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Firm Seeks More Clarity in Final Regs on FDII, GILTI Deductions

OCT. 6, 2020

Firm Seeks More Clarity in Final Regs on FDII, GILTI Deductions

DATED OCT. 6, 2020
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October 6, 2020

Secretary of the Treasury
c/o Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, D.C. 20244

Re: Comments on T.D. 9901

Dear Mr. Secretary:

These comments are filed with respect to T.D. 9901 published in the Federal Register on July 15, 2020, which provides final regulations on the deduction for foreign-derived intangible income (“FDII”) and global intangible low-taxed income (“GILTI”) (section 2501), on behalf of a group of companies that file life/nonlife consolidated Federal income tax returns subject to Treas. Reg. § 1.1502-47. 85 Fed. Reg. 43,042 (July 15, 2020). We previously provided comments on the proposed regulations (REG-104464-18) published in the Federal Register on March 6, 2019, that were finalized with certain modifications in T.D. 9901. 84 Fed. Reg. 8188 (Mar. 6, 2019). The preamble to T.D. 9901 discusses the concerns raised in our prior comment letter on the interaction of the proposed regulations with the rules and framework of Treas. Reg. § 1.1502-47 for life/nonlife consolidated groups and states the Treasury Department and the Internal Revenue Service are studying them. 85 Fed. Reg. 43,070. The preamble also requests further comments on these concerns in the context of the final regulations. Id.

The final regulations provide for consolidation of the section 250 deduction consisting of a “consolidated FDII deduction amount” and a “consolidated GILTI deduction amount.” Treas. Reg. § 1.1502-50(b)(1). These consolidated deductions are determined on an aggregate basis for all of the relevant items of all members of the consolidated group without regard to which member owns the stock of the controlled foreign corporation (“CFC”) giving rise to the GILTI or the location of the FDII. The consolidated section 250 deduction is then allocated to individual group members based on ratios relating to each member's contribution to the consolidated FDII or GILTI amount components of the consolidated section 250 deduction. Treas. Reg. § 1.1502-50(a)(2). This basic approach is unchanged from the proposed regulations. Most significantly for purposes of this comment letter, the final regulations do not address how the rules would apply to members of a life/nonlife consolidated group. As expressed in our previous comment letter, we are concerned that without appropriate clarification the current life/nonlife consolidated return regulations could be misconstrued to apply the consolidated section 250 deduction approach inappropriately to result in a permanent disallowance of the section 250 deduction. In addition, such an interpretation of Treas. Reg. § 1.1502-47 could make the availability of the deduction dependent on which member (and which subgroup) owns the stock of the CFC giving rise to the GILTI or the location of the FDII, which would be contrary to the policy described in the proposed and final regulations. Although we believe for the reasons described below that any purported application of the section 250 deduction that produces these results would be inappropriate and contrary to several sections of the Code, we nevertheless think it is important to address these concerns by adopting the clarification recommended below. Adoption of our recommendation would not only ensure the section 250 deduction is available to life/nonlife consolidated groups as Congress intended, but it would provide certainty as to its application that would improve administrability of the provision for both taxpayers and the Internal Revenue Service.

I. DISCUSSION

Reduction of Subgroup Consolidated Taxable Income Below Zero

After reviewing the final regulations, we believe it is possible to avoid the tax policy concerns expressed in our previous comment letter if certain clarifications are made, in particular, explicitly permitting the section 250 deduction to reduce subgroup consolidated taxable income below zero in computing consolidated taxable income under Treas. Reg. § 1.1502-47. It would then be possible to follow the general rules in Treas. Reg. § 1.1502-50 and allocate the aggregate section 250 deduction to members, just like other consolidated taxpayers. Besides the tax policy concerns previously expressed, we think a mechanical application of Treas. Reg. § 1.1502-50 and a subgroup approach to the section 250 deduction that limits the use of current-year section 250 deductions for life/nonlife consolidated taxpayers is not permitted by sections 1503(c), 250, and 172. Therefore, even without clarification, we believe that our recommendation reflects a reasonable interpretation of the current regulations.

The starting place for the analysis is the statutory language of section 1503(c), which imposes the limitations on the use of current-year nonlife subgroup net operating losses (“NOLs”) in a life/nonlife consolidated return. Section 1503(c)(1) provides as follows:

In general. If an election under section 1504(c)(2) is in effect for the taxable year and the consolidated taxable income of the members of the group not taxed under section 801 results in a consolidated net operating loss for such taxable year, then under regulations prescribed by the Secretary, the amount of such loss which cannot be absorbed in the applicable carryback periods against the taxable income of such members not taxed under section 801 shall be taken into account in determining the consolidated taxable income of the affiliated group for such taxable year to the extent of 35 percent of such loss or 35 percent of the taxable income of the members taxed under section 801, whichever is less. The unused portion of such loss shall be available as a carryover, subject to the same limitations (applicable to the sum of the loss for the carryover year and the loss (or losses) carried over to such year), in applicable carryover years.

Similar language is included in section 1503(c)(2), which also applies only to NOLs:

Losses of recent nonlife affiliates. Notwithstanding the provisions of paragraph (1), a net operating loss for a taxable year of a member of the group not taxed under section 801 shall not be taken into account in determining the taxable income of a member taxed under section 801 (either for the taxable year or as a carryover or carryback) if such taxable year precedes the sixth taxable year such members have been members of the same affiliated group (determined without regard to section 1504(b)(2)).

