Treasury Issues Proposed and Final Regulations Relating to GILTI and Other International Provisions
Treasury Issues Proposed and Final Regulations Relating to GILTI and Other International Provisions
On June 14, 2019, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued proposed regulations (REG-101828-19) regarding the treatment of domestic partnerships for purposes of determining amounts included in the gross income of their partners with respect to foreign corporations. In addition, the proposed regulations include rules regarding gross income that is subject to a high rate of foreign tax under the global intangible low-taxed income (GILTI) provisions. The proposed regulations would affect U.S. persons that own stock of foreign corporations through domestic partnerships and U.S. shareholders of foreign corporations.
In addition, Treasury issued final and temporary regulations (T.D. 9866) that provide guidance to determine the amount of GILTI included in gross income of certain U.S. shareholders of foreign corporations, including U.S. shareholders that are members of a consolidated group. The final regulations also include guidance relating to the determination of a U.S. shareholder’s pro rata share of a controlled foreign corporation’s (CFC) Subpart F income included in the shareholder’s gross income, as well as certain reporting requirements relating to inclusions of Subpart F income and GILTI. Moreover, the final regulations also include rules relating U.S. persons that own stock of foreign corporations through domestic partnerships for purposes of computing inclusions under GILTI, and contain rules relating to certain foreign tax credit provisions applicable to persons that directly or indirectly own stock in foreign corporations.
This tax alert highlights some of the key items included in the proposed and final regulations.
1. Proposed Regulations
a. Adoption of Aggregate Treatment for Purposes of Section 951
The proposed regulations provide that a domestic partnership is treated consistently as an aggregate of its partners in determining the ownership of stock within the meaning of Section 958(a) for purposes of Sections 951, and any provision that applies by reference to Section 951. In other words, the proposed regulations treat a domestic partnership as an aggregate of its partners for purposes of determining its partners’ Subpart F income and Section 956 inclusions. This aggregate treatment does not apply, however, for purposes of determining whether a U.S. person is a U.S. shareholder, whether a U.S. shareholder is a controlling domestic shareholder (as defined in §1.964-1(c)(5)), and whether a foreign corporation is a CFC. This aggregate treatment also does not apply for any other purpose of the Code, including for purposes of Section 1248.
These proposed regulations are proposed to apply to taxable years of foreign corporations beginning on or after the publication date of the Treasury decision to adopt these rules as final regulations in the Federal Register (the finalization date), and to taxable years of a U.S. person in which or with which such taxable years of foreign corporations end. However, with respect to taxable years of foreign corporations beginning before the finalization date, the proposed regulations provide that a domestic partnership may apply these rules to taxable years of a foreign corporation beginning after December 31, 2017, and to taxable years of the domestic partnership in which or with which such taxable years of the foreign corporation end provided certain conditions are satisfied. See the proposed regulations for details.
b. GILTI High Tax Exclusion
The proposed regulations provide that an election may be made for a CFC to exclude under Section 954(b)(4), and thus to exclude from gross tested income, gross income subject to foreign income tax at an effective rate that is greater than 90 percent of the rate that would apply if the income were subject to the maximum rate of tax specified in Section 11 (18.9 percent based on the current rate of 21 percent). The proposed regulations also include various rules such as (i) how to make the election, (ii) who is bound by the election, (iii) revoking the election, and (iv) determining whether income is subject to high foreign income taxes.
The changes related to the election to exclude a CFC’s gross income subject to high foreign income taxes under Section 954(b)(4) are proposed to apply to taxable years of foreign corporations beginning on or after the date that final regulations are published in the Federal Register, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.
Applying an aggregate approach to determine stock owned under Section 958(a) for purposes of Section 951 is consistent with the treatment of domestic partnerships under Section 951A in the final regulations (see discussion below) and should harmonize the two regimes.
It should be noted that until the GILTI High Tax Exclusion regulations are effective, a taxpayer may not exclude any item of income from gross tested income under Section 951A(c)(2)(A)(i)(III) unless the income would be foreign base company income (FBCI) or insurance income but for the application of Section 954(b)(4) and §1.954-1(d).
2. Final Regulations
The final regulations retain the basic approach and structure of the GILTI proposed regulations issued in October 2018 (REG-104390-18) and the foreign tax credit proposed regulations issued in December 2018 (REG-105600-18) with certain revisions. For a summary discussion of the GILTI proposed regulations see our September 2018 alert and see our December 2018 alert for a summary discussion of the foreign tax credit proposed regulations.
a. Pro Rata Share Anti-abuse Rule
Proposed §1.951-1(e)(6) provides that any transaction or arrangement that is part of a plan a principal purpose of which is the avoidance of federal income taxation, including, but not limited to, a transaction or arrangement to reduce a U.S. shareholder’s pro rata share of the Subpart F income of a CFC, which transaction or arrangement would otherwise avoid federal income taxation, is disregarded in determining such U.S. shareholder’s pro rata share of the Subpart F income of the corporation (the pro rata share anti-abuse rule). The pro rata share anti-abuse rule also applies in determining the pro rata share of each tested item of a CFC for purposes of determining a U.S. shareholder’s GILTI inclusion amount under Section 951A(a) and §1.951A -1(b).
