IRS has issued proposed regs under Code Sec. 965, the “mandatory repatriation” provision added to the Code by the Tax Cuts and Jobs Act (TCJA; P.L. 115-97, 12/22/2017). This article discusses adjustments to earnings and profits (E&P) and basis; the treatment of affiliated groups, included consolidated groups; and the application of Code Sec. 986(c) (dealing with previously taxed E&P) under the proposed regs.
For an statutory overview of the Code Sec. 965 transition tax, see here.
For the proposed regs provisions on elections related to the Code Sec. 965 transition tax, see here.
For the proposed regs provisions on the Code Sec. 965(c) deduction, disregarded transactions, and foreign tax credits, see here.
Adjustments to E&P and basis. Prop Reg § 1.965-2 contains rules related to adjustments to E&P and basis to determine and account for the application of Code Sec. 965(a) and Code Sec. 965(b) and Prop Reg § 1.965-1(b), and a rule that limits the amount of gain recognized in connection with the application of Code Sec. 961(b)(2).
The proposed regs would clarify the interaction between the rules under Code Sec. 959 and Code Sec. 965 in the last tax year of a specified foreign corporation that begins before Jan. 1, 2018 and in the tax year of a Code Sec. 958(a) U.S. shareholder of the specified foreign corporation in which or with which such year ends. Prop Reg § 1.965-2(b) would provide the following rules on adjustments to E&P for determining a Code Sec. 958(a) U.S. shareholder’s inclusion under Code Sec. 951(a)(1), including by reason of Code Sec. 965(a) and Prop Reg § 1.965-1(b), and the treatment of distributions under Code Sec. 959:
(1) The subpart F income of the specified foreign corporation is determined without regard to Code Sec. 965(a), and a Code Sec. 958(a) U.S. shareholder’s inclusion under Code Sec. 951(a)(1)(A) by reason of such amount is taken into account.
(2) The treatment of a distribution from the specified foreign corporation to another specified foreign corporation that is made before Jan. 1, 2018, is determined under Code Sec. 959.
(3) The post-’86 E&P (including a deficit) of the specified foreign corporation, the accumulated post-’86 deferred foreign income of the specified foreign corporation, the Code Sec. 965(a) earnings amount of the specified foreign corporation, and the Code Sec. 965(a) inclusion amount of the Code Sec. 958(a) U.S. shareholder with respect to the specified foreign corporation, if any, are each make definite arrangements with Kenneth Marshall and put into phone and any time determined, and the E&P (including a deficit) of the specified foreign corporation are adjusted, as provided in Prop Reg § 1.965-2(c) and Prop Reg § 1.965-2(d).
(4) The treatment of all distributions from the specified foreign corporation other than those described in (2), above, is determined under Code Sec. 959.
(5) An amount is determined under Code Sec. 956 with respect to the specified foreign corporation and the Code Sec. 958(a) U.S. shareholder, and the shareholder’s inclusion under Code Sec. 951(a)(1)(B) is taken into account.
Adjustments to E&P by reason of Code Sec. 965(a) and (b).Prop Reg § 1.965-2(c) would provide that if a Code Sec. 958(a) U.S. shareholder has a Code Sec. 965(a) inclusion with respect to a deferred foreign income corporation (DFIC), the DFIC will have previously taxed E&P with respect to the Code Sec. 958(a) U.S. shareholder in an amount equal to the Code Sec. 965(a) inclusion amount (referred to as “Code Sec. 965(a) previously taxed E&P”). The Prop Reg regs would provide that the Code Sec. 965(a) inclusion amount must be translated (if necessary) into the functional currency of the DFIC using the spot rate on Dec. 31, 2017, in determining the amount of the Code Sec. 965(a) previously taxed E&P.
