The Office of Management and Budget's Office of Information and Regulatory Affairs is reviewing proposed and final regs for determining foreign tax credits under the Tax Cuts and Jobs Act, according to OIRA's website.
Neither set of regs submitted to OIRA October 3 has been deemed economically significant. However, the final regs’ entry in the Unified Agenda of Federal Regulatory and Deregulatory Actions lists them as an economically significant priority.
To be considered economically significant, a set of regs must have an annual non-revenue effect on the economy of $100 million or more.
Both sets of regs are appearing for the first time in the unified agenda, and OIRA has provided little information about follow-on guidance.
The final regs, which were proposed in December 2018, fall under Tax Code provisions dealing with FTCs, including section 861 regarding the allocation and apportionment of deductions; section 904(b), which covers adjustments to the FTC limitation; and section 960 regarding the determination of deemed paid credits, as well as sections 901, 904, 952, 954, and 965.
FTC Regs Forecast
John L. Harrington of Dentons explained that some aspects of the FTC regs will be independently significant. For example, the creation of new income baskets, the repeal of the indirect FTC under section 902, and the increased importance of section 960 for subpart F income and global intangible low-taxed income are features whose manner of implementation will be important.
There is also the broader interaction of the FTC with other provisions, such as the GILTI provisions and the rules governing previously taxed earnings and profits (PTEP), Harrington explained.
“The FTC rules are also going to be relevant — seeing how they fit into the pieces of not just GILTI, but PTEP and similar provisions,” Harrington told Tax Notes. “So they are pieces to a puzzle. Some cases, they are important in their own right. Some cases, they are a piece to a puzzle. And so you’re evaluating in light of the other pieces that you’ve gotten.”
Harrington pointed to the proposed high-tax exclusion under the GILTI regime to illustrate the interaction between the FTC rules and other provisions.
In proposed regulations (REG-101828-19) released in June, the IRS and Treasury outlined an expanded high-tax exclusion for GILTI that would apply electively to all tested gross income subject to a minimum rate of effective tax. The guidance would allow domestic shareholders of a controlled foreign corporation to elect to exclude from gross tested income amounts that have been subject to foreign tax at an effective rate that exceeds 90 percent of the U.S. corporate tax rate.
To assess whether the election is “worthwhile,” taxpayers must know what income will be considered subject to high foreign taxes, Harrington said. The FTC rules will be relevant in determining “how much foreign taxes are really attributable to that GILTI income,” he said, explaining that taxpayers might go through the expense allocation rules and FTC calculations “only to find that there is a discrepancy between the foreign and U.S. tax bases and therefore income that appears to be high-taxed from a foreign standpoint is not high-taxed from a U.S. standpoint or vice versa.”
“So you need to see something like the FTC regulations to evaluate . . . whether that high-tax exception is helpful to you or not,” Harrington said.
Seeking R&D Solution
When the FTC proposed regs were released in November 2018, there was some disappointment that they didn’t address in more detail issues related to research and development expense apportionment.
Many comments from practitioners and industry groups have touched on this topic, according to Robert H.C. Wilkerson of KPMG LLP, who explained that the existing R&D regime is difficult to apply in a post-TCJA world.
Wilkerson noted that the existing rules reflect two methods that taxpayers can select to apportion R&D expenses. One is a “sales method,” which apportions R&D expenses based on taxpayers’ sales, including sales from their CFCs. But the rules are unclear on which sales are taken into account, Wilkerson explained, adding that the rules are unclear on how sales are characterized, for example, between GILTI income and general basket income.
“They don’t deal very well with the apportionment of expenses between the [FTC] baskets, such as GILTI, foreign branch, and general, and they’re very unclear and subject to different interpretations,” Wilkerson said. “Treasury and the IRS have realized that it is a significant item with significant uncertainty.”
Wilkerson said practitioners have been expecting proposed regulations on R&D expense apportionment this year. During an October 4 panel at the American Bar Association Section of Taxation meeting in San Francisco, Daniel McCall, IRS deputy associate chief counsel (international-technical), noted that R&D expense apportionment and allocation is addressed in the regs sent to OIRA.
Amended Returns and Administrative Burdens
TCJA modifications linked to the FTC system included repealing the section 902 pooling mechanics and amending section 960 to provide for the determination of the deemed paid FTC on a current-year basis. Likewise, section 905(c) was amended so that foreign taxes of foreign subsidiaries arising from a foreign tax redetermination must be taken into account for the tax year to which those taxes relate.
