Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), and Consolidated Groups

Federal RegisterDec 17, 2019

Ask Donna

What actually matters in this document.

Text

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1 and 301

[REG-105495-19]

RIN 1545-BP21

Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Financial Services Income, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965(g), and Consolidated Groups

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

This document contains proposed 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, and the application of the foreign tax credit limitation to consolidated groups.

DATES:

Written or electronic comments and requests for a public hearing must be received by February 18, 2020.

ADDRESSES:

Send electronic submissions via the Federal eRulemaking Portal at

www.regulations.gov

(indicate IRS and REG-105495-19) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of the Treasury (the “Treasury Department”) and the IRS will publish for public availability any comment received to its public docket, whether submitted electronically or in hard copy. Send hard copy submissions to: CC:PA:LPD:PR (REG-105495-19), Room 5203, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-105495-19), Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW, Washington, DC 20224.

FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations under §§ 1.861-8, 1.861-9(b), 1.861-12, 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) 317-4916; concerning §§ 1.861-20, 1.904-6, 1.960-1, and 1.960-7, Suzanne M. Walsh, (202) 317-4908; concerning §§ 1.904-4(c), 1.905-3, 1.905-4, 1.905-5, 1.954-1, 301.6227-1, and 301.6689-1, Larry R. Pounders, (202) 317-5465; concerning §§ 1.965-5 and 1.965-9, Karen J. Cate, (202) 317-4667; concerning submissions of comments and requests for a public hearing, Regina Johnson, (202) 317-6901 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

On December 7, 2018, 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”). Those 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. The preamble to those proposed regulations requested comments on how to modify the existing approaches for allocating and apportioning deductions, including in particular the rules under § 1.861-17 for allocating and apportioning research and experimentation (“R&E”) expenditures. The 2018 FTC proposed regulations are finalized in the Rules and Regulations section of this issue of the

Federal Register

(the “2019 FTC final regulations”).

On June 25, 2012, the

Federal Register

published a notice of proposed rulemaking at 77 FR 37837 (the “2012 OFL proposed regulations”) proposing rules for the coordination of the rules for determining high-taxed passive income with required adjustments to the foreign tax credit limitation in respect of capital gains and the allocation and recapture of overall foreign losses and overall domestic losses, as well as the coordination of the recapture of overall foreign losses on certain dispositions of property and other rules concerning overall foreign losses and overall domestic losses. The 2012 OFL proposed regulations are finalized in the 2019 FTC final regulations.

On November 7, 2007, the

Federal Register

published temporary regulations (T.D. 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. Portions of these temporary regulations are finalized in the 2019 FTC final regulations.

This document contains proposed regulations (the “proposed regulations”) addressing the following issues: (1) The allocation and apportionment of deductions under sections 861 through 865, including new rules on the allocation and apportionment of R&E expenditures and certain deductions of life insurance companies; (2) the definition of financial services income under section 904(d)(2)(D); (3) the allocation and apportionment of creditable foreign taxes; (4) the interaction of the branch loss and dual consolidated loss recapture rules with sections 904(f) and (g); (5) the effect of foreign tax redeterminations of foreign corporations on the application of the high-tax exception described in section 954(b)(4) (including 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 and related penalty provisions; (6) the definition of foreign personal holding company income under section 954; (7) the application of the foreign tax credit disallowance under section 965(g); and (8) the application of the foreign tax credit limitation to consolidated groups.

Explanation of Provisions

I. 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, and Interest Expense

1. Stewardship Expenses

Under § 1.861-8(e)(4)(i), stewardship expenses are definitely related and allocable to dividends received or to be received from related corporations. This reflects a determination that stewardship expenses are, at least in part, intended to protect the shareholder's capital investment and thus are factually related to the income that arises from the investment. Before the enactment of the TCJA, taxpayers with foreign subsidiaries often included in their income foreign source income only when that income was distributed to the taxpayer. However, as a result of the enactment of sections 951A and 245A, a significant portion of the foreign source income of foreign subsidiaries is included in income on a current basis or not at all. The Treasury Department and the IRS are aware that some taxpayers may be interpreting the “dividends received, or to be received” phrase in § 1.861-8(e)(4)(ii) to exclude the gross up amount treated as a dividend under section 78 (the “section

78 dividend”), as well as inclusions under section 951(a)(1), section 951A, and similar provisions, even though the stewardship expenses may be factually related to such gross income.

With respect to the allocation of stewardship expenses, income arising because of one's capital investment in a foreign corporation's stock ordinarily includes not only dividends, but also inclusions under sections 951 and 951A, as well as amounts included under sections 1291, 1293, and 1296 (the “passive foreign investment company provisions”). Therefore, the proposed regulations provide that stewardship expenses are allocated to dividends and inclusions received or accrued, or to be received or accrued, from related corporations.

Thus, stewardship expenses are also allocated to inclusions under sections 951 and 951A, section 78 dividends, and all amounts included under the passive foreign investment company provisions.

Duplicative activities or shareholder activities giving rise to stewardship expenses can only be performed with respect to members of a controlled group as described in § 1.482-9(l)(3)(iii)-(iv). Accordingly, relatedness in the context of stewardship expenses includes taxpayers that are members of the same controlled group as defined in § 1.482-1(i)(6). A taxpayer could incur stewardship expenses with respect to a related foreign corporation that is a passive foreign investment company (in addition to a related foreign corporation that is a controlled foreign corporation).

With respect to apportionment, the current regulations do not provide an explicit rule but instead provide examples of permissible methods. The Treasury Department and the IRS have determined that an explicit rule would provide certainty for taxpayers and the IRS on the appropriate methodology for apportioning stewardship expenses while ensuring that stewardship expenses are apportioned to gross income in a manner that reflects the purpose of the expenses to protect capital investments or to facilitate compliance with reporting, legal, or regulatory requirements. Therefore, the proposed regulations provide that stewardship expenses are apportioned based upon the relative values of a taxpayer's stock assets, as determined and characterized under § 1.861-9T(g) (and, as relevant, §§ 1.861-12 and 1.861-13) for purposes of allocating and apportioning the taxpayer's interest expense. Therefore, a taxpayer will be required to use the same method to characterize and value its stock assets for purposes of allocating and apportioning its interest and stewardship expenses, and, in some cases as described in Part 1.A.2 of this Explanation of Provisions, certain damages payments. Accordingly, since the fair market value method may not be used for interest allocation and apportionment, it may also not be used for stewardship and certain damages payments. Conforming changes are also proposed with respect to § 1.861-14T(e)(4), which provides rules for the treatment of stewardship expenses with respect to an affiliated group. See also § 1.861-8(g)(18) (

Example 18

) for an example illustrating the application of the proposed rules for stewardship expenses.

The Treasury Department and the IRS are aware that stewardship expenses that are incurred to facilitate compliance with reporting, legal, or regulatory requirements may be more appropriately treated as definitely related to the gross income produced by the particular asset, or assets, whose ownership required the stewardship expenditure. For example, the owner of an entity in a particular jurisdiction might have unique reporting requirements not triggered by the ownership of a similar entity in a different jurisdiction. The Treasury Department and the IRS request comments regarding exceptions to the general rule for the allocation and apportionment of stewardship expenses where it is more appropriate to treat stewardship expenses as definitely related to a more limited class of gross income. Comments are also requested on whether it is more appropriate in certain cases to allocate and apportion stewardship expenses on a separate entity, rather than an affiliated group, basis.

The proposed regulations maintain the definition of stewardship expenses as a duplicative activity (as defined in § 1.482-9(l)(3)(iii)) or a shareholder activity (as defined in § 1.482-9(l)(3)(iv)).

See

proposed § 1.861-8(e)(4)(ii)(A). In particular, shareholder activities are those that preserve the shareholder's capital investment or facilitate compliance with reporting, regulatory, or legal requirements.

See

§ 1.482-9(l)(3)(iv). However, the Treasury Department and the IRS are aware that it may be difficult for taxpayers to distinguish between stewardship expenses that result from oversight functions and expenses that are supportive in nature, as described in § 1.861-8(b)(3), and are concerned that expenses may be misclassified as either stewardship or supportive expenses in certain cases. For example, day-to-day management activities do not give rise to stewardship expenses and are typically more supportive in nature. However, the distinction between day-to-day management and oversight may change over time as a taxpayer's investments change. Given these concerns, the Treasury Department and the IRS request comments regarding the definition of stewardship expenses and how to readily distinguish such expenses from supportive expenses that are allocated and apportioned under § 1.861-8(b)(3).

The proposed regulations extend the treatment of stewardship expenses to cover expenses incurred with respect to a partnership.

See

proposed § 1.861-8(e)(4)(ii)(D). Rules similar to those with respect to corporations apply to allocate and apportion stewardship expenses incurred with respect to partnerships.

Finally, the Treasury Department and the IRS are considering whether additional changes to the rules for allocating and apportioning stewardship and similar expenses are appropriate in light of the enactment of the TCJA, and in order to better reflect modern business practices that are increasingly global and mobile in nature. Comments are requested on this topic.

2. Litigation Damages Awards, Prejudgment Interest, and Settlement Payments

The current rule for the allocation and apportionment of legal and accounting fees and expenses in § 1.861-8(e)(5) does not specifically address damages awards, prejudgment interest, or settlement payments arising from product liability and similar claims. The Treasury Department and the IRS are aware that large, unplanned, and relatively rare expenses can have a significant effect on the calculation of a taxpayer's taxable income and foreign tax credit limitation, and, in the absence of clear rules, disputes have arisen regarding the proper treatment of such expenses. Proposed § 1.861-8(e)(5) provides that deductions for damages awards, prejudgment interest, and settlement payments arising from product liability and similar or related claims are allocated to the class or classes of gross income produced by the specific sales of products or services that gave rise to the claims for damage or injury. Damages, prejudgment interest, and settlement payments related to events incident to the production of goods or provision of services, such as damages for injuries caused by industrial accidents, are allocated to the class of gross income produced by the assets involved in the event and, if necessary, apportioned between groupings based on the relative value of the assets in such groupings. In the case of claims made by investors that arise from corporate negligence, fraud, or other malfeasance, the

proposed regulations provide that damages, prejudgment interest, and settlement payments paid by the corporation are allocated and apportioned based on the value of all the corporation's assets. In general, the deductions are allocated and apportioned to the statutory or residual groupings to which the related income would be assigned if recognized in the taxable year in which the deductions are allowed.

3. Net Operating Loss Deductions

Under current rules, a net operating loss deduction is allocated and apportioned in the same manner as the deductions giving rise to the net operating loss deduction. However, the rule does not specify how the statutory and residual grouping components of a net operating loss are determined.

See

§ 1.861-8(e)(8). The proposed regulations provide that a net operating loss is assigned to the statutory and residual groupings by reference to the losses in each statutory or residual grouping (determined without regard to adjustments made under section 904(b)) that are not allocated to reduce income in a different grouping in the taxable year of the loss.

See

proposed § 1.861-8(e)(8)(i). Furthermore, the proposed regulations clarify that a net operating loss deduction for a taxable year is allocated and apportioned by reference to the statutory and residual grouping components of the net operating loss that is deducted in the taxable year.

See

proposed § 1.861-8(e)(8)(ii). Finally, the proposed regulations provide that except as provided in regulations, for example, in § 1.904(g)-3, a partial net operating loss deduction is treated as ratably comprising the components of the net operating loss.

See

id.

A partial net operating loss deduction occurs when the full net operating loss is not deductible in the carryover year.

In connection with the proposed regulations under section 250, comments requested clarification on the application of § 1.861-8(e)(8) with respect to net operating losses arising prior to the enactment of the TCJA when the net operating loss is deducted in a post-TCJA year for purposes of applying section 250 as the operative section.

See

84 FR 8188 (March 6, 2019). These comments will be addressed as part of finalizing those proposed regulations.

4. Application of the Exempt Income/Asset Rule to Insurance Companies in Connection With Certain Dividends and Tax-Exempt Interest

As explained in Part II.B.2 of the Summary of Comments and Explanation of Revisions to the 2019 FTC final regulations, one comment to the 2018 FTC proposed regulations suggested that insurance companies reduce exempt income and assets to reflect prorated amounts of dividends and tax exempt interest.

See

sections 805(a)(4), 807, 812, and 832(b)(5)(B). The 2019 FTC final regulations do not address this issue, and the proposed regulations do not adopt this comment.

