Law Firm Suggests Extending Time for Foreign Tax Redeterminations

February 18, 2020

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Ave., N.W.
Washington, D.C. 20220

The Honorable Charles Rettig
Commissioner
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 20224

The Honorable William Paul
Deputy Chief Counsel (Technical)
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 202224

CC:PA:LPD:PR (REG-105495-19)

Re: Prop. Treas. Reg. §§ 1.905-3(b)(2) and 1.905-4(b)(4)

Dear Sirs:

On December 17, 2019, the United States Department of the Treasury (the “Treasury”) and the Internal Revenue Service (the “IRS”) published Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), and Consolidated Groups (the “Proposed Regulations”).¹ The Proposed Regulations address changes implemented as part of the 2017 Tax Cuts and Jobs Act (“TCJA”), and, once finalized, will supplement a prior set of 2018 proposed regulations covering related issues that were finalized concurrently with the publication of the Proposed Regulations. We write to comment on the Proposed Regulations' notification requirements for redeterminations under section 905(c).

Specifically, we respectfully recommend the following. First, for taxpayers undergoing continuous audit we recommend that examination teams be granted discretionary authority to accept foreign tax redeterminations outside of the time periods contemplated in Proposed Treasury Regulation section 1.905-4(b)(4)(ii)(A), (B), and (C) and for years not under current audit. Second, given the potentially enormous U.S. tax compliance burden associated with a change in foreign tax liability, Treasury and the IRS should consider a materiality threshold below which (1) there would be no notification requirement and (2) the taxpayer could take redetermined taxes into account in the year of the redetermination. For example, taxpayers could be relieved of the redetermination requirements until they have aggregate foreign tax changes for a given year in excess of $5,000,000 (adjusted for inflation), and in such case taxpayers could also be permitted to elect to take the redetermined taxes into account in the year of the redetermination instead of the tax year to which the taxes relate. The election, once made, could be required to stay in force for at least five years before it could be reversed. These recommendations are discussed more fully below.

Under the current foreign tax credit regime, any change in a taxpayer's foreign tax liability may affect the amount or availability of claimed foreign tax credits. Section 905(c) provides that, to the extent a foreign tax redetermination occurs, a corresponding redetermination of the taxpayer's U.S. tax liability is required. Following a foreign tax redetermination, taxpayers are required to notify the Secretary if their accrued foreign taxes claimed as credits are: (1) paid in an amount other than the amount accrued, (2) not paid within two years after the close of the year to which they relate, or (3) refunded, either in whole or in part. Notification, often in the form of an amended return, is required for each tax year affected by the redetermination. The TCJA amendments to the foreign tax credit regime and the annual income inclusion under section 951A introduce additional entanglements between a U.S. taxpayer's foreign tax liability and its U.S. federal income tax calculations for a given year, simultaneously increasing the frequency and complexity of foreign tax redeterminations. The Proposed Regulations attempt to address these challenges.

Consistent with the statute, the Proposed Regulations provide that, “a redetermination of U.S. tax liability is required to account for the effect of a redetermination of foreign income taxes taken into account by a foreign corporation in the year accrued, or a refund of foreign income taxes taken into account by the foreign corporation in the year paid.”² If a redetermination is so required, the Proposed Regulations mandate that corresponding computational adjustments be applied to the foreign corporation's taxable income, Subpart F income, tested income, and earnings and profits.³ A redetermination of U.S. tax liability is required for any intervening year between the year of initial accrual of foreign taxes and the year of redetermination if a U.S. shareholder received a distribution or inclusion from the foreign corporation.⁴

Per the Proposed Regulations, if a redetermination increases the taxpayer's U.S. tax liability, then notification is in the form of an amended return⁵ (Form 1118 or Form 1116). In addition, the taxpayer must file a statement, containing certain information sufficient to permit the IRS to calculate the taxpayer's U.S. tax liability, by the due date (including extensions) of the original return for the taxpayer's taxable year in which the foreign tax redetermination occurs.⁶ Multiple redeterminations of U.S. tax liability for a given taxable year that occur within the same taxable year or within two consecutive taxable years may be aggregated under a single notification.⁷ Failure to timely file this notice of redetermination could result in a penalty of up to 25-percent of the deficiency attributable to the redetermination.⁸

Importantly, the Proposed Regulations also state that the notification requirement would be met “if the taxpayer satisfies alternative notification requirements that may be prescribed by the IRS through forms, instructions, publications, or other guidance.”⁹ Additional guidance is encouraged, and we respectfully recommend that the IRS alleviate some of the complexity of the redetermination requirements.

