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Summary of final and proposed foreign tax credit regulations
On December 2, 2019, the IRS and Treasury released final and proposed regulations
addressing the foreign tax credit and related provisions. In addition, the regulations finalize
certain portions of the OFL regulations (published in 2012) and proposed section 905(c) and
986(a) regulations (published in 2007).
With respect to the section 905(c) and 986(a) regulations, the Treasury decision finalizes
(1) the currency translation rules (which are moved from Treas. Reg. § 1.905-3T(b) to
Treas. Reg. § 1.986(a)-1)), (2) the definition of foreign tax redetermination in Treas. Reg. §
1.905-3T(c), (3) the rules under Treas. Reg. § 1.905-3T(d)(1) requiring a redetermination
of U.S. tax liability with respect to foreign income taxes other than those that are deemed
paid under section 960, and (4) the rules in Treas. Reg. § 1.905-3T(e) relating to foreign
income taxes imposed on foreign tax refunds.
As a practical matter, the final regulations are approximately 400 pages long and the
proposed regulations over 200 pages long. Below is a summary of the key provisions of the
final and proposed regulations.
Effective Dates and Key Changes
1. Effective Dates
• Final Regulations:
i. Retains effective dates in the proposed regulations (generally effective
beginning in 2018).
ii. OFL regulation changes are effective for tax years ending after the Fed.
Reg. publication date
iii. 905(c) regulation changes apply to foreign tax redeterminations in tax
years ending on or after the Fed. Reg. publication date.
iv. 986(c) regulations apply to tax years ending on or after the Fed. Reg.
publication date and to tax years of foreign corporations which end with or
within a tax year of a US shareholder ending on or after the Fed. Reg.
publication date.
• Proposed Regulations
i. Many of the proposed regulations apply to taxable years that end on or
after the date that the proposed regulations are published in the federal
register. Presumably, this will include the 2019 calendar taxable year.
ii. The changes to the rules regarding the allocation and apportionment of
R&E and the new Treas. Reg. § 1.861-20 (and related changes including
in Treas. Reg. § 1.904-6) apply to taxable years beginning after December
31, 2019.
• Reliance on the proposed regulations rules for the allocation and
apportionment of R&E expense is allowed for taxable years
beginning after December 31, 2019.
iii. The new definition of a financial services entity and ordering rules for
NOLs apply to table years after the publication of final regulations.
iv. The provisions addressing foreign tax redeterminations and Prop. Treas.
Reg. 1.905-3 – 5 apply to redeterminations occurring after the date that
the proposed regulations are published in the federal register. Proposed
Treas. Reg. § 1.905-3 is limited to foreign tax redeterminations that relate
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to a taxable year of a foreign corporation, only if the redetermination
relates to a taxable year of the CFC beginning after December 31, 2017.
Proposed Treas. Reg. § 1.905-5 is limited to foreign tax redeterminations
that relate to taxable years of foreign corporations beginning January 1,
2018.
v. Proposed Treas. Reg. § 1.965-5(b)(2) applies to taxable years of foreign
corporations that end on or after after the date that the proposed
regulations are published in the federal register
vi. Finally, the provisions of 1.1502-4 apply to taxable years for which the
original consolidated Federal income tax return is due (without extension)
after the date that the proposed regulations are published in the federal
register
2. Key Changes in Regulations
• Final Regulations
i. Provide that the E&P bump rule in Treas. Reg. § 1.861-12 applies for
purposes of valuing the stock of lower tier CFCs.
ii. Revise Treas. Reg. § 1.861-9(j)(2)(ii) to allow upper-tier CFCs to take into
account gross tested income (net of interest expense) of lower-tier CFCs.
This change should eliminate distortions in the case of an upper tier
holding company.
iii. Provide a safe harbor option for assigning a portion of the pre-2018
unused foreign taxes to the post-2017 separate category for foreign
branch category income.
iv. Retain disregarded payment rule with respect to the branch basket
v. Provide that all general partners characterize their distributive share of
income from the partnership based on income of the partnership even if
the general partner owns a less than 10 percent interest in the
partnership
vi. The regulations finalize base and timing difference rules without change.
However, very detailed new rules are included in the proposed
regulations.
• Proposed Regulations
i. Provide that stewardship expenses are also allocated to inclusions under
sections 951 and 951A, section 78 dividends, and all amounts included
under the passive foreign investment company provisions.
ii. Provide new rules for the allocation and apportionment of litigation
damages awards, prejudgment interest, settlement payments, and NOLs.
iii. Contain provisions, similar to the SPL rules of the final regulations,
addressing loans by partnerships to their partners.
iv. Provide that guaranteed payments for the use of capital described in
section 707(c) are treated similarly to interest deductions for purposes of
allocating and apportioning deductions under Treas. Reg. §§1.861-8
through 1.861-14 and are treated as income equivalent to interest under
section 954(c)(1)(E).
