More on Tax Reform: Intercompany Transactions, Single-Entity Issues

I. Background

The Tax Cuts and Jobs Act (P.L. 115-97), generally effective for tax years beginning after 2017, made significant changes to the code beyond lowering the corporate income tax rate to 21 percent and repealing the alternative minimum tax on corporations.¹ Some of those changes will require extensive revision of the consolidated return regulations or the adoption of brand new regulations. Many of the modified or new regulatory provisions will undoubtedly require computations on a consolidated or single-entity basis for affiliated groups filing consolidated federal income tax returns (consolidated groups) rather than on a separate-entity basis.²

This report examines the general effect of intercompany transactions between members of a consolidated group under the TCJA, and it discusses consolidated return issues related to new sections 250, 951A, and 960(d). The application of the timing and attribute redetermination rules of reg. section 1.1502-13 for an intercompany transaction generally achieve appropriate results under the TCJA, with the notable exceptions of determining a consolidated group’s adjusted taxable income under new section 163(j)(1)(B) and calculating a consolidated group’s deemed tangible income return under section 250(b)(2)(B). Also, it is likely that new sections 250, 951A, and 960(d) generally will apply to a consolidated group as if it were a single corporation.

II. Intercompany Transactions and the TCJA

A. Intercompany Transaction Rules

An intercompany transaction is defined in reg. section 1.1502-13(b)(1)(i) as any transaction between the selling member (S) and the buying member (B) if S and B are members of the same consolidated group immediately after the transaction. S’s items of income, gain, deduction, and loss associated with the intercompany transaction are called “intercompany items” under reg. section 1.1502-13(b)(2), and B’s items of income, gain, deduction, and credit are called “corresponding items” under reg. section 1.1502-13(b)(3).

Under reg. section 1.1502-13(c)(2)(i), the timing of B’s corresponding items is generally determined under B’s separate accounting method unless application of the attribute redetermination rules alter B’s timing. Under reg. section 1.1502-13(c)(2)(ii), the timing of S’s intercompany items must reflect the difference between B’s corresponding item, when taken into account by B, and B’s recomputed corresponding item. A recomputed corresponding item is defined by reg. section 1.1502-13(b)(4) as the corresponding item B would have taken into account if the intercompany transaction had been between divisions of a single corporation.

When a corresponding item and intercompany item are taken into account, their attributes — defined by reg. section 1.1502-13(b)(6) as any characteristic of an item relevant to the determination of consolidated taxable income (CTI) or consolidated tax liability (CTL) other than amount, location, and timing — generally are redetermined “to the extent necessary to produce the same effect on [CTI] (and [CTL]) if S and B were divisions of a single corporation and the intercompany transaction were a transaction between divisions.”³ Further, reg. section 1.1502-13(c)(1)(ii) provides that the holding period for property transferred in an intercompany transaction includes the periods during which S and B have held the property, unless B’s basis in the property is determined by reference to other property held or previously held by B. Also relevant is reg. section 1.1502-13(c)(4)(i)(A), which provides that to the extent S’s intercompany item and B’s corresponding item offset, generally the attributes of B’s corresponding item control the redetermination of the attributes of S’s intercompany item.⁴

Reg. section 1.1502-13(d) provides rules governing the acceleration of S’s intercompany items upon the occurrence of an event that prevents any further accounting for the items to produce the effect of treating S and B as divisions of a single corporation. Examples include the departure of S or B from the consolidated group or B’s contribution of property acquired from S in an intercompany transaction to a partnership in a section 721(a) exchange or to a nonmember corporation in a section 351 exchange.⁵ Reg. section 1.1502-13(f) contains rules addressing transactions in stock, and reg. section 1.1502-13(g) provides rules addressing tax consequences related to the issuance, ownership, and disposition of intercompany obligations. Finally, reg. section 1.1502-13(h) contains an antiabuse rule, and reg. section 1.1502-13(j) provides special rules regarding successor assets, successor persons, multiple triggers, multiple intercompany transactions, acquisitions of entire consolidated groups, and group continuations.

B. Straddling 2017 and 2018

While the effective date of the repeal of the AMT and the lower 21 percent corporate rate is tax years beginning on or after January 1, 2018, a special rule applies for a tax year that straddles calendar years 2017 and 2018 (that is, a tax year that begins before and ends on or after January 1, 2018). For such a year, the amount of corporate tax due is the sum of (1) the pre-2018 rate (generally 35 percent) times the taxable income for the full year times a fraction, the numerator of which is the number of days in the period ending December 31, 2017, and the denominator of which is the total number of days in the full year, plus (2) 21 percent times the taxable income for the full year times a fraction, the numerator of which is the number of days in the period beginning January 1, 2018, and ending on the last day of the full year, and the denominator of which is the total number of days in the full year.⁶ What about an intercompany transaction that straddles 2017 and 2018 (that is, an intercompany transaction completed before 2018, but for which the associated income or loss is taken into account in a post-2017 tax year)?

Example 1: Intercompany transaction occurs before 2018 and gain is triggered after 2017. P owns all the stock of S and B, with which P files a consolidated return. In year 1, a tax year beginning before 2018, S sells appreciated investment real estate with a $50 basis to B for $100, recognizing $50 of gain. In year 2, a tax year beginning after 2017, B sells that real property to X, a nonmember, for $100, recognizing no gain or loss. Under the timing rule of reg. section 1.1502-13(c)(2)(ii), S’s intercompany gain is taken into account immediately before B’s sale to the nonmember, in an amount equal to the difference between (1) the gain or loss recognized by B under its separate accounting method ($0) and (2) the gain or loss that would have been recognized by B if the intercompany transaction had been between divisions of a single corporation ($50). Therefore, S’s entire $50 of gain must be taken into account in year 2.

The question is whether S’s $50 of intercompany gain taken into account in year 2 is subject to federal income tax at the rates in effect under section 11(b) for year 1 (a maximum rate of 35 percent) and to the corporate AMT, or whether it is instead subject to the corporate tax regime in effect for year 2 (no AMT, plus a single rate of 21 percent). The answer should be that like other items composing the consolidated group’s CTI and CTL for year 2, S’s $50 of intercompany gain should be subject to corporate tax under the regime in effect for year 2.

Any other answer violates the single-entity policy underlying reg. section 1.1502-13 to equate an intercompany transaction between S and B with a transaction between divisions of a single corporation as far as timing and attributes are concerned. Under reg. section 1.1502-13, for an intercompany transaction, only the amount and location of S’s intercompany item are determined on a separate-entity basis. The attributes of the item and the timing of it being taken into account by S are determined under single-entity principles.⁷

The result for S is identical to what would happen if S had sold the real estate to unrelated X in year 1 in exchange for a $100 installment obligation of X and received a $100 payment from X in satisfaction of the obligation in year 2. Unless S is not entitled to report its gain under the installment sale method or opts out of installment sale reporting under section 453(d), S’s $50 of gain would be reported in the consolidated return filed for year 2, would be subject to corporate income tax at the 21 percent rate in effect for year 2, and would not be subject to corporate AMT.⁸

C. Intercompany Transactions and FDDEI

As discussed below, in computing a taxpayer’s deduction under section 250(a)(1)(A) (37.5 percent of foreign-derived intangible income (FDII)), a key component of FDII is the taxpayer’s foreign-derived deduction-eligible income (FDDEI). FDDEI is composed of deduction-eligible income (DEI) resulting from sales of property to foreign persons for “foreign use” and services provided to persons, or in connection with property, outside the United States.⁹ Section 250(b)(5)(B)(i) generally provides that a sale of property to another person (other than a related party) for further manufacture or other modification in the United States does not qualify as sold for foreign use, even if the buyer later uses the property outside the United States.¹⁰

Section 250(b)(5)(C) contains exceptions to the foregoing general rule for sales to or services performed for related parties that are not U.S. persons. For example, section 250(b)(5)(C)(i) provides that the foreign use requirement is satisfied if the foreign related purchaser later resells the property to an unrelated buyer and establishes that the property is used by the unrelated buyer outside the United States.¹¹ What about intercompany transactions within the meaning of reg. section 1.1502-13(b)(1) in which the buyer of property (B) is a related party but not foreign?

Example 2: Gain from intercompany sale of property redetermined to be FDDEI. P owns all the stock of domestic corporations S and B, with which P files a consolidated return. S manufactures widgets that B markets at home and abroad. At the end of year 1, S sells widgets to B for $300, recognizing gross income of $50. At the beginning of year 2, B sells the widgets for $330 to FC, an unrelated German manufacturer that will use the widgets to manufacture other products in Germany. As a result of the year 2 sale to FC, S takes into account $50 of intercompany income under reg. section 1.1502-13(c)(2)(ii), and B takes into account $30 of income under reg. section 1.1502-13(c)(2)(i). All of B’s income qualifies as FDDEI under section 250(b)(4) and (b)(5)(A).

