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Insurer Seeks Addition of Elective Accounting Method in GILTI Regs

JAN. 15, 2020

Insurer Seeks Addition of Elective Accounting Method in GILTI Regs

DATED JAN. 15, 2020
DOCUMENT ATTRIBUTES

January 15, 2020

The Honorable David J. Kautter
Assistant Secretary (Tax Policy)
Department of the Treasury
1500 Pennsylvania Avenue, NW
Washington, DC 20220

The Honorable Charles P. Rettig
Commissioner
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

The Honorable Michael J. Desmond
Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Guidance Project under Treas. Reg. § 1.952-2

Dear Messrs. Kautter, Rettig, and Desmond:

Unum Group (the “Company” or “we”) respectfully submits this comment letter in response to the request for comments in REG-104390-181 and TD 98662 regarding the application of the rules under Treas. Reg. § 1.952-2 for determining subpart F income, tested income, and tested loss, including whether additional modifications should be made to Treas. Reg. § 1.952-2 for purposes of calculating a controlled foreign corporation's (“CFC's”) tested income and tested loss (the “952 Guidance Project”). As part of the 952 Guidance Project, we respectfully request that the Treasury Department and the IRS amend Treas. Reg. § 1.952-2 to include a rule that enables controlling U.S. shareholders of a CFC to elect to calculate the CFC's gain or loss on assets for U.S. federal income tax purposes under a market-to-market (“MTM”) method of accounting if it is required to calculate gain or loss on the assets for foreign tax purposes under a MTM method of accounting.

As detailed herein, prior to the recent law changes, the Company and similarly situated taxpayers were able to operate effectively under the existing regulatory/legislative regime; recent changes to that regime, however, have shifted the landscape and created the high likelihood that we will be subject to unfair and unintended double taxation. Congress and the Treasury Department have confronted these types of situations in the past in other contexts and moved quickly to address them (as reflected in the many examples set forth in this letter). We believe Congress has conveyed to the Treasury Department and the IRS the authority to take similar corrective measures here, and that there is a compelling reason to do so quickly.

Recommendation: The Treasury Department and the IRS exercise their rule-making authority under sections 446, 952, 954(b)(5), 964(a), and 7805 to amend Treas. Reg. § 1.952-2 to provide that, in addition to the permissible methods of accounting allowed under current Treas. Reg. §§ 1.446-1(c), 1.952-2(c)(2)(iv), and 1.964-1(c)(1)(i), controlling U.S. shareholders of a CFC may elect to calculate the CFC's gain or loss on investment assets for U.S. federal income tax purposes on a MTM method if the CFC computes and reports its income for those assets on a MTM method for local financial accounting purposes and local income tax laws require its taxable income to be computed in accordance with local financial accounting without allowing any reversal of the MTM adjustments (“book-tax conformity rule”).

As further discussed below, our recommended amendment to Treas. Reg. § 1.952-2 is consistent with other elective MTM regimes under the Code and Regulations, as well as the policy underlying the global intangible low-taxed income (“GILTI”) regime. Furthermore, any unintended consequences of an elective MTM regime under Treas. Reg § 1.952-2 should be avoidable by placing certain limits on any such election such as making the election revocable only with Commissioner's consent and applicable to all investment assets of the CFC that are subject to the local financial accounts' MTM accounting, and including valuation rules that are largely consistent similar to those included in Prop. Treas. Reg. § 1.446-3(1) and Treas. Reg. § 1.475(a)-4.

I. Discussion

 

A. Company Background

The Company, a Fortune 500, domestic public stock insurance company, is based in Chattanooga, Tennessee, We are a leading provider of financial protection benefits in the United States and the United Kingdom, and our products include disability, life, accident, and critical illness benefits.

The Company's primary international operations are in the United Kingdom. The U.K. operation offers group disability and other insurance products through a wholly-owned U.K. subsidiary, Unum Limited (“Unum U.K.”), a corporation under U.K. law and a CFC for U.S. federal income tax purposes. Both the Company and Unum U.K. are calendar-year taxpayers for U.S. federal income tax purposes.

B. Unum U.K.'s Local Taxable Income

Under U.K. law, Unum U.K. must calculate its U.K. taxable income by reference to its U.K. GAAP income with certain adjustments. Pursuant to U.K. GAAP, Unum U.K. computes its income recognizing unrealized gains and losses from market movements in its investment portfolio assets; that is, it is on a MTM method of accounting.3 Thus, because Unum U.K. is required under the U.K. book-tax conformity rule to compute its taxable income by reference to its U.K. GAAP income without any reversal of the MTM adjustments, it is effectively required to calculate its U.K. taxable income attributable to its investment portfolio on a MTM basis.

Unum U.K. invests primarily in long-term Gilts and other investment-grade, long-duration fixed-income securities, a portfolio sensitive to interest rate fluctuations. When interest rates rise, the portfolio decreases in value; when interest rates fall, the portfolio rises in value. With a sizeable portfolio, minor changes in interest rates can create large unrealized gains and losses when taxed on a MTM basis. On a realization basis, the portfolio has low turnover with most assets held to maturity, resulting in minimal realized gains and losses. For an investment held to maturity, the cumulative unrealized gains and losses net to zero.

Unum U.K. pays U.K. corporate income tax at a rate of 19 percent under the United Kingdom's generally applicable tax rules.

C. Unum U.K.'s Tested Income and the Company's GILTI Inclusion

1. Current CFC Tax Accounting Method Rules

In order to determine the amount of the Company's subpart F inclusion under section 951(a) and GILTI inclusion under section 951A(a), Unum U.K. must first determine the amount of its subpart F income under section 952(a) and tested income/loss under section 951A(c)(2). In both instances, Unum U.K.'s gross income and allowable deductions are determined under the rules of Treas. Reg. § 1.952-2.4

Among other rules, Treas. Reg. § 1.952-2 provides that a CFC must use the tax accounting method established or adopted by or on behalf of the foreign corporation under Treas. Reg. § 1.964-1(c).5 In turn, Treas. Reg. § 1.964-1(c) provides that a CFC must use a method of accounting reflective of the provisions of section 446 and its underlying Regulations, which generally limit taxpayers to the following permissible methods: (a) cash method; (b) accrual method; (c) other permissible methods prescribed elsewhere in the Code; or (d) a combination of these methods (so long as it clearly reflects income and is consistently used).6

A MTM tax accounting method similar to the method that Unum U.K. is effectively required to follow for U.K. tax purposes pursuant to its book-tax conformity rule is available under U.S. federal tax law in only limited circumstances (each of which is further described below, but includes, for example, section 475(a) for dealers in securities, section 475(e) for dealers in commodities, section 475(f) for traders in securities or commodities, section 1256(a) for “section 1256 contracts,” and Treas. Reg. § 1.446-4 for transactions that properly hedge MTM items). Accordingly, under current law, unless a CFG qualifies for a MTM method of accounting under the Code or Regulations (e.g., because it is considered a trader in securities under section 475(f)), it is required to report its income/loss on a realization basis for U.S. federal income tax purposes even if its foreign taxable income/loss is effectively on a MTM basis by reason of being required under the applicable foreign tax law's book-tax conformity rule to follow local financial accounting which reports income on a MTM basis.

2. Impact of the GILTI Regime

Unum U.K. has determined that it does not qualify for a MTM method of accounting under the Code;7 it thus reverses unrealized gains and losses determined on a MTM basis in order to determine its subpart F income and tested income/loss consistent with the U.S. tax accounting principles described above. Historically, the Company has had minimal subpart F inclusions under section 951(a) with respect to Unum U.K. because Unum U.K.'s insurance income is “exempt insurance income” under section 953(e) and most of Unum U.K.'s investment income (averaging 85 percent) is excluded from section 954(c) foreign personal holding company income as “qualified insurance income” pursuant to section 954(1). As a result, prior to the enactment of the GILTI regime under section 951A, the Company had minimal current inclusions for U.S. federal income tax purposes attributable to Unum U.K.

