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2019 year-end tax letter: international taxation

Key takeaway: The TCJA completely redesigned international tax from a U.S. perspective.  Technical guidance continues to develop, forcing taxpayers to continuously monitor developments with their advisors.

The impact U.S. and international legislative changes have had on global tax policy has been significant and has resulted in tremendous change in how U.S. companies conduct business worldwide. U.S. companies are concerned with not only being compliant with new tax laws, but also planning for such looming issues as Brexit. Additionally, changes made by the Tax Cuts and Jobs Act (TCJA) to help ensure the U.S. is competitive on the global tax front has resulted in a voluminous amount of additional tax guidance in 2019, which came in the form of final, temporary and proposed regulations and amendments to previous guidance.

Notable examples of TCJA guidance issued in 2019 include the final section 965 repatriation tax regulations and finalization of certain aspects of the global intangible low-taxed income (GILTI) rules. The IRS and Treasury also finalized regulations coordinating the application of the U.S. property investment rules of section 956 with the dividends-received deduction rules of section 245A.

Anti-abuse provisions were included earlier this year in the temporary regulations that seek to prevent fiscal year taxpayers from using the section 245A dividends-received deduction rules to shelter certain earnings and profits (E&P) generated during the period where neither section 965 repatriation tax nor the GILTI rules applied. These temporary regulations are meant to prevent “U.S. shareholders” from using certain exemptions to avoid tax on transactions that reduce their interests in controlled foreign corporations (CFCs).

The IRS released proposed GILTI regulations that may have impacted domestic partnerships that provided partners with their 2019 Schedules K-1 prior to the regulations being issued.

Not all guidance issued by the IRS this year related to tax reform, though. Businesses will now wrangle with proposed regulations on the application of the passive foreign investment company (PFIC) and cloud computing rules.

A number of international tax notices and revenue procedures were also issued in 2019. Important issues such as the ordering rules applicable to distributions of previously taxed E&P from CFCs and reporting relief from the application of the so-called downward attribution principles were addressed.

We expect new international tax guidance in the coming months in the form of proposed regulations, notices and other guidance. What follows is a high-level update on the major changes to U.S. international tax provisions in 2019.

Final section 965 repatriation tax

The Act introduced section 965 which required U.S. shareholders (as defined under section 951(b)) to pay a transition tax on the untaxed foreign E&P of certain specified foreign corporations as if those earnings had been repatriated to the U.S.

Final section 965 repatriation tax regulations: The IRS and Treasury Department released final section 965 repatriation tax regulations on Jan. 15, 2019, which was within 18 months of the enactment of the TCJA, and, as such, the regulations generally have a retroactive effective date. As such, taxpayers that may have taken positions contrary to the principles in the final regulations should determine whether amendments are required to rectify their filings.

On Jan. 15, 2019, which was within 18 months of the enactment of the TCJA, the IRS and Treasury Department released final section 965 repatriation tax regulations, so they generally have a retroactive effective date.

Taxpayer-favorable changes in the final regulations include an exception to the term cash position for commodities held in inventory by specified foreign corporations that are not traders or dealers in commodities. Unfortunately, however, the final section 965 regulations do not provide any late election relief for taxpayers that did not make section 965(h) elections to pay their repatriation tax liabilities in installments or shareholders of S corporations that did not make section 965(i) elections to defer their repatriation tax liabilities indefinitely.

Form 965: Section 965 affected many taxpayers’ 2017 income tax returns, but without any detailed forms or disclosures on which to report this information. For tax year 2018, the IRS published Form 965 (including Schedules A through H) and Forms 965-A (for individual taxpayers) and 965-B (for corporate taxpayers) for taxpayers’ use in reporting the historical and current year section 965 inclusion and liability amounts. Any taxpayer that reported — or will report — income under section 965 on either their 2017 or 2018 income tax returns (or both) must complete and attach Forms 965 and 965-A or 965-B to their 2018 income tax return filing. In addition, any taxpayer that would be required to include amounts in income under section 965 but for an aggregate foreign E&P deficit allocated in accordance with section 965(b) must also complete and attach Form 965 to their tax return. Please note that Form 965 is required for all affected U.S. persons (i.e., there is no de minimis exception), and the form is required even if the transition tax statement was signed and included with the 2017 tax return.

Section 965 questions and answers: The IRS released section 965 questions and answers (Q&A) in June 2019, providing answers to questions not specifically related to filing 2017 and 2018 returns (which are covered in separate questions and answers also issued by the IRS). More specifically, the Q&A advised taxpayers that did not receive an installment notice to contact the IRS at +1 (855) 223 4017, extension 729 (individuals) or at +1 (800) 830 5215, extension 708 (businesses). The Q&A also provided information related to filing transfer and consent agreements arising under sections 965(h), which allows taxpayers with a section 965 inclusion to pay their net tax liability in eight installments, and 965(i), which allows S corporation shareholders to defer payment of their section 965 net tax liability until a “triggering event” occurs.

