Temporary DRD Regs Should Be Withdrawn, Group Says

September 16, 2019

CC:PA:LPD:PR (REG–106282–18 and T.D. 9865)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: Comments on final temporary § 245A regulations in T.D. 9865 and parallel proposed § 245A regulations in REG–106282–18

Dear Sirs or Madams,

The Silicon Valley Tax Directors Group (“SVTDG”) hereby submits these comments on the above-referenced final temporary regulations under § 245A of the Internal Revenue Code of 1986, as amended, in T.D. 9865, 84 Fed. 28398 (June 18, 2019) (the “Final Temp Regs”), and the parallel proposed regulations under § 245A in REG–106282–18, 84 Fed. Reg. 28426 (June 18, 2019) (the “Proposed Regs”). The text of the Final Temp Regs serves as the text of the Proposed Regs. SVTDG members are listed in the Appendix to this letter.

Sincerely,

Robert F. Johnson
Co-Chair, Silicon Valley Tax Directors Group
Capitola, CA

---

I. INTRODUCTION AND SUMMARY

A. Background on the Silicon Valley Tax Directors Group

The SVTDG represents U.S. high technology companies with a significant presence in Silicon Valley, that are dependent on R&D and worldwide sales to remain competitive. The SVTDG promotes sound, long-term tax policies that allow the U.S. high tech technology industry to continue to be innovative and successful in the global marketplace.

B. Summary of recommendations

[A] The Final Temp Regs should be withdrawn

Because the Final Temp Regs are susceptible to a number of validity challenges, we recommend they be withdrawn in their entirety.¹

Treasury and the IRS don't have authority to override the plain language of the Tax Cuts and Jobs Act, Public Law 115-97, (the “TCJA”). To evaluate the Final Temp Regs under the Chevron doctrine, a court would start with the clearly prescribed different effective dates in §§ 245A (for distributions after December 31, 2017) and 951A (for taxable years beginning after December 31, 2017), and the measurement dates in § 965. Under the weight of authority, a court would find that the Final Temp Regs override the unambiguous measurement dates of § 965 and effective date of the GILTI regime, and are therefore invalid. The few cases in which courts have ignored the plain language of a statute can be distinguished. Moreover, courts have accepted that Congress can treat different classes of taxpayers differently for tax purposes.

The validity of the Final Temp Regs is also doubtful under the Administrative Procedure Act (“APA”). T.D. 9865 proffers four reasons why Treasury and the IRS qualify for the “good cause” exceptions under 5 U.S.C. §§ 553(b)(B) and 553(d)(3), asserting that the notice-and-comment rulemaking procedure can therefore be ignored, and that the effective date doesn't have to be at least 30 days after publication date. These reasons don't withstand careful scrutiny.

Lastly, § 1.245A-5T(d) can't validly be made retroactive under § 7805(b)(2). To justify § 1.245A-5T(d)(1), T.D. 9865 relies on § 7805(b)(2). But the rule in § 7805(b)(2) requires a regulation to be filed or issued within 18 months of a statute to which the regulation “relates,” and the rule in § 1.245A-5T(d)(1) properly relates to § 954(c)(6), not § 245A. Paragraph 7805(b)(2) is thus unavailing for retroactivity of § 1.245A-5T(d)(1).

[B] If the Final Temp Regs are retained, the definition of “extraordinary disposition” in § 1.245A-5T(c)(3)(iii)(A) should be modified to exclude dispositions of intangible property

The denial in § 1.245A-5T(b)(1) of the full benefits of § 245A on a controlled foreign corporation's (“CFC's”) dividend to its U.S. shareholder, and the denial in § 1.245A-5T(d)(1) of the full benefits of the § 954(c)(6) exception on a lower-tier CFC's dividend to an upper-tier CFC, both turn on the definition of “extraordinary disposition amount.” The “extraordinary disposition amount” depends on the “extraordinary disposition account,”² which depends on the “extraordinary disposition E&P,”³ which depends on net gain recognized by a CFC in an “extraordinary disposition.”⁴ If, during its “disqualified period,”⁵ a CFC disposes of § 367(d)(4) intangible property, and if gain from the disposition isn't gross income described in §§ 951A(c)(2)(A)(i)(I)–(V) — in particular, if the gain isn't subpart F income — the disposition is deemed to be an extraordinary disposition.⁶

So a distribution during the “disqualified period” of appreciated intangible property from a lower-tier CFC to an upper-tier CFC, or a distribution of intangible property from a CFC to its U.S. shareholder, is — because under § 311(b) gain is deemed to arise — deemed to be an extraordinary disposition if the gain isn't subpart F income. Because of this, § 1.245A-5T(b)(1) denies the U.S. shareholder the full benefit of § 245A on its receipt of any associated extraordinary disposition E&P of the CFC; and § 1.245A-5T(d)(1) denies the upper-tier CFC the full benefit of the § 954(c)(6) exception on its receipt of associated extraordinary disposition E&P of the lower-tier CFC.