The entire $80 of income taken into account by S and B in year 2 — not just the $30 of income recognized by B — should qualify as FDDEI under section 250(b) considering the clear directive in reg. section 1.1502-13(c)(1)(i) that the attributes of S’s $50 intercompany item and B’s $30 corresponding item are redetermined as if the intercompany sale had occurred between divisions of a single corporation. There can be no doubt that the FDDEI status of the income items taken into account in year 2 by S and B is an attribute within the meaning of reg. section 1.1502-13(b)(6); it is a characteristic of each of the intercompany item and the corresponding item, other than amount, timing, and location, necessary to determine the item’s effect on taxable income and tax liability.¹² Thus, because divisions of a single corporation would have taken into account $80 of income on the sale of the widgets to FC in year 2, all of which would qualify as FDDEI, S’s $50 of intercompany income should be redetermined to be FDDEI.

Example 2A: Intercompany license of intangible property used to perform services for an unrelated foreign person; royalty income redetermined to be FDDEI. Instead of selling widgets to B, S licenses intangible property to B under a true license, and B uses the intangible property exclusively in the performance of services for FC. In year 1 B pays a $50 royalty to S under the license, for which B is entitled to a deduction under section 162, and B accrues $80 of compensation income from rendering services to FC. Under B’s separate accounting method, both the $80 of compensation income and the $50 royalty deduction are taken into account in determining B’s FDDEI.

B’s $50 deduction for the royalty payment to S in year 1 causes S to take into account $50 of royalty income in year 1 under the timing rule of reg. section 1.1502-13(c)(2)(ii) (B’s corresponding item is a $50 deduction, and its recomputed corresponding item is $0 (no deduction could exist if the license had been between divisions of a single corporation)). Under the offset rule of reg. section 1.1502-13(c)(4)(i)(A), the FDDEI attribute of B’s $50 royalty deduction requires that the qualification of S’s $50 of royalty income as FDDEI be redetermined. That redetermination clearly is consistent with the treatment of S and B as divisions of a single corporation; that is, if the license had been between divisions, the net income qualifying as FDDEI would be $80. Therefore, not only does B’s $30 of year 1 net income from the performance of services for FC qualify as FDDEI, but S’s $50 of year 1 royalty income also qualifies as FDDEI.¹³

It might be asserted in examples 2 and 2A that the antiabuse rule of reg. section 1.1502-13(h)(1) applies to prevent S’s $50 of intercompany income from being redetermined to be FDDEI. However, the antiabuse rule applies only if there is “a principal purpose to avoid the purposes” of the intercompany transaction regulations. The purpose of the intercompany transaction regulations is to prevent intercompany transactions from distorting CTI or CTL (reg. section 1.1502-13(a)(1)), and this is done in part by treating S and B as divisions of a single corporation in determining “the timing, and the character, source, and other attributes” of the items attributable to an intercompany transaction (reg. section 1.1502-13(a)(2)). Because FDDEI status is an attribute of an item of income or deduction, it is squarely within the purposes of the intercompany transaction regulations for S’s $50 of intercompany income in both examples to be redetermined to be FDDEI as if the year 1 intercompany transaction had been between divisions of a single corporation. Therefore, the antiabuse rule does not apply to prevent that redetermination.

The foregoing conclusions are supported by section 250(b)(5)(C), which includes in the scope of qualifying sales and services any sales to, or services provided to, foreign related persons under some circumstances. Arguably, Congress did not have to create a similar exception for intercompany transactions in which the related party is in the United States, because income attributable to those intercompany transactions, when taken into account under the timing or acceleration rule, can qualify as FDDEI under the attribute redetermination rules. Therefore, Congress limited the exceptions in section 250(b)(5)(C) to foreign related parties.¹⁴

D. Participation Deduction

Section 245A (added by TCJA section 14101(a)) allows a 100 percent dividends received deduction (DRD) for the foreign-source portion of a dividend paid by a “specified 10-percent-owned foreign corporation”¹⁵ to a domestic corporation that is a U.S. shareholder of the foreign corporation (that is, a domestic corporation owning at least 10 percent in voting power or value of the foreign corporation’s stock, applying the constructive ownership rules of section 958(b)). There are limitations, however. For example, under section 246(c)(5),¹⁶ the deduction is not allowed unless the foreign corporation share on which the dividend is paid is owned by the domestic corporation receiving the dividend for at least 365 days during the 731-day period beginning 365 days before the date on which the share becomes ex-dividend.

According to the conference report,¹⁷ the term “dividend received” as used in section 245A is to be broadly construed. Thus, it should include items treated as dividend income, such as (1) gain on the sale of stock of a controlled foreign corporation (as defined in section 957) that is treated as a dividend under section 1248(a); (2) all earnings and profits amounts and “section 1248 amounts” included in income under section 367(b) (for example, under reg. section 1.367(b)-3 or 1.367(b)-4) that are treated as dividends under reg. section 1.367(b)-2(e)(2); and (3) boot dividends under section 356(a)(2).¹⁸ Consider the following example.

Example 3: Intercompany sale of CFC stock followed by a distribution. P, the common parent of a calendar-year consolidated group, owns all the stock of S1 (a member of the P consolidated group), and S1 owns all the stock of S2 (a member of the P consolidated group). On January 1 of year 1 (a tax year beginning after 2017), P purchases all the stock of a calendar-year foreign corporation, FC, from unrelated sellers for $50, and FC becomes a CFC wholly owned by P. FC has never generated subpart F income or income effectively connected with a business conducted in the United States. When P purchases the FC stock, FC has an accumulated E&P deficit of $20. For year 1, FC has $40 of current E&P, none of which is previously taxed income (PTI) that can be distributed tax-free under section 959:

• On June 30 of year 1, when P’s basis in the FC stock is $50, P sells all the FC stock to S1 for $80, recognizing gain of $30. Under reg. section 1.1502-80(d), section 304 does not apply to this transaction.

• After June 30 of year 1, FC incurs significant losses. On September 30 of year 1, when S1’s basis in the FC stock is $80, S1 sells all the FC stock to S2 for $20, recognizing a loss of $60. Under reg. section 1.1502-80(d), section 304 does not apply to this transaction.

• After September of year 1, FC recovers from its downturn. On June 30 of year 2, FC makes a cash distribution of $50 to S2. For year 2, FC has $20 of accumulated E&P and $0 current E&P.

During the 18-month pre-distribution period that the FC stock has been owned by P, S1, and S2, the holding period reduction rule of section 246(c)(4) does not apply to any of the FC stock owned by P, S1, or S2.¹⁹

In determining whether S2 is entitled to a participation deduction for the FC dividend, S2 (which has actually owned the FC stock for only nine months as of the FC distribution) should be allowed to tack the holding periods of P (six months as of June 30 of year 1) and S1 (three months as of September 30 of year 1) for the FC stock under reg. section 1.1502-13(c)(1)(ii)²⁰ and (j)(4).²¹ Therefore, S2 should satisfy the holding period requirement of section 246(c), and the foreign-source portion of the dividend portion of the section 301 distribution to S2 should be eligible for the participation deduction of section 245A. More on that later.

This would not be the case if the basis of the FC stock were determined by reference to the basis of other assets held by the transferee-member. For example, if FC stock were later distributed by S2 to S1 in a divisive section 355 transaction, then, because S1’s basis in the FC stock is determined under section 358 by reference to S1’s basis in its S2 stock, the tacking rule of reg. section 1.1502-13(c)(1)(ii) would not apply. Instead, S1’s holding period for the FC stock would be determined under section 1223(1) by reference to S1’s holding period for its S2 stock. Consequently, regardless of how long S2 is deemed to hold the FC stock, if S1 has not owned the S2 stock for at least 365 days before the date of a future FC dividend to S1, section 245A will not apply to the dividend.

Turning to the intercompany transaction regulations, a portion of P’s $30 of intercompany gain on its intercompany sale of FC stock to S1 must be taken into account under the timing rule of reg. section 1.1502-13(c)(2)(ii) and the multiple transactions rule of reg. section 1.1502-13(j)(4). S2’s corresponding items for the $50 distribution under its separate accounting method are $20 of dividend income (FC had $20 of E&P for year 2) and $10 of gain under section 301(c)(3) (a $30 capital distribution less FC stock basis of $20). S2’s recomputed corresponding items vis-à-vis P (the items S2 would have taken into account if the intercompany transactions had been among divisions of a single corporation) are $20 of dividend income and $0 of gain ($30 capital distribution less the $50 basis S2 would have had if P, S1, and S2 had been divisions of a single corporation). Therefore, P takes into account $10 of its $30 intercompany gain in year 2.

What are the attributes of P’s $10 of intercompany gain and S2’s $30 of corresponding income and gain? Under its separate accounting method, section 1248(a) would apply to characterize all of P’s gain as dividend income because FC had sufficient E&P ($40) to cover all the gain when P sold the FC stock to S1. However, at the time of FC’s $50 distribution to S2 in year 2, FC’s $20 of E&P was insufficient to cover both the distribution to S2 and the gain taken into account by P on the FC stock sale. Because the gain taken into account by P in year 2 is attributable solely to a capital distribution by FC to S2, FC’s E&P should be allocated entirely to the distribution FC makes to S2 in year 2 under the attribute allocation rule of reg. section 1.1502-13(c)(4)(ii). That allocation also avoids circularity in applying the timing rule to P’s gain.²² Thus, P has $10 of capital gain in year 2,²³ and S2 has $20 of dividend income qualifying for a DRD under section 245A and $10 of capital gain.

