Executive summary:
Proposed regulations forthcoming
On Dec. 11, 2023, the IRS and Treasury announced their intent to issue proposed regulations to address the application of the foreign tax credit (FTC) and dual consolidated loss (DCL) rules in relation to certain types of taxes described in the “Tax Challenges Arising from the Digitalisation of the Economy – Global Anti-Base Erosion Model Rules (Pillar Two)” (GloBE Model Rules) in Notice 2023-80 (the Notice). Taxpayers will generally be able to rely on the Notice for taxable years that end after Dec. 11, 2023, and on or before the date proposed regulations are published in the Federal Register, provided the taxpayer consistently follows the guidance outlined in the Notice for all taxable years.
Notice 2023-80 also extends Notice 2023-55’s temporary relief period until further notice.
IRS releases guidance on the foreign tax credit and GloBE
GloBE Model Rules
The GloBE Model Rules aim to impose a global minimum corporate tax of 15% on adjusted net income on large international businesses (i.e., companies with consolidated revenues above 750 million euros or equivalent) regardless of the location of the business’ headquarters or jurisdictions in which the business operates. In essence, the GloBE Model Rules will top up the tax burden on a jurisdiction-by-jurisdiction basis to ensure that each jurisdiction is at a 15% tax rate. The Organization for Economic Cooperation and Development (OECD) proposed the GloBe Model Rules and have encouraged member countries to adopt them as part of their internal domestic tax law in order to reduce global tax evasion.
The GloBE rules are complex in their administration and comprise a series of top-up taxes to achieve the 15% rate. The top-up taxes are levied through tax law implementation in the local countries and can be collected under the qualified domestic minimum top-up tax (QDMTT), income inclusion rule (IIR) and under-taxed profits rule (UTPR) when the tax rate falls below 15%.
The Notice addresses the creditability of these top-up taxes (or final top-up tax) in the United States.
Final top-up tax and the foreign tax credit
The Notice defines a foreign income tax (tested tax) as a final top-up tax if, in computing the tested tax, the foreign tax law takes into account:
- The amount of tax imposed on the direct or indirect owners of the entity subject to the tested tax by other countries (including the United States) with respect to the income subject to the tested tax, or
- In the case of an entity subject to the tested tax on income attributable to its branch in the foreign country imposing the tested tax, the amount of tax imposed on the entity by its country of residence with respect to such income.
To the extent any amount of a person’s United States income tax liability is taken into account when computing the final top-up tax, no credit is allowed to such person.
When a final top-up tax is paid by a partnership or controlled foreign corporation (CFC), the final top-up tax is:
- Treated as if the final top-up tax were a creditable tax at the partnership and CFC level, with the disallowance of the credit applying at the level of the partner or U.S. shareholder, as applicable;
- Considered a creditable foreign tax expenditure;
- Considered an eligible current year tax (and thus, deductible for tested income and / or earnings and profits (E&P) purposes);
- Not taken into account in determining whether the subpart F and / or global intangible low-taxed income (GILTI) high-tax exception applies (meaning the final top-up tax is excluded from the amount of foreign income tax but included in the net item of income and / or amount of tentative tested income item when calculating the effective tax rate (ETR)).
If a taxpayer chooses to claim a credit for the taxable year, the taxpayer must apply the gross-up rule of section 78 and the deduction disallowance rule of section 275(a)(4). The Notice confirms that a final top-up tax is required to be included in a taxpayer’s gross income under section 78 when deemed by the taxpayer under sections 960(a), (b), and (d), and that a taxpayer would not be able to claim a deduction for a final top-up tax under section 275(a)(4).
Once the GloBE Model Rules enter into force, taxpayers subject to a final top-up tax may be forced into double taxation scenarios. Not only will final top-up taxes largely be uncreditable, but taxpayers will need to include final top-up taxes in gross income in taxable years when claiming a credit
Separate levy rules
An IIR, UTPR and QDMTT imposed by a foreign country will be treated as separate levies.
Non-duplication requirement
Future proposed regulations will alter the non-duplication requirement in Reg. section 1.903-1(c)(1)(ii) to account for the GloBE Model Rules. The Notice clarifies that “a foreign tax, in order to qualify as an in lieu of tax, need only be in substitution for a generally-imposed net income tax and not in substitution for all net income taxes imposed by that country.”
With respect to the non-duplication requirement, taxpayers may also rely on the guidance described in the Notice for taxable years that begin on or after Dec. 28, 2021, and end on or before Dec. 11, 2023.
Dual consolidated losses
The DCL rules prevent the double dipping of losses which occurs when the “same economic loss offsets or reduces both income subject to U.S. tax (but not a foreign jurisdiction's tax) and income subject to the foreign jurisdiction's tax (but not U.S. tax).” The Notice defines a DCL as a “net operating loss of a dual resident corporation and a net loss of a domestic corporation that is attributable to certain foreign branches or interests in hybrid entities (separate units).”
Under the GloBE Model Rules, a jurisdictional top-up tax will generally be computed when a jurisdiction’s ETR falls below 15%, meaning the GloBE Model Rules take a jurisdictional blending approach (i.e., the income and loss of all constituent entities within a jurisdiction are aggregated). This gives rise to a double dipping concern. The IRS and Treasury are fully aware of this issue and are “studying the extent to which the DCL rules should apply with respect to the GloBE Model Rules.”
The Notice provides relief (and certainty) for legacy DCLs until proposed regulations are issued. The Notice clarifies that foreign use “would not be considered to occur with respect to a legacy DCL solely because all or a portion of the deductions or losses that comprise the legacy DCL are taken into account in determining the Net GloBE Income for a particular jurisdiction.” A legacy DCL is defined as a DCL incurred in:
- Taxable years ending on or before Dec. 31, 2023, or
- Provided the taxpayer’s taxable year begins and ends on the same dates as the fiscal year of the multinational enterprise group that could take into account as an expense any portion of a deduction or loss comprising such a DCL, taxable years beginning before Jan. 1, 2024, and ending after Dec. 31, 2023.
Temporary relief extended
The IRS and Treasury have once again delayed the implementation of the final FTC regulations.
Through Notice 2023-55, the IRS and Treasury granted temporary relief (the relief) under sections 901 and 903 in determining whether a foreign tax qualifies as a creditable tax for purposes of the FTC. The temporary relief gives taxpayers the option to temporarily apply:
- Former section 1.901-2(a) and (b) (i.e., the rules in effect before publication of T.D. 9959), for the definition of a foreign net income tax and for purposes of satisfying the net gain requirement, but subject to a modified non-confiscatory gross basis tax rule, and
- Existing section 1.903-1 without the jurisdiction to tax excluded income and attribution requirements.
The relief was set to sunset for tax years beginning after Dec. 31, 2023, but Notice 2023-80 extends Notice 2023-55’s temporary relief period indefinitely until further notice.
Notice 2023-80 also clarifies that the relief extends to partnerships and that partnerships and their partners are each subject to the consistent application requirement.
Final reminders
The provisions described in this alert are subject to change in any finally enacted regulation package. Nonetheless, taxpayers should contact their advisors to better understand how Notice 2023-80 may affect their tax obligations.
