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Law Firm Seeks Changes to Expense Allocation Rules in FTC Regs

FEB. 5, 2019

Law Firm Seeks Changes to Expense Allocation Rules in FTC Regs

DATED FEB. 5, 2019
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February 5, 2019

CC:PA:LPD:PR (REG-105600-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20224

Re: Proposed Foreign Tax Credit Regulations

Dear Sirs and Mmes.,

On December 7, 2018, the Treasury Department published in the Federal Register proposed regulations, REG-105600-18, addressing various aspects of the foreign tax credit and expense allocations. This comment letter addresses one aspect of the proposed expense allocation rules.

Section 864(e)(4) of the Code provides for an E&P adjustment to the basis of CFC stock for purposes of allocating and apportioning expenses based on assets. The preamble to the proposed regulations states that this adjustment "is intended to better approximate the value of stock."

The preamble also takes issue with a position that some taxpayers may have taken under the existing temporary regulations, § 1.861-12T(c)(2), namely, that the § 864(e)(4) E&P adjustment does not include previously taxed E&P. The proposed regulations, § 1.861-12(c)(2)(i)(B)(2), would specifically provide that, for purposes of the § 864(e)(4) adjustment, a CFC's E&P includes all E&P described in § 959(c). That would include previously taxed E&P described in §§ 959(c)(1) and (c)(2).

We are concerned that the interaction of this proposed rule with another recent Treasury Department regulation would substantially and artificially inflate the amount of CFC E&P included in the § 864(e)(4) adjustment.

Final regulations issued under § 965 of the Code, T.D. 9846, 84 Fed. Reg. 1838 (Feb. 5, 2019), provide that an E&P deficit foreign corporation must increase its E&P for its last taxable year that begins before January 1, 2018, by the portion of the deficit corporation's E&P taken into account under § 965(b). See § 1.965-2(d)(2). The apparent purpose of this E&P increase is to account for the fact that another CFC's E&P is reclassified as previously taxed § 959(c)(2) E&P even though it has never been included in a U.S. shareholder's income. In other words, this adjustment is focused on preserving the total amount of non-previously taxed CFC E&P.

Under the proposed regulations, however, the amount of the § 864(e)(4) E&P adjustment would not depend on whether the CFC's E&P has been previously taxed. Rather, all E&P described in § 959(c) would be included in the adjustment. In this context, the effect of the § 1.965-2(d)(2) E&P increase will be to increase one CFC's § 959(c) E&P without reducing any other CFC's § 959(c) E&P. As a result, the amount of the § 864(e)(4) adjustment would be artificially inflated, in every case, to the extent of the U.S. shareholder's § 965(b) E&P offset amount.

This result would be directly contrary to the stated purpose of the § 864(e)(4) adjustment, i.e., "to better approximate the value of stock." And the amounts involved will be substantial for many taxpayers.

We recommend that the final regulations include a special rule to reverse the double-counting of CFC E&P, so as to prevent the artificial inflation of the § 864(e)(4) adjustment amount. As an alternative, Treasury and the IRS could reconsider their position that previously taxed E&P must be included in the § 864(e)(4) adjustment.

We appreciate your consideration of these comments, and would be glad to discuss them further if you would like.

Sincerely,

Adam S. Halpern
Fenwick & West LLP
Mountain View, CA

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