v. Clarify what it means for an asset to be connected with indebtedness,
modify the existing example, and add a new example, for the purpose of
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limiting the scope of Treas. Reg. § 1.861-12T(f) (i.e., addressing potential
rules under section 163(l)).
vi. Provide that R&E expenditures are not allocated and apportioned to GILTI
or Subpart F income.
vii. Create a new reg section, Treas. Reg. § 1.861-20 which provide new and
comprehensive rules for the allocation of creditable foreign taxes to
income and to the characterization of income where relevant, including:
• Base Differences: Providing an exclusive list of items that are
excluded from U.S. gross income;
• Distributions: In the case of a distribution from a non-hybrid
corporation that is recognized for both Federal income tax law and
foreign tax law purposes, treats foreign gross income arising from
the distribution as a dividend and as capital gain to the extent of
the portions of the distribution that are, under Federal income tax
law, characterized as a dividend and capital gain, respectively.
• Foreign Law Subpart F: Providing that income arising by reason of
a foreign law regime similar to the subpart F provisions under
sections 951 through 959 (a “foreign law subpart F regime”), is
assigned to the same statutory or residual grouping as the gross
income (determined under the foreign law subpart F regime) of the
foreign law CFC that gave rise to the foreign gross income of the
taxpayer;
• Branch Payments: Provides that certain payments from a foreign
branch are assigned to the statutory and residual groupings by
deeming the payment to be made ratably out of the after-tax
income, computed for Federal income tax purposes, of the foreign
branch, and deeming the branch income to arise in the statutory
and residual groupings in the same ratio as the tax book value of
the assets, including stock, owned by the foreign branch. Provides
that foreign gross income from a disregarded payment made by a
foreign branch owner is assigned to the residual grouping and
assigns an item of foreign gross income attributable to gain
recognized under foreign law with respect to the receipt of a
disregarded payment in exchange for property. This rule also
applies to foreign branches owned by foreign corporations.
• Reverse Hybrid: Provides that the foreign gross income that a
taxpayer recognizes from a reverse hybrid is assigned to the
statutory and residual groupings by treating that foreign gross
income as the income of the reverse hybrid.
viii. Taxes Attributable to Subpart F and Reverse Hybrid Inclusions:
• The regulation reassigns to the section 951A category the foreign
gross income that, if the foreign law CFC or reverse hybrid
recognized the foreign gross income instead of the United States
shareholder, would be assigned to the general category tested
income group of the foreign law CFC or reverse hybrid to which an
inclusion under section 951A is attributable.
Final Regulations
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1. Section 861 Final Regulations
• Allocation and Apportionment to GILTI: Consistent with the proposed regulations, the
final regulations reject comments that no expenses should be allocated and
apportioned to the section 951A category. However, the proposed regulations
provide additional rules that should reduce expenses allocated and apportioned to
the section 951A category.
• Exempt Assets: The final regulations revise Treas. Reg. § 1.861-8(d)(2)(ii)(C)(2) to
reduce the portion of assets treated as exempt by reason of FDII. Unlike the
proposed regulations, which required taxpayers to identify assets that produce gross
income included in FDII for purposes of determining the portion of a taxpayer’s
assets that are treated as exempt by reason of having FDII, the final regulations,
consistent with guidance under section 250 providing that the determination of
FDDEI requires applying Treas. Reg. §§1.861-8 through 1.861-14T and 1.861-17 to
allocate and apportion deductions between gross income derived from sales and
services that are FDDEI (“gross FDDEI”) versus gross income that is not gross
FDDEI, refer to assets that produce gross FDDEI rather than income included
in FDII.
• Specified Partnership Loans:
o The final regulations clarify that the SPL rules should not be applied to create
additional gross income and instead solely to match existing income and
expenses relate to a SPL.
o In addition, the anti-avoidance rule of the proposed regulations are retained
and examples are added to further illustrate the operation of these provisions,
including appropriate adjustments that must be made in cases where the
transaction involves a loan to a CFC.
▪ Additional guidance is also provided in the Proposed FTC regulations,
addressing the treatment of loans made by a partnership to a partner
(“upstream loans”).
• Valuation of Assets for Purposes of Interest Expense Apportionment
o The final regulations decline to modify the transition rule in Treas. Reg. §
1.861-9(g)(2)(i)(A) for transition from FMV to TBV or Alternative TBV
method. Thus, taxpayers must use average of beginning of year or end of
first quarter value and end of year value of assets.
o E&P Bump: The final regulations confirm in Treas. Reg. § 1.861-9(g)(4) that
the E&P bump rule in Treas. Reg. § 1.861-12 applies for purposes of valuing
the stock of lower tier CFCs.
o In addition, the final regulations provide that Treas. Reg. § 1.861-12 applies
for all operative sections, and not solely for section 904.
• Treatment of tested income in allocating and apportioning interest expense of a CFC
under the MGI method
o The final regulations revise Treas. Reg. § 1.861-9(j)(2)(ii) to allow upper-tier
CFCs to take into account gross tested income (net of interest expense) of
lower-tier CFCs. This change should eliminate distortions in the case of an
upper tier holding company and is consistent with the group based approach
of section 951A.
