Bulletin No. 2020–49

HIGHLIGHTS

OF THIS ISSUE





Bulletin No. 2020–49

November 30, 2020

These synopses are intended only as aids to the reader in

identifying the subject matter covered. They may not be

relied upon as authoritative interpretations.

EMPLOYEE PLANS

NOTICE 2020-81, page 1454.

This notice sets forth updates on the corporate bond monthly yield curve, the corresponding spot segment rates for

November 2020 used under § 417(e)(3)(D), the 24-month

average segment rates applicable for November 2020, and

the 30-year Treasury rates, as reflected by the application of

§ 430(h)(2)(C)(iv).

NOTICE 2020-82, page 1458.

This notice provides that the IRS will treat a contribution to

a single-employer defined benefit pension plan with an extended due date of January 1, 2021 pursuant to § 3608(a)

(1) of the Coronavirus Aid, Relief, and Economic Security Act

(CARES Act), Pub. L. No. 116-136, as timely if it is made no

later than January 4, 2021 (which is the first business day

after January 1, 2021).

T.D. 9929, page 1220.

These final regulations respond to Executive Order 13877,

“Executive Order on Improving Price and Quality Transparency in American Healthcare to Put Patients First” and are

intended to increase consumer access to price information

for health costs when third-party payers are involved. The

final regulations set forth requirements for non-grandfathered

group health plans and health insurance issuers of non-grandfathered coverage offering group health insurance coverage

to disclose to a participant, beneficiary, or authorized representative for such individual, their cost-sharing liability for

covered items or services from a particular provider. Under

the final regulations, group health plans and health insurance

issuers are required to make such information available for

covered items and services through an internet website and

through non-internet means. The final regulations also require

plans and issuers to disclose provider negotiated rates and

out-of-network provider allowed amounts through three machine-readable files posted on an internet website.

Finding Lists begin on page ii.

T.D. 9930, page 1400.

This document sets forth final regulations providing guidance relating to the life expectancy and distribution period

tables that are used to calculate required minimum distributions from qualified retirement plans, individual retirement

accounts and annuities, and certain other tax-favored employer-provided retirement arrangements. These regulations

affect participants, beneficiaries, and plan administrators of

these qualified retirement plans and other tax-favored employer-provided retirement arrangements, as well as owners,

beneficiaries, trustees and custodians of individual retirement accounts and annuities.

INCOME TAX

REG-101657-20, page 1466.

This document contains proposed regulations relating to the

foreign tax credit, including guidance on the disallowance of

a credit or deduction for foreign income taxes with respect

to dividends eligible for a dividends-received deduction; the

allocation and apportionment of interest expense, foreign income tax expense, and certain deductions of life insurance

companies; the definition of a foreign income tax and a tax in

lieu of an income tax; transition rules relating to the impact

on loss accounts of net operating loss carrybacks allowed by

reason of the Coronavirus Aid, Relief, and Economic Security

Act; the definition of foreign branch category and financial

services income; and the time at which foreign taxes accrue

and can be claimed as a credit. This document also contains

proposed regulations clarifying rules relating to foreign-derived intangible income

REV. PROC. 2020-48, page 1459.

This revenue procedure prescribes discount factors for the

2020 accident year for insurance companies to compute discounted unpaid losses under § 846 of the Internal Revenue

Code and discounted estimated salvage recoverable under

§ 832.

T.D. 9922, page 1139.

This document contains final regulations that modify the foreign tax credit provisions following the Tax Cuts and Jobs

Act. This document contains additional changes to the existing regulations regarding the allocation and apportionment

of expenses. Additionally, this document contains guidance

on the allocation and apportionment of foreign income taxes

to categories of income for purposes of the foreign tax credit. This document also contains final regulations addressing

hybrid deduction accounts, certain hybrid instruments, and

certain payments under section 951A. Finally, this document

also contains numerous other conforming changes to the existing foreign tax credit rules.

NOTICE 2020-75, page 1453.

This notice announces that the Department of the Treasury

(Treasury Department) and the Internal Revenue Service (IRS)

intend to issue proposed regulations to clarify that State and

local income taxes imposed on and paid by a partnership or an

S corporation on its income are allowed as a deduction by the

partnership or S corporation in computing its non-separately

stated taxable income or loss for the taxable year of payment.

The IRS Mission

Provide America’s taxpayers top-quality service by helping

them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.

Introduction

The Internal Revenue Bulletin is the authoritative instrument

of the Commissioner of Internal Revenue for announcing official rulings and procedures of the Internal Revenue Service

and for publishing Treasury Decisions, Executive Orders, Tax

Conventions, legislation, court decisions, and other items of

general interest. It is published weekly.

It is the policy of the Service to publish in the Bulletin all substantive rulings necessary to promote a uniform application

of the tax laws, including all rulings that supersede, revoke,

modify, or amend any of those previously published in the

Bulletin. All published rulings apply retroactively unless otherwise indicated. Procedures relating solely to matters of internal management are not published; however, statements of

internal practices and procedures that affect the rights and

duties of taxpayers are published.

Revenue rulings represent the conclusions of the Service

on the application of the law to the pivotal facts stated in

the revenue ruling. In those based on positions taken in rulings to taxpayers or technical advice to Service field offices,

identifying details and information of a confidential nature are

deleted to prevent unwarranted invasions of privacy and to

comply with statutory requirements.

Rulings and procedures reported in the Bulletin do not have the

force and effect of Treasury Department Regulations, but they

may be used as precedents. Unpublished rulings will not be

relied on, used, or cited as precedents by Service personnel in

the disposition of other cases. In applying published rulings and

procedures, the effect of subsequent legislation, regulations,

court decisions, rulings, and procedures must be considered,

and Service personnel and others concerned are cautioned

against reaching the same conclusions in other cases unless

the facts and circumstances are substantially the same.

The Bulletin is divided into four parts as follows:

Part I.—1986 Code.

This part includes rulings and decisions based on provisions

of the Internal Revenue Code of 1986.

Part II.—Treaties and Tax Legislation.

This part is divided into two subparts as follows: Subpart A,

Tax Conventions and Other Related Items, and Subpart B,

Legislation and Related Committee Reports.

Part III.—Administrative, Procedural, and Miscellaneous.

To the extent practicable, pertinent cross references to these

subjects are contained in the other Parts and Subparts. Also

included in this part are Bank Secrecy Act Administrative

Rulings. Bank Secrecy Act Administrative Rulings are issued

by the Department of the Treasury’s Office of the Assistant

Secretary (Enforcement).

Part IV.—Items of General Interest.

This part includes notices of proposed rulemakings, disbarment and suspension lists, and announcements.

The last Bulletin for each month includes a cumulative index

for the matters published during the preceding months. These

monthly indexes are cumulated on a semiannual basis, and are

published in the last Bulletin of each semiannual period.

The contents of this publication are not copyrighted and may be reprinted freely. A citation of the Internal Revenue Bulletin as the source would be appropriate.

November 30, 2020 

Bulletin No. 2020–49

Part I

245A, 861, 904, 905, 965, 1502T.D. 9922

T.D. 9922

DEPARTMENT OF THE

TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

Guidance Related to

the Allocation and

Apportionment of

Deductions and Foreign

Taxes, Foreign Tax

Redeterminations, Foreign

Tax Credit Disallowance

Under Section 965(g),

Consolidated Groups,

Hybrid Arrangements and

Certain Payments under

Section 951A

AGENCY: Internal Revenue Service

(IRS), Treasury.

ACTION: Final and temporary regulations

and removal of temporary regulations.

SUMMARY: This document contains final regulations that provide guidance relating to the allocation and apportionment

of deductions and creditable foreign taxes,

the definition of financial services income,

foreign tax redeterminations, availability of foreign tax credits under the transition tax, the application of the foreign tax

credit limitation to consolidated groups,

adjustments to hybrid deduction accounts

to take into account certain inclusions in

income by a United States shareholder,

conduit financing arrangements involving

hybrid instruments, and the treatment of

certain payments under the global intangible low-taxed income provisions.

DATES: Effective Date: These regulations are effective on January 11, 2021.

Applicability Dates: For dates of applicability, see §§1.245A(e)-1(h)(2), 1.704-

Bulletin No. 2020–49

1(b)(1)(ii)(b)(1), 1.861-8(h), 1.861-9(k),

1.861-12(k), 1.861-14(k), 1.861-17(h),

1.861-20(i), 1.881-3(f), 1.904-4(q), 1.9046(g), 1.904(b)-3(f), 1.904(g)-3(l), 1.9053(d), 1.905-4(f), 1.905-5(f), 1.951A-7(d),

1.954-1(h), 1.954-2(i), 1.960-7, 1.965-9,

1.1502-4(f), and 301.6689-1(e).

FOR FURTHER INFORMATION

CONTACT: Concerning §1.245A(e)-1,

Andrew L. Wigmore, (202) 317-5443;

concerning §§1.861-8, 1.861-9(b), 1.86112, 1.861-14, 1.861-17, and 1.954-2(h),

Jeffrey P. Cowan, (202) 317-4924; concerning §§1.704-1, 1.861-9(e), 1.904-4(e),

1.904(b)-3, 1.904(g)-3, 1.1502-4, and

1.1502-21, Jeffrey L. Parry, (202) 3174916; concerning §§1.861-20, 1.904-4(c),

1.904-6, 1.960-1, and 1.960-7, Suzanne

M. Walsh, (202) 317-4908; concerning

§1.881-3, Richard F. Owens, (202) 3176501; concerning §§1.965-5 and 1.965-9,

Karen J. Cate, (202) 317-4667; concerning §§1.905-3, 1.905-4, 1.905-5, 1.9541, 301.6227-1, and 301.6689-1, Corina Braun, (202) 317-5004; concerning

§1.951A-2, Jorge M. Oben, at (202) 3176934 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

I. Rules Relating to Foreign Tax Credits

On December 7, 2018, the Department

of the Treasury (the “Treasury Department”) and the IRS published proposed

regulations (REG-105600-18) relating to

foreign tax credits in the Federal Register (83 FR 63200) (the “2018 FTC

proposed regulations”). The 2018 FTC

proposed regulations addressed several

significant changes that the Tax Cuts and

Jobs Act (Pub. L. 115-97, 131 Stat. 2054,

2208 (2017)) (the “TCJA”) made with

respect to the foreign tax credit rules and

related rules for allocating and apportioning deductions in determining the foreign

tax credit limitation. Certain provisions

of the 2018 FTC proposed regulations

relating to §§1.78-1, 1.861-12(c)(2), and

1.965-7 were finalized as part of TD 9866,

published in the Federal Register (84 FR

29288) on June 21, 2019.

1139

The remainder of the 2018 FTC proposed regulations were finalized on December 17, 2019 in TD 9882, published

in the Federal Register (84 FR 69022)

(the “2019 FTC final regulations”). On the

same date, the Treasury Department and

the IRS published proposed regulations

(REG-105495-19) relating to foreign tax

credits in the Federal Register (84 FR

69124) (the “2019 FTC proposed regulations”). The 2019 FTC proposed regulations related to changes made by the TCJA

and other foreign tax credit issues. Correcting amendments to the 2019 FTC final

regulations and the 2019 FTC proposed

regulations were published in the Federal Register on May 15, 2020, see 85 FR

29323 (2019 FTC final regulations) and

85 FR 29368 (2019 FTC proposed regulations). A public hearing on the proposed

regulations was held on May 20, 2020.

On November 7, 2007, the Federal

Register published temporary regulations

(TD 9362) at 72 FR 62771 and a notice

of proposed rulemaking by cross-reference to the temporary regulations at 72

FR 62805 relating to sections 905(c),

986(a), and 6689 of the Internal Revenue

Code (“Code”). Portions of these temporary regulations were finalized in the 2019

FTC final regulations, while certain portions were reproposed in the 2019 FTC

proposed regulations.

This document contains final regulations (the “final regulations”) addressing

the following issues: (1) the allocation

and apportionment of deductions under

sections 861 through 865, including rules

on the allocation and apportionment of

expenditures for research and experimentation (“R&E”), stewardship, legal

damages, and certain deductions of life

insurance companies; (2) the allocation

and apportionment of foreign income taxes; (3) the interaction of the branch loss

and dual consolidated loss recapture rules

with section 904(f) and (g); (4) the effect

of foreign tax redeterminations of foreign

corporations, including for purposes of

the application of the high-tax exception

described in section 954(b)(4) (and for

purposes of determining tested income

under section 951A(c)(2)(A)(i)(III)), and

required notifications under section 905(c)

to the IRS of foreign tax redeterminations

November 30, 2020

and related penalty provisions; (5) the

definition of foreign personal holding

company income under section 954; (6)

the application of the foreign tax credit

disallowance under section 965(g); and

(7) the application of the foreign tax credit

limitation to consolidated groups.

II. Rules Relating to Hybrid Deduction

Accounts, Hybrid Instruments Used in

Conduit Financing Arrangements, and

Certain Payments under Section 951A

On December 28, 2018, the Treasury

Department and the IRS published proposed regulations (REG-104352-18) relating to hybrid arrangements, including

hybrid arrangements to which section

245A(e) applies, in the Federal Register (83 FR 67612) (the “2018 hybrids

proposed regulations”). Those regulations were finalized as part of TD 9896,

published in the Federal Register (85

FR 19802) on April 8, 2020 (the “2020

hybrids final regulations”). On the same

date, the Treasury Department and the IRS

published proposed regulations (REG106013-19) in the Federal Register (85

FR 19858) (the “2020 hybrids proposed

regulations”). Correcting amendments to

the 2020 hybrids final regulations and the

2020 hybrids proposed regulations were

published in the Federal Register on August 4, 2020, August 11, 2020, and August

12, 2020. See 85 FR 47027 (2020 hybrids

final regulations), 85 FR 48485 (2020 hybrids proposed regulations), and 85 FR

48651 (2020 hybrids final regulations).

The 2020 hybrids proposed regulations

address hybrid deduction accounts under

section 245A(e), hybrid instruments used

in conduit financing arrangements under

section 881, and certain payments under

section 951A (relating to global intangible

low-taxed income). The Treasury Department and the IRS received written comments with respect to the 2020 hybrids

proposed regulations. All written comments received in response to the 2020

hybrids proposed regulations are available

at www.regulations.gov or upon request.

A public hearing on the 2020 hybrids proposed regulations was not held because

there were no requests to speak.

This document contains final regulations addressing the following issues: (1)

the reduction to a hybrid deduction ac-

November 30, 2020

count under section 245A(e) by reason of

an amount included in the gross income

of a domestic corporation under section

951(a) or 951A(a) with respect to a controlled foreign corporation (“CFC”); (2)

the treatment of a hybrid instrument as a

financing transaction for purposes of the

conduit financing rules under section 881;

and (3) the treatment under section 951A

of certain prepayments made to a related

CFC after December 31, 2017, and before

the CFC’s first taxable year beginning after December 31, 2017.

III. Scope of Provisions and Comments

Discussed in this Preamble

This rulemaking finalizes, without substantive change, certain provisions in the

2019 FTC proposed regulations and the

2020 hybrids proposed regulations with

respect to which the Treasury Department

and IRS did not receive any comments.

See, for example, §1.904(b)-3, §1.904(g)3,

§1.951A-2(c)(6),

§1.951A-7(d),

§1.1502-4, or §301.6689-1. These provisions are generally not discussed in this

preamble.

Comments received that do not pertain

to the 2019 FTC proposed regulations or

the 2020 hybrids proposed regulations, or

that are otherwise outside the scope of this

rulemaking, are generally not addressed

in this preamble but may be considered in

connection with future guidance projects.

Summary of Comments and

Explanation of Revisions

I. Rules Under Section 245A(e) to Reduce

Hybrid Deduction Accounts

A. Overview

Section 245A(e) was added to the Code

by the TCJA. Section 245A(e) and the

2020 hybrids final regulations neutralize

the double non-taxation effects of a hybrid dividend or tiered hybrid dividend

by either denying the section 245A(a)

dividends received deduction with respect

to the dividend or requiring an inclusion

under section 951(a)(1)(A) with respect

to the dividend, depending on whether the

dividend is received by a domestic corporation or a CFC. The 2020 hybrids final

regulations require that certain sharehold-

1140

ers 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.