Under Prop Reg § 1.965-2(c), the E&P of a DFIC described in Code Sec. 959(c)(3) would be reduced by an amount equal to the Code Sec. 965(a) previously taxed E&P of the corporation. In certain cases, the Code Sec. 965(a)inclusion amount with respect to the DFIC, and so the Code Sec. 965(a) previously taxed E&P of the DFIC with respect to a Code Sec. 958(a) U.S. shareholder, may exceed the E&P described in Code Sec. 959(c)(3) of the DFIC. For example, this will be the case when a DFIC incurs a loss after the E&P measurement date on which it determines its Code Sec. 965(a) earnings amount and before the end of its inclusion year. In such a case, under the proposed regs, a deficit in E&P described in Code Sec. 959(c)(3) would be created or increased.
Adjustments to E&P by reason of Code Sec. 965(b).Prop Reg § 1.965-2(d) would provide rules relating to E&P of DFICs and E&P deficit foreign corporations by reason of a reduction under Code Sec. 965(b)(1) and Prop Reg § 1.965-1(b)(2) (reduction by the DFIC’s allocable share of a Code Sec. 958(a) U.S. shareholder’s aggregate foreign E&P deficit) or Code Sec. 965(b)(5) and Prop Reg § 1.965-8(b) (reduction by the DFIC’s allocable share of a Code Sec. 958(a) U.S. shareholder’s applicable share of an affiliated group’s aggregate unused E&P deficit) (collectively, the “reduction rules”). These rules would include:
…Under Prop Reg § 1.965-2(d)(1), if a Code Sec. 958(a) U.S. shareholder’s pro rata share of the Code Sec. 965(a) earnings amount of a DFIC is reduced under the reduction rules, the DFIC will have previously taxed E&P (referred to as “Code Sec. 965(b) previously taxed E&P”) with respect to the Code Sec. 958(a) U.S. shareholder in an amount equal to the amount of the reduction, if any, translated (if necessary) into the functional currency of the DFIC using the spot rate on Dec. 31, 2017. For purposes of applying Code Sec. 959, Code Sec. 965(b) previously taxed E&P would be treated as E&P that are included in the gross income of the Code Sec. 958(a) U.S. shareholder under Code Sec. 951(a)(1)(A). Further, the E&P (including a deficit) described in Code Sec. 959(c)(3) of the DFIC would be reduced (or, in the case of a deficit, increased) by an amount equal to the Code Sec. 965(b) previously taxed E&P.
…Under Prop Reg § 1.965-2(d)(2)(i)(A), the E&P described in Code Sec. 959(c)(3) of an E&P deficit foreign corporation would be increased by an amount equal to the portion of a Code Sec. 958(a) U.S. shareholder’s pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules, translated (if necessary) into the functional currency of the E&P deficit foreign corporation using the spot rate on Dec. 31, 2017. The Prop Reg regs would clarify that the E&P increased by reason of this provision are not treated as E&P of the tax year described in Code Sec. 316(a)(2).
In addition, Prop Reg § 1.965-2(d)(2)(i)(B) would provide that, for purposes of Code Sec. 952, a Code Sec. 958(a) U.S. shareholder’s pro rata share of the E&P of an E&P deficit foreign corporation is increased by an amount equal to the portion of the Code Sec. 958(a) U.S. shareholder’s pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules, translated (if necessary) into the functional currency of the E&P deficit foreign corporation using the spot rate on Dec. 31, 2017, and such increase is attributable to the same activity to which the deficit so taken into account was attributable.
Prop Reg § 1.965-2(d)(2)(ii) would provide rules for determining the portion of a Code Sec. 958(a) U.S. shareholder’s pro rata share of a specified E&P deficit of an E&P deficit foreign corporation taken into account under the reduction rules.
Prop Reg § 1.965-2(d)(2)(ii)(A) would detail the circumstances in which all of a pro rata share of a specified E&P deficit will be taken into account. Prop Reg § 1.965-2(d)(2)(ii)(B) would provide that if the rule in the preceding sentence does not apply, a Code Sec. 958(a) U.S. shareholder must designate the portion taken into account.