Final and proposed section 951A GILTI regulations

By way of background, section 951A annually subjects U.S. shareholders to current tax on GILTI earned by a CFC in the same manner as “Subpart F” income.

Final GILTI regulations: The IRS and Treasury released final GILTI regulations (T.D. 9866) June 14, 2019, (generally effective on June 21, 2019). As discussed in more detail below, the final regulations do not adopt the proposed “hybrid approach” of determining any GILTI by domestic partnerships.

Additionally, the final regulations provide inter alia that income excluded from Subpart F income under the de minimis exception, as active rents and royalties or as active financing income, is not excluded from gross tested income. The final regulations also allow CFCs that are not required to use the alternative depreciation system (ADS) in calculating income and E&P to elect to determine the adjusted bases of specified tangible property placed in service before the enactment of GILTI using an acceptable book method. Additionally, the regulations confirm the use of ADS in determining the basis in specified tangible property is not a change in method of accounting. Lastly, these GILTI regulations also finalize foreign tax credit rules under sections 78, 861 and 965, which were originally included in the proposed foreign tax credit regulations issued last year.

Domestic partnerships: Under the so-called hybrid approach of the proposed GILTI regulations issued in late 2018, a domestic partnership that was a U.S. shareholder (referred to as a U.S. shareholder partnership) of a CFC (referred to as a partnership CFC) was required to determine any GILTI inclusion amount and report each partner’s distributive share on their Schedule K-1. Any partners of the partnership that were not also U.S. shareholders of the partnership CFC were required to take into account their distributive share of the partnership’s GILTI inclusion amount.

The final GILTI regulations reject the hybrid approach. Instead, for GILTI inclusion purposes the final regulations treat a domestic partnership as an aggregate for purposes of determining the level (that is, partnership or partner) at which a GILTI inclusion amount is calculated and taken into gross income. More specifically the final regulations direct domestic partnerships (and S corporations) to treat each partner as owning a proportionate amount of the stock of the CFC as if the partnership were a foreign partnership.

Notice 2019-46: Recognizing that many domestic partnerships and S corporations may have furnished Schedules K-1 to their partners and shareholders before the final GILTI regulations were issued (and that many partners and shareholder may have filed their returns consistent with the hybrid approach of the proposed regulations), the IRS announced in Notice 2019-46 that domestic partnership and S corporations could apply the proposed GILTI regulation for taxable years ending before June 22, 2019. The notice also provided penalty relief for taxpayers that filed their returns “inconsistently” with information provided to them in Schedules K-1 if certain notification requirements were satisfied.

Proposed GILTI regulations: Proposed GILTI regulations (REG-101828-19) were released in June 2019. The preamble to these regulations provide that the Treasury and IRS are studying whether taxpayers should be permitted to make an election to exclude income — that would not be Subpart F income — from gross tested income under an expanded regulatory GILTI high-tax exclusion. However, until regulations describing the framework for this exception are effective, taxpayers may not elect the expanded regulatory GILTI high-tax exclusion. The Treasury and IRS have also concluded that, to be consistent with the treatment of domestic partnerships under the GILTI rules, for Subpart F inclusion proposes a domestic partnership should be treated as an aggregate of its partners. Taxpayers may early adopt the aggregate approach to determine Subpart F inclusions for taxable years of CFCs beginning on or after Dec. 31, 2017.

Section 962 election with respect to GILTI inclusion: Section 962 allows an individual U.S. shareholder (including a trust or estate) to elect to be taxed at corporate income tax rates on certain Subpart F income inclusions under section 951(a). If you are a U.S. shareholder for GILTI purposes and have a GILTI inclusion, you may want to consider a section 962 election (the election is made on an annual basis). Please note, however, that while making the election offers a potential tax savings in the year it is made, it can ultimately lead to a greater tax burden to the shareholder when the earnings are distributed. Tax modeling may be required to determine whether making a section 962 election would be beneficial.

Final section 956 regulations

The Treasury and the IRS finalized the section 956 regulations (T.D. 9866). Section 956 serves as a backstop to the Subpart F regime to ensure that a CFC’s untaxed earnings are subject to tax when repatriated through means other than a taxable distribution (e.g., a loan from a CFC to a U.S. shareholder). The final regulations, similar to the proposed section 956 regulations issued late last year, generally turn off inclusion under section 956 to the extent that the corporate U.S. shareholder would have received a deduction under section 245A if it had received a distribution from the CFC in an amount equal to the tentative section 956 amount. The final section 956 regulations apply to tax years of a CFC beginning on or after May 23, 2019 (and to tax years of a U.S. shareholder in which or with which such tax years of the CFC end). However, taxpayers may apply the final regulations for tax years of a CFC beginning after Dec. 31, 2017, provided certain consistency requirements are satisfied.

