Treasury Issues Guidance on Foreign Tax Credit, Global Minimum Tax
Treasury Issues Guidance on Foreign Tax Credit, Global Minimum Tax
Treasury and the IRS on December 11 issued Notice 2023-80, a preview of guidance on the interaction of the U.S. foreign tax credit (FTC) rules and Pillar Two. The notice also provides guidance on the interaction of the dual consolidated loss (DCL) rules and Pillar Two, a temporary extension of the December 2021 foreign tax credit rules, and additional rules on the application of Notice 2023-55 to partnerships.
Pillar Two GloBE Model Rules
The Pillar Two GloBE model rules require multinational enterprise (MNE) groups with annual revenue of EUR 750 million or more to pay a minimum level of tax on the income arising in each jurisdiction in which they operate. The proposed taxes under the GloBE regime are collected through an income inclusion regime (IIR), an undertaxed payments rule (UTPR), or a qualified domestic minimum top-up tax (QDMTT). These rules kick in for jurisdictions where the MNE group’s effective tax rate (ETR) is less than 15%.
The GloBE rules operate so that taxes are imposed in the following order of priority:
- Covered taxes (other than controlled foreign corporation (CFC) taxes and certain cross-border taxes).
- CFC Tax regimes.
For example, a QDMTT is computed without regard to taxes paid under a CFC tax regime.
Several jurisdictions have enacted or proposed legislation to implement the GloBE model rules for the IIR and QDMTT for tax years beginning on or after December 31, 2023. For an overview of the Pillar Two GloBE model rules, see BDO’s prior analysis, Two-Pillar Rules Could Impact Multinational Groups Long-Term | BDO.
Treasury and the IRS on July 21, 2023, issued Notice 2023-55, which gave taxpayers the choice to follow the pre-2021 FTC creditability rules for tax years 2022 and 2023. If a foreign tax was creditable prior to the issuance of the final FTC regulations in December 2021, it is expected to be creditable under the temporary relief, subject to certain limitations and eligibility requirements. For an overview of Notice 2023-55, see Notice 2023-55 Offers Temporary Relief from Final FTC Rules | BDO.
Interaction of U.S. FTC Rules & Pillar Two
Notice 2023-80 provides much-needed guidance on the interaction of the U.S. FTC rules, the IIR, and the QDMTT. The notice generally provides that no FTC is allowed for a “final top-up tax.” A final top-up tax is defined as a foreign income tax (tested tax) if, in computing the tested tax, the foreign tax law takes into account:
- The amount of tax imposed on the direct or indirect owners of the entity subject to the tested tax by other countries (including the U.S.) with respect to the income subject to the tested tax, or
- In the case of an entity subject to the tested tax on income attributable to its branch in the foreign country imposing the tested tax, the amount of tax imposed on the entity by its country of residence with respect to such income.
- Under this rule, an IIR should be considered a final top-up tax because it takes into account CFC tax regimes in computing the ETR of a jurisdiction and for applying the top-up tax. There are two exceptions to the general rule of non-creditability for final top-up taxes:
- Minority owners of a CFC will generally be able to take the FTC for a final top-up tax because minority owners generally should not be considered part of the same MNE group as the majority owners and the minority owner’s U.S. tax liability should not be taken into account in computing the final top-up tax.
- A final top-up tax should be considered a creditable tax at the partnership and CFC levels. The foreign tax credit disallowance described above should be applied at the partner or U.S. shareholder level.
In some instances, a final top-up tax could be considered creditable to one partner (or U.S. shareholder), but not to another partner (or U.S. shareholder) depending on the makeup of the MNE group.
A QDMTT should not be considered a final top-up tax because it generally does not take into account CFC tax regimes or other taxes on the direct or indirect owners of the entity in calculating the QDMTT liability. Therefore, under the proposal, taxes under a QDMTT should generally be considered creditable for U.S. federal income tax purposes (with some exceptions).
The notice provides that a final top-up tax is not taken into account in determining whether the Subpart F high-tax exception or the global intangible low-taxed income (GILTI) high-tax exemption applies. Additionally, proposed regulations will be issued amending the non-duplication requirement under Treas. Reg. §1.903-1(c)(1)(ii). It is anticipated that the proposed regulations described in the notice will be applicable for tax years ending after December 11, 2023.
Interaction of DCLs and GloBE Model Rules
A dual consolidated loss (DCL) is generally defined as a net operating loss of a dual resident corporation and a net loss of a domestic corporation that is attributable to certain foreign branches or interests in hybrid entities (separate units). In some cases, for a domestic corporation to use a DCL to offset its U.S. income, it must make a domestic use election under Section 1503(d). A taxpayer generally may not make a domestic use election if there is a foreign use of a dual consolidated loss.
Some issues have arisen with regard to whether there is a foreign use of a DCL if the foreign losses are used to offset GloBE income. The IRS is aware of these issues and will address them in future guidance. The notice provides some relief for “legacy DCLs” by stipulating that a foreign use is not considered to occur with respect to legacy DCLs if the losses comprising the legacy DCLs are taken into account in determining the net GloBE income of a jurisdiction. Legacy DCLs are generally DCLs incurred in taxable years ending on or before Dec. 31, 2023. A taxpayer can generally rely on these rules until further proposed regulations are published.
Notice 2023-55 – Extension & Clarification
As discussed above, Notice 2023-55 gave taxpayers the choice to follow the pre-2021 FTC creditability rules for tax years 2022 and 2023. If a foreign tax was creditable prior to the issuance of the final FTC regulations in December 2021, it is expected to be creditable under the temporary relief, subject to certain limitations and eligibility requirements.
Notice 2023-80 extends the relief period granted under Notice 2023-55 to “taxable years beginning on or after December 28, 2021 and ending before the date that a notice or other guidance withdrawing or modifying the temporary relief is issued.”
The notice also clarifies that with respect to foreign taxes paid or otherwise required to be reported by a partnership, the partnership would apply the temporary relief provided in Notice 2023-55. However, if before December 11, 2023, a partnership did not apply the temporary relief for tax year 2022, a partner may apply the temporary relief for its share of the partnership’s tax year 2022 foreign taxes. Partnerships and their partners are each subject to the consistency requirements, the single-benefit requirement (e.g., they cannot apply the relief while also claiming a deduction for the same foreign taxes), and the application or nonapplication of the temporary relief by a partnership is binding on the partners, unless the partner does not control the partnership’s decision on whether to apply the relief (which is a facts-and-circumstances determination).