Under subchapter L, a nonlife insurance company includes in income its underwriting income, which consists of premiums earned on insurance contracts during the taxable year less losses incurred and expenses incurred. The proration rules reduce the company's losses incurred by the “applicable percentage” of tax exempt interest or deductible dividends received.

See

section 832(b)(5)(B). For a life insurance company, the proration rules apply in the case of tax exempt interest by reducing the closing balance of reserve items by the “policyholder's share” (currently a fixed percentage, originally intended to be the portion of tax favored investment income used to fund the company's obligations to policyholders) of tax exempt interest.

See

sections 807(b)(1)(B) and 812. Similarly, a life insurance company is allowed a dividends received deduction (DRD) for intercorporate dividends from non-affiliates only in proportion to the “company's share” of the dividends, but not for the policyholder's share.

See

section 805(a)(4)(A). Fully deductible dividends from affiliates are excluded from proration for life insurance companies if the dividends are not themselves distributions from tax exempt interest or from dividend income that would not be fully deductible if received directly by the taxpayer.

While the mechanics of the proration rules differ depending on whether a company is a life or nonlife insurance company and whether the amount relates to dividends or tax exempt interest, the purpose of those provisions is the same. That is, the policyholder's share or applicable percentage of dividends and tax exempt interest should not create a double benefit by reason of a DRD or section 103 tax exemption for interest in the first instance and a reduction to income (via increases in unpaid losses and reserves during the taxable year) in the second. Regardless of the mechanics, however, the policyholder's share and applicable percentage adjustments do not change the fact that tax exempt interest and (for a nonlife insurance company) the applicable percentage of dividends eligible for DRDs remain exempt from U.S. tax. Including those exempt amounts and the corresponding exempt assets in the apportionment formula in allocating expenses under § 1.861-8T(d)(2)(i)(B), as the comment suggests, would effectively apportion reserve deductions (which already do not include the disallowed deductions deemed to be attributable to the exempt income, except in the case of the policyholder's share of life insurance DRDs) to exempt U.S. source income, with the result that those deductions would reduce unrelated U.S. source income, in contravention of the rule in § 1.861-8T(d)(2)(i)(B).

See also

Part I.E.1 of this Explanation of Provisions (noting that comments were received in connection with proposed regulations under section 250 and that further changes will be considered as part of addressing comments in finalizing those regulations).

3. Sales Made by Other Entities

The sales method for apportioning R&E expenditures provides that gross receipts from sales of products or provision of services within a relevant SIC code category by controlled parties of the taxpayer are taken into account in apportioning the taxpayer's R&E expenditures if the controlled party is reasonably expected to benefit from the taxpayer's research and experimentation. Under § 1.861-17(c)(3)(iv), the sales of controlled parties that enter a valid cost sharing arrangement (“CSA”) with a taxpayer are excluded from the apportionment formula because the controlled party is not expected to benefit from the taxpayer's remaining R&E expenditures.

Proposed § 1.861-17 clarifies the treatment of CSAs in two respects. First, consistent with § 1.482-7, the taxpayer's R&E expenditures allocated and apportioned under § 1.861-17 do not include any amounts that are not deductible by reason of the second sentence under § 1.482-7(j)(3)(i) (relating to cost sharing transaction payments from a controlled party). Second, the proposed regulations clarify that the exclusion of the controlled party's gross receipts applies only for purposes of apportioning those R&E expenditures that are intangible development costs with respect to the CSA. If a taxpayer who enters a CSA also incurs R&E expenditures that are not intangible development costs with respect to the CSA, then those expenses would be apportioned under the generally applicable rules, including the rules concerning controlled party sales.

See

proposed § 1.861-17(d)(4)(v).

One comment suggested that § 1.861-17 be modified to provide that a taxpayer's R&E expenditures that are funded by a foreign affiliate under a contract research arrangement should be directly allocated to the taxpayer's income from such arrangements. The terms of the contract research arrangement are not clear from the comment, and it is unclear whether the described expenditures that are reimbursed by a foreign affiliate are paid or incurred by the taxpayer to develop or improve a product in connection with the taxpayer's trade or business.

See

§§ 1.174-1 and 1.174-2. If the expenditures are not paid or incurred by the taxpayer to develop or improve a product in connection with its trade or business, the taxpayer may not deduct them under section 174. As a result, § 1.861-17 would not apply to these expenditures. The expenditures would instead be allocated and apportioned under the general rules in § 1.861-8 on the basis of the factual relationship of deductions to gross income.

See

§ 1.861-8(a)(2). The Treasury Department and the IRS request comments on whether contract research arrangements involving expenditures reimbursed by a foreign affiliate are generally paid or incurred by the taxpayer in connection with its trade or business such that a deduction under section 174 is allowable, and whether a special rule for such expenditures should be considered.

Another comment suggested a special rule for “licensor models” whereby CFCs pay royalties to compensate for a taxpayer's R&E expenditures. The comment suggested that in order to avoid allocation and apportionment of R&E expenditures to the section 951A category, the activities of the licensee CFC should be excluded for purposes of apportioning the licensor's R&E

expenditures and should be treated similarly to cost sharing arrangements. The comment suggested in the alternative that if the CFC sales are not excluded entirely, that R&E expenditures should be netted against the royalty income to which the R&E expenditures are apportioned.

The Treasury Department and the IRS agree that R&E expenditures should be allocated and apportioned solely with respect to the gross intangible income of the taxpayer rather than the net income of a licensee, and therefore not allocated and apportioned to the section 951A category.

See

Part I.D.1 of this Explanation of Provisions. Unlike in the case of a CSA, however, a licensor earns royalties or other forms of gross intangible income from the use of its intangible property, and it would not be appropriate to exclude such royalties in allocating R&E expenditures of the licensor. The proposed regulations require the use of the sales method, which would effectively attribute R&E expenditures to the taxpayer's royalty income based on the proportion of the gross receipts of the licensees over the total gross receipts of the taxpayer and its licensees. This approach is preferable to the comment's alternative recommendation of netting R&E expenditures against the amount of royalties because taxpayers may earn different types of gross intangible income (for example, from sales of property as well as royalties) and comparing such amounts could lead to distortive results.

Finally, under § 1.861-17(c)(3)(ii) and (f)(3), sales made by controlled corporations and partnerships taken into account to apportion R&E expenditures are reduced to reflect the taxpayer's percentage ownership of such entities. This reduction is inappropriate because the taxpayer's gross intangible income is not dependent on its percentage ownership of the entity to which it transfers intangible property. The proposed regulations, therefore, eliminate the rule reducing sales of controlled corporations that are taken into account and include partnership sales to the same extent as those made by controlled corporations.

F. Application of Section 904(b) to Net Operating Losses

The 2018 FTC proposed regulations included a rule in § 1.904(b)-3(d) coordinating the application of section 904(b)(4) with sections 904(f) and 904(g), which apply after section 904(b)(4). This rule is finalized substantially as proposed in the 2019 FTC final regulations. However, the 2018 FTC proposed regulations did not coordinate any of the adjustments required under section 904(b) with the net operating loss provisions. Therefore, the proposed regulations include a coordination rule. Under proposed § 1.904(b)-3(d)(2), 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). The Treasury Department and the IRS have determined this rule is appropriate because the amount of the net operating loss eligible to be carried to another year under section 172 is not affected by the adjustments required by section 904(b).

II. Foreign Tax Credit Limitation Under Section 904

A. Definition of Financial Services Entity

Section 904(d)(2)(D) provides that financial services income can only be received by a person “predominantly engaged in the active conduct of a banking, insurance, financing, or similar business.” Under current law, the principal significance of this provision is that under section 904(d)(2)(C), passive income of such a person is not assigned to the passive category. The preamble to the 2018 FTC proposed regulations noted that the Treasury Department and the IRS were considering modifications to the gross income-based test for determining financial services entity (“FSE”) status and requested comments in this regard. One comment was received requesting that any future modifications not affect the classification of income derived by a substantial (and genuinely active) financial services group. The Treasury Department and IRS agree that a substantial and genuinely active financial services group should be included in the definition of an FSE.

However, numerous places in the Code use similar concepts and, at times, the same terms, but provide different definitions (even when largely overlapping in application). The Treasury Department and IRS have determined that interpretive guidance should be simplified and made consistent where possible and appropriate. For example, section 954(h) in the subpart F rules defines “predominantly engaged in the active conduct of a banking, financing, or similar business” (which in the case of a lending or finance business, requires more than 70 percent of the gross income be derived directly from transactions with unrelated customers); section 1297(b)(2)(B) in the passive foreign investment company (“PFIC”) rules defines “active conduct of an insurance business by a qualifying insurance corporation”; and section 953(e)(3) defines the term “qualifying insurance company” in order to determine the amount of passive income excluded from subpart F income as income derived in the active conduct of an insurance business under section 954(i).

In order to promote simplification and greater consistency with other Code provisions that have complementary policy objectives, proposed § 1.904-4(e)(2) modifies the definition of an FSE by adopting a definition of “predominantly engaged in the active conduct of a banking, insurance, financing, or similar business” and “income derived in the active conduct of a banking, insurance, financing, or similar business” that is generally consistent with sections 954(h), 1297(b)(2)(B), and 953(e). Conforming changes are made 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 are requested on whether additional guidance is needed with respect to section 954(h) (including in particular section 954(h)(2)(B)(ii), which authorizes the Treasury Department to issue regulations regarding corporations not licensed as a bank in the United States) and section 952(c)(1)(B)(vi) (defining a qualified financial institution for purposes of the qualified deficit rules).

In addition, when the regulations defining an FSE were originally promulgated in 1988, section 904(d)(1)(C) assigned financial services income to its own separate category. This separate category was repealed in 2004, effective for taxable years beginning after 2006, but the rules in section 904(d)(2)(C) and (D) were retained. The proposed regulations make additional clarifying changes to reflect the repeal of the separate category for financial services income.

Finally, in 2004, a definition of financial services group was added in section 904(d)(2)(C)(ii) which was based on the definition of an affiliated group under section 1504(a) but expanded to include insurance companies and foreign corporations. While the current regulations already include foreign corporations as part of an affiliated group, proposed § 1.904-4(e)(2)(ii) conforms the definition of an affiliated group to also include insurance companies referenced in section 1504(b)(2).

B. Allocation and Apportionment of Foreign Income Taxes

As explained in Part III.G of the Summary of Comments and Explanation of Revisions to the 2019 FTC final regulations, the Treasury Department and the IRS have determined that additional guidance regarding the allocation and apportionment to separate categories of creditable foreign income taxes in § 1.904-6 is warranted. As a result of changes made by the TCJA, the accurate allocation and apportionment of foreign income taxes to the gross income to which they relate has taken on increased importance. See, for example, sections 245A(d), 960, 965(g), and § 1.861-8(e)(6) (allocating the deduction for foreign income taxes, including at the level of a CFC, to statutory and residual groupings). Therefore, taxpayers will benefit from increased certainty on how to match foreign income taxes with income, particularly in the case of differences in how a U.S. taxable base and foreign taxable base are computed with respect to the same transaction. Furthermore, because these rules are relevant in numerous contexts outside of section 904, the general rules in § 1.904-6 (which address allocating and apportioning taxes to separate categories) have been moved to new proposed § 1.861-20 and generalized to apply for purposes of allocating and apportioning foreign income taxes to statutory and residual groupings. Rules specific to the allocation and apportionment of foreign income taxes to separate categories remain in proposed § 1.904-6. Conforming changes are proposed to §§ 1.704-1(b)(4)(viii)(

)(

) and 1.960-1(d), which currently rely on the “principles of” § 1.904-6, as well as § 1.965-5(b)(2) (in the case of foreign corporation taxable years beginning after December 31, 2019).

Current § 1.904-6 provides that the allocation and apportionment of foreign tax expense to a section 904 separate category is made on the basis of the income as computed under foreign law on which the tax is imposed; foreign tax is allocated to the separate category to which the income included in the foreign tax base would be assigned under Federal income tax principles.

See

1.904-6(a)(1). If the foreign tax base includes income in more than one separate category, the tax is apportioned among the separate categories on the basis of the relative amounts of foreign taxable income in each category. In making this determination, foreign law rules apply, with certain modifications, to determine the foreign law deductions that reduce the foreign law gross income to compute the foreign law amount of taxable income in each separate category.

