Treasury Issues Proposed Regulations for Global Intangible Low-Taxed Income, Section 951A

The information in BDO alerts is dependent on tax policies at the time they are published. The subject matter of this alert has since been updated. To find the latest information on this topic, read Treasury Issues Proposed and Final Regulations Relating to GILTI and Other International Provisions.


Summary

On September 13, Department of the Treasury and the Internal Revenue Service (collectively, Treasury) issued proposed regulations (REG-104390-18, hereinafter, the Proposed Regulations) implementing Section 951A.

 

Details

I. Section 951A
Section 951A requires U.S. shareholders of any controlled foreign corporation (CFC) for any taxable year to include in gross income the shareholder’s global intangible low-taxed income (GILTI) for such taxable year. Section 951A applies to taxable years of foreign corporations beginning after December 31, 2017, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations ends.
 
The Proposed Regulations provide guidance for U.S. shareholders to determine the amount of GILTI to include in gross income.  In particular, Prop. Reg. §§ 1.951A-2 through 1.951A-4 provide detailed guidance on items determined at the CFC level, that is, tested income and tested loss, qualified business asset investments (QBAI),[1] and items necessary to determine the amount of certain interest expense that reduces net deemed tangible income return (DTIR).[2] Prop. Reg. §1.951A-1(d) provides rules for determining the U.S. shareholder’s pro rata share of these CFC-level items. Prop. Reg. §1.951A-1(c) provides rules describing the aggregation of the U.S. shareholder’s pro rata share of amounts to determine the shareholder’s GILTI inclusion amount.
 
However, the Proposed Regulations notably do not include any rules relating to foreign tax credits or the deduction under Section 250. The preamble to the Proposed Regulations (the Preamble) states that rules relating to foreign tax credits and the deduction under Section 250 will be included in separate notices of proposed rulemaking. It is worth noting that the Preamble states that it is anticipated that the proposed regulations relating to foreign tax credits will provide rules for assigning the Section 78 gross-up attributable to foreign taxes deemed paid under Section 960(d) to the separate category described in Section 904(d)(1)(A) (i.e., the GILTI foreign tax credit basket).

A. General Rules
A U.S. shareholder's pro rata share of tested income generally is determined in the same manner as its pro rata share of subpart F income under Section 951(a)(2) and Treas. Reg. §1.951-1(b) and (e) (that is, based on the relative amount that would be received by the shareholder in a year-end hypothetical distribution of all the CFC’s current year earnings).[3] For purposes of determining a U.S. shareholder’s pro rata share of a CFC’s QBAI, the amount of QBAI distributed in the hypothetical distribution of Section 951(a)(2)(A) and §1.951-1(e) is generally proportionate to the amount of the CFC’s tested income distributed in the hypothetical distribution.[4] However, a special rule in the Proposed Regulations provides that if a CFC’s QBAI exceeds 10 times its tested income, so that the amount of QBAI allocated to preferred stock would exceed 10 times the tested income allocated to the preferred stock under the general proportionate allocation rule, the excess amount of QBAI is allocated solely to the CFC’s common stock.[5] These rules in the Proposed Regulations ensure that the notional “normal return” associated with the CFC’s QBAI generally flows to the shareholders in a manner consistent with their economic rights in the earnings of the CFC.[6]
 
The Proposed Regulations also include detailed rules for determining a U.S. shareholder’s pro rata share of a CFC’s tested loss, including targeted rules in determining tested loss (and allocation of tested income in subsequent years) in certain cases involving dividend arrearages with respect to preferred stock and common stock with no liquidation value, and a shareholder’s pro rata share of “tested interest expense” and “tested interest income.” See Prop. Reg. §1.951A-1(d)(4) through (6) for additional details. In addition, the Proposed Regulations include foreign currency translation rules. See Prop. Reg. §§ 1.951A-1(d)(1) and 1.951A-6(b)(2)(iii) for additional details.