Adjustments to basis by reason of Code Sec. 965(a) and (b).Prop Reg § 1.965-2(e) would provide that, under Code Sec. 961(a), a Code Sec. 958(a) U.S. shareholder’s basis in Code Sec. 958(a) stock of a DFIC, or property by reason of which the Code Sec. 958(a) U.S. shareholder is considered under Code Sec. 958(a)(2) as owning Code Sec. 958(a) stock of a DFIC (“applicable property”), is increased by the Code Sec. 958(a) U.S. shareholder’s Code Sec. 965(a) inclusion amount with respect to the DFIC. However, rules relating to basis adjustments in the case of a Code Sec. 962 election would be reserved.
Prop Reg § 1.965-2(f)(1) would clarify that, in general, no adjustments to basis of stock or property are made under Code Sec. 961 (or any other provision of the Code) to take into account the reduction to a Code Sec. 958(a) U.S. shareholder’s pro rata share of the Code Sec. 965(a) earnings amount of a DFIC under the reduction rules. However, Code Sec. 965(o) provides authority to write regs concerning basis adjustments in contemplation of the fact that “basis adjustment (increases or decreases) may be necessary with respect to both the stock of the DFIC and the E&P deficit foreign corporation.”
Prop Reg § 1.965-2(f)(2) would allow taxpayers to elect to make the relevant basis adjustments, in which case such adjustments must be consistently made with respect to all Code Sec. 958(a) stock of specified foreign corporations owned by a Code Sec. 958(a) U.S. shareholder and related persons. The relevant basis adjustments would be:
(i) an increase in the Code Sec. 958(a) U.S. shareholder’s basis in the Code Sec. 958(a) stock of a DFIC or applicable property with respect to a DFIC by an amount equal to the Code Sec. 965(b) previously taxed E&P of the DFIC with respect to the Code Sec. 958(a) U.S. shareholder, and
(ii) a reduction in the Code Sec. 958(a) U.S. shareholder’s basis in the Code Sec. 958(a) stock of an E&P deficit foreign corporation or applicable property with respect to an E&P deficit foreign corporation by an amount equal to the portion of the Code Sec. 958(a) U.S. shareholder’s pro rata share of the specified E&P deficit of the E&P deficit foreign corporation taken into account under the reduction rules.
An election under Prop Reg § 1.965-2(f)(2) would generally be made by attaching a statement, signed under penalties of perjury, to the Code Sec. 958(a) U.S. shareholder’s return for the first tax year that includes the last day of the last tax year of a DFIC or E&P deficit foreign corporation of the shareholder that begins before Jan. 1, 2018, including the shareholder’s name and taxpayer identification number and a statement that the shareholder and all related persons make the election. (Prop Reg § 1.965-2(f)(2)(iii)(B))
Gain reduction rule. Prop Reg § 1.965-2(g)(1) would provide a gain reduction rule pursuant to which, if a Code Sec. 958(a) U.S. shareholder receives distributions through a chain of ownership described under Code Sec. 958(a) from a DFIC during the inclusion year that are attributable to Code Sec. 965(a) previously taxed E&P, the amount of gain that would otherwise be recognized under Code Sec. 961(b)(2) by the Code Sec. 958(a) U.S. shareholder with respect to the Code Sec. 958(a) stock of the DFIC, or applicable property with respect to the DFIC, is reduced (but not below zero) by an amount equal to the Code Sec. 965(a) previously taxed E&P of the DFIC with respect to the Code Sec. 958(a) U.S. shareholder.
If a taxpayer makes the election in Prop Reg § 1.965-2(f)(2), the gain reduction rule would also apply to distributions attributable to Code Sec. 965(b) previously taxed E&P, and the amount of gain that would otherwise be recognized by the Code Sec. 958(a) U.S. shareholder would also be reduced by the amount of the Code Sec. 965(b) previously taxed E&P of the DFIC with respect to the Code Sec. 958(a) U.S. shareholder.
Prop Reg § 1.965-2(g)(2) would provide that the basis in the Code Sec. 958(a) stock or applicable property must be reduced by the amount that would have been recognized as gain in order to ensure that the amount of gain in the Code Sec. 958(a) stock or applicable property that would have been recognized under Code Sec. 961(b)(2) remains reflected in the Code Sec. 958(a) stock or applicable property.