The 2020 hybrids proposed regulations

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 GILTI inclusion”

with respect to the share. See proposed

§1.245A(e)-1(d)(4)(i)(B)(1) and (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 section

951(a)(1)(A) (“subpart F inclusion”) or

inclusion under section 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 section

250(a)(1)(B).

The final regulations retain the basic

approach and structure of the 2020 hybrids proposed regulations that reduced

hybrid deduction accounts, with certain

revisions. Part I.B of this Summary of

Comments and Explanation of Revisions

discusses the revisions as well as comments received that relate to these rules.

B. Computation of adjusted subpart F

income inclusion and adjusted GILTI

inclusion

1. In General

Comments suggested several refinements or clarifications to the computation

of an adjusted subpart F inclusion or ad-

Bulletin No. 2020–49

justed GILTI inclusion with respect to a

share of stock of a CFC, generally so that

the adjusted subpart F inclusion or adjusted GILTI inclusion more closely reflects

the extent that the subpart F inclusion or

GILTI inclusion amount is in fact included

in income in the United States.

2. Section 904 Limitation

Under the 2020 hybrids proposed regulations, 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, as a

result of the application of section 960(a)

or (d), 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. See proposed §1.245A(e)-1(d)(4)

(ii)(A) and (B). To minimize complexity,

the 2020 hybrids proposed regulations 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. See proposed

§1.245A(e)-1(d)(4)(ii)(D). A comment

suggested that the final regulations take

into account the limitation under section

904.

The Treasury Department and the IRS

agree with the comment for computing an

adjusted GILTI inclusion. Foreign income

taxes that by reason of section 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. See section 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

regulations therefore provide that such

foreign income taxes are not taken into

account when computing an adjusted

GILTI inclusion. See §1.245A(e)-1(d)(4)

(ii)(D)(2)(iii) and (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 section 904.1

The final regulations do not adopt a

similar rule for computing an adjusted

subpart F inclusion. This is because foreign income taxes that by reason of section

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 section 904(c). Consequently, for example,

the foreign income taxes could in a later

year reduce the extent that an amount is

included in income in the United States,

and could thus inappropriately result in

an outcome similar to the one that would

have occurred had the foreign income taxes given rise to deemed paid credits in the

year of the subpart F inclusion and thereby

reduced the extent that the subpart F inclusion was subject to tax in the United States

at the full statutory rate. The Treasury Department and the IRS have determined that

special rules to prevent such results would

be complex or burdensome as they would

require, for instance, tracking the creditability of the foreign income taxes over

prior or later years (potentially through

a 10-year period), and then adjusting the

hybrid deduction account as the foreign

income taxes become creditable.

3. Section 250 Deduction

Under the 2020 hybrids proposed regulations, an adjusted GILTI inclusion is

computed by taking into account the portion of the deduction allowed under section 250 by reason of section 250(a)(1)(B)

that the domestic corporation is likely to

claim with respect to the GILTI inclusion

amount. See proposed §1.245A(e)-1(d)

(4)(ii)(B). The 2020 hybrids proposed

regulations did not take into account any

limitations on the deduction under section

250(a)(2)(B). See id. A comment suggested that the final regulations take into account the taxable income limitation under

section 250(a)(2).

The Treasury Department and the IRS

agree with the comment, because 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. The final regulations thus provide a rule to this effect.

See §1.245A(e)-1(d)(4)(ii)(B) and (H).

Similar to the rule discussed in Part I.B.2

of this Summary of Comments and Explanation of Revisions (related to the section

904 limitation), 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 section 250 by

reason of section 250(a)(1)(B) is limited

under section 250(a)(2)(B).

4. Limit on Reduction of a Hybrid

Deduction Account

The 2020 hybrids proposed regulations

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 taxable year multiplied by a fraction, the numerator of which is the subpart

F income or tested income, as applicable,

of the CFC for the taxable year and the denominator of which is the CFC’s taxable

income. See proposed §1.245A(e)-1(d)

(4)(i)(B)(1)(ii) and (d)(4)(i)(B)(2)(ii). In

cases in which the CFC’s taxable income

is zero or negative, the 2020 hybrids proposed regulations 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. See proposed §1.245A(e)-1(d)(4)

(i)(B)(1)(ii) and (d)(4)(i)(B)(2)(ii).

For example, in certain cases the section 904 limitation may be affected by the extent to which section 245A(e) applies to a dividend paid by the CFC (in particular, in connection with allocating and apportioning deductions under §§1.861-8 through 1.861-20); the application of section 245A(e) to the dividend may depend on the extent to which a hybrid deduction account is

reduced by reason of an adjusted GILTI inclusion; and the adjusted GILTI inclusion may in turn depend on the section 904 limitation. In such a case, to avoid circularity issues, a taxpayer may

compute the section 904 limitation for purposes of determining the adjusted GILTI inclusion by, for instance, using simultaneous equations, or applying an ordering rule pursuant to which,

solely for purposes of determining the adjusted GILTI inclusion, the section 904 limitation is determined without regard to the application of section 245A(e) (as well as any other provision

the application of which depends on the extent to which section 245A(e) applies).

1

Bulletin No. 2020–49

1141

November 30, 2020

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 regulations

eliminate these distortions by modifying

the fraction so that the numerator and denominator only reflect items of gross income. See §1.245A(e)-1(d)(4)(i)(B)(1)(ii)

and (d)(4)(i)(B)(2)(ii).

5. Clarifications

Comments recommended that the final regulations clarify whether an adjusted subpart F inclusion or adjusted GILTI

inclusion can be negative and result in an

increase to the hybrid deduction account

(that is, whether the hybrid deduction

account can be reduced by a negative

amount). The final regulations clarify that

an adjusted subpart F inclusion or adjusted GILTI inclusion cannot be negative and

thus cannot result in an increase to the hybrid deduction account. See §1.245A(e)1(d)(4)(ii)(A) and (B).

A comment also recommended that

the final regulations clarify whether the

computation of an adjusted subpart F inclusion takes into account an amount that

the domestic corporation includes in gross

income by reason of section 964(e)(4). As

noted in the comment, an amount that the

domestic corporation includes in gross income by reason of section 964(e)(4) is in

many cases offset by a 100 percent dividends received deduction under section

245A(a), and thus no portion of the amount

is included in income in the United States

(that is, taken into account in income and

not offset by a deduction or credit particular

to the inclusion). The final regulations clarify that the computation of an adjusted subpart F inclusion does not take into account

an amount that a domestic corporation includes in gross income by reason of section

964(e)(4), to the extent that a deduction

under section 245A(a) is allowed for the

amount. See §1.245A(e)-1(d)(4)(ii)(A).

6. Comments Outside the Scope of the

2020 Hybrids Proposed Regulations

In response to a comment, the 2020

hybrids final regulations clarified that a

November 30, 2020

deduction or other tax benefit may be a

hybrid deduction regardless of whether

it is used currently under the foreign tax

law. See §1.245A(e)-1(d)(2). The preamble to the 2020 hybrids final regulations

explained that even though a deduction or

other tax benefit may not be used currently,

it could be used in another taxable period

and thus could produce double non-taxation. The preamble also noted that it could

be complex or burdensome to determine

whether a deduction or other tax benefit is

used currently and, to the extent not used

currently, to track the deduction or other

tax benefit and add it to the hybrid deduction account if it is in fact used.

Comments submitted with respect to

the 2020 hybrids proposed regulations

raised additional issues involving the extent to which a hybrid deduction account

should be adjusted based on the availability-for-use of a deduction or other tax

benefit under the foreign tax law. These

issues include the extent to which (or the

mechanism by which) a hybrid deduction

account should be adjusted when a deduction or other tax benefit reflected in the

account is subsequently disallowed under

the foreign tax law (for example, by reason of a foreign audit) or an economically

equivalent adjustment is made under the

foreign tax law, or the deduction or other

tax benefit expires or otherwise cannot be

used under the foreign tax law. The Treasury Department and the IRS are studying

these comments, which are outside the

scope of the 2020 hybrids proposed regulations, and may address these issues in a

future guidance project.

II. Allocation and Apportionment of

Deductions and the Calculation of

Taxable Income for Purposes of Section

904(a)

A. Stewardship expenses, litigation

damages awards and settlement

payments, net operating losses, interest

expense, and other expenses

1. Stewardship Expenses

The 2019 FTC proposed regulations

made several changes to the rules for allocating and apportioning stewardship

expenses, which are generally expenses

incurred to oversee a related corporation.

1142

Although the 2019 FTC proposed regulations did not change the definition of stewardship expenses, the regulations did provide that expenses incurred with respect

to partnerships are treated as stewardship

expenses. The 2019 FTC proposed regulations also expanded the types of income

to which stewardship expenses are allocated to include not only dividends but

also other inclusions received with respect

to stock. The 2019 FTC proposed regulations further provided that stewardship expenses are to be apportioned based on the

relative values of stock held by a taxpayer, as computed for purposes of allocating

and apportioning the taxpayer’s interest

expense. Additionally, the preamble to the

2019 FTC proposed regulations requested

comments regarding how to distinguish

stewardship expenses from supportive expenses.

Several comments addressed the definition of stewardship expenses. Some

comments recommended that the current

regulations’ definition be retained without changes. One comment recommended

that, because stewardship is among those

activities that are not treated as providing a benefit to a related party under the

section 482 regulations, such expenses

should be treated as supportive expenses.

Another recommended that the definition

of stewardship expenses be narrowed to

apply solely to expenses that result from

oversight with respect to foreign subsidiaries or non-affiliated domestic entities.

Comments also requested clarification on

how to identify and distinguish between

stewardship and supportive expenses and

sought greater flexibility in identifying

stewardship expenses. One comment recommended that further guidance be left to

a separate project.

The final regulations generally retain

the existing definition of stewardship expenses as either duplicative or shareholder activities as described in §1.482-9(l)

(3)(iii) or (iv). Therefore, stewardship

expenses either duplicate an expense incurred by the related entity without providing an additional benefit to that entity

or are incurred primarily to protect the

taxpayer’s investment in another entity

or to facilitate the taxpayer’s compliance

with its own reporting, legal or regulatory requirements. In contrast, supportive

expenses are typically incurred in order

Bulletin No. 2020–49

to enhance the income-producing capabilities of the taxpayer itself, and so are

definitely related and allocable to all, or

broad classes, of the taxpayer’s gross income. See §1.861-8(b)(3). The fact that

expenses attributable to stewardship activities do not provide a benefit to the related party does not mean that the expenses are supportive of all of the taxpayer’s

income-producing activity. Instead, expenses categorized under §§1.861-8(e)(4)

(ii) and 1.482-9(l)(3)(iii) and (iv) as stewardship expenses are properly allocated

to income generated by the related party

(and included in income of the taxpayer as

a dividend or other inclusion), rather than

to income earned directly by the taxpayer.

Comments recommended that the definition of stewardship expenses be expanded to include expenses incurred with respect to branches and disregarded entities,

in addition to corporations and partnerships. The Treasury Department and the

IRS agree that stewardship expenses can

also be incurred with respect to all business entities (whether foreign or domestic)

as described in §301.7701-2(a) and not

only those business entities that are classified as corporations or partnerships for

Federal income tax purposes. Therefore,

the final regulations at §1.861-8(e)(4)(ii)

(A) provide that stewardship expenses

incurred with respect to oversight of disregarded entities are also subject to allocation and apportionment under the rules

of §1.861-8(e)(4). However, the Treasury

Department and the IRS have determined

that it is inappropriate to extend the definition of stewardship expense to include

oversight expenses incurred with respect

to an unincorporated branch of the taxpayer, since the branch’s income is income of the taxpayer itself, not income of

a separate entity in which the taxpayer is

protecting its investment, and any reporting, legal or regulatory requirements that

apply to an unincorporated branch of the

taxpayer apply to the taxpayer itself.

Comments also requested that the final

regulations make clear that stewardship

expenses can be allocated and apportioned

to income and assets of all affiliated and

consolidated group members, noting that

a portion of the dividends and stock with

respect to domestic affiliates may be treated as exempt income or assets under section 864(e)(3) and §1.861-8(d)(2)(ii) and

Bulletin No. 2020–49

excluded from the apportionment formula, which could reduce apportionment of

expenses to U.S. source income. In response to the comments, the final regulations at §1.861-8(e)(4)(ii)(A) provide that

the affiliated group rules in §1.861-14 do

not apply for purposes of allocating and

apportioning stewardship expenses. As

a result, stewardship expenses incurred

by one member of an affiliated group in

order to oversee the activities of another

member of the group are allocated and

apportioned by the investor taxpayer on a

separate entity basis, with reference to the

investor’s stock in the affiliated member.

See §1.861-8(e)(4)(ii)(A). Furthermore,

in response to comments, the final regulations at §1.861-8(e)(4)(ii)(C) provide that

the exempt income and asset rules in section 864(e)(3) and §1.861-8(d)(2) do not

apply for purposes of apportioning stewardship expenses.

Comments were also received regarding the rules for allocating stewardship

expenses solely to income arising from

the entity for which the stewardship expenses are being incurred in order to protect that investment. One comment argued

that the rule in the prior final regulations

for allocating stewardship expenses solely

to dividend income should be retained and

should not be expanded to include inclusions such as those under the GILTI rules.

In contrast, another comment agreed with

the approach to expand allocation to include shareholder-level inclusions such as

GILTI inclusions in light of the changes

made by the TCJA.

The Treasury Department and the IRS

have determined that allocating stewardship expenses to all types of income derived from ownership of the entity, rather

than solely dividend income, is appropriate because dividends do not fully capture

all of the statutory and residual groupings

to which income from stock is assigned.

Limiting the allocation of stewardship expenses only to dividends would preclude

allocation to stock in a CFC or passive

foreign investment company (“PFIC”)

whose income gave rise only to subpart

F, GILTI, or PFIC inclusions, even if the

expense clearly relates to overseeing activities that generate income in the CFC

or PFIC that give rise to such inclusions.

Therefore, the Treasury Department and

IRS agree with the comment supporting

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the expansion of stewardship expense allocation in proposed §1.861-8(e)(4)(ii)(B)

to include shareholder-level inclusions.

One comment recommended adding

dividends eligible for a section 245A deduction to the list of income inclusions to

which stewardship expenses are allocable.

The existing regulations are already clear,

however, that stewardship expenses are

allocable to dividends. This allocation is

not affected by the fact that dividends may

qualify for the deduction under section

245A, which does not convert the dividends into exempt or excluded income for

purposes of allocating and apportioning

deductions. See §1.861-8(d)(2)(iii)(C).

To the extent that stewardship expense

is allocated and apportioned to dividend

income in the section 245A subgroup,

section 904(b)(4) requires certain adjustments to the taxpayer’s foreign source

taxable income and entire taxable income

for purposes of computing the applicable

foreign tax credit limitation. Accordingly,

the final regulations are not modified in

response to the comment.

In response to a request for comments

in the 2019 FTC proposed regulations on

possible exceptions to the general rule

for the allocation and apportionment of

stewardship expenses, several comments

recommended allowing taxpayers to show

that stewardship expense factually relates

only to the relevant income of a specific

income-producing entity or entities. The

Treasury Department and the IRS agree

that stewardship expenses may be factually related to the taxpayer’s ownership

of a specific entity (or entities) and should

not be allocated and apportioned to the income derived from all entities in a group

without taking into account the factual

connection between the stewardship expense and the entity being overseen. Accordingly, the final regulations at §1.8618(e)(4)(ii)(B) clarify that at the allocation

step (but before applying the apportionment rules), only the gross income derived

from entities to which the taxpayer’s stewardship expense has a factual connection

are included and, in such cases, the apportionment rule applies based on the tax

book value of the taxpayer’s investment

in those particular entities. This approach

recognizes that stewardship activities are

not fungible in the same manner as interest expense.

November 30, 2020

With respect to the apportionment of

stewardship expenses, several comments

recommended retaining the flexibility of

the prior final regulations, which provide

for several permissible methods of apportionment, or alternatively apportioning

stewardship expenses on the basis of gross

income, rather than assets. One comment

questioned the appropriateness of applying the apportionment rule used for interest expense in the context of stewardship

expenses.

