IRS has issued final regs that cover reductions of hybrid deduction accounts under Code Sec. 245A(e) and calculation of taxable income for purposes of the foreign tax credit limitation.
Background—hybrid deduction accounts.
Code Sec. 245A(e) was added to the Code by the Tax Cuts and Jobs Act (PL 115-97, TCJA). Code Sec. 245A(e) and T.D. 9896 (the 2020 hybrids final regs) neutralize the double non-taxation effects of a hybrid dividend or tiered hybrid dividend by either denying the Code Sec. 245A(a) dividends received deduction with respect to the dividend or requiring an inclusion under Code Sec. 951(a)(1)(A) with respect to the dividend, depending on whether the dividend is received by a domestic corporation or a controlled foreign corporation (CFC).
A hybrid dividend is as an amount received from a CFC for which a dividend received deduction (DRD) would be allowed under Code Sec. 245A(a), and for which the CFC received a deduction (or other tax benefit) with respect to any income, war profits, or excess profits taxes imposed by any foreign country or US possession. (Code Sec. 245A(e)(4)(B)) A tiered hybrid dividend is an amount received by a CFC from another CFC to the extent that the amount would be a hybrid dividend if, for purposes of Code Sec. 245A and the regs thereunder (except for the tiered hybrid dividend rule), the receiving CFC were a domestic corporation. (Reg § 1.245A(e)-1(c)(2))
The 2020 hybrids final regs require that certain shareholders of a CFC maintain a hybrid deduction account with respect to each share of stock of the CFC that the shareholder owns and provide that a dividend received by the shareholder from the CFC is a hybrid dividend or tiered hybrid dividend to the extent of the sum of those accounts. A hybrid deduction account with respect to a share of stock of a CFC reflects the amount of hybrid deductions of the CFC that have been allocated to the share, reduced by the amount of hybrid deductions that gave rise to a hybrid dividend or tiered hybrid dividend.
REG-106013-19 (the 2020 hybrids proposed regs) generally reduced a hybrid deduction account with respect to a share of stock of a CFC by three categories of amounts included in the gross income of a domestic corporation with respect to the share, including an “adjusted subpart F inclusion” or an “adjusted global intangible low-taxed income (GILTI) inclusion” with respect to the share. (Prop Reg §1.245A(e)-1(d)(4)(i)(B)(1) and Prop Reg §1.245A(e)-1(d)(4)(i)(B)(2))
An adjusted subpart F inclusion or an adjusted GILTI inclusion with respect to a share is intended to measure, in an administrable manner, the extent to which a domestic corporation’s inclusion under Code Sec. 951(a)(1)(A) (“subpart F inclusion”) or inclusion under Code Sec. 951A (“GILTI inclusion amount”) attributable to the share is likely “included in income” in the United States — that is, taken into account in income and not offset by, for example, foreign tax credits associated with the inclusion and, in the case of a GILTI inclusion amount, the deduction under Code Sec. 250(a)(1)(B).
Background—limitation on foreign tax credit.
Code Sec. 904(a) provides that the total amount of a foreign tax credit may not exceed the same proportion of the tax against which the credit is taken which the taxpayer’s taxable income from foreign sources (but not in excess of the taxpayer’s entire taxable income) bears to the taxpayer’s entire taxable income for the same tax year.
Final regs—hybrid deduction accounts—Computation of adjusted subpart F income inclusion and adjusted GILTI inclusion.
Section 904 limitation. Under the 2020 hybrids proposed regs, an adjusted subpart F inclusion or adjusted GILTI inclusion with respect to a share of stock is computed by taking into account foreign income taxes that are likely to give rise to deemed paid credits eligible to be claimed by the domestic corporation with respect to the subpart F inclusion or adjusted GILTI inclusion. (Prop Reg §1.245A(e)-1(d)(4)(ii)(A) and Prop Reg §1.245A(e)-1(d)(4)(ii)(B)) To minimize complexity, the 2020 hybrids proposed regs did not take into account any limitations on foreign tax credits when computing foreign income taxes that are likely to give rise to deemed paid credits. (Prop Reg §1.245A(e)-1(d)(4)(ii)(D))
The final regs do take into account the limitation under Code Sec. 904 for computing an adjusted GILTI inclusion. Foreign income taxes that by reason of Code Sec. 904 do not currently give rise to deemed paid credits eligible to be claimed with respect to the GILTI inclusion amount are not creditable in another year through a carryback or carryover. (Code Sec. 904(c)) Thus, there is generally no ability for such excess foreign income taxes to reduce the extent that an amount taken into account in income by the domestic corporation is included in income in the United States. The final regs therefore provide that such foreign income taxes are not taken into account when computing an adjusted GILTI inclusion. (Reg §1.245A(e)-1(d)(4)(ii)(D)(2)(iii) and Reg §1.245A(e)-1(d)(4)(ii)(G))