Following the enactment of the GILTI regime, Unum U.K.'s income that is excluded from subpart F income under the provisions described above constitutes Unum U.K.'s gross tested income.8 Because Unum U.K. does not hold a significant amount of specified tangible property in the normal course of its business,9 Unum U.K.'s tested income is included by the Company in its gross income with minimal offset as a GILTI inclusion under section 951A(a).

3. Currently Applicable FTC Rules

Subject to the limitations of section 904, a U.S. taxpayer is allowed a direct foreign tax credit (“FTC”) for any creditable income, war profits, and excess profits taxes that the taxpayer itself paid or accrued to foreign countries or U.S. possessions during the taxable year. Furthermore, a domestic corporation is allowed a FTC for foreign income taxes that it is deemed to have paid under section 960.

Under section 960(d), if a domestic corporation has a GILTI inclusion under section 951A with respect to a CFC, it is deemed to have paid a portion of the foreign income taxes paid or accrued by the CFC which are properly attributable to the tested income of the CFC taken into account by the domestic corporation.10 Broadly, pursuant to Regulations under section 960, a CFC's foreign income taxes are properly attributable to tested income taken into account by a domestic corporation under section 951A, in an amount equal to the proportionate share of the CFC's current year taxes allocated and apportioned under section 904 principles to the tested income.11 "Current year tax” is defined in the Regulations under section 960 as “the foreign income tax paid or accrued by a [CFC] in a current taxable year.”12

Section 904(d)(1) separates income and creditable foreign taxes into different categories to prevent foreign taxes in one category from being cross-credited against the U.S. federal income tax imposed on income of another category. Along with the enactment of the GILTI regime, the section 904(d)(1) categories were expanded to include a category for any amount includible in gross income under section 951A (other than passive category income).13 with the exception of amounts allocable to passive category income under Treas. Reg. § 1.904-5(c)(6), Regulations provide that any amount included in the gross income of a U.S. person under section 951A(a) is included in the section 951A calegory.14 Similarly, the deemed-paid foreign income taxes under section 960(d) with respect to the U.S. person's GILTI inclusion should be allocated to the section 951A category.15 Although section 904(c) generally allows excess FTCs in a particular category to be carried back and forward from one tax year to another, pursuant to section 904(c) and Treas. Reg. § 1.904-2(3), any excess FTCs in the section 951A category may not be carried back or forward from one tax year to another.16

As evidenced by the simplified fact pattern below, the timing difference between U.K. tax and U.S. tax recognition of Unum U.K.'s investment portfolio gains and losses creates a mismatch of when an item of income at the Unum U.K. level is taxed in each jurisdiction. Because the deemed-paid FTCs and related GILTI inclusion should be allocated to the Company's section 951A category, which does not allow for excess FTCs to be carried back or forward, this timing mismatch results in double taxation (i.e., a higher effective tax rate than the maximum corporate tax rate under U.S. or U.K. tax law).

D. Sample Facts and Analysis

1. Facts

InsureCo U.K. is a CFC, which is wholly owned by U.S. Co, its sole U.S. shareholder. U.S. Co has no interest in other CFCs. InsureCo U.K. earns only exempt insurance income under section 953(e), and all its investment income is treated as qualified insurance income under section 954(i). It has no specified tangible property for purposes of section 951A.

InsureCo U.K. invests primarily in long-term Gilts and other investment-grade, long-duration fixed-income securities, a portfolio sensitive to interest rate fluctuations.

In Year 1, InsureCo U.K. has $100 of MTM losses on its investment portfolio for U.K. tax purposes (unrealized for U.S. federal income tax purposes) and $100 of operating income (realized for U.K. tax and U.S. federal income tax purposes), resulting in no U.K. taxable income and thus no U.K. taxes paid.

In Year 2, InsureCo U.K. has $100 of MTM gains on its investment portfolio for U.K. tax purposes (unrealized for U.S. federal income tax purposes) and $100 of operating income (realized for U.K. tax and U.S. federal income tax purposes), resulting in U.K. taxable income of $200 and U.K. taxes paid of $38 (i.e., 19 percent of $200).

2. Analysis

We analyze these sample facts (a) applying current rules and (b) applying the recommended elective MTM accounting method.

a. Current Rules

In Year 1, under current rules, U.S. Co would have a $100 inclusion under section 951 A(a) because the MTM losses on InsureCo U.K.'s investment portfolio are not realized for U.S. federal income tax purposes and InsureCo U.K. has no specified tangible property. After applying the section 250 deduction, U.S. Co would have a U.S. federal income tax liability of $10.50, with no offset by FTCs.

In Year 2, under current rules, U.S. Co would have a $100 inclusion under sections 951A(a) and 78 because the MTM gains on InsureCo U.K.'s investment portfolio are not realized for U.S. federal income tax purposes and InsureCo U.K. has no specified tangible property. After applying the section 250 deduction, U.S. Co would have a tentative U.S. federal income tax liability of $10.50, which is completely offset by deemed-paid FTCs under sections 901(a) and 960(d) in the amount of $30.40 (i.e., 80 percent of the $38 of U.K. taxes). The excess FTCs in the amount of $19.90 cannot be carried back or forward to another tax year.

As a result of the timing mismatch caused by the different accounting methods that InsureCo U.K. must follow for U.K. tax and U.S. federal income tax purposes, the combined effective tax rate on its $200 of income is 24 percent, an amount in excess of the maximum corporate income tax rates under both U.K. and U.S. tax law. More specifically, as illustrated by the calculations below, the timing mismatch would result in $48.50 of combined U.S. and U.K. income tax on InsureCo U.K.'s $200 of income between Year 1 and Year 2, or approximately 24 percent of InsureCo U.K.'s $200 of income. This combined effective tax rate is higher than both the maximum U.K. corporate income tax rate of 19 percent and the maximum U.S. corporate income tax rate of 21 percent.17

Current Rules - Year 1 and Year 2 charts

b. Election to Follow MTM Consistent with U.K. Taxable Income

In Year 1, if U.S. Co could elect for InsureCo U.K. to apply for U.S. federal income tax purposes the same MTM method of accounting that it must apply under U.K. tax law, U.S. Co would have had a $0 GILTI inclusion under section 951A(a) because the MTM losses on InsureCo U.K.'s investment portfolio would have offset its operating income (i.e., InsureCo U.K. would have had $0 of tested income).

In Year 2, following the same MTM method of accounting for U.K. tax and U.S. federal income tax purposes, U.S. Co would have had a $200 inclusion under sections 951A(a) and 78, the total amount of InsureCo U.K.'s operating income and MTM gains on its investment portfolio. After applying the section 250 deduction, U.S. Co would have had a tentative U.S. federal income tax liability of $21, which would be completely offset by deemed-paid FTCs under sections 901(a) and 960(d) in the amount of $30.40 (i.e., 80 percent of the $38 of U.K. taxes). The excess FTCs in the amount of $9.40 cannot be carried back or forward to another tax year.

Consistent with the maximum foreign effective tax rate at which income typically should not result in a GILTI inclusion (i.e., 13.125 percent),18 InsureCo U.K.'s income would have been subject to only U.K. tax and at an effective tax rate of 19 percent. More specifically, as illustrated by the calculations below, when there is no longer a timing mismatch, InsureCo U.K.'s total income of $200 between Year 1 and Year 2 is subject to tax only once and at a rate that properly does not exceed the maximum corporate income tax rates in the United Kingdom and the United States.

Proposed MTM Election - Year 1 and Year 2

E. Worldwide MTM Regimes

We anticipate that the timing mismatch and associated potential for double taxation described in the example above, which was not likely under the subpart F regime, will affect several U.S. taxpayers unless Treas. Reg. § 1.952-2 is amended to account for the GILTI regime, as such taxpayers have subsidiaries in the U.K., a frequent trading partner, and U.K. tax rules require conformity with financial accounting which may be on a MTM method. In addition, there are other frequent trading partners with similar book-tax conformity rules that are unlikely to match up with a current MTM regime under the Code and Regulations, where financial accounting follows a MTM method. For example, like taxpayers in the U.K. as well as certain taxpayers (including insurance companies) in Australia, Brazil, Canada, and Italy which are subject to similar book-tax conformity rules.