• Characterization of stock of certain foreign corporations under Treas. Reg. § 1.861-
12(c)(3) and -13
o The final regulations decline to adopt a comment that stock of a noncontrolled
10-percent owned foreign corporation owned by a CFC be assigned to the
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specified foreign source general or passive category because a distribution by
the noncontrolled 10-percent owned foreign corporation to a CFC should be
eligible for the section 245A DRD under Treas. Reg. § 1.952-2.
▪ Importantly, the IRS and Treasury again state that future guidance
will provide that any provision expressly limited in its application to
domestic corporation does not apply to CFCs by reason of Treas. Reg.
§ 1.952-2 and that such guidance will address the availability of the
section 245A deduction at the CFC level.
o The final regulations also decline to exempt the gross income or assets of
tested loss CFCs from the expense apportionment rules.
• Section 904(b)(4)
o The final regulations retain the rule assigning stock to a section 245A
subgroup without regard to whether a dividend paid (either in a current or
future year) with respect to the stock may qualify for the section 245A
deduction.
2. FTC Limitation under Section 904
• Treas.Reg. § 1.904-2(j): In response to comments requesting a simplified rule for
assigning a portion of the pre-2018 unused foreign taxes to the post-2017 separate
category for foreign branch category income, final Treas. Reg. § 1.904-2(j)(1)(iii)(B)
provides a safe harbor option.
o Under the safe harbor unused foreign taxes from a particular pre-2017
taxable year are allocated to the post-2018 separate category for foreign
branch category income based on a ratio equal to the amount of foreign
income taxes that were paid or accrued by the taxpayer’s foreign branches
divided by the amount of all foreign income taxes assigned to the general
category that were paid or accrued, or deemed paid by the taxpayer with
respect to the taxable year.
• Treas. Reg. § 1.904(f)-12(j): In response to comments, the regulation is revised to
apply regardless of whether the taxpayer makes an election under Treas. Reg. §
1.904-2(j). The regulation provides a reconstruction approach or safe harbor for
characterizing SLL and OFL accounts and NOLs attributable to pre-2018 years, as
well as rules coordinating Treas. Reg. §§ 1.904(f)-12(j) and 1.904-2(j).
• Treas. Reg. § 1.904-4(f) – Foreign Branch Category Income (“FBI”):
o Generally. The final regulations retain the 2018 proposed rules for attributing
income to a foreign branch, with several clarifications and modifications. The
preamble outlines the policy goals underlying these rules, which are: (i)
attribution of income in a manner commensurate with business activities; (ii)
administrability; (iii) conformity with local country tax law; and (iv) giving
effect to the policies of limiting the deduction under section 250 and the credit
under section 901 by reference to FBI.
o Disregarded Payments. The final regulations retain the disregarded payment
reallocation rules, including the rule preserving the amount, source, and
character of reallocated income, also clarifying that FBI regulations have no
bearing on treaty resourcing analysis. In addition, the regulations decline to
(i) allow netting of disregarded payments or (ii) allow disregarded interest
payments to result in reallocation of income (however, the Treasury and the
IRS are considering future guidance for certain financial institutions that may
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provide for adjustments to FBI by reference to disregarded interest
payments). Finally, the final regulations provide additional (i) ordering rules
for multiple disregarded payments and (ii) guidance related to branch-to-
branch transactions.
o Disregarded Sales of Property. The final regulations provide extensive
additional guidance for applying the disregarded payment rules in cases
where the foreign branch buys or sells inventory or non-inventory property in
a disregarded transaction, i.e., where such payments, if regarded, would give
rise to basis in the property, cost recovery deductions, or COGS.
o Intangible Property Rule. The final regulations retain, with modifications, the
rule for disregarded transfers of IP, which requires the use of section 367(d)
principles to impute disregarded payments, over time, for disregarded
transfers of intangible property (i) from owner to branch, (ii) from branch to
owner, or (iii) from branch to branch. However, as revised, the intangible
property rule does not apply to transfers that occurred before
December 7, 2018. In addition, the rule does not apply to transfers by a
transitory owner of IP, subject to certain limitations.
o Foreign Branch Definition and Books and Records Requirement: The final
regulations replace the presumption in the proposed regulations with a per se
rule that activities conducted outside of the United States that constitute a
permanent establishment under the relevant income tax treaty constitute a
foreign branch. Further, the final regulations provide rules for constructing
hypothetical books and records, where activities otherwise qualify as a foreign
branch but such branch does not have separate books and records, effectively
eliminating the separate books and records requirement from the definition.