If the application of this rule results in circularity or ordering rule issues, a taxpayer may, solely for purposes of computing the adjusted GILTI inclusion, apply any reasonable method to compute the amount of foreign income taxes the creditability of which is limited by Code Sec. 904. (Preamble to TD 9922)
The final regs do not adopt a similar rule for computing an adjusted subpart F inclusion. This is because foreign income taxes that by reason of Code Sec. 904 do not currently give rise to deemed paid credits eligible to be claimed with respect to the subpart F inclusion, may become creditable in another year under Code Sec. 904(c). (Preamble to TD 9922)
Section 250 deduction. Under the 2020 hybrids proposed regs, an adjusted GILTI inclusion is computed by taking into account the portion of the deduction allowed under Code Sec. 250 (foreign-derived intangible income and GILTI) by reason of Code Sec. 250(a)(1)(B) that the domestic corporation is likely to claim with respect to the GILTI inclusion amount. The 2020 hybrids proposed regs did not take into account any limitations on the deduction under Code Sec. 250(a)(2)(B). (Prop Reg §1.245A(e)-1(d)(4)(ii)(B))
The final regs take into account the taxable income limitation under Code Sec. 250(a)(2). IRS reasons that taking into account the taxable income limitation results in an adjusted GILTI inclusion that more closely reflects the extent to which the GILTI inclusion amount is included in income in the United States. (Preamble to TD 9922) The final regs thus provide a rule to this effect. (Reg §1.245A(e)-1(d)(4)(ii)(B) and Reg §1.245A(e)-1(d)(4)(ii)(H))
A taxpayer may, solely for purposes of computing an adjusted GILTI inclusion, apply any reasonable method to compute the extent to which the portion of a deduction allowed under Code Sec. 250 by reason of Code Sec. 250(a)(1)(B) is limited under Code Sec. 250(a)(2)(B). (Preamble to TD 9922)
Limit on reduction of a hybrid deduction account. The 2020 hybrids proposed regs provided a limit to ensure that an adjusted subpart F inclusion or adjusted GILTI inclusion with respect to a share of stock of a CFC does not reduce the hybrid deduction account by an amount greater than the hybrid deductions allocated to the share for the tax year multiplied by a fraction, the numerator of which is the subpart F income or tested income, as applicable, of the CFC for the tax year and the denominator of which is the CFC’s taxable income. (Prop Reg §1.245A(e)-1(d)(4)(i)(B)(1)(ii) and Prop Reg §1.245A(e)-1(d)(4)(i)(B)(2)(ii)) In cases in which the CFC’s taxable income is zero or negative, the 2020 hybrids proposed regs prevented distortions to the fraction – which would otherwise occur because the fraction would involve dividing by zero or a negative number – by providing that the fraction is considered to be zero. (Prop Reg §1.245A(e)-1(d)(4)(i)(B)(1)(ii) and Prop Reg §1.245A(e)-1(d)(4)(i)(B)(2)(ii))
Distortions to the fraction could also occur if the CFC’s taxable income is greater than zero but less than its subpart F income or tested income (due to losses in one category of income) because, absent a rule to address, the fraction would be greater than one. The final regs eliminate these distortions by modifying the fraction so that the numerator and denominator only reflect items of gross income. (Reg §1.245A(e)-1(d)(4)(i)(B)(1)(ii) and Reg §1.245A(e)-1(d)(4)(i)(B)(2)(ii))
Final regs—allocation and apportionment of deductions and the calculation of taxable income for purposes of Code Section 904(a).
The final regs contain numerous rules regarding Code Sec. 904(a). They include rules on:
…Stewardship expenses, litigation damages awards and settlement payments, net operating losses, interest expense, and other expenses.
…Partnership transactions.
…Treatment of Code Sec. 818(f) (life insurance company deduction for reserves, etc.) expenses for consolidated groups.
…Research and experimental expenditures.
…And application of Code Sec. 904(b) (taxable income for purposes of the Code Sec. 904(a) limitation) to net operating losses.
Applicability dates.
Rules relating to hybrid arrangements and section 951A. The rules under Code Sec. 245A(e) relating to hybrid deduction accounts are applicable to tax years ending on or after the date that the regs are published in the Federal Register. A taxpayer may apply the final rules under Code Sec. 245A(e) to a tax year ending before the date of publication in the Federal Register, if it consistently applies those rules to that tax year and any subsequent tax year ending before the date of publication in the federal register. (Reg §1.245A(e)-1(h)(2))
Foreign tax credit expense allocation rules. The foreign tax credit regs apply to tax years beginning after December 31, 2019. (Reg §1.861-8(h)(2); Reg §1.861-14(k))
Regs are advance copy.
The final regs are an advance copy and, as such, do not contain a Federal Register publication date. In addition, the version of the final regs attached above may vary slightly from the published document if minor editorial changes are made during the review process. The document published in the Federal Register will be the official document.
To continue your research on hybrid deduction accounts, see FTC 2d/FIN ¶O-2952.3.
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