If the Final Temp Regs aren't withdrawn in their entirety, we recommend that Treasury and the IRS change the Final Temp Regs to expressly exclude from the definition of “extraordinary disposition” any disposition of intangible property. This modification is necessary to ensure that [1] transactions resulting in the repatriation of intangible property aren't penalized, and [2] other transfers of intangible property — which are already covered by the disqualified basis rules of § 1.951A-2(c)(5) — aren't further penalized.

As Congress explained clearly in the legislative history of the TCJA, an important goal of tax reform was to encourage U.S. multinational corporations to repatriate foreign-held intangible property. As just outlined, a CFC distributing intangible property to its U.S. shareholder, or a lower-tier CFC distributing intangible property to an upper-tier CFC, is adversely affected under the Final Temp Regs because the U.S. shareholder is denied the benefits of § 245A, or of the § 954(c)(6) exception, respectively. The Final Temp Regs thus have consequences contrary to Congressional intent in enacting the TCJA. Congress wouldn't encourage behavior by denying statutory benefits for it.

Foreign-to-foreign related-party intangibles transfers have in any case been addressed by the “disqualified basis” rules of § 1.951A-2(c)(5). Under these rules, amortization deductions based on stepped up basis of transferred intangibles can't be used to offset subpart F income or GILTI. The Final Temp Regs retroactively compound this denial of amortization benefit by imposing a punitive measure, for no good policy reason under §§ 245A or 954(c)(6).

[C] The signaled future guidance project under § 1.952-2 should expressly provide that a foreign corporation is eligible to claim a § 245A deduction

Paragraph 1.952-2(b)(1) provides that the taxable income of a foreign corporation generally shall be determined by treating such corporation as a domestic corporation taxable under § 11 and applying the principles of § 63. A carve-out in § 1.952-2(c)(1) from this general rule provides that certain subchapters of Chapter 1 of the Code shall not apply, but subchapter B — entitled Computation of taxable income, spanning §§ 61–290, and thus including § 245A — isn't included in the carve-out. Thus under § 1.952-2 the taxable income of a foreign corporation should be determined by allowing the foreign corporation to claim a § 245A deduction.

H.R. REP. NO. 115–466, at 599 n.1486 (2017) (the “Conference Report”), also clearly draws this conclusion for a foreign corporation that's a CFC. Citing this language from the Conference Report, the preamble in T.D. 9865 asserts that “questions have arisen as to whether §1.952-2 could be interpreted such that a foreign corporation could claim a section 245A deduction despite the statutory restriction in section 245A(a) expressly limiting the deduction to domestic corporations.”⁷

The T.D. 9865 preamble signals the intent of Treasury and the IRS to address, in a future guidance project, issues related to the application of § 1.952-2. The preamble says the “guidance will clarify that, in general, any provision . . . expressly limited in its application to domestic corporations does not apply to CFCs by reason of § 1.952-2.”⁸

We recommend that Treasury and the IRS clarify — either in the future § 1.952-2 guidance project or before — that CFCs are eligible to claim a deduction under § 245A. This eligibility follows from the plain language of § 245A — in particular from the definition in § 245A(e)(4) of a “hybrid dividend” — and isn't strictly dependent on operation of § 1.952-2. Changes to § 245A in the proposed Tax Technical and Clerical Corrections Act would alter the support but not the overall conclusion about eligibility. Thus it's misleading to state, as the preamble in T.D. 9865 does, that § 245A(a) “by its terms . . . applies only to certain dividends received by 'a domestic corporation,'” because it's clear from the rest of § 245A that foreign corporations should be eligible to claim a deduction under § 245A.

The T.D. 9865 preamble asserts that even if a foreign corporation is generally allowed a § 245A deduction, “[Treasury] and the IRS have determined, however, that in no case would any person, including a foreign corporation, be allowed a section 245A deduction directly or indirectly for the portion of a dividend paid to a CFC that is not eligible for the [§ 954(c)(6)] exception as a result of the [Final Temp Regs].”⁹ Above we explained why — if the Final Temp Regs aren't withdrawn, as we primarily recommend — they should be pared back to exclude from the definition of “extraordinary disposition” any disposition of intangible property. This would permit the § 954(c)(6) exception to apply to dividends comprising distributions of earnings and profits (“E&P”) arising from dispositions of intangible property. Whether or not the § 954(c)(6) exception is available and applies, a CFC getting such a dividend should be eligible to claim a § 245A deduction with respect such dividend. Availability of a § 245A deduction ensures that receipt of the dividend doesn't ultimately give rise to GILTI (if the § 954(c)(6) exception applies) or to subpart F income (if the § 954(c)(6) exception doesn't apply). We accordingly recommend that Treasury and the IRS clarify availability of the § 245A deduction in such circumstances.