F. Various MTM Regimes under the Code and Regulations

Our request for an elective tax accounting method that enables a CFC to calculate its income for U.S. federal income tax purposes under the same or similar MTM method of accounting that it is required to follow for foreign tax purposes under a local book-tax conformity rule is grounded in extensive legislative and regulatory precedent. As described below, taxpayers (including CFCs) currently are required, or may elect, to calculate taxable income on a MTM basis in various other circumstances.

1. Statutory MTM Regimes

a. Dealers in Securities

Perhaps the most notable required MTM accounting regime under the Code, section 475(a) generally requires dealers in securities to account for securities not included in inventory on the following MTM basis: (i) gain or loss from the securities must be recognized as if they were sold for their fair market value (“FMV”) on the last business day of the taxable year; (ii) any gain or loss must be taken into account by the dealer in such taxable year; and (iii) proper adjustments are made to the amount of any gain or loss subsequently realized from the securities for gain or loss already taken into account on a MTM basis.19 The section 475(a) MTM regime is limited to “dealers in securities,” which includes taxpayers who regularly purchase securities from or sell securities to customers in the ordinary course of a trade or business, or who regularly offer to enter into, assume, offset, assign or otherwise terminate positions in securities with customers in the ordinary course of a trade or business.20 The MTM accounting method under section 475(a) only applies to a dealer's “securities” (e.g., shares of corporate stock, interests in a widely held or publicly traded partnership, notes, bonds, and other evidences of indebtedness)21 and, among other narrow exceptions, it does not apply to a security held for investment and properly identified as such?22

Congress added section 475 to the Code in 1993.23 Prior to its enactment, a dealer in securities was permitted for U.S. federal income tax purposes to value its inventory of securities held for sale based on the cost of the securities, the lower of the cost or market (“LCM”) value of the securities, or the market value of the securities.24 While a dealer who valued its securities based on market value had to recognize gains or losses on a MTM basis, a dealer who relied on the cost method or LCM method could recognize gains or losses on a realization basis, in the case of the cost method, or recognize gains on a realization basis and losses on a MTM basis, in the case of the LCM method.25 Because securities dealers were not subject to the so-called “wash sale rule,” Congress believed that the cost method and LCM method generally resulted in a securities dealer understating its income and “that the mark-to-market method most clearly reflects their income.”26 Furthermore, “[i]nventories of securities generally are easily valued at year end, and, in fact, are currently valued at market by securities dealers in determining their income for financial statement purposes.”27 Accordingly, not only did Congress intend section 475 to curb a perceived abuse that would have normally been limited by the wash sale rules, it also reasoned that the application of a MTM method of accounting to dealers in securities would not be burdensome because securities are typically easily valued at year end and securities dealers were already valuing them at year end for financial statement purposes.

With respect to valuation, Congress explained in the legislative history to section 475 that it expected that the Treasury Department would authorize the use of valuation methods that “alleviate unnecessary compliance burdens for taxpayers and clearly reflect income for Federal income tax purposes.”28 In that regard, Treas. Reg. § 1.475(a)-4 provides a valuation safe harbor under which eligible taxpayers are permitted to elect to use the values of positions reported on certain financial statements as the FMV of those positions for purposes of section 475. This safe-harbor valuation election “is based on the principle that, if a mark-to-market method used for financial reporting is sufficiently consistent with the requirements of section 475 and if the financial statement employing that method has certain indicia of reliability, then the values used on that financial statement may be used for purposes of section 475.”29

For purposes of section 475(a), a taxpayer generally is eligible to use the safe-harbor valuation method if it is a dealer in securities so defined under section 475 and it uses a valuation method that requires; (i) valuation of the position no less frequently than annually (including a valuation as of the last business day of the taxable year); (ii) recognition into income on the income statement for each taxable year of MTM gain or loss based on the annual valuation(s); (iii) on disposition of the eligible position, recognition into income as if a year-end mark occurred immediately before such disposition; and (iv) use of a valuation standard that arrives at fair value in accordance with U.S. GAAP.30 The safe-harbor valuation method only applies to values reported on an applicable financial statement, which is defined generally as the taxpayer's primary financial statement if (i) that primary financial statement is prepared in accordance with U.S. GAAP and (ii) it is (I) either required to be filed with the SEC or (II) has significant business use and is required to be filed with a non-IRS government agency or is a certified audited financial statement given to investors or lenders for purposes of evaluating investment or lending decisions (or for other substantial non-tax purposes).31

b. Dealers in Commodities and Traders in Securities/Commodities

In 1997, Congress expanded section 475 to enable dealers in commodities and traders in securities and commodities to elect to apply the same (or a substantially similar) MTM method of accounting that section 475(a) requires securities dealers to apply.32 Under section 475(e), a dealer in commodities may elect to use the section 475(a) MTM method of accounting for the commodities (e.g., any commodity that is actively traded, any notional principal contract with respect to an actively traded commodity, or any other derivative with respect to an actively traded commodity) held by such dealer. The safe-harbor valuation method under Treas. Reg. § 1.475(a)-4 also applies to dealers in commodities who elect to apply the MTM method of accounting.33 Pursuant to section 475(f), a person engaged in a trade or business as a trader in securities or commodities may elect to (i) recognize gain or loss on any security or commodity held in connection with such trade or business at the close of the taxable year as if sold for its FMV on the last business day of such taxable year and (ii) make proper adjustments to the amount of any gain or loss subsequently realized from the securities for gain or loss already taken into account on a MTM basis. An election under section 475(e) or (f) may be made without the Commissioner's consent but, once made, applies to the taxable year for which made and all subsequent taxable years unless revoked with the Commissioner's consent.34

Similar to its explanation for enacting section 475 in 1993, Congress explained the addition of the elective MTM regimes under section 475(e) and (f) was appropriate because MTM "accounting generally provides a clear reflection of income with respect to assets that are traded in established markets.35 Indeed, “[f]or market value assets, mark-to-market accounting imposes few burdens and offers few opportunities for manipulation.”36 Furthermore, “[s]ecurities and exchange-traded commodities have determinable market values,” “securities traders and commodities traders and dealers regularly calculate year-end values of their assets in determining their income for financial statement purposes,” and “[m]any commodities dealers also utilize year-end values in adjusting their inventory using the lower-of-cost-or-market method for Federal income tax purposes.”37 in other words, although Congress did not identify a current abuse (e.g., with respect to the wash sale rules) with respect to traders in securities or traders or dealers in commodities, it recognized that an elective MTM accounting regime would be practical for those taxpayers and provide a clear reflection of income.

c. Stock of Passive Foreign Investment Companies

Specific to certain stock of a passive foreign investment company (“PFIC”) owned (directly or indirectly) by a U.S. person or a CFC, section 1296 provides an election to calculate income from the stock under the following MTM method of accounting: (i) to the extent the FMV of the PFIC stock exceeds its adjusted basis, the U.S. person or CFC must include the excess in gross income as gain; and (ii) if adjusted basis exceeds FMV, the U.S. person or CFC is allowed a loss deduction for such amount (but limited to the amount of prior year gains from such stock included in income as reduced by prior year loss deductions with respect to such stock).38 This MTM election is limited to “marketable stock,” which, broadly speaking, is defined as any stock that is regularly traded on a national securities exchange or certain equivalents as determined under Regulations.39 Once made, this election applies to the taxable year for which made and all subsequent taxable years unless the stock ceases to be marketable or the Commissioner consents to the revocation of the election.40