To illustrate the administrative headache with the section 905(c) change, Wilkerson offered an example of a foreign tax dispute settled in 2020 that relates to a CFC’s foreign tax liability in 2015. The amended section 905(c) would require the adjustment to be reflected on the CFC’s 2015 return. In the future, taxpayers will in many cases have to file amended returns reflecting foreign tax adjustments, he explained, noting that large companies regularly face those adjustments.
“I think that there’s going to be a potential administrative burden for U.S. companies that [are] having to deal with multiple foreign tax redeterminations for CFCs post-tax reform,” Wilkerson said, adding that “neither the government nor taxpayers want to be constantly submitting amended returns to reflect foreign tax redeterminations. So streamlined rules that relieve that administrative complexity would be very useful.”
While the FTC proposed regulations released in November don't address the changes to section 905(c), Wilkerson noted that the IRS is aware of the concerns and could release guidance addressing them by the end of this year.
Harrington noted that temporary and proposed regulations providing guidance under section 905(c) were released in 2007, with the text of the temporary regulations serving as the text of the proposed regs. Although the temporary regulations have sunset, the proposed regulations were never officially pulled.
“To a certain extent, people do look to proposed regs as an indication of how the IRS approaches this,” Harrington said, while noting that the proposed regulations do not permit reliance. He referred to section 32.1.1.2.2 of the Internal Revenue Manual, which provides that when an issue is not addressed by final or temporary regulations that are in effect, relevant proposed regulations can guide the Office of Chief Counsel’s position on the matter. The office “ordinarily should not take any position in litigation or advice that would yield a result that would be harsher to the taxpayer than what the taxpayer would be allowed under the proposed regulations,” the IRM states.
Harrington explained that if the IRS and Treasury use the earlier proposed section 905(c) regulations as the foundation for final guidance, they would have to take into account the changes to the FTC rules and revise accordingly.
Carrying Credits
The November proposed regulations also addressed the carryforward of unused foreign taxes paid or accrued under the pre-TCJA rules to post-2017 tax years and the carryback of post-2017 excess foreign taxes to pre-2018 tax years.
The proposed regulations generally provide for a matching approach to address the double taxation risk arising when pre-2018 foreign tax carryforwards weren't matched with the post-2017 category applicable to the income on which the taxes were imposed. Regarding carrybacks, the proposed regs provide that unused foreign taxes assigned to general category income or foreign branch category income after 2017 would be allocated to the pre-2018 separate category for general category income. Excess foreign taxes assigned to passive category income or a specified separate category after 2017 would be allocated to the same category before 2018.
“You would hope there aren’t significant changes to those carryforward [and] carryback rules because people have already applied those,” Harrington said. “And I think [the IRS and Treasury] would be mindful of that.”
If the IRS or Treasury discovered that taxpayers had adopted an aggressive reading of the proposed regulations and engaged in activity that the federal agencies hadn't intended, the rules could be revised, according to Harrington. However, there has been no indication that the IRS or Treasury have concerns about the application of the carryforward and carryback provisions, he said.
Feeling GILTI About FTC Basket?
The proposed FTC regs in November provided for exempt income and asset treatment for income in the GILTI basket that is offset by the section 250 deduction for GILTI inclusions and a corresponding percentage of the stock of CFCs that generates that income. Taxpayers were looking for a full reprieve, however, in asking Treasury and the IRS to switch off the allocation of expenses to the GILTI basket.
According to the preamble of the FTC proposed regulations, the comments suggested “that in order to assure full utilization of foreign tax credits associated with section 951A category income that is subject to a foreign effective tax rate of 13.125 percent or greater, no expenses should be allocated and apportioned to the section 951A category income.”
Kyle Pomerleau, chief economist and vice president of economic analysis at the Tax Foundation, said that from a tax policy perspective, removal of the expense allocation could be a good solution for companies that are below the GILTI threshold but because of the FTC limitations and expense allocation, are being grossed up in excess of it.
“From a policy perspective, that absolutely would address the problem to a large degree because this all comes back to the fact that when you’ve allocated expenses overseas, foreign profits drop as a share of worldwide profits, thus bringing your FTC down and thus increasing your tax rate on foreign profits. So turning expense allocation off seems like a reasonable way of doing this," Pomerleau said. "The question is, do we see that in the regs, or is that something where lawmakers need to come back to the drawing board and say, 'Oh yeah, this thing we understand as being problematic, so we’ll address this through changing the law.'”
There has been no indication that Treasury and the IRS will release final guidance that deviates from the proposed regs' position on the allocation of expenses to the GILTI basket.
Ryan Finley contributed to this article.