Turning to S1, under the successive intercompany transaction rule of reg. section 1.1502-13(j)(4), P, S1, and S2 are treated as divisions in applying the timing and attribute redetermination rules of reg. section 1.1502-13(c). This means that S2 is treated as having a $50 basis in the FC stock in determining its recomputed corresponding item vis-à-vis S1, with the result that S2 would not have recognized $10 of gain under section 301(c)(3) on receipt of the $30 capital distribution. Thus, the difference between S2’s corresponding item ($10 of gain) and recomputed corresponding items (no gain or loss) is $10. Accordingly, S1 takes into account $10 of loss in year 2. That loss is a capital loss; is not redetermined to be a noncapital, nondeductible expense; and is not subject to deferral under reg. section 1.267(f)-1(c). This is because the loss is required to be taken into account under the intercompany transaction rules and is not required to be redetermined under those rules to be a noncapital, nondeductible expense.

The bottom line for year 2 for the P group is $20 of FC dividend income, for which a $20 DRD is allowed under section 245A, and $0 net capital gain or loss (P’s $10 of capital gain is offset by S1’s $10 capital loss). This is the same result that would have applied if P, S1, and S2 had been divisions of a single corporation and the intercompany transactions had occurred among those divisions.

Example 3A: Taxable sale of CFC stock to unrelated buyer. The facts are the same as Example 3. Nothing else happens regarding FC until January 1 of year 4, when S2 sells all the stock of FC to X, an unrelated buyer, for $100. At the end of year 4, FC has $70 of current and accumulated E&P, and it makes no distributions to any shareholder for year 4.

At the time of the year 4 sale, S2’s basis in the FC stock is $0, thanks to the capital distribution on June 30 of year 2 in Example 3. Thus, S2 recognizes $100 of gain on the sale to X. For P, S2’s recomputed corresponding item is $80 of gain (amount realized of $100 less P’s $50 basis in the FC stock reduced by the $30 year 2 capital distribution), and for S1, S2’s recomputed corresponding item is $50 of gain (amount realized of $100 less S1’s $80 basis in the FC stock reduced by the $30 year 2 capital distribution). Consequently, (1) P’s remaining $20 of its $30 of intercompany gain is taken into account in year 4 under the timing rule (the difference between S2’s $100 corresponding item and its $80 recomputed corresponding item), and (2) S1’s remaining $50 of its $60 of intercompany loss is taken into account in year 4 under the timing rule (the difference between S2’s $100 corresponding item and its $50 recomputed corresponding item).

There is $70 of FC E&P for year 4 to be allocated between P’s $20 of gain and S2’s $100 of gain to determine the extent to which that gain is treated as dividend income under section 1248(a). Because all of P’s $30 of intercompany gain in year 1 would have been treated as dividend income under section 1248(a) had the transaction not been an intercompany transaction, it appears that the proper allocation of the FC E&P for year 4 under reg. section 1.1502-13(c)(4)(ii) is $20 to P and $50 to S2. Therefore, assuming all of FC’s E&P is foreign-source, P should be entitled to a $20 DRD under section 245A, and S2 should be entitled to a $50 DRD under section 245A.

E. Calculation of DTIR

As discussed in Section III.B, in determining the FDII portion of the deduction allowed under section 250(a), DEI is reduced by the taxpayer’s deemed tangible income return (DTIR). DTIR is equal to 10 percent of the taxpayer’s qualified business asset investment (QBAI), generally defined as its average quarterly basis in tangible, depreciable property.²⁴ Interestingly, regardless of whether single-entity or separate-entity principles are applied in determining the DTIR of consolidated group members, an intercompany transaction involving a tangible, depreciable asset can materially distort the computation of FDII and DTIR.

Example 4: Intercompany sale of tangible, depreciable property. S, a member of the P consolidated group, owns Machine, which has a $300 basis and a $100 fair market value. Machine is the only depreciable tangible asset owned by the group. On January 1 of year 1, S sells Machine to B, another member of the P consolidated group, for $100, recognizing a section 1231 loss of $200. B depreciates Machine on a straight-line basis over four years and takes into account a $25 depreciation deduction in year 1. Under the timing rule of reg. section 1.1502-13(c)(2)(ii), S takes into account $50 of its $200 section 1231 loss from the intercompany sale of Machine in year 1 (the difference between B’s $25 depreciation deduction and the $75 depreciation deduction B would have taken into account if S and B had been divisions, such that B’s basis in Machine would have been $300).

In determining the QBAI of the consolidated group, if the intercompany transaction is taken into account under section 250(b)(2)(B), the QBAI for year 1 (that is, the average quarterly basis of Machine in year 1) is $84.38.²⁵ Absent the intercompany transaction, the group’s year 1 QBAI would have been $253.13.²⁶ Thus, the group lowers its consolidated DTIR from $25.313 (10 percent of $253.13) to $8.438 (10 percent of $84.38). This $16.875 reduction in DTIR alone increases the P group’s FDII deduction by $6.33 (37.5 percent of $16.88), which can be meaningful if you put five or six zeros behind it.

Further, if section 250 is applied on a separate entity basis to each of S and B, the intercompany transaction would have the desirable result of eliminating S’s large QBAI for year 1 at the expense of increasing B’s QBAI by only one-third of the amount of S’s reduction. The quid pro quo is that S’s DEI, as determined under section 250(b)(3)(A), is decreased by the $50 loss taken into account by S in year 1. This, however, may be a good outcome because the $50 loss replaces a $75 depreciation deduction. For example, if B has little or no separately determined DEI, then, as a result of the intercompany sale of Machine, S has both a $25 increase in its separately determined DEI and a reduction in its DTIR from $25.313 to $0 without any adverse section 250 consequences to B.²⁷

On the other hand, if the components of FDII are determined on a consolidated basis, the only benefit from the intercompany sale of Machine is the reduction in DTIR from $25.313 to $8.438. Consolidated DEI for year 1 will still be reduced by $75 (now by the sum of S’s $50 loss plus B’s $25 depreciation deduction rather than by a single $75 depreciation deduction incurred by S) such that the only benefit is the $16.88 decrease in the group’s DTIR. Nonetheless, there seems to be no downside in trying to achieve this more modest $6.33 increase in the group’s consolidated FDII deduction.

It seems highly unlikely that Treasury and the IRS would allow an intercompany transaction like the one in Example 4 to have this effect on a section 250 deduction because, without the increase in the section 250 deduction, the transaction has absolutely no effect on the group’s CTI.²⁸ Section 951A(d)(4) authorizes broad antiabuse rules for purposes of determining a corporation’s QBAI, including a rule addressing transfers of tangible, depreciable property in which avoidance is a motivating factor. Also, reg. section 1.1502-13(h)(1) contains an antiavoidance rule that prevents an intercompany transaction from distorting CTI if a principal purpose for undertaking the transaction is to avoid the purposes of reg. section 1.1502-13.²⁹ Given the material increase in the FDII portion of the section 250 deduction resulting from the intercompany transaction in Example 4, it seems likely that the IRS would assert either or both sets of antiabuse rules with a high probability of success. Because the antiabuse rules require some degree of mens rea, one may wonder, however, whether relying on an antiabuse rule to reach a better answer in Example 4, considering the administrative difficulties that would be encountered, is a good policy answer. Thus, it would not be surprising if regulations implementing section 250 address these intercompany transactions by reversing or disregarding their effects.

F. Limitation on Interest Deductions

Section 163(j)(1)(A) and (B) limits a taxpayer’s business interest deduction to the sum of its business interest income plus 30 percent of its adjusted taxable income. Section 163(j)(8) defines adjusted taxable income as the taxable income for the year (1) decreased by any business interest income; (2) decreased by any income or gain, and increased by any deduction or loss, that is not properly allocable to a trade or business;³⁰ (3) increased by a net operating loss deduction under section 172; (4) increased by any deductions for interest or taxes; and (5) increased by any depreciation or amortization deductions, but eliminating the addback of depreciation and amortization expense for tax years beginning after 2021. Although the limitation will likely be applied to consolidated groups on a single-entity basis,³¹ intercompany transactions can still create distortions.

Example 5: Intercompany transaction increases section 163(j)(1)(B) limitation. P owns all the stock of S, with which P files a consolidated return on a calendar-year basis. Without regard to intercompany items, P and S have the following items, as summarized in Table 1, for year 1.

