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25 January 2019
On November 28, 2018, the Internal Revenue Service (IRS) and the US Department of the Treasury released proposed regulations (REG-105600-18) that address the calculation of a corporate US shareholder's deemed paid foreign tax credits under section 960. The proposed regulations also make clear that certain foreign income taxes paid by controlled foreign corporations (CFCs) will be "lost," and the corporate US shareholder can never claim a deemed paid credit with respect to such taxes.
Prior to the 2017 Tax Act, former sections 902 and 960(a)(1) permitted a corporate US shareholder to claim a credit for foreign taxes paid by a CFC when the related income was either distributed to the shareholder as a dividend or included in the shareholder's income under section 951(a). In both scenarios, the amount of deemed paid foreign taxes was based on multi-year "pools" of earnings and taxes, with the shareholder generally deemed to have paid the same proportion of the CFC's post-1986 foreign income taxes as the amount of the dividend or subpart F inclusion bore to such CFC's post-1986 undistributed earnings. In addition, former section 960(a)(3) generally applied the rules of former section 902 in allowing the corporate US shareholder to claim a deemed paid credit for foreign income taxes paid by a CFC on a distribution of previously taxed earnings and profits (PTEP).
The 2017 Tax Act repealed section 902, modified section 960 and generally changed the system for determining the deemed paid credit from multi-year pooling to a "properly attributable" standard. Under new sections 960(a) and (d), a corporate US shareholder can claim a deemed paid credit for foreign income taxes that are properly attributable to current year subpart F income and global intangible low taxed income (GILTI) inclusions, respectively (current year taxes). Current year taxes attributable to GILTI inclusions are further subject to a 20 percent "haircut." Under new section 960(b), a shareholder is generally deemed to have paid foreign income taxes that are properly attributable to distributions of PTEP received from a first-tier CFC (in the case of a corporate US shareholder) or from a lower-tier CFC (in the case of an upper-tier CFC shareholder) (in both cases, PTEP group taxes). Except for PTEP group taxes, only foreign income taxes paid or accrued by the CFC in a current tax year generally can be deemed paid by a US shareholder.
The proposed regulations provide rules for determining a corporate US shareholder's deemed paid credits with respect to a CFC's current year taxes and PTEP group taxes. The determination of deemed paid credits for current year taxes is first made at the lowest-tier CFC and is then repeated for each CFC on a "bottom-up" basis:
Deemed paid PTEP group taxes are also determined on a "bottom-up" basis, starting with the lowest-tier CFC:
The proposed regulations do not address the ordering of PTEP distributions. Instead, the preamble notes that the IRS and Treasury anticipate that ordering will be addressed in forthcoming regulations under section 959. Notice 2019-01, as noted above, describes regulations that Treasury intends to issue involving the ordering of PTEP upon distribution and reclassification.
Under the Proposed Regulations, certain foreign income taxes paid by CFCs will be "lost" and unavailable to be credited by corporate US shareholders, including:
In addition, the proposed regulations generally allocate taxes attributable to "timing differences" (defined in the proposed regulations as taxes imposed on an item of income that is not recognized for US federal income tax purposes in the current year) to the section 904 category and income group to which the related income would have been allocated if it had been recognized for US federal income tax purposes. If the shareholder does not have subpart F income or GILTI inclusions with respect to such income group in the current year, these taxes would generally be lost, even when the corporate US shareholder recognizes the related income for US tax purposes in a later year. Given the potential for lost taxes, taxpayers should identify any material base differences or timing differences in their CFCs to determine if there will be any related US income inclusions in the current year.
The effective dates in the proposed regulations vary, depending on the provision. The regulations under section 960 are proposed to have "retroactive" effectiveness for taxable years of a foreign corporation beginning after December 31, 2017, and a taxable year of a domestic corporation that is a US shareholder of the foreign corporation in which or with which such taxable year of such foreign corporation ends.
For further information on this topic please contact Bradford E LaBonte or Enrica Ma at McDermott Will & Emery by telephone (+1 202 756 8000) or email (firstname.lastname@example.org or email@example.com) The McDermott Will & Emery website can be accessed at www.mwe.com.
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