The GILTI Rules – A Comprehensive Q&A on the New Proposed Regulations
The US Department of the Treasury and the Internal Revenue Service provided guidance on the Global Intangible Low Taxed Income rules, answering some, but by no means all, of the questions raised by taxpayers and practitioners since the enactment of the Tax Cuts and Jobs Act in December 2017. This LawFlash discusses some of the more significant issues in the guidance in a detailed Q&A, and lists topics on which Treasury and the IRS are seeking taxpayer comments.
The US Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) took the first step on September 13 in providing significant and much anticipated guidance on Section 951A, the so-called "Global Intangible Low Taxed Income" or GILTI rules, with the issuance of proposed regulations (the Proposed Regulations).[1]
The GILTI rules require 10% domestic shareholders (US Shareholders) of controlled foreign corporations (CFCs) to include in gross income annually the US Shareholders' pro rata share of GILTI for the year.[2] In broad strokes, for a US Shareholder, GILTI is the sum of the pro rata shares of the Tested Income of each of its CFCs less (i) the sum of the pro rata shares of the Tested Losses of each of its CFCs; and (ii) its net deemed tangible income return (NDTIR).[3] NDTIR is 10% of a US Shareholder's pro rata share of the qualified business asset investment (QBAI) of each of its Test Income CFCs, less specified interest expense.[4]
The Proposed Regulations are roughly 88 pages long, and the accompanying preamble includes an additional 69 pages of guidance. Together, the new guidance answers a number of open questions that taxpayers and practitioners have been wrestling with since the enactment of the Tax Cuts and Jobs Act (TCJA),[5] but also leaves a number of questions unanswered. Specifically, the Proposed Regulations provide no guidance on the calculation of the GILTI deduction available under Section 250, the calculation of foreign tax credits (FTCs) available with respect to GILTI inclusions, or the corresponding Section 78 gross-up;[6] the preamble notes that guidance on these topics will be released in subsequent issued notices of proposed rulemaking and proposed regulations.[7]
This LawFlash provides a high-level overview of some of the more significant and interesting developments and guidance introduced in the Proposed Regulations (e.g., the treatment of partnerships and consolidated groups, and the introduction of new anti-abuse provisions), framed in a series of questions and responses. At the end of this LawFlash, we have included a list of the topics and issues on which Treasury and the IRS have requested taxpayer comments. (This LawFlash will be followed by a longer, more comprehensive whitepaper that will provide detailed observations and analysis of the Proposed Regulations and the implications for domestic and multinational companies.)
Determining Tested Income and Tested Losses
1. Determining Tested Income of "partial year" CFCs. If a foreign corporation satisfies the requirements under Section 957(a) to be treated as a CFC for only part of its taxable year, are all of the CFC's relevant earnings for the entire year nevertheless taken into account in determining its Tested Income for the year?
No. Tested Income only includes earnings accrued while a foreign corporation satisfies the requirements to be treated as a CFC under Section 957(a) – though the path to that conclusion is not as obvious or straightforward as one might think. Initially, all of a CFC's relevant earnings accrued during a CFC Inclusion year are taken into account in determining the CFC's Tested Income.[8] However, once that initial determination is made, a US Shareholder is allocated a pro rata share of the CFC's Tested Income under the same rules used to allocate subpart F income to US Shareholders of a CFC – namely, those under Section 951(a)(2) and Treas. Reg. § 1.951-1(b) and (e).[9] Under these rules, a US Shareholder in practice only takes into account the portion of the CFC's overall Tested Income earned during periods that the CFC satisfied the requirements of Section 957(a).[10]
The Proposed Regulations include several additional amendments to Treas. Reg. § 1.951-1(e) that may indirectly modify the way in which Tested Income, Tested Loss, and other GILTI items are allocated between different classes of CFC stock (discussed below).[11] The proposed amendments also introduce an anti-abuse rule that disregards transactions and/or arrangements a principal purpose of which is to reduce a US Shareholder's pro rata share of subpart F income.[12] Because pro rata determinations of GILTI items are based on subpart F principles, allocations of Tested Income, Tested Loss, QBAI, and other GILTI attributes will also be subject to these new anti-abuse rules.
2. Expenses deductible against Tested Income. What limitations or restrictions (if any) do the Proposed Regulations impose on the ability to deduct expenses against Tested Income?
The Proposed Regulations clarify that determinations of gross income and allowable deductions for GILTI are made in a manner similar to the determination of subpart F income, under the rules of Treas. Reg. § 1.952-2.[13] Tested Income or Tested Loss of a CFC is determined by first treating the CFC as a domestic corporation.[14] Only those items that would be deductible by a domestic corporation may be taken into account in determining a CFC's Tested Income or Tested Loss; an item that would not be deductible by a domestic corporation cannot be taken into account for purposes of determining the Tested Income or Tested Loss of the CFC, even if the item otherwise reduces the CFC's earnings and profits (E&P).[15] At the same time, however, expenses the deductibility of which would ordinarily be deferred under Sections 267(a)(3)(B) (deferral of related party expense until related party income recognized) or 163(e)(3)(B)(i) (deductibility of original issue discount (OID)) are not deferred to the extent the corresponding GILTI item is taken into account in determining the US Shareholder's GILTI inclusion amount.[16]
3. Deductions "properly allocable" to Tested Income. What deductions of a CFC are treated as "properly allocable" to Tested Income (within the meaning of Section 951(A)(c)(2)(a)(ii))?
