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Authored by Jim Alajbegu and Chris Brown

The new net operating loss (NOL) carryback rules in the Coronavirus Aid, Relief, and Economic Security (CARES) Act can potentially affect numerous U.S. international tax provisions in relation to U.S. taxpayer’s tax filings on its overseas operations. Below, we discuss various issues involving the interaction of the CARES Act NOLs with the so-called “repatriation tax” of section 965(a); U.S. shareholders with controlled foreign corporations (CFCs) that generated global intangible low-tax income (GILTI) (potentially also taking advantage of foreign taxes paid by their CFCs as foreign tax credits and/or availing themselves of the GILTI section 250 deduction); foreign-derived intangible income (FDII); and taxpayers that were subject to the base erosion and anti-abuse tax (BEAT). 

In the case of the section 965(a) repatriation tax, the IRS issued guidance on the application of the changes to the NOL rules of section 172 brought about by the CARES Act. Understanding this guidance and modeling the impact of any NOL carryback is key for clients to optimize the intended tax result. 

Separately, the IRS also issued three revenue procedures that may provide relief from potential tax obligations resulting from COVID-19. Rev. Proc. 2020-20 applies to nonresident aliens stranded in the United States that, because of certain related travel restrictions, may become resident here. Rev. Proc. 2020-27 provides guidance to U.S. individuals seeking to qualify under section 911 that left their foreign residences during a certain period of time due to COVID-19. Rev. Proc. 2020-30 includes U.S. trade or business/permanent establishment issues and dual consolidated loss relief guidance due to travel restrictions. 

Guidance on the interaction of CARES Act NOL carryback rules and section 965 repatriation tax

Background

The CARES Act amended section 172(b)(1) to allow taxpayers to carry back any NOL arising in a taxable year beginning after Dec. 31, 2017, and before Jan. 1, 2021 (applicable NOLs), to each of the five taxable years preceding the taxable year in which the NOL arises (the carryback period). This is potentially taxpayer favorable in that applicable NOLs may offset income taxed at a higher marginal tax rate than is in effect today. However, the CARES Act also amended section 172(b)(1) to provide that if an applicable NOL is carried back to a repatriation tax year, the taxpayer will be treated as having made the election under section 965(n). As such, the taxpayer will be required to exclude the section 965(a) inclusion amount in determining its NOL deduction. In other words, applicable NOLs carried back to a repatriation tax year will not reduce any section 965(a) inclusion tax liability. Taxpayers can make certain elections in order to tailor the CARES Act’s NOL carryback provisions to provide the most tax-efficient result.

Rev. Proc. 2020-24

In April, the IRS issued Rev. Proc. 2020-24, providing guidance on NOL carryback election provisions introduced in the CARES Act. For taxpayers to elect how to use an applicable NOL, the revenue procedure provides three alternatives:

  1. Election to waive the NOL carryback period for an applicable NOL
    – Made no later than the due date (including extensions) for filing the taxpayer’s federal income tax return for the first taxable year ending after March 27, 2020
    – Made by attaching separate statement to its return for each taxable year it intends to make the election
  2.  Election to exclude from the carryback period any taxable year in which the taxpayer has a section 965(a) inclusion
    –  Made no later than the due date (including extensions) for filing the taxpayer's federal income tax return for the first taxable year ending after March 27, 2020
    – An NOL arising in a taxable year beginning after Dec. 31, 2019, and before Jan. 1, 2021, must make the election no later than the due date (including extensions) for filing the taxpayer's federal income tax return for the taxable year in which the NOL arises

    An election under the second alternative to exclude all section 965 years from the carryback period for an NOL allows a taxpayer to disregard repatriation tax years when applying an NOL to the carryback period. Excluding such years may result in a refundable overpayment or a credit for any of the remaining years in the carryback period to which the NOL is applied. A taxpayer who makes this election must include all repatriation tax years for purposes of counting the five taxable years in the carryback period for the NOL.
  3.  Guidance for elections under the CARES Act to waive any carryback period; to reduce any carryback period; or to revoke any election made under section 172(b) to waive any carryback period for a taxable year that began before Jan. 1, 2018, and ended after Dec. 31, 2017.

