property” to be, with respect to a section 958(a) U.S. shareholder and an SFC, property owned by such U.S. shareholder (including through foreign passthrough entities) by reason of which the section 958(a) U.S. shareholder is considered under section 958(a)(2) as owning section 958(a) stock of the SFC. Proposed Regulation section 1.965-2(i)(2) defines “foreign passthrough” entity to mean a foreign partnership, foreign estate, or foreign trust within the meaning of section 7701(a)(31). Proposed Regulation section 1.965-2(i)(3) defines “property” to mean property within the meaning of Regulation section 1.961-1(b)(1).

3. Proposed Regulation Section 1.965-3 — Section 965(c) Deductions

Proposed Regulation section 1.965-3 provides rules regarding the section 965(c) deduction and the section 965(c) deduction amounts.

Proposed Regulation section 1.965-3(b)(1) provides rules regarding the aggregate foreign cash position of a section 958(a) U.S. shareholder that are generally consistent with the rules set forth in Notice 2018-07, section 3.01. Under these rules, any account payable, account receivable, short-term obligation, or derivative financial instrument between an SFC with respect to which a section 958(a) U.S. shareholder owns section 958(a) stock and a related SFC on a “cash measurement date” is disregarded to the extent of the smallest of the product of the amount of the item on such cash measurement date of each SFC and the U.S. shareholder's ownership percentage of section 958(a) stock of the SFC on such date.¹⁶¹ As noted below, this rule applies even in the context of a consolidated group (e.g., each member determines the items disregarded on a separate entity basis). Treasury has recognized, however, that separate entity treatment may overstate the aggregate foreign cash position of a consolidated group for purposes of applying Proposed Regulation section 1.965-3(b).¹⁶² Consequently, Treasury has stated that final regulations will provide that all members of a consolidated group that are section 958(a) U.S. shareholders of an SFC are also treated as a single section 968(a) U.S. shareholder for purposes of Proposed Regulation section 1.965-3(b).¹⁶³

Proposed Regulation section 1.965-3(b)(2) provides the relief announced in Notice 2018-26, section 3.05(a), to prevent the double-counting of assets of an SFC in determining a section 985(a) U.S. shareholder's aggregate cash position when those assets have been including in determining the U.S. shareholder's pro rata share of the cash position of another SFC. The U.S. shareholder must attach a statement to its timely-filed tax return for the inclusion year providing the following information: (i) a description of the asset that would be taken into account with respect to both SFCs; (ii) a statement of the amount by which its pro rata share of the cash position of SFC is reduced; (iii) a detailed explanation of why there would otherwise be double-counting, including the computation of the amount taken into account with respect to the other SFC; and (iv) an explanation of why Proposed Regulation section 1.965-3(b)(1) does not apply to disregard such amount.¹⁶⁴ Relief is not available under Regulations sections 301.9100-2 or 301.9100-3 to allow late filing of the statement.

Proposed Regulation section 1.965-3(c) provides rules for determining a section 958(a) U.S. shareholder's aggregate cash position for an inclusion year; the rules are consistent with those announced in Notice 2018-07, section 3.05(a). If a section 958(a) U.S. shareholder has a single inclusion year, the U.S. shareholder's aggregate foreign cash position for such single inclusion year is equal to its aggregate foreign cash position.¹⁶⁵ If a section 958(a) U.S. shareholder has multiple inclusion years, the U.S. shareholder's cash position is allocated to an inclusion year in the following manner:

Proposed Regulation section 1.965-3(c)(3) allows a section 958(a) U.S. shareholder to assume that its pro rata share of the cash position of any SFC is zero if the SFC has a taxable year beginning before January 1, 2018, and ending after the date the return for such U.S. shareholder inclusion year is timely filed. If the pro rata share is assumed to be zero but the section 958(a) U.S. shareholder's pro rata share of the SFC's cash position on the final cash measurement date exceeds one half the sum of the SFC's cash position on the first and second cash measurement dates, then the U.S. shareholder may avoid interest and penalties by filing an amended return the year after the section 958(a) U.S. shareholder's inclusion year with the correct aggregate foreign cash position.¹⁶⁸

Proposed Regulation section 1.965-3(d) provides rules coordinating the section 965(c) deduction with the section 965(l) expatriated provisions, requiring recapture of all section 965(c) deductions taken by an expatriated entity without regard to whether the expatriated entity was itself a section 958(a) U.S. shareholder.

Proposed Regulation section 1.965-3(e) provides that, in the case of an individual making a section 962 election, any section 965(c) deduction taken into account under Proposed Regulation section 1.962-1(b)(1)(i)(B) in determining taxable income is used in section 11 and is not taken into account for purposes of determining the individual's taxable income under section 1.

Consistent with Notice 2018-26, section 3.06, Proposed Regulation section 1.965-3(f)(1) provides that the section 965(c) deduction is not treated as an itemized deduction for any purpose of the Code. Proposed Regulation section s1.965-3(f)(3) and (f)(4) clarify, respectively, that, a section 965(c) deduction is not treated as (i) being properly allocable to any section 965(a) inclusion for purposes of section 1411 and section 1.1411-4(f)(6), nor as (ii) an ordinary and necessary expense paid or incurred for the production or collection of gross investment income for purposes of section 4940(c)(3)(A).

Proposed Regulation section 1.965-3(f)(2)(i) provides that, in the case of a domestic partnership or S corporation, the net section 965(a) inclusion (i.e., the section 965(a) inclusion less the section 965(c) deductions) is treated as a separately stated item of net income for purposes of calculating basis under sections 705 and 1367(a)(1) and Regulations sections 1.705-1(a) and 1.367-1(f), as the case may be. Treasury and the Service believe that this rule will allow shareholders of S corporations and partners of domestic partnerships to take into account their share of a section 965(c) deduction amount that may otherwise not be allocated to them with the corresponding amount of the section 965(a) inclusion under the rules of subchapters S or K.¹⁶⁹ Additionally, Proposed Regulation section 1.965-3(f)(2)(ii) provides that, in the case of an S corporation, the aggregate amount of its section 965(a) inclusions equal to the aggregate amount of its section 965(c) deductions is treated as income not exempt from tax solely for purposes of determining whether an adjustment is made to its AAA under Regulations sections 1368(e)(1)(A) and 1.1368-2(a)(2).

Proposed Regulation section 1.965-3(g), applicable for purposes of determining a domestic passthrough owner's share of the section 965(c) deduction, provides that a section 965(c) deduction amount must be allocated to the domestic passthrough owner in the same proportion as an aggregate section 965(a) inclusion amount of the domestic passthrough entity for the inclusion year is allocated to such owner.

4. Proposed Regulation Section 1.965-4 — Disregard of Certain Transactions

Proposed Regulation section 1.965-4 provides rules to disregard certain transactions for purposes of applying 965.

Proposed Regulation section 1.965-4(b) provides an anti-avoidance rule that disregards transactions taken with a principal purpose of changing the amount of a “section 965 element.” The rule is generally consistent with the rule announced in Notice 2018, section 3.04, except that the rule is based on a change in a “section 965 element” instead of a change in the “section 965 liability.” The term “section 965 element” means, with respect to any section 958(a) U.S. shareholder, any of the following amounts: (i) the U.S. shareholder's section 965(a) inclusion; (ii) the U.S. shareholder's aggregate foreign cash position; or (iii) the amount of foreign income taxes of an SFC deemed paid by the U.S. shareholder under section 960 as a result of a section 965(a) inclusion.¹⁷⁰

Treasury and the Service did not adopt a taxpayer-proposed suggestion that the anti-avoidance rule not apply when a reduction in the section 965(a) liability is offset by an equal amount of tax under a different Code provision.¹⁷¹ Treasury and the Service noted that, because the anti-avoidance rule includes a “principal purpose” test, transactions that do not reduce overall tax liability may not, under certain facts and circumstances, implicate Proposed Regulation section 1.965-4(b).¹⁷² Treasury and the Service also did not adopt a de minimis rule for purposes of the anti-avoidance rule.¹⁷³

Proposed Regulation section 1.965-4(c) makes clear that accounting method changes and entity classification changes are disregarded solely for purposes of section 965. In this regard, Treasury and the Service issued regulations applying the anti-avoidance rule when the change is from an impermissible to a permissible accounting method.¹⁷⁴

Proposed Regulation section 1.965-4(f) provides rules regarding the double-counting of “specified payments” between SFCs occurring between E&P Measurement Dates. These rules are consistent with those announced in Notice 2018-07, section 3.02(a), and provide that amounts paid or incurred between related SFCs of a section 958(a) U.S. shareholder between E&P Measurement Dates that would otherwise reduce the post-1986 earnings of the payor SFC are disregarded for purposes of both the payor and payee SFC as of the December 31, 2017, E&P Measurement Date. Treasury and the Service received comments asking to expand these rules to include (i) deductible payments by an SFC to a U.S. shareholder or partnership owned by a U.S. shareholder and (ii) distribution by an SFC to a U.S. shareholder.¹⁷⁵ In the Preamble, Treasury and the Service explained that possible double-counting of post-1986 E&P arises only in the context of payments between related SFCs, not from payments by an SFC to its U.S. shareholder, and disregarding SFC-to-U.S. shareholder payments could have other consequences (e.g., the availability of section 902 credits to the U.S. shareholder and the impact they would have on the section 965(g)(1) limitation) that would need to be considered if such payments were disregarded.¹⁷⁶ Thus, Treasury and the Service declined to expand the rule to cover the proposed transactions.

5. Proposed Regulations Sections 1.965-5 and 1.965-6 — Allowance of Credit or Deduction for Foreign Tax Credits; Computation of Foreign Tax Credits Deemed Paid, and Allocation and Apportionment of Deductions

Proposed Regulation sections 1.965-5 and 1.965-6 provide rules related to the allowance and calculation of deductions or credits for foreign income taxes paid or accrued.