See

§ 1.904-6(a)(1)(ii).

Proposed § 1.861-20 adopts the principles of § 1.904-6 but provides more detailed guidance on how to apply those principles, which are illustrated by several examples. Proposed § 1.861-20(c) provides 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)(1) provides a general rule for assigning foreign gross income to a statutory or residual grouping. Under this rule, a foreign gross income item is assigned to a grouping by characterizing the item under Federal income tax law. If an item of gross income or loss arises under Federal income tax law from the same transaction or realization event from which the foreign gross income item arose (a “corresponding U.S. item”), the foreign gross income item is assigned to the same statutory or residual grouping as the corresponding U.S. item. In the case of a corresponding U.S. item that is an item of loss (or zero), the foreign gross income is assigned to the same grouping to which an item of gain would be assigned had the transaction or realization event given rise to an item of gain under Federal income tax law.

See

proposed § 1.861-20(d)(1).

Proposed § 1.861-20(d)(2) sets forth rules for assigning a foreign gross income item to a grouping if there is no corresponding U.S. item in the U.S. taxable year in which the taxpayer paid or accrued the foreign income tax imposed on foreign taxable income that includes the foreign gross income item. Proposed § 1.861-20(d)(2)(i) generally addresses the circumstance in which there is no corresponding U.S. item either because the event giving rise to the foreign gross income is a nonrecognition event under Federal income tax law or because the recognition event giving rise to the foreign gross income occurred under Federal income tax law in a different U.S. taxable year. In both cases, proposed § 1.861-20(d)(2)(i) assigns the foreign gross income to the grouping to which the corresponding U.S. item would be assigned if the event giving rise to the foreign gross income resulted in the recognition of gross income or loss under Federal income tax law in the same U.S. taxable year in which the foreign income tax is paid or accrued.

Proposed § 1.861-20(d)(2)(ii) provides guidance regarding the treatment of foreign gross income items that are either excluded from gross income under Federal income tax law or attributable to base differences. Under § 1.861-20(d)(2)(ii)(A), with the exception of base difference items, foreign gross income that is a type of income expressly excluded from gross income under Federal income tax law is assigned to the grouping to which the gross income would be assigned if it were included in U.S. gross income. Proposed § 1.861-20(d)(2)(ii)(B) provides 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. The items are death benefits described in section 101, gifts and inheritances described in section 102, contributions to capital described in section 118 and the receipt of property in exchange for stock described in section 1032, the receipt of property in exchange for a partnership interest described in section 721, returns of capital described in section 301(c)(2), and distributions to partners described in section 733. The Treasury Department and the IRS have determined that foreign tax on these items, which are excluded from U.S. gross income, is particularly difficult to associate with a particular type of U.S. gross income. Accordingly, foreign tax on base difference items is assigned to the residual grouping, with the result that no credit is allowed if the tax is paid by a CFC, and the tax is assigned to the separate category described in section 904(d)(2)(H)(i) if paid (or treated as paid) by a taxpayer claiming a direct credit under section 901. Comments are requested on whether the list should be expanded to include other items that have no logical analogue to items included in U.S. gross income, or whether a different assignment of any of these types of foreign gross income would be more appropriate.

Proposed § 1.861-20(d)(3) sets forth special rules that apply for purposes of assigning certain items of foreign gross income to a grouping, including rules for distributions that both Federal income tax law and foreign law recognize, certain foreign law distributions such as consent dividends, inclusions under foreign law CFC regimes, disregarded payments, inclusions from reverse hybrids, and gain on the sale of a disregarded entity.

In the case of a distribution from a non-hybrid corporation that is recognized for both Federal income tax

law and foreign tax law purposes, proposed § 1.861-20(d)(3)(i)(B) treats foreign gross income arising from the distribution as a dividend and as capital gain to the extent of the portions of the distribution that are, under Federal income tax law, characterized as a dividend and capital gain, respectively. The foreign gross income is assigned to the same statutory and residual groupings as the corresponding amounts of dividend and capital gain as computed for U.S. tax purposes. Foreign gross income arising from the portion of the distribution that is a return of capital under Federal income tax law is treated as a base difference under proposed § 1.861-20(d)(2)(ii)(B).

If foreign law, but not Federal income tax law, recognizes a deemed distribution or consent dividend (a “foreign law distribution”), proposed § 1.861-20(d)(3)(i)(C) assigns the resulting foreign gross income to a statutory or residual grouping by applying proposed § 1.861-20(d)(3)(i)(B) as though Federal income tax law recognized the distribution in the U.S. taxable year in which the taxpayer paid or accrued tax with respect to the foreign law distribution. For example, if a taxpayer recognizes foreign gross income arising from a foreign law distribution, and proposed § 1.861-20(d)(3)(i)(B) (as applied for purposes of section 904 as the operative section) would treat the distribution as made out of general category section 965(a) previously taxed earnings and profits if the distribution had also occurred under Federal income tax law, the foreign gross income is assigned to the general category.

If a taxpayer (including an upper-tier CFC) includes an item of foreign gross income by reason of a foreign law regime similar to the subpart F provisions under sections 951 through 959 (a “foreign law subpart F regime”), proposed § 1.861-20(d)(3)(i)(D) assigns that item to the same statutory or residual grouping as the gross income (determined under the foreign law subpart F regime) of the foreign law CFC that gave rise to the foreign gross income of the taxpayer. The taxpayer's gross income included under the foreign law subpart F regime is, in other words, treated as the foreign gross income of the foreign law CFC, and the general rules of proposed §§ 1.861-20(d)(1) and (2) apply to characterize that foreign gross income and assign it to the statutory and residual groupings. For example, in applying proposed § 1.861-20(d)(3)(i)(D) in applying section 960 as the operative section where an upper-tier CFC is the taxpayer, the upper-tier CFC's foreign law subpart F inclusion is treated as the foreign gross income of the foreign law CFC, which is treated as if it were the taxpayer. If the foreign law CFC has a corresponding U.S. item of subpart F income for which its United States shareholder elects to apply the high tax exception under section 954(b)(4), the foreign gross income and the associated foreign tax paid by the upper-tier CFC are assigned to a residual income group under § 1.960-1(d). In addition, § 1.904-6(f) includes a special rule assigning certain items of foreign gross income recognized by a United States shareholder of a CFC that is also a foreign law CFC to the section 951A category for purposes of applying section 904 as the operative section.

Proposed § 1.861-20(d)(3)(ii) addresses the assignment 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 assigns the item to the statutory and residual groupings by deeming the payment to be made ratably out of the after-tax income, computed for Federal income tax purposes, of the foreign branch, and deeming the branch income to arise in the statutory and residual groupings in the same ratio as the tax book value of the assets, including stock, owned by the foreign branch. 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 assigns the item to the residual grouping. However, proposed § 1.861-20(d)(3)(ii)(C) assigns an item of foreign gross income attributable to gain recognized under foreign law with respect to the receipt of a disregarded payment in exchange for property under the rule in § 1.861-20(d)(2)(i). In addition, proposed § 1.904-6(b)(2) includes special rules assigning foreign gross income items arising from certain disregarded payments for purposes of applying section 904 as the operative section.

Proposed § 1.861-20(d)(3)(iii) addresses the assignment to a statutory or residual grouping of foreign gross income that a taxpayer includes by reason of its ownership of a reverse hybrid. Under this rule, the foreign gross income that a taxpayer recognizes from a reverse hybrid is assigned to the statutory and residual groupings by treating that foreign gross income as the income of the reverse hybrid and applying the general rules of proposed § 1.861-20(d). However, § 1.904-6(f) includes a special rule assigning certain items of foreign gross income recognized by a United States shareholder of a controlled foreign corporation that is a reverse hybrid to the section 951A category for purposes of applying section 904 as the operative section. The Treasury Department and the IRS request comments on whether additional rules are needed to address other fact patterns in which the U.S. and a foreign country tax different persons on the same item of income, for example, in the case of a sale-repurchase agreement.

Finally, under proposed § 1.861-20(d)(3)(iv), if a taxpayer recognizes an item of foreign gross income that is gain from the sale of a disregarded entity, and Federal income tax law characterizes the transaction as a sale of the assets of the disregarded entity, the foreign gross income is assigned to the statutory and residual groupings in the same proportion as the gain that the taxpayer would have recognized if foreign law also treated the transaction as a sale of assets.

Changes to § 1.904-6 and § 1.960-1 are proposed to clarify and, in certain cases, modify the application of proposed § 1.861-20 for purposes of computing the foreign tax credit limitation under section 904 and foreign income taxes deemed paid under section 960.

Proposed § 1.904-6(b)(1) assigns foreign gross income that is attributable to a base difference, and the associated tax, to the separate category described in section 904(d)(2)(H)(i). Proposed § 1.904-6(b)(2)(i) generally provides that if a foreign branch makes a disregarded payment to another foreign branch or to its owner that causes the taxpayer's gross income under Federal income tax law that is otherwise attributable to the foreign branch to be attributed to another foreign branch or to the foreign branch owner under § 1.904-4(f)(2)(vi)(A) or § 1.904-4(f)(2)(vi)(D), the foreign gross income that arises by reason of the disregarded payment is assigned to the same category as the reattributed U.S. gross income. Under proposed § 1.904-6(b)(2)(ii), items of foreign gross income that a taxpayer includes solely by reason of the receipt by a foreign branch of a disregarded payment from its foreign branch owner that is a United States person are generally assigned to the foreign branch category (or, in the case of a foreign branch owner that is a partnership, to the partnership's general category income that is attributable to the foreign branch). However, items of foreign gross income attributable to gain recognized under foreign law with respect to the receipt of a disregarded payment in exchange for property are characterized

and assigned under the rules of § 1.861-20(d)(2)(i). Under proposed § 1.904-6(b)(3), if a taxable disposition of property acquired in a disregarded sale results in the recognition of U.S. gross income that is reattributed to or from a foreign branch under § 1.904-4(f)(2)(vi)(A) or § 1.904-4(f)(2)(vi)(D), any foreign gross income arising from that disposition of property under foreign law is assigned to the same separate category as the corresponding U.S. item of gain under § 1.861-20(d)(1) without regard to the reattribution of U.S. gross income. This rule is intended to better match income and taxes in situations where the foreign country only taxes gain that arises during the period that follows the disregarded sale.

Finally, § 1.904-6(f) addresses the circumstance in which a United States shareholder pays or accrues foreign income tax with respect to foreign gross income that it recognizes because it owns a foreign law CFC or a reverse hybrid. The foreign income tax is allocated and apportioned to a category by treating the foreign gross income of the United States shareholder as the foreign gross income of the foreign law CFC or reverse hybrid under proposed §§ 1.861-20(d)(3)(i)(D) or 1.861-20(d)(3)(ii)(B). Proposed § 1.904-6(f) reassigns to the section 951A category the foreign gross income that, if the foreign law CFC or reverse hybrid recognized the foreign gross income instead of the United States shareholder, would be assigned to the general category tested income group of the foreign law CFC or reverse hybrid to which an inclusion under section 951A is attributable. The amount of the foreign gross income that is reassigned is based upon the inclusion percentage, as defined in § 1.960-2(c)(2), of the United States shareholder.

The Treasury Department and the IRS are continuing to study the allocation and apportionment of foreign income tax that is imposed on foreign gross income that is associated with the general category tested income group of a foreign law CFC or reverse hybrid under proposed §§ 1.861-20(d)(3)(i)(D) and 1.861-20(d)(3)(ii)(B), respectively. Comments are requested on the proper treatment of such foreign income tax in the circumstance in which some or all of the tax is not assigned to the section 951A category under proposed § 1.904-6(f) because no inclusion is attributable to the tested income group, or the inclusion percentage of the United States shareholder is less than 100 percent. In particular, comments are requested on the interaction of proposed § 1.904-6(f) with sections 245A(g) and 909.

Proposed § 1.960-1(d)(3)(ii) makes conforming changes and in addition clarifies that, if proposed § 1.861-20 would otherwise apply to assign foreign gross income to a PTEP group that is not increased as a result of a distribution described in section 959(b), the foreign taxable income is assigned to the income group to which the income, computed under Federal income tax law, that gave rise to the PTEP would be assigned if recognized under Federal income tax law in the year in which tax was imposed.