The Treasury Department and the IRS

have determined that it is appropriate to

provide a single, clear rule for the apportionment of stewardship expenses and that

the asset-based rule for interest expense

apportionment is the most appropriate

method. The Treasury Department and the

IRS have also determined that an explicit

rule provides certainty for both taxpayers

and the IRS and will minimize disputes.

By definition, stewardship expenses typically relate to protecting the value of the

taxpayer’s ownership interest in another

entity. Therefore, such expenses should be

apportioned on the basis of the tax book

value (or alternative tax book value) of

the taxpayer’s interest in the entity (or entities) in question, since that value more

closely approximates the income generated by the entity over time, while income

distributed from an entity (or entities) and

taxed to the owner can vary from year to

year and may not properly reflect all the

income-generating activity of the entity.

Although stewardship activities may be

definitely related to indirectly-owned entities, the Treasury Department and the

IRS have determined that apportioning

stewardship expenses based on the value

of an indirectly-owned entity would lead

to unnecessary complexity for taxpayers

and administrative burdens for the IRS;

instead, such expenses are apportioned

based on the values of the entities that

are owned directly by the taxpayer. See

§1.861-8(e)(4)(ii)(C).

For purposes of determining the value of an entity, the final regulations at

§1.861-8(e)(4)(ii)(C) provide that the

value of the stock in an affiliated corporation is characterized as if the corporation were not affiliated and the stock is

characterized by the taxpayer in the same

ratios in which the affiliate’s assets are

characterized for purposes of allocating

November 30, 2020

and apportioning the group’s interest

expense. The final regulations also provide that the tax book value of a taxpayer’s investment in a disregarded entity

is determined and characterized under

the rules that would apply if the entity’s

stock basis were regarded for purposes of

allocating and apportioning the investor

taxpayer’s interest expense.

2. Litigation Damages Awards,

Prejudgment Interest, and Settlement

Payments

The 2019 FTC proposed regulations

included special rules for the allocation

and apportionment of damages awards,

prejudgment interest, and settlement payments incurred in settlement of, or in anticipation of, claims for damages arising

from product liability, events incident to

the production or sale of goods or provision of services, and investor suits.

Damages or settlement awards related to

product liability, or events incident to the

production or sale of goods or provision

of services, are allocated to the class of

gross income produced by the specific

sales of products or services that gave rise

to the claims for damages or injury, or to

the class of gross income produced by the

assets involved in the production or sales

activity, respectively. Damages awards

related to shareholder suits are allocated

to all income of the corporation and apportioned based on the relative values of

all of the corporation’s assets that produce income in the statutory and residual

groupings.

One comment suggested that the proposed rules lacked clearly articulated rationales, in contrast to, for example, the

rules for R&E expenditures. The Treasury

Department and the IRS have determined

that the rules included in the 2019 FTC

proposed regulations for specific types of

litigation-related expenses are consistent

with the general principles of the allocation and apportionment rules, which are

based on the factual connection between

deductions and the class of gross income

to which they relate. See §1.861-8(b)

(1). Accordingly, no change is made in

the final regulations in response to this

comment. However, the final regulations

at §1.861-8(e)(5)(ii) include a new paragraph heading and a sentence to clarify

1144

that the damages rule is not limited to

product liability claims.

One comment stated that the 2019 FTC

proposed regulations could be interpreted

to require a double allocation of deductions to royalty income, for example, if

a taxpayer incurs damages from a patent

infringement lawsuit and also indemnifies

its CFC for damages paid in a separate

lawsuit filed against the CFC. The Treasury Department and the IRS have determined that indemnification payments, to

the extent deductible, are governed by the

generally-applicable rules for allocating

and apportioning expenses based on the

factual relationship between the deduction

and the class of gross income to which the

deduction relates. The allocation of separate deductions that are both related to the

same class of gross income does not constitute a double allocation. Accordingly,

no changes are made in the final regulations in response to this comment.

The 2019 FTC proposed regulations

contained an explicit apportionment rule

for damages awards in response to industrial accidents and investor lawsuits,

but not for product liability and similar

claims. The final regulations add a sentence at §1.861-8(e)(5)(ii) to clarify that

deductions relating to product liability

and similar claims are apportioned among

the statutory and residual groupings based

on the relative amounts of gross income in

the relevant class in the groupings in the

year the deductions are allowed.

Finally, several comments disagreed

with the approach in the 2019 FTC proposed regulations regarding lawsuits filed

by investors against a corporation. These

comments argued that it is inappropriate

to allocate deductions for such payments

to income produced by all of the taxpayer’s assets, because these expenses can

have a closer factual connection to the

jurisdiction where the litigation occurs or

where the events (for example, any negligence, fraud, or malfeasance) at issue

in the lawsuit occurred. Some comments

advocated for a more flexible rule, noting

that certain shareholder claims may have

a very narrow geographic scope, whereas

other claims may relate to a broader range

of activities.

The Treasury Department and the IRS

have determined that it is inappropriate

to allocate deductions for payments with

Bulletin No. 2020–49

respect to investor lawsuits on the basis of the situs of the underlying events

or the location of the lawsuit. The purpose of direct investor lawsuits against a

company is generally to compensate investors for damages to their investment

in the entire company. Even where the

underlying misconduct directly relates

to only a portion of the taxpayer’s business activities, the harm to the investor

is generally attributable to the taxpayer’s

business more generally and, therefore,

any damages payment is related to all of

the taxpayer’s income-producing activities. Moreover, any rule that attempted

to quantify the portion of damages or

settlements that relate to specific business activities and the portion that relates to more general reputational loss

would by its nature be difficult for taxpayers to comply with and for the IRS

to administer. Furthermore, the Treasury

Department and the IRS disagree with

the comments suggesting that award

payments should be allocated based on

the geographic location in which the

lawsuit is filed, which could be governed

by contractual terms or choice-of-law

rules that have little to no factual relationship to the underlying activities to

which the lawsuit relates. Accordingly,

the comments are not adopted.

3. Net Operating Loss Deductions

The 2019 FTC proposed regulations

clarified the treatment of net operating

losses (NOLs) by specifying how the

statutory and residual grouping components of an NOL are determined in the

taxable year of the loss and by clarifying the manner in which the net operating loss deduction allowed under section

172 is allocated and apportioned in the

taxable year in which the deduction is

allowed. Comments requested that for

purposes of applying §1.861-8(e)(8)

to section 250 as the operative section,

NOLs arising in taxable years before the

TCJA’s enactment of section 250 should

not be allocated and apportioned to gross

FDDEI. On July 15, 2020, the Treasury

Department and the IRS finalized regulations under section 250, which provide

that the deduction under section 172(a) is

not taken into account in computing FDDEI. See §1.250(b)-1(d)(2)(ii). There-

Bulletin No. 2020–49

fore, the comment is moot. However, a

sentence is added to the final regulations

at §1.861-8(e)(8)(i) to clarify that in

determining the component parts of an

NOL, deductions that are considered absorbed in the year the loss arose for purposes of an operative section may differ

from the deductions that are considered

absorbed for purposes of another provision of the Code that requires determining the components of an NOL. Therefore, for example, a taxpayer’s NOL may

comprise excess deductions allocated to

foreign source general category income

for purposes of section 904, even though

for purposes of section 172(b)(1)(B)(ii)

the NOL is a farming loss comprising excess deductions allocated to U.S. source

income from farming.

4. Application of the Exempt Income/

Asset Rule to Insurance Companies in

Connection with Certain Dividends and

Tax-exempt Interest

The 2019 FTC proposed regulations

clarified in proposed §1.861-8(d)(2)(ii)

(B), (d)(2)(v), and (e)(16) the effect of

certain deduction limitations on the treatment of income and assets generating dividends-received deductions and tax-exempt interest held by insurance companies

for purposes of allocating and apportioning deductions to such income and assets.

Specifically, the 2019 FTC proposed regulations provided that in the case of insurance companies, exempt income includes

dividends for which a deduction is provided by sections 243(a)(1) and (2) and

245, without regard to the proration rules

under section 805(a)(4)(A)(ii) disallowing

a portion of the deduction attributable to

the policyholder’s share of the dividends

or any similar disallowance under section

805(a)(4)(D). Similarly, the regulations

provided that the term exempt income includes tax-exempt interest without regard

to the proration rules.

One comment requested that the final

regulations modify §1.861-8T(d)(2) to

permit insurance companies to adjust the

amount of income and assets that are exempted in apportioning deductions. The

comment asserted that such adjustment is

required in order to reflect the addition of

section 864(e)(7)(E) and relied on legislative history to a provision in proposed

1145

technical corrections legislation (Technical Corrections Act of 1987, H.R. 2636,

100th Cong., section 112(g)(6)(A)) (June

10, 1987)) (the “1987 bill”) to suggest that

Congress intended to create a different result for insurance companies than for other companies.

The 1987 bill, however, was not enacted, and the language in section 864(e)

(7)(E) is not the same as the language

proposed in the bill. Section 864(e)(7)

(E) provides regulatory authority for the

Secretary to issue regulations regarding

any adjustments that may be appropriate

in applying section 864(e)(3) to insurance companies. The legislative history

to section 864(e)(7)(E) (which was enacted in 1988) does not contain the same

language as did the committee reports

from the 1987 bill, and the rule that was

proposed in the 1987 bill is contrary to

subsequent case law. See Travelers Insurance Company v. United States, 303

F.3d 1373 (2002). Therefore, the Treasury Department and the IRS have concluded that although section 864(e)(7)(E)

provides regulatory authority for a rule

applying section 864(e)(3) to insurance

companies, there is no indication that

Congress intended for Treasury to adopt

a rule mirroring the rule in the 1987 bill

(which Congress did not enact).

Section 864(e)(3) is clear that exempt

income includes income for which a deduction is allowed under sections 243

and 245, and no exception is provided in

the statute for insurance companies. Furthermore, as explained in Part I.A.4 of

the Explanation of Provisions in the 2019

FTC proposed regulations, a special rule

for either tax-exempt interest of a life insurance company or dividends-received

deductions and tax-exempt interest of

a nonlife insurance company is not appropriate because when a policyholder’s share or applicable percentage is

accounted for as either a reserve adjustment or a reduction to losses incurred,

no further modification to the generally

applicable rules is required to ensure that

the appropriate amount of expenses are

apportioned to U.S. source income. Instead, the rule suggested by the comment

would inappropriately distort the allocation and apportionment of deductions to

U.S. source income. Therefore, the comment is not adopted.

November 30, 2020

5. Treatment of the Section 250

Deduction

One comment requested clarification

on the allocation and apportionment of

the deduction allowed under section 250

(“section 250 deduction”) with respect to

members of a consolidated group. In general, under §1.1502-50(b), a consolidated

group member’s section 250 deduction is

determined based on the member’s share

of the sum of all members’ positive FDDEI or GILTI. Separate from this determination under §1.1502-50(b), a taxpayer

must also allocate and apportion the section 250 deduction to gross income for

purposes of determining its foreign tax

credit limitation. For this purpose, in allocating and apportioning the section 250

deduction to statutory and residual groupings, under §1.861-8(e)(13) the portion of

the section 250 deduction attributable to

FDII is treated as definitely related and

allocable to the specific class of gross

income that is included in the taxpayer’s

FDDEI and then apportioned between the

statutory and residual groupings based on

the relative amounts of FDDEI in each

grouping. In the context of an affiliated

group, under §1.861-14T(c)(1) expenses

are generally allocated and apportioned by

treating all members of an affiliated group

as if they were a single corporation.

In response to the comment requesting

clarity on the allocation and apportionment of the section 250 deduction with

respect to members of a consolidated

group, the final regulations provide that

the section 250 deduction is allocated and

apportioned as if all members of the consolidated group are treated as a single corporation. See §1.861-14(e)(4). However,

in the case of an affiliated group that is not

a consolidated group, the section 250 deduction of a member of an affiliated group

is allocated and apportioned on a separate

entity basis under the rules of §1.861-8(e)

(13) and (14).

6. Other Requests for Comments on

Expense Allocation

The preamble to the 2019 FTC proposed regulations requested comments

on whether future regulations should allow taxpayers to capitalize and amortize

certain expenses solely for purposes of

November 30, 2020

the rules in §1.861-9 for allocating and

apportioning interest expense in order to

better reflect asset values under the tax

book value method. One comment was received recommending that such a rule be

included with respect to R&E and advertising expenditures. The Treasury Department and the IRS agree with this comment

and, accordingly, this rule is included in

a notice of proposed rulemaking in the

Proposed Rules section of this issue of

the Federal Register (the “the 2020 FTC

proposed regulations”). See Part V.A of

the Explanation of Provisions in the 2020

FTC proposed regulations.

One comment requested that a special

rule be adopted in §1.861-10T to directly

allocate certain interest expense related to

regulated utility companies. The Treasury

Department and the IRS agree that a special rule is warranted, and have included

a rule in the 2020 FTC proposed regulations. See Part V.B. of the Explanation of

Provisions in the 2020 FTC proposed regulations.

Finally, the preamble to the 2019 FTC

proposed regulations requested comments

on whether the rules in §1.861-8(e)(6)

for allocating and apportioning state income taxes should be revised in light of

changes made by the TCJA and changes to

state rules for taxing foreign income. One

comment was received requesting that the

existing rules, which rely on state law to

determine the income to which state taxes

relate, be retained. The Treasury Department and the IRS agree that no changes

to the rules in §1.861-8(e)(6) are required

at this time.

7. Examples Illustrating Allocation and

Apportionment of Certain Expenses of an

Affiliated Group of Corporations

Examples 1 through 6 in §1.861-14T(j)

apply the temporary regulations to fact

patterns involving affiliated groups of

corporations. However, Examples 1 and 4

of §1.861-14T(j) are no longer consistent

with current law, and therefore the final

regulations append an informational footnote to §1.861-14T(j) to reflect this fact.

The Treasury Department and the IRS are

also studying whether the remaining examples should be modified and whether

new examples should be included in future guidance.

1146

B. Partnership transactions

The 2019 FTC proposed regulations

revised §§1.861-9(b) and 1.954-2(h)(2)

(i) to provide that guaranteed payments

for the use of capital described in section

707(c) are treated similarly to interest deductions for purposes of allocating and

apportioning deductions under §§1.861-8

through 1.861-14, and are treated as income equivalent to interest under section

954(c)(1)(E). These rules were intended to

prevent the use of guaranteed payments to

avoid the rules under §§1.861-9(e)(8) and

1.954-2(h) that apply to partnership debt.

One comment stated that while guaranteed payments for capital are economically similar to interest payments in

some respects, guaranteed payments are,

for Federal income tax purposes, payments with respect to equity, not debt,

and regulations issued under section 707

narrowly circumscribe the situations in

which a guaranteed payment is treated as

something other than a distributive share

of partnership income. The comment recommended that guaranteed payments for

capital be treated as interest only in cases

when the taxpayer harbors an abusive motive to circumvent the relevant rule.

The Treasury Department and the IRS

have determined that guaranteed payments for the use of capital share many

of the characteristics of interest payments

that a partnership would make to a lender and, therefore, should be treated as

interest equivalents for purposes of allocating and apportioning deductions under

§§1.861-8 through 1.861-14 and as income equivalent to interest under section

954(c)(1)(E). This treatment is consistent

with other sections of the Code in which

guaranteed payments for the use of capital are treated similarly to interest. See,

for example, §§1.469-2(e)(2)(ii) and

1.263A-9(c)(2)(iii). In addition, the fact

that a guaranteed payment for the use of

capital may be treated as a payment attributable to equity under section 707(c),

or that a guaranteed payment for the use

of capital is not explicitly included in the

definition of interest in §1.163(j)-1(b)(22),

does not preclude applying the same allocation and apportionment rules that apply

to interest expense attributable to debt, nor

does it preclude treating such payments

as “equivalent” to interest under section

Bulletin No. 2020–49

954(c)(1)(E). Instead, the relevant statutory provisions under sections 861 and 864,

and section 954(c)(1)(E), are clear that the

rules can apply to amounts that are similar

to interest.