Consistent with section 965(g), no deduction or credit will be allowed for the applicable percentage¹⁷⁷ of foreign income taxes paid or accrued (or treated as paid or accrued) and attributable to the section 965(c) deduction applicable to a section 965(a) inclusion amount.¹⁷⁸ Similarly, Proposed Regulation section 1.965-5(b) further clarifies no deduction or credit will be allowed for the applicable percentage of foreign income taxes paid or accrued (or treated as paid or accrued) with respect to distributions of section 965(a) or (b) previously taxed E&P.¹⁷⁹ This rule applies to withholding taxes and certain other taxes.¹⁸⁰

With respect to a distribution of section 965(a) or 965(b) PTI, only the foreign income taxes paid or accrued (including withholding taxes) by an upper-tier foreign corporation in regards to a distribution of section 958(a) or (b) PTI from a lower-tier foreign subsidiary will be considered foreign income taxes deemed paid by a domestic corporation under section 960(a)(3).¹⁸¹ Furthermore, a credit under section 960(a)(3) is not allowed for any foreign income taxes that would be deemed paid under section 960(a)(1) for the portion of the section 965(a) earnings reduced by allocable E&P deficit since no taxes were paid on that amount.¹⁸²

Treasury and the Service have reserved on foreign income taxes deemed paid under new section 960(b) as applicable to tax years beginning after December 31, 2017.¹⁸³

Section 902, as in effect in 2017, applies as if the section 965(a) inclusion is a dividend paid by the DFIC.¹⁸⁴ Consistent with current law, the Proposed Regulations provide that the section 902 fraction for either a DFIC or an E&P deficit foreign corporation is the amount of a dividend paid by or a section 951(a)(1) inclusion (including a section 965(a) inclusion) (the “numerator”) with respect to the foreign corporation divided by the foreign corporation's post-1986 undistributed earnings (the “denominator”).¹⁸⁵ If the denominator is positive but less than the numerator for a section 902 fraction, the fraction is treated as being one.¹⁸⁶ If the denominator is zero or less than zero, the section 902 fraction is treated as being zero. No foreign income taxes are deemed paid.¹⁸⁷

The E&P of an E&P deficit corporation is increased under section 965(b)(4)(B) and Proposed Regulation section 1.965-2(d)(2)(i)(A) for purposes of section 902(c)(1) as of the first day of an E&P deficit foreign corporation's first tax year following the inclusion year.¹⁸⁸ Section 965(c) deductions do not cause any part of the section 965(a) inclusion or related assets or stock to be treated as exempt, excluded or eliminated for purposes of apportioning interest and other expenses under section 864(e)(3) or Temporary Regulation section 1.861-8(d).¹⁸⁹ Similarly, sections 965(a) and (b) PTI is not treated as exempt under section 864(e)(3).¹⁹⁰

Treasury and the Service have requested comments regarding to additional rules that may be necessary to take into account basis adjustments similar to those required under section 864(e)(4) as a result of section 965(b)(4)(A) and (B), as well as application of section 904 basketing rules.¹⁹¹

6. Proposed Regulation Section 1.965-7 — Elections and Payment Rules

a) Section 965(h) Election

Proposed Regulation section 1.965-7(b) deals with the election under section 965(h) allowing taxpayers to pay their section 965(h) net tax liability in eight installments. The section 965(h) election may be revoked only by paying the outstanding amount of the section 965(h) net tax liability.¹⁹²

In response to concerns regarding the underpayment of the first installment payment, the Proposed Regulations provide that if a deficiency is assessed with respect to a section 965(h) net tax liability or a return or an amended return is filed increasing the taxpayer's section 965(h) net tax liability, the additional amount or deficiency is prorated among the installments.¹⁹³ Further, if the amount of the first installment must be increased, the remaining installments will not be accelerated.¹⁹⁴

The Proposed Regulations expand on the acceleration events identified in section 965(h)(3). The acceleration events would include an exchange or other disposition of substantially all of the assets of a taxpayer in addition to their liquidation or sale. An acceleration event would also include an event that causes a person to no longer be a U.S. person, such as a resident becoming a non-resident. Finally, with respect to a consolidated group, a non-member becoming a member or a group ceasing to exist will constitute an acceleration event.¹⁹⁵

 

A liquidation, sale, exchange or other disposition of a taxpayer's assets, a non-member becoming a member of a consolidated group, or a consolidated group ceasing to exist will not result in acceleration of the remaining installments if the relevant parties (referred in the Proposed Regulations as the transferor and transferee) enter into a transfer agreement.¹⁹⁶ The Proposed Regulations outline the requirements and procedural rules for the transfer agreement. These include a representation that the section 965(h) eligible transferee is able to make the outstanding payments and the acknowledgement that the transferor and any successor to the transferor will remain jointly and severally liable for any unpaid installments.¹⁹⁷

Treasury and the Service declined to accept comments requesting that the section 965(h) election be made by default.¹⁹⁸ Elections must be made by the due date of the relevant return (including extensions).¹⁹⁹ The Proposed Regulations provide that late election relief under Regulation sections 301.9100-2 or 301.9100-3 is not available. Treasury and the Service also declined to apply section 965(h) to tax due under other chapters such as section 1411.²⁰⁰

b) Section 965(i) Election

Proposed Regulation section 1.965-7(c) provides additional guidance for S corporation owners to make an election under section 965(i) to defer payment of the section 965 net tax liability.

Consistent with Notice 2018-26, section 3.05(b), any shareholder of an S corporation that is a U.S. shareholder of a DFIC may make the election.²⁰¹ The election must be made by filing a statement with the shareholder's return for the relevant year. The Proposed Regulations outline the information that must be included in the statement.²⁰²

The Proposed Regulations also outline events which will trigger the section 965 net tax liability, as provided in section 965(i). However, a transfer of any share of stock of the S corporation by the shareholder (including by reason of death or otherwise) may be exempted as a triggering event if a transfer agreement is entered into pursuant to the Proposed Regulation.²⁰³

Treasury and the Service confirmed that, by its terms, section 965(i) affects only the timing of the payment of the section 965 net tax liability, but does not affect timing of the section 965(a) inclusion.²⁰⁴

Elections must be made by the due date of the relevant return (including extensions).²⁰⁵ No relief is available under Regulation sections 301.9100-2 or 301.9100-3.

c) Section 965(m) Election

The Proposed Regulations provide the procedural rules regarding how a REIT can make an election under section 965(m) to defer its section 965(a) inclusion. Treasury and the Service did not adopt comments requesting that RICs be allowed to make a similar election.²⁰⁶

Elections must be made by the due date of the relevant return (including extensions).²⁰⁷ No relief is available under Regulation sections 301.9100-2 or 301.9100-3.

d) Section 965(n) Election

The Proposed Regulations also provide procedural rules for making an election under section 965(n) to not take the section 965(a) inclusions and corresponding section 78 gross-ups into account for determining a taxpayer's NOL or taxable income that may be reduced by NOL carryovers or carrybacks.²⁰⁸ In other words, the election allows a taxpayer not to use its NOLs to reduce its section 965(a) inclusion.

Consistent with Notice 2018-26 section 3.05(d), Treasury and the Service have determined that the election should apply to both NOLs for the tax year for which the election is made, as well as NOL carryovers and carrybacks to the tax year.²⁰⁹ Furthermore, in response to comments, the section 965(n) election applies to the taxpayer's NOL amount in its entirety (i.e., no partial elections are permitted) and applies to all NOLs of a consolidated group.

Elections must be made by the due date of the relevant return (including extensions).²¹⁰ No relief is available under Regulation sections 301.9100-2 or 301.9100-3.

e) Election to use Alternative Method for Calculation of Post-1986 E&P

Generally, the Proposed Regulations follow section 3.02 of Notice 2018-13. However, a comment requested that individuals be allowed to pro-rate year-end numbers in order to determine post-1986 E&P as of November 2, 2017. Treasury and the Service declined to adopt this comment because it would allow taxpayers to determine their E&P as of a single date rather than two measurement dates as intended under section 965.²¹¹

7. Proposed Regulation Section 1.965-8 — Affiliated Groups, including Consolidated Groups

Proposed Regulation section 1.965-8 generally expands on Notice 2013-07 and provides rules for treatment of affiliated and consolidated groups.

Generally, a consolidated group is treated as a single section 958(a) shareholder for purposes of the section 965(b) E&P deficit calculation, as well as section 965(k) and the elections under section 965(h) and (n).²¹² However, each member must calculate its own section 965(a) inclusion, foreign income taxes deemed paid, and any other purpose other than one specifically listed in the regulations.²¹³ A section 965(c) deduction must also be calculated on a separate entity basis. For consolidated group purposes, aggregate foreign cash position is determined by multiplying the separate entity's section 965(a) inclusion by the group cash ratio of the consolidated group; however, as noted previously, each member that is a section 958(a) U.S. shareholder determines on a separate entity basis which accounts payable, accounts receivable, short-term obligations and derivative financial instruments are to be disregarded in determining its aggregate foreign cash position.²¹⁴

Proposed Regulation section 1.965-8(b) provides computational rules under section 965(b)(5). Section 965(b)(5) allows an affiliated but non-consolidated member that has a net section 965(a) inclusion amount to reduce its section 965(a) inclusion amount by its applicable share of the unused E&P deficit of an affiliated group.²¹⁵

Proposed Regulation section 1.965-8(c) provides record-keeping requirements for those affiliated members with net E&P deficits. The Proposed Regulations require such members to maintain in books and records a statement indicating the portion of E&P deficit used under section 965(b)(5).²¹⁶

In general, a “two-step” process applies for determining whether unused aggregate foreign E&P deficits of affiliated group members can be used to offset section 965(a) inclusion amounts of other members.²¹⁷ First, each section 958(a) U.S. shareholder determines its section 965(a) inclusion amount under the general rules, taking into account any aggregate foreign E&P deficits in its ownership chain.²¹⁸ Following this first step, certain affiliated group members may have positive section 965(a) inclusion amounts (an “E&P net surplus shareholder”)²¹⁹ and certain other members may have no section 965(a) inclusion amount because the aggregate foreign E&P deficits in its section 958(a) ownership chain exceed the accumulated post-1986 deferred foreign income of its DFICs (an “E&P net deficit shareholder”).²²⁰ Second, each E&P net surplus shareholder reduces its section 965(a) inclusion amount by its applicable share of the affiliated group's aggregate unused E&P deficit, which is the sum of the excess deficits of all E&P net deficit shareholders of the affiliated group.²²¹ If a section 958(a) U.S. shareholder is a member of a consolidated group, all section 958(a) U.S. shareholders that are members of that group are treated as a single section 958(a) shareholder for purpose of allocating the group's aggregate foreign E&P deficit.²²²

8. Proposed Regulation Section 1.965-9 — Applicability Dates

The Proposed Regulations are generally effective for the last tax year of a foreign corporation beginning before January 1, 2018, and to the tax years of U.S. persons in which or with which the tax year of the foreign corporation ends. However, Proposed Regulation section 1.965-4 applies regardless of whether a transaction, effective date of method of accounting change or entity classification election, or specified payment as described in Proposed Regulation section 1.965-4, occurred earlier.

