Upon the closure of the public comment period for proposed regs addressing issues related to dual consolidated losses (DCL) and rules on certain disregarded payments resulting in losses for foreign tax purposes, the IRS received pushback from several tax organizations challenging the agency’s new position on items arising from stock ownership.
Background.
The current DCL regime was enacted under Code Sec. 1503(d) as part of the Tax Reform Act of 1986. As explained in the IRS’ international audit guidelines, the DCL provisions were designed to prevent an entity “from using a loss to offset income of a domestic affiliate in the United States while using the same loss to offset income of a foreign affiliate which is not subject to U.S. tax.”
Example.
A U.S. corporation submits a consolidated return with a domestic subsidiary. The corporation is controlled abroad and is subject to the tax laws of the foreign country for its global income. It also files a consolidated return with another subsidiary in the foreign country with its tax agency. In the applicable tax year, the corporation uses a net operating loss to offset the income of both the domestic and foreign subsidiaries.
It is the IRS’ view that the corporation in the example above “double dipped” its loss.
On August 6, 2024, the IRS issued proposed regs clarifying various aspects of the DCL regime, including intercompany transactions, stock ownership, and adjustments to conform with U.S. tax principles. Additionally, the regs give consideration to the Organization for Economic Cooperation and Development’s (OECD) framework on base erosion and profit-shifting, particularly the 15% global minimum on multinational enterprises known as “Pillar Two” of the OECD international tax model.
Comments on the proposed regs were due October 7.
Stock inclusion.
Among the revisions in the proposed regs was the IRS’ decision to no longer take into account in the computation of income or a dual consolidated loss items arising from the ownership of stock. Such items include gain from the sale or exchange of stock, Code Sec. 1248 dividends, Code Sec. 951(a) inclusions, and deductions relating to Code Sec. 245A(a) or Code Sec. 250(a)(1)(B).
As the IRS illustrated in the preamble of the proposed regs, this change was made due to the “prevalence” of regimes that exempt income with respect to stock and the trend of taxpayers “structuring into the rules to reduce or eliminate dual consolidated losses.”
An exception carves out dividends “arising from a separate unit or dual resident corporation’s ownership of portfolio stock” or a domestic or foreign corporation, meaning stock worth less than 10% of the value of the corporation.
The American Institute of Public Certified Accountants (AICPA) asked for the regs to be withdrawn because of the elimination of the stock inclusion rule. Alternatively, the final regs should at least allow for the “inclusion of stock attributable to foreign corporations organized in the same foreign country” as a dual resident corporation (DRC), the AICPA told the IRS.
Arguing that the existing DCL regime is “completely rational” for curtailing double-dipping, the AICPA contested the IRS’ points concerning administrability, tax rate disparities, and the growing commonality of participation exemption and foreign tax credit regimes. “[T]hese justifications are insufficient when considering the clear fact patterns where a double deduction issue is not present but the proposed regulations apply a blunt instrument that penalizes taxpayers in a manner which is inconsistent” with congressional intent, the AICPA commented.
The New York State Bar Association (NYSBA) Tax Section suggested two approaches for dealing with potential dual-inclusion income given that the global intangible low-tax income, or GILTI, regime created by the Tax Cuts and Jobs Act (P.L. 115-97) “changes the landscape in critical ways.” Domestic corporations or DRCs, the NYSBA wrote in its comment letter, are taxed on controlled foreign corporation (CFC) income “at the same time” as the foreign jurisdiction taxes the same income, creating a dual inclusion situation that prevents DCL rules from applying.
The first approach, similar to the AICPA’s, would keep the existing DCL regime with the acceptance that there are “many more sympathetic fact patterns” than the “abusive” tendencies the IRS is concerned about. Or, the NYSBA said, the IRS could move forward with the stock inclusion change but write in more exceptions. For instance, final regs could “permit inclusions on CFC stock to give rise to dual inclusion income where the relevant [foreign disregarded entity (FDRE)] and CFC are tax resident in the same jurisdiction and are subject to a tax consolidation regime such that losses of FDRE are available to offset income of CFC,” according to the NYSBA.
Echoing these sentiments, the U.S. Chamber of Commerce suggested in its comment letter that DCL should be governed by U.S. tax principles for determining the extent of foreign use a loss amount has. Further, the Chamber believes that the removal of the stock inclusion rule is especially egregious in instances where a separate unit and the corporate subsidiary are in the same tax jurisdiction.
“To exclude items of stock ownership where the separate unit is in the same jurisdiction as the underlying corporation giving rise to the excluded items would be a significant misalignment with the policy behind the DCL rules,” said the Chamber. “As acknowledged in the preamble, there is no policy concern in this fact pattern, as in fact, the inclusion is taken into account in the foreign jurisdiction (at the level of the underlying corporate subsidiary).”
For more on dual consolidated losses and the proposed regs, see Checkpoint’s Federal Tax Coordinator ¶ E-9200.
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