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Tax Cuts and Jobs Act

Final regs on global intangible low-taxed income, subpart F income

Thomson Reuters Tax & Accounting  

Thomson Reuters Tax & Accounting  

T.D. 9866;  Reg § 1.951-1Reg § 1.951A-1, Reg § 1.951A-2, Reg § 1.951A-3, Reg § 1.951A-4, Reg § 1.951A-5, Reg § 1.951A-6,  Reg § 1.1502-12Reg § 1.1502-32Reg § 1.1502-51, Reg § 1.6038-2,  Reg § 1.6038-5

IRS has issued final regs that provide guidance: a) on determining the amount of global intangible low-taxed income (GILTI) included in the gross income of controlled foreign corporations (CFCs), including U.S. shareholders that are members of a consolidated group; b) on determination of CFC subpart F income included in the shareholder’s gross income and c) on certain reporting requirements relating to inclusions of subpart F income and GILTI.

The regs also finalized certain foreign tax credit rules. Those rules will be discussed in a future Federal Tax Update.

Background—CFC rules.  The U.S. shareholders of a CFC must generally include in gross income, among other things, their pro rata share of the CFC’s subpart F income and the increase during the tax year in earnings of the CFC invested in U.S. property (to the extent not included as Subpart F income). (Code Sec. 951) Subpart F income generally consists of certain types of passive income. (Code Sec. 952)

Before the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017), Code Sec. 951(b) defined a U.S. shareholder of a foreign corporation as a U.S. person (“U.S. person”) that holds at least 10% of the total combined voting power of all classes of stock entitled to vote in a foreign corporation. Section 14214(a) of the TCJA amended this definition to include a U.S. person that holds at least 10% of the total value of shares of all classes of stock of the foreign corporation.

Background—GILTI rules. Under Code Sec. 951A(a), a U.S. shareholder of any CFC for a tax year must include in gross income its GILTI for that year. A GILTI inclusion is treated in a manner similar to a Code Sec. 951(a)(1)(A)inclusion of a CFC’s subpart F income for many purposes of the Code, but a GILTI inclusion is determined in a fundamentally different way.

The determination of a U.S. shareholder’s GILTI inclusion amount begins with the calculation of certain items of each CFC owned by the shareholder, such as tested income, tested loss, and qualified business asset investment (QBAI). Under Code Sec. 951A(e)(1), the U.S. shareholder then determines its pro rata share of each of these CFC-level items in a manner similar to a shareholder’s pro rata share of subpart F income under Code Sec. 951(a)(2), except that the U.S. shareholder’s pro rata shares of these items are not amounts included in gross income, but rather amounts taken into account by the shareholder in determining the GILTI included in the shareholder’s gross income.

The U.S. shareholder aggregates (and then nets or multiplies) its pro rata share of each of these items into a single shareholder-level amount.The ultimate GILTI inclusion amount is the excess (if any) of: (A) the shareholder’s net CFC tested income for the tax year, over (B) the shareholder’s net deemed tangible income return (net DTIR) for the tax year. (Code Sec. 951A(b))

Background—adjusting the basis of the stock of a consolidated group subsidiary.  Reg. § 1.1502-32 provides rules for adjusting the basis of the stock of a consolidated group subsidiary owned by another member to reflect, among other items, the subsidiary’s items of income.

Background—proposed regs.  In September 2018, IRS issued proposed regs that provided: (a) rules with respect to the application of the GILTI rules, including rules that were specific to consolidated groups; and (b) rules that closed to CFC loopholes and made changes to CFC regs so that they would conform with Code changes made by the TCJA. (Preamble to Prop Reg REG-104390-18; see Proposed regs explain & clarify global intangible low-taxed income (GILTI) regime)

Final regs.  The final regs retain the basic approach and structure of the proposed regs, with certain revisions.

Amounts included in gross income of U.S. shareholders. The final regs make changes with respect to amounts in the gross income of U.S. shareholders.

Hypothetical distribution of allocable E&P. In general, a U.S. shareholder’s pro rata share of subpart F income is determined based on its proportionate share of a hypothetical distribution of all the current earnings and profits (“E&P” and “current E&P”) of the CFC. (Code Sec. 951(a)(2)(A)Reg §1.951-1(b)(1)(i) and Reg §1.951-1(e)(1)) A U.S. shareholder’s pro rata share of tested income, tested loss, QBAI, tested interest expense, and tested interest income generally are also determined based on a hypothetical distribution of current E&P. (Code Sec. 951A(e)(1) and Reg §1.951A-1(d))

The definition of the term “current earnings and profits” for this purpose differs significantly from the definition of “earnings and profits” provided in Code Sec. 964(a). To avoid confusion,, the final regs replace the term “current earnings and profits” with “allocable earnings and profits” (“allocable E&P”). (Reg §1.951-1(e)(1)(ii))