B. Tested Income and Tested Loss
Under Treas. Reg. §1.952-2(a)(1) and Prop. Reg. §1.951A-2(c)(2), subject to the special rules in Treas. Reg. §1.952-2(c), tested income or tested loss of a CFC is determined by treating the CFC as a domestic corporation taxable under Section 11 and by applying the principles of Section 61 and the regulations thereunder. Therefore, only items of deduction that would be allowable in determining the taxable income of a domestic corporation may be taken into account for purposes of determining a CFC’s tested income or tested loss. If an item of a CFC would be disallowed as a deduction in determining the CFC’s taxable income if the CFC were a domestic corporation, the item cannot be taken into account for purposes of determining the tested income or tested loss of the CFC even if the item reduces the CFC’s earnings and profits.
 
The Proposed Regulations also provide that tested income and tested loss are determined without regard to the application of Section 952(c).[7] In addition, the Proposed Regulations provide that allowable deductions determined under the principles of Treas. Reg. §1.952-2 are allocated and apportioned to gross tested income under the principles of Section 954(b)(5) and Treas. Reg. §1.954-1(c), treating gross tested income that falls within a single separate category (as defined in Treas. Reg. §1.904-5(a)(1)) as an additional category of income for this purpose.[8]

C. QBAI
The Proposed Regulations include rules for determining QBAI, adjusted basis of specified tangible property and net DTIR for short taxable years. See Prop. Reg. §1.951A-3 for additional details.
 
Section 951A(d)(3) (i.e., the “partnership QBAI paragraph”) states that if a CFC holds an interest in a partnership at the close of the CFC’s taxable year, the CFC takes into account under Section 951A(d)(1) its “distributive share of the aggregate of the partnership’s adjusted bases (determined as of such date in the hands of the partnership)” in specified tangible property in computing its QBAI. The Proposed Regulations determine a CFC partner’s share of the partnership’s adjusted basis in specified tangible property by reference to the partnership’s average adjusted basis in the property as of the close of each quarter of the partnership’s taxable year that ends with or within the CFC’s taxable year.[9] The Proposed Regulations provide that a CFC partner determines its share of the partnership’s average adjusted basis in specified tangible property based on the amount of its distributive share of the gross income produced by the property that is included in the CFC partner’s gross tested income relative to the total amount of gross income produced by the property.[10]
 
The Proposed Regulations also include certain anti-abuse provisions. The Proposed Regulations provide that specified tangible property of a tested income CFC is disregarded for purposes of determining the tested income CFC’s average aggregate basis in specified tangible property if the tested income CFC acquires the property with a principal purpose of reducing the GILTI inclusion amount of a U.S. shareholder and holds the property temporarily but over at least one quarter end. For this purpose, property held for less than a twelve month period that includes at least one quarter end during the taxable year of a tested income CFC is treated as temporarily held and acquired with a principal purpose of reducing the GILTI inclusion amount of a U.S. shareholder.[11]
 
The Preamble also states that Treasury has determined that it would be inappropriate for a taxpayer to reduce its GILTI inclusion amount for any taxable year by reason of a stepped-up basis in CFC assets attributable to transactions between related CFCs during the period after December 31, 2017, but before the effective date of Section 951A. Accordingly, the Proposed Regulations disallow the benefit of a stepped-up basis in specified tangible property transferred between related CFCs during the period before the transferor CFC’s first inclusion year for purposes of calculating the transferee CFC’s QBAI.[12] These rules are also cross-referenced in Prop. Reg. §1.951A-2(c)(5) to disregard a stepped-up basis in any property that is depreciable or amortizable (including for example, intangible property) for purposes of calculating tested income and tested loss.

D. Specified Interest Expense
The Proposed Regulations provide that a U.S. shareholder’s specified interest expense is the excess of its aggregate pro rata share of the tested interest expense of each CFC over its aggregate pro rata share of the tested interest income of each CFC.[13] Tested interest expense and tested interest income are generally defined by reference to all interest expense and interest income that is taken into account in determining a CFC’s tested income or tested loss.[14] The Proposed Regulations also include certain exclusions and exceptions for purposes of determining tested interest expense and tested interest income. See Prop. Reg. §1.951A-4(b) for additional details.

