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‘Favorable’ NOL Carryback Rules Apply to Deemed Repatriations

Posted on Apr. 1, 2020

Multinational businesses with prior years’ deemed repatriation income may want to take advantage of the special net operating loss carryback rules in the coronavirus stimulus package, a practitioner says.

The Coronavirus Aid, Relief, and Economic Security (CARES) Act (P.L. 116-136), signed into law March 27, provides two “very favorable special rules” for companies that carry back NOLs to a section 965 inclusion year, according to Mark Hoffenberg of KPMG LLP.

However, there could be a trap for the unwary related to the effects of the loss carryback in those situations, Hoffenberg said March 31 during a webcast sponsored by his firm.

The CARES Act modified section 172 to address liquidity issues arising from the COVID-19 pandemic by temporarily repealing the 80 percent NOL limitation and allowing deductions for loss carryovers and carrybacks to fully offset taxable income for tax years beginning before January 1, 2021.

The new law also allows companies to carry back losses arising in tax years from 2018 through 2020 for up to five years before the year of the loss.

“The five-year carryback is clearly giving rise to a lot of interest and a lot of thoughts about tax planning already,” Hoffenberg said. That’s not just because of liquidity — “getting cash quickly instead of waiting until losses can be used for carryovers — but there’s a big rate benefit,” he said.

Hoffenberg emphasized that the losses are still being generated in a 21-percent-tax-rate environment, but that if taxpayers carry them back to offset income in years preceding the Tax Cuts and Jobs Act, "that can offset taxable income at a 35 percent benefit.”

“So the carryback [provision] is a very lucrative and helpful rule put in this emergency legislation,” Hoffenberg added.

The 965 Connection

The TCJA imposes a one-time transition tax — 15.5 percent for cash positions and 8 percent for other amounts — on U.S. shareholders’ share of a specified 10-percent-owned foreign corporation’s deferred earnings and profits.

Under section 965(h), taxpayers may elect to pay their transition tax liability in eight annual installments: 8 percent of the liability for the first five installments, 15 percent for the sixth installment, 20 percent for the seventh, and 25 percent for the eighth. 

Also, companies may make a section 965(n) election not to apply their NOL deduction to their transition tax liability, and instead, for example, apply foreign tax credits that they might otherwise be unable to use.

The CARES Act’s NOL provision states that if taxpayers carry back losses to a tax year that includes section 965 income, they will be deemed to have made the section 965(n) election for that year. Thus, taxpayers won’t be allowed to apply their NOL deduction to offset their transition tax liability.

“That rule is helpful because otherwise that [NOL offset] could supplant foreign tax credits that you could have gotten equal benefits from,” Hoffenberg said.

The second rule states that if taxpayers carry back NOLs to one or more tax years that are section 965 inclusion years, they may — “in lieu of the election otherwise available” to waive NOL carrybacks under section 172(b)(3) — elect to exclude all such tax years from the five-year carryback period.

According to Hoffenberg, the IRS’s view is that if a company carries back losses to a section 965 inclusion year, the NOL carryback, instead of being refunded to the taxpayer, “could be treated as an advance payment of the future installments of the section 965 liability for that year.”

Thus, the CARES Act rule is helpful because it permits taxpayers to carry back NOLs for five years — applying them to the earlier year first, and then moving forward — and “just skip over the [section] 965 inclusion years and continue with subsequent years for your carryback period,” Hoffenberg said.

Practitioners discussing more broadly the international effects of the CARES Act have warned, however, that many of the changes in the law that are intended to be business-friendly — like the NOL changes and the section 163(j) business interest deduction changes — could have negative interactions with the TCJA’s international provisions.

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