Foreign Tax Credit Changes Addressed
Highly anticipated foreign tax credit regulations have been issued that provide guidance on the significant changes made to the foreign tax credit rules by the Tax Cuts and Jobs Act (TCJA). The proposed regulations address:
- allocation and apportionment of the deductions under Internal Revenue Code (IRC) Sections 861 through 865, and adjustments to the foreign tax credit limitation under IRC Section 904(b)(4);
- transition rules for overall foreign loss, separate limitation loss, and overall domestic loss accounts under IRC Section 904(f) and (g), and for the carryover and carryback of unused foreign taxes under IRC Section 904(c);
- addition of separate foreign tax credit limitation categories for foreign branch income and global intangible low-taxed income (GILTI), and other updates to the foreign tax credit limitation rules;
- calculation of the high-tax income exception from subpart F income;
- determination of the IRC Section 960 deemed paid credits and the gross-up under IRC Section 78; and
- the election under IRC Section 965(n) not to apply the net operating loss deduction when calculating the IRC Section 965 transition tax.
Deduction Allocation and Apportionment
The proposed regulations generally apply the existing approach of the expense allocation rules to income in the new IRC Section 951A (GILTI) and foreign branch categories. The proposed regulations also provide for exempt income and exempt asset treatment for income in the GILTI category that is offset by the IRC Section 250 deduction. This will reduce the amount of expenses apportioned to the GILTI category.
Rules are provided for the allocation and apportionment of the IRC Section 250 deduction. A new rule addresses loans to partnerships by certain partners and their affiliates to prevent abusive borrowing arrangements that artificially increase foreign source income. Under the proposed regulations, interest income attributable to borrowing through a partnership is allocated across the foreign tax credit separate categories in the same manner as the associated interest expense.
The proposed allocation and apportionment regulations also revise the netting rule for controlled foreign corporations (CFCs), and provide rules for: valuing assets, characterizing stock for elections related to research and experimentation (R&E) expenses, and applying the IRC Section 904(b)(4) adjustment.
Because the existing expense allocation rules have not been updated since 1988, the Treasury Department and IRS expect to reexamine existing approaches to allocating and apportioning expenses including, for example, the rules for allocating interest, R&E expenses, stewardship and general and administrative expenses.
The proposed regulations eliminate deadwood, and reflect statutory amendments made prior to the TCJA. New and transitional rules account for the separate categories for GILTI and foreign branch income. For example, foreign tax credit carryovers will by default remain in the general category, but taxpayers are allowed to allocate the transitional foreign tax credit carryovers to the foreign branch category. Also, the look-through rules are revised to clarify that nonpassive look-through payments cannot be assigned to an IRC Section 951A category, and are generally assigned to the general category or the foreign branch category.
Additionally, changes are made to the rules relating to the passive category for high-taxed income, export financing income, and financial services income. Also addressed is the separate category for income resourced under a treaty, and rules for assigning the IRC Section 78 gross-up and IRC Section 986(c) gain or loss to a separate category.
Deemed Paid Tax Credits
The proposed regulations provide rules for determining a domestic corporation’s deemed paid taxes under IRC Section 960, as revised by the TCJA. The proposed regulations treat a GILTI inclusion as a subpart F inclusion for purposes of IRC Section 960(c). The proposed regulations also reflect the changes made by the TCJA to the IRC Section 78 gross-up.
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