Following the statute, the Proposed Regulations confirm that allowable deductions are allocated and apportioned to gross Tested Income under the principles of Section 954(b)(5).[17] The Proposed Regulations thus treat gross Tested Income as an additional separate category of income and deductions should be allocated and apportioned to Tested Income similar to other categories of subpart F income.
4. Effect of E&P limitations on Tested Income. What effect do a CFC's E&P and the subpart F limitation under Section 952(c) have in calculating Tested Income?
Tested income and Tested Loss are determined without regard to the application of Section 952(c).[18] Thus, if in a given year, subpart F income is limited by the E&P of a CFC under Section 952(c), the entire amount of the subpart F income is still excluded from gross Tested Income (not just the amount that was included in the US Shareholder's return). By the same token, however, if in a later year subpart F income is "recaptured" under Section 952(c)(2), the recapture amount included in the income of the US Shareholder is not excluded from gross Tested Income.[19]
5. CFC E&P adjustments relating to Tested Losses. Must a Tested Loss of a CFC actually be used to offset Tested Income in order for E&P to be increased under Section 952(c)(1)(A) for purposes of determining subpart F inclusions?
A Tested Loss CFC increases its E&P by an amount equal to its Tested Loss, regardless of whether the Tested Loss actually offsets Tested Income.[20] Increasing the E&P of the Tested Loss CFC results in a corresponding increase to the CFC's Section 952(c)(1)(A) limitation which, as discussed above, generally limits the subpart F income of a CFC for a taxable year to the current E&P of the CFC for the year.[21]
6. Foreign currency conversion. How are tested items denominated in a non-US-dollar functional currency converted into US dollars?
A US Shareholder's pro rata share of any CFC tested item is translated into US dollars using the average exchange rate for the CFC inclusion year of the CFC.[22] Similarly, the GILTI inclusion amount of a US Shareholder that is allocated to a Tested Income CFC under Section 951A(f)(2) is translated from US dollars into the CFC's functional currency using the average exchange rate for the taxable year of the Tested Income CFC.[23]
7. Excess Tested Losses and/or excess QBAI (no carryforward). May a US Shareholder carryforward the unused portion of any Tested Losses and/or QBAI of a CFC (similar to the treatment of NOLs)?
The Proposed Regulations do not include any rules or specific guidance that allow CFCs (or US Shareholders) to carryforward unused Tested Losses and/or QBAI to future inclusion years. Absent such guidance, there does not appear to be any statutory or regulatory basis for a taxpayer to carryforward Tested Losses and/or QBAI. As a result, a US Shareholder of a CFC with previously unused Tested Losses or QBAI may be required to recognize GILTI inclusions with respect to the CFC when it has Tested Income in a later year, even though the US Shareholder did not realize (or recognize) a net positive economic return with respect to the CFC in earlier years (i.e., "phantom income").
8. Anti-avoidance rule – deductions and losses attributable to basis "step-up" transactions (fiscal year CFCs). Will transactions that (i) were implemented prior to the first taxable year in which a CFC is subject to GILTI; and (ii) which give rise to basis that will ultimately reduce a US Shareholder's GILTI inclusion (for example, by creating depreciation or amortization deductions that reduce Tested Income) be respected for purposes of determining Tested Income or Tested Loss?
No. The Proposed Regulations effectively deny US Shareholders any depreciation or amortization benefit resulting from basis "step-up" transactions engaged in by fiscal year CFCs prior to their first GILTI CFC inclusion year.[24] Specifically, the Proposed Regulations provide that any deduction or loss attributable to "disqualified basis" of "specified property" that is allocated and apportioned to gross Tested Income is disregarded for purposes of determining the Tested Income or Tested Loss of a CFC.[25]
Specified property is any property with respect to which a deduction is allowable under Section 167 or Section 197 and, thus, could include both tangible and intangible property.[26] Disqualified basis is the excess of (i) the adjusted basis of specified property immediately after a disqualified transfer over (ii) the sum of (a) the adjusted basis of the property immediately before the transfer; and (b) in broad strokes, the gain recognized on the transfer that is subject to current US taxation (e.g., subpart F taxation or income effectively connected with a US trade or business).[27] A disqualified transfer includes any transfer of property by a CFC (regardless of whether it is a Tested Income or Tested Loss CFC at the time of the transfer) during the disqualified period to a related person[28] in a transaction in which gain is recognized. The disqualified period for a CFC begins on January 1, 2018, and ends on the close of the CFC's last taxable year that is not a CFC inclusion year (i.e., the last day of its last pre-GILTI fiscal year).[29]
Determining Pro Rata Share of GILTI Items
1. Pro rata share of Tested Income, Tested Loss, and other GILTI items. Does a US Shareholder determine its pro rata share of its CFCs' Tested Income, Tested Losses, and other tested items similar to the manner in which subpart F inclusions are calculated?