Table 1

Member	Separate Taxable Income	Business Interest Deduction	Depreciation Amortization	Separate Adjusted Taxable Income	Section 163(j) Limitation
P	$500	-$650	-$350	$1,500	$450
S	$400	$0	-$100	$500	$150
Consolidated	$900	-$650	-$450	$2,000	$600

At the beginning of year 1, P sells a zero-basis depreciable asset (Machine) with a value of $1,000 to S, recognizing $1,000 of gain that is deferred under reg. section 1.1502-13. S depreciates Machine over four years on a straight-line basis and is entitled to a depreciation deduction of $250 in year 1. Under reg. section 1.1502-13(c)(1)(i) and (c)(2)(ii), P takes into account $250 of ordinary income in year 1 in connection with the intercompany sale of Machine, which is offset in the year 1 consolidated return by S’s $250 depreciation deduction.

Although the group’s CTI remains $900 for year 1 (assuming all of P’s business interest expense is deductible), P’s separate taxable income is increased from $500 to $750 because of P’s $250 of intercompany income, and S’s separate taxable income is decreased from $400 to $150 because of S’s additional $250 of depreciation deduction. Thus, if the intercompany sale of Machine is given effect for purposes of section 163(j), the relevant items are adjusted as summarized in Table 2.

Table 2

Member	Separate Taxable Income	Business Interest Deduction	Depreciation Amortization	Separate Adjusted Taxable Income	Section 163(j) Limitation
P	$750	-$650	-$350	$1,750	$525
S	$150	$0	-$350	$500	$150
Consolidated	$900	-$650	-$700	$2,250	$675

Even though the $250 of additional income to P and depreciation to S has no effect on the group’s CTI (it remains $900), (1) on a separate-entity basis, P’s adjusted taxable income is increased by $250, from $1,500 to $1,750, thereby increasing P’s separately determined section 163(j) limitation by $75, from $450 to $525; and (2) on a consolidated basis, if S’s additional $250 of depreciation deduction is added back to CTI in computing the group’s consolidated adjusted taxable income, the group’s consolidated adjusted taxable income is increased by $250, from $2,000 to $2,250, and its consolidated section 163(j) limitation is increased from $600 to $675. It would be surprising if Treasury and the IRS were to allow such a relatively simple (and completely harmless) transaction to materially increase the group’s section 163(j) limitation, whether determined on a single-entity or separate-entity basis.

The IRS is not without weapons to combat the distortion in the P group’s adjusted taxable income caused by the intercompany sale of Machine in Example 5. A good argument can be made that because a principal purpose of the intercompany transaction is to distort CTI by increasing the group’s business interest deduction through an increase in its adjusted taxable income within the meaning of section 163(j)(8), an adjustment must be made under the antiabuse rule of reg. section 1.1502-13(h)(1) that eliminates the $250 increase in P’s adjusted taxable income. For example, P’s $250 of income could be redetermined to be excluded from gross income, and S’s $250 depreciation deduction could be redetermined to be a noncapital, nondeductible expense. Because the antiabuse rules require that P act with a principal purpose of reducing CTI or CTL, one may wonder, however, whether relying on the antiabuse rule to reach a better answer in Example 5, considering the administrative difficulties that would be encountered, is a good policy answer.

G. Conclusion

The foregoing indicates that as a general proposition, the application of the timing, acceleration, and attribute redetermination rules of reg. section 1.1502-13(c) and (d) produce appropriate results under the TCJA (for example, sections 245A, illustrated by examples 3 and 3A, and section 250(b)(4), illustrated by examples 2 and 2A). That is not always the case, however. In some situations it may be necessary to adjust the application of the intercompany transaction rules to reach a proper result under the TCJA, as illustrated in Example 4 (section 250(b)(2)(B)) and Example 5 (section 163(j)(8)). In those special cases, additional rules may be required to disregard or reverse the effect of an intercompany transaction. While one or more antiavoidance rules (such as section 951A(d)(4) or reg. section 1.1502-13(h)(1)) might apply in cases like examples 4 and 5 to set things straight, it seems likely that Treasury and the IRS would not view reliance on those rules as adequate.

III. GILTI, Related Deductions, and Credits

A. Section 951A

To discourage U.S. multinationals from deferring tax on income derived from the use of intangible property by foreign corporations in tax havens or low-tax jurisdictions, section 951A, enacted by TCJA section 14201(a), creates a new item of income attributable to a U.S. shareholder’s interest in one or more CFCs, called global intangible low-taxed income.³² Section 951A is a stick designed to punish U.S. multinationals that own intangible property outside the United States and use it to earn income on which tax is otherwise deferred until repatriated. This punishment is made more poignant by Congress’s failure to enact the carrot (proposed section 966³³) designed to entice U.S. multinationals to move intangible property back to the United States. Moreover, TCJA section 14221(a), effective for tax years beginning after 2017, amended section 936(h)(3)(B) to include goodwill and going concern value in the definition of intangible property subject to imputed royalty income under section 367(d) when transferred to a foreign corporation in a nonrecognition transaction (for example, under section 351 or 361). Thus, there is much to encourage retention of intangible property in the United States and nothing to encourage or facilitate the movement of intangible property owned abroad back to the United States.

Turning to the statute, GILTI is the excess of the shareholder’s net CFC tested income for the year over its net deemed tangible income return (NDTIR) for the year.³⁴ The net CFC tested income of a U.S. shareholder³⁵ for a tax year of the shareholder is the excess of (1) the aggregate of the shareholder’s pro rata shares of the tested income of each CFC for which the shareholder is a U.S. shareholder for the tax year (determined for each tax year of that CFC that ends in or with the tax year of the U.S. shareholder), over (2) the aggregate of the shareholder’s pro rata share of the tested loss of each CFC for which the shareholder is a U.S. shareholder for that tax year (determined for each tax year of the CFC that ends in or with the tax year of the U.S. shareholder).³⁶ For this purpose, tested income of a CFC is the amount by which its gross income (subject to some adjustments³⁷) exceeds the deductions (including taxes) properly allocable to its gross income (as adjusted) under the principles of section 954(b)(5).³⁸ Tested loss of a CFC is the amount by which its deductions (including taxes) that are properly allocable under the principles of section 954(b)(5) to its gross income (as adjusted) exceed the CFC’s adjusted gross income.³⁹

The most significant adjustment to gross income in determining tested income and tested loss is the exclusion of high-tax income described in section 954(b)(4) (that is, income subject to an effective rate of foreign income tax of at least 18.9 percent (90 percent of the maximum federal income tax rate under section 11)).⁴⁰ Notably, net CFC tested income is determined on an aggregate basis and can exist only if the taxpayer’s aggregate, pro rata shares of the tested income of all CFCs for which the taxpayer is a U.S. shareholder for the tax year exceeds the taxpayer’s aggregate, pro rata shares of the tested loss of all CFCs for which the taxpayer is a U.S. shareholder for the tax year.

The U.S. shareholder’s NDTIR for each tax year is also determined on an aggregate basis. A shareholder’s NDTIR for a tax year is the excess of (1) 10 percent of the aggregate of the shareholder’s pro rata shares of the QBAI of each CFC for which the shareholder is a U.S. shareholder for the tax year (determined for each tax year of each such CFC that ends in or with the tax year of that U.S. shareholder), over (2) the amount of interest expense taken into account in determining the shareholder’s net CFC tested income for the tax year to the extent the interest income attributable to that expense is not taken into account in determining the shareholder’s net CFC tested income.⁴¹

The term “qualified business asset income” means, for any CFC for any tax year, the average of the corporation’s aggregate adjusted bases as of the close of each quarter of the tax year in specified tangible property used in a trade or business and for which depreciation under section 167 (or amortization in lieu of depreciation) is allowed.⁴² Section 951A(d)(2) defines specified tangible property as (1) any tangible property used in the production of tested income for which depreciation deductions (or amortization deductions in lieu of depreciation) are allowed; and (2) for depreciable tangible property used in the production of both tested income and income that is not tested income, the portion of the property equal to the proportion that the gross income of the CFC attributable to the use of the property that is taken into account in determining the CFC’s tested income or tested loss bears to the total income attributable to the use of the property. To prevent distortions of a taxpayer’s QBAI, section 951A(d)(4) contains two antiabuse rules, one of which applies to transitory transfers or ownership of property, and the second of which applies when avoidance of the QBAI rules is a factor in the transfer or ownership of property.

Finally, section 951A(f)(1) treats a GILTI inclusion as a subpart F inclusion for purposes of sections 168(h)(2)(B), 535(b)(10), 851(b), 904(h)(1), 959, 961, 962, 993(a)(1)(E), 996(f)(1), 1248(b)(1), 1248(d)(1), 6501(e)(1)(C), 6654(d)(2)(D), and 6655(e)(4) (and as may be provided in regulations). Section 951A(f)(2) increases CFC stock basis by allocating the inclusion among the shares of all CFCs owned by the U.S. shareholder that have positive tested income in proportion to the shareholder’s pro rata share of the CFCs’ respective amounts of positive tested income. In the consolidated return context, not only does an allocation of GILTI to the stock of a CFC held by a subsidiary give rise to basis and a previously taxed E&P account under sections 959 and 961 for the CFC stock, but the GILTI increase in the basis of CFC stock directly held by the subsidiary during a consolidated return year gives rise to a positive adjustment to the basis of the subsidiary’s stock under reg. section 1.1502-32(b)(2)(i). Notably, no investment adjustment is made to reflect that a member’s tested loss or QBAI is used to reduce the consolidated group’s GILTI inclusion. That is because neither of those GILTI components has any effect on the inside asset basis of the consolidated group member; they are used solely in calculating the group’s GILTI inclusion for the tax year in question.