The regulations apply the principles in the DCL regulations for this purpose.
o Final regulations do not address comments deemed to be outside the scope
of these regulations, including comments related to the allocation and
apportionment of expenses to foreign branch income, certain consolidated
group issues, operation of section 367(d), etc. However, the Preamble notes
that future guidance projects are being considered, including:
▪ Guidance coordinating the allocation and apportionment of expenses
with the determination of foreign branch category income for regulated
financial institutions (describing two potential options for this
purpose),
▪ Possible additional rules for allocating and apportioning certain
expenses, including R&E expense, to foreign branch category income.
• Treas. Reg. § 1.904-4(n) – Distributive Shares of Partnership Income
o The final regulations revise Treas. Reg. § 1.904-4(n) (and Treas. Reg. §
1.861-9(e)(4)), consistent with prior final Treas. Reg. § 1.904-5(h), to
provide that all general partners characterize their distributive share of
income from the partnership based on income of the partnership even if the
general partner owns a less than 10 percent interest in the partnership.
• Look Through Rules: The final regulations confirm that the look-through rules do not
apply to characterize interest, rents, and royalties paid by a CFC to a US shareholder
as section 951A category income
• Timing Delay in Deductibility: The final regulations clarify that the allocation and
apportionment of interest expense rules in Treas. Reg. § 1.904-5(c)(2) apply in the
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year interest income is taken into account, even if the interest expense is disallowed
under section 163(j).
3. Allocation and Apportionment of Foreign Taxes
• Treatment of Base Differences: Based on the statutory language and cross
references, the final regulations provide that foreign taxes associated with a base
difference are assigned solely to the foreign branch category.
• Base and Timing Differences: The regulations finalize base and timing difference
rules without change, concluding that the regulation generally reflects the
appropriate principles regarding what constitutes a base or timing difference.
However, new rules providing additional guidance are included in proposed
regulations.
4. Translation of Foreign Income Taxes and Foreign Tax Redeterminations
The regulations finalize portions of the 2007 section 905(c) regulations (and move parts of
those regulations to section 986 regulations). The Preamble addresses comments submitted
on the 2007 regulations and makes a number of clarifying changes in response to those
comments. Very generally, the final regulation:
• Treas. Reg. §§1.986(a)-1(a)(2)(i), 1.986(a)-1(c), and 1.905-3(a), clarify that two
years means 24 months and not a potentially shorter length of time due to a short
tax year for section 905(c)(1)(B) which provides that if accrued taxes are not paid
before the date two years after the close of the taxable year to which such taxes
relate, the taxpayer must notify the IRS and redetermine its U.S. tax liability for the
year or years in which it claimed a credit for such taxes.
• Clarifies that the relevant taxable year to which the tax relates is that of the person
that is considered to pay the tax under §1.901-2(f). Thus, in the partnership context
the relevant tax year is that of the partnership rather than the partner.
• Addresses the definition of and translation rules for inflationary currency.
• To minimize compliance burdens for taxpayers, provide that taxpayers may translate
accrued but unpaid taxes (including foreign taxes deemed paid under section 960)
into dollars using the spot rate on the date of payment, in lieu of the provisional
year-end rate, on the original return for the year for which the credit is claimed if
such taxes are paid before the due date (with extensions) of such original return and
such return is timely filed.
• Expands the scope of and provide further guidance on the election under section
986(a)(1)(D) to translate certain foreign taxes at the spot rate when paid.
• Clarifies that a foreign tax redetermination.
o A foreign tax redetermination includes corrections of errors in computing the
foreign tax credit and payments of contested taxes following resolution of the
contest).
o To better coordinate the application of the foreign tax redetermination and
currency translation rules and to ease compliance burdens, the definition of a
foreign tax redetermination has been revised to include “accrued taxes that
are not paid on or before the date 24 months after the close of the taxable
year to which such taxes relate.”
• Provides that if a foreign tax redetermination occurs with respect to direct foreign
taxes and the taxpayer cannot use all of the additional taxes in the year to which
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those taxes relate, amended returns are also required for any year to which the
taxes are carried under section 904(c).
• Clarify that taxes that first accrue after the date 24 months after the close of the
taxable year to which such taxes relate may not be claimed as a credit or added to
PTEP group taxes until they are paid.
5. Deemed Paid Taxes Under Section 960
• Current year taxes (1.960-1(b)(4))
o The preamble to the final regulations reject a comment that under the all
events test, foreign taxes may accrue on a date other than the close of the
foreign tax year.
o The final regulation reject any effort to address mismatches caused by
different US and foreign tax years. Instead, they retains the rule that current
year taxes are foreign taxes that accrue with or within the US tax year.
▪ Accordingly, current year taxes are allocated and apportioned to an
income group based on the income on which they are imposed under
foreign law, even if that income is in part recognized in a different US
tax year due to a difference between US and foreign year ends.
Although, Treasury and the IRS recognize that this may result in taxes
being allocated to a group that has no current year income, they
conclude that a multi-year approach would be inconsistent with the
repeal of section 902.
• In addition, the final regulations confirm that no deemed paid credits are allowed
with respect to a section 956 inclusion.