The Treasury Department and the IRS are also studying whether additional guidance should be provided on allocating and apportioning foreign taxes described in section 903 (tax in lieu of income tax), and foreign income taxes for which the foreign taxable base is computed formulaically with respect to a unitary business. The Treasury Department and the IRS are also studying 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. Comments are requested on these topics.

C. Overall Foreign Loss Recapture on Property Dispositions

One comment was received with respect to the 2012 OFL proposed regulations, which recommended addressing dispositions that result in additional income recognition under branch loss recapture and dual consolidated loss recapture rules. The comment pointed out that these additional income recognition amounts are determined after first determining the additional recognition amount under section 904(f)(3) and therefore recommended adding the coordination of these rules as a new Step Nine in the ordering rules of § 1.904(g)-3. The comment recommended that the additional income recognition amounts resulting from branch loss recapture and dual consolidated loss recapture should not be subject to the overall foreign loss (OFL) recapture rules.

The branch loss recapture rules under section 367(a) referenced by the comment letter were repealed by the TCJA (subject to a special savings clause that applies with respect to losses incurred before January 1, 2018) and replaced with a new set of branch loss recapture rules in section 91. One of the principal differences between the two regimes is that previously the branch loss recapture amounts were treated as foreign source income, whereas under new section 91(d) they are treated as U.S. source income. Accordingly, although the branch loss recapture amounts for losses incurred after December 31, 2017, are no longer subject to the OFL recapture rules or separate limitation loss (SLL) recapture rules, they are now potentially subject to the overall domestic loss (ODL) recapture rules, and therefore ordering rules are still needed for the application of the branch loss recapture rules, including the rules for losses incurred before January 1, 2018, that are subject to the special savings clause.

The Treasury Department and the IRS agree with the recommendation to add a new Step Nine to § 1.904(g)-3 to clarify that additional income amounts recognized by reason of branch loss recapture and dual consolidated loss recapture are not taken into account for purposes of the ordering rules until after the section 904(f)(3) amounts are determined. However, the Treasury Department and the IRS do not agree that those additional income amounts should not be subject to the OFL or ODL recapture rules. The fact that a loss recapture rule may provide that the additional income amount is treated as U.S. source income does not mean it should be treated any differently than any other U.S. source income that is subject to the ODL recapture rules. The same reasoning applies to additional income amounts that are treated as foreign source income and therefore subject to the OFL recapture rules. Accordingly, Step Nine in proposed § 1.904(g)-(3)(j) provides that like section 904(f)(3) recapture amounts addressed in Step Eight, the additional income recognized by reason of branch loss and dual consolidated loss recapture will be subject to the first seven steps of the ordering rules. However, Step Nine applies only to additional income amounts with respect to branch loss and dual consolidated loss recapture that are determined after taking into account an offset for a section 904(f)(3) recapture amount. For example, if a taxpayer has a dual consolidated loss recapture in a year in which there is no section 904(f)(3) recapture, then there is only one application of Steps One through Seven, which takes into account the additional income, and Steps Eight and Nine will not apply.

When Step Nine applies, the proposed regulations provide that for purposes of determining how much of the additional income with respect to branch loss and dual consolidated loss recapture will be subject to the ODL, OFL or SLL recapture rules, any increases to an ODL, OFL or SLL account balance in the current year due to the original application of Steps One

through Seven (prior to the application of Steps Eight or Nine) are taken into account.

In addition, if any additional income with respect to a branch loss or dual consolidated loss recapture is foreign source income in a separate category for which there is a remaining OFL account balance after Steps One through Eight, a special rule applies for purposes of determining the OFL recapture amount under § 1.904(f)-2(c) (the lesser of the maximum potential recapture or 50 percent of total foreign source income). The special rule provides that a taxpayer must first determine a hypothetical OFL recapture amount, which is the OFL recapture amount that would have been determined in the original application of Steps One through Seven (prior to the application of Steps Eight and Nine) if the additional income in Step Nine were also taken into account. From that hypothetical OFL recapture amount, the taxpayer subtracts the actual OFL recapture amount that was determined in the original application of Steps One through Seven (without taking into account the additional income in Step Nine). The remainder is then the OFL recapture amount with respect to the additional income in Step Nine. This special rule is necessary because a simple reapplication of the OFL recapture amount rules in § 1.904(f)-2(c) to just the additional income in Step Nine could result in requiring an excessive amount of recapture, because the same amount of foreign source income in other separate categories may be used twice to increase the OFL recapture amount (once in the original calculation and again in the second calculation with respect to the additional income).

III. Foreign Tax Redeterminations Under Section 905(c)

As discussed in Part III of the Background section of the 2019 FTC final regulations, portions of the temporary regulations relating to sections 905(c), 986(a), and 6689 (TD 9362) (the “2007 temporary regulations”) are being reproposed in order to provide taxpayers an additional opportunity to comment on those rules in light of the changes made by the TCJA. References in this preamble to the 2007 temporary regulations are understood to refer to the corresponding provisions of the accompanying proposed regulations, which were issued by cross-reference to the 2007 temporary regulations at 72 FR 62805.

In particular, the rules being reproposed are: (1) § 1.905-3T(d)(2), which addresses foreign tax redeterminations that affect foreign taxes deemed paid under section 960, (2) § 1.905-4T, which in general provides the procedural rules for how to notify the IRS of a foreign tax redetermination, and (3) § 301.6689-1T, which provides rules for the penalty for failure to notify the IRS of a foreign tax redetermination. In addition, the proposed regulations contain 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 before the amendments made by the TCJA.

See

Part III.D of this Explanation of Provisions.

A. Adjustments to Foreign Taxes Paid by Foreign Corporations

Section 1.905-3T(d)(2) of the 2007 temporary regulations reflects the law in effect before the TCJA, which generally required foreign tax redeterminations of foreign corporations to be taken into account by prospectively adjusting the foreign corporations' pools of post-1986 undistributed earnings and post-1986 foreign income taxes, rather than by adjusting the calculation of deemed-paid taxes and the United States shareholder's (“U.S. shareholder”) U.S. tax liability in the prior year or years in which the adjusted foreign tax was included in the calculation of foreign taxes deemed paid. Section 1.905-3T(d)(3) of the 2007 temporary regulations provides exceptions to the pooling adjustment rules that required redeterminations of the U.S. shareholder's U.S. tax liability in situations where refunds or other downward adjustments to a foreign corporation's foreign tax liability would otherwise cause a substantial overstatement of deemed paid taxes. With the repeal of the pooling regime and related amendments to section 905(c) in the TJCA, the statute now requires U.S. tax redeterminations to reflect all foreign tax redeterminations, including those that result in adjustments to foreign taxes deemed paid. Accordingly, proposed § 1.905-3(b)(2)(i) provides that a U.S. tax redetermination is required in all cases to account for the effect of a foreign corporation's foreign tax redetermination.

Section 1.905-3T(d)(3)(ii), illustrated by an example in § 1.905-3T(d)(3)(iii), provides that the required U.S. tax redetermination is made by taking the foreign tax redetermination into account in the prior year to which the redetermined foreign tax relates, and further provides that a U.S. tax redetermination is also required for any subsequent year in which the domestic corporate shareholder received or accrued a distribution or inclusion from the foreign corporation, which under pre-TCJA law would have resulted in foreign taxes deemed paid. Under these rules, the amount of the adjusted foreign tax was deemed to “relate back” and adjust the foreign corporation's earnings and profits, as well as its creditable foreign taxes, in the adjusted year.

In any case where a U.S. tax redetermination and adjustment to deemed paid taxes is required, an adjustment to the foreign corporation's taxable income and earnings and profits in the functional currency amount of the adjusted foreign tax (whether upward to reflect a refund or downward to reflect an additional payment of foreign tax) in the relation-back year is necessary in order to coordinate the computation of the U.S. shareholder's inclusions with the amount of the section 78 dividend in the amount of the adjusted foreign taxes deemed paid. This is because under sections 954(b)(5) and 951A(c)(2)(ii), the creditable foreign tax reduces the foreign corporation's subpart F income, tested income, and earnings and profits, so that the amount included in the U.S. shareholder's income under sections 951 and 951A is an after-foreign-tax amount; the section 78 dividend prevents the effective allowance of both a deduction and a credit for an amount of foreign tax that both reduces the inclusion and is allowed as a deemed paid foreign tax credit. If the foreign corporation's deduction from income and earnings and profits in respect of foreign taxes were adjusted in a different year than the year in which its creditable foreign taxes were adjusted, the amount of foreign tax that reduces the U.S. shareholder's inclusion and the amount added to income under section 78 in respect of the deemed paid tax would not match, such that the U.S. shareholder's income would be understated or overstated by the amount of the foreign tax adjustment.

Accordingly, proposed § 1.905-3(b)(2)(ii) clarifies that the required adjustments 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. The TCJA amendments, by eliminating deemed paid taxes under section 902 with respect to dividends and basing deemed paid taxes under section 960

with respect to subpart F and GILTI inclusions on current year income and taxes rather than multi-year pools, will require more redeterminations of U.S. tax liability to adjust deemed paid credits under section 960, but fewer adjustments to intervening years, since a foreign tax adjustment to one year will generally no longer affect the calculation of deemed paid taxes with respect to inclusions in other years. New examples at proposed § 1.905-3(b)(2)(v) illustrate these rules.

Section 905(c)(1)(B) and (C) require a redetermination of U.S. tax if accrued taxes remain unpaid after two years, or if any tax paid is refunded in whole or in part. These provisions are not limited to cases in which the foreign tax redetermination reduces the amount of the foreign tax credit. Accordingly, proposed §§ 1.905-3(a) and 1.905-3(b)(2)(ii) also provide that the rules under section 905(c) apply in cases in which foreign tax redeterminations affect U.S. tax liability even though there may be no change to the amount of foreign tax credits originally claimed. For example, under the proposed regulations a redetermination of U.S. tax liability is required when a foreign tax redetermination affects whether or not a taxpayer is eligible for the high-tax exception under section 954(b)(4) (the “subpart F high-tax exception”) in the year to which the redetermined foreign tax relates. Similarly, a foreign tax redetermination could affect the subpart F income, tested income, and earnings and profits of a CFC in the year to which the tax relates, see proposed § 1.905-3(b)(2)(ii), and therefore affect the amount of a U.S. shareholder's inclusion under section 951 or section 951A with respect to the adjusted year. Corresponding amendments are proposed to the rules in §§ 1.904-4(c)(7) and 1.954-1(d).

B. Foreign Tax Redeterminations of Successor Entities

The proposed regulations at § 1.905-3(b)(3) add a rule clarifying 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. This could occur, for example, if a disregarded entity is sold to a different taxpayer, or if a CFC liquidates into another CFC that has transferee liability for the liquidated CFC's foreign tax. The proposed regulations further provide 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. Thus, for example, when the original taxpayer owns the successor which remits a tax that was the legal liability of, and considered paid by, the original taxpayer (for example, if a controlled foreign corporation that was formerly a disregarded entity pays additional tax after a foreign audit), then a distribution can result from the successor to the original taxpayer.

See Herbert Enoch,

57 T.C. 781 (1972) (finding constructive dividend when a corporation discharged its shareholder's personal liability on debt). The Treasury Department and the IRS request comments on whether additional rules are required to address situations involving predecessors or successors.

C. Notification to the IRS of Foreign Tax Redeterminations and Related Penalty Provisions

Proposed § 1.905-4 contains rules for notifying the IRS of a foreign tax redetermination. Proposed § 301.6689-1 contains rules regarding the penalty for failure to notify the IRS of a foreign tax redetermination. This Part III.C describes changes made to §§ 1.905-4 and 301.6689-1 relative to the rules that were contained in the 2007 temporary regulations.

1. Notification Through Amended Returns

Section 1.905-4T(b)(1)(iv) of the 2007 temporary regulations provides that, if more than one foreign tax redetermination requires a redetermination of U.S. tax liability for the same taxable year of the taxpayer (the affected year) and those redeterminations occur within two consecutive taxable years, the taxpayer generally may file for the affected year one amended return, Form 1118 (Foreign Tax Credit—Corporations) or Form 1116 (Foreign Tax Credit), and one statement under § 1.905-4T(c) with respect to all of the redeterminations. Proposed § 1.905-4(b)(1)(iv) clarifies 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 proposed § 1.905-4(c) with respect to all of the redeterminations. Proposed § 1.905-4(b)(1)(iv) also provides that the due date of the amended return and statement varies depending on whether the net effect of the foreign tax redeterminations reduces or increases the U.S. tax liability in the affected taxable year.