B. Related Deductions

To encourage domestic corporations to maximize their export profits and provide a partial participation exemption for GILTI inclusions,⁴³ section 250 (enacted by TCJA section 14202(a)) entitles a domestic corporation to an annual deduction equal to the sum of (1) 37.5 percent (21.875 percent for tax years beginning after 2025) of its FDII for the tax year, plus (2) 50 percent (37.5 percent for tax years beginning after 2025) of the sum of (A) the GILTI amount (if any) included in the gross income of the domestic corporation under section 951A for that tax year, plus (B) any amount treated as a dividend received by the domestic corporation under section 78 (the gross-up for creditable foreign income taxes) that is attributable to the GILTI amount.⁴⁴ If the sum of the domestic corporation’s FDII and GILTI for a tax year exceeds its taxable income for the year, then, solely to determine the corporation’s section 250 deduction, (1) FDII is reduced by the excess of the sum of FDII and GILTI over taxable income times a fraction, the numerator of which is FDII and the denominator of which is the sum of FDII and GILTI, and (2) GILTI is reduced by the remainder of the excess.⁴⁵

FDII for a tax year is determined under section 250(b) by the following computations:

• First, the domestic corporation’s DEI is determined to be the excess of (1) its gross income, less any subpart F inclusion, GILTI inclusion, financial services income (as defined in section 904(d)(2)(D)), dividend income from a CFC, foreign branch income (as defined in section 904(d)(2)(J)), and domestic oil and gas extraction income (determined under section 907(c)(1) by substituting “within the United States” for “without the United States”), over (2) the deductions (including taxes) properly allocable to that gross income.⁴⁶

• Second, the corporation’s FDDEI is determined to be the portions of DEI attributable to either or both (1) property sold to a foreign person that the taxpayer establishes is for foreign use, and (2) services provided to a person, or in connection with property, that the taxpayer establishes is outside the United States.⁴⁷ Section 250(b)(5)(B)(i) generally provides that a sale of property to another person (other than a related party) for further manufacture or other modification in the United States does not qualify as sold for foreign use, even if the buyer later uses the property outside the United States. Section 250(b)(5)(C) contains exceptions to the foregoing general rule for sales to related parties that are not U.S. persons (for example, the foreign use requirement is satisfied if the foreign related party later sells the property to an unrelated buyer and establishes that the property is used by the unrelated buyer outside the United States). For additional discussion, see Section II.C.

• Third, the DTIR of the domestic corporation is determined by multiplying the corporation’s QBAI by 10 percent. QBAI is determined as provided in section 951A(d) (discussed in Section III.A) by substituting “deduction eligible income” for “tested income” in paragraph (2) and without regard to whether the corporation is a CFC.⁴⁸ Unlike NDTIR in the GILTI computation, DTIR is not reduced by interest expense incurred by the taxpayer.⁴⁹ Finally, the antiabuse rules of section 951A(d)(4) (summarized in Section III.A) presumably apply in determining a taxpayer’s QBAI under section 250(b)(2)(B).

• Fourth, FDII is then determined under this formula: FDII = (DEI - DTIR) x (FDDEI/DEI).⁵⁰

C. Related Foreign Tax Credits

The TCJA has made significant changes to the foreign tax credit regime of sections 901-909 and section 960,⁵¹ effective for tax years of a foreign corporation beginning after 2017 and for tax years of U.S. shareholders with or in which the tax year of the foreign corporation ends.⁵² The principal changes are to the provisions allowing FTCs and those limiting the FTC.

1. Provisions allowing credits.

Section 902 is repealed by TCJA section 13301(a), meaning a domestic corporation owning 10 percent or more of the stock of a foreign corporation is no longer entitled to claim an FTC for a distribution from the foreign corporation for any creditable foreign tax expense of the foreign corporation associated with the distributed earnings. Presumably, the reason for this repeal is that the participation deduction of section 245A replaces the FTC previously allowed by section 902 for dividends paid by a foreign corporation to a 10 percent shareholder that is a domestic corporation.⁵³

Also, section 960 is amended by TCJA section 13301(b) to limit its provisions to domestic corporations (for example, an individual U.S. shareholder of a CFC incurring a section 951(a) inclusion is no longer entitled to claim an FTC for any creditable foreign tax expense of the CFC attributable to the subpart F income resulting in the inclusion). Thus, for domestic corporations, FTCs are now available solely under section 901 (foreign taxes directly paid by the domestic corporation or a disregarded entity owned by the corporation) or section 960 for (1) subpart F inclusions (including section 956 inclusions) under section 951(a); (2) the one-time deemed subpart F inclusion under section 965 (subject to the FTC reduction required by section 965(g)); (3) GILTI inclusions under section 951A; and (4) some distributions of previously taxed income.

In the GILTI context, section 960(d)(1) allows a domestic corporation having a GILTI inclusion for a tax year to take into account an FTC for each CFC having tested income taken into account in determining the inclusion (that is, each CFC with tested income of which the domestic corporation is a U.S. shareholder, as defined in section 951(b)). The amount of the allowed credit is 80 percent of the creditable foreign tax expense of the CFC properly attributable to its tested income, times a fraction (the allocation fraction), the numerator of which is the domestic corporation’s GILTI inclusion and the denominator of which is the total amount of tested income taken into account in determining the domestic corporation’s GILTI inclusion.⁵⁴ Under section 78, the gross-up for an FTC allowed under section 960(d) is determined without regard to the 80 percent haircut; that is, the gross-up equals the creditable foreign tax expense times the allocation fraction. Once the amount of allowable FTCs for a domestic corporation is determined under section 960(d), the section 904 limitation is applied to determine how much of the allowed FTCs is permitted to reduce the domestic corporation’s tax liability.

2. Limitations on credits.

Section 904(a) generally limits the amount of FTC that can be claimed for a tax year against a taxpayer’s federal income tax liability to the product of the federal income tax incurred for the year times a fraction (not exceeding 1), the numerator of which is the portion of the taxable income for the year derived from sources outside the United States and the denominator of which is total taxable income for the year. Further, section 907(a) generally reduces any foreign oil and gas taxes otherwise creditable under section 901 for a tax year by the excess of those taxes over the product of the foreign oil and gas income for the year times, for a corporation, the highest rate of tax specified by section 11(b) (that is, 21 percent for tax years beginning after 2017).

The principal changes to the FTC limitation of section 904 are:

• section 904(b)(5) was added, which provides that a domestic corporation that is a U.S. shareholder of a foreign corporation (that is, a domestic corporation entitled to a participation deduction under section 245A for the foreign-source portion of dividends received from the foreign corporation) determines its income from sources outside the United States without regard to either (1) the foreign portion of any dividend from the foreign corporation or (2) any deductions allocable to the stock, or to any income (other than subpart F income or GILTI) attributable to the stock, of the foreign corporation; and

• section 904(d) creates new FTC baskets (that is, categories of income requiring the separate application of the section 904(a) limitation).

The baskets now requiring separate application of the limitation under section 904(d)(1) are (1) any GILTI amount includable in gross income under section 951A (other than passive category income),⁵⁵ (2) foreign branch income,⁵⁶ (3) passive category income,⁵⁷ and (4) general category income.⁵⁸

In the consolidated return context, reg. section 1.1502-4 requires the computation of FTCs and the former section 904 limitation in effect before the changes made by the TCJA on a consolidated basis. Reg. section 1.1502-9 generally does the same for overall foreign losses and overall domestic losses under former section 904(f) and (g). The basketed FTC limitations of section 904 (including the new basket for GILTI and foreign branch income found in section 904(d)(1)(A) and (B)⁵⁹) likely (if not certainly) will be applied on a consolidated, basket-by-basket basis under rules similar to reg. section 1.1502-4(h). The principal reason for this is to prevent distortions of the limitations by, for example, locating deductions properly allocable against a basket of foreign-source income in one or more members having no meaningful amount of high-tax foreign-source income in that basket, thereby increasing the section 904 limitation for those members having substantial amounts of high-tax foreign-source income falling within the basket. Thus, there should be little doubt that new provisions in sections 901 and 904 (for example, the new baskets for foreign branch income and section 951A income) will also be applied on a consolidated basis.

D. Single- vs. Separate-Entity Treatment

There are several settings in which separate- versus single-entity treatment under sections 250, 951A, and 960(d) can make a significant difference. The following illustrates a few of those settings.