In general, yes. As discussed, a US Shareholder is allocated a pro rata share of a CFC's Tested Income under the same rules used to allocate subpart F income to US Shareholders of a CFC – namely, those under Section 951(a)(2) and Treas. Reg. § 1.951-1(b) and (e).[30] In broad strokes, the rules rely on a year-end hypothetical distribution of current year E&P (the Hypothetical Distribution) to allocate Tested Income and Tested Loss to US shareholder(s) (and, as discussed below, between different classes of stock and shares within a class of stock).[31] In the case of Tested Losses, however, the rules are modified slightly such that, in practice, Tested Losses will principally (if not exclusively) be allocated to common stock.[32]
The Proposed Regulations confirm that a US Shareholder determines its pro rata share of tested interest income and tested interest expense under the same rules it uses to determine its pro rata share of Tested Income and Tested Loss, i.e., Section 951(a)(2) and Treas. Reg. § 1.951-1(b) and (3).[33] Similarly, a US Shareholder's pro rata share of QBAI of a CFC largely follows its pro rata share of the Tested Income of the CFC. That is, a US Shareholder is allocated a portion of a CFC's total QBAI in the same proportion as (i) the US shareholder's pro rata share of CFC Tested Income bears to (ii) the total Tested Income of the CFC for the CFC inclusion year.[34]
2. Preferred and multiple classes stock. How are Tested Income, Tested Losses, and other tested items allocated between preferred and/or different classes of stock of a CFC and common stock of the CFC?
As discussed above, Tested Income, Tested Loss, and other GILTI items are allocated to US Shareholders of a CFC using the same rules used to allocate subpart F income.[35] The Proposed Regulations amend Treas. Reg. § 1.951-1(e) and, indirectly, the way in which Tested Income, Tested Loss, and other GILTI items are allocated between different classes of CFC stock. Prop. Treas. Reg. § 1.951-1(e) provides that, for purposes of determining a US Shareholder's pro rata share of subpart F income, a CFC's E&P for an inclusion year is first treated as distributed among the CFC's various classes of stock, and then to each share within each class of stock. Importantly, the Proposed Regulations provide that E&P is not allocated based solely on the distribution rights or fair market value of each class and share of CFC stock, but instead based on all facts and circumstances.[36] In addition, and as noted above, the proposed amendments introduce an anti-abuse rule which disregards transactions and/or arrangements a principal purpose of which is to reduce a US Shareholder's pro rata share of subpart F income.[37] Because pro rata determinations of GILTI items are based on subpart F principles, allocations of Tested Income, Tested Loss, QBAI, and other GILTI attributes will also be subject to these amendments.
In addition to the amendments above, the Proposed Regulations introduce special rules that apply when a Tested Loss CFC with issued and outstanding preferred stock has an E&P balance below the amount necessary to pay accrued but unpaid dividends on the preferred stock. In broad strokes, the shortfall in E&P is distributed first to preferred stock and, only then, is any remaining E&P allocated to common stock (i.e., in effect the opposite of the way in which the rules normally operate).[38]
The Proposed Regulations provide similar corresponding rules to allocate QBAI between preferred (and/or multiple classes of) stock and common stock of a CFC.[39] However, it is worth noting that, when a Tested Income CFC has QBAI for an inclusion year that exceeds 10 times its Tested Income for that year (excess QBAI), its preferred shares do not receive full "credit" for the QBAI that would otherwise be attributable and allocable to the preferred shares. In such circumstances, QBAI not in excess of 10 times Tested Income is allocated under the normal allocation rules described above. However, excess QBAI is, in most cases, allocated only to common stock.[40]
Specified Interest Expense and Tested Interest Expense and Income
1. Tested interest income "attributable" to tested interest expense. How does a US Shareholder determine whether tested interest income is "attributable" to tested interest expense?
As a threshold matter, a US Shareholder's NDTIR is reduced by its "specified interest expense."[41] Specified interest expense is (i) a US Shareholder's pro rata share of tested interest expense properly allocable to gross Tested Income, reduced by (ii) the US Shareholder's pro rata share of tested interest income included in gross Tested Income "attributable to" the tested interest expense.[42]
The Proposed Regulations adopt a so-called "netting" approach for purposes of establishing when tested interest income is considered attributable to tested interest expense.[43] That is, specified interest expense is calculated as the excess of (i) the aggregate of a US Shareholder's pro rata shares of the tested interest expense of each of its CFC over (ii) the aggregate of its pro rata shares of the tested interest income of each of its CFCs.[44] Treasury and the IRS considered, but ultimately rejected, a stricter "tracing" approach for determining whether tested interest income is attributable to tested interest expense, due to the complexity and administrative burden it would place on both taxpayers and the IRS.[45]
2. Financing and insurance CFCs. Is the interest expense of a CFC involved in the business of either banking or insurance taken into account in determining a US Shareholder's specified interest expense?
No, tested interest expense (the starting point for specified interest expense) excludes most interest expenses of a "qualified CFC."[46] A qualified CFC includes (i) an "eligible CFC" described in Section 954(h)(2), which includes any CFC that is predominantly engaged in the active conduct of a banking, financing, or similar business, and (ii) a "qualifying insurance company" described in Section 953(e)(3), which includes a CFC licensed, authorized, or regulated by the applicable insurance regulatory body for its home country to sell insurance, reinsurance, or annuity contracts to persons other than related persons.