Section 1.905-4T(b)(1)(v) of the 2007 temporary regulations provides that, if a foreign tax redetermination requires a redetermination of U.S. tax liability that otherwise would result in an additional amount of U.S. tax due, but such amount is eliminated as a result of a carryback or carryover of an unused foreign tax under section 904(c), the taxpayer may, in lieu of applying the rules of §§ 1.905-4T(b)(1)(i) and (b)(1)(ii), notify the IRS of such redetermination by attaching a statement to the original return for the taxpayer's taxable year in which the foreign tax redetermination occurs. Section 1.905-4T(b)(1)(v) of the 2007 temporary regulations does not apply if the foreign tax redetermination does not change the U.S. tax liability for the taxable year to which the tax relates for a reason other than the carryback or carryover of an unused foreign tax. Section 1.905-4T(b)(1)(v) of the 2007 temporary regulations also does not apply if more than one foreign tax redetermination occurring within the same taxable year or two consecutive taxable years requires a redetermination of U.S. tax liability for the same taxable year but, taking into account all such foreign tax redeterminations on a net basis, results in no additional amount of U.S. tax liability due for such taxable year.

Proposed § 1.905-4(b)(1)(v) provides that, if a foreign tax redetermination (either alone or in combination with certain other foreign tax redeterminations as provided in proposed § 1.905-4(b)(1)(iv)) does not result in a change to the amount of U.S. tax due for a taxable year, for reasons including but not limited to a carryover or carryback of unused foreign taxes under section 904(c), no amended return is required for such year. Instead, appropriate adjustments are made to the amounts carried over from that year (for example, unused foreign taxes). If no amended return is required for any year, the taxpayer must attach a statement containing the information described in § 1.904-2(f) to the taxpayer's timely filed (with extensions) original return for the taxpayer's taxable year in which the foreign tax redetermination occurs.

2. Foreign Tax Redeterminations of Pass-Through Entities

The 2007 temporary regulations did not specifically provide guidance for

pass-through entities that report creditable foreign taxes to their partners, shareholders, or beneficiaries and subsequently have a foreign tax redetermination with respect to such foreign taxes. The proposed regulations provide rules whereby these entities can satisfy their obligations under section 905(c). Proposed § 1.905-4(b)(2) generally provides 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, in 2015, Congress introduced the centralized audit partnership regime, which requires that certain adjustments be made at the level of the partnership, rather than by partners.

See

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. 115-141). Under this regime, in order to make an adjustment to a partnership-related item (as defined in section 6241(2)), the partnership must file an administrative adjustment request (“AAR”). Sections 6227(d) and 6235(a) contemplate that these rules will be coordinated with the application of section 905(c).

On June 14, 2017, the Treasury Department and the IRS published in the

Federal Register

(82 FR 27334) a notice of proposed rulemaking and on November 30, 2017, the Treasury Department and the IRS published in the

Federal Register

(82 FR 56765) another notice of proposed rulemaking. Each notice of proposed rulemaking requested comments on how a partnership subject to the centralized partnership audit regime should fulfill the requirements of section 905(c). One comment was received with respect to this issue and it recommended that partnerships satisfy their obligations under section 905(c) by filing an AAR under section 6227 and by following the procedures under that section to take necessary adjustments into account. Consistent with this request and with sections 6227(d) and 6235(a), proposed § 1.905-4(b)(2)(ii) provides 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 AAR under section 6227 without regard to the time restrictions on filing an AAR in section 6227(c).

See also

§ 1.6227-1(g).

The use of the AAR process, even if the period under section 6227(c) is closed, is intended to further the purpose of sections 905(c), 6227(d), 6235(a), and 6241(11). An AAR is analogous to an amended return, which is required from other taxpayers who have a foreign tax redetermination, and provides an administrable process whereby a partnership, and its partners, can satisfy their obligations under section 905(c). The Treasury Department and the IRS request comments on any further coordination that may be required between sections 905(c) and 6227 in order to carry out the purposes of the foreign tax credit and the centralized partnership audit regime.

3. Alternative Notification Requirements

Proposed § 1.905-4(b)(3) provides that an amended return and Form 1118 (Foreign Tax Credit—Corporations) or Form 1116 (Foreign Tax Credit), is not required to notify the IRS of a foreign tax redetermination and redetermination of U.S. tax liability if the taxpayer satisfies alternative notification requirements that may be prescribed by the IRS through forms, instructions, publications, or other guidance. For example, as provided in Notice 2016-10, 2016-1 I.R.B. 1, the Treasury Department and the IRS intend to issue regulations providing for alternative notification procedures in the case of tax refunds received by regulated investment companies making the election to pass through foreign tax credits under section 853. The Treasury Department and the IRS request comments on additional alternative approaches to complying with the notification requirements in section 905(c) that minimize burdens to both taxpayers and the IRS.

4. Foreign Tax Redeterminations of LB&I Taxpayers

Section 1.905-4T(b)(3) of the 2007 temporary regulations provides a special rule for U.S. taxpayers under the jurisdiction of the Large and Mid-Size Business Division. The proposed regulations reflect the organization's name change to Large Business and International Division (LB&I).

Under the special rule for U.S. taxpayers under LB&I jurisdiction (“LB&I rule”), such taxpayers are required, in limited circumstances, to provide to their examiners notice of a foreign tax redetermination that requires a redetermination of U.S. tax, in lieu of filing an amended return. One of the threshold requirements of § 1.905-4T(b)(3) of the 2007 temporary regulations is that the taxpayer must provide the statement describing the foreign tax redetermination no later than 120 days after the latest of (1) the date the foreign tax redetermination occurs, (2) the opening conference of the examination for the affected taxable year, or (3) the hand-delivery or postmark date of the opening letter concerning the examination. In no case, however, can the alternative notification procedure apply if the 120-day period within which notification must be made would start after the due date of the return for the taxable year in which the foreign tax redetermination occurs.

The LB&I rule contained in the proposed regulations is generally the same as the rule in the 2007 temporary regulations, and the Explanation of Provisions of the 2007 temporary regulations contains an explanation of the rules. However, one change has been made with respect to § 1.905-4T(b)(3) of the 2007 temporary regulations. Section 1.905-4T(b)(3) provides that, if that provision applies to permit notification during an audit, in lieu of filing an amended return a taxpayer must provide to the examiner the statement described in § 1.905-4T(c) of the 2007 temporary regulations, which contains information that enables the IRS to verify and compare the original computations with respect to a claimed foreign tax credit, the revised computations resulting from the foreign tax redetermination, and the net changes resulting therefrom. In order to satisfy the requirements of § 1.905-4T(c), a taxpayer is required to recompute its U.S. tax liability during the course of an examination, rather than only at the conclusion of the audit. To minimize administrative burdens, the statement requirement at proposed § 1.905-4(b)(4)(iii) requires the taxpayer to provide to the examiner the original amount of foreign taxes paid or accrued in the year to which the foreign tax redetermination relates, the revised amount of foreign taxes paid or accrued, and documentation with respect to the revisions, including exchange rates and dates of accrual and/or payment. This information must be provided with a penalties-of-perjury declaration signed by a person authorized to sign the return of the taxpayer.

In order to clarify when the special rules for LB&I taxpayers apply, the proposed regulations reorganize certain portions of the 2007 temporary regulations into a list of conditions, all of which must be met in order for § 1.905-4(b)(4) to apply. These

conditions are as follows: (1) A foreign tax redetermination occurs while the U.S. taxpayer is under the jurisdiction of LB&I (or a successor division); (2) 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; (3) the foreign tax redetermination requires a redetermination of U.S. tax liability and accordingly, but for § 1.905-4(b)(4), the taxpayer would be required to notify the IRS of such foreign tax redetermination under § 1.905-4(b)(1)(ii) by filing an amended return; (4) the return for the taxable year for which a redetermination of U.S. tax liability is required is under examination; and (5) the due date specified in § 1.905-4(b)(1)(ii) for providing notice of such foreign tax redetermination is not before the latest of the opening conference or the hand-delivery or postmark date of the opening letter concerning the examination of the return for the taxable year for which a redetermination of U.S. tax liability is required by reason of such foreign tax redetermination.

5. Penalty Provisions

Section 6689 provides that a taxpayer may be subject to a penalty if it fails to notify the IRS of a foreign tax redetermination on or before the date prescribed by regulations. Section 301.6689-1T(a) (issued in TD 8210 on June 22, 1988) states that the penalty may apply if a taxpayer fails to notify the IRS of a foreign tax redetermination “on or before the date prescribed in regulations.” However, the preamble of the 2007 temporary regulations, in describing section 6689, provides that, “Under section 6689, a taxpayer that fails to notify the IRS of a foreign tax redetermination in the time

and manner

prescribed by regulations for giving such notice is subject to a penalty.” (Emphasis added.) Because it is implicit in section 6689 that the required notification must comply with the requirements of section 905(c), the proposed regulations conform to the preamble description in the 2007 temporary regulations. Accordingly, proposed § 301.6689-1(a) provides that the penalty may apply if a taxpayer fails to notify the IRS of a foreign tax redetermination “on or before the date and in the manner prescribed in regulations.”

The penalty under section 6689 is generally computed by reference to the amount of the deficiency resulting from a foreign tax redetermination. If a partnership fails to timely file an AAR as required under proposed § 1.905-4(b)(2)(ii) such that the penalty under section 6689 is applicable there is ambiguity regarding the correct base upon which the penalty is computed because partnerships do not generally have deficiencies in chapter 1 tax. Under the centralized partnership audit regime enacted by the BBA, if an adjustment is made to a partnership-related item of a partnership that is subject to the BBA (either by the IRS or by the partnership upon the filing of an AAR), the default rule is that the partnership is liable for an imputed underpayment calculated on the adjustments, which is an approximate substitute for the amount of chapter 1 tax that would have been owed by its partners.

See

sections 6221(a) and 6225. The fact that section 6689 is silent as to the proper base for calculating a section 6689 penalty for a partnership that is subject to BBA creates a special enforcement consideration and requires clarification. Therefore, consistent with the principles of section 6233(a)(3) (which treats the imputed underpayment as an understatement or underpayment for purposes of computing a penalty) and the requirement in section 6227(d) that regulations coordinate the application of sections 905(c) and 6227, proposed § 301.6689-1 provides that in computing the amount of the penalty imposed under section 6689, the penalty is calculated on a deficiency or by reference to the amount of the imputed underpayment that results from the foreign tax redetermination.

Finally, because section 6662 may apply if a taxpayer's U.S. tax liability is understated on an original return even if section 6689 applies to a failure to notify the IRS of a subsequent foreign tax redetermination, the proposed regulations eliminate the reference in § 301.6689-1(b) to section 6653(a) (the predecessor to section 6662).

D. Transition Rule Relating to the TCJA

The TCJA repealed the pooling rules of section 902 and related provisions of section 905(c) that mandated prospective pooling adjustments to account for redeterminations of foreign taxes paid by foreign corporations that were eligible to be deemed paid by domestic corporate shareholders of the foreign corporations. Proposed §§ 1.905-3(b)(2)(iv) and 1.905-5 provide a transition rule providing that post-2017 redeterminations of pre-2018 foreign income taxes must be accounted for by adjusting the foreign corporation's taxable income and earnings and profits, post-1986 undistributed earnings, and post-1986 foreign income taxes (or pre-1987 accumulated profits and pre-1987 foreign income taxes, as applicable) in the pre-2018 year to which the redetermined foreign taxes relate. A redetermination of U.S. tax liability is required to account for the effect of the foreign tax redetermination on foreign taxes deemed paid by domestic corporate shareholders of the foreign corporation in the relation-back year and any subsequent pre-2018 year in which the domestic corporate shareholder computed a deemed-paid credit under section 902 or 960 with respect to the foreign corporation, as well as any year to which unused foreign taxes from any such year were carried. The proposed regulations generally apply the currency translation rules applicable under prior law and the notification requirements of proposed § 1.904-4 to redeterminations of U.S. tax liability required by proposed § 1.905-3(b)(2)(iv) in these circumstances.

The Treasury Department and the IRS request 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.

