On December 2, 2019, the Treasury Department issued final regulations that provide guidance regarding the determination of foreign tax credits. Of particular note, these regulations finalize proposed foreign tax credit regulations published on December 7, 2018 related to the 2017 Tax Cuts and Jobs Act (the "2017 Tax Act"). The final regulations could potentially limit a taxpayer's ability to offset U.S. taxable income with foreign taxes paid or accrued.
The 2017 Tax Act created two new foreign tax credit limitation categories for global intangible low-tax income (GILTI) and foreign branch income. These regulations finalized the proposed rules relating to the allocation and apportionment of deductions for purposes of these new limitation categories, offering taxpayers guidance on how to calculate their foreign tax credit in light of the changes introduced by the 2017 Tax Act.
In addition, the final regulations include transition rules for assigning carryforwards of unused foreign taxes paid or accrued in pre-2018 tax years to post-2017 separate categories, including the new categories for GILTI and foreign branch income.
The final regulations relating to the 2017 Tax Act generally apply to tax years beginning after December 31, 2017. Other provisions that do not relate to the 2017 Tax Act apply to tax years ending on or after December 4, 2018. As such, these rules could have a retroactive effect in certain circumstances.
The Omnibus Tax Package attached to the 2020 Appropriations Package, signed into law on December 20, 2019, extends the application of the beneficial look-through rule for related controlled foreign corporations (CFCs) for one year, through tax years beginning before January 1, 2021.
The look-through rule under IRC Section 954(c)(6) provides that dividends, interest, rents, and royalties received or accrued by a CFC from a related CFC will not be treated as foreign personal holding company income. Foreign personal holding company income is a type of phantom Subpart F income, which is currently includible as taxable income for U.S. shareholders regardless of whether such income is actually distributed by the CFC. The look-through rule applies only if the payment from the related CFC is not sourced from Subpart F or effectively connected income.
On May 22, 2019, the Treasury Department issued final regulations under IRC Section 956 to reduce a U.S. shareholder's inclusion with respect to a CFC's investment in U.S. property. The final regulations are expected to provide a more favorable result for domestic corporate U.S. shareholders and may eliminate the Section 956 inclusion for many taxpayers, which will be particularly relevant as taxpayers prepare to file their 2019 federal returns.
The methodology adopted in the final regulations reduces a U.S. shareholder's Section 956 inclusion amount when a deemed distribution from the CFC would have otherwise resulted in a dividend eligible for deduction under Section 245A. Among other modifications to the proposed regulations published November 5, 2018, the final regulations expand the scope of applicability to include domestic partnerships with U.S. corporate shareholders.
Although this new approach may minimize the effects of Section 956 for many taxpayers, the final regulations do not eliminate Section 956 altogether. Effectively connected income and other earnings of a CFC (other than undistributed foreign earnings) may continue to result in a Section 956 inclusion. In addition, taxpayers that are ineligible for the U.S. participation exemption under Section 245A will not receive any Section 956 relief under the final regulations. Moreover, the final regulations could result in a greater Section 956 inclusion in these instances if the proposed regulations under Section 960 (regarding disallowance of foreign tax credits related to Section 956 inclusions) are finalized.
The final regulations apply to CFCs' tax years beginning on or after July 22, 2019. However, taxpayers may apply the final regulations to tax years beginning after December 31, 2017 if the taxpayer and its related U.S. persons consistently apply the final regulations to all of their CFCs at that time.
How Can Venable Help?
The 2017 Tax Act has ushered in a period of significant U.S. international tax legislative changes that materially impact U.S. taxpayers with international footprints. Venable's international tax team can help clients develop and implement effective tax planning strategies in order to navigate these developments.