Finally, a rule that would require determining whether the transaction had an

abusive motive would be difficult to administer. Therefore, the comment is not

adopted.

C. Treatment of section 818(f) expenses

for consolidated groups

Section 818(f)(1) provides that a life

insurance company’s deduction for life

insurance reserves and certain other deductions (“section 818(f) expenses”) are

treated as items which cannot definitely

be allocated to an item or class of gross

income. When the life insurance company is a member of an affiliated group of

corporations, proposed §1.861-14(h)(1)

provided that section 818(f) expenses are

allocated and apportioned on a separate

company basis.

One comment argued that the separate

company approach was inconsistent with

the general rule in section 864(e)(6) that

expenses other than interest that are not

directly allocable or apportioned to any

specific income-producing activity are allocated and apportioned as if all members

of the affiliated group were a single corporation. The comment also argued that

the separate company approach would

encourage consolidated groups to use intercompany transactions, such as related

party reinsurance arrangements, to shift

their section 818(f) expenses and achieve

a more desirable foreign tax credit result.

The comment advocated that the regulations instead adopt a single entity approach for life insurance companies that

operate businesses and manage assets and

liabilities on a group basis (a “life subgroup” approach).

In contrast, another comment argued

that the separate company approach adopted in the proposed regulations was

consistent with the fact that life insurance

companies are regulated with respect to

their reserves, investable assets, and capital. The comment, however, acknowledged that a life subgroup approach may

be appropriate in certain cases, such as

when an affiliated group of life insurance

Bulletin No. 2020–49

companies manages similar products on a

cross-entity, product-line basis, rather than

on an entity-by-entity basis. The comment

recommended that final regulations provide a one-time election for taxpayers to

choose either the separate company or life

subgroup approach for allocating and apportioning section 818(f) expenses.

The Treasury Department and the IRS

agree that there are merits and drawbacks

to both the separate company and the life

subgroup approaches and that a one-time

election, as suggested by the comments,

should be considered. Therefore, the final regulations at §1.861-14(h) do not

include the separate company rule for section 818(f) expenses. The 2020 FTC proposed regulations instead propose a life

subgroup approach as well as a one-time

election for taxpayers to choose the separate company approach.

D. Allocation and apportionment of R&E

expenditures

The 2019 FTC proposed regulations

proposed several changes to §1.861-17,

including eliminating the gross income

method of apportionment, eliminating

the legally-mandated R&E rule, and limiting the class of income to which R&E

expenditures could be allocated to gross

intangible income reasonably connected

with a relevant Standard Industrial Code

(SIC) category. In addition, the rule for

exclusive apportionment of R&E expenditures was modified by eliminating the

possibility of increased exclusive apportionment based on taxpayer-specific facts

and circumstances, and by providing that

exclusive apportionment applies solely for

purposes of section 904.

1. Scope of Gross Intangible Income

Before being revised, §1.861-17(a)

provided that R&E expenditures are related to all income reasonably connected

to a broad line of business or SIC code

category. The 2019 FTC proposed regulations narrowed and clarified the class of

gross income to which R&E expenditures

are considered to relate. The 2019 FTC

proposed regulations defined the relevant

class of gross income as gross intangible

income (“GII”), which is defined as all

income attributable, in whole or in part,

1147

to intangible property, including sales or

leases of products or services derived, in

whole or in part, from intangible property,

income from sales of intangible property,

income from platform contribution transactions, royalty income, and amounts taken into account under section 367(d) by

reason of a transfer of intangible property. GII does not include dividends or any

amounts included in income under section

951, 951A, or 1293.

One comment disagreed with the exclusion from GII of section 951A inclusions. According to this comment, R&E

expenditures ultimately benefit foreign

subsidiaries such that allocation to income described in section 904(d)(1)(A)

(the “section 951A category”) is appropriate and should not be treated differently from other taxpayer expenses that

reduce income in the section 951A category. Other comments generally supported the exclusion of GILTI and other income inclusions from GII on the

grounds that a taxpayer incurring R&E

expenditures to develop intangible property should be fully compensated for the

value of that intellectual property and,

conversely, the earnings of CFCs should

not reflect returns on intellectual property

owned by another person.

The Treasury Department and the IRS

have determined that GII should continue to exclude GILTI or other inclusions

attributable to ownership of stock in a

CFC. As described in §1.861-17(b), R&E

expenditures, whether or not ultimately

successful, are incurred to produce intangible property. Under the rules of sections

367(d) and 482, the person incurring the

R&E expenditures must be compensated at arm’s length when such intangible

property is licensed, sold, or otherwise

gives rise to income of controlled parties,

and it is this income that gives rise to GII.

In transactions not involving the direct

transfer of intangible property to a related

party, the section 482 regulations require

compensation for the intangible property

embedded in the underlying transaction.

See generally §1.482-1(d)(3)(v). For example, §1.482-3(f) requires that intangible

property embedded in tangible property be

accounted for when determining the arm’s

length price for the transaction. Similarly,

§1.482-9(m) requires that intangible property used in a controlled services transac-

November 30, 2020

tion be accounted for in determining the

arm’s length price for the transaction.

In contrast to R&E expenditures giving

rise to income required by sections 367(d)

and 482, subpart F or GILTI inclusions reflect income earned by a CFC and not the

taxpayer incurring the R&E expenditures;

the fact that such taxpayer is deemed under section 951 or 951A to have income

through an inclusion from a CFC licensee does not mean that such income is a

result of the R&E expenditures incurred

by the taxpayer, assuming that the CFC

pays the taxpayer an arm’s length price

for the transfer of the intangible property

or, in the case of an exchange described in

sections 351 or 361, the taxpayer reports

the required annual income inclusion.2

Therefore, including income in the section

951A category in GII would result in a

mismatch between the R&E expenditures

and the income generated by such expenditures. Although (as noted in a comment)

R&E expenditures that are ultimately unsuccessful could be viewed as intended to

benefit a taxpayer’s foreign subsidiaries

more broadly, the Treasury Department

and the IRS have determined that the GII

earned by the taxpayer provides a reasonable proxy for how the taxpayer expects

to recover its R&E costs, and providing

separate rules for identifying and attributing unsuccessful R&E expenditures to a

broader class of income would be unduly

burdensome for taxpayers and difficult for

the IRS to administer.

Several comments noted that while income in the section 951A category is excluded from GII, income giving rise to foreign-derived intangible income (“FDII”)

is included in GII. These comments generally argued that the exclusion from GII

of income in the section 951A category

and inclusion of amounts included in FDII

created a lack of parity between the two

provisions even though the methodology

and calculations of both are meant to be

similar.

The Treasury Department and the IRS

disagree with these comments. The allocation and apportionment of R&E expenditures to separate categories for purposes

of section 904 as the operative section and

the allocation and apportionment of R&E

expenditures to FDDEI for purposes of

section 250 as the operative section both

require identifying the class of income to

which the R&E expenditures are attributable. R&E expenditures incurred by a

United States shareholder (“U.S. shareholder”) are not allocated and apportioned

to income in the section 951A category

because such income, which relates to an

inclusion of income earned by the CFC,

is not a return on the U.S. shareholder’s

R&E expenditures and, thus, is not included in gross intangible income. In contrast,

income giving rise to FDII is earned directly by the same taxpayer that incurs

R&E expenditures and may include a return on those R&E expenditures. Income

that gives rise to FDII is reduced by “the

deductions (including taxes) properly allocable to such gross income.” See section

250(b)(3)(A)(ii) and §1.250(b)-1(d)(2).

There is no indication that Congress intended to exclude R&E expenditures from

that calculation. Furthermore, because

expenses incurred by a CFC are allocated and apportioned to income of the CFC

for purposes of computing tested income

under section 951A(c)(2)(A)(ii), contrary

to the suggestion in the comments, R&E

expenditures of the CFC are in fact allocated and apportioned to tested income

under §1.861-17 and reduce the ultimate

amount of the taxpayer’s GILTI inclusion.

Accordingly, the comment is not adopted.

One comment requested modifications

to the definition of GII to exclude both

acquired intangible property and income

from certain platform contribution transactions described in §1.482-7(b)(1)(ii).

According to the comment, income from

these items should be excluded from GII

because a taxpayer’s R&E expenditures

could not relate to gross income from

intangible property acquired from a different taxpayer (as opposed to developed

by the taxpayer), or to gross income from

certain platform contributions.

The Treasury Department and the IRS

have determined that the comment does not

accurately describe the premise on which

the R&E allocation and apportionment

rules are based. R&E expenditures are not

reasonably expected to produce any current

income in the taxable year in which the

expenditures are incurred, and as the regulations explicitly recognize, the results of

R&E expenditures are speculative. Accordingly, R&E expenditures are allocated to a

class of currently recognized gross income

only because it generally will be the best

available proxy for the income that the current expense is reasonably expected to produce in the future. Specifically, although

current R&E expense of a taxpayer likely

does not directly contribute to gross intangible income currently recognized, it is reasonable to expect that R&E will contribute

to GII earned by the taxpayer group in the

future. The definition of GII is not intended to require a strict factual connection between the R&E expenditure and GII earned

in the taxable year, but merely that the expenditures be “reasonably connected” with

a class of income. The Treasury Department and the IRS have also determined that

requiring the comment’s suggested level of

explicit factual connection between R&E

expenditures and GII would outweigh the

administrative benefit and ease of broadly

defining GII. Moreover, in cases in which

a taxpayer has a valid cost sharing agreement, even though R&E expenditures may

be allocated to PCT payments, those expenses are generally apportioned based on

sales by the taxpayer or other entities reasonably expected to benefit from current

research and experimentation. This ensures

that R&E expenditures offset the categories

of income included in GII that are expected

to benefit from those expenditures. Accordingly, the comment is not adopted.

One comment requested clarification of

the definition of GII and specifically that the

final regulations provide that the services

income included in GII does not include

gross income allocated to or from a foreign

branch under §1.904-4(f)(2)(vi) by reason

of a disregarded payment for services performed by or for the foreign branch that

contribute to earning GII of the taxpayer.

Under §1.904-4(f)(2)(vi)(B), a disregarded payment from a foreign branch

To assist in determining an arm’s length price in related party transactions, section 14221 of the TCJA and related technical corrections in the 2018 Consolidated Appropriations Act amended

sections 482 and 367(d) to clarify the methods that may be applied to determine the value of intangible property and that the definition of intangible property includes workforce, goodwill

and going concern value, or other items the value or potential value of which is not attributable to tangible property or the services of any individual. To the extent the comment reflects a

concern that arm’s length compensation for intangible property has not always been paid under sections 367(d) and 482, the comment raises issues beyond the scope of this rulemaking.

2

November 30, 2020

1148

Bulletin No. 2020–49

owner to its foreign branch to compensate

the foreign branch for the provision of contract R&E services that, if regarded, would

be allocable to general category gross intangible income attributable to the foreign branch owner under the principles of

§§1.861-8 through 1.861-17, would cause

the general category GII attributable to the

foreign branch owner to be adjusted downward and the GII attributable to the foreign

branch and included in foreign branch category income to be adjusted upward. Although a disregarded payment for R&E services does not give rise to gross income for

Federal income tax purposes and so does

not in and of itself constitute GII, to the

extent the disregarded payment results in

the reattribution of regarded gross income

that is GII from the general category to the

foreign branch category (or vice versa),

that income is treated as GII in the foreign

branch category (or the general category).

The final regulations at §1.861-17(b)(2)

clarify that although GII does not include

disregarded payments, certain disregarded

payments that would be allocable to GII if

regarded may result in the reassignment of

GII from the general category to the foreign branch category or vice versa. Part

II.D.6 of this Summary of Comments and

Explanation of Revisions further describes

comments regarding R&E expenditures

and foreign branches.

One comment sought clarification regarding the portion of product sales derived from intangible property that would

be considered GII. The final regulations at

§1.861-17(b)(2) clarify that GII includes

the full amount of gross income from sales

or leases of products or services, if the income is derived in whole or in part from

intangible property. Under the definition

of GII, there is no bifurcation or splitting

of sales income between a portion attributable to intangible property and other

amounts such as distribution or marketing functions. Additionally, the definition

of GII has been modified to more clearly

delineate between amounts from sales or

leases of products derived from intangible

property versus sales or licenses of intangible property itself.

2. Allocation of R&E Expenditures

One comment requested modifications

to the general rule that allocates R&E ex-

Bulletin No. 2020–49

penditures to GII that is reasonably connected with one or more relevant SIC

code categories. The comment noted that

in some cases, taxpayers are restricted by

law or contract from exploiting research,

with the result that the research would

only generate income in a particular statutory grouping after several years from

the date of the contract. Accordingly, the

comment requested that such R&E expenditures be allocated to the statutory or

residual grouping of income within GII

that corresponds to the market restrictions

on the use of the R&E. Alternatively, the

comment requested that taxpayers be provided with the option to allocate R&E

expenditures in a manner consistent with

the taxpayer’s books and records to the

extent there is a clear factual relationship

between the expenditures and a particular

category of income.

The Treasury Department and the IRS

have determined that it is inappropriate to

provide exceptions to the general rule that

R&E expenditures are allocated to GII

reasonably connected with one or more

relevant SIC code categories. The two approaches suggested by the comment are

premised on a goal of seeking to “trace”

R&E expenditures to the actual income

that they are expected to produce in the future. However, as discussed in Part II.D.1

of this Summary of Comments and Explanation of Revisions, R&E expenditures

are not reasonably expected to produce

any current income in the taxable year in

which the expenditures are incurred, and

the regulations recognize that the results

of R&E expenditures are speculative. Instead, §1.861-17 relies on the use of current year sales as a proxy for the income

that the expenses are reasonably expected

to produce in the future, in recognition of

the fact that it is difficult to ascertain the

composition of future income that would

be generated from R&E expenditures.

This approach generally already takes into

account the types of market or legal restrictions described by the comment — to

the extent that a taxpayer’s sales of products in the same SIC code category are

generally restricted to a particular market,

these restrictions will be reflected in its

sales and therefore are already taken into

account under the sales method provided

in proposed §1.861-17. Moreover, rules

that specially allocate particular R&E ex-

1149

penditures based on the reasonableness

of speculative expectations about sales

that may or may not actually arise several

years in the future would be very difficult

for taxpayers to comply with and for the

IRS to administer.

Finally, allowing taxpayers to elect the

use of a books-and-records method to allocate R&E expenditures to less than all of

a taxpayer’s GII would lead to inappropriate results, as taxpayers would only elect

such option if the additional information

reflected in the taxpayer’s books and records improved the tax result; in contrast,

the IRS would not have any such information available to it if the taxpayer chose

not to make the election. Since this information would generally be in the form of

predictions about future income streams,

an elective books-and-records rule would

create administrability concerns for the

IRS, which would have substantial difficulty verifying whether the predictions

were reasonable. Accordingly, the comments are not adopted.

One comment recommended that the

Treasury Department and the IRS reconsider the elimination of the “legally

mandated R&E” rule from the 2019 FTC

proposed regulations, noting that the rule

seemed to be required by section 864(g)

(1)(A). As explained in the preamble to

the 2019 FTC proposed regulations, the

legally mandated R&E rule was eliminated in light of changes to the international

business environment and to simplify the

regulations, and the comment does not

argue the change is inappropriate. Additionally, the comment misstates the application of section 864(g)(1)(A), which

is not applicable to the taxable years to

which the final regulations apply. See section 864(g)(6). Accordingly, the comment

is not adopted.

One comment sought clarification on

the allocation of R&E expenditures where

research is conducted with respect to more

than one SIC code category. The comment

noted that the current final regulations at

§1.861-17(a)(2)(iii) mention two digit

SIC code categories, or Major Groups in

the terminology of the SIC Manual, yet

the 2019 FTC proposed regulations omitted references to two digit SIC codes.