The tested interest expense of a CFC includes all interest expense paid or accrued by a CFC that is taken into account in determining its Tested Income (or Tested Loss), less the "qualified interest expense" of the CFC. Qualified interest expense is (i) (a) interest expense paid or accrued by a qualified CFC taken into account in determining the Tested Income or Tested Loss of the CFC, multiplied by (b) a fraction described in Prop. Treas. Reg. §1.951A-4(b)(1)(iii)(A); and (ii) then reduced by the amount of interest income of the qualified CFC that is excluded from foreign personal holding company income (FPHCI) under Section 954(c)(3) or (6). The fraction in Prop. Treas. Reg. §1.951A-4(b)(1)(iii)(A) is a bit complicated, but in broad strokes, is essentially equal to the average aggregate adjusted bases, as of the close of each quarter, of (i) obligations or financial instruments held by the qualified CFC that give rise to income excluded from FPHCI, over (ii) all assets held by the qualified CFC.[47]
As noted above, specified interest expense decreases the amount of a US Shareholder's NDTIR, which in turn increases the US Shareholder's GILTI inclusion for the year.[48] While interest expense of a qualified CFC also may reduce the amount of QBAI taken into account by a US Shareholder, the reduction will generally be less than the reduction that would result from a non-qualified CFC with the same interest expense amount.
CFC Stock Basis Adjustments
1. Test losses and stock basis adjustments. If Tested Losses reduce Tested Income, is a US Shareholder required to make a negative or downward basis adjustment to the stock of the Tested Loss CFC(s)?
For corporate US Shareholders, yes. Although the statute itself does not require or provide for stock basis reductions for Tested Loss CFCs whose Tested Losses reduce Tested Income,[49] Treasury and the IRS determined that downward basis reductions are appropriate to avoid duplication of losses.[50] These basis reductions are made only at the time stock of the Tested Loss CFC is disposed of.[51] The basis reductions are based on the net amount of Tested Losses considered "used" by the US Shareholder with respect to such CFC. Note that the basis reductions with respect to a particular CFC may be limited if such CFC has Tested Income in other years that is considered offset.[52]
2. Basis adjustments to stock of lower-tier CFCs. Will a reduction in basis of stock of a lower-tier CFC held by a non-wholly owned CFC trigger subpart F income attributable to such basis adjustment for other US Shareholders?
No. By way of background, since the use of a Test Loss is determined at the US Shareholder level and dependent in part on a US Shareholder's pro rata share of Tested Income from other CFCs, the amount of the Tested Loss that is considered "used" by US Shareholders (and therefore the basis adjustment) with respect to a particular CFC may not be in proportion to such shareholders' pro rata share of Tested Loss attributable to such CFC. The Proposed Regulations adopt a "tracing" approach modeled after Section 704(c) to ensure that subpart F income associated with reductions in stock basis is only required to be included by the US Shareholder on whose account such basis adjustment is made.[53]
3. Negative basis? Can a downward basis adjustment exceed the adjusted basis in the stock of the relevant Tested Loss CFC?
Yes. Similar to the treatment of excess loss accounts (ELAs) under the consolidated return regulations and the treatment of distributions of previously taxed income (PTI) under Section 961(b), the downward basis reductions required under the Proposed Regulations are not limited to the outside basis in the shares of the Tested Loss CFC.[54] Any required basis reduction in excess of available CFC stock basis is treated as gain from the sale or exchange of such stock.[55]
4. Interaction with Section 1248. In the event gain is required to be recognized as a result of a stock basis reduction in excess of available stock basis, is the gain subject to recharacterization as dividend income under Section 1248?
The Proposed Regulations do not specifically address this point. However, Section 1248(a) generally applies to gain from the sale or exchange of CFC stock and also treats a taxpayer as having sold stock if the taxpayer is treated as realizing gain from the sale or exchange of stock. Thus, it is possible that Section245A could potentially apply to such gain.
Qualified Business Asset Investment QBAI) and Net Deemed Tangible Income Return (NDTIR)
1. Used in the production of Tested Income. Are there any specific requirements for property to be considered to be used in the production of Tested Income (a precondition for property to constitute QBAI)?
The Proposed Regulations do not provide any specific guidance, limitations, or restrictions regarding when tangible property is considered used in the production of Tested Income and when it is not. The Proposed Regulations appear to largely leave this determination to taxpayers.
2. Dual-use property. How is tax basis of property that is used both in the production of Tested Income and income other than Tested Income allocated between the two activities?
The portion of the tax basis of such property that is considered specified tangible property (and, therefore, QBAI) is the product of (i) the average adjusted basis of the property; and (ii) the so-called "dual use ratio."[56] Calculation of the dual use ratio depends on whether or not the property in question produces directly identifiable Tested Income. If it produces directly identifiable income, the dual use ratio is the ratio of gross Tested Income produced by the property for the CFC inclusion year over the total amount of gross income produced by the property for the inclusion year.[57]
If, on the other hand, the property in question does not produce directly identifiable Tested Income (but rather only indirectly contributes to the production of Tested Income), the dual use ratio is the ratio of gross Tested Income of the CFC for the CFC inclusion year over the total amount of CFC gross income for the inclusion year.[58]
1. Anti-avoidance rules – property "transferred or held, temporarily". Did Treasury and the IRS exercise their authority under Section 951A(d)(4) to issue guidance on the treatment of property "transferred, or held, temporarily"?