As were the elective MTM accounting regimes under section 475(e) and (f), section 1296 was added to the Code by the Taxpayer Relief Act of 1997.41 It appears that section 1296 was added to the Code based on the recognition that the interest-charge method for PFIC income inclusions under section 1291 was a source of substantial complexity for PFIC shareholders, and that taxpayers would prefer to avoid this complexity with a qualified electing fund election if they could obtain the necessary financial information.42 With respect to CFCs, the Regulations under section 1296 provide that a “section 1296 election by a CFC shall be made by its controlling United States shareholders, as defined in § 1.964-1(c)(5), and shall be included with the Form 5471, 'Information Return of U.S. Persons with Respect to Certain Foreign Corporations', for that CFC by the due date” of the controlling U.S. shareholder's original income tax return for the year made.43 If a section 1296 election is made for a CFC, it shall be binding on all U.S. shareholders of the CFC.44

d. Section 1256 Contracts

Added to the Code in 1981,45 section 1256(a) requires a taxpayer to apply the following MTM method of accounting to each section 1256 contract held by the taxpayer at the close of the taxable year: (i) each contract is treated as if it were sold for its FMV on the last business day of such taxable year (and any gain or loss must be taken into account for the taxable year); (ii) proper adjustments are made to the amount of any gain or loss subsequently realized with respect to the section 1256 contract for gain or loss already taken into account on a MTM basis; and (iii) any gain or loss shall be treated as 40 percent short-term capital gain or loss and 60 percent long-term capital gain or loss. A “section 1256 contract” is any regulated futures contract, any foreign currency contract, any nonequity option, any dealer equity option, and any dealer securities futures contract, all as further defined under section 1256.46

The legislative history to section 1256 indicates that Congress added it to the Code in order to curtail perceived straddle abuses and to better match the taxation of section 1256 contracts with the economics of futures trading.47 The Senate Finance Committee stated that its enactment, “based on the actual operations of futures trading, will end [the abusive] use of futures for tax-avoidance purposes, establish an accurate method for determining a taxpayer's futures income (or loss), and ease tax administration and paperwork for both government officials and taxpayers.”48 Congress recognized that the system of marking-to-market employed by the U.S. commodity futures exchanges required daily deposits to reflect a trader's position in a futures contract and, more or less applying the doctrine of constructive receipt, section 1256 taxes these daily increases or decreases (i.e., marks).49 With respect to valuation. Congress acknowledged that under section 1256, “[o]rdinarily, the settlement prices determined by an exchange for its futures contracts on the year's last business day are to be considered the contract's fair market value.”50

2. Regulatory MTM Regimes

a. Hedges of MTM Hedged Items

Section 446 provides broad authority for the Treasury Department and the IRS to require a taxpayer to adopt a method of accounting that, in their opinion, clearly reflects income.51 Pursuant to that authority, Treas. Reg. § 1.446-4 was issued in 1994 and starts by providing that “[t]he method of accounting used by a taxpayer for a hedging transaction [(as defined in Treas. Reg. § 1.1221-2(b))] must clearly reflect income,”52 According to the Regulations, in order to clearly reflect income, the accounting method used must reasonably match the timing of income, deduction, gain, or loss from the hedging transaction with the timing of the income, deduction, gain, or loss from the underlying hedged items.53 in that regard, the Regulations specify that when a transaction "hedges an item that is marked to market under the taxpayer's method of accounting, marking the hedge to market clearly reflects income.”54 Accordingly, a MTM method of accounting is effectively required for hedges of underlying hedged items that are marked to market under the taxpayer's method of accounting.

In addition to the elective (or allowable) MTM methods of accounting present in other Regulations (and recommended herein), the adoption under Treas. Reg. § 1.446-4 of the MTM method of accounting for certain hedges evidences that the Treasury Department and the IRS can and will exercise regulatory authority to require the use of a MTM method of accounting if doing so is necessary to achieve a clear reflection of income.

b. Section 988 Transactions

Recently issued proposed Regulations under section 988 allow taxpayers, including CFCs, to elect to apply a MTM method of accounting to determine foreign currency (“FX”) gain or loss with respect to all of the taxpayer's section 988 transactions.55Section 988 transactions” generally include certain nonfunctional currency denominated transactions, such as the acquisition or issuance of a debt instrument, the accruing of income or expense that is to be paid or received at a later date, and the entering into or acquiring of a forward contract or other similar derivative.56 Under this MTM method of accounting, only FX gain or loss is taken into account and the amount is determined under the same MTM principles that apply to section 1256 contracts, described above.57 In the case of a CFC, controlling U.S. shareholders make this MTM election on behalf of the CFC by filing a statement that clearly indicates such election has been made with the U.S. shareholders' timely filed, original federal income tax returns for the taxable year of the U.S. shareholders ending with or within the taxable year of the CFC for which the election is made.58 The election may be revoked at any time without the Commissioner's consent but, once revoked, a new election cannot be made until the sixth taxable year following the year in which the previous election was revoked.59

The preamble to the proposed Regulations explains that the primary purpose of the proposed Regulations is to allow CFCs to match the timing of FX gains or losses.60 The preamble explains that treasury center CFCs, in particular, often borrow in a nonfunctional currency and then on lend the funds, in the same nonfunctional currency, to related CFCs.61 While the currency fluctuations associated with the lending and borrowing activities typically offset, the tax consequences may not.62 For example if a treasury center CFC is considered a dealer in securities, it is required to use the MTM method of accounting for the loan receivables (which are securities under section 475), but it is not allowed to use the MTM method of accounting for the borrowing transactions (which are not securities under section 475).63 This means that the associated FX gains or losses on the loan receivables are reported each year, while the offsetting FX gains or losses on the borrowing transactions are not reported until principal and interest is paid.64

As the proposed Regulations acknowledge, because “a foreign currency loss generally will not reduce the CFC's subpart F income except to the extent there are other foreign currency gains in the year the loss is recognized,” the timing mismatch described above “may have significant adverse consequences."65 The proposed Regulations address this timing mismatch caused by the U.S. tax accounting rules by allowing a CFC to elect the MTM method of accounting with respect to all of the CFC's section 988 transactions. Accordingly, “[a] treasury center CFC that uses a mark-to-market method for securities under section 475 and that makes the election under proposed § 1.988-7 will be able to match the timing of foreign currency gain or loss with respect to an interest-bearing liability . . . with economically offsetting foreign currency loss or gain arising from its nonfunctional currency denominated assets.”66

c. Notional Principal Contracts

Proposed Regulations under section 446 applicable to notional principal contracts (“NPCs”) provide that a taxpayer may elect to apply a MTM method of accounting to certain NPCs that provide for nonperiodic payments (e.g., an upfront payment for an off-market swap).67 if the proposed election were made, the taxpayer would be required to determine income inclusions and deductions with respect to the NPC by reference to the gain or loss that would be realized if the NPC were sold for its FMV on the last business day of the taxable year, and proper adjustments would be made to the amount of any gain or loss subsequently realized for gain or loss already recognized on a MTM basis.68

Significantly, among other limited types of NPCs, the MTM election would be available for actively traded NPCs and NPCs that are “[m]arked to market by the taxpayer for purposes of determining the taxpayer's financial income,” provided for the latter that the taxpayer meets certain requirements for the use of financial statement values that were reserved in the proposed Regulations.69 For actively traded NPCs, the FMV of the NPC on the last business day of the taxable year would be determined based on the mean between the bid and asked prices quoted for the contract on an established financial market (as defined in Treas. Reg. § 1.1092(d)-1(b)(1)), or, if bid and asked prices are not available, comparable prices determined on the basis of recent quotations (described in Treas. Reg. § 1.1092(d)-1(b)(2)).70 If the election were made with respect to NPCs that are marked to market for financial income purposes, the fair market value of the NPCs on the last business day of the taxable year would be “the value used by the taxpayer for purposes of preparing its financial statements.”71 The election to apply the MTM accounting method would be required to be made with respect to all applicable NPCs to which the taxpayer is a party and would be effective for the taxable year for which made and all subsequent taxable years, unless revoked with the Commissioner's consent.72

In 2001, the Treasury Department and the IRS issued Notice 2001-44,73 requesting comments on how to treat financial instruments in general and NPCs in particular. The notice laid out four potential methods: Noncontingent Swap Method, the Full Allocation Method, the Modified Full Allocation Method, and the MTM Method.74 The notice pointed out that the MTM method “has the advantages of being certain and clear with respect to timing and character” and accurately reflects economic position.75 While the notice also noted that the MTM method may “be difficult to administer for non-exchange traded instruments to the extent that there is no consensus on the fair market value of the NPC,” it also reasoned that “[t]his problem may be partially overcome by requiring appropriate record keeping and information reporting.”76