9. Other Proposed Regulations

a) Proposed Regulation section 1.986(c)-1 — Coordination with Section 965

Proposed Regulation section 1.986(c)-1 provides that foreign currency gain or loss on distributions of section 965(a) previously taxed amounts will be determined based on the movements in the exchange rate between December 31, 2017, and the date on the which the previously taxed earnings are actually distributed, consistent with Notice 2018-13, Section 3.05(b). This rule does not apply to distributions of section 965(b) previously taxed amounts.²²³ Any gain or loss is reduced in proportion by the applicable section 965(c) deduction.²²⁴

b) Proposed Regulations Sections 1.962-1(b) and 1.962-2(a) — Coordination with Section 965

Proposed Regulations sections 1.962-1(b) and 1.962-2(a) provide rules consistent with Notice 2018-26, section 5, regarding elections under section 962. Proposed Regulations section 1.962-1(b)(1)(i)(A) defines the term “taxable income” to allow the section 965(c) deduction to be taken against the tax imposed on the electing individual shareholder under section 11; the electing individual's section 11 liability cannot be reduced by any other amounts or deductions. The section 965(c) deduction cannot then be deducted again at the individual level for purposes of determining the individual's actual taxable income.²²⁵

Proposed Regulations section 1.962-2(a) clarifies that the section 962 election may be made by an individual who is a U.S. shareholder and who by reason of section 958(b) owns stock in a DFIC through a domestic passthrough entity within the meaning of Proposed Regulations section 1.965-1(f)(19). This means that a U.S. person who is a partner in a domestic partnership and owns ten percent or more of a CFC through the partnership may make the section 962 election; the partnership does not make the election.

C. Comments Regarding the Treatment of Certain Passthrough Entities and Individuals

1. Impact on Partnerships and Partners

a) Controlled Partnerships

The Proposed Regulations provide a special rule that expands upon the reference in Notice 2018-26²²⁶ to Notice 2010-41²²⁷ and, if certain conditions are satisfied, treats a CDP described in Proposed Regulation section 1.965-1(e)(2) as a foreign partnership for purposes of the Proposed Regulations. In general, if a CDP is treated as a foreign partnership, it is not a U.S. shareholder of any SFC and its (direct and indirect) U.S. partners may be section 958(a) U.S. shareholders with respect to an SFC held by the partnership.

Included in the conditions that must be satisfied to treat a CDP as a foreign partnership is a requirement that “[i]f the controlled domestic partnership (and all other controlled domestic partnerships in the chain of ownership of the specified foreign corporation) were treated as foreign—”

Defining the term CDP “with respect to a United States shareholder described in . . . Proposed Regulation section 1.965-1(e)(1)(ii)(B) . . .” raises the question as to whether a domestic partnership is treated as a CDP with respect to all of its partners or solely with respect to the U.S. shareholder described in Proposed Regulation section 1.965-1(e)(1)(ii)(B). It appears the intent of the rule is to treat a CDP that satisfies all of the conditions in Proposed Regulation section 1.965-1(e)(1)(i) and (ii) as a foreign partnership with respect to all partners of the partnership “for purposes of determining the section 958(a) U.S. shareholder of a specified foreign corporation and the section 958(a) stock of the specified foreign corporation owned by the section 958(a) U.S. shareholder.” Treating a CDP as a foreign partnership with respect to all of its partners (i.e., on an entity basis) is also consistent with Notice 2010-41 and the announcement in Notice 2018-26 that Treasury and the Service intended to issue Regulations “treating certain domestic partnerships as foreign partnerships for purposes of identifying which United States shareholders are required to include amounts in gross income under section 951(a).”

If a CDP is treated as a foreign partnership with respect to only certain partners (i.e., the U.S. shareholder described in Proposed Regulation section 1.965-1(e)(1)(ii)(B) and related persons) but is respected as a domestic partnership as to other partners, there could be various complexities associated with capital accounts, tax basis, and allocations because the partnership could be a section 958(a) U.S. shareholder with respect to some but not all of its partners. For example, although the capital account and basis consequences are not clear, the partners with respect to whom the partnership is respected as a domestic partnership may increase their capital accounts and their bases in the partnership for their distributive shares of the partnership's section 965(a) inclusion, while the partners with respect to whom the partnership is treated as foreign may have no corresponding increase to their capital accounts because a foreign partnership may not have a section 965(a) inclusion. These adjustments could cause capital account and basis results that are not consistent with the economic arrangement of the partners and the partnership.

Accordingly, we recommend that the Regulations, when finalized, clarify that a CDP that is treated as a foreign partnership for purposes of the Regulations under section 965 is treated as a foreign partnership with respect to all partners of the partnership (and not solely with respect to the U.S. shareholder described in Proposed Regulation section 1.965-1(e)(1)(ii)(B)).

b) Specified Basis Adjustments under Proposed Regulation section 1.965-2(h)(5)

(1) Application of Section 743(b) Rules to Specified Basis Adjustments for Foreign Passthrough Entities

(a) Section 961 Basis Adjustments

As discussed above, section 961 provides that a U.S. shareholder makes appropriate adjustments to the basis of the stock of a CFC and certain other property to account for the amount required to be included in the U.S. shareholder's gross income under section 951(a) (i.e., section 956 and subpart F income). In general, the purpose of these basis adjustments is “to avoid double taxation of the income of a later disposition of the stock of [a CFC]” where the U.S. shareholder previously included subpart F income with respect to the CFC.²³⁰

Sections 961(a) and (b) prescribe basis adjustments that are made to a U.S. shareholder's stock of a CFC and property of a U.S. shareholder by reason of which the U.S. shareholder is considered under section 958(a)(2) as owning stock of a CFC. In addition, section 961(c) generally provides for basis adjustments similar to the adjustments provided by section 961(a) and (b) to stock of a CFC that is owned by another CFC in a chain of ownership described in section 958(a)(2) with respect to the U.S. shareholder. There is no provision in section 961 for adjusting the basis of stock or other property held by a foreign partnership, and practitioners disagree as to whether a foreign partnership, the outside basis of which is adjusted under section 961(a) and (b), may adjust the basis in stock of a CFC in which the partnership holds stock, although there is widespread agreement that it would, as a tax policy matter, be appropriate to make such adjustments.

(b) Specified Basis Adjustments

The Proposed Regulations provide a general rule for basis adjustments described in Proposed Regulation section 1.965-2(e), (f)(2), or (g)(2) (each a “specified basis adjustment”) with respect to a section 965 inclusion.²³¹ Proposed Regulation section 1.965-2(h)(5)(i) provides that, in general, “a specified basis adjustment is made solely with respect to section 958(a) stock owned by the section 958(a) U.S. shareholder within the meaning of section 958(a)(1)(A) or applicable property²³² owned directly by the section 958(a) U.S. shareholder.”

The Proposed Regulations also provide a special rule that applies specified basis adjustments to section 958(a) stock or applicable property held by a foreign passthrough entity for purposes of determining the foreign passthrough entity's basis in such property with respect to the section 958(a) U.S. shareholder.²³³

If the applicable property of the section 958(a) U.S. shareholder described in paragraph (h)(5)(i) of this section is an interest in a foreign pass-through entity, then, for purposes of determining the foreign pass-through entity's basis in section 958(a) stock or applicable property, as applicable, with respect to the section 958(a) U.S. shareholder, a specified basis adjustment is made with respect to section 958(a) stock or applicable property of the section 958(a) U.S. shareholder owned through the foreign pass-through entity in the same manner as if the section 958(a) stock or applicable property were owned directly by the section 958(a) U.S. shareholder. In the case of tiered foreign pass-through entities, this paragraph (h)(5)(ii) applies with respect to each foreign pass-through entity.²³⁴

We believe the purpose and function of the specified basis adjustment rules, similar to section 961, is to avoid double taxation of income when section 958(a) stock or applicable property is disposed or when an SFC makes a distribution. The language “with respect to the section 958(a) U.S. shareholder” seems to give effect to the policy that this basis adjustment should be made solely for the benefit of the section 958(a) U.S. shareholder that has a section 965(a) inclusion by reason of its ownership of the foreign passthrough entity. In light of the purposes of the specified basis adjustment rules, we agree with this policy result.

If the specified basis adjustment of a foreign passthrough entity is not made solely for the benefit of the section 958(a) U.S. shareholder (or an intermediate foreign passthrough entity between the foreign passthrough entity and the section 958(a) U.S. shareholder, as the case may be), there could be double taxation of the income of an SFC that is already included in the income of a section 958(a) U.S. shareholder under section 965 and inappropriate deferral for others.

Example 1 A domestic corporation (USCo) and an unrelated foreign corporation (ForCo) each own 50 percent of the capital and profits of a foreign partnership (FP). FP owns all of the outstanding stock of a foreign corporation (FC). All of the entities have taxable years ending on December 31. Before any basis adjustments are made pursuant to the Proposed Regulations, FP has zero basis in its FC stock. On both Measurement Dates, FC has $100 of post-1986 deferred foreign income. USCo's pro rata share of FC's section 965(a) earnings amount is $50. On September 1, 2018, FP sells all of its FC stock for $100.