6. PTEP Groups in Annual PTEP Accounts/Deemed Paid Taxes on PTEP Distributions
• The final regulations reduce the number of separate PTEP groups to be tracked from
16 to 10.
• In addition, the final regulations confirm that taxes not deemed paid under section
965 by reason of section 965(b)(4) cannot be treated as taxes deemed paid with
respect to a PTEP distribution. In addition, the Treasury and IRS reject the argument
that they have authority to fix a section 78 statutory “glitch” by regulation and
instead confirm that a section 78 gross-up is required for taxes deemed paid on a
PTEP distribution.
Proposed Regulations
Allocation and Apportionment of Deductions and the Calculation of Taxable
Income for Purposes of Section 904(a)
1. In General
• Treatment of Stewardship Expenses: The proposed regulations provide that that
stewardship expenses are allocated to dividends and inclusions received or accrued,
or to be received or accrued, from related corporations. Unlike the current
regulations, the proposed regulations provide that stewardship expenses are also
allocated to inclusions under sections 951 and 951A, section 78 dividends, and all
amounts included under the passive foreign investment company provisions.
o For this purpose, the proposed regulations provide that stewardship expenses
are apportioned based upon the relative values of a taxpayer’s stock assets,
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as determined and characterized under Treas. Reg. § 1.861-9T(g) (and, as
relevant, Treas. Reg. §§ 1.861-12 and 1.861-13) for purposes of allocating
and apportioning the taxpayer’s interest expense.
o The proposed regulations extend the treatment of stewardship expenses to
cover expenses incurred with respect to a partnership.
• Litigation damages awards, prejudgment interest, and settlement payments:
o The proposed regulations provide that deductions for damages awards,
prejudgment interest, and settlement payments arising from product liability
and similar or related claims are allocated to the class or classes of gross
income produced by the specific sales of products or services that gave rise to
the claims for damage or injury.
o Damages, prejudgment interest, and settlement payments related to events
incident to the production of goods or provision of services, such as damages
for injuries caused by industrial accidents, are allocated to the class of gross
income produced by the assets involved in the event and, if necessary,
apportioned between groupings based on the relative value of the assets in
such groupings.
o In the case of claims made by investors that arise from corporate negligence,
fraud, or other malfeasance, the proposed regulations provide that damages,
prejudgment interest, and settlement payments paid by the corporation are
allocated and apportioned based on the value of all the corporation’s assets.
• NOL Deduction: The proposed regulations provide that a net operating loss is
assigned to the statutory and residual groupings by reference to the losses in each
statutory or residual grouping (determined without regard to adjustments made
under section 904(b)) that are not allocated to reduce income in a different grouping
in the taxable year of the loss.
• Application of the exempt income/asset rule to insurance companies in connection
with certain dividends and tax-exempt interest
o The proposed regulations provide that in the case of insurance companies, the
term exempt income includes dividends for which a deduction is provided by
sections 243(a)(1) and (2) and 245, without regard to the proration rules
disallowing a portion of the deduction. Similarly, the term exempt income
includes tax exempt interest without regard to the proration rules.
2. Loans between Partners and Partnerships
• Upstream Loans: The proposed regulations contain provisions addressing loans by
partnerships to their partners. Under these provisions, to the extent the borrower in
an upstream partnership loan transaction takes into account both interest expense
and interest income with respect to the same loan, the interest income is assigned to
the same statutory and residual groupings as those groupings from which the
matching amount of interest expense is deducted, as determined under the
allocation and apportionment rules in Treas. Reg. §§ 1.861-9 through 1.861-13.
o Like the provisions of the final regulations, for purposes of applying the
allocation and apportionment rules, the borrower does not take into account
as an asset its proportionate share of the loan, as otherwise provided under
Treas. Reg. § 1.861-9(e)(2) and (3).
o Further, these provisions apply to transactions that are not loans but that give
rise to deductions that are allocated and apportioned in the same manner as
interest expense and also contain anti abuse rules.
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• Treatment of Guaranteed Payments: The proposed regulations revise Treas. Reg. §
1.861-9(b) and Treas. Reg. § 1.954-2(h)(2)(i) explicitly to provide that guaranteed
payments for the use of capital described in section 707(c) are treated similarly to
interest deductions for purposes of allocating and apportioning deductions under
Treas. Reg. §§1.861-8 through 1.861-14 and are treated as income equivalent to
interest under section 954(c)(1)(E).
3. Treatment of assets connected with capitalized, deferred, or disallowed interest
• The proposed regulations clarify what it means for an asset to be connected with
indebtedness, modify the existing example, and add a new example, with the
purpose of limiting the scope of this provision.
4. Treatment of section 818(f) expenses
• The proposed regulations adopt the separate entity method for allocating and
apportioning section 818(f) expenses. Under this method, the allocation and
apportionment of section 818(f) expenses is done on a separate company basis.
