Foreign Trade Council Comments on Subpart F High-Rate Exception Regs

September 21, 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
Principal Deputy Chief Counsel and Deputy Chief Counsel
Internal Revenue Service
1111 Constitution Ave., N.W.
Washington, D.C. 202224

Re: The Proposed Subpart F High-Tax Exeption Election [REG-127732-19]

Dear Sirs:

On behalf of the National Foreign Trade Council (“NFTC”), I would like to express our appreciation to the U.S. Department of the Treasury (“Treasury”) and the Internal Revenue Service (“Service”) for permitting us to comment on the proposed Subpart F High-Tax Exception regulations.

The NFTC, organized in 1914, is an association of approximately 200 U.S. business enterprises engaged in all aspects of international trade and investment. Our membership covers the full spectrum of industrial, commercial, financial and service activities and the NFTC therefore seeks to foster an environment in which U.S. companies can be dynamic and effective competitors in the international business arena. The NFTC's emphasis is to encourage policies that will expand U.S. exports and enhance the competitiveness of U.S. companies by eliminating major tax inequities in the treatment of U.S. companies operating abroad. To achieve this goal, American businesses must be able to participate fully in business activities throughout the world, through the export of goods, services, technology, and entertainment and through direct investment in facilities abroad. Foreign trade is fundamental to the economic growth of U.S. companies.

While the NFTC applaud the Treasury's and the Service's efforts in developing the GILTI High-Tax Election, there are a number of issues with coordinating and changing the Subpart F HTE election that would have a very significant impact on U.S. income tax administration and compliance.

CFC DEFINITION

Issue:

Under the current proposed definition of a “CFC group” and “controlling domestic shareholder”, a minority U.S. shareholder can “stop” a high-tax election for a CFC that has no impact on such shareholder. For example, consider a foreign corporation (“FP”) that owns (i) 100% of a U.S. corporation (“US1”), that in turn owns 100% of foreign corporation (“CFC1”) and (ii) 75% of foreign corporation (“CFC2”), which is owned 25% by a minority U.S. investor (“US2 ”). Under Prop. Treas. Reg. § 1.954-1(d)(6)(v), (i) CFC1 and CFC2 would be members of the same CFC group (parented by FP), (ii) US1 would be the controlling domestic shareholder of CFC1, and (iii) US2 would be the controlling domestic shareholder of CFC2. Under the proposed regulations, it would appear that US2 could prevent US1 from making a high-tax election for CFC1, even though US2 is simply a minority owner of a foreign corporation that is not even owned directly by US1 and even though US2 is unaffected by whether a high-tax election is made for CFC1. Similarly, it would appear that US1 could prevent US2 from making a high-tax election for CFC2, even though US1 is unaffected by whether a high-tax election is made for CFC2.

Recommendation:

A simple fix would be to require that the group parent must be either a CFC or a U.S. shareholder, similar to the CFC group definition in Prop. Treas. Reg. § 1.163(j)-7. Under this fix, in the example above, CFC1 and CFC2 would be in separate CFC groups. This would better reflect the economic reality that whether CFC1 makes a high-tax election has no effect on US2 and whether CFC2 makes a high-tax election has no effect on US1.

Alternatively, if the CFC group definition is not changed, the controlling domestic shareholder for a CFC group could be defined as the U.S. shareholder who owns, within the meaning of Section 958(a), the largest percentage interest in any single CFC that is a member of the group. This would prevent minority U.S. shareholders from vetoing high-tax elections by majority U.S. shareholders. In the example above, US1 would be the sole controlling domestic shareholder for the CFC group that includes CFC1 and CFC2, such that US2 would not be able to prevent US1 from making a high-tax election for CFC1, although oddly, US1 could “drag” US2 into a high-tax election for CFC2 when it has no consequence to US1. This majority rule, including the ability to “drag” minority U.S. shareholders, would be consistent with the way Treas. Reg. § 1.964-1(c)(5) and Prop. Treas. Reg. § 1.954-1(d)(8)(iii) currently work.

As yet another alternative if the CFC group definition is not changed, the current definition of the controlling domestic shareholders for a CFC group could be tweaked to add that that if any U.S. shareholders own, within the meaning of Section 958(a), more than 50% of any single CFC in the group, then such U.S. shareholders would be the only controlling U.S. shareholders of the CFC group. This would similarly prevent minority U.S. shareholders from vetoing high-tax elections by majority U.S. shareholders of the same or different CFCs. Thus, in the example above, US2 would not be able to veto a high-tax election by US1 for CFC1. However, this would also force majority U.S. shareholders of different CFCs that may be part of the same CFC group to work together, again somewhat consistent with the way Treas. Reg. § 1.964-1(c)(5) and Prop. Treas. Reg. § 1.954-1(d)(8)(iii) currently require U.S. shareholders that together own a majority to work together.

SAME COUNTRY COMBINATION RULE

Issue:

Local country consolidation rules and group relief regimes will cause improper distortions in the tested unit effective tax rate calculation. Allowing cross-CFC same-country unit combination in these circumstances allows taxpayers flexibility and increases the accuracy of the effective tax rate calculation.

For example, in Spain, when a consolidated tax regime is elected, all Spanish taxpayers that have indirect common ownership are required to be included in the consolidated group, regardless of direct ownership.

Recommendation:

The combination rule under 1.954-1(d)(2)(iii) should allow, on an elective basis, for same-country cross-CFC unit combination in order to properly calculate the effective tax rate on the combined unit.

ANTI-ABUSE RULE

Issue:

The applicable financial statement anti-abuse rule is unclear and too broad. As currently written, the anti-abuse rule is so broad that it could capture local country financial statement presentation requirements as abusive.

Recommendation:

The combination rule under Prop. Treas. Reg. § 1.954-1(d)(2)(iii) should allow for same-country cross-CFC unit combination in order to properly calculate the effective tax rate on the combined unit.

SUBPART F QUALIFIED DEFICITS COULD BE LOST

Issue:

In the context of Subpart F, it is unclear how the proposed regulations reconcile with the statutory framework already present where certain computations are required to be done at the CFC level. This is of particular concern with respect to the determination of the amount, and the utilization of, a qualified deficit. It is unclear whether a net loss that is treated as high-taxed (because of the proposed rule for negative/undefined tax rates) would then not be treated as a qualified deficit even if otherwise attributable to a qualified activity. If not treated as a qualified deficit, it may not be available to offset in future years Subpart F income attributable to the same qualified activity.

Recommendation:

Clarify that qualified deficits will not be impacted due the high tax election and continue to be generated from qualifying activities.

* * * * * * *

Again, thank you very much for the opportunity to provide these comments. Please do not hesitate to contact me should you have any questions on the above. We would be glad to meet with you to discuss these comments more fully and hereby formally request a public hearing to present our oral comments on the Proposed Regulations and, in particular, the Subpart F High-Tax Election.

Sincerely,

Catherine G. Schultz
Vice President for Tax Policy
National Foreign Trade Council
Washington, DC