Analysis On December 31, 2017, USCo makes a specified basis adjustment to its partnership interest in FP in the amount of $50.²³⁵ In addition, on December 31, 2017, for purposes of determining FP's basis in the section 958(a) stock of FC with respect to USCo, a specified basis adjustment is made with respect to section 958(a) stock of USCo owned through FP in the amount of $50 (because USCo would have made a $50 specified basis adjustment to the FC stock if USCO owned such stock directly).²³⁶

FP recognizes gain on the sale of its FC stock in the amount of $50 ($100 amount realized less $50 basis²³⁷). We believe that, under the Proposed Regulations, FP allocates all $50 of the gain to FC and none to USCo. This is the same result that would have been reached if USCo had owned the stock of FC directly, the basis adjustments under section 961(a) and Proposed Regulation section 1.965-2(e)(1) would have eliminated all of USCo's gain on the sale of FC stock. If, on the other hand, FP treats the specified basis adjustment as basis that is common to all partners of the partnership and allocates $25 of gain to each of USCo and ForCo, USCo will temporarily suffer double taxation.²³⁸

For these reasons, we recommend that the Regulations, when finalized, clarify that a specified basis adjustment made by a foreign passthrough entity to section 958(a) stock or applicable property is made solely for the benefit of the section 958(a) U.S. shareholder described in Proposed Regulation section 1.965-2(h)(5)(i).²³⁹

(c) Section 743(b) Basis Adjustments

If Treasury and the Service agree with our prior recommendation, we also recommend that the specified basis adjustments made by a foreign partnership be made using the framework of section 743(b). Section 743(b) has an established and well-understood framework for computing and managing basis adjustments that are allocated to property owned by a partnership and that are only with respect to a certain partner. Furthermore, the language in section 743(b) providing that a basis adjustment under section 743(b) “shall constitute an adjustment to the basis of partnership property with respect to the transferee partner only” is similar to language used in Proposed Regulation section 1.965-2(h)(5)(ii), which provides, in part, that a specified basis adjustment is made “with respect to the section 958(a) U.S. shareholder.”

Basis adjustments under section 743(b) are generally made only if there is a sale or exchange of an interest in a partnership.²⁴⁰ Nevertheless, Temporary Regulations under section 367(a) (the “367(a) Temporary Regulations”) adopted section 743(b) as a mechanism to associate basis adjustments with a partner who recognizes gain under section 367(a) (as a result of a partnership's transfer of property to a foreign corporation) even though there is no actual sale or exchange of an interest in the partnership.²⁴¹

In order to provide a section 743(b) adjustment with respect to a partner that is treated as transferring a proportionate share of the property of a partnership to a foreign corporation, the 367(a) Temporary Regulations provide that (i) the partner's basis in the partnership is increased by the amount of gain recognized by the partner under section 367(a) and (ii) solely for purposes of determining the basis of the partnership in the stock of the transferee foreign corporation, the partner is treated as having a newly acquired interest in the partnership for an amount equal to the gain recognized.²⁴² Thus, the 367(a) Temporary Regulations make an adjustment to the basis of the partner's partnership interest and then allow an adjustment to be made to the basis of partnership property under section 743(b) to account for the difference between the partner's basis in the (newly acquired) partnership interest and the partner's share of the partnership's basis in the stock of the foreign corporation.

(d) Application and Recommendation

The long-standing basis adjustment rules under section 743(b) have provided an administrable method of computing and managing basis adjustments necessitated by section 367(a) in a manner consistent with the purposes of section 367(a) and Subchapter K of the Code. We recommend that the Regulations, when finalized, apply the rules of section 743(b) for purposes of associating a specified basis adjustment made by a foreign passthrough entity with the section 958(a) U.S. shareholder with respect to whom the specified basis adjustment is made.²⁴³ We further recommend that the rules of the Regulations, when finalized, applying section 743(b) for this purpose follow the framework established by Temporary Regulation section 1.367(a)-1T(c)(3)(i)(B).

(2) Reduction of a Foreign Passthrough Entity's Specified Basis Adjustment for Distributions

As discussed above, the specified basis adjustment rules generally prescribe special rules for the application of section 961 for purposes of section 965. By providing for specified basis adjustments to be made by foreign passthrough entities “in the same manner as if the section 958(a) stock or applicable property were owned directly by the section 958(a) U.S. shareholder,” the Proposed Regulations effectively apply the rules of section 961(a), for purposes of section 965, to adjust the basis of property held by a foreign passthrough entity.

Any increase in basis made by section 961(a) is generally subject to a decrease in basis under section 961(b)(1). However, the only specified basis adjustment that reduces the basis of section 958(a) stock and applicable property with respect to a distribution by an SFC in the Proposed Regulations is the decrease to basis that occurs as a result of a distribution, during the inclusion year, to which the gain reduction rule applies.²⁴⁴ In order to maintain the alignment between basis adjustments made under section 961(a) and the specified basis adjustments under Proposed Regulation section 1.965-2(h)(5), we recommend that the Regulations, when finalized, clarify that specified basis adjustments made by a foreign passthrough entity are subject to reduction for distributions made by an SFC under the rules of section 961(b)(1) in the same manner as if the section 958(a) stock or applicable property were owned directly by the section 958(a) U.S. shareholder.²⁴⁵

(3) Basis Adjustments for Domestic Partnerships

A domestic partnership (other than a CDP that is treated as a foreign partnership for purposes of the Proposed Regulations) that owns ten percent or more of the voting stock of the CFC is a section 958(a) U.S. shareholder that recognizes a section 965(a) inclusion and a section 965(c) deduction and allocates that inclusion and deduction among its partners in accordance with section 704(b) (i.e., without regard to whether such partners are domestic or foreign).²⁴⁶ In the case of a domestic partnership, the Proposed Regulations prescribe certain basis adjustments that are made to (1) the partners' interests in the partnership²⁴⁷ and (2) property held by the partnership.²⁴⁸

Specifically, Proposed Regulation section 1.965-3(f)(2) provides rules for adjusting the basis of a partner's interest in a domestic partnership under section 705(a) with respect to the partner's share of the partnership's section 965(a) inclusion and section 965(c) deduction. We believe the basis adjustment rules in Proposed Regulation section 1.965-3(f)(2) appropriately provide for basis adjustments under section 705(a) with respect to each partner of a domestic partnership that receives an allocation of a section 965(a) inclusion and a section 965(c) deduction from the domestic partnership.

The Proposed Regulations also provide rules for adjusting the basis of (1) a domestic partnership's basis in section 958(a) stock or applicable property owned directly by the domestic partnership²⁴⁹ and (2) a foreign partnership's basis in section 958(a) stock or applicable property owned directly by the foreign partnership.²⁵⁰

Thus, the Proposed Regulations provide for both inside and outside basis adjustments for both foreign and domestic partnerships. It is not entirely clear, however, whether the Proposed Regulations provide for both adjustments for CDPs. As noted earlier, the Proposed Regulations provide that certain domestic partnerships (i.e., CDPs) are treated as foreign partnerships for certain purposes:

For purposes of the section 965 regulations, a controlled domestic partnership is treated as a foreign partnership for purposes of determining the section 958(a) U.S. shareholder of a specified foreign corporation and the section 958(a) stock of the specified foreign corporation owned by the section 958(a) U.S. shareholder if [certain] conditions are satisfied.²⁵¹

Further, with respect to a CDP that is treated as a foreign partnership, a person that is treated as a section 958(a) U.S. shareholder is subject to the specified basis adjustment rules under Proposed Regulation section 1.965-2(h)(5)(i) (with respect to section 958(a) stock or applicable property held by such shareholder).²⁵²

Nevertheless, while the CDP rule applies for “purposes of the section 965 regulations” and for “purposes of determining the section 958(a) U.S. shareholder . . . the section 958(a) stock,” it is not clear that a domestic partnership that is treated as a foreign partnership for such purposes is treated as a foreign partnership within the meaning of Proposed Regulation section 1.965-2(i)(2) (which defines the term “foreign passthrough entity” for purposes of the specified basis adjustment rules). If a CDP that is treated as a foreign partnership is not subject to the specified basis adjustment rules for a foreign passthrough entity under Proposed Regulation section 1.965-2(h)(5)(ii), then there exists the potential for double taxation of foreign earnings because the section 958(a) U.S. shareholder's basis in the partnership interest of the CDP will be increased pursuant to Proposed Regulation section 1.965-2(h)(5)(i) but there will be no corresponding increase to the basis of the section 958(a) stock (or applicable property) held by the CDP (as may be the case with foreign partnerships today with respect to subpart F inclusions). We believe a purpose of the special specified basis adjustment rules for foreign passthrough entities is to prevent the potential for such double taxation. Consistent with that purpose, we recommend that the Regulations, when finalized, clarify that a CDP that is treated as a foreign partnership pursuant to Proposed Regulation section 1.965-1(e)(1) is also treated as a foreign passthrough entity for purposes of the specified basis adjustment rules under Proposed Regulation section 1.965-2(h)(5)(ii).

c) Downward Attribution in the Case of Small Partners and Modification of Examples to Avoid Sideways Attribution

The term SFC includes any foreign corporation in which a U.S. corporation is a U.S. shareholder.²⁵³ Section 318(a)(3)(A) provides for downward attribution of stock owned by a partner to its partnership and section 318(a)(2)(A), in conjunction with section 318(a)(5)(C), provides for attribution of that stock to other partners in that partnership. These attribution rules are taken into account in determining whether a foreign corporation is an SFC under section 965(e)(1)(B). However, Proposed Regulation section 1.965-1(f)(45)(ii) provides that solely for purposes of determining whether a foreign corporation is an SFC within the meaning of section 965(e)(1)(B) and 251. Prop. Reg. § 1.965-1(e)(1) (emphasis added).