5. Allocation and Apportionment of R&E Expenses
• In general, the Treasury Department and the IRS agree with the comments that the
rules under Treas. Reg. § 1.861-17 should be modified to reflect the fact that R&E
expenditures that are deductible or amortizable under section 174 or section 59(e)
generally give rise to intangible property, and that under the rules in sections 367(d)
and 482, the person incurring such R&E expenditures must be compensated properly
when such intangible property gives rise to income.
• Accordingly, R&E expenditures ordinarily are considered deductions that are
definitely related to all gross intangible income reasonably connected with the
relevant Standard Industrial Classification Manual code (“SIC code”) category (or
categories) of the taxpayer and so are allocable to all items of gross intangible
income related to the SIC code category (or categories) as a class.
o Gross intangible income is defined as all gross income earned by a taxpayer
that is attributable, in whole or in part, to intangible property derived from
R&E expenditures and does not include dividends or any amounts
included under section 951, 951A, or 1293. The proposed regulations do
not directly address but may significantly increase the amount of R&E
expense apportioned to gross FDDEI and gross non-FDDEI.
• The proposed regulations also:
o Eliminate the optional gross income method and require R&E expenditures in
excess of the amount exclusively apportioned under Treas. Reg. § 1.861-
17(b) to be apportioned among the statutory and residual groupings within
the class of gross intangible income on the basis of the relative amounts of
gross receipts from sales and services in each grouping. Gross receipts are
assigned to the grouping to which the gross intangible income related to the
sale, lease, or service is assigned.
o Clarify the rules relating to goods or property that are described in the SIC
code category for “wholesale trade” or “retail trade.
o Eliminate the legally mandated R&E rule.
o Eliminate the increased exclusive apportionment rule.
o Clarifies that the exclusive apportionment rule applies only to section 904 as
the operative section.
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o Clarify the treatment of CSA under section 482 in two respects.
▪ First, the taxpayer’s R&E expenditures allocated and apportioned
under §1.861-17 do not include any amounts that are not deductible
by reason of the second sentence under §1.482-7(j)(3)(i).
▪ Second, the proposed regulations clarify that the exclusion of the
controlled party’s gross receipts applies only for purposes of
apportioning those R&E expenditures that are intangible development
costs with respect to the CSA.
o Modify the special rules for partnerships’ gross receipts
6. Application of section 904(b) to net operating losses
• The 2018 FTC proposed regulations did not coordinate any of the adjustments
required under section 904(b) with the net operating loss provisions. Therefore, the
proposed regulations include a coordination rule. Under this coordination rule, for
purposes of determining the source and separate category of a net operating loss,
the separate limitation loss and overall foreign loss rules of section 904(f) and the
overall domestic loss rules of section 904(g) are applied without taking into account
the adjustments required under section 904(b).
Foreign Tax Credit Limitation Under Section 904
1. Financial Services Entities:
• Proposed Treas. Reg. § 1.904-4(e)(2) modifies the definition of an FSE by adopting a
definition of “predominantly engaged in the active conduct of a banking, insurance,
financing, or similar business” and “income derived in the active conduct of a
banking, insurance, financing, or similar business” that is generally consistent with
sections 954(h), 1297(b)(2)(B), and 953(e). A significant difference between the
current final section 904 regulation definition of active financing income and the
definition in section 954(h) (and the 1998 legislative history as there are no
regulations under section 954(h)) is that section 954(h) requires all income to be
derived from dealings with customers. Adopting the section 954(h) definition thus
may result in fewer entities qualifying as FSEs under section 904.
2. Allocation and Apportionment of Foreign Taxes
• The proposed regulations move the general rules in §1.904-6 (which address
allocating and apportioning taxes to separate categories) to new proposed Treas.
Reg. § 1.861-20 and include provision that apply for purposes of allocating and
apportioning foreign income taxes to statutory and residual groupings. Rules specific
to the allocation and apportionment of foreign income taxes to separate categories
remain in proposed §1.904-6.
• Proposed Treas. Reg. § 1.861-20 adopts the principles of §1.904-6 but provides
more detailed guidance on how to apply those principles, which are illustrated by
several examples.
• In addition, Prop. Treas. Reg. § 1.861-20(c) provides that foreign tax expense is
allocated and apportioned among the statutory and residual groupings by first
assigning the items of gross income under foreign law (“foreign gross income”) on
which a foreign tax is imposed to a grouping, then allocating and apportioning
deductions under foreign law to that income, and finally allocating and apportioning
the foreign tax among the groupings
o Proposed Treas. Reg. § 1.861-20(d)(1) provides a general rule for assigning
foreign gross income to a statutory or residual grouping
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▪ Under this rule, a foreign gross income item is assigned to a grouping
by characterizing the item under Federal income tax law. If an item of
gross income or loss arises under Federal income tax law from the
same transaction or realization event from which the foreign gross
income item arose (a “corresponding U.S. item”), the foreign gross
income item is assigned to the same statutory or residual grouping as
the corresponding U.S. item.
