The Treasury and IRS have issued another piece of guidance on the foreign earnings transition tax under Code Sec. 965. The new provision, which was enacted as part of the Tax Cuts and Jobs Act ( P.L. 115-97), imposes a transition tax on the untaxed foreign earnings of U.S. companies’ foreign subsidiaries by deeming those earnings repatriated. Foreign earnings held in cash and cash equivalents are taxed at a 15.5 percent rate, and the remaining earnings are taxed at an 8 percent rate. Previous guidance was issued in Notice 2018-7, I.R.B. 2018-4, 317, Notice 2018-13, I.R.B. 2018-6, 341 and Rev. Proc. 2018-17, I.R.B. 2018-9, 384.
The guidance provides anti-avoidance rules, rules for special elections, reporting and paying the transition tax, and relief from estimated tax penalties. The guidance also addresses a number of other issues under the transition tax, including the constructive ownership rules that allow for the downward attribution of stock from a partner to a partnership, the determination of cash measurement dates, and the treatment of accrued foreign income taxes for determining post-1986 earnings and profits. The Treasury and IRS intend to issue regulations reflecting the guidance, which may be relied upon until the regulations are issued.
The Treasury and IRS intend to issue anti-avoidance rules for transactions undertaken with the principal purposes of reducing the Code Sec. 965 tax liability. A transaction will be disregarded if the transaction (1) occurs in whole or part after November 2, 2017, (2) is undertaken with the principal purposes of reducing the Code Sec. 965 tax liability of the U.S. shareholder, and (3) would, absent the rules, reduce the Code Sec. 965 tax liability. Cash-reduction transactions, E&P reduction transactions and certain pro rata share transactions are presumed to be undertaken with the principal purpose of reducing the U.S. shareholder’s Code Sec. 965 tax liability. Additionally, a change in method of accounting made for a tax year of a specified foreign corporation that ends in 2017 or 2018 will be disregarded if the change would reduce the Code Sec. 965 tax liability of the U.S. shareholder. The rule will not apply if Form 3115 was filed before November 2, 2017. Entity classification elections made on or after November 2, 2017, that reduce the Code Sec. 965 tax liability of the U.S. shareholder are also disregarded.
Individuals who receive an extension of time to file and pay tax under Reg. §1.6081-5 or Reg. §1.6081-6 will also have an extended period of time to make installment payments under Code Sec. 965(h) (i.e., the 15th day of the sixth month following the close of the tax year).
The instructions to the estimated tax forms will be modified to clarify that no underpayment penalty will be imposed under Code Sec. 6654 or Code Sec. 6655 with respect to a taxpayer’s net tax liability under Code Sec. 965, and the amounts are not included when calculating required installments. Additionally, if the amendment to Code Sec. 965 or Code Sec. 958(b) (i.e., downward stock attribution rule) caused an underpayment related to a required installment due on or before January 15, 2018, the estimated tax penalty will not apply.
Domestic-Pass-Through Owner Elections
The Treasury and IRS have determined that if a domestic pass-through entity is a U.S. shareholder that has a Code Sec. 965 amount with respect to Code Sec. 958(a) stock in a deferred foreign income corporation (DFIC), a U.S. person that is a domestic pass-through owner, directly or indirectly, is subject to net income tax on its share of the inclusion amount. The specified elections under Code Sec. 965(h), (m) and (n) may be made by the domestic pass-through owner. Regulations will be issued to clarify that a domestic pass-through owner who is an individual and a U.S. shareholder with respect to the DFIC may elect under Code Sec. 962 to be subject to tax as a corporation with respect to the individual’s share of the inclusion. Additionally, in computing the amount of tax due as a result of the election, the Code Sec. 965(c) deduction may be taken into account.
Constructive Ownership Rules and Downward Attribution of Stock
The Treasury and IRS will issue regulations that provide that solely for purposes of determining whether a foreign corporation is a specified foreign corporation, stock owned directly or indirectly by or for a partner will not be considered owned by a partnership under Code Sec. 958(b) and Code Sec. 318(a)(3)(A), if the partner owns less than five percent of the interests in the partnership’s capital and profits.
Cash Measurement Dates
A specified foreign corporation may not be owned by a U.S. shareholder on all cash measurement dates if, for example, the corporation ceases to exist or the stock is sold or acquired between dates. The regulations will define the first, second and final cash measurement dates. A U.S. shareholder must take into account its pro rata share of the cash position of a specified foreign corporation as of any cash measurement date of the specified foreign corporation on which the U.S. shareholder is a U.S. shareholder of the specified foreign corporation, regardless if the U.S. shareholder is a U.S. shareholder of the specified foreign corporation on any other cash measurement date, including the final date.
Post-1986 Earnings and Profits
A special rule applies for purposes of determining the specified foreign corporation’s post-1986 earnings and profits as of the measurement date on November 2, 2017. Any foreign income tax that accrues (1) within the specified foreign corporation’s U.S. tax year that includes November 2, 2017, and (2) after November 2, 2017, but on or before December 31, 2017, will be allocated between the respective portions of the tax base on which the accrued foreign taxes are determined that are attributable to the part of the U.S. tax year ending on November 2, 2017, and the part of the U.S. tax year beginning after November 2, 2017.
The Treasury and IRS intend to issue regulations reflecting the guidance. Code Sec. 965 is effective for the last tax year of foreign corporations that begins before January 1, 2018, and with respect to U.S. shareholders, for the tax years in which or with which such tax years of foreign corporations end. The guidance is effective beginning for the first tax year of a foreign corporation (and with respect to U.S. shareholders, the tax years in which or with which such tax years of the foreign corporations end) to which Code Sec. 965 applies. The guidance may be relied upon until regulations are issued.
The Treasury and the IRS request comments on the rules described in the notice, and on what additional guidance should be issued to assist taxpayers in computing the transition tax. Written comments may be submitted to the Office of Associate Chief Counsel (International), Attention: Leni C. Perkins, Internal Revenue Service, IR-4579, 1111 Constitution Avenue, NW, Washington, D.C. 20224. Alternatively, taxpayers may submit comments electronically to Notice.firstname.lastname@example.org.