Proposed Regulation section 1.965-1(f)(45)(i)(B), stock owned, directly or indirectly, by or for a partner will not be considered as being owned by a partnership under sections 958(b) and 318(a)(3)(A) and Regulation section 1.958-2(d)(1)(i) if the partner owns less than five percent of the interests in the partnership's capital and profits.

We commend Treasury and the Service for recognizing the administrative difficulties of applying downward attribution in the case of partners with small interests for this purpose. We recommend, however, that a distinction be made regarding partners that are capable of controlling or managing a partnership and those who are not. Partners who cannot manage or control the partnership may have difficulty accessing the information necessary to comply with the attribution rules. More importantly, partnerships may have difficulty collecting the information from those partners necessary for the partnership to comply with the attribution rules. Thus, we recommend that the five percent threshold apply in the case of general partners, partners active in the management of the partnership, or partners with control and information rights that would give them access to the information required to analyze constructive ownership under sections 318 and 958(b), but that in the case of other partners, a fifteen percent threshold would be appropriate. Such a threshold would increase the likelihood of there being a sufficient relationship between the partner and the partnership that the requisite information sharing necessary for compliance with these rules occurs.

We also recommend that Treasury modify examples 1 and 2 of Proposed Regulation section 1.965-1(g) so that while downward attribution of stock from a partner to a partnership is “turned off” when the partner owns less than the requisite interest in the partnership (the “special attribution rule of Proposed Regulation section 1.965-1(f)(45)(ii)”), it is done in a manner that is not contrary to the statutory prohibition on “sideways” attribution set forth in section 318(a)(5)(C). Currently, those examples apply the special attribution rule in a manner that is inconsistent with the anti-reattribution rule in section 318(a)(5)(C) and existing IRS guidance.²⁵⁴

In example 1, A, an individual, owns 100 percent of the stock of a domestic corporation, DC, and one percent of the interests in a partnership, PS. A United States citizen, USI, owns 10 percent of the interests in PS and 10 percent by vote and value of the stock of a foreign corporation, FC. The remaining 90 percent by vote and value of the stock of FC is owned by non-United States persons that are unrelated to A, USI, DC, and PS.

The analysis in example 1 of Proposed Regulation section 1.965-1(g) provides, in part, that “absent the special attribution rule in [Proposed Regulation section 1.965-1(f)(45)(ii)], PS would be treated as owning 100 percent of the stock of DC and 10 percent of the stock of FC” and, “under sections 958(b), 318(a)(5)(A), and 318(a)(3)(C), and section 1.958-2(f)(1)(i) and (d)(1)(iii), DC would be treated as owning the stock of FC treated as owned by PS.”

Section 318(a)(5)(C) provides that “[s]tock constructively owned by a partnership, estate, trust, or corporation by reason of the application of paragraph (3) shall not be considered as owned by it for purposes of applying paragraph (2) in order to make another the constructive owner of such stock”.²⁵⁵ This provision and the IRS guidance interpreting it allow for reattribution of stock deemed owned through downward attribution, but do not permit such stock to be reattributed through upward reattribution or through other means that result in sideways attribution or overlapping ownership attribution. Thus, PS may not attribute the shares of DC or FC upstream.²⁵⁶ Consequently, we recommend that Treasury modify examples 1 and 2 of Proposed Regulation section 1.965-1(g) by having PS own directly, and not through attribution, the shares of DC or to otherwise modify the example to eliminate the impermissible attribution to avoid a conflict between the examples and section 318(a)(5)(C).

We recommend that the facts and analysis of example 1, as modified, generally provide:

• PS, a partnership, owns 100 percent of the stock of a domestic corporation, DC. A United States citizen, USI, owns four percent of the capital and profits interests in PS and 10 percent by vote and value of the stock of a foreign corporation FC. The remaining 90 percent by vote and value of the stock of FC is owned by non-United States persons that are unrelated to USI, DC, and PS.

• Absent the special attribution rule under Proposed Regulation section 1.965-1(f)(45)(ii), PS would be treated as owning 10 percent of the stock of FC under sections 958(b) and 318(a)(3)(A) and Regulation section 1.958-2(d)(1)(i). As a result, under sections 958(b), 318(a)(5)(A), and 318(a)(3)(C), and Regulation section 1.958-2(f)(1)(i) and (d)(1)(iii), DC would be treated as owning the stock of FC treated as owned by PS, and thus DC would be a U.S. shareholder with respect to FC within the meaning of section 951(b), causing FC to be an SFC within the meaning of Proposed Regulation section 1.965-1(f)(45).

• However, under the special attribution rule, solely for purposes of determining whether a foreign corporation is an SFC, the stock of FC owned by USI is not treated as owned by PS because USI owns less than five percent of the interests in PS's capital and profits. Accordingly, FC is not an SPC within the meaning of Proposed Regulation section 1.965-1(f)(45).

d) Foreign Cash Position Through Partnerships

The conference report for the Act²⁵⁷ (the “Conference Report”) indicates that special rules should be applied to determine a U.S. shareholder's cash position attributable to cash of a partnership. Specifically, the conference report noted the following:

The conference agreement also provides that the cash position of a U.S. shareholder does not generally include the cash attributable to a direct ownership interest in a partnership, but preserves the rule that cash positions of certain noncorporate foreign entities owned by a specified foreign corporation are taken into account if such entities would be specified foreign corporations with respect to the U.S. shareholder if the entity were a foreign corporation. For example, if a U.S. shareholder owns a five-percent interest in a partnership, the balance of which is held by a specified foreign corporation with respect to which such shareholder is a U.S. shareholder, the partnership is treated as a specified foreign corporation with respect to the U.S. shareholder, and the cash or cash equivalents held by the partnership are includible in the aggregate cash position of the U.S. shareholder on a look-through basis. The conferees anticipate that the Secretary will provide guidance for taking into account only the specified foreign corporation's share of the partnership's cash position, and not the five-percent interest directly owned by the U.S. shareholder.²⁵⁸

Consistent with the Conference Report, we recommend that the final regulations provide that that the SFC must (1) take into account an SFC's share of the cash position of a partnership in which the SFC is partner, and (2) not take into account the cash position of a partnership to the extent the partnership is held directly by a U.S. shareholder or another person that is not an SFC.

e) Coordination with the Section 965 Q&A on IRS.gov

The Preamble to the Proposed Regulations helpfully directs taxpayers to the Questions and Answers about Reporting Related to Section 965 on 2017 Tax Returns available on the Service's website (the “Section 965 Q&A”) for instructions on “how and when to properly report section 965-related amounts and file returns reporting such amounts” for the 2017 tax year.²⁵⁹ There are, however, a few provisions of the Proposed Regulations that we believe could be better coordinated with the contents of the Section 965 Q&A.

As noted earlier, the Proposed Regulations provide that relief is not available under Regulation section 301.9100-2 or 301.9100-3 to make a late election under section 965(h), (i), (m), and (n) (each a “Section 965 Election”).

Given the approaching tax return deadlines for many taxpayers with respect to the inclusion year and the denial of late election relief by the Proposed Regulations, we recommend that Treasury and the Service clarify the requirements for statements that must be attached to a taxpayer's return for the inclusion year by:

f) Interaction with Section 1411

Proposed Regulation section 1.965-1(d) provides that an SFC described in section 965(e)(1)(B) and Proposed Regulation section 1.965-1(f)(45)(i)(B) that is not otherwise a CFC is treated as a CFC for, among other things, purposes of Regulation section 1.1411-10. Regulation section 1.1411-10 addresses the application of the net investment income tax (the “NIIT”) to shareholders of CFCs, by providing that gross income inclusions for subpart F income and CFC earnings invested in U.S. property “are not treated as dividends” under the income tax rules.²⁶⁰

As such, amounts includible pursuant to section 951(a) (either as subpart F income, investments in U.S. property, or GILTI) are not subject to the NIIT imposed under section 1411 until those amounts are actually distributed.²⁶¹ Proposed Regulation section 1.965-3(f)(3) provides that an SFC that is not otherwise a CFC is treated as a CFC for purposes of sections 965(b), 951, 961 and Regulation section 1.1411-10.

On the one hand, Proposed Regulation section 1.965-7(b)(3)(ii)(D) states that any event that results in a person no longer being a U.S. person (which includes a resident alien becoming a nonresident alien) is an acceleration event triggering any payments otherwise deferred under a properly executed section 965(h) election. On the other hand, however, Regulation section 1.1411-2(a)(1) explicitly excludes nonresident aliens from the purview of the section 1411 NIIT.

The regulations under section 1411 could be interpreted as implying that no NIIT is due under section 1411 with respect to section 965(a) income even when an acceleration of the section 965(h) net tax liability arises from a resident alien becoming a nonresident alien. In light of this possible interpretation, we suggest that Treasury and the Service clarify the interaction of the NIIT rules with those under section 965, as they apply to persons that cease to be U.S. tax residents after incurring the section 965 tax liability.

2. Impact on Individual U.S. Shareholders

a) Changes in Method of Accounting

The Proposed Regulations provide that any change in the method of accounting by U.S. shareholders with respect to an SFC will be disregarded if the change results in reduction of a section 965 element.²⁶² The Proposed Regulations go further than announced in Notice 2018-26, as they apply to any reduction of a section 965 element.²⁶³

We agree it is appropriate for the Proposed Regulations to disregard changes from calendar year end SFCs to fiscal year end SFCs, because those changes would defer the payment of section 965 liability. Changing the SFC's method of accounting from fiscal year-end to a calendar year-end, however, would accelerate the section 965 liability; and, while possibly reducing a section 965 element, should not be treated as an abusive transaction, even if the change of method of accounting has been requested by the SFC after November 2, 2017.