Three years later, the Treasury Department and the IRS issued the proposed Regulations under section 446, which included the elective MTM regime described above.77 According to the preamble to the proposed Regulations, “[b]ecause the determination of fair market value takes into account the expected value of future nonperiodic payments, the mark-to-market methodology constitutes a reasonable basis for amortizing . . . nonperiodic payments over the term of the contract.”78 With respect to a taxpayer who elects to use the MTM method for an NPC that the taxpayer marks to market for financial income purposes, the preamble to the proposed Regulations explained that comments were requested in 2003 on appropriate rules that should apply to use financial statement values under the section 475 MTM regimes and that the Treasury Department and the IRS would take into account those comments for purposes of the NPC MTM rules.79 The safe-harbor valuation rules under Treas. Reg. § 1.475(a)-4 discussed above — which provide specific rules to determine appropriate values for MTM purposes on the basis of a taxpayer's financial statements — were adopted only after consideration of the comments received by the Treasury Department and the IRS in response to the 2003 request for comments.80 If, and when, final Regulations adopting an elective MTM regime for NPCs are published, it therefore seems likely that they would include similar safe-harbor valuation rules to those provided in Treas. Reg. § 1.475(a)-4.

d. Mixed Straddle Account

Section 1092(b) provides authority for the Treasury Department and the IRS to issue Regulations with respect to gain or loss on positions which are a part of a straddle (i.e., offsetting positions with respect to personal property), including Regulations that allow a taxpayer to offset gains and losses from positions which are part of mixed straddles by the establishment of a mixed straddle account. Pursuant to that authority, the Treasury Department and the IRS issued temporary Regulations in 1985,81 under which a taxpayer may elect to establish one or more mixed straddle accounts for determining gains and losses from all offsetting positions held as capital assets in a designated class of activities.82 If a mixed-straddle-account election is made, gain or loss is determined on a MTM basis as of the close of each business day for each position in the mixed straddle account as if the position were sold for its FMV at the close of each business day.83 On the last business day of the taxable year, the annual account net gain or loss for the mixed straddle account is determined by netting the daily account net gain or loss for each business day in the taxable year.84 The mixed-straddle-account election for a taxable year must be made by the due date of the taxpayer's income tax return for the immediately preceding taxable year, and it is made by attaching the Form 6781 to the taxpayer's return.85 it is applicable on a year-by-year basis and only with respect to the positions in the mixed straddle account for which the election is made.86

e. Property of Former U.S. Residents.

Pursuant to section 937(b), for purposes of determining the source of income of a bona fide resident of a U.S. possession (e.g., Puerto Rico), rules similar to the sourcing rules that apply under the Code to determine U.S.-source income and income effectively connected with the conduct of a U.S. trade or business shall apply to determine possession-source income and income effectively connected with the conduct of a possession trade or business. Where an individual becomes a bona fide resident of a U.S. possession, in general, income from sources within the relevant possession does not include gains from the disposition of certain property that was owned by the individual before becoming a bona fide resident of the possession.87 However, under Regulations, such an individual “may elect to treat as gain from sources within the relevant possession the portion of the gain attributable to the individual's possession holding period”88 and, for marketable securities, gain is calculated by looking to the FMV of the securities on the day the individual became a resident of the possession.89 As the Treasury Department and the IRS explained in the preamble to the Regulations under section 937, they agreed that the special gain rule of Treas. Reg. § 1.937-2(0(1) should be modified to precisely target the gain attributable to appreciation occurring during the time an individual was not a bona fide resident of the relevant possession, and that the mark-to-market allocation enabled the individual to elect to split the source of gains from the disposition of appreciated property.90

f. Constructive Ownership Transactions

In general, section 1260 recharacterizes a portion of the capital gain attributable to a constructive ownership transaction (“COT”) with respect to any financial asset as ordinary income and adds an interest charge to the amount recharacterized as ordinary income to compensate for the deemed tax deferral with respect to that amount. Broadly, section 1260(d) defines a COT with respect to any financial asset as including certain types of positions in derivatives that simulate the return of an equity interest in a pass-thru entity, certain debt instruments, and certain stock (i.e., financial assets that may produce ordinary income if held directly). Section 1260 was added to the Code by the Ticket to Work and Work Incentives Improvement Act of 1999,91 and Congress provided in section 1260(g) the authority for the Treasury Department and the IRS to prescribe Regulations as may be necessary or appropriate, including Regulations that permit taxpayers to mark to market COTs in lieu of applying section 1260.92 Although the Treasury Department and the IRS have not yet issued Regulations under section 1260, the authority granted in section 1260(g) is yet another example of the general view that the MTM method of accounting avoids, rather than creates, the potential for abuse.

G. Authority for Proposed MTM Election

The general rule-making authority granted under section 7805(a), as well as the more specific grants of authority under sections 446, 954(b)(5), and 964(a), provide the Treasury Department and the IRS with the authority to adopt the proposed elective MTM method of accounting by Regulation, Furthermore, adopting the proposed MTM election as an amendment to Treas. Reg. § 1.952-2 would be consistent with other provisions in Treas. Reg. § 1.952-2, each of which was adopted without a specific grant of authority under section 952 and each of which deviates where necessary from the rules that generally apply to domestic corporations. Indeed, original Treas. Reg. § 1.952-2 was proposed in July 1964 under the authority contained in section 7805 in order to conform the Regulations to the significant changes in the U.S. international tax rules under the Revenue Act of 1962 (i.e., the addition of subpart F to the Code).93 Just as the Treasury Department and the IRS at that time had to adopt all needful rules and regulations (not provided by statute) for a CFG to compute the amount of its gross and taxable income for subpart F purposes, the Treasury Department and the IRS must now adopt all needful rules and regulations to coordinate Treas. Reg. § 1.952-2 with the new GILTI and FTC rules, including the proposed elective MTM method of accounting.94 Finally, adopting the proposed MTM election by Regulation would also be consistent with certain current U.S. MTM tax regimes, which as discussed above, were adopted (or proposed) by Regulation and not by legislation (e.g., Treas. Reg. § 1.446-4, Prop. Treas. Reg. § 1.446-3(1), and Prop. Treas. Reg. 1.988-7).

Accordingly, the Treasury Department and the IRS not only have the authority to adopt the proposed elective MTM method of accounting as an amendment to Treas. Reg. § 1.952-2, but doing so would also be consistent with the existing provisions in Treas. Reg. § 1.952-2 and current regulatory MTM regimes.

H. Proposed Safeguards

As Congress has recognized, a MTM accounting method generally limits, rather than creates, the potential for abusive tax consequences and manipulation. Therefore, the potential for abuse under a MTM method for tax is generally less, not more. For instance, Congress added section 475 to the Code in 1993 because prior methods of accounting available to securities dealers often resulted in manipulation and understatement of income.95 Similarly, section 1256 was added to the Code because, among other reasons, it was expected to end the abusive use of futures trades for tax-avoidance purposes.96 In a similar vein, Congress and the Treasury Department have recognized that elective MTM regimes generally do not leave room for abuse. Instead, particularly for assets with independently verifiable market values, MTM “accounting generally provides a clear reflection of income with respect to assets that are traded in established markets”;97 “[f]or market value assets, mark-to-market accounting imposes few burdens and offers few opportunities for manipulation";98 the MTM method of accounting “ha[s] the advantage of being certain and clear with respect to timing and character,” it “accurately reflects the change in economic position over time . . . to the extent the mark is accurate,” and “the most flexible of methods, . . . it is constrained only by the ability to provide a consistent system for measuring the market value of instruments.”99

Considering the historical preference for MTM accounting regimes in order to avoid potential tax abuses, this request for an elective MTM accounting method to calculate a CFC's income is unlikely to raise many opportunities for abuse or manipulation. Furthermore, consistent with the Treasury Department's and the IRS's rationale for the recently issued Prop. Treas. Reg. § 1.988-7, an elective MTM accounting regime for computing certain CFCs' tested income would cure a timing mismatch attributable to the GILTI and FTC regimes that undoubtedly causes significant adverse tax consequences.100

Although the likelihood for abuse is small, we recognize that there are potential narrow areas in which this could occur, the most prominent of which is valuation. In that regard, as outlined below in the Proposed Regulatory Language Section, we recommend that the proposed elective MTM regime include valuation safeguards (and perhaps, safe harbors) similar to those included in Prop. Treas. Reg. § 1.446-3(i) and Treas. Reg. § 1.475(a)-4, The elective MTM regime for NPCs proposed in Prop. Treas. Reg. § 1.446-3(i) would apply, among other limited types of NPCs, to NPCs that are actively traded and NPCs that are marked to market for purposes of determining the taxpayer's financial income, provided in the latter case that the taxpayer meets certain requirements for the use of financial statement values that were reserved in the proposed Regulations, As discussed above, based on the preamble to Prop. Treas. Reg. § 1.446-3(i), it appears that if, and when, final Regulations adopting an elective MTM regime for NPCs are issued, they are likely to include similar rules to Treas. Reg. § 1.475(a)-4 for purposes of determining whether a taxpayer can rely on financial statement values. Accordingly, as a safeguard against potential valuation abuses, we recommend in the Proposed Regulatory Language Section below similar valuation requirements to those included in Prop. Treas. Reg. § 1.446-3(i) and limits associated with financial statement values in Treas. Reg. § 1.475(a)-4.