The final regulations clarify that the anti-abuse rule applies only to require appropriate adjustments to the allocation of allocable E&P that would be distributed in a hypothetical distribution with respect to any share outstanding as of the hypothetical distribution date. Thus, under the rule, if applicable, adjustments will be made solely to the allocation of allocable E&P in the hypothetical distribution between shareholders that own, directly or indirectly, stock of the CFC as of the relevant hypothetical distribution date. As clarified, the rule will not apply to adjust the allocable E&P allocated to a shareholder by reason of a transfer of CFC stock, except by reason of a change to the distribution rights with respect to stock in connection with such transfer (for example, an issuance of a new class of stock, including by recapitalization).
b. Gross Income Excluded by Reason of Section 954(b)(4)
The final regulations retain the GILTI high tax exclusion from the October 2018 GILTI proposed regulations without modification. However, see the discussion above in section 1.b. regarding the new proposed GILTI High Tax Exclusion regulations and our BDO Insights discussing when a taxpayer may apply such rules.
c. Section 952(c) Coordination Rule and Coordination with De Minimis Rule, Full Inclusion Rule and High Tax Exception
The final regulations adopt the Section 952(c) coordination rule in proposed §1.951A-2(c)(4)(i) but revises the rule to apply also to disregard the effect of a qualified deficit or a chain deficit in determining gross tested income.
The final regulations also include rules that coordinate the Subpart F exclusion in Section 951A(c)(2)(A)(i)(II) with the de minimis rule, full inclusion rule, and high tax exception to Subpart F income.
d. Deduction or Loss Attributable to Disqualified Basis
The final regulations broaden the rule in proposed §1.951A-2(c)(5) and treat any deduction or loss attributable to disqualified basis as not “properly allocable” to gross tested income, Subpart F income, or effectively connected income of the CFC. In addition, this rule in the final regulations applies to deductions or losses attributable to disqualified basis in any property, other than property described in Section 1221(a)(1), regardless of whether the property is of a type with respect to which a deduction is allowable under Section 167 or 197 (as compared to the rule in the proposed regulations that only applied to deductions or losses attributable to property that is of a type with respect to which a deduction is allowable under Section 167 or 197).
e. Determination of Basis under Alternative Depreciation System (ADS)
The final regulations provide that a CFC that is not required to use ADS for purposes of computing income and E&P may elect, for purposes of calculating QBAI, to use its non-ADS depreciation method to determine the adjusted basis in specified tangible property placed in service before the first taxable year beginning after December 22, 2017, subject to a special rule related to salvage value. The election also applies to the determination of a CFC’s partner adjusted basis under §1.951A-3(g)(3) in partnership specified tangible property placed in service before the CFC’s first taxable year beginning after December 22, 2017.
The preamble to the final regulations confirms that a CFC does not need the Commissioner’s consent to use ADS for purposes of determining its adjusted basis in specified tangible property in determining its QBAI. However, a change to ADS from another depreciation method for purposes of computing tested income or tested loss is a change in method of accounting subject to Section 446(e). In the preamble, Treasury states that it intends to publish another revenue procedure further expanding the availability of automatic consent for depreciation changes and updating the terms and conditions in Sections 7.07 and 7.09 of Rev. Proc. 2015-13 (related to the source, separate limitation classification, and character of Section 481(a) adjustments) to take into account Section 951A.
Also, the final regulations clarify that the period in the CFC inclusion year to which such depreciation relates is determined without regard to the applicable convention under Section 168(d). Accordingly, in the year property is placed in service, the depreciation deduction allowed for the taxable year is prorated from the day the property is actually placed in service, and in the year property is disposed of, the depreciation deduction allowed for the taxable year is prorated to the date of disposition.
f. Definition of Tested Interest Expense and Tested Interest Income and Interest Expense Paid or Accrued by a Tested Loss CFC
The final regulations define “interest expense” and “interest income” by reference to the definition of interest expense and interest income under Section 163(j). In addition, the final regulations reduce a tested loss CFC’s tested interest expense by its tested loss QBAI amount, an amount equal to 10 percent of the QBAI that the tested loss CFC would have had if it were instead a tested income CFC.