II. SVTDG CONCERNS AND RECOMMENDATIONS

A. The Final Temp Regs should be withdrawn

1. Treasury and the IRS don't have authority to override the plain language of the TCJA

The Final Temp Regs work to override the unambiguous measurement dates of § 965 and effective date of the GILTI regime. Because Treasury and the IRS don't have authority to modify these statutorily-prescribed dates, the validity of the Final Temp Regs is subject to challenge. We therefore recommend that the Final Temp Regs be withdrawn.

In Chevron v. Natural Resources Defense Council, Inc., 467 U.S. 837 (1984), the Supreme Court set forth a two-part standard for determining the extent to which an administrative agency's interpretation of a statute is entitled to judicial deference. In connection with Part One of the Chevron inquiry, a court will determine whether Congress has directly spoken to the precise question at issue. If not, under Chevron Part Two, a court will ask whether the agency's interpretation is based on a permissible construction of the statute. If Congress has spoken clearly on a particular matter (i.e., if there's no ambiguity under Part One), the analysis is over and the agency must give effect to Congress' intent. To assess whether — under Chevron Part One — there's ambiguity, a Court must use traditional tools of statutory construction, which can include reference to the legislative history.

We believe a court would hold that the Final Temp Regs are invalid under Chevron Part One, as an attempt to change: [1] the unambiguous, statutorily prescribed-effective date of the GILTI regime, and/or [2] the unambiguous, statutorily-prescribed measurement dates under § 965.

To discern congressional intent, a court will start with the text of the statute itself.¹⁰ When the words of the statute are clear, they must be given effect. The Supreme Court has held that an agency has no power to “tailor” legislation to bureaucratic policy goals by rewriting unambiguous statutory terms, and has indicated that it's “hard to imagine a statutory term less ambiguous than . . . precise numerical thresholds.”¹¹ Like precise numerical thresholds, statutorily-prescribed effective dates aren't subject to judicial revision.¹² Moreover, as courts have repeatedly held, the fact that a tax statute might treat similarly-situated taxpayers differently (e.g., fiscal-year versus calendar-year taxpayers), is irrelevant.¹³ The tax law has a history of drawing distinctions between similarly-situated taxpayers.¹⁴

Even if measurement or effective dates in the TCJA were somehow viewed as ambiguous under Chevron Part One, the Final Temp Regs fail under Chevron Part Two because they don't reflect a permissible construction of the TCJA. An agency interpretation is only entitled to deference if it's “rationally related to the goals of the Act.”¹⁵ And in this case, as discussed in detail in Section II.B.2 (below), the legislative history of § 245A and related provisions suggests that the Final Temp Regs run contrary to one of the central goals of the TCJA.

2. Treasury and the IRS have no authority to issue the Final Temp Regs without notice and comment

Treasury and the IRS issued the Final Temp Regs without following the APA's notice-and-comment procedure. Although T.D. 9865 gives four reasons why Treasury and the IRS can rely on the “Good Cause Exception” to the notice-and-comment requirement, none of these reasons is sufficient.

First, Treasury and the IRS indicate there would be potential for opportunistic taxpayer behavior if the notice-and-comment procedures were followed. The prescribed opportunistic behavior could, however, as easily have been prevented by issuing a notice, or proposed regulations, addressing transactions and announcing that, under § 7805(b)(1), final rules will apply to such transactions conducted in taxable years ending on or after the date of the notice or proposed regulations.

Second, Treasury and the IRS assert that a delayed effective date could increase taxpayer compliance costs because certain taxpayers would only be able to comply with the regulations by amending and refiling returns and paying additional taxes owed with interest. This reason isn't persuasive. Cases show that the Good Cause Exception is usually invoked in emergencies and is narrowly construed and only reluctantly countenanced.¹⁶ The possibility of having to file amended returns is unlikely to constitute an emergency or threat of imminent harm.

Third, Treasury and the IRS note that the regulations are by their nature short term and there's an opportunity to comment before final rules are introduced. Post-promulgation notice and comment has been held not to justify good cause.¹⁷

Fourth, Treasury and the IRS assert that qualifying for retroactivity under § 7805(b)(2) required meeting a June 22, 2019 deadline. Although a deadline can give rise to a valid good cause exception, an agency must still show it's impracticable to provide notice and comment and meet that deadline.¹⁸ T.D. 9865 hasn't done that — it describes no unique aspects of the Final Temp Regs that prevented them from being issued with notice and comment.