The change from being a fiscal year end SFC to a calendar year end SFC may be primarily requested for reducing administrative burden on taxpayers whose exercise in calculating the section 965 liability may be challenging and burdensome. This may be especially true for those individual U.S. shareholders who are required to calculate the section 965 liability because of the existence of a domestic corporate U.S. shareholder. We, therefore, recommend allowing the changes of method of accounting from fiscal year end SFC to a calendar year end SFC.

b) Section 962 Election Revocation

The Proposed Regulations, consistent with the Code, provide that amounts included in gross income under section 951(a) by an individual who makes a section 962 election are treated as if they were received by a domestic corporation for purposes of section 960.²⁶⁴

The section 962 election cannot be revoked for the year without the Commissioner's consent.²⁶⁵ The Service will not consent unless a “material and substantial change in circumstances occurs which could not have been anticipated when the election was made.”²⁶⁶ The Proposed Regulations do not provide any guidance on whether individual U.S. shareholders would be allowed to revoke their section 962 election immediately after the year of section 965 inclusion. This may present significant burdens for the individual U.S. shareholders, even if the section 962 election might otherwise be beneficial for other purposes of the Act (for example, GILTI provisions).

The Conference Report provides that “individual U.S. shareholders, and the investors in U.S. shareholders that are pass-through entities, generally can elect application of corporate rates for the year of inclusion.”²⁶⁷ This language seems to suggest that Congress saw this election as a one-time election to address, among other potential areas of concern, the rates at which individual taxpayers paid tax on section 965 inclusions. Accordingly, we believe that granting individual U.S. shareholders who make the section 962 election the ability to revoke the election after the year of the section 965 inclusion is consistent with Congressional intent.

D. Comments Regarding Deficits, Basis Adjustments, and Gain Reduction Rule

1. Deficits

a) Reduction of Section 959(c)(3) Deficit by PTI in Defining E&P Deficit Foreign Corporation

Like section 3.01 of Notice 2018-13, the Proposed Regulations provide that a deficit in post-1986 E&P exists only if the deficit exceeds the aggregate of the SFC's post-1986 E&P described in section 959(c)(1) and (c)(2), or, in other words, its PTI.²⁶⁸ As discussed in the Preamble, under the statute, post-1986 E&P is not reduced by PTI whereas accumulated post-1986 deferred foreign income is reduced by PTI.²⁶⁹ If these rules were applies literally, taxpayers would be able to use a deficit in one company to offset the deferred foreign income in another company if the deficit company has PTI. For example, assume that SFC1 has a deficit in post-1986 E&P of 50 and it has a section 959(c)(2) account of 50. Further assume that SFC2 has post-1986 deferred foreign income of 100. Under a literal reading of the definitions, the 50 of deficit in SFC1 is effectively absorbed by the 50 in PTI and is not available to offset the income in SFC2.²⁷⁰

A literal application of these rules would increase the likelihood of a CFC having both PTI and a deficit in section 959(c)(3) E&P,²⁷¹ which raises the question of whether PTI can be distributed from a CFC having such a deficit.²⁷² Most importantly, offsetting a “taxable deficit” against PTI essentially eliminate the benefit of section 965(b), which we believe was intended to permit deficits to offset otherwise deferred earnings subject to the transition tax.²⁷³ Consequently, there appears to be a conflict between the congressionally-provided benefit of section 965(b) and a strict technical reading of the definition of E&P. We recommend that Treasury reconsider this portion of the Proposed Regulations and provide a rule in the final regulations that permits the full amount of the deficit to be available to reduce a section 965(a) inclusion as Congress intended. We recognize that Treasury and the Service may feel that a technical correction is required to adopt such a position, and, if so, would recommend that the issue be addressed in the preamble to the final regulations.

2. Basis Adjustment Rules

a) Basis Adjustment May Provide No Actual Benefit

The Proposed Regulations generally provide that no adjustments to the basis of stock or other applicable property with respect to a DFIC are made under section 961 or otherwise to take into account the reduction in a section 958(a) U.S. shareholder's pro rata share of a DFIC's section 965(a) earnings amount by an allocable share of the shareholder's aggregate foreign E&P deficit.²⁷⁴ A section 958(a) U.S. shareholder, however, may elect to adjust the basis of each DFIC and each E&P deficit foreign corporation in accordance with the Proposed Regulations.²⁷⁵ The basis adjustment rules, however, may actually provide no appreciable benefit when the DFIC and E&P deficit foreign corporations are located in the same ownership chain.²⁷⁶ Although this situation may not pose any concern if the relevant deficits were equity funded at the top of the chain (as sufficient basis would then exist apart from the section 965 allocation scheme), a distribution of section 965(b) PTI could result in fully taxable income (taxable at the 21% rate for C corporations) if the offsetting deficits were not fully equity funded at the first-tier level (e.g., they were debt funded).²⁷⁷ In such a case, section 965(b) PTI may be taxed immediately if the section 958(a) U.S. shareholder has made a basis adjustment election pursuant to Proposed Regulation 1.965-2(f)(2) because there may be insufficient basis in the deficit chain to absorb the downward basis adjustment to the stock or other applicable property in respect of an E&P deficit foreign corporation.²⁷⁸ Further, if no basis election is made, section 965(b) PTI may be subject to full taxation (currently at 21 percent) when distributed (assuming there is an absence of other, unrelated, tax basis to absorb the required section 961(b) basis reduction).

b) Address Basis Adjustment for Section 965(b) PTI

The conference report states that “[t]he conferees recognize that basis adjustments (increases or decreases) may be necessary with respect to both the stock of the deferred foreign income corporation and the E&P deficit foreign corporation and authorizes the Secretary to provide for such basis adjustments or other adjustments, as may be appropriate.”²⁷⁹ For example, with respect to the stock of the deferred foreign income corporation, the Secretary may determine that a basis increase is appropriate in the taxable year of the section 951A inclusion or, alternatively, the Secretary may modify the application of section 961(b)(1) with respect to such stock.”²⁸⁰ Thus, Congress contemplated that adjustments to the section 961 basis rules may be necessary in respect of section 965 PTI. To avoid the potential of taxing section 965(b) PTI upon distribution at current tax rates, while the original benefit arising from the deficit giving rise to such PTI was used to offset income taxed at the lower rates of tax under section 965, we recommend that the final regulations not require a downward basis adjustment under section 961(b) from the distribution of section 965(b) PTI. If this suggestion is not adopted, we recommend that the final regulations adopt an ordering rule such that section 965(b) PTI is treated as the last PTI to be distributed (see also the discussion below in respect of the gain reduction rule).

3. Gain Reduction Rule

A U.S. shareholder having insufficient basis in the stock or other applicable property in respect of an E&P deficit foreign corporation to absorb the required basis reduction may be required to recognize gain immediately if the election to adjust basis is made.²⁸¹ Even if the U.S. shareholder does not make the basis election, the gain reduction rule would subject to immediate tax the U.S. shareholder's receipt of section 965 PTI (assuming no other basis exists to absorb that PTI).²⁸² As a result, in the absence of an ordering rule governing PTI, taxpayers are uncertain as to the tax consequences of a distribution of PTI (e.g., whether what they are distributing is section 965(a) PTI or section 965(b) PTI),²⁸³ which may inhibit repatriations of cash, one of the primary benefits of section 965.

To avoid this result, we recommend that the final regulations provide a special ordering rule in respect of the gain reduction rule that would apply it first to available section 965(a) PTI. We recommend that the gain reduction rule should be applicable to section 965(b) PTI only after available section 965(a) PTI has been fully distributed. In other words, section 965(b) PTI should be last-in-line in terms of distributed PTI.

E. Comments Regarding Estimated Tax Payments

As mentioned previously, in March, April and June of 2018, the Service published and updated the FAQs relating to the application of section 965 for the 2017 taxable year. Q&A 14 addresses whether taxpayers that make an election under section 965(h) to pay the section 965(h) net tax liability²⁸⁴ in eight installments could receive refunds of any 2017 payments or estimated tax payments that exceeded the sum of their (i) 2017 net income tax liability determined without regard to section 965 and (ii) the first annual installment of section 965(h) net tax liability due in 2018. Answer 14 states that taxpayers are not eligible for a refund of this amount unless and until the amount of payments exceeds the entire unpaid 2017 income tax liability, including all amounts to be paid in installments under section 965(h) in subsequent years. It further provides that any excess amounts paid are applied to the “next successive annual installment (due in 2019), and to the extent such excess exceeds the amount of that installment due, then to the next such successive annual installment (due in 2020), etc.” In response to taxpayers' concerns with the legal basis for the statement in Q&A 14, the Service issued PMTA 2018-016 (August 2, 2018) (the “PMTA”) explaining that the Service has no authority under section 6402 to provide a refund or credit of any amount paid exceeding the amount currently due because no overpayment of tax exists in respect of 2017.

1. Ordinary Course Tax Overpayments is a Common Practice

To avoid penalties for underpayment of taxes, taxpayers frequently overpay estimated taxes. In 2017, as the Service noted, many taxpayers followed their usual practice and paid amounts in excess of their 2017 net income tax liability (determined without regard to section 965) and the applicable 2018 estimated tax liability. In accordance with Q&A 10, originally issued on March 13, 2018, taxpayers were required to make a separate payment in respect of their first installment payment of section 965(h) net tax liability. It was only after the FAQs were updated on April 13, 2018, however, that taxpayers were alerted to the Service's position that overpayments would not be refunded or credited against 2018 estimated tax liability.

2. Precluding Refunds and Credits Inconsistent with Congressional Intent

Congress intended to provide taxpayers with flexibility to pay the section 965(h) net tax liability over time in light of the significant tax liability arising from the transition tax. The conference agreement follows the Senate amendment in this regard and backloads the installment payments over the eight-year period.²⁸⁵ There is no indication that Congress expected taxpayers who elected to pay the transition tax in installments would have ordinary course overpayments of tax (including estimated tax) used to pay the transition tax liability before the installment payments are otherwise due.²⁸⁶ Stated differently, Congress provided for the ability to defer payments and provided for certain acceleration of those required payments. There is no evidence that Congress expected prepayments or overpayments of other taxes to result in the effective prepayment of the section 965 tax liability.

