Article featured on Thomson Reuters' Taxnet Pro, December 2019.

Leave it to the IRS and Treasury Department to officially kick off the holiday season, gifting us this week with new regulation packages on foreign tax credits (“FTC”) and the base erosion and anti-abuse tax (“BEAT”). In a surprise double feature, the IRS modified and finalized rules that have remained in proposed form for months, while also issuing new proposed rules of immediate interest to the international tax community. In this edition of Tax Advisor Weekly, we will focus on the FTC regulations, highlighting some changes in the final rules and a few surprises out of the new proposals. Given the timing of their release, these regulations will be of immediate importance to taxpayers looking to make estimated tax payments, preparing for year-end provisions, and budgeting their cash tax obligations.

Foreign Tax Credits

The Tax Cuts and Jobs Act (“TCJA”) significantly expanded the taxation of US persons’ foreign earnings, demanding even more guidance in the already-complex area of FTCs. The advent of the Global Intangible Low-Taxed Income (“GILTI”) regime forced many taxpayers who previously relied on deferral of foreign income to dive into the FTC arena for the first time. Further, the addition of new Sec. 904 limitation baskets required substantial guidance on the application of legacy rules such as expense allocation, plus rules on how to transition to the new regime.

Proposed regulations issued in December 2018 were helpful in addressing a large scope of issues, such as attributing foreign taxes to different categories of income, allocating and apportioning expenses to the various FTC limitation baskets, and transitioning pre-TCJA attributes into the new FTC regime.

This week’s final FTC regulations largely adopt last year’s guidance, with a few notable changes and newly proposed rules, including:

• Proposed rules that provide that research and development expenses are not allocated or apportioned to dividends, Subpart F, or GILTI.
• Proposed rules providing that stewardship expenses are allocated and apportioned according to tax basis, similar to interest expense.
• Expanded guidance in the proposed regulations on allocating and apportioning foreign taxes to the income to which they relate, including the impact of timing and base differences. Further, updates to the redetermination rules will likely require amended returns to update foreign tax credit calculations when foreign tax amounts change.
• Simplified safe harbor transition rules for moving pre-TCJA general limitation FTC carryovers into the foreign branch basket, as well for as general basket overall foreign losses, separate limitation losses, and foreign components of net operating losses.
• Coordination between Sec. 861 expense allocation and Sec. 250 deduction regulations around the treatment of assets that give rise to the Foreign Derived Intangible Income (“FDII”) deduction.
• Reduction of the number of previously-taxed earnings and profits (“PTEP”) categories from 16 to 10.
• Limitation on the application of the foreign branch disregarded payment rules to transfers of intangible property occurring prior to the issuance of the 2018 proposed regulations.
• Change to the modified gross income method of allocating and apportioning interest expense at the controlled foreign corporation (CFC) level, requiring CFCs to look through to lower-tier CFCs and tier up gross tested income.
• Ability for corporate general partners who hold less than 10% of a partnership to characterize their distributive share of income by looking through to the character of income in the hands of the partnership (rather than defaulting to passive).

Of most significant to many taxpayers is the proposed rules on R&D expense apportionment. For companies who had assumed that a high-rate of foreign tax would eliminate the effect of GILTI, these proposals offer some relief, in the form of a higher Sec. 904 limitation

Many of the other areas of the final and proposed regulations address highly-specific fact patterns with less broad application, so taxpayers should carefully review their existing calculations against the full body of rules over the coming days. The items with more general applicability largely address complex rules around categorizing income or assets into the various statutory groupings. To that end, taxpayers ought to be revisiting their basketing calculations and updating their FTC limitation models in advance of the upcoming income tax provision season.

Applicability Dates – The specific applicability dates of the final regulations vary, depending on the relation of the rules to the TCJA. However, the full breadth of the final rules is applicable for 2019 tax years. Newly proposed regulations are largely applicable only after finalized, although select portions may be applicable earlier. Taxpayers relying on these rules should carefully review the applicability date specified for each regulation.

Alvarez & Marsal Taxand Says

This week’s guidance will demand a quick digest for many multinational corporations, with both Dec. 15 estimated payments and year end provision calculations looming for calendar year filers. Of immediate importance is reviewing prior models and assumptions, and whether the new rules have a material impact on prior positions for the 2019 year or future projections. We are working with clients immediately to identify the relevant changes and update documentation for upcoming attest firm review, while modeling the future impact of the proposed rules, if finalized in their current form.

Be on the lookout over the coming days for our discussion of the final and proposed BEAT regulations.