On Dec. 2, 2019, the Treasury Department and the IRS published final regulations (T.D. 9882; the Final Regulations) and proposed regulations (REG-105495-19; the 2019 Proposed Regulations) for determining foreign tax credits (FTCs) under the Internal Revenue Code. The Final Regulations largely retained the structure of the prior proposed regulations (REG-105600-18; the 2018 Proposed Regulations), released Nov. 28, 2018, however there are certain notable modifications from the 2018 Proposed Regulations.
The regulation package addresses the structural changes made by the Tax Cuts and Jobs Act (TCJA) that impact the FTC calculation. TCJA changes included the repealed section 902, which allowed deemed-paid tax credits, and added separate FTC limitation categories for foreign branch income and amounts includible under the new Global Intangible Low-Taxed Income (GILTI) provisions. Accordingly, the regulation package provides clarification and rules regarding altering the approach to calculating exempt assets that give rise to Foreign-Derived Intangible Income (FDII), allowing the grouping of tested income within a tier of CFCs for purposes of determining CFC stock value, and extending the time for taxpayers to change their allocation method with respect to research and experimental (R&E) expenses. For a discussion of these and other changes, and an overview of the 2018 Proposed Regulations, please see our prior article here: Proposed regulations contain key foreign tax credit transition rules.
The Final Regulations made several notable changes from the 2018 Proposed Regulations, some of the more significant changes include:
The creation of new safe harbor methods for applying transition rules for the carryover of foreign taxes and loss accounts with the foreign branch category. Specifically, the Final Regulations provide
- A Safe harbor rule that allows allocation of unused FTCs carried forward from prior years based on a ratio of foreign taxes paid by a branch divided by total foreign taxes in the taxable year.
- Transition rules that can be applied to SLL and OFL carryovers when there is an FTC carryover. These new rules now allow for a full reconstruction of a SLL or OFL as well as a safe harbor rule that follows similar mechanics to the FTC transition rule above.
- The 16 PTEP groups (Notice 2019-01) have been reduced to 10.
- Special rules related to disregarded transfers of IP for allocating income to the foreign branch category.
- A new requirement that an upper-tier CFC must take the gross tested income of lower-tier CFCs into account for purposes of allocating and apportioning its interest expense under the modified gross income method.
- For tiers of CFCs, in determining asset value/stock value of a CFC, final regulations now allow grouping of tested income at the top tier CFC level
- For purposes of the 250 deduction related to FDII, the rules used to determine exempt assets that create FDII are now linked to the section 250 regulations that identify assets that produce gross FDDEI (rather than FDII as provided under the 2018 Proposed Regulations).
The 2019 Proposed Regulations primarily address the allocation and apportionment of R&E expenses. The significant provisions include the following:
The time to make the change in allocation method has been extended through taxable years that begin before Jan. 1, 2020.
- New rules could preclude allocation of R&E to GILTI income
- A mandatory sales-based apportionment to R&E based on the relevant product SIC code.
- Product liability claims are allocated to the type of gross income created by the activity that gave rise to the claim.
- New interest matching rules for certain upstream loans from certain controlled partnerships.
While various effective dates apply under the Final and 2019 Proposed Regulations they are generally effective as of Dec. 7, 2018, the date the 2018 Proposed Regulations were published in the Federal Register. Given the complexity of the Final Regulations and 2019 Proposed Regulations, taxpayers with a significant foreign operations should consult with their tax advisors to assess the impact of these regulations. The Final and Proposed Regulations introduce a number of new elections and method changes. These changes may provide significant tax benefits, however the time to make these changes is limited. Therefore, it is important that taxpayers understand how these regulations may impact their tax filing positions now and going forward.