g. Adoption of Aggregate Treatment for Purposes of Determining GILTI Inclusion Amounts
Rather than adopting the hybrid approach that was included in the proposed regulations, the final regulations provide that, in general, for purposes of Section 951A and the Section 951A regulations, and for purposes of any other provision that applies by reference to Section 951A or the Section 951A regulations (for instance, Sections 959, 960, and 961), a domestic partnership is not treated as owning stock of a foreign corporation within the meaning of Section 958(a). Rather, the partners of a domestic partnership are treated as owning proportionately the stock of CFCs owned by the partnership in the same manner as if the partnership were a foreign partnership under Section 958(a)(2). Because a domestic partnership is not treated as owning Section 958(a) stock for purposes of Section 951A, a domestic partnership does not have a GILTI inclusion amount and thus no partner of the partnership has a distributive share of a GILTI inclusion amount. Furthermore, because only a U.S. shareholder can have a pro rata share of a tested item of a CFC under Section 951A(e)(1) and §1.951A-1(d), a partner that is not a U.S. shareholder of a CFC owned by the partnership does not have a pro rata share of any tested item of the CFC. These final regulations apply to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end. Given these changes, domestic partnerships that have already filed tax returns applying the rules in the prior GILTI proposed regulations may need to consider amending or superseding their tax returns and also revising their K-1s based on the final regulations.
The final regulations provide that the aggregation rule for domestic partnerships does not apply for purposes of determining whether a U.S. person is a U.S. shareholder, whether a U.S. shareholder is a controlling domestic shareholder (as defined in §1.964-1(c)(5)), or whether a foreign corporation is a CFC.
h. Adjustments to Basis Related to Net Used Tested Loss
The final regulations do not adopt the rules in proposed §1.951A-6(e) related to downward adjustments to the adjusted basis in stock of a tested loss CFC to the extent its tested loss was used to offset tested income of another CFC. Treasury states in the preamble that rules related to basis adjustments will be considered in a separate project and any such rules will apply only with respect to tested losses incurred in taxable years of CFCs and their U.S. shareholders ending after the date of publication of any future guidance.
i. Consolidated Groups
The final regulations generally adopt the aggregation approach from the proposed regulations without substantial changes. However, the special rules for consolidated groups related to basis adjustments to member stock is reserved. In addition, the final regulations also do not finalize the rules in proposed §1.1502-32(b)(3)(ii)(F) that would treat a member as receiving tax-exempt income immediately before another member recognizes income, gain, deduction, or loss with respect to a share of the first member’s stock (the F adjustment). As a result, taxpayers may not rely on the F adjustment.
j. Regulations under Sections 78, 861 and 965
The final regulations also finalize certain rules included in the foreign tax credit proposed including:
- Rules that do not treat dividends under Section 78 that relate to taxable years of foreign corporations that begin before January 1, 2018 (as well as Section 78 dividends that relate to later taxable years), as dividends for purposes of Section 245A.
- Rules on adjusting stock basis in CFC stock taking into account Section 965 basis adjustment elections.
- Rules related to the Section 965(n) election to forgo use of a net operating loss.
k. Applicability Dates
For dates of applicability, see §§1.78-1(c), 1.861-12(k), 1.951-1(i), 1.951A-7, 1.1502-51(g), 1.6038-2(m), and 1.6038-5(e).
For additional details, along with other revisions and clarifications included in the final regulations that are not discussed in this tax alert, see the final regulations.
While the final regulations largely adopt the proposed regulations, certain key modifications were made that could substantially alter a taxpayer’s GILTI inclusion amount. Please contact a BDO international tax specialist for assistance in understanding and applying the final regulations.
 See proposed §1.958-1(d).
 See proposed §1.951A-2(c)(6)(i).
 See §1.951-1(e)(6).
 See §1.951A-2(c)(4)(ii).
 See §§ 1.951A-2(c)(4)(i) and §1.951A-2(c)(4)(iii)(C).
 See §1.951A-2(c)(5)(i).
 See §§1.951A-2(c)(5)(iii)(A) and 1.951A-3(h)(2)(ii).
 See §1.951A-3(e)(3)(ii).
 See id.
 See §1.951A-3(e)(1).
 See §1.951A-4(b)(1)(ii) and (2)(ii).
 See §1.951A-4(b)(1)(i) and (iv) and (c) Example 5.
 See §1.951A-1(e)(1).
 See id.
 See §1.951A-1(e)(2).
 See §§1.1502-32(b)(3)(ii)(E) and (b)(3)(iii)(C), and 1.1502-51(c) and (d).
 See §1.78-1(c).
 See §1.861-12(c)(2)(i).
 See §1.965-7(e).