Because none of the reasons proffered by Treasury and the IRS — either individually or collectively — justify application of the Good Cause Exception, the Final Temp Regs would be found invalid under the APA.

3. Subsection 7805(b) doesn't give Treasury and the IRS authority to make § 1.245A-5T(d) retroactive

T.D. 9865 relies on §§ 7805(b)(1) and (b)(2) to make § 1.245A-5T(d) — which partially overrides the § 954(c)(6) exception for distributions of “extraordinary disposition amounts” — retroactive to distributions made after December 31, 2017. Because T.D. 9865 relies in part on § 7805(b)(1) for retroactivity, Treasury and the IRS must believe there's an earlier notice “substantially describing the expected contents” of § 1.245A-5T(d). T.D. 9865 refers to Notice 2007-9 (addressing additional guidance to be issued with respect to § 954(c)(6)), but none of the transactions listed in Notice 2007-9 relate in any material respect to the transactions covered by § 1.245A-5T(d).

Paragraph 7805(b)(2) provides that the directive in § 7805(b)(1) (i.e., that no temporary, proposed, or final tax regulation shall apply to any taxable period ending before the earliest of three dates) doesn't apply “to regulations filed or issued within 18 months of the date of the enactment of the statutory provision to which the regulation relates.” Because T.D. 9865 relies in part on § 7805(b)(2), Treasury and the IRS thus tacitly assert that a regulation preventing abuse of § 954(c)(6) “relates” to § 245A. But § 245A isn't a vehicle for regulations preventing abuse of the purposes of § 954(c)(6); such a regulation — if valid — would “relate” to § 954(c)(6), not § 245A.

B. If the Final Temp Regs are retained, the definition of “extraordinary disposition” in § 1.245A-5T(c)(3)(iii)(A) should be modified to exclude dispositions of intangible property

If the Final Temp Regs are retained, we recommend they be modified to ensure that dispositions of intangible property aren't treated as “extraordinary dispositions.”

In T.D. 9865, Treasury and the IRS indicate that [1] the extraordinary disposition rules shouldn't apply to all disqualified period E&P generated by a CFC, and [2] the Final Temp Regs are only intended to apply to a “narrowly and objectively defined” class of E&P in circumstances that are inconsistent with the international provision of the TCJA.¹⁹ T.D. 9865 requests comments on whether further refinements are needed to achieve this goal.²⁰ Our recommendation addresses this request.

1. How the Final Temp Regs apply to dispositions of intangible property

a. Subsections 1.245A-5T(b) & -5T(c) — limitation of the amount eligible for a § 245A deduction for distributions from an extraordinary disposition account

For any dividend a fiscal year U.S. shareholder gets after December 31, 2017, from a wholly-owned CFC, the Final Temp Regs limit the amount of the section 245A deduction to the portion of the dividend not constituting an “ineligible amount.”²¹ The “ineligible amount” is 50 percent of the portion of the dividend attributable to certain E&P arising from certain related-party transactions during the “disqualified period” (50 percent of the “extraordinary disposition amount”). If all of a dividend from the CFC to its U.S. shareholder is attributable to the extraordinary disposition amount, the ineligible amount is half of that amount, and so the U.S. shareholder would — under § 1.245A-5T(b)(1) — only be allowed a § 245A deduction for half of the dividend.

The “extraordinary disposition amount” of any dividend is the portion of the dividend a U.S. shareholder gets from a CFC that's paid out of the “extraordinary disposition account.”²² The “extraordinary disposition account” is an account the balance of which is the “extraordinary disposition E&P.” The “extraordinary disposition E&P” of a CFC is the aggregate net gain it recognizes from each “extraordinary disposition” of “specified property.”²³ “Specified property” of a CFC is any property if gain recognized from such property during the “disqualified period”²⁴ isn't described in §§ 951A(c)(2)(A)(i)(I)–(V). An “extraordinary disposition” is any disposition of specified property during the disqualified period “to a related party if the disposition occurs outside the ordinary course of the [CFC's] activities.”²⁵ A per se rule treats a disposition as occurring outside the ordinary course of a CFC's activities if the disposition is of § 367(d)(4) intangible property.²⁶

The Final Temp Regs have an “ordering rule” for distributions. To determine the portion of any CFC dividend a U.S. shareholder gets that's paid out of the CFC's extraordinary disposition account, the dividend is first considered paid out of non-extraordinary disposition E&P, and is next considered paid out of the extraordinary disposition account to the extent of the extraordinary disposition account balance.²⁷