E. Domestic Partnerships and their Partners
After discussing the possible approaches to addressing domestic partnerships in the context of the GILTI regime, as more fully discussed below, Treasury decided to treat a domestic partnership as an entity with respect to partners that are not U.S. shareholders of any CFC owned by the partnership, but treat the partnership as an aggregate for purposes of partners that are themselves U.S. shareholders with respect to one or more CFCs owned by the partnership.
 
The Proposed Regulations provide that, in general, a domestic partnership that is a U.S. shareholder of one or more CFCs (U.S. shareholder partnership) computes its own GILTI inclusion amount in the same manner as any other U.S. shareholder, and each partner takes into account its distributive share of the domestic partnership’s GILTI inclusion amount under Section 702 and Treas. Reg. §1.702-1(a)(8)(ii).[15] However, for purposes of Section 951A and the Proposed Regulations, a partner that is itself a U.S. shareholder (within the meaning of Section 951(b)) (U.S. shareholder partner) of one or more CFCs owned directly or indirectly by a domestic partnership (partnership CFC) is treated as owning proportionately Section 958(a) stock in each such partnership CFC as if the partnership were a foreign partnership.[16]
 
A U.S. shareholder partnership is therefore required to provide to its partners their distributive share of the partnership’s GILTI inclusion amount, as well as provide to each U.S. shareholder partner the partner’s proportionate share of the partnership’s pro rata share (if any) of each CFC tested item of each partnership CFC of the partnership, and forms and instructions will be updated accordingly.[17]

F. Treatment of GILTI Inclusion Amount and Adjustments to E&P and Basis
The Proposed Regulations clarify that a GILTI inclusion amount is treated in the same manner as an amount included under Section 951(a)(1)(A) for purposes of applying Section 1411 (i.e., the Net Investment Income Tax).[18] The Preamble also states that because a GILTI inclusion amount is treated as a Section 951(a)(1)(A) inclusion for purposes of Section 959, the determination of the amount included under Section 951(a)(1)(B) is made after the determination of the amount of a Section 951(a)(1)(A) inclusion and the GILTI inclusion amount.[19]
 
Also, the Proposed Regulations provide that a deduction is allowed under Sections 163(e)(3)(B)(i) and 267(a)(3)(B) for an item taken into account in determining the net CFC tested income of a U.S. shareholder, including a U.S. shareholder treated under the Proposed Regulations as owning Section 958(a) stock of a CFC owned by a domestic partnership.[20] In the case of a U.S. shareholder that is a domestic partnership, this rule applies only to the extent that one or more U.S. persons (other than domestic partnerships) that are direct or indirect partners of the domestic partnership include in gross income their distributive share of the partnership’s GILTI inclusion amount or the item is taken into account by a U.S. shareholder partner of the domestic partnership by reason of Prop. Reg. §1.951A-5(c).[21]
 
The Proposed Regulations include rules regarding certain types of basis adjustments. In particular, Prop. Reg. §1.951A-6(e) generally provides that in the case of a corporate U.S. shareholder (excluding regulated investment companies and real estate investment trusts), for purposes of determining the gain, loss, or income on the direct or indirect disposition of stock of a CFC, the basis of the stock is reduced by the amount of tested loss that has been used to offset tested income in calculating net CFC tested income of the U.S. shareholder. The basis reduction is only made at the time of the disposition and therefore does not affect the stock basis prior to a disposition. According to Treasury, requiring the basis reduction only at the time of the disposition prevents the use of tested losses alone from causing the recognition of gain if the reduction exceeds the amount of stock basis. The basis adjustments apply only to the extent a “net” tested loss of the controlled foreign corporation has been used. Similar adjustments apply when the tested loss CFC is treated as owned by the U.S. shareholder through certain intervening foreign entities by reason of Section 958(a)(2) to prevent the indirect use of the duplicative loss through the disposition of interests in those intervening entities. The regulations provide an exception to those rules in certain cases when the tested loss CFC and the CFC that generated the tested income that is offset by the tested loss are in the same Section 958(a)(2) ownership chain; adjustments are not appropriate in these cases because there is no duplicative loss to the extent the shares of both CFCs are directly or indirectly disposed of.[22]
 