▪ In the case of a corresponding U.S. item that is an item of loss (or
zero), the foreign gross income is assigned to the same grouping to
which an item of gain would be assigned had the transaction or
realization event given rise to an item of gain under Federal income
tax law.
o Proposed Treas. Reg. § 1.861-20(d)(2) sets forth rules for assigning a foreign
gross income item to a grouping if there is no corresponding U.S. item in the
U.S. taxable year in which the taxpayer paid or accrued the foreign income
tax imposed on foreign taxable income that includes the foreign gross income
item.
o Proposed §1.861-20(d)(2)(ii) provides guidance regarding the treatment of
foreign gross income items that are either excluded from gross income under
Federal income tax law or attributable to base differences.
▪ Proposed §1.861-20(d)(2)(ii)(B) provides an exclusive list of items
that are excluded from U.S. gross income and that, if taxable
under foreign law, are treated as base differences. The items are death
benefits described in section 101, gifts and inheritances described in
section 102, contributions to capital described in section 118 and the
receipt of property in exchange for stock described in section 1032,
the receipt of property in exchange for a partnership interest described
in section 721, returns of capital described in section 301(c)(2), and
distributions to partners described in section 733.
o Proposed §1.861-20(d)(3) sets forth special rules that apply for purposes of
assigning certain items of foreign gross income to a grouping, including rules
for distributions that both Federal income tax law and foreign law recognize,
certain foreign law distributions such as consent dividends, inclusions under
foreign law CFC regimes, disregarded payments, inclusions from reverse
hybrids, and gain on the sale of a disregarded entity.
▪ In the case of a distribution from a non-hybrid corporation that is
recognized for both Federal income tax law and foreign tax law
purposes, Prop. Treas. Reg. §1.861-20(d)(3)(i)(B) treats foreign gross
income arising from the distribution as a dividend and as capital gain
to the extent of the portions of the distribution that are, under Federal
income tax law, characterized as a dividend and capital gain,
respectively. The foreign gross income is assigned to the same
statutory and residual groupings as the corresponding amounts of
dividend and capital gain as computed for U.S. tax purposes. Foreign
gross income arising from the portion of the distribution that is a
return of capital under Federal income tax law is treated as a base
difference.
▪ If a taxpayer (including an upper-tier CFC) includes an item of foreign
gross income by reason of a foreign law regime similar to the subpart
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F provisions under sections 951 through 959 (a “foreign law subpart F
regime”), Prop. Treas. Reg. § 1.861-20(d)(3)(i)(D) assigns that item
to the same statutory or residual grouping as the gross income
(determined under the foreign law subpart F regime) of the foreign law
CFC that gave rise to the foreign gross income of the taxpayer.
o Proposed Treas. Reg. § 1.861-20(d)(3)(ii) addresses the assignment of
foreign gross income arising from disregarded payments between a foreign
branch (as defined in §1.904-4(f)(3)) and its owner.
▪ If the foreign gross income item arises from a payment made by a
foreign branch to its owner, Prop. Treas. Reg. § 1.861-20(d)(3)(ii)(A)
generally assigns the item to the statutory and residual groupings by
deeming the payment to be made ratably out of the after-tax income,
computed for Federal income tax purposes, of the foreign branch, and
deeming the branch income to arise in the statutory and residual
groupings in the same ratio as the tax book value of the assets,
including stock, owned by the foreign branch.
▪ If the item of foreign gross income arises from a disregarded payment
to a foreign branch from its owner, Prop. Treas. Reg. § 1.861-
20(d)(3)(ii)(B) generally assigns the item to the residual grouping.
However, Prop. Treas. Reg. § 1.861-20(d)(3)(ii)(C) assigns an item of
foreign gross income attributable to gain recognized under foreign law
with respect to the receipt of a disregarded payment in exchange for
property under the rule in Prop. Treas. Reg. § 1.861-20(d)(2)(i).
▪ In addition, proposed §1.904-6(b)(2) includes special rules assigning
foreign gross income items arising from certain disregarded payments
for purposes of applying section 904 as the operative section.
o Prop. Treas. Reg. § 1.861-20(d)(3)(iii) addresses the assignment to a
statutory or residual grouping of foreign gross income that a taxpayer
includes by reason of its ownership of a reverse hybrid.
▪ Under this rule, the foreign gross income that a taxpayer recognizes
from a reverse hybrid is assigned to the statutory and residual
groupings by treating that foreign gross income as the income of the
reverse hybrid and applying the general rules of Prop. Treas. Reg. §
1.861-20(d).
▪ However, Treas. Reg. § 1.904-6(f) includes a special rule assigning
certain items of foreign gross income recognized by a United States
shareholder of a controlled foreign corporation that is a reverse hybrid
to the section 951A category for purposes of applying section 904 as
the operative section. The Treasury Department and the IRS request
comments on whether additional rules are needed to address other
fact patterns in which the U.S. and a foreign country tax different
persons on the same item of income, for example, in the case of a
sale-repurchase agreement.
o Finally, Prop. Treas. Reg. § 1.861-20(d)(3)(iv), provides that if a taxpayer
recognizes an item of foreign gross income that is gain from the sale of a
disregarded entity, and Federal income tax law characterizes the transaction
as a sale of the assets of the disregarded entity, the foreign gross income is
assigned to the statutory and residual groupings in the same proportion as
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the gain that the taxpayer would have recognized if foreign law also treated
the transaction as a sale of assets.