Proposed section 250 deduction regulations

In March 2019, proposed regulations covering the section 250 GILTI and foreign-derived intangible income (FDII) deductions were issued. Section 250 potentially offers domestic C corporations deductions for FDII and GILTI income. The proposed regulations provide guidance on both the computation of the deductions available under section 250 and determination of FDII. New reporting rules requiring the filing of Form 8993, “Section 250 Deduction for Foreign-Derived Intangible Income and Global Intangible Low-Taxed Income,” are also described in the proposed regulations.

Proposed regulations addressing ownership attribution rules and relief

The Act repealed section 958(b)(4) which prevented “downward attribution” of stock from a foreign entity to a U.S. person under section 318(a)(3). Because of this repeal, U.S. persons that were not previously U.S. shareholders may be treated as such and foreign corporations that were not previously treated as CFCs may become CFCs. Some relief to the additional compliance burdens associated with the application of the downward attribution rules was provided in Notice 2018-13.

Notice 2019-40: On Oct. 1, 2019, the IRS issued Rev. Proc. 2019-40, which provides a safe harbor for U.S. persons who own interests in so-called “foreign-controlled CFCs” (i.e., foreign entities that would not be CFCs without applying the downward attribution rules). If the safe harbor requirements are satisfied, the IRS will accept a taxpayer’s determination that the foreign entity is not a CFC.

The notice also acknowledges that certain U.S. shareholders of foreign-controlled CFCs may find it difficult to obtain the required information to determine any Subpart F and/or GILTI inclusion amounts. As such, the notice provides a hierarchy list of so-called “alternative information” that U.S. shareholders of foreign-controlled CFCs can use to satisfy their reporting requirements. Alternative information can be described as financial statements prepared under certain principles or used for internal management purposes. Finally, Notice 2019-40 provides reporting relief to certain foreign-controlled CFC “Category 5” filers of Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations.”

Proposed downward attribution regulations: The IRS and Treasury also issued proposed regulations (REG-104223-18) on Oct. 1, 2019, that revise other (i.e., non-Subpart F) Treasury regulations affected by the downward attribution rules. For example, the proposed downward attribution regulations revise proposed regulations under section 267(a) (which are used to determine when accrual basis taxpayers can deduct accrued but unpaid amounts owed to a CFC) to account for foreign entities treated as CFCs under the downward attribution rules. Separately, the proposed downward attribution regulations also amend the section 958(b) regulations (used to determine direct, indirect and constructive ownership) to align with the repeal of section 958(b)(4). The proposed regulations apply to tax years of foreign corporations or shareholders that end on (and certain transactions that occur on) or after Oct. 1, 2019.

Proposed withholding tax regulations on transfer of partnership interests

The IRS issued proposed regulations (REG-105476-18) on May 7, 2019, that address the withholding provisions applicable to transfers of partnership interests under section 1446(f). The framework of the withholding regime starts out broadly by imposing a 10% withholding obligation on any transferee on any transfer of a partnership interest in any partnership. The proposed regulations then provide enumerated exceptions that exempt a transferee from the withholding requirement. However, no exception applies unless the transferee obtains the prescribed certification from either the transferor or the partnership.

Final section 987 foreign currency regulations

One important regulation package not related to the TCJA provisions includes the finalization of certain section 987 foreign currency regulations. On May 10, 2019, the Treasury and the IRS submitted final section 987 regulations (T.D. 9857) to be published in the Federal Registrar. By way of background, section 987 provides rules related to the determination of the taxable income or loss of a taxpayer with certain qualified business units (QBUs) and the timing, amount, character and source of currency gains or losses under that section. The final regulations finalize certain of the temporary regulations (e.g., combinations, separations and terminations of certain QBUs subject to section 987 and the allocation of QBU assets and liabilities of certain partnerships) while continuing to defer the applicability date of the remaining temporary regulation package.

Proposed PFIC regulations

Although the Act did not make significant changes to the PFIC rules, the Treasury and IRS did issue proposed regulations (REG-105474-18) in July that contained guidance on a number of PFIC-related issues. Recall that a foreign entity will be treated as a PFIC if at least 75% of its income is “passive income” or at least 50% of its average percentage of assets produce passive income. The proposed regulations provide guidance on: 1) attribution rules used to determine ownership through partnerships, 2) certain aspects of the 75% PFIC income test and the 50% PFIC asset test, 3) the so-called look-through rule for 25%-owned corporations and certain domestic subsidiaries and 4) application of the PFIC insurance exception.

Notice 2019-01 — previously taxed E&P rules

In December 2018, the IRS released Notice 2019-01 announcing that it intended to issue proposed regulations containing guidance on the application of the previously taxed E&P rules to distributions from CFCs. Very broadly, the ordering rules in Notice 2019-01 would prioritize sourcing distributions from section 965 previously taxed E&P. We expect 2020 to be another busy year of international tax guidance.

View more insights in the 2019 year-end tax planning letter >

Download the 2019 year-end tax planning letter >

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The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.

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