Pro rata share anti-abuse rule.  The proposed regs provided that any transaction or arrangement that is part of a plan a principal purpose of which is the avoidance of Federal income taxation, including, but not limited to, a transaction or arrangement to reduce a U.S. shareholder’s pro rata share of the subpart F income of a CFC, which transaction or arrangement would otherwise avoid Federal income taxation, is disregarded in determining such U.S. shareholder’s pro rata share of the subpart F income of the corporation (the “pro rata share anti-abuse rule”). The pro rata share anti-abuse rule also applies in determining the pro rata share of each tested item of a CFC for purposes of determining a U.S. shareholder’s GILTI inclusion amount under Code Sec. 951A(a) and Reg §1.951A-1(b). (Prop Reg §1.951-1(e)(6))

The final regs clarify that the rule applies only to require appropriate adjustments to the allocation of allocable E&P that would be distributed in a hypothetical distribution with respect to any share outstanding as of the hypothetical distribution date.  (Reg §1.951-1(e)(6)) Thus, under the rule, if applicable, adjustments will be made solely to the allocation of allocable E&P in the hypothetical distribution between shareholders that own, directly or indirectly, stock of the CFC as of the relevant hypothetical distribution date. The rule will not apply to adjust the allocable E&P allocated to a shareholder by reason of a transfer of CFC stock, except by reason of a change to the distribution rights with respect to stock in connection with such transfer (for example, an issuance of a new class of stock, including by recapitalization). (T.D. 9866)

Subpart F income and tested income.  Under Code Sec. 951(a)(2)(B), a U.S. shareholder’s pro rata share of subpart F income with respect to stock for a tax year is reduced by the amount of distributions received by any other person during the year as a dividend with respect to the stock, subject to a limitation. Code Sec. 951A(e)(1) provides that the pro rata share of tested income, tested loss, and QBAI is determined under the rules of Code Sec. 951(a)(2) in the same manner as such section applies to subpart F income. Accordingly, Prop Reg §1.951A-1(d)(2) provided that a U.S. shareholder’s pro rata share of tested income is determined under Code Sec. 951(a)(2) and Reg §1.951-1(b) and Reg. §1.951-1(b), generally substituting “tested income” for “subpart F income” each place it appears.

Because Code Sec. 951(a)(2)(B) applies for purposes of determining the pro rata share of both subpart F income and tested income, the proposed regs could be interpreted as permitting a dollar-for-dollar reduction under Code Sec. 951(a)(2)(B) in both a U.S. shareholder’s pro rata share of subpart F income and its pro rata share of tested income. To avoid such an inappropriate double benefit, Reg §1.951-1(b)(1)(ii) provides that a dividend received during the tax year by a person other than the U.S. shareholder reduces the U.S. shareholder’s pro rata share of subpart F income and its pro rata share of tested income in the same proportion as its pro rata share of each amount bears to its aggregate pro rata share of both amounts.

Tested income and tested loss. The final regs contain rules for computing tested income and tested loss.

Life insurance companies. The proposed regs provide that, for purposes of determining tested income and tested loss, the gross income and allowable deductions of a CFC for a CFC inclusion year are determined under the rules of Reg §1.952-2 for determining the subpart F income of a CFC. (Prop Reg §1.951A-2(c)(2))

Reg § 1.952-2(b)(2) provides that the taxable income of a CFC engaged in the business of reinsuring or issuing insurance or annuity contracts and which, if it were a domestic corporation engaged in such business, would be taxable as a life insurance company to which subchapter L applies, is generally determined by treating such corporation as a domestic corporation taxable under subchapter L and by applying the principles of Reg §1.953-4 and Reg §1.953-5 for determining taxable income. These regs, which were promulgated in ’64, have not been updated to reflect current Code Sec. 953(a)Code Sec. 953(b)(3), and Code Sec. 954(i).

The final regs confirm that the rules of Code Sec.953 and Code Sec. 954(i) apply in determining the tested income or tested loss of a CFC described in Reg §1.952-2(b)(2). (Reg §1.951A-2(c)(2)(i)) However, no inference is intended that a CFC may determine reserve amounts based on foreign statement reserves in the absence of a ruling request. IRS intends to address, in separate guidance, the use of foreign statement reserves for purposes of measuring qualified insurance income under Code Sec. 954(i). (T.D. 9866)

 Deemed payments under Code Sec. 367(d).  In general, Code Sec. 367(d) provides that if a U.S. person transfers intangible property to a foreign corporation in an exchange described in Code Sec. 351 or Code Sec. 361, the person is treated as having sold the property in exchange for payments contingent upon the productivity, use, or disposition of such property. The deemed payment may be treated as an expense of the transferee foreign corporation that is properly allocated and apportioned to gross income subject to subpart F. (Reg §1.367(d)-1T(c)(2)(ii) and Reg §1.367(d)-1T(e)(2)(ii))

The final regs clarify that a deemed payment under Code Sec. 367(d) is treated as an allowable deduction for purposes of determining tested income and tested loss. (Reg §1.951A-2(c)(2)(ii)) Accordingly, such deemed payments may be allocated and apportioned to gross tested income to the extent provided under Reg §1.951A-2(c)(3).