3. National Taxpayer Advocate Position Identified

In a recent blog posting, the National Taxpayer Advocate, Nina Olson, identified the inconsistency of the Service's approach to section 965(h) with Congressional intent to mitigate the burden of the transition tax on taxpayers.²⁸⁷ She noted that “[a]s a practical matter, this interpretation sharply limits the value of [s]ection 965(h), and in some cases, it may even render it meaningless.”²⁸⁸ In addition to two suggested alternatives, noted below, the Taxpayer Advocate stated that if the Service does not adopt either of the approaches, the Service should consider other possible interpretations of the relevant statutes that would enable it to implement the law consistent with Congressional intent or “corporations will not receive any of the benefits Congress provided by enacting Section 965(h).”²⁸⁹

The Taxpayer Advocate Blog notes that, in addition to other potential approaches, the Service should consider alternatives such as analogizing the transition tax to a recapture of tax eligible for exclusion from the computation of estimated tax liability.²⁹⁰ Such treatment would allow a taxpayer to compute estimated tax liability without regard to transition tax liability and then seek a refund of estimated tax overpayments as so computed,²⁹¹ even if, including its transition tax liability, the corporate taxpayer's actual tax liability exceeds its estimated tax overpayment. Treating the transition tax liability separate from the taxpayer's regular tax liability, for which it has made estimated tax payments, would allow the refund of overpayments of estimated tax, consistent with Congressional intent as well as arguably the intent of the estimated tax overpayment section and the relevant tax form.²⁹²

The Taxpayer Advocate Blog also notes that Treasury has the authority, pursuant to section 965(o)(2), to “prescribe” guidance “to prevent the avoidance of the purposes of this section.” Given that the purpose of section 965(h) is to allow taxpayers to pay the transition tax over an eight-year period, the Taxpayer Advocate asks why the Service believes it does not have the authority to issue guidance enabling taxpayers to elect credits or refunds of extra installments under section 965(h), as requested on Form 4466 before assessment (or even after assessment).

4. Reconsideration of the Restrictions on Refunds or Credits in Respect of Tax Liabilities Unrelated to Section 965(h) Net Tax Liability

Consistent with the approach in the FAQs, which requires separate accounting and separate payment of the section 965(h) net tax liability, and for the reasons noted above and as described by other taxpayers and organizations, we recommend that the position in the PTMA and the FAQs be reconsidered. Leaving the FAQs as they are, would, in effect, result in a significant restriction on the Congressionally-designed installment payment regime Moreover, taxpayers would, on the one hand, be penalized if they underpay, but, on the other hand, would have no access to a refund or credit if they overpay installments on the other. Consequently, we recommend that the Service consider, for example, treating each section 965(h) installment payment as a separate tax liability such that each installment payment would stand on its own in terms of whether an overpayment has arisen for a particular taxable year. If our recommendation is not accepted, we respectfully request that the Service consider permitting a refund or credit for an overpayment in 2017 because many taxpayers conservatively overpaid estimated taxes as a precautionary measure to preclude the imposition of estimated tax penalties in light of the timing of the enactment of the Act and the timing of the available guidance, as many taxpayers were unaware of the Service's view of the law as described in the FAQs and PMTA.²⁹³

F. Comments Regarding Foreign Tax Credits

1. Allocation of Foreign Taxes to Taxable Year of SFC

Under Proposed Regulation section 1.965-1(f)(29)(ii), a taxpayer is permitted to reduce the post-1986 E&P of certain SFCs by a portion of the foreign income taxes that are deemed to accrue as of November, 2, 2017. We commend Treasury and the Service for proposing this rule, as it responds directly to taxpayer concerns that foreign corporations typically do not accrue earnings or foreign income taxes, on a consistent, month-to-month basis. Indeed, the opposite is true. In most circumstances, foreign income taxes accrue as of the end of the tax year of the foreign corporation. Without the rule in the Proposed Regulations, there could be a significant distortion in the measurement of post-1986 E&P.

As currently proposed, the rule provides that the SFC's post-1986 E&P as of November 2, 2017, is reduced by the “applicable portion” of such foreign income taxes.²⁹⁴ The applicable portion is “the amount of the taxes that are attributable to the portion of the taxable income (as determined under foreign law) that accrued on or before November 2, 2017.”²⁹⁵ While the intent of the Proposed Regulations is clear, namely, that the foreign income taxes can be treated as accruing during the year, and not only at the close of the taxable year, the clause itself is, as drafted, could leave room for different interpretations. For example, the parenthetical could be read to modify only the noun “taxable income,” such that the principles of foreign law would be used to determine when and how taxable income accrues, and how much of it had accrued as of November 2, 2017. In that case, only after understanding and applying the principles of foreign law to determine the accrual of taxable income would the taxpayer determine the ratio of accrued taxable income as of November 2, 2017 to December 31, 2017. This ratio would then be applied against the foreign income taxes accrued as of December 31, 2017, to determine a hypothetical amount of foreign income taxes deemed accrued as of November 2, 2017.

Another possible interpretation could be that foreign income taxes are “attributable to” the portion of taxable income accrued at the time when estimated payments are required to be made under foreign law. For example, where a foreign corporation is obligated to make monthly or quarterly estimated tax payments, such obligation might be treated as being fixed at the time of payment, making the accrual at least traceable to actual payments recorded on the financial statements of the foreign corporation.

In order to reduce uncertainty, we recommend the final regulations modify the rule in Proposed Regulation 1.965-1(f)(29)(ii) to provide that foreign income taxes are treated as paid or accrued by a foreign corporation in an amount equal to a ratio comparing the E&P as of November 2, 2017 to that as of December 31, 2017. Adopting this method of calculation would be easier to implement as taxpayers could point directly to a ratio easily verifiable (and consistent with) the post-1986 E&P as of each measurement date, rather than determining the incidence of foreign income accrual under foreign tax law.

2. Disallowance of Foreign Tax Credits under Section 965(g)

Similar to inclusions under Subpart F, the U.S. corporate shareholder inclusion under section 965(a) is eligible to “pull” foreign tax credits to the extent the credits are with respect to the amount of the inclusion. Generally, this requires a measurement to determine the ratio of the amount of the current inclusion as compared to the pool of post-1986 E&P. This ratio is applied to determine the pro-rata share of foreign income taxes that the U.S. shareholder is eligible to claim (subject to all other requirements under section 901 and, importantly, also still subject to the limitations under section 904).

Section 965(g) provides for a reduction in certain foreign income taxes treated as eligible for a credit under section 960. More specifically, the statute limits the creditable foreign income taxes by disallowing a credit for the “applicable percentage” of any taxes paid or accrued, or treated as paid or accrued, with respect to any amount for which a deduction was provided for under section 965(c). The statute is intended to allow a credit only for the ratable portion of the foreign income that is subject to US taxation. Because the tax rate applicable to the section 965(a) inclusion amount which is attributable to the cash position of the U.S. shareholder is 15.5 percent, the “applicable percentage” of disallowed foreign income taxes is 55.7 percent²⁹⁶. The gross-up under section 78 is subject to a similar reduction.²⁹⁷

The Proposed Regulations take the section 965(g) limitation a step further by applying the same calculation to any foreign withholding taxes and similar foreign taxes imposed on the distribution of PTI. For example, Proposed Regulation section 1.965-5(b) provides that “neither a deduction nor a credit under section 901” is allowed for the applicable percentage of any foreign income taxes attributable to distributions of PTI generated under either section 965(a) or section 965(b). By example, the Proposed Regulations then state that “accordingly, no deduction or credit is allowed for the applicable percentage of any withholding taxes imposed on a United States shareholder.”

While the extension of the applicable percentage disallowance of section 965(g) to foreign distribution taxes furthers the policy of limiting foreign tax credits in the same proportion as the underlying deferred foreign earnings were so limited, we believe that the extension of the rule adds unneeded complexity to the calculation of creditable foreign income taxes by requiring taxpayers to track multiple E&P and PTI pools, potentially for decades, even though section 965 is a one-time inclusion event. Moreover, we are not aware of anything in the statute or legislative history that mandates that foreign distribution taxes be subject to the section 965(g) reduction. This limitation is especially harsh on individual U.S. shareholders and those U.S. shareholders who reside outside the U.S. If indeed the FTC were to be limited by the applicable percentage amount, in some cases the section 965 liability would be significantly higher (double) of what it otherwise might be without such a “haircut.” Note that the section 965 liability of individual U.S. shareholders is already higher due to graduated income tax rates that apply for purposes of calculating the tax rate of section 965 liability, and that the individuals do not claim the tax credit pursuant to section 960, unless they have made the section 962 election.

We do not see any reason to apply the “haircut” to actual distributions to individual U.S. shareholders who do not get a benefit of the 100 percent dividend received deduction in the future, or a reason to apply the “haircut” to any excess foreign tax credit that individual U.S. shareholders may choose to carryforward or carryback, if available. We recommend that the final regulations limit availability of the FTC in those instances to, for example, instances in which the foreign tax in question is in the same basket as the section 965 inclusion amount.

Given the burden on taxpayers that this rule will create, as well as realistic double taxation potential (especially for those individual U.S. shareholders who reside outside the U.S.), and the fact that it imposes an incremental limitation on FTCs on top of that already imposed under section 904, we recommend removing the limitation on withholding taxes from Proposed Regulation section 1.965-5(b).

3. Coordination with IRS Form 1118

In order to provide urgently needed guidance relating to the filing of returns and reporting of the section 965(a) inclusions, Treasury and the Service have published the Section 965 Q&A.²⁹⁸ We commend the IRS and Treasury for their speed in addressing these issues and providing clarity with respect to many unresolved issues as the compliance season comes to bear.

Presumably in an effort to streamline the compliance process for Section 965 inclusions, the Section 965 Q&A effectively separates a taxpayer's pre-existing US tax returns and the reporting required for section 965. This separation creates some unusual complexities with respect to foreign tax credit calculations under section 965 and IRS Form 1118.