Yes. The Proposed Regulations provide that specified tangible property acquired by Tested Income CFC (the acquiring CFC) is disregarded if the acquired property is held temporarily with a principal purpose of reducing a US Shareholder's GILTI inclusion.[59] Property held by a CFC over a quarter end but for less than 12 months is per se treated as being held temporarily with a principal purpose reducing the GILTI inclusion of a US Shareholder.[60]
2. Anti-avoidance rules – QBAI attributable to basis "step-up" transactions (fiscal year CFCs). Will transactions that (i) were implemented prior to the first taxable year in which a CFC is subject to GILTI; and (ii) will ultimately reduce a US Shareholder's GILTI inclusion (for example, by creating QBAI that reduces Tested Income) be respected for purposes of applying the GILTI rules?
No. The Proposed Regulations provide that tax basis of specified tangible property arising from a disqualified transfer (disqualified basis) is disregarded for purposes of calculating QBAI.[61] This rule largely parallels the Tested Income/Tested Loss anti-avoidance rule discussed above. A disqualified transfer includes any transfer of property by a CFC (regardless of whether it is a Tested Income or Tested Loss CFC at the time of the transfer) during the disqualified period to a related person[62] in a transaction in which gain is recognized. The disqualified period for a CFC begins on January 1, 2018, and ends on the close of the CFC's last taxable year that is not a CFC inclusion year (i.e., the last day of its last pre-GILTI fiscal year).[63]
The disqualified basis amount is (i) the excess of the basis of specified tangible property immediately after a disqualified transfer, over (ii) the sum of (a) any amounts subject to US tax under Section 882 (effectively connected income) as a result of the transfer and (b) any US Shareholder's pro rata share of gain recognized by the transferor CFC that is included in gross income under Section 951(a)(1)(A) (i.e., a subpart F inclusion associated with the transfer).[64]
3. Anti-avoidance Rules – commercial transactions. Are commercial transactions and arrangements that are common or ordinary within a particular industry exempt from the anti-avoidance rules?
The Proposed Regulations currently do not provide any specific exception or relief for transactions that are common or ordinary with a particular industry (i.e., entered into in the ordinary course of business).
4. Anti-avoidance Rules – transactions where avoidance is a "factor". Did Treasury and the IRS exercise their authority under Section 951A(d)(4) to issue guidance regarding when, or under what circumstances, the avoidance of Paragraph 951A(d)[(4)] will be considered a "factor" in the transfer or holding of property?
No. The Proposed Regulations currently do not provide any specific guidance regarding when the avoidance of Paragraph 951A(d)(4) will be considered a factor in the transfer or holding of property.
US Partnerships Under the GILTI Regime
1. Domestic partners of US Shareholder partnerships (Partnership CFCs). How does a domestic partner of a domestic partnership that is a US Shareholder with respect to a CFC (a US Shareholder partnership) determine its GILTI inclusion amount with respect to CFC stock owned directly or indirectly by the US Shareholder partnership (each a Partnership CFC)? In other words, is the domestic partner allocated a distributive share of the US Shareholder partnership's GILTI inclusion amount? Or does the domestic partner determine its GILTI inclusion amount based on allocations (from the US Shareholder partnership) of the Partnership CFC's Tested Income, Tested Losses, and other GILTI items?
The answer depends on whether or not the domestic partner is, on a standalone basis, considered a US Shareholder of a Partnership CFC. The Proposed Regulations adopt a so-called "aggregate approach" in circumstances where a domestic partner owns, either directly or indirectly (including through a US Shareholder partnership), enough stock in a Partnership CFC to be considered a US Shareholder of the CFC.[65] Under the aggregate approach, the domestic partner is allocated (through its interest in the US Shareholder partnership) items of Partnership CFC Tested Income, Tested Loss, QBAI, and other GILTI items.[66] The domestic partner then determines its annual GILTI inclusion amount by combining those GILTI items with GILTI items attributable to and allocated from other non-Partnership CFCs.[67] This approach is taxpayer-favorable to the extent that it allows a domestic partner to net or offset non-Partnership CFC Tested Losses against Tested Income of a Partnership CFC (or vice versa).
If, on the other hand, the domestic partner is not, standing alone, considered a US Shareholder of a Partnership CFC, the Proposed Regulations apply a so-called entity approach.[68] Under this approach, the US Shareholder partnership determines its GILTI inclusion amount at the partnership level and then allocates a portion of that amount to the domestic partner in accordance with the partner's distributive share.[69]
Observations on future guidance under Section 250, Sections 901 and 902, and Section 78. The preamble includes a lengthy discussion of Treasury's and the IRS's reasons for adopting the "hybrid approach" outlined above, rather than a pure aggregate or a pure entity approach for purposes of making partnership GILTI determinations and allocations.[70] The "aggregate" features of the hybrid approach ensure that US Shareholder partners of a US Shareholder partnership are eligible for the deduction under Section 250 and any foreign tax credit available under Section 960(d), outcomes that appear to be intended by Congress. On the other hand, the "entity" features of the hybrid approach ensure that small, non-US Shareholder partners of a US Shareholder partnership do not completely escape GILTI taxation. The preamble explains that the hybrid approach was chosen, in part, because it "harmonizes the treatment of domestic partners across all provisions of the GILTI regime". The explicit references to Section 250 in the preamble, as well as the similar tensions between the treatment of US Shareholder partners vs. non-US Shareholder parties that are likely to arise in the foreign tax credit context, may foreshadow that forthcoming guidance on the Section 250 deduction, the treatment of foreign taxes paid with respect to Tested Income, and the corresponding Section 78 gross-up may adopt a similar "hybrid" framework and principles.
