IRS gets ahead of taxpayer attempts to defer transition tax liability
On Feb. 13, 2018 the IRS issued Rev. Proc. 2018-17, which prevents taxpayers from changing the taxable years of specified foreign corporations (SFCs) in order to reduce or defer income inclusions under section 965. The Tax Cuts and Jobs Act (TCJA) has brought significant changes to international tax provisions of the Internal Revenue Code (IRC). Under revised section 965, U.S. taxpayers are generally required to include into income the accumulated post-1986 deferred foreign income of SFCs determined as of either Nov. 2, 2017 or Dec. 31, 2017, i.e. the transition tax. Some taxpayers had sought to defer the required income inclusion by changing their accounting method to move the year-end of their SFCs. By issuing Rev. Proc. 2018-17, the IRS is exercising its anti-avoidance authority under section 965(o).
Section 965 requires taxpayers to calculate their transition tax inclusion for the last taxable year of the SFC that begins before Jan. 1, 2018. Accordingly, calendar year U.S. taxpayers are required to include into income the transition tax amount of calendar year SFCs in 2017 while the income inclusion of fiscal year (i.e. Nov. 30, 2017) SFCs would generally be included in tax year 2018.
Given the timing of when U.S. taxpayers are required to include the transition tax, taxpayers could be inclined to elect to change the tax year of their SFCs for the purpose of deferring their transition tax inclusion to 2018. If an SFC with an original calendar year-end elected a taxable year-end of Nov. 30 effective for the taxable year beginning Jan. 1, 2017, the election could defer the SFCs income inclusion under section 965 until the 2018 tax year. This had been possible because the IRS, through revenue procedure 2006-45, has traditionally granted automatic approval to certain taxpayer requests under section 442 for changes to the taxable year of foreign corporations. Specifically, revenue procedure 2006-45 generally provides that taxpayers could obtain automatic approval to change the annual accounting periods of their specified foreign corporations to one month earlier than the U.S. shareholder year.
As mentioned above, section 965(o) grants the Secretary the authority to issue regulations or guidance as necessary to prevent the avoidance of the purposes of section 965, including through reductions in earnings and profits, changes in entity classification or accounting methods, or otherwise. Therefore, pursuant to section 965(o), the IRS issued Rev. Proc. 2018-17 to modify Rev. Proc. 2002-39 and Rev. Proc. 2006-45 and disallow automatic changes to taxable year-ends, or annual accounting periods, of specified foreign corporations to the extent that such a change is from a calendar year end with the first effective year begin on Jan. 1, 2017 and end on a date before Dec. 31, 2017, and the U.S. shareholder(s) generally would have a section 965 inclusion amount without regard to the requested change in accounting period. These limitations will apply to any request to change an annual accounting period filed for tax years ending in 2017, regardless of when the request was filed. Therefore, to the extent any taxpayers have already made requests under the old procedure, they will not be honored.