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SIFMA Raises Concerns With Mechanics of GILTI High-Tax Exclusion

SEP. 12, 2019

SIFMA Raises Concerns With Mechanics of GILTI High-Tax Exclusion

DATED SEP. 12, 2019
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September 12, 2019

Internal Revenue Service
CC:PA:LPD:PR (REG-101828-19)
Room 5203, Post Office Box 7604
Ben Franklin Station
Washington, DC 20044

Re: GILTI Regulations

Ladies and Gentlemen:

This letter provides comments on behalf of the Securities Industry and Financial Markets Association (“SIFMA”)1 regarding the regulations under section 951A that were issued on June 21, 2019.2 The final regulations address many of the concerns that taxpayers had raised regarding the prior proposed regulations. We commend the drafters for their efforts to take account of taxpayer comments.

This letter focuses primarily on the provisions of the proposed regulations that confirm that the high-tax exclusion will be available in respect of all income that is subject to foreign tax at a rate greater than 18.9%. This determination represents an appropriate and sensible exercise of the drafters' regulatory authority, and will bring the GILTI rules into closer conformity with what we believe Congress to have intended.3

We have technical and practical concerns regarding the mechanics of the exclusion, and particularly regarding the extent to which the proposed regulations would diverge from the longstanding statutory provision on which it is based: the elective exclusion for subpart F purposes, commonly referred to as the “high-tax kickout”.4 Our recommendations regarding the high-tax exclusion are set out in paragraphs 1 through 5 of this letter. We have noted a couple of small comments regarding other issues in paragraphs 6 and 7.

1. The exclusion should be conformed to the high-tax kickout.

The GILTI exclusion is based on the high-tax kickout. However, the proposed regulations would introduce significant differences between the GILTI and subpart F rules. We believe that the differences are inappropriate and unnecessary.

2. The foreign tax rate should be determined at the level of CFCs, not QBUs.

For subpart F purposes, the foreign tax rate computation generally is made with respect to all of a CFC's income in a particular category, without assigning significance to whether the income is earned by a foreign corporation through its home office or through a separate branch. By contrast, the proposed regulations would determine eligibility for the GILTI exclusion separately with respect to each qualified business unit of a controlled foreign corporation.

This requirement is unprecedented and unnecessary. We encourage you to eliminate it, and to provide instead for computations at the level of each CFC. Requiring that income and tax computations be made separately in respect of each QBU seems particularly inappropriate in the context of the GILTI rules. Under those rules, determinations generally are made on a combined basis with respect to a U.S. shareholder's entire foreign group. In the context of a rule that aggregates the income and losses of multiple foreign corporations, it doesn't make sense to require each such corporation to make disaggregated computations of income and taxes with respect to its qualified business units.

In the context of the GILTI rules, and for purposes of the high-tax exclusion, we don't agree that the blending of income that is subject to taxation at different rates is problematic, or that it should make a difference whether the income is derived by a corporation directly or through a QBU. Income derived from the conduct of an active foreign business may be subject to foreign tax at different rates for a variety of reasons. If a CFC's active business income is subject to an effective rate of foreign tax that exceeds 18.9%, it shouldn't make a difference whether that rate reflects the averaging of amounts taxed at different rates, or whether the differences relate to the conduct of activities through QBUs.

The requirement to make effective rate computations at the level of each QBU would give rise to additional compliance burdens, and an increased potential for inappropriate results. The resulting costs seem to us disproportionately greater than any possible benefit of such computations.

The drafters clearly understood that QBU-level computations would be complex.5 However, they may have failed to fully appreciate the novelty of such a requirement. For many years, U.S. shareholders have been required to determine the earnings and foreign tax liability of their foreign subsidiaries using U.S. tax accounting principles. No similar generally applicable requirement applies to branches or QBUs of foreign subsidiaries. In many cases, a U.S. shareholder will not even have had occasion to consider whether a particular activity conducted by a foreign subsidiary constitutes a QBU, because it doesn't matter.6 Partially as a result of the limited practical significance of QBU classification prior to the enactment of the TCJA, the rules for determining what constitutes a QBU, and how to measure its income, are not fully developed, and some basic questions remain unanswered.7

For the reasons discussed in this letter, we think it is important that the new GILTI exclusion be coordinated with the longstanding subpart F rule. In many or most cases, it will be significantly more practical to determine the effective rate of foreign tax on a CFC-by-CFC basis. Taxpayers have been required to make such computations for subpart F and foreign tax credit purposes for more than 30 years.