The Treasury Department and the IRS

have determined that it is appropriate to

aggregate some or all three digit SIC cat-

November 30, 2020

egories within the same Major Group, but

it is inappropriate to aggregate any three

digit SIC categories within different Major Groups. While R&E expenditures are

speculative, it is not reasonable to expect R&E conducted for one broad line

of business to benefit an unrelated line

of business and, therefore, the allocation

and apportionment of expenses should

not be determined by aggregating different Major Groups. For example, if a taxpayer engages in both the manufacturing

and assembling of cars and trucks (SIC

code 371) it may aggregate that category

with another three digit category in Major

Group 37, which includes six other three

digit categories (for example, aircraft and

parts (SIC code 372) or railroad equipment (SIC code 374)), but taxpayers may

not aggregate a three digit SIC code from a

Major Group with another three digit SIC

code from a different Major Group, except

as provided in §1.861-17(b)(3)(iv) (requiring aggregation of R&E expenditures

related to sales-related activities with the

most closely related three digit SIC code,

other than those within the wholesale and

retail trade divisions, if the taxpayer conducts material non-sales-related activities

with respect to a particular SIC code). The

final regulations are modified accordingly.

3. Exclusive Apportionment of R&E

Expenditures

i. Computation of FDII

Several comments argued that if the

Treasury Department and the IRS determine that GII should include amounts

giving rise to FDII, then the rule in

the 2019 FTC proposed regulations in

§1.861-17(c), which limits exclusive apportionment of R&E expenditures solely

for purposes of applying section 904 as

the operative section, should be revised

to also allow for exclusive apportionment

for purposes of calculating a taxpayer’s

FDII deduction. The comments generally

argued that the exclusive apportionment

provision be applied such that 50 percent

of a taxpayer’s R&E expenditures should

be apportioned to income that is not foreign derived deduction eligible income

(“FDDEI”) provided that at least 50 percent of the taxpayer’s research activities

are conducted in the United States. Com-

November 30, 2020

ments argued that such an exclusive apportionment rule would encourage R&E

activity in the United States, consistent

with the general intent of the TCJA to

eliminate tax incentives for shifting activity and intellectual property overseas. Additionally, comments asserted that R&E

expenditures provide greater value to the

location where R&E is performed and that

there is a technology “lag” before successful products are exported to foreign markets.

The Treasury Department and the IRS

have determined that it is not appropriate

to apply an exclusive apportionment rule

for purposes of computing FDII. As discussed in Part II.D.1 of this Summary of

Comments and Explanation of Revisions,

R&E expenditures are not reasonably expected to produce any current income in

the taxable year in which the expenditures

are incurred, and the regulations explicitly

recognize that the results of R&E expenditures are speculative. Furthermore, to

the extent there is consistently a “lag” before a taxpayer’s successful products are

exported to foreign markets, then such lag

should generally be reflected in current

year sales of newly successful products

(which relate to R&E incurred in prior

taxable years) being weighted towards

domestic markets. Therefore, the rules’

use of current year sales as a proxy for

the income that the expense is reasonably

expected to produce in the future already

takes into account to some extent the potential for a “lag” between exploiting intangible property in the domestic market

versus foreign markets.

In addition, the Treasury Department

and the IRS have determined that nothing

in the text of the TCJA or its legislative

history suggests that Congress intended that existing rules on allocation and

apportionment of R&E expenditures be

modified in a way to create particular incentives. Section 250(b)(3) requires determining the deductions that are “properly

allocable” to deduction eligible income,

and §1.250(b)-1(d)(2) confirms that the

general rules under §1.861-17 apply for

purposes of allocating and apportioning

R&E expenditures to deduction eligible

income and FDDEI. Nothing in the statute or legislative history suggests that any

alternative allocation and apportionment

rule should apply. Furthermore, adopting

1150

an R&E allocation and apportionment

rule solely for purposes of increasing the

amount of the FDII deduction to incentivize R&E activity (whether or not such

expenditures were “properly” allocable

to non-FDDEI income) would be inconsistent with the United States’ position,

including as stated in forums such as the

OECD’s Forum on Harmful Tax Practices, that the FDII regime is not intended to

provide a tax inducement to shifting activities or income, but is intended to neutralize the effect of providing a lower U.S.

effective tax rate with respect to the active

earnings of a CFC of a domestic corporation (through a deduction for GILTI) by

also providing a lower effective U.S. tax

rate with respect to FDII earned directly

by the domestic corporation. Such parity is generally furthered by ensuring that

R&E expenditures incurred by a domestic

corporation are allocated and apportioned

to FDII in the same manner as R&E expenditures incurred by a CFC are allocated and apportioned to tested income that

gives rise to GILTI.

Therefore, the final regulations provide that the exclusive apportionment rule

is limited to section 904 as the operative

section.

ii. Increased exclusive apportionment

Two comments recommended reinstating the rule allowing for an increased

exclusive apportionment of R&E expenditures. Under the increased exclusive

apportionment rule, a taxpayer may establish to the satisfaction of the Commissioner that an even greater amount of

R&E expenditures should be exclusively

apportioned. One comment indicated that

there may be circumstances where an

even greater amount of R&E expenditures

should be apportioned, such as following

the termination of a cost sharing arrangement (“CSA”). Another comment pointed

out that the 2019 FTC proposed regulations reduce taxpayer options by eliminating both increased exclusive apportionment and the gross income method.

The Treasury Department and the IRS

have determined that a rule allowing for

increased exclusive apportionment is not

warranted. The facts and circumstances

nature of the determination that would

be required and the potential for disputes

Bulletin No. 2020–49

outweigh the benefits of affording taxpayers additional flexibility in rare or unusual

cases. Additionally, to the extent that there

is a tendency to exploit intellectual property in the same market where the taxpayer conducts R&E, this will already be

reflected in current sales, as those in part

reflect the results of recently-developed

intellectual property. Accordingly, this

comment is not adopted.

iii. Mandatory application of exclusive

apportionment

Two comments generally objected to

the required application of exclusive apportionment for purposes of section 904.

According to the comments, in certain

situations where a taxpayer has insufficient domestic source gross income to

absorb the apportioned R&E expenditures, the resulting overall domestic loss

(“ODL”) would reduce foreign source

income in each separate category described in §1.904-5(a)(4)(v), including

the section 951A and foreign branch categories, reducing the taxpayer’s ability to

claim foreign tax credits. The comments

recommended that taxpayers either be

allowed to elect out of exclusive apportionment or alternatively that it be applied in an amount less than 50 percent

of the taxpayer’s R&E expenditures. One

comment alternatively recommended a

modification to the ODL and R&E expenditure rules such that the majority of

the amounts otherwise subjected to exclusive apportionment would instead be

allocated to income in the general category rather than the section 951A or foreign branch categories.

The TCJA did not modify the operation

of section 904(f) or (g) with respect to the

section 951A or foreign branch categories,

nor is there any indication in the TCJA or

legislative history that Congress intended

the rules under section 904(f) and (g), or

the allocation and apportionment rules

under section 861, to apply differently in

connection with section 951A or foreign

branch category income. To the extent an

ODL account is created as the result of a

domestic loss offsetting foreign source income in the section 951A or foreign branch

category under section 904(f)(5)(D), this

reduction is reversed in later years through

the recapture provisions in section 904(g)

Bulletin No. 2020–49

(3), when U.S. source income is recharacterized as foreign source income in the

separate categories that were offset by the

ODL. Additionally, the Treasury Department and the IRS have determined that

the consistent application of the exclusive

apportionment rule for purposes of section

904 promotes simplicity and certainty,

whereas an optional rule would be more

difficult to administer. Accordingly, these

comments are not adopted.

4. Elimination of the Gross Income

Method

Several comments requested that the

gross income method for apportioning

R&E expenditures be retained. In general, these comments recommended allowing taxpayers to choose either the gross

income method or the sales method rather than being required to utilize only the

sales method, including by allowing taxpayers to choose one method for certain

operative sections and another method

for other operative sections. Some comments asserted that the mandatory use of

the sales method would inappropriately

allocate and apportion more R&E expenditures to FDDEI than under the gross

income method in cases where U.S. taxpayers license their intellectual property

for foreign use but sell products directly

to U.S. customers. One comment argued

that the sales method could be distortive

in certain situations where a taxpayer

licenses its intellectual property to entities whose sales are at least partially attributable to self-developed intellectual

property. Another comment argued that

where a taxpayer’s primary type of GII is

royalty income, it will be difficult to apportion R&E based on sales numbers and

that therefore the gross income method

should be maintained.

The Treasury Department and the IRS

have determined that, on balance, the

sales method results in substantially fewer

distortions than the gross income method. Before being modified by these final

regulations, taxpayers were permitted to

apportion R&E expenditures under either

a gross income or sales method. The Explanation of Provisions in the 2019 FTC

proposed regulations explained that the

gross income method could produce inappropriate, distortive results in certain cas-

1151

es. In particular, distortions could arise because the gross income method looks only

to gross income earned directly by the

taxpayer. Gross income that is earned by

the taxpayer and that is attributable to one

grouping (such as U.S. source income)

may reflect value unrelated to intangible

property, for example gross income from

sales that reflect value from marketing

or distribution activities of the taxpayer,

whereas gross income of such taxpayer

that is attributable to another grouping

(such as foreign source income) may exclude such non-IP related value due, for

example, to the fact that such gross income

is earned solely from licensing intangible

property to a related party without the performance of any marketing or distribution

activities. The distortions arise both because gross income reflects a reduction of

gross receipts for cost of goods sold but

not for related deductible expenses, and

also because the gross income method

does not distinguish between gross income earned from customers (for which

the gross income generally captures all of

the value related to the product or service

arising from the IP) versus from related

parties (for which gross income generally

only captures an intermediate portion of

the value of the relevant product or service, which will generally be enhanced by

the related party).

In contrast, the sales method provides

a consistent, reliable method with fewer

distortions than the gross income method.

In particular, the sales method focuses on

the gross receipts from sales of a product

to final customers. This approach is more

likely to achieve consistent results in the

case of the same or similar final products,

and thereby allows for a consistent comparison of value derived from intangible

property with respect to each grouping.

That is the case regardless of whether the

taxpayer chooses to license its intangible

property to other persons (including related parties) for purposes of manufacturing

final products, or the taxpayer manufactures products itself, and regardless of

whether other persons enhance the product with additional value attributable to

other intangible property. Therefore, the

sales method ensures that differences in

supply chain structures do not alter the

nature of how R&E expenditures are allocated and apportioned.

November 30, 2020

Alternatively, some comments recommended modifying the gross income

method. One comment recommended

modifying the gross income method to

more accurately match income to related

R&E expenditures by using only gross

income that is attributable to the intangible property owned by the taxpayer.

However, the Treasury Department and

the IRS have determined that it would

lead to complexity for taxpayers and administrative burdens for the IRS to seek

to accurately determine the share of gross

income that is attributable to intangible

property when the intangible property is

embedded in a final product. In addition,

such a rule would be unlikely to result

in significantly different results than under the sales method, because the ratio

of gross income among groupings that is

attributable solely to intangible property

is likely to be broadly similar to the ratio

of gross receipts from sales within those

groupings, since the intangible component

of gross income from sales is likely to be

determined as a fraction of gross receipts,

and such fraction would generally be the

same for each grouping.

One comment argued that the gross

income method must be included in the

final regulations because it is statutorily

required under section 864(g)(1). However, section 864(g) is not applicable to the

taxable years covered by the final regulations. See section 864(g)(6). Therefore,

the comment is not adopted.

Finally, one comment recommended

allowing taxpayers to use the gross income method if using the sales method

would otherwise cause the taxpayer to

have an ODL. The Treasury Department

and the IRS have determined that it would

be inappropriate to allow for the targeted

application of a method solely for the purpose of avoiding the ODL rules, which are

statutorily mandated. The regulations under section 861, including §1.861-17, are

premised on associating deductions in as

accurate and reasonable a manner as possible with the income to which such deductions relate. It is inconsistent with this

overall policy of relating deductions to the

relevant income to revise the regulations

under section 861 simply to achieve a specific result under an operative section. Accordingly, the final regulations eliminate

the gross income method.

November 30, 2020

5. Application of Sales Method

The 2019 FTC proposed regulations

retained the rule in the prior final regulations which provides that for apportionment purposes, the sales method includes

certain gross receipts of related and unrelated entities that are reasonably expected

to benefit from the taxpayer’s R&E expenditures, but does not include the receipts

of entities that have entered into a valid

CSA with the taxpayer. The 2019 FTC

proposed regulations made limited changes to the sales method as it existed under

the prior final regulations.

One comment requested guidance on

the application of the sales method in the

context of foreign branch category income; this comment is discussed in Part

II.D.6 of this Summary of Comments and

Explanation of Revisions.

Two comments asked for a modification to the treatment of controlled entities that terminate an existing CSA with

a taxpayer. Under the sales method, gross

receipts from sales of products or the

provision of services within a relevant

SIC code category by controlled parties

of the taxpayer are taken into account

when apportioning the taxpayer’s R&E

expenditures if the controlled party is

reasonably expected to benefit from the

taxpayer’s research and experimentation.

Under proposed §1.861-17(d)(4)(iv), the

sales of controlled parties that enter into

a valid CSA with a taxpayer are generally excluded from the apportionment formula because the controlled party is not

expected to benefit from the taxpayer’s

R&E expenditures. The comments argued that when a CSA is terminated and

a taxpayer licenses newly-developed intangibles to a controlled party, all gross

receipts from the controlled party are

included in the apportionment formula,

even though for some post-termination

period the controlled party may benefit

more from intangibles created by its own

R&E expenditures incurred under the previously-existing CSA rather than from the

newly-developed and licensed intangibles. The comments recommended varying adjustments, including rules specific

to CSA terminations or alternatively more

generalized adjustments such as the retention of the increased exclusive apportionment rule or the gross income method.

1152

The Treasury Department and the IRS

disagree with the comments’ characterization of §1.861-17 as seeking directly

to match R&E expenditures with the income that such expenditures generate.

According to the comments, following a

CSA termination with a controlled party,

a taxpayer’s current R&E expenditures

should not offset the controlled party’s

royalty payment to the taxpayer because

the controlled party’s gross receipts would

be attributable to the intangibles funded

by the controlled party during the period

the CSA existed. This assertion assumes

that current sales are used to apportion

R&E expenditures because they result

from a taxpayer’s current or recent research and, therefore, it is inappropriate

to include gross receipts attributable to

the research of a different taxpayer. The

regulations, however, are based in part

on the acknowledgement that R&E is a

speculative, forward-looking activity that

often does not result in income or sales in

the current year, or even in future years.

As discussed in Part II.D.2 of this Summary of Comments and Explanation of

Revisions, current sales are nevertheless

used because they generally will be the

best available proxy for the income R&E

expenditures are expected to produce in

future years. Accordingly, once a CSA is

terminated, it is appropriate to include the

sales of a controlled party that previously participated in a CSA if that controlled

party is reasonably expected to benefit

from the taxpayer’s current R&E expenditures to generate future sales. Additionally, the Treasury Department and the IRS

have determined that attempting to distinguish between the sales attributable to the

controlled party’s intangible property and

those attributable to intangible property licensed from the taxpayer is generally difficult and uncertain and may often lead to

disputes, making such a rule difficult for

taxpayers to comply with and burdensome

for the IRS to administer. Because those

concerns also exist when a taxpayer and a

controlled party enter into a CSA, the final

regulations also do not adopt comments

requesting such a rule in that context. Furthermore, the Treasury Department and

the IRS have determined that the tax consequences of terminating a CSA may vary

depending on the facts and circumstances

and are considering whether it would be

Bulletin No. 2020–49

appropriate to provide special rules for

these transactions, and thus it would not

be appropriate to provide special rules

in connection with §1.861-17 until these

transactions have undergone further study.

Therefore, the comments are not adopted.

Finally, several comments requested a modification to the rule in proposed

§1.861-17(d)(3) and (4) providing that if a

taxpayer has previously licensed, sold, or

transferred intangible property related to

a SIC code category to a controlled or uncontrolled party, then the taxpayer is presumed to expect to do so with respect to

all future intangible property related to the

same SIC code category. The comments

argued that the 2019 FTC proposed regulations’ use of the term “presumption”

suggested that taxpayers would be unable

to rebut the presumption in appropriate

cases. In response to the comments, the final regulations clarify that taxpayers may

rebut the presumption by demonstrating

that prior exploitation of the taxpayer’s

intangible property is inconsistent with

reasonable future expectations.