Effect of losses in other categories of income. The proposed regs provided that allowable deductions are allocated and apportioned to gross tested income under the principles of Code Sec. 954(b)(5) and Reg §1.954-1(c), by treating gross tested income within a single category as a single item of gross income. (Prop Reg §1.951A-2(c)(3))

The final regs clarify that losses in other categories of income cannot reduce gross tested income, and that tested losses cannot reduce other categories of income. (Reg §1.951A-2(c)(3))

QBAI. The final regs contain rules with respect to QBAI.

Determination of depreciable property.   Code Sec. 951A(d)(1)(B) provides that specified tangible property is taken into account in determining QBAI only if the property is of a type with respect to which a depreciation deduction is allowable under Code Sec. 167Prop Reg §1.951A-3(c)(2) defines “tangible property” as property for which the depreciation deduction provided by Code Sec. 167(a) is eligible to be determined under Code Sec. 168 without regard to Code Sec. 168(f)(1)Code Sec. 168(f)(2), or Code Sec. 168(f)(5) and the date placed in service.

The final regs revise the definition of tangible property in Reg §1.951A-3(c)(2) to exclude certain intangible property to which Code Sec. 168(k) applies, namely, computer software, qualified film or television productions, and qualified live theatrical productions described in Code Sec. 168(k)(2)(A).

…Dual use property.  Prop Reg §1.951A-3(d)(1) provides that if tangible property is used in both the production of gross tested income and other income, the portion of the adjusted basis in the property treated as adjusted basis in specified tangible property is determined by multiplying the average of the adjusted basis in the property by the dual use ratio. If the property produces directly identifiable income for a CFC inclusion year, the dual use ratio is the ratio of the gross tested income produced by the property to the total amount of gross income produced by the property. (Prop Reg §1.951A-3(d)(2)(i)) In all other cases, the dual use ratio is the ratio of the gross tested income of the tested income CFC to the total amount of gross income of the tested income CFC. (Prop Reg §1.951A-3(d)(2)(ii))

IRS recognizes that application of the directly identifiable standard could result in substantial uncertainty and controversy. Accordingly, the final regs provide that the dual use ratio, with respect to tangible property for a CFC inclusion year, is: a) the sum of the amount of the depreciation deduction with respect to the property for the CFC inclusion year that is allocated and apportioned to gross tested income for the CFC inclusion year under Reg §1.951A-2(c)(3) and the depreciation with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account in determining tested income for the CFC inclusion year, divided by b) the sum of the total amount of the depreciation deduction with respect to the property for the CFC inclusion year and the total amount of depreciation with respect to the property capitalized to inventory or other property held for sale, the gross income or loss from the sale of which is taken into account for the CFC inclusion year. (Reg §1.951A-3(d)(3))

Consolidated group rules.  Prop Reg §1.1502-32(b)(3)(ii)(F) treated a member as receiving tax-exempt income immediately before another member recognizes income, gain, deduction, or loss with respect to a share of the first member’s stock (the “F adjustment”). The amount of the tax-exempt income would be determined based in part on the aggregate tested income and aggregate tested losses of the member’s CFCs in prior tax years.

IRS has become aware of serious flaws with the F adjustment. Examples of the problems include unintended and duplicative tax benefits, distortive effects, and possible avoidance of Code provisions and regs. Therefore, IRS has decided not to finalize the F adjustment, and taxpayers may not rely on the F adjustment. (T.D. 9866)

Applicability dates. Consistent with the applicability date of Code Sec. 951AReg §1.951A-1 through Reg §1.951A-6 apply to tax years of foreign corporations beginning after December 31, 2017, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end. (Reg §1.951A-7)

The applicability dates with respect to the rules in Reg §1.951-1 are as follows. Paragraphs (a), (b)(1)(ii), (b)(2), (e)(1)(ii)(B), and (g)(1) apply to tax years of foreign corporations beginning after December 31, 2017, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end. Paragraph (e), except for paragraph (e)(1)(ii)(B), applies to tax years of U.S. shareholders ending on or after October 3, 2018. Paragraph (h) applies to tax years of domestic partnerships ending on or after May 14, 2010. (Reg §1.951-1(i))

Reg §1.6038-2(a) and Reg §1.6038-5 apply to tax years of foreign corporations beginning on or after October 3, 2018. (Reg §1.6038-2(m)Reg §1.6038-5(e))

For U.S. shareholders that are members of a consolidated group, the applicability date is tax years of such members for which the due date (without extensions) of the consolidated return is after June 21, 2019. However, the final regs provide that a consolidated group may apply the rules of Reg §1.1502-51 in their entirety to all of its members for all tax years described in Reg §1.951A-7. (Reg §1.1502-51(g))

References: For global intangible low-taxed income under Code Sec. 951A, see FTC 2d/FIN ¶O-2790 et seq.; United States Tax Reporter ¶951A4. For subpart F income, see FTC 2d/FIN ¶ O-2470United States Tax Reporter ¶ 9524.

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