• Proposed Treas. Reg. § 1.904-6(b)(2)(i) generally provides that if a foreign branch
makes a disregarded payment to another foreign branch or to its owner that causes
the taxpayer’s gross income under Federal income tax law that is otherwise
attributable to the foreign branch to be attributed to another foreign branch or to the
foreign branch owner under §1.904-4(f)(2)(vi)(A) or §1.904-4(f)(2)(vi)(D), the
foreign gross income that arises by reason of the disregarded payment is assigned to
the same category as the reattributed U.S. gross income.
o Items of foreign gross income that a taxpayer includes solely by reason of the
receipt by a foreign branch of a disregarded payment from its foreign branch
owner that is a United States person are generally assigned to the foreign
branch category (or, in the case of a foreign branch owner that is a
partnership, to the partnership’s general category income that is attributable
to the foreign branch).
o Items of foreign gross income attributable to gain recognized under foreign
law with respect to the receipt of a disregarded payment in exchange for
property are characterized and assigned under the rules of Prop. Treas. Reg.
§1.861-20(d)(2)(i).
o If a taxable disposition of property acquired in a disregarded sale results in
the recognition of U.S. gross income that is reattributed to or from a foreign
branch under §1.904-4(f)(2)(vi)(A) or §1.904-4(f)(2)(vi)(D), any foreign
gross income arising from that disposition of property under foreign law is
assigned to the same separate category as the corresponding U.S. item of
gain under Treas. Reg. § 1.861-20(d)(1) without regard to the reattribution of
U.S. gross income.
• Proposed Treas. Reg. § 1.904-6(f) addresses the circumstance in which a United
States shareholder pays or accrues foreign income tax with respect to foreign gross
income that it recognizes because it owns a foreign law CFC or a reverse hybrid.
o The foreign income tax is allocated and apportioned to a category by treating
the foreign gross income of the United States shareholder as the foreign gross
income of the foreign law CFC or reverse hybrid.
o Accordingly, the regulation reassigns to the section 951A category the foreign
gross income that, if the foreign law CFC or reverse hybrid recognized the
foreign gross income instead of the United States shareholder, would be
assigned to the general category tested income group of the foreign law CFC
or reverse hybrid to which an inclusion under section 951A is attributable. The
amount of the foreign gross income that is reassigned is based upon the
inclusion percentage of the United States shareholder.
OFL Recapture on Property Dispositions
The proposed regulations address comments on proposed section 904(f) and 904(g)
regulations published in 2012.
• One comment recommended that additional income required to be recognized on a
disposition under the branch loss recapture and dual consolidated loss (“DCL”)
recapture rules not be subject to the OFL recapture rules. Prop. Reg. § 1.904(g)-3
rejects this comment but clarifies the ordering rules for applying the new branch loss
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recapture rule in section 91, the DCL recapture rules, and the OFL and ODL
recapture rules.
Section 905(c) Foreign Tax Redeterminations
The proposed regulations include new guidance under section 905(c), replacing proposed
regulations published in 2007. The regulations:
• Require a U.S. tax redetermination (i.e., an amended return) to account for any
foreign tax redetermination at the U.S. level or foreign corporation level.
• Clarify that a foreign tax redetermination results in adjustments to earnings and
profits and inclusions under section 951 and 951A in the year to which the
redetermined foreign taxes relate. In addition, the regulations provide that the high
tax exception is applied taking into account the redetermined foreign tax and
resulting E&P adjustments in the year to which the redetermined foreign taxes
relate.
• Provide that a foreign tax redetermination is required even if there is no impact on
the U.S. taxpayers foreign tax credit for the year to which the redetermined foreign
taxes relate.
• Provides that the required redetermination of U.S. tax liability is made as if the
foreign tax redetermination occurred in the hands of the original taxpayer. It is not
clear how this rule would apply where the current taxpayer is unrelated to the
original taxpayer.
• Reproposes with modifications the notification requirements in the 2007 temporary
regulations.
• Addresses the application of the notification requirements to partners and
partnerships, including partnerships subject to the centralized partnership audit
regime.
• Provides for penalties if the taxpayer fails to comply with the section 905(c)
regulations notification requirements.
• The Treasury Department and the IRS request comments on whether an alternative
adjustment to account for post-2017 foreign tax redeterminations with respect to
pre-2018 taxable years of foreign corporations, such as an adjustment to the foreign
corporation’s taxable income and earnings and profits, post-1986 undistributed
earnings, and post-1986 foreign income taxes as of the foreign corporation’s last
taxable year beginning before January 1, 2018, may provide for a simplified and
reasonably accurate alternative.
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