Suppose that, during the disqualified period, a wholly-owned CFC distributes intangible property to its U.S. shareholder, giving rise to $X of gain under § 311(b), and suppose the gain isn't described in §§ 951A(c)(2)(A)(i)(I)–(V) — in particular, such gain isn't described in

§951A(c)(2)(A)(i)(II) (gross income taken into account in determining the subpart F income of the CFC). Then the distribution is an extraordinary disposition of specified property, and so the $X gain is extraordinary disposition E&P in the CFC's extraordinary disposition account. The $X of the CFC's extraordinary disposition E&P is § 959(c)(3) E&P, and the ordering rule assures that other § 959(c)(3) E&P — whenever accumulated — will be deemed distributed before the $X of extraordinary disposition E&P is deemed distributed. That is, the $X of extraordinary disposition E&P will be treated as the last E&P distributed by the CFC. For each $1 distributed from the $X of the CFC's extraordinary disposition E&P, the ineligible amount is 50¢ and so the U.S. shareholder only gets a § 245A deduction for 50¢.

b. Section 1.245A-5T(d) — limitation of the amount eligible for the § 954(c)(6) exception for distributions from an extraordinary disposition account of a lower-tier CFC

Subsection 1.245A-5T(d) prevents the § 954(c)(6) exception from applying to inter-CFC dividends by piggybacking on the results of denial, in §§ 1.245A-5T(b) & -5T(c), of the benefit of § 245A. Simply put, § 1.245A-5T(d)(1) prevents the § 954(c)(6) exception from applying to a dividend from a lower-tier CFC to an upper-tier CFC if the dividend would be an “extraordinary disposition amount” if distributed directly to the U.S. shareholder. Subsection 1.245A-5T(d) provides that the § 954(c)(6) exception applies only to the extent the amount of the dividend exceeds the U.S. shareholder's “extraordinary disposition account” with respect to the lower-tier CFC, multiplied by 50 percent.²⁸

More precisely, if, after December 31, 2017, an upper-tier CFC gets a dividend from a lower-tier CFC, the dividend is eligible for the § 954(c)(6) exception only to the extent that the amount that would be eligible for the § 954(c)(6) exception (determined without regard to § 1.245A-5T(d)) exceeds the “disqualified amount.”²⁹ The “disqualified amount” is 50 percent of the U.S. shareholder's “tiered extraordinary disposition amount” with respect to the lower-tier CFC.³⁰ The term “tiered extraordinary disposition amount” means, with respect to a dividend received by the upper-tier CFC from the lower-tier CFC and with respect to the § 245A shareholder, the portion of the dividend that would be an “extraordinary disposition amount” if the U.S. shareholder got the entire dividend from the lower-tier CFC.³¹

Suppose that, during the disqualified period, a lower-tier CFC distributes intangible property to an upper-tier CFC, giving rise to $X of gain under § 311(b), and suppose the gain isn't described in §§ 951A(c)(2)(A)(i)(I)–(V) — in particular, such gain isn't described in § 951A(c)(2)(A)(i)(II) (gross income taken into account in determining the subpart F income of the CFC). Then the distribution is an extraordinary disposition of specified property, and so the $X gain is extraordinary disposition E&P in the lower-tier CFC's extraordinary disposition account. The $X of the lower-tier CFC's extraordinary disposition E&P is § 959(c)(3) E&P, and the ordering rule assures that other § 959(c)(3) E&P — whenever accumulated — will be deemed distributed before the $X of extraordinary disposition E&P is deemed distributed. That is, the $X of extraordinary disposition E&P will be treated as the last E&P distributed by the lower-tier CFC. The tiered extraordinary disposition amount would also be $X, and so the disqualified amount would be ½$X. Thus under § 1.245A-5T(d) only half of any dividend the upper-tier CFC gets from E&P from the lower-tier CFC's extraordinary disposition account qualifies for the § 954(c)(6) exception. The remaining half would generally be foreign personal holding company income under § 954(c)(1)(A).

2. If the Final Temp Regs aren't withdrawn, the definition of “extraordinary disposition” in § 1.245A-5T(c)(3)(iii)(A) should be modified to exclude dispositions of intangible property

If the Final Temp Regs aren't withdrawn in their entirety (our primary recommendation), we recommend the definition of “extraordinary disposition” in § 1.245A-5T(c)(3)(iii)(A) be revised to exclude dispositions of intangible property. This modification is necessary to ensure that [1] transactions resulting in the repatriation of intangible property aren't adversely affected, and [2] other related-party transfers of intangible property — which are already denied amortization-deduction benefits by the disqualified basis rules of § 1.951A-2(c)(5) — aren't further subject to punitive measures.