IV. Foreign Income Taxes Taken Into Account Under Section 954(b)(4)

As discussed in Part III.A of this Explanation of Provisions, proposed § 1.905-3(b)(2) provides that a U.S. tax redetermination is required when a foreign tax redetermination affects whether or not a taxpayer is eligible for the subpart F high-tax exception. Proposed § 1.954-1(d)(3)(iii) therefore provides that the subpart F high-tax exception is applied by taking into account the redetermined foreign tax in the adjusted year.

The proposed regulations also include an additional clarification relating to schemes involving jurisdictions that do not impose corporate income tax on a CFC until its earnings are distributed. The Treasury Department and the IRS are aware that certain taxpayers claim that taxes are treated as paid or accrued for purposes of § 1.954-1(d)(3) even in the absence of any distribution triggering foreign tax. The IRS may challenge this position under existing law. Furthermore, the proposed regulations clarify that foreign income taxes that have not accrued because they are contingent on a future distribution are not taken into account for purposes

of determining the amount of foreign income taxes paid or accrued with respect to an item of income. However, if a redetermination of U.S. tax liability is required under proposed §§ 1.905-3(a) and 1.905-3(b)(2)(ii) when tax is imposed on the foreign corporation in connection with a distribution, the redetermined foreign tax is taken into account in applying § 1.954-1(d)(3) in the adjusted year.

V. Disallowance of Foreign Tax Credits Under Section 965(g)

The Treasury Department and the IRS are aware that certain taxpayers may have engaged in certain transactions that are intended to avoid the disallowance of foreign tax credits under section 965(g) with respect to distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits. For example, certain U.S. shareholders of specified foreign corporations may incur foreign income taxes on distributions recognized for foreign tax purposes that are not recognized for U.S. tax purposes (for example, consent dividends). When the section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits are distributed for U.S. tax purposes, no foreign income tax is imposed by the foreign jurisdiction. The taxpayers may argue that the foreign income taxes on the foreign distributions are not associated with a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits for U.S. tax purposes, and, accordingly, the credit need not be reduced by the section 965(g) disallowance.

Proposed § 1.965-5(b)(2) clarifies that the principles of § 1.904-6 apply in determining the extent to which foreign income taxes are attributable to distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits for purposes of § 1.965-5(b)(1). For example, under the principles of § 1.904-6, foreign withholding taxes imposed on an amount that is recognized as a dividend for foreign, but not Federal income, tax purposes are attributable to an item of income to which that amount would be assigned if recognized as a distribution for Federal income tax purposes. To the extent a distribution would be a distribution of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits if it were recognized for U.S. tax purposes, under proposed § 1.965-5(b)(2) the tax would be associated with section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits and disallowed in part by reason of section 965(g). For foreign corporation taxable years beginning after December 31, 2019, § 1.861-20 applies in lieu of § 1.904-6.

The IRS may challenge the credits claimed for foreign income taxes imposed on distributions recognized solely for foreign tax purposes in prior years to the extent that such foreign income taxes would be considered imposed on distributions of section 965(a) previously taxed earnings and profits or section 965(b) previously taxed earnings and profits had such distributions been recognized for U.S. tax purposes.

VI. Updates to Consolidated Foreign Tax Credit Rules

Proposed § 1.1502-4 includes amendments to regulations under section 1502 relating to the computation of the consolidated foreign tax credit. The proposed amendments update the regulations to reflect changes in the law, such as by eliminating out-of-date references to the per-country limitation. For purposes of determining the foreign tax credit limitation, the proposed regulations also provide that the amount of foreign source income in each separate category, used as the numerator in the foreign tax credit limitation fraction, is determined by applying the rules of § 1.1502-11, as well as sections 904(f) and 904(g), on a group-wide basis, rather than applying those rules on a separate member basis and combining the results.

The proposed regulations also add new rules for purposes of determining the source and separate category of a consolidated NOL, as well as the portion of a consolidated net operating loss (“CNOL”) that is apportioned to a separate return year of a member. The Treasury Department and the IRS have determined that, when characterizing a CNOL that is apportioned to a separate return year, it is generally appropriate to link the source and separate category of the CNOL with the member's assets that are expected to produce income with that same source and separate category so as to minimize the creation of loss accounts under sections 904(f) and 904(g) in the year in which the CNOL is used. The proposed regulations achieve this result formulaically through a two-step process that generally determines a CNOL's source and separate category by reference to the statutory and residual groupings described in § 1.861-8 for purposes of applying section 904 as the operative section, which are foreign source income in each separate category, and the residual grouping, which is U.S. source income.

First, the member determines a tentative apportionment, which is a proportionate share of the amount of the CNOL in each grouping based on a comparison of the value of the member's assets in that grouping to the value of the group's total assets in the grouping. Because the total of tentative apportionments of the CNOL does not necessarily equal the member's total share of the CNOL, an adjustment is provided. If the total tentative apportionments exceed the CNOL attributable to the member, the tentative apportionment in each grouping is reduced by a pro rata share of the excess, in proportion to the amount of the tentative apportionment in that grouping over the total tentative apportionments. In contrast, if the total tentative apportionments are less than the CNOL attributable to the member, the tentative apportionment in each grouping is increased by a pro rata share of that deficiency, in proportion to the remaining CNOL in that grouping (after subtracting the tentative apportionment) over the total remaining CNOL in all groupings.

VII. Applicability Dates

The rules in proposed §§ 1.861-8, 1.861-9, 1.861-12, 1.861-14, 1.904-4(c)(7) and (8), 1.904(b)-3, 1.954-1, and 1.954-2, generally apply to taxable years that end on or after December 16, 2019.

The rules in proposed §§ 1.704-1(b)(4)(viii)(

)(

), 1.861-17, 1.861-20, 1.904-6, and 1.960-1 apply to taxable years beginning after December 31, 2019. However, taxpayers that are on the sales method for taxable years beginning after December 31, 2017, and before January 1, 2020, may rely on proposed § 1.861-17 if they apply it consistently. Therefore, a taxpayer on the sales method for its taxable year beginning in 2018 may rely on proposed § 1.861-17 but must also apply the sales method (relying on proposed § 1.861-17) for its taxable year beginning in 2019.

Proposed §§ 1.904-4(e) and 1.904(g)-3 apply to taxable years ending on or after the date the final regulations are filed with the

Federal Register

In general, proposed §§ 1.905-3, 1.905-4, 1.905-5, and 301.6689-1 apply to foreign tax redeterminations (as defined in § 1.905-3(a)) occurring in taxable years ending on or after December 16, 2019, and to foreign tax redeterminations of foreign corporations occurring in taxable years that end with or within a taxable year of a U.S.

shareholder ending on or after December 16, 2019. In the case of foreign tax redeterminations of foreign corporations, proposed § 1.905-3 is limited to foreign tax redeterminations that relate to taxable years of foreign corporations beginning after December 31, 2017, and proposed § 1.905-5 is limited to foreign tax redeterminations that relate to taxable years of foreign corporations beginning before January 1, 2018.

Proposed § 1.965-5(b)(2) applies to taxable years of foreign corporations that end on or after December 16, 2019, and with respect to a United States person, to the taxable years in which or with which such taxable years of the foreign corporations end.

Proposed § 1.1502-4 applies to taxable years for which the original consolidated Federal income tax return is due (without extensions) after December 17, 2019.

Special Analyses

I. Regulatory Planning and Review

Executive Orders 13563 and 12866 direct agencies to assess costs and benefits of available regulatory alternatives and, if regulation is necessary, to select regulatory approaches that maximize net benefits (including potential economic, environmental, public health and safety effects, distributive impacts, and equity). Executive Order 13563 emphasizes the importance of quantifying both costs and benefits, reducing costs, harmonizing rules, and promoting flexibility. The Executive Order 13771 designation for any final rule resulting from these proposed regulations will be informed by comments received.

The proposed regulations have been designated by the Office of Information and Regulatory Affairs (OIRA) as subject to review under Executive Order 12866 pursuant to the Memorandum of Agreement (MOA, April 11, 2018) between the Treasury Department and the Office of Management and Budget regarding review of tax regulations. The Office of Information and Regulatory Affairs (OIRA) has designated these proposed regulations as significant under section 1(b) of the MOA. Accordingly, these proposed regulations have been reviewed by OIRA.

A. Background and Need for the Proposed Regulations

Before the Tax Cuts and Jobs Act (TCJA), the United States taxed its citizens, residents, and domestic corporations on their worldwide income. However, to the extent that a foreign jurisdiction and the United States taxed the same income, this framework could have resulted in double taxation. The U.S. foreign tax credit (FTC) regime alleviated potential double taxation by allowing a non-refundable credit for foreign income taxes paid or accrued that could be applied to reduce the U.S. tax on foreign source income. Although TCJA eliminated the U.S. tax on some foreign source income, the United States continues to tax other foreign source income, and to provide foreign tax credits against this U.S. tax. The changes made by TCJA to international taxation necessitate certain changes in this FTC regime.

The FTC calculation operates by defining different categories of foreign source income (a “separate category”) based on the type of income.

Foreign taxes paid or accrued as well as deductions for expenses borne by U.S. parents and domestic affiliates that support foreign operations are also allocated to the separate categories under similar principles. The taxpayer can then use foreign tax credits allocated to each category against the U.S. tax owed on income in that category. This approach means that taxpayers who pay foreign taxes on income in one category cannot claim a credit against U.S. taxes owed on income in a different category, an important feature of the FTC regime. For example, suppose a domestic corporate taxpayer has $100 of active foreign source income in the “general category” and $100 of passive foreign source income, such as interest income, in the “passive category.” It also has $50 of foreign taxes associated with the “general category” income and $0 of foreign taxes associated with the “passive category” income. The allowable FTC is determined separately for the two categories. Therefore, none of the $50 of “general category” FTCs can be used to offset U.S. tax on the “passive category” income. This taxpayer has a pre-FTC U.S. tax liability of $42 (21 percent of $200) but can claim a FTC for only $21 (21 percent of $100) of this liability, which is the U.S. tax owed with respect to active foreign source income in the general category. The $21 represents what is known as the taxpayer's foreign tax credit limitation. The taxpayer may carry the remaining $29 of foreign taxes ($50 minus $21) back to the prior taxable year and then forward for up to 10 years (until used), and is allowed a credit against U.S. tax on general category foreign source income in the carryover year, subject to certain restrictions.

Prior to the TCJA, these categories were primarily the passive income and general income categories. The TCJA added new separate categories for global intangible low-taxed income (the section 951A category) and foreign branch income.

The proposed regulations are needed to address changes introduced by the TCJA and to respond to outstanding issues raised in comments to the 2018 FTC proposed regulations. In particular, the comments highlighted the following areas of concern: (a) Uncertainty concerning appropriate allocation of R&E expenditures across FTC categories, (b) the need to treat loans from partnerships to partners the same as loans from partners to partnerships with respect to aligning interest income to interest expense, and (c) uncertainty regarding the appropriate level of aggregation (affiliated group versus subgroup) at which expenses of insurance companies should be allocated to foreign source income. In addition, the proposed regulations are needed to expand the application of section 905(c) to cases where a foreign tax redetermination changes a taxpayer's eligibility for the high-taxed exception under subpart F and GILTI.

B. Overview of the Proposed Regulations

These proposed regulations address the following issues: (1) The allocation and apportionment of deductions under sections 861 through 865, including new rules on the allocation and apportionment of research and experimentation (R&E) expenditures and certain deductions of life insurance companies; (2) the definition of financial services income under section 904(d)(2)(D); (3) the allocation of foreign income taxes to the foreign income to which such taxes relate; (4) the interaction of the branch loss and dual consolidated loss recapture rules with sections 904(f) and (g); (5) the effect of foreign tax redeterminations of foreign corporations on the application of the high-tax exception described in section 954(b)(4) (including 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 and related penalty provisions; (6) the definition of foreign personal holding company income under section 954; (7) the application of the foreign tax credit disallowance under section 965(g); and (8) the application of the foreign tax credit limitation to consolidated groups.

C. Economic Analysis

1. Baseline

The Treasury Department and the IRS have assessed the benefits and costs of these proposed regulations relative to a no-action baseline reflecting anticipated Federal income tax-related behavior in the absence of these regulations.