1. Determining NDTIR.

As discussed in Section III.A, NDTIR (10 percent of QBAI minus specified interest expense) is subtracted in determining a taxpayer’s GILTI inclusion. Hence, the larger the NDTIR, the smaller the income inclusion. In determining the amount of a corporation’s GILTI inclusion under section 951A for a tax year, the corporation’s aggregate NDTIR for each specified foreign corporation of which it is a 10 percent shareholder must be determined and subtracted from net CFC tested income. As discussed above, section 951A(b)(2) defines NDTIR for a tax year as the excess of (1) 10 percent of the aggregate of the shareholder’s pro rata shares of the QBAI of each CFC for which the shareholder is a U.S. shareholder for the tax year (determined for each tax year of each CFC that ends in or with the tax year of the U.S. shareholder), over (2) the amount of interest expense taken into account in determining the shareholder’s net CFC tested income for the tax year to the extent the corresponding interest income attributable to that expense is not taken into account in determining the shareholder’s net CFC tested income.⁶⁰ Should single-entity principles apply in determining whether interest expense is disregarded in computing NDTIR?

Example 6: Interest expense and NDTIR. P, the common parent of a consolidated group, owns all the stock of S, a member of the group, and all the stock of FC1, a CFC. S owns all the stock of FC2, a CFC. For year 1, FC1 incurs a $10 interest expense on debt owed to FC2 that reduces FC1’s tested income by $10 and increases FC2’s tested income by $10. Neither FC1 nor FC2 has any subpart F income or income that is effectively connected with the conduct of a trade or business in the United States for year 1.

If single-entity principles apply for purposes of section 951A, FC1’s $10 of interest expense is not taken into account in determining the group’s consolidated NDTIR for the tax year under consideration because the “single corporation” composed of P and S takes into account the entire $10 of interest income of FC2 in determining consolidated net CFC tested income. If separate-entity principles are applied, none of FC1’s $10 of interest expense is disregarded in determining P’s NDTIR, because none of the interest expense increases P’s separately determined net CFC tested income.

If the interest expense incurred by FC1 in year 1 had reduced FC1’s subpart F income or effectively connected income, the interest income would not be excluded from FC2’s subpart F income under the look-through rule of section 954(c)(6) and, hence, would not increase FC2’s tested income for the tax year under section 951A(c)(2)(A)(i)(II). Thus, in cases like Example 6, interest expense paid by one CFC to another related CFC is excluded in determining the corporate U.S. shareholder’s NDTIR (1) only if section 951A applies on a consolidated basis, and then (2) only to the extent the interest income is excluded from the payee-CFC’s subpart F income under the look-through rule.

2. Determining net CFC tested income.

In addition to differences in determining amounts of NDTIR under section 951A(b)(2), a major difference can result in the determination of the amounts of net CFC tested income and section 250 deductions, depending on whether separate- or single-entity principles are applied.

Example 7: Computation of GILTI and FDII in consolidation. P, S1, S2, and S3 are members of a calendar-year consolidated group of which P is the common parent. P owns all the stock of S1 and S2, and S2 owns all the stock of S3 and FC2, a CFC. S1 owns all the stock of FC1, a CFC. S3 owns 50 percent of the stock of FC3, a CFC, and FC1 owns the remaining 50 percent of FC3. For year 1 (a pre-2026 tax year), (1) P’s sole source of income is $1,000 of profit from P’s production of widgets in the United States and sale of the widgets in Europe, all of which qualifies as FDDEI;⁶¹ (2) in addition to its ownership of all the stock of S1 and S2, P directly owns throughout year 1 specified tangible property qualifying as QBAI under section 951A(d) with an average quarterly basis of $1,100; (3) the CFCs have the GILTI components summarized in Table 3 below; and (4) the only other income or deduction of the P group in addition to P’s manufacturing profits and the subsidiaries’ GILTI inclusions is a $300 NOL originated by S1 through a domestic real estate venture.

The GILTI components of FC1, FC2, and FC3 are as follows:

Table 3

CFC	Section 951A(c)(2) Tested Income (loss)	Section 951A(d)(1) QBAI
FC1	$400	$100
FC2	-$250	$200
FC3	$50	$600
Consolidated	$200	$900

From Table 3, one can readily see that, on a separate-entity basis, S1 is the only member with net CFC tested income of $385, equal to the sum of $25 (50 percent of FC3’s $50 of tested income) + $400 (all of FC1’s tested income) - 10 percent x ($100 (FC1’s QBAI) + $300 (50 percent of FC3’s $600 of QBAI)) = $425 - $40 = $385.⁶² By contrast, on a single-entity or consolidated basis, the P group’s net CFC tested income is only $110 (consolidated tested income of $200 - 10 percent of the $900 aggregate QBAI of FC1, FC2, and FC3). The reason for this significant difference is that FC2’s tested loss of $250 is wasted under separate-entity principles.

a. Separate-entity application.

If the provisions of sections 951A and 250 are applied on a separate-entity basis, the year 1 income and deductions of the members of the P group are as summarized in Table 4.

Thus, applying separate-entity principles in calculating GILTI inclusions and the P group’s section 250 deduction results in CTI of $708.75 (P’s $1,000 of foreign sales profits, plus S1’s $385 GILTI inclusion, minus S1’s $300 real estate NOL, minus P’s $333.75 separate section 250 deduction, and minus S1’s $42.50 separate section 250 deduction).

b. Single-entity application.

If both GILTI and the section 250 deduction are determined on a consolidated basis, the computations for year 1 would be as summarized in Table 5.

Under section 250(a)(2), the $190 excess of “consolidated” FDII/GILTI over pre-deduction CTI is allocated $169.10 to P’s $890 of FDII ($190 x $890/$1,000), reducing that deduction factor to $720.90, and allocated $20.90 to S1’s $110 of GILTI, reducing that deduction factor to $89.10. Thus, the consolidated section 250 deduction is $314.89 (37.5 percent of $720.90 + 50 percent of $89.10).

Table 4

Member	FDDEI	GILTI	NOL	Pre-Section 250 Separate Taxable Income	Section 250 Deduction
P	$890a	$0	$0	$1,000	37.5% x $890 = $333.75
S1	$0	$385	-$300-	$85	50% x $85 = $42.50b
S2	$0	$0	$0	$0	$0
S3	$0	$0	$0	$0	$0
aP’s FDDEI is its $1,000 of profit from foreign widget sales less 10 percent of P’s DTIR of $1,100, or $1,000 - $110 = $890. bUnder section 250(a)(2), if a corporation’s FDII and GILTI exceed its taxable income (here S1’s $385 of GILTI exceeds its $85 of taxable income (GILTI of $385 minus the $300 NOL) by $300), then the excess reduces the corporation’s FDII and/or GILTI. The $300 excess is allocated proportionately between FDII and GILTI, and the amount allocated to each reduces the amount that goes into the computation of the deduction. Because S1 has no FDII, all of the $300 reduction is allocated to S1’s GILTI, meaning the amount of S1’s separately determined section 250 deduction is $42.50 (50 percent of $85).

Therefore, if both provisions (sections 250 and 951A) are applied on a consolidated basis in this example, CTI would be $495.11 (P’s $1,000 of foreign sales profits, plus S1’s $110 GILTI inclusion, minus S1’s $300 real estate NOL, and minus the $314.89 consolidated section 250 deduction).

Note that if the computations are made on a separate-entity basis, the P group’s year 1 CTI is $708.75, which well exceeds its CTI of $495.11 if the provisions are applied on a single-entity basis. Also note that if the computations are made on a separate-entity basis, the total section 250 deduction for year 1 is $376.25, which well exceeds the $314.89 deduction if the provisions are applied on a single-entity basis. Thus, making the GILTI and FDII computations on a separate-entity basis overstates the P group’s CTI by $213.64 and overstates the amount of the section 250 deduction for year 1 by $61.36.

Table 5

Member	Consolidated Pre-Section 250 Taxable Income	FDII/ GILTI	Excess FDII/GILTI Over Taxable Income
P	$1,000	$890
S1	$110a - $300 = -$190	$110	$1,000 - $810 = $190
	$810	$1,000

c. Separate-entity with restructuring.

Suppose that on the last day of the tax year ending before year 1, S2 merges into S1 in a tax-free reorganization, and S3 merges into S1 in a tax-free reorganization or section 332 liquidation. Thus, on the first day of year 1 S1 directly and indirectly owns all the stock of FC1, FC2, and FC3. Suppose further that the GILTI and section 250 calculations are made on a separate-entity basis. Because S1’s $300 real estate NOL does not reduce P’s $1,000 of separate taxable income from its foreign manufacturing and sales operations, there is no section 250(a)(2) reduction in P’s FDII of $890 (that is, P’s separately computed section 250 deduction is $333.75, or 37.5 percent of $890). S’s separately computed GILTI inclusion, however, is now $110 because S1 directly and indirectly owns all the stock of FC1, FC2, and FC3 and, hence, may use FC2’s $250 of tested loss to offset the entire $450 of tested income of FC1 and FC3, resulting in a GILTI inclusion of $110 (net CFC tested income of $200 less DTIR of $90). S1’s separate taxable income now becomes an NOL of $190 (a $110 GILTI inclusion less the $300 real estate NOL), and section 250(a)(2) eliminates S1’s GILTI for purposes of the section 250 deduction. Consequently, the only section 250 deduction for year 1 is that allowed to P under separate-entity principles ($333.75). Therefore, for year 1, the P group’s CTI would be $476.25 (P’s $1,000 of taxable income, minus S1’s $190 NOL, minus P’s section 250 deduction of $333.75).⁶³ In short, applying the GILTI and section 250 provisions on a separate-entity basis gives the P group a transactional election (merging S2 and S3 into S1) that understates its CTI (a reduction of $18.86, from $495.11 to $476.25) by overstating its section 250 deduction (an increase of $18.86, from $314.89 to $333.75).