a. An express goal of TCJA was to encourage repatriation of intangible property

An important purpose of the TCJA was to encourage taxpayers to repatriate intangible property to the U.S. The Final Temp Regs are contrary that goal by penalizing such repatriations (by denying statutory benefits), and therefore should be modified. In legislative history of the TCJA, Congress repeatedly expressed concern over the way then-current tax law incentivized U.S. companies to locate income-generating intangible property (and the valuable economic activity associated with it) in low tax foreign jurisdictions. One of the central goals of tax reform was to reverse this incentive. The Senate Budget Committee explained:

The Committee believes that the current U.S. system of worldwide taxation . . . encourages U.S. corporations to locate intangible income abroad, particularly in low- or zero-tax jurisdictions. The location of intangible income in those jurisdictions may require, or be facilitated by, the location of valuable economic activity in those jurisdictions. One of the Committee's goals in tax reform is to remove the tax incentive to locate intangible income abroad and encourage U.S. taxpayers to locate intangible income, and potentially valuable economic activity, in the United States.³²

In its discussion of Proposed § 966,³³ the Committee indicated that a goal of the “bill as a whole” was to promote tax neutrality and to encourage corporations to bring their value intangible property back to the U.S.:

The Committee believes that innovation is an important source of economic growth and seeks to encourage businesses to locate intangible property in the United States. The bill as a whole provides reduced corporate tax rates for intangible income and makes a number of changes intended to promote tax neutrality with respect to where businesses locate intangible property and the income derived from such property. While the Committee believes that these changes, by themselves, will encourages [sic] U.S. corporations to bring back existing intangible property that is currently held by their CFCs, it seeks to facilitate this process by giving taxpayers a limited period of time in which they can distribute intangible property held by CFCs back to the U.S. parent corporation without triggering tax on the gain from the distribution.³⁴

To the extent the Final Temp Regs deny the full benefit of § 245A, or of the § 954(c)(6) exception, to distributions of E&P arising from repatriation of intangibles, they're contrary to the clear goals of the TCJA as expressed by Congress in the legislative history. By modifying the definition of “extraordinary disposition” in § 1.245A-5T(c)(3)(iii)(A) to exclude dispositions of intangible property, the Final Temp Regs would align with the policy goals of the TCJA.

b. Because amortization benefits of offshore related-party intangible property dispositions are already targeted in § 1.951A-2(c)(5), the Final Temp Regs are punitive for no rational policy reasons under §§ 245A or 954(c)(6)

Under § 1.951A-2(c)(5)(i), any deduction of a CFC attributable to “disqualified basis” is allocated and apportioned solely to “residual CFC gross income” — i.e., gross income other than gross tested income, gross income taken into account in determining subpart F income, or ECI.³⁵ “Disqualified basis” of intangible property is the excess of (a) the property's adjusted basis immediately after a transfer of such property during the disqualified period over (b) the sum of the property's adjusted basis immediately before such transfer and the “qualified gain amount” with respect to the disqualified transfer.³⁶ The “qualified gain amount” for a such a transfer of property includes any gain recognized by the CFC that's taken into account in determining the U.S. shareholder's subpart F income inclusion under § 951(a)(1)(A). So if such a transfer of intangible property doesn't give rise to a subpart F inclusion for the U.S. shareholder, the disqualified basis is any basis increase for the property as a result of the transfer. So if gain on a transfer doesn't result in a subpart F inclusion, amortization deductions based on the stepped up basis in the transferred intangibles can't be used to offset subpart F income or GILTI.

Because amortization benefits are, under § 1.951A-2(c)(5), denied to such offshore related-party intangible dispositions,³⁷ no rational policy goals under §§ 245A or 954(c)(6) are furthered by also imposing tax on such dispositions through denial of full benefits of the § 954(c)(6) exception. We thus recommend the Final Temp Regs — if they're not withdrawn in accordance with our primary recommendation — be revised to specifically exclude dispositions of intangible property from the definition of “extraordinary dispositions.”

C. The signaled future guidance project under § 1.952-2 should expressly provide that a foreign corporation is eligible to claim a § 245A deduction

Under § 245A(a), a corporate U.S. shareholder is allowed a deduction with respect to the foreign source portion of certain dividends received from specified 10-percent owned foreign corporations. Paragraph 245A(e)(1) clarifies that § 245A(a) doesn't apply to “hybrid dividends.” Defined in § 245A(e)(4), a “hybrid dividend” is a dividend received from a CFC for which: [1] a deduction would be allowed under § 245A(a) but for § 245A(e), and [2] the CFC got a deduction (or other tax benefit) in a foreign jurisdiction. Paragraph 245A(e)(2) addresses the treatment of certain inter-CFC hybrid dividends (i.e., dividends paid by one CFC to another). Under this rule, if a domestic corporation is a U.S. shareholder of two CFCs, and if one of those CFCs distributes a hybrid dividend to the other, that dividend is treated as subpart F income of the recipient CFC.

