On December 14th, the IRS and Treasury released Notice 2019-1 addressing questions about previously taxed E&P (PTEP) in the post-TCJA world. The Notice is a 21-page preview of the impending proposed regulations under sections 959 and 961, largely focused on nuances related to the new PTEP group regime. Taxpayers should expect to apply the guidance for years ending after the Notice’s issuance (i.e., calendar year 2018), creating a short window to absorb what the IRS itself proclaims as “complex” rules with “administrative and compliance challenges.” We have sifted through the density to provide a brief overview of the rules described within the Notice.
16 PTEP Groups (Within each section 904 category)
The Notice adds six additional PTEP groups to the list of ten called for in the proposed regulations under section 960 (deemed paid credit) released earlier this month. As set forth in the proposed 960 regulations, there may be upwards of nine section 904 categories. A controlled foreign corporation (CFC) and its U.S. shareholders must maintain PTEP groups within each section 904 category, representing each type of U.S. shareholder income inclusion (legacy Subpart F, section 956, toll-charge (section 965), GILTI (section 951A) etc.), including groups under code sections which Congress has since repealed (section 956A, dealing with excess passive assets). Thus, the total number of PTEP groups will depend on the number of Section 904 Categories the CFC has and the types of PTEP within each category. Some CFCs may only have one or two section 904 categories and only one or two PTEP groups within each category. CFCs fitting that description would only have four or fewer PTEP groups. But for CFCs with diverse holdings and operations, there could conceivably be several dozen PTEP groups. Further, a PTEP group may not fall cleanly into one of the section 904 categories. To the extent that a PTEP group overlaps section 904 categories, any distribution out of that PTEP group is treated as made pro-rata from PTEP in each section 904 category.
Each year, a taxpayer maintains the 16 groups within an annual account for each section 904 category. If distributed or reclassified (as a result of an investment in U.S. property under section 956) in a subsequent year, an item of income stays in the annual account to which it was originally assigned but is reclassified to a different PTEP group. The Notice also suggests that the proposed regulations will necessitate tracking U.S. dollar basis at the level of each PTEP group within each annual account. Doing so will facilitate foreign exchange gain or loss calculations required under section 986 when PTEP is distributed, many of which may carry a cash tax impact.
Annual PTEP accounts for taxable years ending on or before December 14, 2018, are slightly less detailed. A taxpayer may aggregate multiple years of section 956, section 956A, and legacy Subpart F groups into one average U.S. dollar basis account for the last taxable year prior to the applicability date. One notable exception to the transitory relief is that in a taxpayer’s toll charge year, they must segregate the section 965 PTEP groups in accordance with the proposed guidance.
As an exception to the general last-in-first-out (LIFO) approach for sourcing PTEP distributions, the Notice prioritizes distributions of toll-charge PTEP. Under section 959(a), distributions are made first from section 956 and 956A PTEP, second from other PTEP, and third from undistributed, untaxed E&P. The Notice layers the prioritization of section 965 PTEP groups into this general ordering principle. Specifically, distributions are made from E&P in the following order: reclassified section 965 PTEP groups, remaining section 956 PTEP groups (using LIFO), 965 PTEP groups, remaining other PTEP groups (using LIFO), and, lastly, undistributed, untaxed E&P.
Income Inclusions Exceeding E&P
GILTI inclusions are not subject to an E&P limitation (unlike legacy Subpart F income). The Notice addresses the adjustments required for years in which an income inclusion exceeds the CFC’s current E&P. Current E&P is first characterized as undistributed, untaxed E&P and then reallocated to section 956 PTEP and other PTEP as appropriate, which may have the effect of creating or increasing a deficit in undistributed E&P. This rule ensures that the sum of section 956 PTEP, other PTEP, and undistributed, untaxed E&P equals the total current E&P of the foreign corporation even when income inclusions exceed current E&P in a given year.
Alvarez & Marsal Says
The complicated PTI account maintenance provided for in Notice 2019-01 leaves even the IRS asking for suggestions on simplification. Despite acknowledging the associated challenges, the IRS made the rules almost immediately applicable to calendar year taxpayers. Fortunately, the transition rules provide taxpayers an opportunity to begin to establish the process for tracking this breadth of data on a somewhat smaller scale. Proper attention to creating a PTEP database in this transitional period will be essential to accurate and efficient reporting in the future. Reach out to us for assistance in building this foundation in your organization.