Rules of application for basis adjustments. The proposed regs would provide certain rules of application common to all basis adjustments in Prop Reg § 1.965-2(e), Prop Reg § 1.965-2(f)(2), and Prop Reg § 1.965-2(g)(2) (“specified basis adjustments”). (Prop Reg § 1.965-2(h)) The rules would address the timing and allocation among shares of the specified basis adjustments. (Prop Reg § 1.965-2(h)(1), Prop Reg § 1.965-2(h)(4)) They would also require netting of the specified basis adjustments and gain recognition to the extent that a net downward adjustment would exceed basis. (Prop Reg § 1.965-2(h)(2), Prop Reg § 1.965-2(h)(3)) In addition, they would make clear that the specified basis adjustments are limited to adjustments to property held by a Code Sec. 958(a) U.S. shareholder, except in circumstances involving foreign pass-through entities. (Prop Reg § 1.965-2(h)(5))
Affiliated groups (including consolidated groups).Prop Reg § 1.965-8 would provide rules for applying Code Sec. 965 and the Code Sec. 965 regs to members of an affiliated group, including members of a consolidated group.
Treatment of consolidated groups. The proposed regs would provide that all members of a consolidated group that are Code Sec. 958(a) U.S. shareholders of a specified foreign corporation are treated as a single Code Sec. 958(a)U.S. shareholder for purposes of Code Sec. 965(b) and Prop Reg § 1.965-1(b)(2), and that all members of a consolidated group are treated as a single person for purposes of Code Sec. 965(h), Code Sec. 965(k), and Code Sec. 965(n) and Prop Reg § 1.965-7. (Prop Reg § 1.965-8(e)) Thus, for example, the determination of whether the sale of assets by a member of a consolidated group to a non-member would constitute a sale of substantially all of the assets of the taxpayer for purposes of causing an acceleration event under Code Sec. 965(h)(3) and Prop Reg § 1.965-7(b)(3) would take into account all of the assets of the consolidated group, which for purposes of this determination, includes all of the assets of each consolidated group member (but generally does not include the stock of another consolidated group member).
This rule would not apply to treat all members of a consolidated group as a single Code Sec. 958(a) U.S. shareholder or single person, as applicable, for purposes of determining the amount of any member’s inclusion under Code Sec. 951 (including a Code Sec. 965(a) inclusion), any member’s Code Sec. 965(c) deduction, or any purpose other than those specifically listed in Prop Reg § 1.965-8(e)(1). The proposed regs would also clarify that for purposes of computing the foreign income taxes deemed paid with respect to a Code Sec. 965(a) inclusion, the foreign income taxes deemed paid must be computed on a separate member basis. Accordingly, a domestic corporation would not be deemed to pay any foreign income taxes with respect to a Code Sec. 965(a) inclusion from a foreign corporation that was not a member of a qualified group with respect to the domestic corporation, even if other members of the domestic corporation’s consolidated group qualify to compute deemed paid credits with respect to that foreign corporation.