1. The text and legislative history of § 245A confirm that a foreign corporation is eligible for the deduction.

In the Conference Report, Congress states that a § 245A deduction is permitted with respect to the foreign source portion of any dividend received by “a [CFC] treated as a domestic corporation for purposes of computing the taxable income thereof.”³⁸ Referencing § 1.952–2(b)(1), Congress confirms that, “a CFC receiving a dividend from a 10-percent owned foreign corporation that constitutes subpart F income may be eligible for the DRD with respect to such income.”³⁹

A foreign corporation's ability to claim a § 245A deduction is also confirmed by the statute itself. Paragraph 245A(e)(2) addresses the treatment of inter-CFC hybrid dividends. Paragraph 245A(e)(4) defines “hybrid dividend” as an amount received from a CFC and for which a deduction would be allowed under § 245A(a) but for § 245A(e). If a foreign corporation was prohibited from claiming a § 245A deduction, there could never be an inter-CFC hybrid dividend. Paragraph 245A(e)(2) would be rendered meaningless.

As the Supreme Court explained in U.S. v. Menasche, 348 U.S. 528, 538–39 (1955) (citations omitted), “'[t]he cardinal principle of statutory construction is to save and not to destroy.' . . . It is our duty 'to give effect, if possible, to every clause and word of a statute,' rather than to emasculate an entire section, as the Government's interpretation requires.” In FDA v. Brown & Williamson Tobacco Corp., 529 U.S. 120, 133 (2000) (citation omitted), the Supreme Court explained that a court must, “'interpret the statute as a symmetrical and coherent regulatory scheme,' . . . and 'fit, if possible, all parts into a harmonious whole.'” Interpreting § 245A to not apply to dividends received by foreign corporations would violate this fundamental principle of statutory construction, as such an interpretation would fail to give any meaning to § 245A(e)(2).

2. Revisions proposed in the Tax Technical and Clerical Corrections Act wouldn't change this result.

On January 2, 2019, the House Committee on Ways and Means released a Discussion Draft of proposed legislation entitled Tax Technical and Clerical Corrections Act (the “Discussion Draft Act”), suggesting a number of amendments to recently enacted tax reform. The Discussion Draft Act proposed revisions to § 245A, including:

• The addition of new § 245A(g), addressing dividends received by CFCs from specified 10-percent owned foreign corporations. Under this rule, if a domestic corporation (“A”) is a U.S. shareholder of a CFC (“B”) and of a specified 10-percent owned foreign corporation (“C”), and if B gets a dividend from C, the dividend is treated for purposes of § 245A as if it were paid directly to A;

• A simplification of the definition of “hybrid dividend” in § 245(e)(4). Under the proposed definition, the term “hybrid dividend” refers to any dividend received from a CFC and for which the distributing CFC got a deduction or other tax benefit in a foreign jurisdiction; and

• No change to §§ 245A(e)(1) or (2), meaning the § 245A(a) deduction isn't available for hybrid dividends and if a hybrid dividend is paid between CFCs, it's treated as subpart F income of the recipient CFC.

The effect of these proposed revisions is that if a specified 10-percent owned foreign corporation were to distribute a dividend to a CFC, that dividend would be treated for purposes of § 245A as if it were paid directly to U.S. shareholder A, which would then be eligible to deduct the foreign source portion of the dividend under § 245A(a). If the dividend were a hybrid dividend (i.e., because the distributing corporation is a CFC and it got a deduction/tax benefit in another jurisdiction), no deduction would be allowed under § 245A(e) and the amount distributed would, under § 245A(e)(2), be treated as subpart F income to the recipient CFC.

Unlike current § 245A (which allows a deduction at the level of the recipient CFC), the Discussion Draft Act proposal would treat the dividend as having been received by the recipient CFC's U.S. shareholder, and would allow a deduction at the U.S. shareholder level. Thus, although the Discussion Draft Act changes the recipient of the deduction, it doesn't change the result that § 245A(a) applies in the context of dividends received by a foreign corporation.

