The IRS and U.S. Treasury have now issued their final regulations for transition tax under Section 965 of the IRC. This relates to transition tax and U.S. shareholders of foreign corporations that have deferred foreign income accumulated post-1986. This section of the IRC states that there will be a transition tax imposed on the inclusion for international accounting purposes.
While these final regulations keep the basic structure and approach of the proposed regulations, there are some changes. In general terms, they apply from the foreign corporation’s final tax year beginning before January 1, 2018. They apply to U.S. citizens starting from the tax year with or in which that foreign corporation’s tax year ends. The following will examine and clarify the basic differences between the former regulations and the new regulations.
Controlled Domestic Partnerships
Specified controlled domestic partnerships are now considered a foreign partnership. This applies when determining the U.S. shareholders of a specified foreign corporation that is owned by a controlled domestic partnership. It includes the stock under Section 958(a) that its shareholders own. In terms of a definition, “controlled domestic partnership” has been revised with respect to U.S. shareholders. The controlled foreign partnership is considered a foreign partnership for every partner when the rule applies.
Pro Rata Sharing
The terms “U.S. shareholder inclusion year” and “pro rata share” are now modified. These final regulations now require inclusion under Section 965(a) by U.S. shareholders under Section 958(a). This only occurs when the specific foreign corporation is no longer a specific foreign corporation in its inclusion year. This is the case even if it is not a controlled foreign corporation (CFC).
The Rule of Downward Attribution
A specific rule is applicable if determining the downward attribution from one partner to the partnership. This is relevant if that specified partner has de minimis interest in that partnership. The threshold to apply this rule increased from 5% to 10% and now includes trusts.
Rules for Basis Election
These final regulations allow a taxpayer the opportunity to increase his or her deferred foreign income corporation’s (DFIC’s) stock by the lesser of either of the following:
- Profits and earnings that have been previously taxed
- Amount by which it may be able to reduce its earnings and profits DFIC’s stock basis without recognizing any gain
Taxpayers designate the DFIC stock they want to increase and the amount within certain limits.
Anti-Abuse Rules Exceptions
Another change in these final regulations is with regard to anti-abuse rules. If specified incorporation transactions meet certain requirements, they qualify for an exception to the rules and, therefore, they do not apply. This refers to the disregarding of a stock transfer of specified foreign corporation stock by U.S. shareholders of domestic corporations. Of course, the transactions must meet certain requirements in such cases. The inclusion amount under Section 965(a) respecting transferred foreign corporation stock is not reduced.
Cash Position
Section 965 of the IRC taxes U.S. domestic corporate shareholders’ foreign cash earnings at a rate of 15.5%. All other earnings get taxed at 8%. For these purposes, the term cash also includes cash equivalents. These new final regulations also allow for a slight exception from a cash position definition. This is in respect to specific commodities that foreign corporations hold in their ordinary course of business and to specific contracts that have privately negotiated to sell and purchase such assets.
Payment and Election Rules
An individual can satisfy the election statement’s signature requirement by attaching the unsigned copy to the return and retaining his or her signed original.
Transition rules have been updated pertaining to the filing of transfer agreements. It is with regard to acceleration or triggering events that occur before or on December 31, 2018. In such cases, the individual must have filed the transfer agreement by no later than January 31, 2019.
There are also new rules to address the possible elimination of S corporation shareholder transferors and modifications to specific requirements regarding transfer agreement terms.
One further change applies when there is a report of additional liability on a return. While deficiency rules stay the same, prorated installment amounts of which the due date has passed now become due when the return reports that additional amount. This means deficiency payments prorated to installments with an already past due date become due on demand and notice.
Liability for Total Net Taxation
Taxpayers can elect to defer payments of their total net tax liability under Section 965(i) and (h) of the IRC. These final regulations under Section 951(a)(1)(B) of the IRC disregard any effective repatriations similarly taxed to dividends. This refers to any profits resulting from investments in property in the United States under Section 956 of the IRC.
Consolidated Groups
Regarding the cash position by consolidated group aggregates, it will now be determined as if every U.S. shareholder member of the group is a single shareholder.
These new transition tax final regulations are relevant in terms of international accounting. For those who are already familiar with the earlier regulations, these new regulations have brought a few changes. However, broadly speaking, they have remained almost identical in basic structure and approach. The changes outlined here sum up the basic differences that are now in place. With this overview guide, you will be able to see at a glance the areas in which changes have occurred.
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