2. Summary of Economic Effects

The proposed regulations provide certainty and clarity to taxpayers regarding the allocation of income, expenses, and foreign income taxes to the separate categories. In the absence of the enhanced specificity provided by these regulations, similarly situated taxpayers might interpret the foreign tax credit provisions of the tax code differently, potentially resulting in inefficient patterns of economic activity. For example, in the absence of the proposed regulations, one taxpayer might have chosen not to undertake research (that is, incur R&E expenses) in a particular location, based on that taxpayer's interpretation of the tax consequences of such expenditures, that another taxpayer, making a different interpretation of the tax treatment of R&E, might have chosen to pursue in that same location. If this difference in interpretations confers a competitive advantage on the less productive enterprise, U.S. economic performance may suffer. The guidance provided in these regulations helps to ensure that taxpayers face more uniform incentives when making economic decisions. In general, economic performance is enhanced when businesses face more uniform signals about tax treatment.

Because the TCJA is new, the Treasury Department and the IRS do not know with reasonable precision the tax interpretations that taxpayers might make in the absence of this guidance. To the extent that taxpayers would generally have interpreted the foreign tax credit rules as being less favorable to the taxpayer than the proposed regulations provide, the proposed regulations may result in additional international activity by these taxpayers relative to the no-action baseline. This additional activity may include both activities that are beneficial to the U.S. economy (perhaps because they represent enhanced international opportunities for businesses with U.S. owners) and activities that are not beneficial (perhaps because they are accompanied by reduced activity in the United States). In essence, the Treasury Department and the IRS recognize that additional foreign economic activity by U.S. taxpayers may be a complement or substitute to activity within the United States and that to the extent these regulations change this activity (relative to the no-action baseline or alternative regulatory approaches), a mix of results may occur.

The Treasury Department and the IRS have not undertaken quantitative estimates of the economic effects of these regulations. The Treasury Department and the IRS do not have readily available data or models to estimate with reasonable precision (i) the tax stances that taxpayers would likely take in the absence of the proposed regulations or under alternative regulatory approaches; (ii) the difference in business decisions that taxpayers might make between the proposed regulations and the no-action baseline or alternative regulatory approaches; or (iii) how this difference in those business decisions will affect measures of U.S. economic performance.

In the absence of such quantitative estimates, the Treasury Department and the IRS have undertaken a qualitative analysis of the economic effects of the proposed regulations relative to the no-action baseline and relative to alternative regulatory approaches. This analysis is presented in part I.C.3 of these Special Analyses.

3. Economic Effects of Specific Provisions

i. Rules for Allocating R&E Expenditures Under the Sales Method

a. Background

Under long-standing foreign tax credit rules, taxpayers must allocate expenditures to income categories. In the case of research and experimentation (R&E) expenditures, taxpayers can elect between a “sales method” and a “gross income method” to allocate the R&E expenses.

If the taxpayer chooses the gross income method, 25 percent of the R&E expenditures are exclusively apportioned to the source where more than 50 percent of the taxpayer's R&E activities occur (generally the United States), and the other 75 percent is apportioned ratably. If a taxpayer chooses the sales method then 50 percent of the R&E expenditures are exclusively apportioned on the same basis, and the other 50 percent is apportioned ratably.

The TCJA created some uncertainty regarding the application of the sales method because of the introduction of the section 951A category. In particular, comments raised issues regarding whether any R&E expenditures should be allocated to the section 951A category. The fact that sales by CFCs generate tested income and tested income is generally assigned to the section 951A category might imply that R&E expenditures should be allocated to the section 951A category. But the fact that royalty payments from the CFC to the U.S. taxpayer (

e.g.,

in remuneration for IP held by the parent that is licensed to the CFC to create the products that are sold) are in the general category implies that R&E expenditures should be allocated to the general category.

The gross income method is based on a different apportionment factor (gross income) as compared to the sales method (gross receipts). However, the gross income method is subject to certain conditions that require the result to be within a certain band around the result under the sales method, because historically the Treasury Department and the IRS have considered that the gross income method could lead to anomalous results and could be more easily manipulated than the sales method.

The uncertainty with respect to R&E expense allocation under the sales method needed resolution, and because the gross income method is tied to the sales method, any changes to the sales method required consideration of the gross income method.

The gross income method is more susceptible to manipulation because taxpayers can manage the type and amount of their foreign gross income by, for example, not paying a dividend and because presuming a factual relationship between the R&E expenditure and the related class of income based on the relative amounts of a taxpayer's gross income was more attenuated than a factual relationship based on sales.

b. Options Considered for the Proposed Regulations

The Treasury Department and the IRS considered three options with respect to the allocation of R&E expenditures to the section 951A category for purposes of calculating the FTC limitation. The first option was to confirm that R&E expenditures are allocated to the section 951A category under the sales method and to otherwise leave their treatment under the gross income method unchanged. The second option was to revise the sales method to provide that R&E expenditures are only allocated to the income that represents the taxpayer's return on intellectual property (thus, R&E expenditures could not be allocated to income from the taxpayer's CFC sales) and otherwise leave their treatment under the gross income method unchanged. The third option was to revise the sales method as considered in the second option and eliminate the gross income method for purposes of allocating R&E expenditures.

The proposed regulations adopt the last option. This option allows for the provision of an allocation and apportionment method for R&E

expenditures that generally matches the expense reasonably with the income it generates. The matching of income and expenses generally produces a more efficient tax system contingent on the overall Code. Additionally, because this option results in no R&E expense being allocated to section 951A category income, it does not incentivize taxpayers with excess credits in the section 951A category to perform R&E through foreign subsidiaries; instead, the chosen option generally incentivizes choosing the location of R&E based on economic considerations rather than tax-related reasons, contingent on the overall Code. Finally, because the proposed regulations adopt the principle of allocating and apportioning R&E expenditures to IP-related income of the U.S. taxpayer, the gross income method is no longer relevant, because it allocates and apportions R&E expenditures to the section 951A category, and section 951A category gross income is not IP income to the U.S. taxpayer.

c. Number of Affected Taxpayers

The Treasury Department and the IRS have determined that the population of affected taxpayers consists of any U.S. taxpayer with R&E expenditures and foreign operations. There are around 2,500 such taxpayers in currently available tax filings from taxable years 2015-2017. Based on Statistics of Income data for 2014, approximately $40 billion of R&E expenses of such taxpayers were allocated to foreign source income, out of a total of $190 billion in qualified research expenses reported by such taxpayers in that year.

Note, however, that these taxpayers might have additional R&E expenses which are not qualified R&E expenses. The tax data do not separately identify such expenses.

ii. Application of Section 905(c) To Changes Affecting the High-Tax Exception

a. Background

Section 905(c) provides special rules for a foreign tax redetermination (FTR), which is when the amount of foreign tax paid in an earlier year (origin year) is changed in a later year (FTR year). This redetermination may be necessary, for example, because the taxpayer gets a refund or because a foreign audit determines that the taxpayer owes additional foreign tax. Since these additional taxes (or refunds) relate to the origin year, an FTR affects a taxpayer's origin year tax position (as well as FTC carryovers from that year).

Prior to TCJA, FTRs of foreign corporations generally resulted in prospective “pooling adjustments” to foreign tax credits. Under this approach, taxpayers simply added to or reduced the amount of foreign taxes in their foreign subsidiary's FTC “pool” going forward rather than amend the deemed paid taxes claimed on their origin year return. TCJA eliminated the pooling mechanism for taxes (because the adoption of a participation exemption system along with the elimination of deferral made it unnecessary) and replaced it with a system where taxes are deemed paid each year with an inclusion or distribution of previously taxed earnings and profits (“PTEP”).

The 2019 FTC final regulations make clear that an FTR of a United States taxpayer must always be accounted for in the origin year, and that the taxpayer must file an amended return reflecting any resulting change in the taxpayer's U.S. tax liability. Section 905(c) provides tools to enforce this amended return requirement. It suspends the statute of limitations with respect to the assessment of any additional U.S. tax liability that results from an FTR, and imposes a civil penalty on taxpayers who fail to notify the IRS (through an amended return) of a FTR. To reflect the repeal of the pooling mechanism, the proposed regulations generally require taxpayers to account for FTRs of foreign subsidiaries on an amended return that reflects revised foreign taxes deemed paid under section 960 and any resulting change in the taxpayer's U.S. tax liability. However, the 2019 FTC final regulations require U.S. tax redeterminations only by reason of FTRs that affect the amount of foreign tax credit taxpayers claimed in the origin year. The rules do not apply to other tax effects, such as when the FTR changes the amount of earnings and profits the taxpayer's CFC had in the origin year, or affects whether or not the CFC's income qualifies for the high-tax exception under GILTI or subpart F.

The interaction of FTRs and the high-tax exception under GILTI and subpart F increases the importance of filing an origin year amended return. In particular, FTRs can give rise to inaccurate origin year U.S. liability calculations in the absence of an amended return precisely because they can change taxpayers' eligibility for the high-tax exception. Therefore, the proposed regulations provide that the section 905(c) rules cover situations in which the FTR affects not only the amount of FTCs taxpayers claimed in the origin year, but also whether or not their CFC's income qualified for the high-tax exception.

b. Options Considered for the Proposed Regulations

The Treasury Department and the IRS considered two options for expanding section 905(c) to cover the high-tax exception. The first option was to limit section 905(c) to changes in the amount of FTCs. The second option was to provide that section 905(c) applies in connection with the high-tax exceptions under GILTI and subpart F.

The proposed regulations adopt the second option. The first option would lead to frequent occurrences of inaccurate results with respect to the GILTI and subpart F high-tax exceptions because it is common for foreign audits to change the amount of tax paid in a prior year. Furthermore, taxpayers would have an incentive to overpay their CFC's foreign tax in the origin year, claim the high-tax exception to avoid subpart F or GILTI inclusions, wait for the 3 year statute of limitations to pass, and then claim a foreign tax refund with the foreign authorities. Without section 905(c) applying, taxpayers would have no obligation or threat of penalty for not amending the origin year return. Although there are FTC regulations that deny a credit if taxpayers make a noncompulsory payment of tax (

i.e.,

taxpayers paid more foreign tax than is necessary under foreign law), those rules are challenging to administer. While taxpayers have the burden to prove that they were legally required to pay the tax, the IRS may need to engage foreign tax law experts to establish that the taxpayer could have successfully fought paying it.

The second option provides a more accurate tax calculation than the first option, and it is instrumental in avoiding abuse. The increased number of amended returns will increase compliance costs for taxpayers, but the Treasury Department and the IRS consider that, in light of the high-tax exception, accurate origin year tax liability calculations necessitate these increased costs; however, the Treasury Department and the IRS solicit comments on this issue.

c. Number of Affected Taxpayers

The Treasury Department and the IRS determined that the proposed regulations potentially affect those U.S. taxpayers that pay foreign taxes and have a redetermination of that tax. Although data reporting the number of taxpayers subject to an FTR in a given year do not exist, some taxpayers currently subject to FTRs will file amended returns. The Treasury Department and the IRS estimate that there are approximately 300 to 600 U.S.

companies with foreign affiliates that file amended returns per year. However, the expansion of the section 905(c) requirement to file an amended return to instances where a FTR changes eligibility for the high-tax exception under GILTI or subpart F has the potential to significantly increase the number of taxpayers filing amended returns. The Treasury Department and the IRS have determined that a high upper bound for the number of taxpayers subject to a FTR that will be required to file amended returns (

i.e.,

taxpayers affected by this provision) can be derived by estimating the number of taxpayers with a potential GILTI or subpart F inclusion. Based on currently available tax filings for taxable years 2015 and 2016, there were about 15,000 C corporations with CFCs that filed at least one Form 5471 with their Form 1120 return. In addition, for the same period, there were about 30,000 individuals with CFCs that e-filed at least one Form 5471 with their Form 1040 return. In 2015 and 2016, there were about 3,000 S corporations with CFCs that filed at least one Form 5471 with their 1120S return. The identified S corporations had an estimated 150,000 shareholders, as an upper bound. Finally, the Treasury Department and the IRS estimate that there were approximately 7,000 U.S. partnerships with CFCs that e-filed at least one Form 5471 as Category 4 or 5 filers in 2015 and 2016. The identified partnerships had approximately 2 million partners, as indicated by the number of Schedules K-1 filed by the partnerships. This number includes both domestic and foreign partners, so it substantially overstates the number of partners that would actually be affected by the final regulations because it includes foreign partners.

iii. Extension of the Partnership Loan Rule to Loans From the Partner to the Partnership

a. Background

The 2019 FTC final regulations provide a rule that aligns interest income and expense when a U.S. partner makes a loan to the partnership. Under this matching rule, the partner's gross interest income is apportioned between U.S. and foreign sources in each separate category based on the partner's interest expense apportionment ratios. This rule minimizes the artificial increase in foreign source taxable income based solely on offsetting amounts of interest income and expense from a related party loan to a partnership. Comments in response to the 2018 FTC proposed regulations requested an equivalent rule when the partnership makes a loan to a U.S. partner.

b. Options Considered for the Proposed Regulations

The Treasury Department and the IRS considered two options with respect to this rule. The first option was to not provide a rule, because the abuse the Treasury Department and the IRS were concerned about was not relevant with respect to loans from the partnership to the partner. In the absence of a matching rule, the U.S. partner's U.S. source taxable income would be artificially increased but this income is not eligible to be sheltered by FTCs. The second option was to provide an identical rule for loans from the partnership to the partner as was provided in the 2019 FTC final regulations for loans from the partner to the partnership. The proposed regulations adopt the second option. This symmetry helps to ensure that similar economic transactions are treated similarly.

c. Number of Affected Taxpayers

The Treasury Department and the IRS consider the population of affected taxpayers to consist of any U.S. partner in a partnership which has a loan from the partnership to the partner or certain other parties related to the partner. The Treasury Department and the IRS estimate that there are approximately 450 partnerships and 5,000 partners that would be affected by this regulation.

iv. Allocation and Apportionment of Expenses for Insurance Companies

a. Background

Section 818(f) provides that for purposes of applying the expense allocation rules to life insurance companies, the deduction for policyholder dividends, reserve adjustments, death benefits, and certain other amounts are treated as items that cannot be definitely allocated to an item or class of gross income. That means, in general, that the expenses are apportioned ratably across all gross income.