2. QBAI owned through a partnership. If a CFC is a partner in a partnership, can it take into account QBAI owned by the partnership, and if so, to what extent?
Yes. For purposes of determining its Tested Income, a CFC partner may increase its QBAI by the amount of any "partnership QBAI".[71] Partnership QBAI is the sum of the CFC partner's share of the adjusted basis of any specified tangible property (in practice, QBAI) owned by the partnership.[72] A CFC's "share" of such basis is determined based on the "Partnership QBAI ratio" with respect to the underlying property.[73]
The Partnership QBAI ratio is calculated in a manner similar to the dual-use ratio that applies for determining the portion of dual-use property that is considered QBAI (discussed above). That is, the calculation largely depends on whether or not the property in question produces directly identifiable Tested Income. If it produces directly identifiable income, the Partnership QBAI ratio is the ratio of the CFC partner's distributive share of gross Tested Income produced by the property for the partnership taxable year over the total amount of gross income produced by the property for the year.[74]
If, on the other hand, the property does not produce directly identifiable Tested Income (but rather indirectly contributes to the production of Tested Income), the dual use ratio is the ratio of the CFC partner's distributive share of the gross income of the partnership for the partnership taxable year over the total amount of partnership gross income for the year.[75]
3. Special rule for US Shareholder partnerships on deductions attributable to related parties. If a US Shareholder partnership had a deduction from a payment made to a related CFC, is the deduction taken into consideration for purposes of calculating its GILTI inclusion amount?
Yes, but the US Shareholder partnership is only permitted to take into consideration that deduction arising from a related party payable to the extent that one or more US persons (other than domestic partnerships) that are direct or indirect partners include in gross income their distributive share of the GILTI inclusion amount (or their pro rata share if they are US Shareholder partners).[76]
Consolidated Group Issues
1. Single-entity treatment. Are US Shareholders that are members of the same US consolidated group treated as a signal corporation for purposes of applying the GILTI rules?
For the most part, yes. In general, a US consolidated group aggregates each US Shareholder member's pro rata share of Tested Loss, QBAI, tested interest expense, and tested interest income and then allocates those items to each member that is a US Shareholder of a Tested Income CFC.[77] The allocation of GILTI items is based on the proportion of a member's aggregate pro rata share of Tested Income to the total Tested Income of the overall US consolidated group (the GILTI Allocation Ratio).[78]
2. Consolidated group NDTIR. Is the NDTIR calculated at the consolidated group level or the member level?
At the member level. The member that is a US Shareholder of a Tested Income CFC is allocated its proportionate amount of consolidated group QBAI based on its GILTI Allocation Ratio.[79] Once the member has received its Allocable Share of QBAI, the NDTIR can be calculated.
3. Consolidated group investment adjustments. Are investment adjustments allowed with respect to the stock basis of consolidated group members that hold CFC stock?
Yes, although adjustments do not apply to the consolidated group parent's stock. Stock held in a member is adjusted (increased) to take into account a portion of the member's offset test income amounts by treating such amounts as tax-exempt income and also adjusted (decreased) by the member's used tested loss amount by treating such amount as a non-capital, nondeductible expenditure. In addition, new rules were added to mitigate any tax-incentive a consolidated group parent (or other member) may have to sell the stock of a CFC instead of the stock of the member of the consolidated group that holds that CFC.[80] Proposed Treasury Regulation Section 1.1502-32(b)(3)(iii)(F) provides that a member will be treated as receiving tax-exempt income, thereby increasing the basis in such member's stock held by another member immediately before such other member recognizes income, gain, deduction, or loss with respect to a share of the subsidiary member's stock. This allocation of tax-exempt income equals the amount equal to the net offset tested income[81] amount allocable to the shares of any CFC that member owns that would qualify for the Section 245A deduction if those CFCs distributed such income. Treasury and IRS are requesting comments on several aspects of this basis adjustment, including on the coordination of the rules found in Prop. Treas. Reg. Sections 1.951A-6(e) and 1.1502-51(c).
Treasury and IRS Requests for Comments
Although the Proposed Regulations are helpful and provide much needed guidance on a variety of issues, it is clear from the preamble that much additional work remains for Treasury and the IRS. Specific comments are requested by Treasury and the IRS. These comments, as well as any request for a public hearing, must be received within 60 days of the date on which the Proposed Regulations are published in the Federal Register. The most significant of these requested comments are set forth below.