The guidance in the Section 965 Q&A states as follows:

“Do not enter the relevant section 965(a) amount, the relevant section 965(c) deduction, the deemed paid foreign taxes with respect to the relevant section 965(a) amount, and the foreign taxes disallowed under section 965(g) on Form 1118. Report the deemed paid foreign taxes with respect to the section 965(a) amount and the foreign taxes disallowed under section 965(g) on IRC 965 Transition Tax Statement, Lines 4a and 4b.”

This makes the determination and presentation of the section 904 limitation uncertain. The guidance could be interpreted to mean that none of the section 965 inclusions, including the foreign tax credits, should be included as part of the taxpayer's overall foreign tax credit limitation calculation. However, there is nothing in the statute or the legislative history indicating that the foreign tax credits attributable to mandatory repatriation are somehow exempt from, or outside of, the ordinary section 904 requirements. Indeed, it seems clear that taxpayers may utilize foreign tax credit carryforwards (generated outside of mandatory repatriation) against their section 965 liability. That is, we believe that there is a single section 904 limitation applicable to the foreign tax credits claimed by a given taxpayers — regardless of whether those foreign tax credits are generated by section 965 or another provision of the Code.

In order to eliminate the uncertainty resulting from this issue, it is recommended that Treasury and the Service modify the Section 965 Q&A to provide that taxpayers may “pull” the section 965 amounts on to the respective IRS Form 1118, with proper documentation identifying the source of each category of foreign income and the foreign taxes attributable to such income. This could be accomplished by adding a category of inclusions reportable under Schedule A, column 1, identified simply as 965 rather than utilizing a country abbreviation. This would provide a more accurate section 904 limitation calculation and facilitate compliance. Future amendments to IRS Form 1118 could similarly create a separate category of inclusion for section 965 so that taxpayers have a single place to track PTI balances and foreign tax credit pools going forward.

4. Eligibility of Foreign Taxes on Distributions from DREs and Partnerships for a Foreign Tax Credit.

We recommend that Treasury and the Service consider clarifying that references in Proposed Regulation section 1.965-5(c)(1)(ii) to “upper-tier foreign corporation,” “distribution,” and “lower-tier foreign corporation” are to principles of foreign law and not U.S. tax classification. If those terms were applied by reference to U.S. tax classification, it appears that the Proposed Regulations would be limited to distributions between two recognized CFCs such that foreign withholding, distribution and recipient taxes imposed in respect of a distribution from a lower-tier partnership or lower-tier disregarded entity would not be eligible for a foreign tax credit under section 960(a)(3). When a disregarded entity distributes cash to its owner, or a partnership distributes cash to its partners after the imposition of U.S. tax on those earnings, the distribution may not be recognized for U.S. tax purposes as a distribution of PTI, but it would be recognized as a distribution for foreign tax purposes and, consequently, subject to foreign withholding, distribution or recipient taxes that should be eligible for a foreign tax credit pursuant to section 960(a)(3) because the underlying earnings to which the foreign tax relates was taxed under section 965(a).

Section 960(a)(3) provides that any portion of a distribution to a domestic corporation that is PTI is treated by the domestic corporation as a dividend solely for purposes of taking into account under section 902 any income, war profits or excess profits taxes paid to any foreign country on or with respect to the accumulated profits of such foreign corporation from which such distribution is made so long as such taxes were previously deemed paid. Nothing in section 960(a)(3) suggests that it is limited to taxes imposed on distributions between corporations recognized as such for U.S. tax purposes.

5. Increase Foreign Tax Credits of E&P Deficit Foreign Corporation for Foreign Tax Credits Related to a Hovering Deficit

We respectfully recommend that Treasury and the Service reconsider their position that suspended foreign income taxes related to a hovering deficit that has reduced the post-1986 E&P of a DFIC cannot be taken into account for any other purpose, including in calculating the amount of post-1986 foreign income taxes deemed paid with respect to an inclusion under section 965. Treasury and the Service declined to adopt comments seeking to increase the post-1986 foreign income taxes of a DFIC in the inclusion year for foreign income taxes related to a hovering deficit that reduced the post-1986 E&P of the DFIC because the existing rules, set forth in Treasury Regulation section 1.367(b)-7, adequately address this issue. As the existing rules generally offset hovering deficits with post-transaction earnings in the same separate category of post-1986 undistributed earnings as of the first day of the foreign surviving corporation's first taxable year following the year in which the post-transaction earnings accumulated,²⁹⁹ foreign income taxes related to a hovering deficit likely will never be creditable due to the changes in the foreign tax credit system as a result of the Act.³⁰⁰ In promulgating the existing rules set forth in Treasury Regulation section 1.367(b)-7, Treasury recognized that the hovering deficit rule is a legislative mechanism designed to deter the trafficking of favorable tax attributes.³⁰¹ As the Act has changed the foreign tax credit system in a manner that likely precludes foreign income taxes related to a hovering deficit from ever being creditable in a post-2017 taxable year, no trafficking in such foreign income taxes will be possible, and the rational for the hovering deficit rule does not exist in respect of these taxes. Thus, the last possible taxable year in which such taxes may be eligible to be claimed is in respect of an inclusion year under section 965. Consequently, we recommend that Treasury and the Service reconsider permitting taxpayers to access foreign income taxes related to a hovering deficit in the section 965 inclusion year. It could do so through either (i) increasing the post-1986 foreign income taxes of the DFICs to which the associated hovering deficit is allocated under section 965(b), or (ii) increasing the post-1986 foreign income taxes of the E&P deficit foreign corporation to which the hovering deficit relates for the inclusion year.³⁰²

G. Comments on Miscellaneous Issues

1. Section 9100 Relief

Section 965(h)(5) states that the election to pay the section 965(h) tax liability over the 8-year period specified in section 965(h)(1) must be made “not later than the due date for the return of tax.” On March 13, 2018, the Service posted the FAQs. Q&A number 12 stated that if a person already filed a 2017 tax return and failed to submit the appropriate repatriation tax information and elections, then the —

person should consider filing an amended return based on the information provided in these FAQs and Appendices. Failure to submit a return in this manner may result in processing difficulties and erroneous notices being issued. Failure to accurately reflect the net tax liability under section 965 of the Code in total tax could result in interest and penalties.

The Proposed Regulations note that relief under Regulations sections 301.9100-2 and 301.9100-3 (i.e., regulatory relief allowing the Service to grant additional time to file for late filings of missed regulatory or specified statutory elections) is not available with respect to Section 965 elections. Notably, because the time for election is statutory, not regulatory, and not specified by proposed amendment to Regulation section 301.9100-2, a procedure to request additional time to elect, by default, is not available.³⁰³

In light of the language in Q&A 12, as opposed to the relief under Regulations sections 301.9100-2 and 301.9100-3 and the limiting language in the Proposed Regulations, greater clarification of the time to file and/or amend missed filings would be helpful because both taxpayers and certain practitioners may be more likely to access the FAQs than the final regulations and, consequently, erroneously believe they have a three-year period to elect. Specifically, we recommended that Q&A 12 be amended to conform to the language in Proposed Regulation Section 1.965-(f)(iii)(B), which states explicitly that relief is not available beyond the due date for a timely filed return for the first taxable year that includes the last day of the last taxable year of a deferred foreign income corporation of the shareholder that begins before January 1, 2018.

2. Eligible Section 965(h) Transferee

The unpaid portion of any remaining installment payments under section 965(h) are generally due on the date of an acceleration event.³⁰⁴ There is an exception to the acceleration of installments if the person with respect to whom the acceleration event occurs is an eligible section 965(h) transferor and the requirements of Proposed Regulation section 1.965-7(b)(3)(iii)(A) are satisfied.³⁰⁵ One of the requirements is that the eligible section 965(h) transferor and an eligible section 965(h) transferee enter into a transfer agreement pursuant to Proposed Regulation section 1.965-7(b)(3)(iii)(B). “For this purpose, the term eligible section 965(h) transferee refers to a single United States person that is not a domestic passthrough entity.”³⁰⁶ Although we understand Treasury and the Service may be worried about collecting the section 965 tax liability, we do not understand why a domestic passthrough entity is the only person excluded from the definition of the term “eligible section 965(h) transferee.”

Fundamentally, an eligible section 965(h) transferee is a person who steps into the shoes of the eligible section 965(h) transferor with respect to the liability to make all remaining installment payments under the transferor's section 965(h) election. We recommend that the Regulations, when finalized, provide that the term “eligible section 965(h) transferee” does not exclude a domestic passthrough entity.

3. Disregarded Transactions — Proposed Regulation section 1.965-4

While we recognize that anti-avoidance rules are necessary to prevent transactions entered into with a principal purpose of changing a section 965 element, Proposed Regulation section 1.965-4 imposes certain prohibitions that may be inflexible or inappropriate. The primary test is based on a “principal purpose” of changing a section 965 element and also delineates certain transactions that create presumptions that are rebuttable if the of facts and circumstances “clearly” established the lack of such a principal purpose and require disclosure of same.

Other transactions are automatically, or “per se,” deemed to be undertaken with a principal purpose of changing the section 965 element. These include transactions involving cash reduction by means of: a specified distribution to a U.S. shareholder to the extent there is a plan or intent for the distributee to transfer certain amounts to an SFC of the shareholder or the distribution is a non pro rata distribution to a related foreign person; E&P reduction transactions (i.e., distributions that reduce E&P made either to owners or related parties); and complete liquidations (regardless of purpose).

Treasury and the Service declined to adopt a de minimis exception to these per se avoidance transactions. In addition, by eliminating any ability to rebut a presumption based on facts and circumstances even by means of a clear and convincing standard, this proposed rule casts too wide of a net. The rule goes beyond its stated intention covering certain transactions perceived to be abusive as it encompasses transactions that are not abusive, e.g., transactions that may have been planned prior to or merely coincidental to the time frame of the passage of section 965. It is recommended therefore that the “per se” provisions be removed and replaced by a rebuttable presumption standard, perhaps having a higher evidentiary standard such as “clear and convincing.”