In addition, the final regulations make

other revisions to the sales method. First,

the final regulations specify under what

circumstances the sales or services of uncontrolled or controlled parties are taken

into account. In particular, the final regulations specify that the gross receipts are

taken into account if the uncontrolled or

controlled party is expected to acquire

(through license, sale, or transfer) intangible property arising from the taxpayer’s current R&E expenditures, products

in which such intangible property is embedded or used in connection with the

manufacture or sale of such products, or

services that incorporate or benefit from

such intangible property. Second, the final

regulations revise §1.861-17(d)(4) to refer

to sales by controlled parties (which is defined as any person that is related to the

taxpayer)), rather than controlled corporations, to clarify that, for example, sales

made by a controlled partnership that is

reasonably expected to license intangible

property from the taxpayer are fully taken

into account under the sales method. Finally, the final regulations revise §1.86117(f)(3) to provide that if a partnership

incurs R&E expenditures (and is not also

an uncontrolled party or controlled party

described in §1.861-17(d)(3) or (4)) and

Bulletin No. 2020–49

makes related sales, then those sales are

considered made by the partners in proportion to their distributive shares of gross

income attributable to the sales.

6. Foreign Branch Category Income and

R&E Expenditures

Two comments addressed the interaction of §1.861-17 and foreign branch category income. One comment requested

that a portion of sales earned by a foreign

branch should be attributed to the general category for purposes of apportioning R&E expenditures in circumstances

where a foreign branch utilizes intellectual property of the foreign branch owner to

earn GII and pays a disregarded royalty to

its U.S. owner. Under §1.904-4(f)(2)(vi)

(A), the amount of foreign branch category income would be adjusted downward

and the foreign branch owner’s general

category income would be adjusted upward by the amount of the disregarded

royalty. According to the comment, after

exclusive apportionment (as applicable),

the 2019 FTC proposed regulations would

apportion entirely to foreign branch category income the remaining R&E expense,

which should instead be apportioned to

the general category income originally attributable to the GII of the foreign branch

that was reassigned by reason of the disregarded royalty.

The Treasury Department and the IRS

have determined that the 2019 FTC proposed regulations, in combination with

§1.904-4(f)(2)(vi), already operate in the

manner requested by the comment. Under

proposed §1.861-17(d)(1)(iii), gross receipts are assigned to the statutory grouping (or groupings) or residual grouping to

which the GII related to the sale, lease,

or service is assigned. Adjustments to the

amounts of gross income attributable to a

foreign branch by reason of disregarded

payments change the separate category

grouping to which the gross income is assigned, but do not change the total amount,

character, or source of a United States

person’s gross income. See §1.904-4(f)(2)

(vi)(A). After application of §1.904-4(f)

(2)(vi), GII related to the foreign branch’s

sales is assigned to the general category

in the amount of the disregarded royalty

payment, and only the balance of the GII

is assigned to the foreign branch catego-

1153

ry. Accordingly, a proportionate amount

of the gross receipts from sales made by

the foreign branch to which a disregarded

royalty payment would be allocable is assigned to the general and foreign branch

categories in the same ratio as the disregarded royalty payment bears to the gross

income attributable to the sales. The final

regulations in §1.861-17(d)(1)(iii) clarify that the assignment of gross receipts

occurs after gross income in the separate

categories is adjusted under §1.904-4(f)

(2)(vi) and clarify through an example the

formula used to reassign gross receipts as

a result of a disregarded reallocation transaction. See §1.861-17(g)(6) (Example 6).

The second comment requested changes to the treatment of foreign branches

that provide contract R&E services for

the benefit of the foreign branch owner.

According to the comment, when disregarded payments made by the foreign

branch owner in respect of the provision

of contract R&E services by a foreign

branch cause GII to be reallocated to the

foreign branch, R&E expenditures incurred by the foreign branch owner may

be apportioned to foreign branch category income in a manner inconsistent with

the economics of the branch’s activities

as a services provider, creating disparate

tax results compared to those that would

obtain if the services were performed by

a CFC. The comment suggested that the

foreign branch’s regarded costs of providing the research services that give rise to

the disregarded payment from the foreign

branch owner should reduce the amount

of GII that was assigned to the foreign

branch category, or more generally that

GII should not be assigned to the foreign

branch category by reason of disregarded

payments for research services.

The Treasury Department and the IRS

agree that R&E expenditures, including deductible expenses for the foreign

branch’s costs in providing research services to the foreign branch owner, may

be apportioned to foreign branch category income that is GII, including GII that

is treated as attributable to the foreign

branch category under §1.904-4(f)(2)(vi)

by reason of disregarded payments from

the foreign branch owner compensating

the foreign branch for its research services that will generate GII for the foreign

branch owner, and that the apportionment

November 30, 2020

is based upon gross receipts assigned to

the statutory groupings. However, as noted in §1.904-4(f)(2)(vi)(A), the reattribution of gross income between the general

and foreign branch categories by reason of

disregarded payments cannot change the

character of a taxpayer’s realized gross

income. The Treasury Department and

the IRS have determined that the different characterization of services income

earned by a CFC, which may not be GII,

and sales income reflecting GII that is attributed to a foreign branch by reason of

disregarded payments for services, results

from the Federal income tax treatment of

disregarded payments, which do not give

rise to gross income, and that it is not appropriate effectively to override the characterization of gross income by modifying

the rules for allocating and apportioning

recognized R&E expenditures. Accordingly, the comment is not adopted.

7. Contract Research Arrangements

In the Explanation of Provisions in the

2019 FTC proposed regulations, the Treasury Department and the IRS requested

comments on whether contract research

arrangements involving expenditures that

are reimbursed by a foreign affiliate are

generally paid or incurred by a U.S. taxpayer such that a deduction under section

174 would be allowable for such expenditures, and whether any special rules for

such arrangements should be considered.

Generally, the comments received stated

that where contract research is performed

in the United States and is connected with

a U.S.-based multinational’s trade or business, a deduction under section 174, rather

than section 162, may be appropriate.

The Treasury Department and the IRS

have determined that it is beyond the

scope of the final regulations to determine

whether contract research expenses are, or

are not, eligible to be deducted under either section 162 or 174.

8. Amended Returns and Applicability

Dates

One comment requested clarification

of the applicability date provisions of the

§1.861-17 portion of the 2019 FTC proposed regulations. The comment noted

that it was unclear whether a taxpayer

November 30, 2020

that originally elected to apply the gross

income method on its 2018 tax return

would be eligible to amend its 2018 tax

return to apply the sales method. The 2019

FTC final regulations included a provision

addressing the binding election contained

in former §1.861-17(e)(1). Under this provision, as modified in the 2019 FTC final

regulations at §1.861-17(e)(3), taxpayers

otherwise subject to the binding election

were permitted to change their election.

On May 15, 2020, correcting amendments

to the 2019 FTC final regulations were issued in 85 FR 29323. These amendments

make clear that the change in method can

occur on an original or an amended return. See also Part VII of this Summary of

Comments and Explanation of Revisions

for a discussion of the ability for taxpayers

to rely on the proposed or final versions

of §1.861-17 for taxable years before the

years in which the final regulations are

applicable. Accordingly, changes to the

applicability date provisions are not necessary in response to this comment.

Finally, one comment requested that

the applicability of the regulations under

section 250 be deferred until after §1.86117 is finalized. Because the applicability

of the regulations under section 250 has

been deferred until taxable years beginning on or after January 1, 2021, which

is consistent with the applicability date

of §1.861-17, the comment is moot. See

§1.250-1(b).

E. Application of section 904(b) to net

operating losses

Proposed §1.904(b)-3(d)(2) contained

a coordination rule providing that for

purposes of determining the source and

separate category of a net operating loss,

the separate limitation loss and overall

foreign loss rules of section 904(f) and

the overall domestic loss rules of section

904(g) are applied without taking into account the adjustments required under section 904(b). No comments were received

on this provision, which is finalized without change.

One comment requested that the final

regulations include a rule switching off

the application of section 904(b)(4) with

respect to pre-2018 U.S. source NOLs that

offset foreign source income and created

ODL accounts in pre-2018 taxable years,

1154

because in certain cases the increase in

the denominator of the foreign tax credit limitation fraction required by section

904(b)(4) could limit the utilization of

foreign tax credits that would otherwise

be allowed by reason of the recapture of

the ODL.

Nothing in section 904(b)(4) allows for

the rule to be applied differently in cases when a taxpayer recaptures a pre-2018

ODL versus a post-2017 ODL or has no

ODL recapture at all. Instead, the adjustments required by section 904(b)(4) apply

in all taxable years beginning after 2017.

Therefore, the comment is not adopted.

III. Conduit Financing Rules Under

§1.881-3 to Address Hybrid Instruments

A. Overview

The conduit financing regulations in

§1.881-3 allow the IRS to disregard the

participation of one or more intermediate entities in a “financing arrangement”

where such entities are acting as conduit

entities, and to recharacterize the financing arrangement as a transaction directly

between the remaining parties for purposes of imposing tax under sections 871,

881, 1441 and 1442. In general, a financing arrangement exists when through a series of transactions one person advances

money or other property (the financing

entity), another person receives money or

other property (the financed entity), the

advance and receipt are effected through

one or more other persons (intermediate

entities), and there are “financing transactions” linking each of those parties. See

§1.881-3(a)(2)(i). An instrument that for

U.S. tax purposes is stock (or a similar

interest, such as an interest in a partnership) is not a financing transaction under

the existing conduit financing regulations,

unless it is “redeemable equity” or is otherwise described in §1.881-3(a)(2)(ii)(B)

(1).

The 2020 hybrids proposed regulations

expanded the definition of a financing

transaction, such that an instrument that

for U.S. tax purposes is stock or a similar interest is a financing transaction if:

(i) under the tax law of a foreign country

where the issuer is a tax resident or has

a taxable presence, such as a permanent

establishment, the issuer is allowed a de-

Bulletin No. 2020–49

duction or another tax benefit, including

a deduction with respect to equity, for an

amount paid, accrued, or distributed with

respect to the instrument; or (ii) under the

issuer’s tax laws, a person related to the

issuer is entitled to a refund, including a

credit, or similar tax benefit for taxes paid

by the issuer upon a payment, accrual,

or distribution with respect to the equity

interest and without regard to the related

person’s tax liability in the issuer’s jurisdiction. See proposed §1.881-3(a)(2)

(ii)(B)(1)(iv) and (v). The 2020 hybrids

proposed regulations relating to conduit

financing arrangements were proposed to

apply to payments made on or after the

date that final regulations are published in

the Federal Register.

B. Scope of instruments treated as

financing transactions

A comment agreed that a financing

transaction should include an instrument

that is stock or a similar interest for U.S.

tax purposes but debt under the tax law of

the issuer’s country because, according to

the comment, cases of potential conduit

abuse are likely to involve “classic” hybrid instruments not covered by the types

of equity described in §1.881-3(a)(2)(ii)

(B)(1). However, the comment recommended that an instrument that is equity

for purposes of both U.S. tax law and the

issuer’s tax law not be treated as a financing transaction, except in limited circumstances, such as if the instrument is issued

by a special purpose company formed to

facilitate the avoidance of tax under section 881 and the instrument gives rise to

a notional deduction or a refund or credit

to a related person. According to the comment, the proposed rule that treated an instrument that is equity for both U.S. and

foreign tax purposes as a financing transaction was overbroad – as it could deem an

operating company to have entered into a

financing transaction simply because foreign tax law provides for notional interest

deductions or a similar regime of general

applicability – or was unclear or vague in

certain cases.

If the final regulations were to retain

the proposed rules treating other types of

equity instruments as financing transactions, the comment requested several clarifications, modifications, and limitations

Bulletin No. 2020–49

with respect to the rules. These included:

(i) treating an instrument that is equity in

a partnership for U.S. tax purposes and

under the issuer’s tax law as a financing

transaction only if the partnership is a hybrid entity that claims treaty benefits; (ii)

either eliminating or clarifying the rule

providing that an instrument can be a financing transaction by reason of generating tax benefits in a jurisdiction where

the issuer has a permanent establishment;

and (iii) modifying the applicability date

for payments under existing financing arrangements.

Consistent with the comment, the final regulations adopt without substantive

change the rule that included as a financing transaction an instrument that is stock

or a similar interest (including an interest

in a partnership) for U.S. tax purposes

but debt under the tax law of the country

of which the issuer is a tax resident. See

§1.881-3(a)(2)(ii)(B)(1)(iv). In addition,

the final regulations provide that if the issuer is not a tax resident of any country,

such as an entity treated as a partnership

under foreign tax law, the instrument is

a financing transaction if the instrument

is debt under the tax law of the country

where the issuer is created, organized, or

otherwise established. See id.

The final regulations do not include the

rules under the 2020 hybrids proposed regulations that treated as a financing transaction an instrument that is stock or a similar

interest for U.S. tax purposes but gives rise

to notional interest deductions or other tax

benefits (such as a deduction or credit allowed to a related person) under foreign tax

law. The Treasury Department and the IRS

plan to finalize those rules separately, in order to allow additional time to consider the

comments received. In addition, the Treasury Department and the IRS are continuing to study instruments that generate tax

benefits in the jurisdiction where the issuer

has a permanent establishment and may address these instruments in future guidance.

IV. Foreign Tax Credit Limitation Under

Section 904

A. Definition of financial services entity

In order to promote simplification and

greater consistency with other Code provisions that have complementary policy ob-

1155

jectives, §1.904-4(e)(2) of the 2019 FTC

proposed regulations proposed to define a

financial services entity as an individual or

a corporation “predominantly engaged in

the active conduct of a banking, insurance,

financing, or similar business,” and proposed to define financial services income

as “income derived in the active conduct of

a banking, insurance, financing, or similar

business.” These modified definitions are

generally consistent with sections 954(h),

1297(b)(2)(B), and 953(e); the 2019 FTC

proposed regulations also included conforming changes to the rules for affiliated groups

in proposed §1.904-4(e)(2)(ii) and partnerships in proposed §1.904-4(e)(2)(i)(C).

Comments stated that the 2019 FTC

proposed regulations increased uncertainty and resulted in the disqualification of

certain banks or insurance companies that

would qualify as financial services entities

under the existing final regulations. Comments also suggested that it was inappropriate to seek to align the relevant definitions

in section 904 with those in section 954

because of the differing policies and scope

of the two rules. Comments suggested various modifications to more closely align the

revisions with the existing approach under

§1.904-4(e), or in the alternative, withdrawing the proposed rules entirely.

The Treasury Department and the IRS

have determined that revisions to the financial services entity rules in §1.9044(e) continue to be necessary in light of

statutory changes made in 2004 (under

the American Jobs Creation Act of 2004,

Pub. L. 108-357) and the changes to the

look-through rules in §1.904-5 in the 2019

FTC final regulations, which were precipitated by the revisions to section 904(d)

under the TCJA. However, the Treasury

Department and the IRS have determined

the changes to §1.904-4(e) should be reproposed to allow further opportunity for

comment. Therefore, the 2020 FTC proposed regulations contain new proposed

regulations under §1.904-4(e), as well as a

delayed applicability date. See Part IX.B.

of the Explanation of Provisions in the

2020 FTC proposed regulations.

B. Allocation and apportionment of

foreign income taxes

Proposed §1.861-20 provided detailed

guidance on how to match foreign income

November 30, 2020

taxes with income, particularly in the case

of differences in how U.S. and foreign law

compute taxable income with respect to

the same transactions. Proposed §1.86120(c) provided that foreign tax expense

is allocated and apportioned among the

statutory and residual groupings by first

assigning the items of gross income under

foreign law (“foreign gross income”) on

which a foreign tax is imposed to a grouping, then allocating and apportioning deductions under foreign law to that income,

and finally allocating and apportioning the

foreign tax among the groupings. See proposed §1.861-20(c).

