Highlights of the Recently Issued Final and Proposed Foreign Tax Credit Regulations
Author: Brian Abbey, Managing Director, International Tax Services, Global Tax Management
On December 2 2019, the Treasury and IRS issued both final and newly proposed foreign tax credit regulations. The regulations were a long time coming; the original 2018 proposed regulations were issued on November 28, 2018. While largely consistent with the 2018 proposed regulations – including the multi-step process contained in Prop. Reg. § 1.861-13 – there are some noteworthy changes that taxpayers should be aware of within the newly issued regulations. Highlights include:
- Several new safe harbors for determining the appropriate Section 904 basket for pre-TCJA (i.e., pre branch basket) foreign tax credit carryovers, separate limitation losses, net operating losses, and overall foreign losses
- A reduction in the number of previously taxed earnings and profits categories to 10, from the original 16 set forth in Notice 2019-1
- Clarification that the stock basis of a lower tier CFC includes the lower tier CFC’s E&P. In other words, the E&P bump does not just apply to first tier CFC stock basis; rather, it applies as each CFC applies the asset method to allocation and apportion its own interest expense
- Additional guidance on the disregarded payment rule for transactions between a foreign branch owner and its foreign branch, specifically in the area of disregarded property transactions
- The new requirement that tested income tier up to each CFC for purposes of applying the modified gross income method in apportioning CFC interest expense
The proposed foreign tax credit regulations, which were issued at the same time, provide some relief in the allocation and apportionment of research and development expenses. They accomplish this by stating that the only income that benefits from R&D is intangible income, excluding subpart F, GILTI, and the Section 78 gross-up. The regulations also eliminate the optional gross income method entirely. Any R&D remaining after exclusive apportionment is allocated and apportioned based on gross receipts.
In addition, the proposed regulations significantly modify how stewardship is allocated and apportioned. Specifically, stewardship is allocated and apportioned using stock basis similar to interest expense. The regulations are also clear that, unlike R&D, stewardship is allocated to subpart F, GILTI, and the Section 78 gross-up.
The proposed regulations also introduce additional rules on allocating and apportioning foreign taxes in new Prop. Treas. Reg. § 1.861-20. This new section expands existing guidance in Treas. Reg. § 1.904-6 as well, and addresses scenarios when allocating and apportioning taxes is necessary beyond the operative provision of Section 904. These provisions provide extensive guidance in several areas, including a list of US-foreign base differences and allocation of foreign taxes to non-US anti-deferral regimes, among other nuances.
We will provide additional insights as these regulations and their impacts are further analyzed.