The reason for the overstatement of the section 250 deduction is that S1’s $190 NOL is not taken into account as a reduction in P’s $890 of FDII under section 250(a)(2). This would not happen if the provisions of section 250 are applied on a consolidated basis. Thus, while one can hardly quibble with the goal of bringing FC2’s $250 tested loss into position to be netted against the $450 of tested income of FC1 and FC3, one might question whether preventing S1’s NOL from reducing P’s FDII is an appropriate result.

d. What happens to consolidated items?

Not only would separate-entity applications of sections 250 and 951A present opportunities for a restructuring that lowers CTI (from $495.11 to $476.25 in Example 7), but it would create difficulties in allocating consolidated items (such as consolidated capital gain net income described in reg. section 1.1502-11(a)(3)). For example, suppose that in year 1, in addition to P’s $1,000 of separate taxable income from the manufacture and sale of widgets, the group has $100 of consolidated capital gain net income, composed of a $400 capital gain recognized by P and a $300 capital loss recognized by S1. How is this consolidated item to be allocated in determining the separate DEI of P and S1? Would P’s separate DEI be unchanged, or would it be increased? If increased, would the increase be $100 or $400? Would S1’s separate DEI be unchanged, or would it be decreased by $300? What would happen under separate-entity principles if the numbers were reversed, such that the group has a $100 consolidated capital loss carryover from year 1 composed of a $300 P capital gain and a $400 S1 capital loss?

3. Bringing foreign tax credits into the mix.

As discussed above, section 960(d) allows a corporate U.S. shareholder of a CFC a deemed-paid FTC for 80 percent of any creditable foreign tax expense of the CFC attributable to the portion of the tested income of the CFC taken into account in determining the U.S. shareholder’s GILTI inclusion. The allowed FTC equals the total creditable foreign tax expense paid by the CFC times 80 percent times the shareholder’s GILTI inclusion divided by the shareholder’s aggregate tested income. Section 78 will increase the U.S. shareholder’s income inclusion for the CFC in an amount equal to the CFC’s deemed-paid FTC without the 80 percent haircut. As noted earlier, the allowed GILTI credit is also limited by section 904, which creates a new GILTI FTC basket.

In examples 8 and 9 below, because all the P group’s CTI is GILTI, the group’s section 904(d)(1)(A) limitation is 100 percent (that is, the amount of FTC allowed to reduce the group’s CTL is not reduced under section 904).⁶⁴ Note, however, that the section 904(d)(1)(A) limitation will almost certainly be applied on a single-entity basis under reg. section 1.1502-4 for the reasons discussed above. Although this does not alter any of the results in examples 8 and 9, that may not always be the case.

Example 8: Positive and negative GILTI from different high-tax and low-tax CFCs held by different members: Separate entity beats single entity. P is the common parent of a consolidated group that includes S1 and S2. P owns all the stock of S1 and S2. S1 owns all the stock of FC1 and FC2, which are both CFCs. S2 owns all the stock of FC3, also a CFC.

For year 1, (1) the P group’s only items of income, gain, deduction, and loss are the GILTI items attributable to FC1, FC2, and FC3; (2) FC1, FC2, and FC3 incur no interest expense and have no QBAI; and (3) FC1, FC2, and FC3 have the following section 951A items:

Table 6

CFC Attributes	FC1	FC2	FC3
U.S. shareholder	S1	S1	S2
Tested income/(loss)	$1,000	-$800	$2,000
Foreign tax rate	5%	10%	15%
Foreign tax paid	$50	$0	$300

As a single entity, the P group has $3,000 of aggregate tested income attributable to FC1 and FC3, an $800 tested loss attributable to FC2, and $350 of creditable foreign tax expense ($50 paid by FC1 and $300 paid by FC3). As will be seen, under these facts the P group incurs significantly less income tax by applying separate-entity principles. The reason is that on a separate-entity basis, the large tested loss of FC2 reduces only the low-tax tested income of FC1, whereas on a consolidated basis, two-thirds of the tested loss reduces the high-tax tested income of FC3.

If the provisions of sections 250, 904, 951A, and 960(d) are applied on a separate-entity basis, the P group’s year 1 CTL is $15.55, determined as summarized in Table 7.

Table 7

Separate-Entity Calculation	S1	S2	Consolidated
GILTI	$200a	$2,000	$2,200
Section 960(d) credit calculationb	$8	$240	$248
Section 78 gross-upc	$10	$300	$310
Total net income	$210	$2,300	$2,510
Section 250 deductiond	-$105	-$1,150	-$1,255
Separate taxable income	$105	$1,150	$1,255
Tentative federal income tax (21%)	$22.05	$241.50	$263.55
FTC	-$8	-$240	-$248
CTL due	$14.05	$1.50	$15.55
aS1’s net GILTI equals FC1’s $1,000 of tested income minus FC2’s $800 of tested loss. bThe credit allowed under section 960(d) is 80 percent of the CFC’s creditable foreign tax expense ($50 for FC1 and $300 for FC3) x the shareholder’s GILTI inclusion ($200 for S1 and $2,000 for S2) ÷ the shareholder’s aggregate tested income ($1,000 for S1 and $2,000 for S2). Thus, the credit allowed to S1 is $8 (0.8 x $50 x $200/$1,000), and the credit allowed to S2 is $240 (0.8 x $300 x $2,000/$2,000). cThe gross-up is the full amount of the FTC attributable to the GILTI inclusion resulting from the CFCs with tested income without the 80 percent haircut. Thus, for S1, which has GILTI of $200, aggregate tested income of $1,000, and a creditable foreign tax expense of $50, the section 78 gross-up attributable to the $200 of GILTI is $10 ($50 x $200/$1,000). For S2, which has GILTI of $2,000, the section 78 gross-up is $300 ($300 x $2,000/$2,000). dThe section 250 deduction for GILTI for tax years beginning before 2026 is 50 percent of the sum of the amount of the GILTI inclusion plus related income, including the section 78 gross-up.

If the provisions of sections 250, 904, 951A, and 960(d) are applied on a single-entity basis, the P group’s year 1 CTL is $52.62.

Table 8

Single-Entity Calculation	P Consolidated Group
GILTI	$2,200
Section 960(d) credit calculationa	$205.33
Section 78 gross-up	$256.67
Total net income	$2,456.67
Section 250 deduction	-$1,228.33
CTI	$1,228.33
Tentative CTL (21%)	$257.95
FTC	-$205.33
CTL due	$52.62
aOn a consolidated basis, the section 960(d) credit is $350 (the P group’s consolidated creditable foreign tax expense) x 80 percent x $2,200 (the P group’s consolidated GILTI inclusion) / $3,000 (the P group’s aggregate tested income) = $205.33. The consolidated section 78 gross-up is $350 x $2,200 (the P group’s consolidated GILTI inclusion) / $3,000 (the P group’s aggregate tested income) = $256.67.

Example 8 illustrates a situation in which separate-entity treatment materially lowers the consolidated group’s CTL. There are also cases in which separate-entity treatment would materially increase the group’s CTL, such as Example 9.

Example 9: Positive and negative GILTI from different high-tax and low-tax CFCs held by different members: Single entity beats separate entity. The facts are the same as Example 8, except there is no FC3, and S2 owns all the stock of FC2 (the CFC with an $800 tested loss).

Thus, the altered facts are:

Table 9

CFC Attributes	FC1	FC2
U.S. shareholder	S1	S2
Tested income/(loss)	$1,000	-$800
Foreign tax rate	5%	10%
Foreign tax paid	$50	$0

Under these facts, if separate-entity treatment applies, (1) the $800 FC2 loss is wasted; and (2) S1 will have a $1,000 GILTI inclusion, a $50 section 78 gross-up inclusion, a $525 section 250 deduction, $110.25 of tentative CTL, and a $40 FTC. Consequently, the total CTL for the P group is $70.25 under separate-entity treatment.

In contrast, on a consolidated basis the P group would have $200 of GILTI, a $10 section 78 gross-up inclusion, a $105 section 250 deduction, $22.05 of tentative federal income tax liability, and an $8 FTC, for a total CTL of $14.05. Example 9 indicates that whenever a high-earning, low-tax CFC is owned by a member other than the member owning a CFC generating a meaningful loss, the consolidated group will prefer single-entity treatment over separate-entity treatment.⁶⁵

4. Leaving or joining a consolidated group.

Single- versus separate-entity concerns also arise in the context of a member leaving or joining a consolidated group, taking with it stock of a CFC having tested income for the year of its status change.