FAQ about carrybacks of NOLs for taxpayers who have had section 965 inclusions

The IRS issued frequently asked questions (FAQ) on its website that further describe the interaction of the NOL carryback rules to taxpayers that had a section 965 inclusion and the procedures for making the elections described above. The FAQ clarifies certain questions regarding the application of Rev. Proc. 2020-24 such as:

  • Taxpayers may file an election to either waive the entire carryback period or to exclude all of section 965 years from the carryback period;
  • The statements that taxpayers use to make the elections (i.e., either a Form 1139, Corporation Application for Tentative Refund, or Form 1045, Application for Tentative Refund, applying the NOL to a taxable year in the carryback period); and
  • The due dates for filing such statements.

Issues to consider when carrying back applicable NOLs

In deciding which year to carry back an NOL, taxpayers should bear in mind the potential impact of the following points:

  • An election to waive the carryback period altogether might make sense where there is a trade-off with foreign tax credits which might go unutilized over a 10-year carryforward period;
  • Any overpayment of tax created through reduction of “without section 965” income must be applied to pay down any remaining installments of transition tax liability payable over an eight-year installment period where a section 965(h) election had been made before any cash refund can be processed;
  • An NOL carryback to a FDII or GILTI tax year could result in a reduction of the section 250 deduction where the sum of FDII and GILTI exceeds taxable income (before taking any section 250 deduction, and after being adjusted for the NOL carryback) for that tax year;
  • The effect of any NOL deduction on a taxpayer’s BEAT base erosion percentage; and/or
  • The impact on interest deductions under section 163(j) on calculated BEAT liability.

Again, careful and detailed modeling may be required to obtain the best tax result from carrying back applicable NOLs to offset taxable income.

Other COVID-19-related international tax guidance

 Rev. Proc. 2020-20

The IRS issued Rev. Proc. 2020-20 in mid-April and notes that alien individuals who are not lawful permanent residents (i.e., “green card” holders) and who meet the substantial presence test by virtue of being present in the United States for a certain period of time are generally treated as U.S. residents for that year. The revenue procedure provides relief to some nonresident individuals who would not have been in the U.S. in 2020 long enough to be considered resident aliens, if not for COVID-19 emergency travel disruptions.

Relief may be achieved by excluding up to 60 consecutive days spent in the U.S. starting on or after Feb. 1, 2020, and on or before April 1, 2020 (with the specific start date to be chosen by each individual) under the substantial presence test’s medical exception provision. Rev. Proc. 2020-20 also provides procedures for individuals to exclude certain days present in the U.S. in order to claim tax treaty benefits for dependent personal services income.

Rev. Proc. 2020-27

Section 911(a) allows individuals to claim the foreign earned income and housing costs exclusion if certain requirements (including being resident in a foreign country for a certain period) are satisfied. Rev. Proc. 2020-27 provides relief to individuals that reasonably expected to qualify for the section 911 exclusions that left:

  • China on or after Dec. 1, 2019;
  • Another foreign country on or after Feb. 1, 2020
  • But on or before July 15, 2020, if the individual otherwise establishes he or she would have met the ordinarily applicable qualified individual eligibility requirements but for a “COVID-19 emergency.”

Rev. Proc. 2020-30

On May 7, 2020, the IRS released Rev. Proc. 2020-30 to address the application of COVID-19 travel restrictions (such as transportation disruptions, shelter-in-place orders, quarantines, etc.) on foreign branches. According to the revenue procedure, certain activities conducted in a foreign country for 60 consecutive calendar days in 2020 by individuals temporarily present there due to travel disruptions will not be taken into account for purposes of determining whether a domestic corporation has a foreign branch separate unit. As a result, such activities will not give rise to a foreign branch separate unit under section 1503(d) and the taxpayer will not have an obligation to file a Form 8858, Information Return of U.S. Persons With Respect to Foreign Disregarded Entities (FDEs) and Foreign Branches (FBs).

Transfer pricing

Due to COVID-19, many international businesses are experiencing — or anticipating — negative impacts to their global supply chain. Disruptions to businesses’ supply chains may have unexpected or unintended tax consequences related to additional expenses or decreases in revenue. Some taxpayers with intercompany transactions may incur extraordinary expenses due to necessary reactions to the new market conditions. These extraordinary expenses should be analyzed to see if they should be treated differently for tax purposes, both from a domestic and foreign perspective. Taxpayers with intercompany transactions should revisit their transfer pricing strategies and pricing arrangements due to COVID-19’s influence on their global business.

View more insights from our guide to tax planning during and after COVID-19

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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