Proposed §1.861-20(d)(2)(ii)(B) provided that if a taxpayer recognizes an item

of foreign gross income that is attributable

to a base difference, then the item of foreign gross income is assigned to the residual grouping, with the result that no credit

is allowed if the tax on that item is paid by

a CFC. The proposed regulations provided

an exclusive list of items that are excluded

from U.S. gross income and that, if taxable under foreign law, are treated as base

differences.

Several comments requested that distributions described in sections 301(c)

(2) and 733, representing nontaxable returns of capital, be removed from the list

of base differences on the grounds that

foreign tax on such distributions is more

likely to result from timing differences.

Some comments argued that the foreign

law characterization of the distribution

should govern the determination of the

income group to which the foreign tax is

allocated. Other comments suggested that

foreign tax on return of capital distributions should be associated with passive

category capital gains, because by reducing basis such distributions may increase

the amount of capital gain recognized for

U.S. tax purposes in the future.

The purpose of the rules in §1.86120, as well as §1.904-6, is to allocate and

apportion foreign income taxes to groupings of income determined under Federal

income tax law, and the final regulations

at §1.861-20(d)(1), consistent with the

approach in former §1.904-6, provide that

Federal income tax law applies to characterize foreign gross income and assign it

to a grouping. Characterizing items solely

based on foreign law, with no comparison to the U.S. tax base, would altogeth-

November 30, 2020

er eliminate base differences, which are

expressly referenced in section 904(d)(2)

(H)(i).

However, the Treasury Department

and the IRS have determined that in most

cases, a foreign tax imposed on distributions described in sections 301(c)(2) and

733 is likely to represent tax on earnings

and profits of the distributing entity that

are accounted for at different times under

U.S. and foreign tax law, such as earnings

of a hybrid partnership, earnings that are

accelerated and subsequently eliminated

for U.S. tax purposes by reason of a section 338 election, or earnings and profits

of lower-tier entities, rather than tax on

amounts that are permanently excluded

from the U.S. tax base. Although in some

cases involving net basis foreign income

taxes imposed at the shareholder level,

distributions described in sections 301(c)

(2) and 733 may reflect a timing difference

in the recognition of unrealized gain with

respect to the equity of the distributing entity, the Treasury Department and the IRS

have determined that these situations are

less likely to occur than timing differences in the recognition of earnings subject

to withholding taxes because of the prevalence of foreign participation exemption

regimes. Moreover, treating the foreign

tax on distributions as representing a timing difference on earnings and profits of

the distributing entity is more consistent

with the general approach in the Code and

regulations to the treatment of distributions as representing a tax on the earnings

(see, for example, sections 904(d)(3) and

(4), and 960(b)) and with treating gain on

stock sales as related in part to earnings

and profits (see section 1248(a)).

Therefore, these distributions are removed from the list of base differences,

and the final regulations at §1.861-20(d)

(3)(ii)(B)(2) generally associate a foreign

law dividend that gives rise to a return of

capital distribution under section 301(c)

(2) with hypothetical earnings of the distributing corporation, measured based on

the groupings to which the tax book value

of the corporation’s stock is assigned under the asset method in §1.861-9. Similar

rules are included in the 2020 FTC proposed regulations for partnership distributions described in section 733.

The Treasury Department and the IRS

have determined that similar rules should

1156

apply in appropriate cases to associate a

portion of foreign tax imposed on an item

of foreign gross income constituting gain

recognized on the sale or other disposition

of stock in a corporation or a partnership

interest with amounts that constitute nontaxable basis recovery for U.S. tax purposes. Such similar treatment is appropriate to minimize differences in the foreign

tax credit consequences of a sale or a distribution in redemption of the taxpayer’s

interest. Proposed rules on the allocation

of foreign income tax on such dispositions

are included in the 2020 FTC proposed

regulations.

Proposed §1.861-20 addressed the assignment to statutory and residual groupings of foreign gross income arising from

disregarded payments between a foreign

branch (as defined in §1.904-4(f)(3)) and

its owner. If the foreign gross income

item arises from a payment made by a

foreign branch to its owner, proposed

§1.861-20(d)(3)(ii)(A) generally assigned

the item by deeming the payment to be

made ratably out of the foreign branch’s

accumulated after-tax income, calculated based on the tax book value of the

branch’s assets in each grouping. If the

item of foreign gross income arises from

a disregarded payment to a foreign branch

from its owner, proposed §1.861-20(d)(3)

(ii)(B) generally assigned the item to the

residual grouping, with the result that any

taxes imposed on the disregarded payment

would be allocated and apportioned to the

residual grouping as well. In addition,

proposed §1.904-6(b)(2) included special rules assigning foreign gross income

items arising from certain disregarded

payments for purposes of applying section

904 as the operative section.

Several comments asserted that foreign tax on disregarded payments from a

foreign branch owner to a foreign branch

should not be allocated and apportioned

to the residual grouping, which results in

an effective denial of foreign tax credits

in the case of a branch of a CFC, because

items of foreign gross income that arise

from disregarded payments of items such

as interest or royalties should give rise to

creditable foreign income taxes despite

being nontaxable for Federal income tax

purposes. Some comments recommended

adopting a tracing regime similar to the

rules in §1.904-4(f) to trace foreign gross

Bulletin No. 2020–49

income that a taxpayer includes by reason

of a disregarded payment to current year

income of the payor for purposes of determining the grouping to which tax on

the disregarded payment is allocated and

apportioned. Comments also requested

that the final regulations clarify whether

the rule for remittances or contributions

applies in the case of payments between

two foreign branches.

The Treasury Department and the IRS

generally agree with the comments that

rules similar to the rules in §1.904-4(f)

should apply under §1.861-20 to trace

foreign gross income that a taxpayer includes by reason of a disregarded payment

to the current year income of the payor to

which the disregarded payment would be

allocable if regarded for U.S. tax purposes. However, in order to provide taxpayers

additional opportunity to comment, the

final regulations reserve on the allocation and apportionment of foreign tax on

disregarded payments, and new proposed

rules are contained in the 2020 FTC proposed regulations. See Part V.F.4 of the

Explanation of Provisions in the 2020

FTC proposed regulations. Similarly, the

special rules in proposed §1.904-6(b)(2)

for assigning foreign gross income items

arising from certain disregarded payments

for purposes of applying section 904 as

the operative section are reproposed in the

2020 FTC proposed regulations. The other special rules in proposed §1.861-20(d)

(3) for allocating foreign tax in connection

with a taxpayer’s investment in a corporation or a disregarded entity are reorganized, and some of the definitions in proposed §1.861-20(b) are correspondingly

revised, in the final regulations to group

the rules on the basis of how the entity

is classified, and whether the transaction

giving rise to the item of foreign gross

income results in the recognition of gross

income or loss, for U.S. tax purposes. The

rule in proposed §1.904-6(b)(3) relating to

dispositions of property resulting in certain disregarded reallocation transactions

is removed and reproposed as part of proposed §1.861-20 as contained in the 2020

FTC proposed regulations.

Finally, one comment requested that

§§1.904-1 and 1.904-6 clarify that the

tax allocation rules apply to taxes paid to

United States territories, which are generally treated as foreign countries for pur-

Bulletin No. 2020–49

poses of the foreign tax credit. The final

regulations clarify this point by including

a cross reference to §1.901-2(g), which

defines a foreign country to include the

territories. See §1.861-20(b)(6).

V. Foreign Tax Redeterminations Under

Section 905(c) and Penalty Provisions

Under Section 6689

Portions of the temporary regulations

relating to sections 905(c), 986(a), and

6689 (TD 9362) (the ‘‘2007 temporary

regulations’’) were reproposed in order to

provide taxpayers an additional opportunity to comment on those rules in light of

the changes made by the TCJA. In particular, the rules in the 2007 temporary regulations that were reproposed in the 2019

FTC proposed regulations were: (1) proposed §1.905-3(b)(2), which addressed

foreign taxes deemed paid under section

960, (2) proposed §1.905-4, which in general provided the procedural rules for how

to notify the IRS of a foreign tax redetermination, and (3) proposed §301.6689-1,

which provided rules for the penalty for

failure to notify the IRS of a foreign tax

redetermination. In addition, the 2019

FTC proposed regulations contained a

transition rule in proposed §§1.905-3(b)

(2)(iv) and 1.905-5 to address foreign tax

redeterminations of foreign corporations

that relate to taxable years that predated

the amendments made by the TCJA.

A. Adjustments to foreign taxes paid by

foreign corporations

One comment requested clarification

on whether multiple payments to foreign

tax authorities under a single assessment

(for example, payments to stop the running of interest and penalties) each result

in a foreign tax redetermination under section 905(c).

Under §1.905-3(a) of the 2019 FTC final regulations, each payment of tax that

has accrued in a later year in excess of the

amount originally accrued results in a separate foreign tax redetermination. However, the 2019 FTC proposed regulations

at §1.905-4(b)(1)(iv), which is finalized

without change, only required one amended return for each affected prior year to reflect all foreign tax redeterminations that

occur in the same taxable year. In the case

1157

of payments that are made across multiple taxable years, §1.905-4(b)(1)(iv) of

the final regulations also provides that,

if more than one foreign tax redetermination requires a redetermination of U.S.

tax liability for the same affected year and

those redeterminations occur within the

same taxable year or within two consecutive taxable years, the taxpayer may file

for the affected year one amended return

and one statement under §1.905-4(c) with

respect to all of the redeterminations. Otherwise, separate amended returns for each

affected year are required to reflect each

foreign tax redetermination. Accordingly,

no changes are made in response to this

comment.

The comment also requested that the

Treasury Department and the IRS clarify

whether contested taxes that are paid before the contest is resolved are considered

to accrue for foreign tax credit purposes

when paid or whether they represent an

advance payment against a future liability

that does not accrue until the final liability

is determined. Proposed rules addressing

this issue are included in the 2020 FTC

proposed regulations. See Part X.D.3 of

the Explanation of Provisions in the 2020

FTC proposed regulations.

B. Deductions for foreign income taxes

One comment requested clarification

on whether the general rules under section

905(c) apply to taxpayers who elect to

take a deduction, rather than a credit, for

creditable foreign taxes in the prior year

to which the adjusted taxes relate. Additionally, the comment requested that the

Treasury Department and the IRS clarify

whether the ten-year statute of limitations

under section 6511(d)(3)(A) applies to refund claims based on such deductions.

In the case of a U.S. taxpayer that directly pays or accrues foreign income

taxes, no U.S. tax redetermination is required in the case of a foreign tax redetermination of such taxes if the taxpayer

did not claim a foreign tax credit in the

taxable year to which such taxes relate.

See §1.905-3(b)(1) (a redetermination of

U.S. tax liability is required with respect

to foreign income tax claimed as a credit

under section 901). However, in the case

of a U.S. shareholder of a CFC that pays

or accrues foreign income tax, proposed

November 30, 2020

§1.905-3(b)(2)(i) and (ii), which are finalized without substantive change, provided

that a redetermination of U.S. tax liability

is required to account for the effect of a

foreign tax redetermination even in situations in which the foreign tax credit is not

changed, such as for purposes of computing earnings and profits or applying the

high-tax exception described in section

954(b)(4), including in the case of a U.S.

shareholder that chooses to deduct foreign

income taxes rather than to claim a foreign

tax credit. Additional guidance addressing

the accrual rules for creditable foreign taxes that are deducted or claimed as a credit

is included in §1.461-4(g)(6)(B)(iii) and

in the 2020 FTC proposed regulations.

The question of whether section

6511(d)(3)(A) applies to refunds relating

to foreign taxes that are deducted, instead

of taken as a foreign tax credit, is beyond

the scope of this rulemaking. See, however, Trusted Media Brands, Inc. v. United States, 899 F.3d 175 (2d. Cir. 2018)

(holding that section 6511(d)(3)(A) only

applies to refund claims based on foreign

tax credits). In addition, the 2020 FTC

proposed regulations include proposed

amendments to the regulations under section 901(a), which provides that an election to claim foreign income taxes as a

credit for a particular taxable year may

be made or changed at any time before

the expiration of the period prescribed

for claiming a refund of U.S. tax for that

year. See Part X.B.2 of the Explanation

of Provisions in the 2020 FTC proposed

regulations.

tax redetermination affects whether the

taxpayer is eligible for the GILTI hightax exclusion. Specifically, the comment

stated that because a redetermination of

U.S. tax liability is required when the foreign tax redetermination affects whether

a taxpayer is eligible for the subpart F

high-tax election under section 954(b)

(4), a similar result should apply for taxpayers that make (or seek to make) the

GILTI high-tax exclusion election, and

that taxpayers should be allowed to make

the election on an annual basis. Further,

the comment suggested that if taxpayers

are allowed to make an annual election

under the final GILTI high-tax exclusion

regulations, then taxpayers should be

permitted to make or revoke the election

on an amended return following a foreign

tax redetermination.

Proposed §1.905-3(b)(2)(ii) provided

that the required U.S. tax redetermination applies for purposes of determining

amounts excluded from a CFC’s gross

tested income under section 951A(c)(2)

(A)(i)(III), and this provision is retained in

the final regulations with minor modifications. Furthermore, under final regulations

issued on July 23, 2020 (TD 9902, 85 FR

44620), taxpayers may make the GILTI

high-tax exclusion election on an annual

basis and may do so on an amended return

filed within 24 months of the unextended

due date of the original income tax return.

See §1.951A-2(c)(7)(viii)(A)(1)(i).

C. Application to GILTI high-tax

exclusion

Proposed §1.905-3(b)(3) provided that

if at the time of a foreign tax redetermination the person with legal liability for the

tax (the ‘‘successor’’) is a different person

than the person that had legal liability for

the tax in the year to which the redetermined tax relates (the ‘‘original taxpayer’’), the required redetermination of U.S.

tax liability is made as if the foreign tax

redetermination occurred in the hands of

the original taxpayer. The proposed regulations further provided that Federal income tax principles apply to determine the

tax consequences if the successor remits,

or receives a refund of, a tax that in the

year to which the redetermined tax relates

was the legal liability of, and thus considered paid by, the original taxpayer.

Proposed §1.905-3(b)(2)(ii) provided

that the required adjustments to U.S. tax

liability by reason of a foreign tax redetermination of a foreign corporation include not only adjustments to the amount

of foreign taxes deemed paid and related

section 78 dividend, but also adjustments

to the foreign corporation’s income and

earnings and profits and the amount of the

U.S. shareholder’s inclusions under sections 951 and 951A in the year to which

the redetermined foreign tax relates.

One comment requested that final regulations clarify whether a U.S. tax redetermination is required when the foreign

November 30, 2020

D. Foreign tax redeterminations of

successor entities

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One comment suggested that proposed

§1.905-3(b)(3), as drafted, did not clearly

address cases where the ownership of a

disregarded entity changes. The comment

recommended clarifying that in the case

of a disregarded entity, the owner of the

disregarded entity is treated as the person

with legal liability for the tax or the person

with the legal right to a refund, as applicable.

The Treasury Department and the IRS

have determined that no clarification is

necessary. Existing regulations make clear

that the owner of a disregarded entity is

considered to be legally liable for the tax.

See §1.901-2(f)(4)(ii) (legal liability for

income taxes imposed on a disregarded

entity).

The same comment stated that the preamble to the proposed regulations incorrectly suggested that under U.S. tax principles the payment of tax by a successor

entity owned by the original taxpayer (for

example, by a CFC that was formerly a

disregarded entity) is treated as a distribution. The comment further recommended

addressing the issue of contingent liabilities in future guidance. The Treasury Department and the IRS agree that there may

be multiple ways to characterize the tax

consequences of tax paid by a successor

in the example described in the preamble

to the proposed regulations. Furthermore,

the Treasury Department and the IRS have

determined that the issue of contingent

foreign tax liabilities in connection with

foreign tax redeterminations under section

905(c) requires further study and may be

considered as part of future guidance.

E. Notification to the IRS of foreign tax

redeterminations and related penalty

provisions

1. Notification Through Amended

Returns

In general, proposed §1.905-4(b)(1)

(i) provided that any taxpayer for which a

redetermination of U.S. tax liability is required must notify the IRS of the foreign

tax redetermination by filing an amended

return.