Under the expense allocation rules, for most purposes, affiliated groups are treated as a single entity, although there are exceptions for certain expenses. The statute is unclear, however, about how affiliated groups are to be treated with respect to the allocation of certain expenses for insurance companies. Depending on the approach, the results could be different because the gross income categories across the affiliated group could be calculated in multiple ways. The Treasury Department and the IRS received comments and are aware that in the absence of further guidance taxpayers are likely to take opposite positions on this treatment. Some taxpayers argue that the expenses described in section 818(f) are apportioned based on the gross income of the entire affiliated group, while others argue that expenses are apportioned on a separate company or subgroup basis taking into account only the gross income of life insurance companies.

b. Options Considered for the Proposed Regulations

The Treasury Department and the IRS are aware of at least five potential methods for allocating section 818(f) expenses in a life-nonlife consolidated group. First, the expenses might be allocated solely among items of the life insurance company that has the reserves (“separate entity method”). Second, to the extent the life insurance company has engaged in a reinsurance arrangement that constitutes an intercompany transaction (as defined in § 1.1502-13(b)(1)), the expenses might be allocated in a manner that achieves single entity treatment between the ceding member and the assuming member (“limited single entity method”). Third, the expenses might be allocated among items of all life insurance members (“life subgroup method”). Fourth, the expenses might be allocated among items of all members of the consolidated group (including both life and non-life members) (“single entity method”). Fifth, the expenses might be allocated based on a facts and circumstances analysis (“facts and circumstances method”).

In response to the request for comments in the 2018 FTC proposed regulations, the Treasury Department and the IRS received comments advocating for certain of the aforementioned allocation methods. The proposed regulations adopt the separate entity method because it is consistent with section 818(f) and with the separate entity treatment of reserves under § 1.1502-13(e)(2). The Treasury Department and the IRS recognize, however, that this method may create opportunities for consolidated groups to use intercompany transactions to shift their section 818(f) expenses and achieve a more desirable foreign tax credit result. Accordingly, the Treasury Department and the IRS request comments on whether a life subgroup method more accurately reflects the relationship between section 818(f) expenses and the income producing activities of the life subgroup as a whole, and whether the life subgroup method is less susceptible to abuse

because it might prevent a consolidated group from inflating its foreign tax credit limitation through intercompany transfers of assets, reinsurance transactions, or transfers of section 818(f) expenses. The Treasury Department and the IRS also request comments regarding the appropriate application of § 1.1502-13(c) to neutralize the ancillary effects of separate-entity computation of insurance reserves, such as the computation of limitations under section 904.

c. Number of Affected Taxpayers

The Treasury Department and the IRS have determined that the population of affected taxpayers consists of life insurance companies that are members of an affiliated group. The Treasury Department and the IRS have established that there are approximately 60 such taxpayers.

II. Paperwork Reduction Act

For purposes of the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) (“PRA”), there is a collection of information in proposed §§ 1.905-4 and 1.905-5(b).

When a redetermination of U.S. tax liability is required by reason of a foreign tax redetermination (FTR), the proposed regulations generally require the taxpayer to notify the IRS of the FTR and provide certain information necessary to redetermine the U.S. tax due for the year or years affected by the FTR. If there is no change in the U.S. tax liability as a result of the FTR or if the FTR is caused by certain de minimis fluctuations in foreign currency rates, the taxpayer may simply attach the notification to their next filed tax return and make any appropriate adjustments in that year. However, taxpayers are generally required to file an amended return (or an administrative adjustment request in the case of certain partnerships) for the year or years affected by the FTR along with an updated Form 1116 Foreign Tax Credit (Individual, Estate, or Trust) (covered under OMB Control Number 1545-0074 individual, or 1545-0121 estate and trust) or Form 1118 Foreign Tax Credit-Corporations (OMB Control Number 1545-0123), and a written statement providing specific information relating to the FTR. Since the burden for filing amended income tax returns and the Forms 1116 and 1118 are covered under the OMB Control Numbers listed in the prior sentence, the burden estimates for OMB Control Number 1545-1056 only cover the burden for the written statements.

For purposes of the PRA, the reporting burden associated with proposed §§ 1.905-4 and 1.905-5(b) will be reflected in the PRA submission associated with OMB control number 1545-1056, which is set to expire on December 31, 2020. The number of respondents to this collection was estimated at 13,000 and the total estimated burden time was estimated to be 54,000 hours and total estimated monetized costs of $2,430,540 ($2016).

For taxpayers who are required to file an amended return (along with related Form 1116 or Form 1118) in order to report an FTR, and for purposes of the PRA, the reporting burden for filing the amended return will be reflected in OMB control numbers 1545-0123 (relating to business filers, which represents a total estimated burden time, including all related forms and schedules, of 3.157 billion hours and total estimated monetized costs of $58.148 billion ($2017)), 1545-0074 (relating to individual filers, which represents a total estimated burden time, including all related forms and schedules, of 1.784 billion hours and total estimated monetized costs of $31.764 billion ($2017)), and 1545-0121 (relating to estate and trust filers, which represents a total estimated burden time, including all related forms and schedules, of 25,066,693 hours). These overall burden estimates for OMB control numbers 1545-0123, 1545-0074, and 1545-0121 include, but do not isolate, the estimated burden of the foreign tax credit-related forms as a result of the information collection in the proposed regulations. These numbers are therefore unrelated to the future calculations needed to assess the burden imposed by the proposed regulations. These burdens have also been reported for other regulations related to the taxation of cross-border income and the Treasury Department and the IRS urge readers to recognize that these numbers are duplicates and to guard against overcounting the burden that international tax provisions imposed prior to the TCJA.

As a result of the changes made in the TCJA to the foreign tax credit rules generally, and to section 905(c) specifically, the Treasury Department and the IRS anticipate that the number of respondents may increase modestly among taxpayers who file Form 1120 series returns. The possible increase in the number of respondents is due to the elimination of adjustments to pools of post-1986 earnings and profits and post-1986 foreign income taxes as an alternative to filing an amended return following the changes made in the TCJA. These changes to the burden estimate will be reflected in the PRA submission for the renewal of OMB control number 1545-1056 as well as in the OMB control numbers 1545-0074 (for individuals) and 1545-0123 (for business taxpayers).

The estimates for the number of impacted filers with respect to the collections of information described in this Part II of the Special Analyses are based on filers of income tax returns that file a Form 1065, Form 1040, or Form 1120 series because only filers of these forms are generally subject to the collection of information requirement. The IRS estimates the number of impacted filers to be the following:

Tax Forms Impacted

Collection of information

Number of

respondents

(estimated)

Forms to which the information may be attached

§ 1.905-4

8,900-11,700

Form 1065 series, Form 1040 series, and Form 1120 series.

§ 1.905-5(b)

8,900-11,700

Form 1065 series, Form 1040 series, and Form 1120 series.

The Treasury Department and the IRS request comments on all aspects of information collection burdens related to these proposed regulations, including estimates for how much time it would take to comply with the paperwork burdens described in this Part II of the Special Analyses and ways for the IRS to minimize the paperwork burden. No burden estimates specific to the proposed regulations are currently available. The Treasury Department has not estimated the burden, including that of any new information collections, related to the requirements under the proposed regulations. Those estimates would capture both changes made by the TCJA and those that arise out of

discretionary authority exercised in the proposed regulations. The Treasury Department and the IRS welcome comments on all aspects of information collection burdens related to the foreign tax credit. In addition, when available, drafts of IRS forms are posted for comment at

https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.

III. Regulatory Flexibility Act

Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that the proposed regulations will not have a significant economic impact on a substantial number of small entities within the meaning of section 601(6) of the Regulatory Flexibility Act.

The proposed regulations provide guidance needed to comply with statutory changes and affect individuals and corporations claiming foreign tax credits. The domestic small business entities that are subject to the foreign tax credit rules in the Code and in the proposed regulations are generally those domestic small business entities that are at least 10 percent corporate shareholders of foreign corporations, and so are eligible to claim dividends-received deductions or compute foreign taxes deemed paid under section 960 with respect to inclusions under subpart F and section 951A from CFCs. Other aspects of these proposed regulations also affect domestic small business entities that operate in foreign jurisdictions or that have income from sources outside of the United States. Based on 2017 Statistics of Income data, the Treasury Department and the IRS computed the fraction of taxpayers owning a CFC by gross receipts size class. The smaller size classes have a relatively small fraction of taxpayers that own CFCs, which suggests that many domestic small business entities would be unaffected by these regulations.

Many of the important aspects of the proposed regulations, including all of the rules in proposed §§ 1.861-8(d)(2)(ii)(B), 1.904-4(c)(7), 1.904-6(f), 1.905-3(b)(2), 1.905-5, 1.954-1, 1.954-2, and 1.965-5(b)(2) apply only to U.S. persons that operate a foreign business in corporate form, and, in most cases, only if the foreign corporation is a CFC. Because it takes significant resources and investment for a business to operate outside of the United States in corporate form, and in particular to own a CFC, the owners of such businesses will infrequently be domestic small business entities, as indicated by the Table. Other provisions in the proposed regulations, including the rules in proposed §§ 1.861-8(d)(2)(v), 1.861-8(e)(16), 1.861-14, 1.904-4(e), 1.1502-4, and 1.1502-21, generally apply only to members of a consolidated group and insurance companies or other members of the financial services industry earning income from sources outside of the United States. It is infrequent for domestic small entities to operate as part of an affiliated group, to be taxed as an insurance company, or to constitute a financial services entity, and also earn income from sources outside of the United States. Consequently, the Treasury Department and the IRS project that the proposed regulations are unlikely to affect a substantial number of domestic small business entities, however adequate data are not available at this time to certify that a substantial number of small entities would be unaffected.

Fraction of U.S. Corporate Taxpayers Reporting CFC Ownership, by Gross Receipts Size Class

Gross receipts size class

Percentage with a CFC

<1 mil

0.40

1-5 mil

0.80

5-10 mil

2.70

10-20 mil

4.50

20-30 mil

9.30

30-50 mil

12.00

50-100 mil

19.70

100-150 mil

26.80

150-200 mil

32.50

200-250 mil

37.40

250-500 mil

43.70

>=500 mil

63.50

* Data based on 2017 Statistics of Income sample for all 1120 returns except 1120-S and return type=2 (1120-L, 1120-RIC, 1120-F, 1120-REIT, 1120-PC,1120, 1120-L Consolidated 1504c return (controlling industries 524142 and 524143),1120-PC Consolidated 1504C return (controlling industries 524156, 524159), and 1120 Section 594/1504c consolidated return (controlling industries not 524142, 524143, 524156, 524159), 1120 Non-consolidated return).

The Treasury Depart

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.