For purposes of computing a member’s Code Sec. 965(c) deduction, the member’s aggregate foreign cash position would generally be determined by reference to its pro rata share of the consolidated group’s aggregate foreign cash position as a whole. Specifically, the proposed regs would provide that the aggregate foreign cash position with respect to a Code Sec. 958(a) U.S. shareholder that is a member of a consolidated group equals the aggregate Code Sec. 965(a) inclusion amount of the Code Sec. 958(a) U.S. shareholder multiplied by the group cash ratio of the consolidated group. For this purpose, the term “group cash ratio” means the ratio of the consolidated group aggregate foreign cash position (generally, the sum of the aggregate foreign cash positions of the members of a consolidated group) to the sum of the aggregate Code Sec. 965(a) inclusion amounts of all members of the consolidated group. (Prop Reg § 1.965-8(e)(3), Prop Reg § 1.965-8(f)(4), Prop Reg § 1.965-8(f)(8))
The proposed regs would indicate that the regs under Reg § 1.1502-32 provide for adjustments to the basis of the stock of each member of the consolidated group. (Prop Reg § 1.965-8(d)(2))
Affiliated groups. The proposed regs would include guidance regarding the application of Code Sec. 965(b)(5) to determine the Code Sec. 965(a) inclusion amounts of a member of an affiliated group. Prop Reg § 1.965-8(b) would apply when, after the application of the rules in Prop Reg § 1.965-1(b)(2) (which generally implements the operative rule of Code Sec. 965(b)(1)), a Code Sec. 958(a) U.S. shareholder is both an E&P net surplus shareholder and a member of an affiliated group in which not all members are members of the same consolidated group. When Prop Reg § 1.965-8(b) applies, the U.S. dollar amount of a Code Sec. 958(a) U.S. shareholder’s pro rata share of the Code Sec. 965(a) earnings amount of a DFIC is reduced (but not below zero) by the DFIC’s allocable share of the Code Sec. 958(a) U.S. shareholder’s applicable share of the affiliated group’s aggregate unused E&P deficit. The proposed regs would include rules and definitions for determining, respectively, a DFIC’s allocable share and a Code Sec. 958(a) U.S. shareholder’s applicable share of an affiliated group’s aggregate unused E&P deficit. (Prop Reg § 1.965-8(f)(2), Prop Reg § 1.965-8(f)(3)) If some but not all members of an affiliated group are properly treated as members of a consolidated group, then the consolidated group would be treated as a single member of the affiliated group. (Prop Reg § 1.965-8(b)(2))
Source of aggregate unused E&P deficits. Prop Reg § 1.965-8(c) would provide guidance for designating the source of an aggregate unused E&P deficit of an affiliated group that is not a consolidated group when, generally, the amount of the affiliated group’s aggregate unused E&P deficit exceeds the aggregate Code Sec. 965(a) inclusion amounts of E&P net surplus shareholders of the affiliated group determined without regard to the application of Code Sec. 965(b)(5) and Prop Reg § 1.965-8(b)). Generally, when Prop Reg § 1.965-8(c) applies, each member of an affiliated group that is an E&P net deficit shareholder would have to designate by maintaining in its books and records a statement (identical to the statement maintained by all other such members of the affiliated group) setting forth the portion of its excess aggregate foreign E&P deficit that is taken into account by one or more net E&P net surplus shareholders of the affiliated group.
If some but not all members of an affiliated group are properly treated as members of a consolidated group, then the consolidated group would be treated as a single member of the affiliated group for purposes of this rule. (Prop Reg § 1.965-8(c)(2))
Application of Code Section 986(c). The proposed regs would provide that, for purposes of Code Sec. 986(c), foreign currency gain or loss with respect to distributions of Code Sec. 965(a) previously taxed E&P would be determined based on movements in the exchange rate between Dec. 31, 2017, and the date on which such E&P were actually distributed. (Prop Reg § 1.986(c)-1(a))
The proposed regs would also provide that any gain or loss recognized under Code Sec. 986(c) with respect to distributions of Code Sec. 965(a) previously taxed E&P would be reduced in the same proportion as the reduction by a Code Sec. 965(c) deduction amount of the Code Sec. 965(a) inclusion amount that gave rise to such Code Sec. 965(a) previously taxed E&P, consistent with the statute and other indicia of congressional intent. (H.R. Rep. No. 115-466, at 620 (2017) (Conf. Rep.), Prop Reg § 1.986(c)-1(b)) Prop Reg § 1.986(c)-1(c) would provide that Code Sec. 986(c) does not apply with respect to distributions of Code Sec. 965(b) previously taxed E&P.
References: For the treatment of pre-2018 deferred foreign income treated as subpart F income under Code Sec. 965, see FTC 2d/FIN ¶ O-2700 et seq.; United States Tax Reporter ¶9654.