Deductions ordinarily only available to domestic corporations. Whether the Proposed Regulations should allow a CFC a deduction, or require a CFC to take into account income, that is expressly limited to domestic corporations under the Code (e.g., whether a CFC may be entitled to a dividends received deduction under Section 245A, even though that section by its terms applies only to dividends received by a domestic corporation)
Characterization of GILTI inclusions. Whether there are other circumstances or arrangements in which the characterization of a GILTI inclusion amount is relevant and, if so, whether the inclusion should be treated in the same manner as a Section 951(a)(1)(A) inclusion or in some other manner (e.g., as a dividend)[82]
Specified tangible property held by a partnership. Comments generally on the treatment of specified tangible property held through a partnership, including the proposed rules addressing property that does not produce directly identifiable income[83]
Treatment of domestic partnerships and their partners. Whether other approaches to the treatment of domestic partnerships and their partners should be considered (i.e., other than a pure entity, pure aggregate, or hybrid approaches described in the preamble) that would more appropriately harmonize the provisions of the GILTI regime (particularly with regard to administrative and compliance burdens for both taxpayers and the IRS)[84]
Aggregate approach - attribute adjustments. Comments generally on adjustments required by reason of computing a GILTI inclusion amount (in whole or in part) under an aggregate approach (i.e., at the partner level) (e.g., adjustments affecting a partner's basis in a partnership interest or its Section 704(b) capital account, a partnership's basis in CFC stock under Section 961, and a CFC's previously taxed earnings and profits with respect to the partner or partnership under Section 959[85]
Dispositions of CFC stock. With regard to dispositions of CFC stock, whether (i) the definition of "disposition" should be modified; and (ii) additional adjustments to stock basis or E&P should be made to account for a used Tested Loss or offset Tested Income.[86] And, in both cases, whether the same rules should apply to corporate and non-corporate US Shareholders, given that non-corporate US Shareholders are not eligible for the deduction under Section 245A[87]
Consolidated return investment adjustments. Comments generally on the coordination between (i) Prop. Treas. Reg. Sections 1.951A-6(e) and 1.1502-51(c); and (ii) the investment adjustment rules in Treas. Reg. Section 1.1502-32.[88] In this regard, the preamble specifically requests comments on
whether the amount of the adjustments to the basis of member stock should be limited to the amount of the adjustments to the basis of the stock of a CFC under the rules of proposed Treas. Reg. Section 1.951A-6(e);
whether the adjustments to the basis of member stock should all be made on a current basis, made to the extent of the basis adjustments provided in Prop. Treas. Reg. Section 1.951A-6(e) on a current basis with any remaining adjustments being made at the time of a disposition of stock of a CFC or of a member, or made only at the time of a disposition of the stock of a CFC or of a member; and
whether rules should provide that a deduction under Section 245A should not be treated as tax-exempt income to the extent that the underlying dividend is attributable to offset Tested Income for which basis adjustments have already been made.
Deemed dispositions of CFC stock. Whether there are any circumstances in which there should be a deemed disposition of the stock of a CFC owned by a member, such that the rules of proposed Treas. Reg. Section 1.951A-6(e) would apply, including, but not limited to, a deconsolidation or taxable disposition of the stock of a member that owns (directly or indirectly) the stock of a CFC to either a person outside of the consolidated group or to another member, and a transfer of the stock of a member in an intercompany transaction that is a non-recognition transaction
Consolidated return. Whether there are other transactions that should be described in the definition of transferred shares in proposed Treas. Reg. Section 1.1502-32(b)(3)(ii)(F)(1), such as a deemed disposition pursuant to Treas. Reg. Section 1.1502-19(c)(1)(iii)(B)
Duplication of gain or loss. Whether any other adjustments are necessary to prevent the duplication of gain or loss resulting from a member's ownership of a CFC, including situations where a member owning a CFC joins another consolidated group
Additional rulemaking. Whether additional rules under Treas. Reg. Section 1.1502-33 or any other regulations issued under Section 1502 are necessary[89]
Small entities. Comments generally on the impact of the Proposed Regulations on small entities.[90]
If you have any questions or would like more information on the issues discussed in this LawFlash,
please contact any of the following Morgan Lewis lawyers:
Michael Liu
Josh Richardson
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San Francisco/Silicon Valley
Barton W.S. Bassett
Rod Donnelly
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Scott Farmer
Peter Daub
[1] As of the date of publication of this LawFlash, the Proposed Regulations and the corresponding preamble (the Preamble) have not been published in the Federal Register. The citations referenced herein are based on the document that Treasury submitted to the Office of Federal Register on September 13, 2018.
[2] IRC § 951(A)(a).
[3] IRC § 951(A)(b)(1).
[5] Pub. L. 115-97 § 14103 (Dec. 22, 2017).
[6] Preamble at 3.
[8] See Prop. Treas. Reg. §1.951A-2(c).
[9] Prop. Treas. Reg. §1.951A-1(d)(2).
[10] Section 951(a)(2). To illustrate with a simple example, assume that a US Shareholder owns an interest in only one foreign corporation and the US Shareholder and the foreign corporation are both calendar year taxpayers. If that foreign corporation qualified as a CFC for seven months of its year and has Tested Income of $120, the US Shareholder's pro rata share of the CFC's Tested Income would be $70.
[11] See Prop. Treas. Reg. § 1.951-1(e)(4).
[12] Prop. Treas. Reg. §1.951-1(e)(6).
[13] Prop. Treas. Reg. § 1.951A-2(c)(2).
[14] Prop. Treas. Reg. § 1.951A-2(c)(2); Treas. Reg. § 1.952-2(a)(1).
[16] Prop. Treas. Reg. § 1.951A-6(c)(1); Preamble at 38.
[20] See Prop. Treas. Reg. § 1.951A-6(d).
[21] See Prop. Treas. Reg. § 1.951A-6(d); cf definition of "used Tested Loss amount" in Prop. Treas. Reg. § 1.951A-6(e)(2)(ii).
[22] Prop. Treas. Reg. § 1.951A-1(d)(1).
[23] Prop. Treas. Reg. § 1.951A-6(b)(2)(ii).
[24] See Prop. Treas. Reg. § 1.951A-2(c)(5)(i).