Other potential abuses with an elective MTM regime for certain CFCs could depend on the bounds of the election (e.g., whether the election can be made on an asset-by-asset basis or whether the election is made annually or otherwise is revocable), although there are guardrails to help prevent this type of abuse as well. For example, if a controlling U.S. shareholder is able to make the election for its CFC on an asset-by-asset basis, the shareholder could conceivably choose to make the election only for assets whose FMVs were expected to decrease by year-end, thereby reducing tested income (or creating tested loss). Similarly, if a controlling U.S. shareholder can choose annually whether to make or revoke the election, it could choose to make the election only in years where the FMVs of assets were expected to decrease, reducing tested income (or creating tested loss) in that year without any requirement to recognize in income an FMV increase in the following year. In addition, we recognize, as did Congress when it added section 475 to the Code, that nonrecognition transactions may be used to take unfair advantage of an elective MTM regime for certain CFCs.101 pop example, a contributing CFC that is not subject to the MTM accounting regime may contribute in a section 351 exchange to a transferee CFC that is subject to the MTM accounting regime an asset that has a built-in loss in the hands of the contributing CFC.102

Considering these potential abuses, we recommend in the Proposed Regulatory Language Section below that the proposed elective MTM accounting method be revocable only with the Commissioner's consent and that it apply to all investment assets held by the CFC that the CFC is required to mark to market for local law purposes. Furthermore, we recommend in the Proposed Regulatory Language Section below terms similar to Treas. Reg. § 1.475(a)-3 to ensure that the MTM method of accounting applies to substituted basis property only with respect to the change in value of the property that occurs after the CFC acquires it.

Additionally, the Treasury Department and the IRS may also consider restricting the elective regime to regulated financial service entities, which are most likely to be adversely affected under a foreign book-tax conformity rule due to their significant investment assets and immaterial amounts of QBAI.

I. Effect on Earnings and Profits

If a controlling U.S. shareholder elects for its CFC to apply the proposed MTM regime for purposes of calculating the CFC's income, for the reasons discussed below, we would recommend that the same accounting method apply for purposes of determining the CFC's earnings and profits Section 964(a) provides the general rule that, under Regulations, the E&P of any foreign corporation, and the deficit in E&P of any foreign corporation, for any taxable year is determined according to rules substantially similar to those applicable to domestic corporations. Regulations under section 964 mandate that a foreign corporation compute its E&P for a taxable year substantially as if it were a domestic corporation by, among other steps, making adjustments to its regularly maintained profit and loss statement to conform the statement to certain tax accounting standards.103 For this purpose, the Regulations state that a foreign corporation's “method of accounting shall reflect the provisions of section 446 and the regulations thereunder,” and that “[effect shall be given to any election made in accordance with an applicable provision of the Code and the regulations thereunder and these regulations.104 Because the proposed elective MTM regime would be a tax accounting method that a controlling U.S. shareholder elects for a CFC, pursuant to section 964(a) and the Regulations thereunder, we would therefore recommend that the same MTM method of accounting apply for purposes of determining the CFC's E&P.

J. Proposed Regulatory Language

Considering the technical and policy justifications for the proposed elective MTM accounting method for CFCs, as well as the safeguards against abuse discussed above, we recommend that the Treasury Department and the IRS create targeted amendments to Treas. Reg. § 1.952-2. Specifically, relying extensively on language employed by Congress in section 475 and the Treasury Department and the IRS in Treas. Reg. § 1.475(a)-3, Treas. Reg. § 1.475(a)-4. Prop. Treas. Reg. § 1.446-3(1), and Prop. Treas. Reg. § 1.988-7, we respectfully recommend that the Treasury Department and the IRS amend Treas. Reg. § 1.952-2(c)(2)(iv) to provide as follows:

(iv) Tax accounting methods.

(a) In general. Except as provided in (b) of this subdivision, the tax accounting methods to be employed are those established or adopted by or on behalf of the foreign corporation under paragraph (c) of § 1.964-1. Thus, such accounting methods must be consistent with the manner of treating inventories, depreciation, and elections referred to in subdivisions (ii), (iii), and (iv) of paragraph (c)(1) of § 1.964-1 and used for purposes of such paragraph; however, if, in accordance with paragraph (c)(6) of § 1.964-1, a foreign corporation receives foreign base company income before any elections are made or before an accounting method is adopted by or on behalf of such corporation under paragraph (c)(3) of §1.964-1, the determinations of whether an exclusion set forth in section 954(b) applies shall be made as if no elections had been made and no accounting method had been adopted.

(b) Election to mark to market. In the case of a controlled foreign corporation which, under the taxation laws of the foreign country which subjects the controlled foreign corporation to tax on the basis of residence, is required to determine its income on its investment assets pursuant to a mark-to-market method of accounting, an election may be made to adopt a mark-to-market method of accounting on behalf of the controlled foreign corporation to determine the gain or loss of the controlled foreign corporation with respect to all of its investment assets (elective mark-to-market method of accounting).

1. General rule. In the case of any investment asset held by the controlled foreign corporation at the close of the taxable year for which the elective mark-to-market method is in effect, the controlled foreign corporation shall recognize gain or loss as if such investment asset were sold for its fair market value on the last business day of the taxable year and any gain or loss shall be taken into account for such taxable year. Proper adjustment shall be made in the amount of any gain or loss subsequently realized for gain or loss taken into account under the preceding sentence.

2. Determination of fair market value. For purposes of the elective mark-to-market method of accounting, the fair market value of investments assets on the last business day of the taxable year shall be determined — 

(i) For an investment asset that is actively traded within the meaning of § 1.1092(d)-1(c) (determined without regard to the limitation in § 1.1092(d)-1(c)(2)), based on the mean between the bid and asked prices quoted for the contract on an established financial market as defined in § 1.1092(d)-1(b)(i), or, if bid and asked prices are not available, comparable prices determined on the basis of recent price quotations; or

(ii) For any investment asset (whether or not actively traded within the meaning of § 1.1092(d)-1(c)), based on the value used in preparing the controlled foreign corporation's applicable financial statement so long as the controlled foreign corporation uses an eligible method for the valuation of its investments assets on its applicable financial statement.

(3) Investment asset. The term "investment asset” means any —

(i) security held for investment;

(ii) security which is acquired by the controlled foreign corporation in the ordinary course of a trade or business of the controlled foreign corporation and which is not held for sale; and

(iii) obligation to acquire a security if such obligation is entered into in the ordinary course of a trade or business of the controlled foreign corporation and which is not held for sale.

(4) Security. The term “security” means any —

(i) share of stock in a corporation;

(ii) partnership or beneficial ownership interest in a widely held or publicly traded partnership or trust;

(iii) note, bond, debenture, or other evidence of indebtedness;

(iv) interest rate, currency, or equity notional principal contract;

and

(v) evidence of an interest in, or a derivative financial instrument in, any security described in clause (i), (ii), (iii), or (iv), or any currency, including any option, forward contract, short position, and any similar financial instrument in such a security or currency.

