Firm Comments on Proposed FTC Regs, NOL Deduction Election

February 5, 2019

CC:PA:LPD:PR (REG-105600-18)
Room 5203
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, D.C. 20224

Re: REG-105600-18

Dear Sir or Madam:

Miller & Chevalier Chartered respectfully submits this letter in response to the Notice of Proposed Rulemaking providing Guidance Related to the Foreign Tax Credit, Including Guidance Implementing Changes Made by the Tax Cuts and Jobs Act, published in the Federal Register on December 7, 2018 (the “Proposed Regulations”).

I. REQUESTED GUIDANCE

In light of the proposed rules relating to the election under section 965(n)¹ in the Proposed Regulations, we request that the Treasury Department (“Treasury”) and Internal Revenue Service (“IRS”) provide guidance under section 965 to treat any taxpayer that has made a timely election under section 965(n) as having made a timely election under section 965(h).

II. BACKGROUND AND ANALYSIS

The Proposed Regulations included provisions that affected the computation of the foreign tax credit available to taxpayers that made elections section 965(n) and thereby affected the amount of such taxpayers' net tax liability under section 965.²The Proposed Regulations were published after the due date for section 965(h) elections. As a result, a calendar-year taxpayer that made a timely election under section 965(n) on its 2017 tax return, and whose net tax liability under section 965 would be affected by the rules in the Proposed Regulations, did not have an opportunity to make a section 965(h) election according to the procedures set forth in the Treas. Reg. § 1.965-7(b)(2) with knowledge of its net tax liability under section 965. Accordingly, we request guidance to deem such taxpayers to have made a timely election under section 965(h).

Under section 965(h), a U.S. shareholder of a deferred foreign income corporation may elect to pay the net tax liability under section 965 in eight installments. Section 965(h)(5) provides that the election shall be made not later than the due date for the tax return for the U.S. shareholder's inclusion year under section 965. Final Regulations under section 965 state that relief is not available under § 301.9100-2 or 301.9100-3 to file a late election under section 965. See Treas. Reg. § 1.965-7(b)(2)(ii).

If an election under section 965(h) was made, the first installment payment of the net tax liability under section 965 was due on the due date (determined without regard to any extensions of time for filing the return) for the tax return for the U.S. shareholder's inclusion year. In April 2018, the Internal Revenue Service announced that it would apply estimated tax payments for the 2017 taxable year to the taxpayer's “entire unpaid 2017 income tax liability, including all amounts to be paid in installments under section 965(h) in subsequent years.”³

Under section 965(n), a taxpayer may elect not to take into account the amount of its net section 965 inclusion in determining its net operating loss (“NOL”) for the taxable year or in applying NOL carryovers or carrybacks to such taxable year. Section 965(n)(3) provides that this election shall be made not later than the due date for filing the U.S. shareholder's return for the taxable year. Final regulations under section 965 (the “Final Regulations”)⁴ include procedures for making this election under section 965(n). See Treas. Reg. § 1.965-7(e)(2).

Prior to the issuance of the Proposed Regulations, the interaction of the section 965(n) election and section 904 was unclear in the case where a taxpayer made the election with respect to current-year losses. One potential approach to applying section 904 in case of a section 965(n) election was a “wall-off approach,” whereby the net section 965 inclusion was considered the specific item of income that was unreduced by expenses or losses and subject to tax in the U.S. shareholder's inclusion year.⁵ The wall-off approach was supported by the IRS's historical treatment of losses under former section 965, as set forth in Notice 2005-64, and was otherwise a reasonable construction of the statute. Section 965(n), as it has been interpreted by Notice 2018-26, proposed regulations published on August 9, 2018,⁶ and the Final Regulations, provides that if the section 965(n) election is made, the amount of the net section 965 inclusion “shall not be taken into account” in computing a current year NOL. Taxpayers reasonably interpreted this language to mean that no deductions or expenses were considered to reduce this amount in the transition year, both for purposes of determining taxable income and for purposes of applying section 904 in the transition year.

If a taxpayer made an election under section 965(n) on its 2017 tax return and computed its foreign tax credit using a wall-off approach, it may have determined that its net tax liability under section 965 was zero (because the tax liability was fully offset by foreign tax credits), or it may have determined that its net tax liability under section 965 was already satisfied with 2017 estimated tax payments in accordance with the IRS's stated policy. For such a taxpayer, an election under section 965(h) to pay the net tax liability under section 965 in installments would have had no effect. Indeed, if a taxpayer determined that it had no net tax liability, arguably it was not possible to file an election under section 965(h).

The Proposed Regulations did not adopt a wall-off approach to section 965(n) and section 904. Rather, the Proposed Regulations provided that deductions that would have been allowed for the taxable year but for the section 965(n) election are allocated and apportioned under Treas. Reg. §§ 1.861-8 through 1.861-17 to the net section 965 inclusion. As a result, such expenses may reduce the U.S. shareholder's foreign tax credit limitation under section 904 in the inclusion year. If the Proposed Regulations are finalized before June 22, 2019, it is expected that they will be effective retroactively as of the applicability date of section 965, in accordance with section 7805(b)(2).

The Proposed Regulations address an interpretive question not directly answered by the statute. Taxpayers, exercising reasonable diligence, may not have anticipated the rules set forth in the Proposed Regulations, and therefore could not have complied with their tax obligations and satisfied relevant due dates. Specifically, in the case of a taxpayer that made a section 965(n) election on its 2017 tax return and computed its tax liability using a wall-off approach, the Proposed Regulations (if finalized) may increase the taxpayer's net tax liability under section 965. Guidance is necessary to enable taxpayers that made an election under section 965(n) to comply with the rules set forth in the Proposed Regulations and at the same time avail themselves of the statutory installment election under section 965(h).

The requested guidance would be equitable and consistent with sound tax administration. The installment election under section 965(h) was provided by Congress to all U.S. shareholders with net tax liabilities under section 965 to allow such taxpayers to elect to pay these liabilities over an eight-year period. Taxpayers who, as a result of the Proposed Regulations, would have a net tax liability in excess of amounts paid with respect to 2017 should not be precluded from the installment payment method that would have been available if guidance had been issued prior to the due date for the return. Moreover, the requested guidance would not require the IRS to exercise discretion to provide section 9100 relief with respect to a statutory election. Rather, the requested guidance would deem affected taxpayers, i.e., those who made a section 965(n) election, to have made a timely section 965(h) election.⁷ The requested guidance would have no effect on other taxpayers, and affected taxpayers who would not otherwise have elected the installment payment method would suffer no detriment from the deemed election.

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Thank you in advance for your consideration of this request.

Respectfully submitted,

Rocco V. Femia
202.626.5823
rfemia@milchev.com

Layla J. Asali
202.626.5866
lasali@milchev.com