It may be helpful to note that neither of the possible methodologies inherently favors taxpayers. Some taxpayers in fact may prefer to determine whether income is high-taxed on a QBU-by-QBU basis.8 We would have no objection if the Service wishes to permit taxpayers to use this methodology if they wish to do so. But a rule that requires all taxpayers to determine the rate of foreign tax on a QBU-by-QBU basis seems to us unnecessary and inappropriate.

The drafters may have believed that CFC-level computations could produce inappropriate results in some cases. They may have intended the requirement that the effective rate of foreign tax be determined on a QBU-by-QBU basis as an anti-stuffing rule, to prevent taxpayers from seeking to maximize the benefit of the GILTI high-tax exclusion by combining unrelated businesses within a single corporation. We don't know how often this will represent a real-world opportunity.9 We question whether it should be seen as a problem. But if this is the concern, it would be strongly preferable to deal with this limited fact pattern by prescribing a targeted anti-abuse rule, instead of by imposing burdensome new requirements on all taxpayers.

3. The GILTI high-tax election should be made annually on a company-by-company basis.

In addition to the issues discussed above, the proposed regulations would deviate very significantly from the longstanding subpart F rules in two important respects:

  • Annual elections.

    • Subpart F. Taxpayers may elect to claim the benefit of the high-tax kickout on an annual basis.

    • GILTI. An election to claim the benefit of the exclusion, once made, must remain in effect for five years.

  • Company-by-company elections.

    • Subpart F. Taxpayers may invoke the high-tax kickout selectively in respect of some foreign subsidiaries and not others.

    • GILTI. The election must be made on an all-or-nothing basis: if a taxpayer wishes to claim the benefit of the high-tax exclusion in respect of any foreign income, it must do so in respect of all foreign income.

Note, in this regard, that when Congress modified the high-tax kickout in 1986, its clear intention was to make the application of the provision elective, objective, and readily available.10 The differences highlighted above would make the GILTI exclusion less readily available, and more difficult to apply, than the high-tax kickout. There is no indication in the TCJA or the legislative history that Congress intended for there to be any such differences.

We recommend that the GILTI regulations be conformed to the subpart F rules, so that taxpayers are permitted to choose whether to invoke the exclusion annually on a CFC-by-CFC basis.

The ability to make elections in respect of some subsidiaries and not others would enable taxpayers to reduce exposure to the unfavorable interaction between the GILTI and interest allocation rules (as discussed in Annex 2) to the maximum extent possible without triggering incremental U.S. taxes on GILTI.11

The tax policy considerations supporting the approach taken by the subpart F rules seem to us even stronger in the context of the GILTI rules. The preamble to the proposed regulations notes that, if an appropriately inclusive high-tax exclusion is not provided, taxpayers will have incentives to reconfigure their business processes to replace GILTI with subpart F income. The proposed regulations are intended to reduce the use of formal and economically inefficient self-help strategies by eliminating the need for them. This is a powerful and persuasive rationale for the drafters' decision regarding the scope of the exclusion.

The same rationale applies with equal or greater force to the questions regarding the mechanics of the exclusion that are discussed in this section. An election could have unfavorable consequences for financial services businesses in some cases.12 It is impossible to predict whether an election will produce net benefits, or net costs, over a multi-year period. The requirement that the election be irrevocable for five years, as contemplated by the proposed regulations, will defeat the purpose described in the preamble by discouraging companies from taking advantage of the exclusion.

Finally, the use of the same statutory framework to delineate two very different exclusions could give rise to significant complexity. In the event that there are any remaining differences between the high-tax kickout and the GILTI exclusion, the regulations should provide clear guidance concerning how the rules will interact with each other.13

4. Relief should be provided in cases where mismatched taxable years produce distortions.

Under prior law, the amount of foreign tax allocable to a particular item of income (including for purposes of the high-tax kickout) was determined by reference to multiyear pools of earnings and foreign taxes. This methodology tended to reduce the significance of differences between U.S. and foreign tax accounting principles. Multiyear pooling of course is no longer available following the enactment of the TCJA. Taxpayers now are required to compute foreign taxes allocable to items of income by reference to the amount of foreign taxes payable in respect of a particular year.