[25] See Prop. Treas. Reg. § 1.951A-2(c)(5)(ii), (iii).
[26] See Prop. Treas. Reg. § 1.951A-2(c)(5)(ii).
[27] See Prop. Treas. Reg. § 1.951A-2(c)(5)(ii); see also Prop. Treas. Reg. § 1.951A-3(h)(2)(ii).
[28] Relatedness is determined under Sections 267(b) and 707. See Prop. Treas. Reg. § 1.951A-3(h)(2)(ii)(E).
[29] See Prop. Treas. Reg. § 1.951A-3(h)(2)(ii)(C).
[30] See Prop. Treas. Reg. § 1.951A-1(d)(2).
[32] Prop. Treas. Reg. §1.951A-1(e)(4). Specifically, the modified rules provide that, for purposes of the Hypothetical Distribution, (a) the amount of current E&P of a CFC for the CFC inclusion year is deemed to be equal to the Tested Loss of the CFC for the inclusion year, (b) the deemed distribution is generally treated as made with respect to only common stock of the CFC, and (c) the amount deemed distributed to a shareholder is reduced if the shareholder does not own stock for the entire year.
[33] Prop. Treas. Reg. §1.951A-1(d)(1).
[34] Prop. Treas. Reg. §1.951A-1(d)(3)(i).
[35] See Prop. Treas. Reg. § 1.951A-1(d)(2). See also Section 951(a)(2) and Treas. Reg. § 1.951-1(b) and (e).
[38] Prop. Treas. Reg. §1.951A-1(d)(4)(ii).
[41] IRC §951A(b)(2)(B).
[42] Prop. Treas. Reg. §1.951A-4(b).
[43] Preamble at 27.
[45] Preamble pg. 26-27.
[46] Prop. Treas. Reg. §1.951A-4(b)(1)(iv).
[47] Prop. Treas. Reg. §1.951A-4(b)(1)(iii)(A)
[48] IRC § 951(a), (b).
[49] Positive or upward basis increases associated with Tested Income, on the other hand, are provided for under Section 961 via Section 951A(f)(1), (2).
[50] Preamble at 39-40.
[51] See Prop. Treas. Reg. § 1.951A-6(e).
[52] See Prop. Treas. Reg. § 1.951A-6(e)(2).
[53] See Prop. Treas. Reg. § 1.951A-(6)(e)(7).
[54] See Prop. Treas. Reg. § 1.951A--6(e)(1).
[57] Prop. Treas. Reg. § 1.951A-3(d)(2)(i).
[58] Prop. Treas. Reg. § 1.951A-3(d)(2)(ii).
[59] Prop. Treas. Reg. § 1.951A-3(h)(1).
[63] Prop. Treas. Reg. § 1.951A-3(h)(2)(ii)(D).
[64] Prop. Treas. Reg. § 1.951A-3(h)(2)(ii)(A).
[65] Prop. Treas. Reg. §1.951A-5(b); (e)(3). See also Preamble at 32-33.
[66] Id.
[68] Prop. Treas. Reg. §1.951A-5(b)(2). See also Preamble at 32-33.
[70] See Preamble at 31-34.
[71] Prop. Treas. Reg. § 1.951A-3(g)(1).
[72] Prop. Treas. Reg. § 1.951A-3(g)(1), (2)(i).
[73] Prop. Treas. Reg. § 1.951A-3(g)(2)(ii).
[74] Prop. Treas. Reg. § 1.951A-3(g)(2)(ii)(A).
[75] Prop. Treas. Reg. § 1.951A-3(g)(2)(ii)(B).
[76] Preamble at 38; Prop. Treas. Reg. § 1.951A-6(c)(2).
[77] Preamble at 46, 47. See Prop. Treas. Reg. § 1.1502-51(b). Treasury reasoned that since the GILTI regime differs from the subpart F regime, in that it is an aggregate US Shareholder-level calculation, to permit the member's GILTI inclusion amount calculated based only on its Section 958(a) ownership might not result "in a clear reflection of the consolidated group's income tax liability." From example, it left open the ability to segregate CFCs with QBAI from those with tested interest expense, inflating a member's NDTIR as compared to the overall groups. Alternatively, it could also result in a higher than appropriate tax liability for the group, because a member with a Tested Loss would be unavailable to reduce another member's Tested Income.
[78] See Prop. Treas. Reg. § 1.1502-51(e).
[80] Preamble at 48. This incentive could exist without the modified 1502 proposed regulations because "gain recognized on the disposition of stock of a CFC attributable to offset tested income would, in most cases, be eliminated as a result of the application of Section 964(e)(4) or Section 1248(a) and (j), to the extent that gain or income is eligible for the dividends received deduction under section 245A." The sale of stock of a member that held the CFC (absent a Section 338(h)(10) election) would generally not have produced the same result under Section 245A.
[81] Net offset tested income means "with respect to a domestic corporation and a controlled foreign corporation, the excess (if any) of the aggregate of" the domestic corporation's offset tested income amount with respect to a CFC for each US Shareholder inclusion year over the aggregate domestic corporation's used tested loss amount with respect to the CFC for the same years. See Prop. Treas. Reg. § 1.951A-6(e)(3).
[82] Pg. 37.
[85] Pg. 36-37.
[86] See, e.g., Treas. Reg. § 1.965-2(d) and (f).
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