First, Proposed Treasury Regulation section 1.905-4(b)(4) provides an alternative notification regime for taxpayers under audit by the Large Business and International Division. The taxpayer may notify the exam team if: (1) a foreign tax redetermination occurs while the taxpayer is under audit, (2) the foreign tax redetermination results in a downward adjustment of the amount of foreign taxes paid or accrued by the taxpayer, (3) the foreign tax redetermination increases the taxpayer's U.S. tax liability, (4) the return for which a redetermination of U.S. tax liability is required is under examination, and (5) the due date for notification is not before the later of the opening conference or the delivery date of the opening letter concerning examination.¹⁰

We respectfully recommend that these requirements be relaxed, expanding the flexibility taxpayers and exam teams have for managing the redetermination process. For example, for a taxpayer under continuous audit, if a single foreign tax redetermination affects multiple tax years, some of which are under examination and others of which are not, we recommend that the examination team be granted discretion to permit a taxpayer to satisfy the notification requirement for all periods through a single notification to the exam team. We also recommend that the Proposed Regulations be modified to provide that the notification deadline identified in section 1.904-4(b)(4)(ii)(A), (B), and (C) can be extended upon request by the taxpayer and subject to the discretion of the exam team. These changes would enable taxpayers and exam teams to better navigate the nuances of a given foreign tax redetermination within the context of the many possible variables of ongoing and continuous examinations.

Second, to alleviate the burdens placed on the IRS and taxpayers, we respectfully recommend that the IRS establish a materiality threshold before a notification requirement is triggered and which would permit the taxpayer to take into account a foreign tax redetermination in the year of the redetermination. The Proposed Regulations would appear to require amended returns recalculating the U.S. shareholder's income and the complex computational consequences of those adjustments even if the redetermination would result in only a relatively small U.S. tax adjustment. In many cases, the cost of compliance could be vastly disproportionate to the amount of the U.S. tax adjustment resulting from the redetermination. This is particularly the case with multinational entities operating in multiple foreign jurisdictions. Jurisdictional timing differences make it unlikely that all of a given tax year's redeterminations will take place within the redetermination period that would permit aggregation.

For example, the threshold could be set so that a redetermination for a prior year would not be required until the aggregate change to the foreign tax exceeds $5,000,000 (adjusted for inflation). An electing taxpayer could be afforded the opportunity to treat such redetermined taxes as adjustments to taxes paid or accrued in the redetermination year for U.S. federal income tax purposes.

We note in this regard that Treasury permits rules of convenience to remedy substantial and disproportionate administrative burdens. See, e.g., Treas. Reg. § 1.706-4 (permitting the determination of partners' distributive shares of partnership items on a pro rated basis when a partner's interest varies during the taxable year); and Treas. Reg. § 1.263(a)-1(f) (providing a de minimis safe harbor election that permits a taxpayer to not capitalize, or to treat as a material or supply, certain amounts paid for tangible property that it acquires or produces during the taxable year).

We are cognizant of a potential concern that taxpayers could opportunistically determine whether to invoke such an election on a year-by-year basis, and therefore we would propose that taxpayers be limited in their ability to switch between amending past returns and including adjustments in the year in which the foreign tax redetermination is made. The IRS could, for example, adopt a rule similar to the one proposed in Prop. Treas. Reg. § 1.951A-2(c)(6)(v)(D), which generally provides that five years must pass following the revocation of a GILTI high tax exception election before a new election can be made with respect to the same controlled foreign corporation.¹¹

By permitting the aggregation of redetermined foreign tax liability with other foreign tax liabilities paid or accrued during the year of the redetermination, the foreign tax credit redetermination regime would become more administrable and reduce a potentially disproportionate administrative burden that would be created without such an option.

Sincerely,

FENWICK & WEST LLP
Mountain View, CA

David Forst