Several comments suggested that taxpayers should be allowed to report adjustments to U.S. tax liability in prior years by

reason of foreign tax redeterminations on

Bulletin No. 2020–49

an attachment to their Federal income tax

return for the taxable year in which the redetermination occurs, instead of requiring

taxpayers to file amended tax returns for

the taxable year in which the adjusted foreign tax was claimed as a credit and any

intervening years in which the foreign tax

redetermination affected U.S. tax liability. Specifically, comments suggested that

taxpayers could be allowed to file a statement with their return for the taxable year

in which the foreign tax redetermination

occurs notifying the IRS of overpayments

or underpayments of U.S. tax and applicable interest due for prior taxable years

that resulted from the foreign tax redetermination. One comment suggested that

taxpayers could be required to maintain

books and records reflecting all the adjustments that would normally accompany an

amended return, without actually being

required to prepare and file such a return.

Another comment suggested that the IRS

could amend Schedule E on Form 5471 to

include this type of information about the

changes to prior year U.S. tax liabilities

that result from foreign tax redeterminations. Comments noted that providing an

alternative to filing amended Federal income tax returns would relieve taxpayers

from having to file amended state tax returns.

The Treasury Department and the IRS

have determined that, based on existing processes, the only manner in which

taxpayers can properly notify the IRS of

a change in U.S. tax liability for a prior

taxable year that results from a foreign

tax redetermination is by filing an amended return reflecting all the necessary U.S.

tax adjustments. In addition, the Treasury

Department and the IRS have determined

that the type of statement suggested by

the comments, reflecting a recomputation

of Federal income tax liability for a prior year, could be viewed by state tax authorities as the functional equivalent of an

amended Federal income tax return that

may not necessarily operate to relieve taxpayers of their obligations to file amended

state tax returns. In any event, taxpayer

requests for relief from state tax filing obligations are properly directed to state tax

authorities, rather than to the Treasury Department and the IRS. Therefore, the comments are not adopted. However, the Treasury Department and the IRS continue to

Bulletin No. 2020–49

study whether new processes or forms can

be developed to streamline the filing requirements while ensuring that the IRS receives the necessary information to verify

that taxpayers have made the required adjustments to their U.S. tax liability. Under

§1.905-4(b)(3) of the final regulations, the

IRS may prescribe alternative notification

requirements through forms, instructions,

publications, or other guidance.

Comments also suggested that the notification due date should be extended (for

example, to up to three years from the due

date of the original return for the taxable

year in which the foreign tax redetermination occurred).

The Treasury Department and the IRS

have determined that deferring the due

date of the required amended returns beyond the due date (with extensions) of

the return for the year in which the foreign tax redetermination occurs would not

substantially reduce compliance burdens

and could be more difficult for the IRS to

administer, because the same filing obligations would be required, though with respect to foreign tax redeterminations that

occurred three years earlier rather than

in the current taxable year. In addition,

taxpayers have an economic incentive to

promptly file amended returns claiming a

refund of U.S. tax in cases where a foreign tax redetermination reduces, rather than increases, U.S. tax liability; the

Treasury Department and the IRS have

determined that it is appropriate to require

comparable promptness when a foreign

tax redetermination increases U.S. tax due

in order to permit timely verification of

the required U.S. tax adjustments when

the relevant documentation and personnel

are more readily available. Accordingly,

the comments are not adopted. However,

a transition rule is added at §1.905-4(b)

(6) to give taxpayers an additional year to

file required notifications with respect to

foreign tax redeterminations occurring in

taxable years ending on or after December

16, 2019, and before November 12, 2020.

Comments also requested that the final

regulations provide that for foreign tax

redeterminations below a certain de minimis threshold (for example, 10 percent

of foreign taxes as originally accrued, or

$5 million), taxpayers should be allowed

to account for the foreign tax redeterminations by making adjustments to current

1159

year taxes and foreign tax credits claimed

in the taxable year in which the foreign tax

redetermination occurs, rather than by adjusting U.S. tax liability in the prior year

or years in which the adjusted foreign taxes were claimed as a credit. Alternatively,

some comments requested that for foreign

tax redeterminations below a de minimis

or materiality threshold, taxpayers should

be completely relieved of adjusting U.S.

tax liability and from all notification and

amended return requirements.

The Treasury Department and the IRS

have determined that, as amended by the

TCJA, section 905(c) mandates retroactive adjustments to U.S. tax liability when

foreign taxes claimed as credits are redetermined. The TCJA repealed section 902

and the regulatory authority at the end of

section 905(c)(1) to prescribe alternative

adjustments to multi-year pools of earnings and taxes of foreign corporations in

lieu of the required adjustments to U.S.

tax liability for the affected years. Recharacterizing prior year taxes as current

year taxes would have substantive effects

on the amounts of a taxpayer’s GILTI and

subpart F inclusions, the applicable carryover periods for excess credits, the applicable currency translation conventions,

the amounts of interest owed by or due to

the taxpayer, and the applicable statutes

of limitation for refund or assessment.

Therefore, the comments are not adopted.

Finally, a comment requested that

§1.905-4(b)(1)(ii) be amended to allow a

taxpayer that avails itself of special procedures under Revenue Procedure 94-69 to

notify the IRS of a foreign tax redetermination when the taxpayer makes a Revenue Procedure 94-69 disclosure during an

audit for the taxable year for which U.S.

tax liability is increased by reason of the

foreign tax redetermination.

In relevant part, Revenue Procedure

94-69 provides special procedures for a

taxpayer in the Large Corporate Compliance program (formerly the Coordinated

Examination Program or Coordinated

Industry Case program) to avoid the potential application of the accuracy-related penalty currently described in section

6662. Under Revenue Procedure 94-69, a

taxpayer may file a written statement that

is treated as a qualified amended return

within 15 days after the IRS requests it.

However, Revenue Procedure 94-69 does

November 30, 2020

not provide any protection for penalties

under section 6689 for failure to file a notice of a foreign tax redetermination, and

it requires a statement that is less detailed

than the notification statement required

under §1.905-4(b)(1)(ii). Further, section

905(c) contemplates that the burden is on

the taxpayer to notify the IRS of a foreign

tax redetermination, whereas Revenue

Procedure 94-69 places the burden on the

IRS to request information. Finally, the

notification requirement under §1.9054(b)(1)(ii) affords a taxpayer more time to

satisfy its reporting obligation as opposed

to the 15-day notification requirement in

Revenue Procedure 94-69. Therefore, the

comment is not adopted.

2. Foreign Tax Redeterminations of Passthrough Entities

Proposed §1.905-4(b)(2) generally

provided that a pass-through entity that

reports creditable foreign income tax to its

partners, shareholders, or beneficiaries is

required to notify the IRS and its partners,

shareholders, or beneficiaries if there is a

foreign tax redetermination with respect

to such foreign income tax. See proposed

§1.905-4(c) for the information required

to be provided with the notification. Additionally, proposed §1.905-4(b)(2)(ii)

provided that if a redetermination of U.S.

tax liability would require a partnership

adjustment as defined in §301.6241-1(a)

(6), the partnership must file an administrative adjustment request (“AAR”) under

section 6227 without regard to the time

restrictions on filing an AAR in section

6227(c). See also §1.6227-1(g).

One comment suggested that S corporations should be allowed to follow similar notification procedures as partnerships

that are subject to sections 6221 through

6241 (enacted in §1101 of the Bipartisan Budget Act of 2015, Pub. L. 114-74

(‘‘BBA’’) and as amended by the Protecting Americans from Tax Hikes Act of

2015, Pub. L. 114-113, div Q, and by sections 201 through 207 of the Tax Technical Corrections Act of 2018, contained in

Title II of Division U of the Consolidated

Appropriations Act of 2018, Pub. L. 115141).

By their terms, the BBA rules only apply to partnerships and not S corporations,

except in the limited circumstance in which

November 30, 2020

an S corporation is a partner in a partnership subject to the BBA rules. See sections

6226(b)(4) and 6227(b). But in cases where

the S corporation is not a partner in a BBA

partnership that made the election, there is

no provision under BBA or any other provision of the Code to allow the S corporation

to pay the imputed underpayment on behalf of its shareholders. Because the statute

does not generally allow for S corporations

to pay imputed underpayments on behalf

of its shareholders, the approach suggested

by the comment is not viable and therefore

the comment is not adopted. However, as

described in Part V.E.1 of this Summary of

Comments and Explanation of Revisions,

the Treasury Department and the IRS continue to study whether new processes or

forms can be developed to streamline the

amended return requirements, including in

the case of S corporations that report foreign tax redeterminations to their shareholders.

3. Foreign Tax Redeterminations of

LB&I Taxpayers

Proposed §1.905-4(b)(4) provided a

limited alternative notification requirement for U.S. taxpayers that are under the

jurisdiction of the IRS’s Large Business &

International (“LB&I”) Division. Under

proposed §1.905-4(b)(4)(i)(B), the alternative notification requirement is available only if certain conditions are met,

including that an amended return reflecting a foreign tax redetermination would

otherwise be due while the return for the

affected taxable year is under examination, and that the foreign tax redetermination results in a downward adjustment to

the amount of foreign tax paid or accrued,

or included in the computation of foreign

taxes deemed paid.

Several comments suggested broadening the scope of proposed §1.905-4(b)(4)

to include upward adjustments to foreign

taxes paid or accrued. The comments also

recommended that the special notification

rules apply when multiple foreign tax redeterminations involving different foreign

jurisdictions occur in the same taxable

year and result in offsetting adjustments,

for example, if there is an additional payment of foreign tax in one jurisdiction and

a refund of a comparable amount in another jurisdiction.

1160

The proposed regulations limited the

alternative notification requirement to cases where the foreign tax redetermination

results in a downward adjustment to the

amount of foreign taxes paid or accrued

because failure to comply with the notification requirements exposes taxpayers

to penalties under section 6689 only if the

foreign tax redetermination results in an

underpayment of U.S. tax. As provided in

§1.905-4(b)(1)(iii), if a foreign tax redetermination results in an overpayment of

U.S. tax, in order to claim a refund of U.S.

tax the taxpayer must file an amended return within the period specified in section

6511. See section 6511(d)(3)(A), providing a special 10-year period of limitations

for refund claims based on foreign tax

credits. However, in unusual circumstances, an increase in foreign tax liability for a

prior year may result in an underpayment

(rather than an overpayment) of U.S. tax

(for example, if an increase in foreign income tax liability causes a CFC to have a

tested loss or to qualify for the high-tax

exclusion of section 954(b)(4), reducing the amount of foreign taxes deemed

paid). In addition, in some cases the complexity of the required computations may

make it difficult for taxpayers to identify

easily which particular foreign tax redeterminations will ultimately result in an

underpayment of U.S. tax. Accordingly,

the final regulations extend the alternative notification procedures to cover the

case of any adjustment (whether upward

or downward) of foreign taxes by reason

of a foreign tax redetermination that increases U.S. tax liability, and so would

otherwise require the filing of an amended return while the affected year of the

LB&I taxpayer is under examination. In

addition, the final regulations provide that

an LB&I taxpayer that has a foreign tax

redetermination that decreases U.S. tax

liability for an affected year that is under

examination may (but is not required to)

notify the examiner of the adjustment in

lieu of filing an amended return to claim a

refund (within the time period provided in

section 6511). However, because section

6511(d)(3) generally allows taxpayers 10

years to seek a U.S. tax refund attributable

to foreign tax credits and the regulations

do not preclude taxpayers from filing such

an amended return before the audit of an

affected year is completed, the IRS may

Bulletin No. 2020–49

either accept the alternative notification

or require the taxpayer to file an amended return. The additional flexibility added

to the final regulations will assure timely notification of, and penalty protection

for taxpayers with respect to, all foreign

tax redeterminations that may increase or

decrease U.S. tax liability for an affected

taxable year, including in the case of offsetting foreign tax redeterminations that

occur in the same taxable year.

Finally, comments recommended that

examiners should be granted authority to

accept notifications of foreign tax redeterminations outside the periods specified in

§1.905-4(b)(4)(ii)(A) through (C) and for

affected taxable years that are not currently under examination. For example, the

comments suggested that the notification

deadline for an LB&I taxpayer should be

extended upon the taxpayer’s request and

at the examiner’s discretion.

The Treasury Department and the IRS

have determined that amended returns reflecting additional U.S. tax due should be

timely filed in order to ensure examiners

have sufficient time to take into account any

redetermination of U.S. tax liability without

prolonging the audit. In addition, the special notification rules are not extended to

taxpayers that are not currently under examination. The alternative notification rules

in §1.905-4(b)(4) are predicated on the fact

that the examiner is in the process of determining whether to propose adjustments to

the items included on the taxpayer’s return

for the taxable year under examination, and

it is appropriate to defer the requirement

to file an amended return reflecting the effect of a foreign tax redetermination on the

taxpayer’s U.S. tax liability for that taxable

year until the examination has concluded.

These considerations do not apply to affected taxable years that are not currently under examination when an amended return

would otherwise be due. Accordingly, these

comments are not adopted.

F. Transition rule relating to the TCJA

Proposed §§1.905-3(b)(2)(iv) and

1.905-5 provided a transition rule providing that post-2017 redeterminations

of pre-2018 foreign income taxes of foreign corporations must be accounted for

by adjusting the foreign corporation’s

taxable income and earnings and profits,

Bulletin No. 2020–49

post-1986 undistributed earnings, and

post-1986 foreign income taxes (or pre1987 accumulated profits and pre-1987

foreign income taxes, as applicable) in the

pre-2018 year to which the redetermined

foreign taxes relate.

The preamble to the 2019 FTC proposed regulations requested comments

on whether an alternative adjustment to

account for post-2017 foreign tax redeterminations with respect to pre-2018 taxable years of foreign corporations, such

as an adjustment to the foreign corporation’s taxable income and earnings and

profits, post-1986 undistributed earnings,

and post-1986 foreign income taxes as of

the foreign corporation’s last taxable year

beginning before January 1, 2018, may

provide for a simplified and reasonably

accurate alternative.

Several comments supported this suggestion. A comment further noted that

certain taxpayers should be excluded from

any alternative rule where it would be distortive. For example, the comment suggested excluding taxpayers that distributed

material amounts of earnings and profits,

as well as taxpayers who took advantage of

the subpart F high-tax exception in the foreign corporation’s final pre-TCJA taxable

year. Another comment noted that taxpayers should be allowed to adjust the foreign

corporation’s final pre-2018 year only if the

adjustments would not cause a deficit in the

foreign corporation’s tax pool in that final

year. A comment also suggested that the alternative rule should provide that in case of

foreign corporations that ceased to be subject to the pooling regime before 2018 (for

example, due to a liquidation or sale to a

foreign acquiror), the required adjustments

should be made in the foreign corporation’s

last year in which the pooling rules are relevant). Additionally, several comments

suggested that foreign tax redeterminations

of foreign corporations below a certain

threshold should not require a redetermination or adjustment of a taxpayer’s section

965(a) inclusion or the amount of foreign

taxes deemed paid with respect to such section 965(a) inclusion. Instead, some comments suggested that the redetermination

be taken into account in the post-2017 year

of the redetermination.

In response to comments, the final

regulations under §1.905-5(e) provide an

irrevocable election for a foreign corpora-

1161

tion’s controlling domestic shareholders

to account for all foreign tax redeterminations that occur in taxable years ending on

or after November 2, 2020, with respect to

pre-2018 taxable years of foreign corporations as if they occurred in the foreign

corporation’s last taxable year beginning

before January 1, 2018 (the “last pooling year”). The rules in §§1.905-3T and

1.905-5T (as contained in 26 CFR part 1

revised as of April 1, 2019) will apply for

purposes of determining whether a particular foreign tax redetermination must instead be accounted for in the year to which

the redetermined foreign tax relates, instead of in the last pooling year. The election is made by the foreign corporation’s

controlling domestic shareholders, and is

binding on all persons who are, or were in

a prior year to which the election applies,

U.S. shareholders of the foreign corporation with respect to which the election is

made for all of its subsequent foreign tax

redeterminations, as well as foreign tax

redeterminations of other members of the

same CFC group as the foreign corporation for which the election is made. For

this purpose, the definition of a CFC group

in

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