3. Future guidance under § 1.952-2 should expressly provide that a foreign corporation is eligible to claim a § 245A deduction

In the preamble to T.D. 9865, Treasury and the IRS assert that “[§ 245A(a)], by its terms, applies only to certain dividends received by 'a domestic corporation.'”⁴⁰ The preamble acknowledges that § 1.952-2 “sets forth rules for determining gross income and taxable income of a foreign corporation,” and that “for these purposes a foreign corporation is treated as a domestic corporation.”⁴¹ Noting that “questions have arisen as to whether § 1.952-2 could be interpreted such that a foreign corporation could claim a [§] 245A deduction,” Treasury and the IRS indicate they intend to issue future guidance relating to the application of § 1.952-2.⁴² The preamble says the “guidance will clarify that, in general, any provision . . . expressly limited in its application to domestic corporations does not apply to CFCs by reason of § 1.952-2.”⁴³

Paragraph 1.952-2(b)(1) provides that the taxable income of a foreign corporation shall generally be determined by treating such corporation as a domestic corporation taxable under § 11 and applying the principles of § 63. Paragraph 1.952-2(c)(1) provides that certain subchapters of Chapter 1 of the Code shall not apply for these purposes, but subchapter B — entitled Computation of taxable income, spanning §§ 61–290, and thus including § 245A — isn't included in this carve-out. Thus, under § 1.952-2, the taxable income of a CFC is determined by applying § 245A and allowing a deduction for the foreign source portion of dividends received from a lower tier foreign corporation.

We recommend that Treasury and the IRS clarify — either in the future § 1.952-2 guidance project or before — that CFCs are eligible to claim a deduction under § 245A. As discussed in Section II.C.1 (above), this result is required by the legislative history and plain language of § 245A. Although amendments proposed in the Discussion Draft Act change the recipient of the deduction, they don't change the result that § 245A(a) applies in the context of dividends received by a foreign corporation.

The T.D. 9865 preamble asserts that even if a foreign corporation is generally allowed a § 245A deduction, “[Treasury] and the IRS have determined, however, that in no case would any person, including a foreign corporation, be allowed a section 245A deduction directly or indirectly for the portion of a dividend paid to a CFC that is not eligible for the [§ 954(c)(6)] exception as a result of the [Final Temp Regs].”⁴⁴ Above we explained why — if our primary recommendation to withdraw the Final Temp Regs isn't adopted — the Final Temp Regs be revised to specifically exclude dispositions of intangible property from the definition of “extraordinary dispositions.” This change would permit the § 954(c)(6) exception to apply to dividends comprising distributions of E&P arising from dispositions of intangible property. Whether or not the § 954(c)(6) exception is available and applies, a CFC getting such a dividend should be eligible to claim a § 245A deduction with respect such dividend. Availability of a § 245A deduction ensures that receipt of the dividend doesn't ultimately give rise to GILTI (if the § 954(c)(6) exception applies) or to subpart F income (if the § 954(c)(6) exception doesn't apply). We accordingly recommend that Treasury and the IRS clarify availability of the § 245A deduction in such circumstances.

---

Appendix — SVTDG Membership

10x Genomics

Accenture

Activision Blizzard

Adobe

Agilent

Airbnb

Amazon

AMD

Analog Devices

Ancestry.com

Apple

Applied Materials

Aptiv

Arista

Atlassian

Autodesk

Bio-Rad Laboratories

BMC Software

Broadcom Limited

CA Technologies

Cadence

CDK Global

Chegg, Inc.

Cisco Systems, Inc.

Coinbase

Confluent

Crowdstrike, Inc.

Cypress Semiconductor

Dell Inc.

Dolby Laboratories, Inc.

Dropbox Inc.

eBay

Electronic Arts

Expedia, Inc.

Facebook

FireEye

Fitbit, Inc.

Flex

Fortinet

Genentech

Genesys

Genomic Health

Gigamon, Inc.

Gilead Sciences, Inc.

GLOBALFOUNDRIES

GlobalLogic

Google Inc.

GoPro

Grail, Inc.

Guidewire

Hewlett-Packard Enterprise

HP Inc.

Indeed.com

Informatica

Ingram Micro, Inc.

Intel

Intuit Inc.

Intuitive Surgical

Keysight Technologies

KLA Corporation

Lam Research

Lime

LiveRamp

Marvell

Maxim Integrated

MaxLinear

Mentor Graphics

Microsoft

Netflix

NVIDIA

Oracle Corporation

Palo Alto Networks

PayPal

Pivotal Software, Inc.

Pure Storage

Qualcomm

Red Hat Inc.

Ripple Labs, Inc.

Robinhood

salesforce.com

Sanmina-SCI Corporation

Seagate Technology

ServiceNow

Snap, Inc.

Stripe

SurveyMonkey

Symantec Corporation

Synopsys, Inc.

The Cooper Companies

The Walt Disney Company

TiVo Corporation

Trimble, Inc.

Uber Technologies

Velodyne LiDAR

Verifone

Veritas

Verizon Media

Visa

VMware

Western Digital

Workday, Inc.

Xilinx, Inc.

Yelp