Example 10: Change in ownership of member owning a CFC after the CFC makes a distribution. P1, the common parent of a calendar-year consolidated group, owns all the stock of S1, a member of the P1 group. S1 owns all the stock of CFC, a calendar-year CFC. P2 is the common parent of a different calendar-year consolidated group. At the close of year 1 (a tax year beginning on January 1, 2018), CFC has $150 of E&P, all of which is net CFC tested income. On June 30 of year 1, CFC makes a $100 distribution to S1 under section 301. On September 30 of year 1, P1 sells all the stock of S1 to P2, resulting in S1’s last day as a member of the P1 consolidated group being September 30, 2018, and in S1’s first day as a member of the P2 consolidated group being October 1, 2018.⁶⁶

Suppose single-entity principles are applied in determining the ownership of CFC such that the P1 group is treated as owning CFC for the portion of the year ending on September 30, 2018, and the P2 group is treated as owning CFC for the remainder of 2018. In that case, a different person (the P1 group) would be treated as receiving the CFC distribution from the U.S. shareholder (the P2 group) required to include the section 951A amount in income at the close of the CFC tax year. Thus, the amount of the inclusion for the P2 group would be $75 — $150 of total section 951A income minus 75 percent (the nine-month period the P2 group did not own the CFC stock divided by 12 months) of the $100 dividend — reduced by the section 250 deduction allowed to the P2 group. The bad news for the seller is that the income to the P1 group is $100. (All of the $100 distribution is a taxable dividend to the P1 group because CFC has at least $100 of E&P for 2018, and the $75 section 951A inclusion to the P2 group apparently does not create previously taxed income that can be distributed tax-free to the P1 group under section 959.) Therefore, the total ordinary income inclusion to the P1 and P2 groups for 2018 is apparently $175, reduced by the deduction allowed to the P2 group under section 250. In essence, $25 of CFC’s $150 of tested income is taxed twice.

If separate-entity principles are applied, it appears that because S1 is the same shareholder of CFC at the time of the $100 June 30 distribution and at the end of the CFC tax year, (1) the only income inclusion is a $150 section 951A inclusion at the end of the CFC tax year, taxable in the consolidated return filed by the P2 group for 2018 and reduced by the deduction allowed under section 250; and (2) the $100 distribution by CFC to S1 on June 30 (while S1 is a member of the P1 group) is a tax-free distribution of PTI under section 959.

Of relevance to Example 10 is that reg. section 1.1502-76(b)(2)(vi)(A) applies a single-entity approach regarding the allocation of items of conduits, to the effect that if S is a partner in a partnership (or similar conduit) when it joins or leaves a consolidated group, S is treated as if it sold its interest in the entity immediately before its change in status for purposes of allocating S’s distributive share of conduit items.⁶⁷ Of greater importance is that this single-entity rule does not apply to foreign corporations, including CFCs and passive foreign investment companies.⁶⁸ In the foregoing example, if the $150 of calendar 2018 E&P of CFC had been subpart F income, because S1 is not treated under reg. section 1.1502-76(b)(2)(vi) as selling its CFC stock immediately before joining the P2 group, the compelling inference is that S1 must be respected as the sole shareholder of CFC both before and after S1 joins the P2 group. Thus, the $100 dividend paid to S1 by CFC while S1 was a member of the P1 consolidated group should be a tax-free distribution of previously taxed income under section 959(a), and the entire $150 subpart F inclusion should be taxable in the P2 group’s consolidated return filed for 2018.⁶⁹ Presumably, the same analysis applies under section 951A, such that S1 (not the P1 consolidated group) is respected as the sole shareholder of CFC throughout year 1 for purposes of sections 951(a), 951A, and 959.⁷⁰

E. Why Single-Entity Is Likely

Treasury likely will write regulations under sections 951A and 960(d) that apply single-entity rules in the consolidated return context. This would avoid overinclusions and underinclusions of GILTI in consolidated groups and avoid the internal restructurings that would be necessitated by applying the provisions of section 951A on a separate-entity basis. Adoption of the single-entity approach would also address the significant inconsistencies in CTL arising in cases like those illustrated by examples 8 and 9, whose results depend on whether single-entity or separate-entity principles are applied. Further, because (1) under section 250(a)(2), both the FDII and the GILTI components of the section 250 deduction are limited to the corporate U.S. shareholder’s taxable income, and (2) according to the Supreme Court, the only notion of taxable income in the consolidated return context is that of “consolidated taxable income,”⁷¹ single-entity principles should be applied in determining the corporation’s section 250 deduction. This is particularly true because the GILTI component of the section 250 deduction apparently is part and parcel of a participation exemption designed to reduce the effective tax rate on the consolidated group’s CTI resulting from a GILTI inclusion.

If both GILTI and the section 250 deduction were determined on a separate-entity basis in the consolidated return context, it would be necessary to allocate the CTI items that are determined on a consolidated basis under reg. section 1.1502-11(a) (such as consolidated capital gain net income, consolidated NOL deductions, and consolidated charitable contribution deductions) among the relevant members in determining their FDII and applying the taxable income limitation in section 250(a)(2) for each relevant member. There would also seem to be a risk that the amount of the section 250 deduction or CTI or both would be understated or overstated.⁷² Moreover, a separate-entity application of the provisions would create materially different results for stand-alone corporations operating through divisions and corporations operating through consolidated subsidiaries. Further, issues could arise from a separate-entity application of sections 951A and 960(d) given that the GILTI FTC limitation of section 904(d)(1)(A) likely will be applied on a consolidated basis. Thus, it is anticipated that single-entity principles will be applied by Treasury regulations adopted under sections 250, 951A, and 960(d).

IV. What to Do Pending Guidance

Unlike section 965(b)(5), which authorizes treatment of members of an affiliated group as a single corporation for limited purposes under that statute, there is no provision in section 250, 951A, or 960(d) addressing how those rules apply to affiliated groups or consolidated groups. Consequently, the only statutory authorization for single-entity treatment under sections 250, 951A, and 960(d) is section 1502. That statute states:

The Secretary shall prescribe such regulations as he may deem necessary in order that the tax liability of any affiliated group of corporations making a consolidated return . . . may be returned, determined, computed, assessed, collected, and adjusted, in such manner as clearly to reflect the income tax liability and the various factors necessary for the determination of such liability, and in order to prevent avoidance of such tax liability.

Obviously, section 1502 does not authorize taxpayers to write consolidated return regulations. So what should a consolidated group do in planning transactions or filing returns involving items of income, gain, loss, deduction, or credit requiring determinations under sections 250, 951A, and 960(d)?

A conservative approach might be to strictly apply separate-entity principles under the theory that taxpayers are not authorized to apply single-entity principles under section 1502 absent express guidance from Treasury or the IRS. There appears to be sufficient authority supporting a separate-entity approach, provided it is reasonable, consistently applied pending contrary guidance, and consistent with the underlying policies of sections 250, 951A, and 960(d).⁷³

On the other hand, it is not accurate to think that section 1502 prevents consolidated groups from taking reasonable single-entity positions in applying sections 250, 951A, and 960(d). A group wishing to apply those provisions by taking into account consolidated GILTI, consolidated NDTIR, consolidated DTIR, consolidated DEI, and consolidated FDEI is hardly writing a consolidated return regulation under section 1502, but rather is simply determining its CTL using a rational approach in the absence of direction from the subject matter expert. This is particularly true because (1) existing consolidated return regulations (reg. section 1.1502-4 and -9) adopt a single-entity approach in determining a consolidated group’s FTC and the various limitations and factors affecting the extent to which the credit is allowed to reduce tentative CTL; and (2) there is a strong likelihood that the subject matter expert will ultimately write regulations applying sections 250, 951A, and 960(d) to consolidated groups on a single-entity basis. Thus, if a consolidated group determines that a single-entity approach in the application of sections 250, 951A, and 960(d) is more favorable than a separate-entity approach, there should be little risk that the approach will not be sustained pending contrary guidance, so long as the approach is reasonable, consistently applied, and consistent with the underlying statutory purposes.

In the mergers and acquisitions area, however, taxpayers’ flexibility in allocating attributes under sections 250, 951A, and 960(d) is severely limited, as illustrated by Example 10. The allocation rules of reg. section 1.1502-76(b)(2) now in effect provide a separate entity rule regarding members joining or leaving a consolidated group in terms of income items attributable to CFC stock owned by those members. Unless those allocation rules are altered by the subject matter expert, it appears that they apply to items described in sections 250, 951A, and 960(d) and hence should be complied with by taxpayers.

Finally, regardless of whether, pending guidance, a group takes a separate-entity or single-entity position in applying sections 250, 951A, and 960(d) outside the context of reg. section 1.1502-76(b), it should pay careful attention to the effect of intercompany transactions, as discussed in Section II. First and foremost, whether using separate- or single-entity principles, the group should not overlook the possibility that intercompany income qualifies as FDDEI, as in examples 2 and 2A. Similarly, as in Example 3, the group should take care in determining the extent to which a CFC dividend or intercompany gain from a disposition of CFC stock qualifies for the participation deduction of section 245A. On the negative side, an intercompany transaction that appears to create a tax benefit may prove to be a false hope, as illustrated by examples 4 and 5.