Year-by-year effective rate computations will increase the practical significance of disparities between the U.S. and foreign rules governing the timing of accrual of items of income, expense and foreign tax. As shown in Example 3, the effective rate of foreign tax determined by reference to the results of a single year can deviate significantly from the stated rate of foreign tax even in a case where the U.S. and foreign systems are substantially similar.14

We recommend that the regulations provide relief in the limited circumstances described below. Taxpayers should be allowed to claim the benefit of the high-tax exclusion if they can establish to the satisfaction of the Secretary that income derived in a particular year will be subject to foreign tax at a rate greater than 18.9%, even if the tax would not be considered to have accrued in that year for U.S. tax purposes.15 This circumstance could arise, for example, if a CFC is required to use an April 30 taxable year for foreign purposes and a calendar year for U.S. purposes. Making the exclusion available in cases where disparities between U.S. and foreign rules otherwise would produce distortions is not inconsistent with the Congressional determination that foreign tax credits should be determined on a year-by-year basis. The GILTI high-tax exclusion is not a foreign tax credit rule: foreign tax credits are not allowable in respect of income that qualifies for the benefit of the exclusion.

5. The exclusion should be available retroactively to the date of enactment.

The proposed regulations provide that the high-tax exclusion will be available only in respect of periods after the regulations are published in final form. The considerations supporting the decision to make the exclusion generally available apply with equal force to income earned before and after regulations are issued in final form. Taxpayers should be permitted to claim the benefit of the exclusion in respect of all periods beginning on the date the GILTI rules entered into force.

6. Basis adjustment rule.

In our comment letter concerning the prior proposed regulations, we expressed concern about a basis adjustment rule that was intended to prevent taxpayers from deriving duplicative benefits from a single economic loss. We noted that the rule could require a taxpayer to make a basis adjustment even if there was no potential for duplicative benefits, and recommended that the rule be modified to avoid this outcome. The final regulations do not include the proposed basis adjustment rule. The preamble indicates that the Service is considering how to craft a workable and fair rule. We respectfully request that the Service take account of the concerns that we had raised about the proposed rule.

7. Compliance and reporting issues.

The final regulations are effective retroactively to the date on which the GILTI rules entered into force. The regulations make a number of important changes, including with respect to the application of the GILTI rules to interests held through U.S. partnerships. Some of the changes could not reasonably have been anticipated. Some taxpayers have been required to make complex computations, to prepare and deliver information returns, or to file tax returns, based on determinations made in good faith before the final regulations became available.

In the absence of guidance, there could be significant diversity of practice regarding how to deal with such cases. Some taxpayers may conclude that they are required in all cases to rerun the numbers, and to provide amended information returns, without regard to whether the required changes are material; others may wish to take account of materiality and costs; others may prefer to make true-up adjustments on future filings instead of preparing amended returns.

Notice 2019-46 provides helpful guidance concerning some cases in which actions were required to be taken prior to the issuance of the final regulations. As similar fact patterns are identified, the Service should endeavor to foster uniformity without imposing unreasonable burdens on affected taxpayers.

* * *

We appreciate the opportunity to comment on the GILTI regulations. Please do not hesitate to contact me at (202) 615-4732 or jwall@sifma.org if you have questions or would like to discuss our comments in more detail.

Respectfully submitted,

Jamie Wall
Executive Vice President, Advocacy
SIFMA
New York, NY

cc:
David J. Kautter
Assistant Secretary for Tax Policy

L.G. “Chip” Harter
Deputy Assistant Secretary (International Tax Affairs)

Doug Poms
International Tax Counsel

Peter Blessing
Associate Chief Counsel (International)

FOOTNOTES

1 SIFMA is the leading trade association for broker-dealers, investment banks and asset managers operating in the U.S. and global capital markets. On behalf of our industry's nearly 1 million employees, we advocate for legislation, regulation and business policy, affecting retail and institutional investors, equity and fixed income markets and related products and services. We serve as an industry coordinating body to promote fair and orderly markets, informed regulatory compliance, and efficient market operations and resiliency. We also provide a forum for industry policy and professional development. SIFMA, with offices in New York and Washington, D.C., is the U.S. regional member of the Global Financial Markets Association (GFMA). For more information, visit http://www.sifma.org.

2 See T.D. 9866, Guidance Related to Section 951A (Global Intangible Low-Taxed Income) and Certain Guidance Related to Foreign Tax Credits, 84 FR 29,288 (final and temporary regulations). The proposed regulations were included as part of Guidance Under Section 958 (Rules for Determining Stock Ownership) and Section 951A (Global Intangible Low-Taxed Income), 84 FR 29,114.

3 Annex 1 to this letter includes examples illustrating (i) the difficulties associated with computing the effective rate of foreign tax on a QBU-by-QBU basis (Example 1); (ii) the reasons why multiyear elections would be particularly problematic for U.S. taxpayers that conduct foreign operations through branches as well as subsidiaries (Example 2); and (iii) the need for relief in cases where mismatched taxable years create distortions (Example 3). Annex 2 provides a more detailed account, based on the facts of Example 2, of the reasons why section 904(b)(4) does not provide full relief in all cases for financial services companies from the unfavorable interaction between the GILTI and interest allocation rules.