(5) Eligible method;

(i) General requirements. The method —

(A) Frequency. Must require a valuation of the investment asset no less frequently than annually, including a valuation as of the last business day of the taxable year;

(B) Recognition at the mark. Must recognize into income on the income statement for each taxable year mark-to-market gain or loss based upon the valuation or valuations described in subclause (A);

(C) Recognition on disposition. Must require, on disposition of the investment asset, recognition into income (on the income statement for the taxable year of disposition) as if a year-end mark occurred immediately before such disposition; and

(D) Fair value standard. Must require use of a valuation standard that arrives at fair value in accordance with the applicable foreign jurisdiction's generally accepted accounting principles.

(ii) Limitations.

(A) Valuations based on present values of projected cash flows. If the method of valuation consists of projecting cash flows from an eligible position or positions and determining the present value of those cash flows, the method must not take into account any cash flows attributable to a period of time on or before the valuation date. In addition, adjustment of the gain or loss recognized on the mark may be required with respect to payments that will be made after the valuation date to the extent that portions of the payments have been recognized for tax purposes before the valuation and appropriate adjustment has not been made for purposes of determining financial statement value.

(B) Accounting for costs and risks. Valuations may account for appropriate costs and risks, but no cost or risk may be accounted for more than once, either directly or indirectly. Further, no valuation adjustment for any cost or risk may be made if that valuation adjustment is not also permitted by, and taken for, the applicable foreign jurisdiction's generally accepted accounting principle purposes on the controlled foreign corporation's applicable financial statement. If appropriate, the costs and risks that may be accounted for include, but are not limited to, credit risk (appropriately adjusted for any credit enhancement), future administrative costs, and model risk. An adjustment for credit risk is implicit in computing the present value of cash flows using a discount rate greater than a risk-free rate. Accordingly, a determination of whether any further downward adjustment to value for credit risk is warranted, or whether an upward adjustment is required, must take that implicit adjustment into consideration.

(6) Applicable financial statement.

(i) Definition. A controlled foreign corporation's applicable financial statement for a taxable year is the controlled foreign corporation's certified audited financial statement if the certified audited financial statement has significant business use. Otherwise, or if the controlled foreign corporation does not have a certified audited financial statement for the taxable year, the controlled foreign corporation does not have an applicable financial statement for the taxable year.

(ii) Certified audited financial statement. A financial statement is a certified audited financial statement if it is certified by an independent certified public accountant from a Registered Public Accounting firm, as defined in section 2(a)(12) of the Sarbanes-Oxley Act of 2002, Public Law 107-204, 116 Stat. 746 (July 30, 2002), 15 U.S.C. § 7201(a)(12), and rules promulgated under that Act, and is —

(A) certified to be —

(I) fairly presented (a “clean” opinion);

(II) fairly presented subject to a concern about a contingency, other than a contingency relating to the value of eligible positions (a qualified “subject to” opinion); or

(III) fairly presented except for a method of accounting with which the Certified Public Accountant disagrees and which is not a method used to determine the value of an eligible position held by the eligible taxpayer (a qualified “except for” opinion);

(B) prepared in accordance with the applicable foreign jurisdiction's generally accepted accounting principles; and

(C) given to creditors for purposes of making lending decisions, given to equity holders for purposes of evaluating their investment in the controlled foreign corporation, or provided for other substantial non-tax purposes (and that the controlled foreign corporation reasonably anticipates will be directly relied on for the purposes for which it was given or provided),

(iii) Significant business use. A financial statement has significant business use if the financial statement contains values for investment assets, the controlled foreign corporation makes significant use of financial statement values in most of the significant management functions of its business, and that use is related to the management of all or substantially all of the controlled foreign corporation's business.

(7) Election, The controlling United States shareholders (as defined in § 1.964-1(c)(5)) make the election to adopt the elective mark-to-market method of accounting on behalf of the controlled foreign corporation by filing a statement that clearly indicates that such election has been made with their timely filed, original federal income tax returns for the taxable year of such United States shareholders in which or with which the taxable year of the controlled foreign corporation for which the election is made ends. The election is effective for the taxable year for which made and all subsequent taxable years, unless revoked with the consent of the Commissioner.

(8) Substituted basis transactions. If a controlled foreign corporation has adopted the elective mark-to-market method of accounting, and the controlled foreign corporation acquires investment assets the basis of which is determined in the controlled foreign corporation's hands, in whole or in part, either by reference to the basis of that investment asset in the hands of the person from whom the investment asset was acquired or by reference to other property held at any time by the controlled foreign corporation —

(i) the elective mark-to-market method of accounting applies only to changes in the value of the investment asset occurring after the transaction; and

(ii) any built-in gain or loss with respect to the investment asset (based on the difference between the fair market value of the investment asset on the date the controlled foreign corporation acquired it and its basis to the controlled foreign corporation on that date) is taken into account at the time, and has the consequences, provided by the sections of the Internal Revenue Code that would apply to the built-in gain or loss if the elective mark-to-market method of accounting did not apply to the investment asset.

II. Conclusion

Considering the post-GILTI timing mismatch and corresponding double taxation that could potentially apply on a broad scale to CFCs currently subject to a foreign tax law MTM regime, as well as the regulatory precedent for elective MTM accounting methods, we recommend that the Treasury Department and the IRS exercise their rule-making authority under sections 446, 952, 954(b)(5), 964(a), and 7805 to amend Treas. Reg. § 1.952-2 to adopt an elective MTM accounting method for CFCs similar to the one outlined in the Proposed Regulatory Language Section above.

We appreciate the opportunity to provide input on this important issue for Unum and similarly situated taxpayers and would welcome the opportunity for a follow-up meeting or to provide additional information upon request. Please feel free to contact Cherie Pashley at 423-294-1478 with any questions.

Very truly yours,

Cherie Pashley
SVP, Tax & Treasury
Unum Group
Chattanooga, TN

Enclosures

Cc (by email):

Douglas Poms
International Tax Counsel
Department of the Treasury
1500 Pennsylvania Ave., NW
Washington, DC 20220
douglas.poms@treasury.gov

Brett York
Associate International Tax Counsel
Department of the Treasury
1500 Pennsylvania Ave.,
NW Washington, DC 20220
brett.york@treasury.gov

Jason Yen
Attorney-Advisor
Department of the Treasury
1500 Pennsylvania Ave., NW
Washington, DC 20220
jason.yen@treasury.gov

Angela Walitt
Attorney Advisor
Department of Treasury
1500 Pennsylvania Ave., NW
Washington, DC 20220
angela.walitt@treasury.gov

Peter Merkel
Branch Chief
Office of Associate Chief Counsel (International)
1111 Constitution Ave., NW
Washington, DC 20224
david.p.merkel@irscounsel.treas.gov

Steven Jensen
Senior Counsel
Office of Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224
steven.d.jensen@irscounsel.treas.gov

Je Y. Baik
Senior Technician Reviewer
Office of Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224
je.y.baik@irscounsel.treas.gov

Josephine H. Firehock
Attorney-Advisor
Office of Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224
josephine.firehock@irscounsel.treas.gov

Kristine Crabtree
Senior Technician Reviewer
Office of Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224
kristine.a.crabtree@irscounsel.treas.gov

Melinda Harvey
Attorney-Advisor
Office of Associate Chief Counsel (International)
Internal Revenue Service
1111 Constitution Ave., NW
Washington, DC 20224
melinda.harvey@irscounsel.treas.gov

FOOTNOTES

1Fed. Reg. 51072, 51075 (Oct. 10, 2018).

2Fed. Reg. 29288, 29293 (June 21, 2019).

3Gains and losses from market movements in Unum U.K.'s investment assets are also recorded for U.S. GAAP purposes. For U.S. GAAP purposes, the gains and losses are recorded in other comprehensive income rather than profit and loss.

4These rules historically applied for purposes of determining a CFC's subpart F income. The final GILTI regulations provide that Treas. Reg. § 1.952-2 also applies for purposes of determining a CFC's tested income and tested loss. See Treas. Reg. § 1.951A-2(c)(2)(i).

5Treas. Reg. § 1.952-2(c)(2)(iv).