The operative language in section 1503(c) that, in our view, implements section 250 in a manner consistent with legislative intent in the Tax Cuts and Jobs Act is that limitations on current-year nonlife subgroup losses apply only to a nonlife consolidated “net operating loss for such taxable year.” A “net operating loss” for the taxable year is a defined term in section 172(c) that essentially is an amount equal to the excess of deductions over gross income (i.e., negative taxable income) in the loss year with modifications specified in section 172(d) (e.g., a “net operating loss” is determined without regard to NOL carryover deductions from other loss years). The statutory rule that governs the section 250 outcome in life/nonlife consolidated returns is section 172(d)(9), which excludes a section 250 deduction from the computation of a “net operating loss.” The effect of these interrelated statutory provisions (sections 1503(c)(1) and 172(c) and (d)(9)) is that the statute excludes the section 250 deduction from being included in the carryback of current-year nonlife losses as well as any remaining current-year nonlife loss that is subject to the 35-percent limitations and on losses of ineligible nonlife companies in the current loss year. This exclusion means that a section 250 deduction in the nonlife subgroup can offset life subgroup income dollar-for-dollar without regard to the section 1503(c) limitations. Thus, by its terms, the statute provides the appropriate result for life/nonlife consolidated taxpayers, i.e., that the current-year section 250 deductions of nonlife companies (both eligible and ineligible) are treated just like other consolidated taxpayers without an artificial 35-percent limitation or five-year wait on their use against life subgroup income. And, the section 250 deductions work effectively as a rate reduction on GILTI for life/nonlife consolidated taxpayers as Congress intended. The application of the life/nonlife consolidated rules in Treas. Reg. § 1.1502-47 should be clarified to comply with the statute and the policy of section 250.

As indicated above, we believe that current Treas. Reg. § 1.1502-47 would permit a section 250 deduction, to the extent such deduction reduces a subgroup's consolidated taxable income below zero, to offset the other subgroup's consolidated taxable income even though subgroup consolidated taxable income cannot be negative under Treas. Reg. § 1.1502-47(g). Nevertheless, we think it is appropriate to amend the regulations to make this result explicit so that there is certainty the section 250 deduction is available as Congress intended.

An allocation of the aggregate section 250 deduction to each member's separate taxable income (a member-by-member approach to the section 250 deduction) in a life/nonlife consolidated return is workable as long as it is implemented in a way to prevent the subgroup approach of Treas. Reg. § 1.1502-47 from imposing limitations on the use of current-year section 250 deductions that are not required by section 1503(c). Specifically, the general provisions of Treas. Reg. § 1.1502-50 could be fully operative with the allocable section 250 deduction included in each member's separate taxable income under Treas. Reg. § 1.1502-12, if the regulations are clarified to provide that a current-year section 250 deduction allocated to member(s) of one subgroup can offset current-year taxable income in the other subgroup to the extent such deduction reduces its subgroup consolidated taxable income below zero.

Ineligible Nonlife Losses

Under section 1503(c)(2), there is a five-year waiting period for the ability of new nonlife members of a life/nonlife consolidated return to use NOLs to offset life subgroup income. Like section 1503(c)(1), this limitation applies only to NOLs as defined in section 172(c), as modified by section 172(d)(9). As a result, the limitation on the use of ineligible nonlife losses as an offset to life subgroup income does not apply to the section 250 deduction of ineligible nonlife members.

II. RECOMMENDATIONS

To ensure that the aggregate section 250 deduction allowed to members of a life/nonlife consolidated group remains consistent regardless of the consolidated group composition, we recommend amending the regulations to explicitly permit the section 250 deduction to reduce subgroup consolidated taxable income below zero in computing consolidated taxable income under Treas. Reg. § 1.1502-47. As discussed above, we believe that the statutory framework treats NOLs and section 250 deductions independently, which means that the 35-percent limitation in section 1503(c)(1) based on life subgroup taxable income should not take into account the section 250 deduction. Likewise, the limitation on the use of ineligible nonlife losses as an offset to life subgroup income does not apply to the section 250 deduction of ineligible nonlife members. It would be useful if these conclusions were confirmed in a preamble or as part of an example(s) in the modified regulations.

We note that the preamble to T.D. 9901 states Treasury and the IRS are considering a separate guidance project to address the interaction of sections 163(j), 172, 250(a)(2), and other sections that refer to taxable income, and that this guidance may include an option to permit the use of simultaneous equations in lieu of an ordering rule. 85 Fed. Reg. 43,044. Because we have determined that the statute does not subject the section 250 deduction to the section 1503(c) limitations on current-year losses of the nonlife subgroup, we believe our recommended modification to the regulations should work whether or not simultaneous equations are used. We recommend, however, that any decision to allow the use of simultaneous equations be done only on an elective basis. Simultaneous equations would prove to be too complicated and burdensome to be administrable in certain situations, particularly where it is necessary to interpose the application of the subgroup approach to life/nonlife consolidation in Treas. Reg. § 1.1502-47, and the limitations in section 1503(c)(1) based on taxable income, into all of the other deduction limitations measured by taxable income using simultaneous equations.

Sincerely yours,

Peter H. Winslow

Lori J. Jones

Brion D. Graber

Scribner, Hall & Thompson, LLP
Washington, DC

FOOTNOTES

1Unless otherwise indicated, all section references are to the Internal Revenue Code of 1986 (the “Code”), as amended.

END FOOTNOTES

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