4 See section 951A(c)(i)(III) (the GILTI high-tax exclusion), which incorporates section 954(b)(4) (the high-tax kickout) by reference.

5 The topics with respect to which the drafters asked for comments provide a daunting, but by no means comprehensive, roadmap of the questions that taxpayers and tax administrators will need to address, including how to apply the rule in the context of fact patterns involving multiple QBUs in the same country, group relief and similar systems, and cases where the foreign tax base does not correspond to the QBU's books.

6 The question whether an activity conducted by a foreign corporation outside the United States constitutes a QBU for U.S. tax purposes can be relevant for purposes of section 987 (methodology for reconciling accounts kept in more than one functional currency) and section 954 (transactions effected through a foreign branch can give rise to foreign base company sales and services income; exceptions for income derived in the conduct of an active business in some cases require separate QBU-level determinations).

7 Example 1 illustrates the practical difficulties that could arise if effective rate computations are required to be made at the QBU level. The example involves a holding company structure in which a CFC owns multiple subsidiaries in the same foreign country, and those subsidiaries have elected to be disregarded as entities separate from the holding company. Our concerns about QBU-level computations are not limited to this fact pattern.

8 For example, a U.S. shareholder may prefer to make a QBU-level election if a CFC's home-country income is taxed at a 19% rate and income derived by a clearly separate foreign QBU is taxed at a 13.125% rate.

9 There are a variety of practical constraints, including the difficulty of predicting the average rate of foreign tax on multiple streams of operating income derived from disparate businesses.

10 The description of the change provides that: “Congress intended, by making the operation of this rule more certain, to ensure that it could be used more easily than the subjective test of prior law could be. This is important because it lends flexibility to Congress' general broadening of the categories of income that are subject in the first instance to current tax under subpart F. Congress' judgement was that because movable income could often be as easily earned through a U.S. corporation as a foreign corporation, a U.S. taxpayer's use of a foreign corporation to earn that income may be motivated primarily by tax considerations. If, however, in a particular case no U.S. tax advantage is gained by routing income through a foreign corporation, then the basic premise of subpart F taxation is not met, and there is little reason to impose current tax under subpart F. Thus, since the scope of transactions subject to subpart F is broadened under the Act and may sweep in a greater number of non-tax motivated transactions, Congress expected that the flexibility provided by a readily applicable exception for such transactions would become a substantially more important element of the subpart F system.” [emphasis added]. See Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, p. 983.

11 For example, assume that a taxpayer has three foreign operating subsidiaries, each of which has pretax income of 1,000. Sub1 and Sub2 are subject to foreign tax at a 20% rate; Sub3 is taxed at an 8% rate. Depending on the relationship between the interest allocation detriment and the incremental GILTI cost, it could be in the taxpayer's interest to make a high-tax election with respect to both Sub1 and Sub2, and incur residual U.S. tax on GILTI derived from Sub3. Alternatively, it may be preferable to make a high-tax election only in respect of Sub1, so that the average rate of foreign tax on income derived from Sub2 and Sub3 is greater than 13.125%. We don't see a good reason to prevent taxpayers from making this judgment on a case-by-case basis in the context of their particular circumstances. It would be inappropriate to require taxpayers to claim the benefit of the high-tax exclusion with respect to both subsidiaries or neither of them.

12 See the discussion in Annex 2 and Example 2.

13 For example, if a taxpayer claims the benefit of the high-tax kickout in respect of a single foreign subsidiary, would it be deemed to have made a GILTI election in respect of all of its foreign subsidiaries? Would a taxpayer be permitted to claim the benefit of the high-tax kickout annually, and with respect to some subsidiaries and not others, if it has made a GILTI election in respect of income that would not otherwise have been subject to taxation under subpart F?

14 Congress made a policy judgment to eliminate pooling. It is not permissible or desirable to revisit that judgment. Congress presumably believed that pooling would not be compatible with the new system for taxing foreign income, and that the benefits of the new system outweighed the potentially serious disadvantages associated with year-by-year computations. The creation of a multiyear pooling system in 1986 was motivated in part by Congress's desire to eliminate planning opportunities available to taxpayers under the prior year-by-year system. At the very least, year-by-year computations will make it more difficult to effectively forecast and provide for taxes, and will increase the level of uncertainty.

15 Alternatively, taxpayers could be allowed to accrue foreign taxes on a mark-to-market basis, as if the foreign taxable year had ended concurrently with the U.S. taxable year.

END FOOTNOTES

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