6See Treas. Reg. § 1.446-1(c)(1).

7For example, Unum U.K. has determined that it is not a trader in securities and thus is not eligible to make an election to MTM under section 475(f).

8See section 951A(c)(2); Treas. Reg. § 1.951A-2(c)(1).

10Specifically, the domestic corporation is deemed to have paid foreign income taxes equal to 80 percent of the product of (i) the ratio of the domestic corporation's GILTI inclusion over the aggregate tested income taken into account by the domestic corporation, multiplied by (ii) the aggregate foreign income taxes paid or accrued by the domestic corporation's CFCs which are properly attributable to tested income of such CFCs taken into account by the domestic corporation under section 951A.

11See Treas. Reg. § 1.960-2(c)(4).

12Treas. Reg. § 1.960-1(b)(4).

13Section 904(d)(1)(A); see also Treas. Reg. § 1.904-4(a).

14Treas. Reg. § 1.904-4(g). Amounts are allocable to passive category income under Treas. Reg. § 1.904-5(c)(6) if they are attributable to income received or accrued by the CFC that is passive category income. Treas. Reg. § 1.904-4(b)(2) provides that passive category income generally includes income that is of a kind that would be foreign personal holding company income (as defined in section 954(c)) if the taxpayer were a CFC. Unum U.K. is a CFC and, as discussed above, most of its income is of a kind that is not foreign personal holding company income as defined in section 954(c).

15See Treas. Reg. § 1.904-6(b)(i). Prior to the enactment of the GILTI regime and the addition of the section 951A category under section 904(d)(1), the Company had historically calculated its FTC limitation exclusively under the general category since its taxable income from all CFCs, including Unum U.K., met the definition of "financial services income." Despite the statutory classification of the Company's CFC income as general category, under Regulations, the Company's section 951A inclusions are included in the section 951A category, including the inclusions attributable to investment or insurance income from the active conduct of an insurance trade or business. See Treas. Reg. § 1.904-4(e)(1). Acknowledging that the lack of an FTC carryover provision was Congress's intent when it enacted section 951 A, the Company questions whether Congress also intended to tax under GILTI foreign activity "ordinary and necessary for the proper conduct of its insurance business" that is subject to a foreign tax rate in excess of 13.125 percent. The statutory mechanism to offset tested income, net deemed tangible income return, typically is not available to insurance companies as their business model does not rely on specified tangible property to generate normal business income.

16Section 904(c) (last sentence); Treas. Reg. § 1.904-2(3).

17For completeness, we note that the double-taxation issue presented by this simplified example would not be solved by the GILTI high-tax exception election under Prop. Treas. Reg. § 1.951A-2(c)(6), even if it is published in its current form as a final regulation in the Federal Register. If the Company made the GILTI high-tax-exception election in Year 2, it may result in no GILTI inclusion, but the double taxation occurs here because of the GILTI inclusion in Year 1, a year in which the GILTI high-tax exception would not have applied. The double taxation results from a timing mismatch due to the limited permissible tax accounting methods available to CFCs, which often do not align with required tax accounting methods under foreign tax law.

18See H.R. Rep. No. 115-466, at 627 (2017).

19Securities held for investment (and identified as such) are excluded, as are certain hedges and debt instruments acquired or originated in the ordinary course of a trade or business and not held for sale. Section 475(b)(1)(A) and (b)(1)(B)-(C).

23Omnibus Budget Reconciliation Act of 1993, Pub. L. No. 103-66, § 13223.

24H.R. Rep. No, 103-111, at 660 (1993).

25Id, at 660-61.

26Id. at 661.

27Id.

28H.R. Rep. No. 103-213, at 616 (1993).

29Treas. Reg. § 1.475(a)-4(a)(i).

30See Treas. Reg. § 1.475(a)-4(c)(1) and (d).

31See Treas. Reg. § 1.475(a)-4(h). A financial statement is a "certified audited financial statement” if it is certified by an independent certified public accountant from a Registered Public Accounting Firm, as defined in section 2(a)(12) of the Sarbanes-Oxley Act of 2002, Pub. L, No. 107-204, 116 Stat, 746 (2002), and the rules promulgated thereunder, and is: (i) certified to be fairly presented; (ii) certified to be fairly presented subject to a concern about contingency, other than a contingency relating to the value of eligible positions; or (iii) certified to be fairly presented except for a method of accounting with which the Certified Public Accountant disagrees and which is not a method used to determine the value of an eligible position held by the eligible taxpayer. Treas. Reg. § 1.475(a)-4(h)(7).

32Taxpayer Relief Act of 1997, Pub. L. No. 105-34, § 1001.

33See Treas. Reg. § 1.475(a)-4(c)(2).

34Section 475(e)(3) and (f)(3).

35H.R. Rep. No. 105-148, at 445 (1997).

36Id.

37Id.

38Section 1296(a), (d), and (f).

41Pub. L. No. 105-34, § 1122.

42See Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in 1997 (JCS-23-97) at 309; H.R. Rep. No. 105-220, at 623-27.

43Treas. Reg. § 1.1296-1(h)(1)(ii).

44Id.

45Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, § 503.

47See S. Rep. No, 97-144, at 156 (1981).

48Id.

49Id. at 157.

50Id.

52Treas. Reg. § 1.446-4(6).

53Treas. Reg. § 1.446-4(6).

54Treas. Reg. § 1.446-4(e)(2).

55Prop. Treas. Reg. § 1.988-7(3).

57See Prop. Treas. Reg. § 1.988-7(3).

58Prop. Treas. Reg. § 1.988-7(c).

59Prop. Treas. Reg. § 1.988-7(d).

60Fed. Reg. 60135, 60138.

61Id.

62Id.

63Id.

64Id.

65Id.

66Fed. Reg. 60135, 60140.

67Prop. Treas. Reg. § 1.446-3(1).

68See Prop. Treas. Reg. § 1.446-3(i)(1).

69Prop. Treas. Reg. § 1.446-3(i)(2)(i) and (ii).

70Prop. Treas. Reg. § 1.446-3(i)(3)(i).

71Prop. Treas. Reg. § 1.446-3(i)(3)(ii).

72Prop. Treas. Reg. § 1.446-3(i)(6).

73Notice 2001-44, 2001-30 I.R.B.

74Id.

75Id. at 80.

76Id.

77See 69 Fed. Reg. 8886 (Feb. 26, 2004).

78Id. at 8889.

79Id. at 8890.

80See 72 Fed. Reg. 32172, 32173 (June 12, 2007).

81Fed. Reg. 3351 (Jan. 24, 1985).

82See Temp. Treas. Reg. § 1.1092(b)-4T(a) and (b).

83Temp. Treas. Reg. § 1.1092(b)-4T(c)(1).

84Temp. Treas. Reg. § 1.1092(b)-4T(c)(2).

85Temp. Treas. Reg. § 1.1092(b)-4T(f)(1) and (2).

86Temp. Treas. Reg. § 1.1092(b)-4T(f)(2) and (4).

87Treas. Reg. § 1.937-2(f)(1)(i)-(iii).

88Treas. Reg. § 1.937-2(f)(1)(vi).

89Treas. Reg. § 1.937-2(f)(1)(vi)(A).

90Fed. Reg. 19350, 19352 (Apr. 9, 2008).

91Pub. L. No. 106-170, § 534.

92See also section 1260(d)(2) (excluding from section 1260 any COT if all of the positions which are part of the transaction are marked to market).

93See 29 Fed. Reg. 9440 (July 10,1964).

94See section 7805(a) ("[T]he Secretary shall prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue”) (Emphasis added).

95H.R. Rep. No. 103-111, at 660.

96See S. Rep. No. 97-144, at 156.

97H.R. Rep. No. 105-148, at 445.

98Id.

99Notice 2001-44, 2001-30 I.R.B, at 80.

100See 82 Fed. Reg. at 60138.

101See H.R. Rep. No. 103-213, at 615.

102See id.

103Treas. Reg. § 1.964-1(a)(1)(iii).

104Treas. Reg. § 1.964-1(c)(1)(i) and (iv).

END FOOTNOTES

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