The Proposed Regulations also include rules that take into account certain nonrecognition transactions involving CFCs, such as the acquisition of CFC stock by a domestic corporation and transactions described in Section 381. These rules are intended to prevent the elimination or avoidance of the basis adjustments through these types of transactions. See Prop. Reg. §1.951A-6(e)(4)(ii) and (e)(5) for additional details.
 
Also, the Proposed Regulations provide a special rule to address dispositions of CFC stock by another CFC that is not wholly owned by a single domestic corporation. See Prop. Reg. §1.951A-6(e)(7) for additional details.

II. Section 951
The Proposed Regulations also include additional guidance under Section 951.
 
The Proposed Regulations under Section 951 propose to amend Treas. Reg. §1.951-1(e) to address certain avoidance structures that result in non-economic allocations of subpart F income to shareholders of CFCs that are not U.S. shareholders, which implicates Section 951A as well as Section 951.  See Prop. Reg. §1.951-1(e) for additional details.
 
The Proposed Regulations also treat certain controlled domestic partnerships as foreign partnerships for purposes of identifying a U.S. shareholder for purposes of Sections 951 through 964. See Prop. Reg. §1.965-1(e) (adopting a similar partnership blocker rule provided in Notice 2010-41 for purposes of the Section 965 regulations) for additional details.

III. Sections 1502, 1.6038-2(a) and 1.6038-5
Proposed Regulations under Section 1502 provide that, to determine a member’s GILTI inclusion amount, the pro rata shares of tested loss, QBAI, tested interest expense, and tested interest income of each consolidated group member are aggregated, and then a portion of each aggregate amount is allocated to each member of the group that is a U.S. shareholder of a tested income CFC based on the proportion of such member’s aggregate pro rata share of tested income to the total tested income of the consolidated group.[23] The Proposed Regulations also include special rules for making certain basis adjustments in the consolidated group context. See Prop. Reg. §§ 1.1502-51(c) and 1.1502-32(b)(3)(ii)(E) and (iii)(C) for additional details.
 
The Proposed Regulations also include rules regarding filing obligations for U.S. shareholders under Sections 1.6038-2(a) and 1.6038-5 to take into account changes made by the 2017 federal tax overhaul (known as the Tax Cuts and Jobs Act), including Section 951A.
 
Lastly, it should be noted that the Preamble and the Proposed Regulations include various rules and clarifications that are not discussed in this summary.
 
See the Preamble and the Proposed Regulations for additional details along with the applicability dates for the rules discussed above.

 

BDO Insights

While the Proposed Regulations do not address foreign tax credit issues and the Section 250 deduction, the Proposed Regulations still provide welcomed guidance for U.S. shareholders of CFCs. BDO can assist clients with understanding and applying these rules when calculating their GILTI inclusions.   

[1] QBAI means with respect to any CFC for any taxable year, the average of such corporation’s aggregate adjusted bases as of the close of each quarter of such taxable year in specified tangible property used in a trade or business, and of a type with respect to which a deduction is allowed under Section 167. Section 951A(d).
[2] Net DTIR means, with respect to any U.S. shareholder for any taxable year, the excess of 10 percent of the aggregate of such shareholder’s pro rata share of the QBAI of each CFC with respect to which such shareholder is a U.S. shareholder for such taxable year (determined for each taxable year of each such CFC which ends in or with such taxable year of such U.S. shareholder), over the amount of interest expense taken into account under IRC §951A(c)(2)(A)(ii) in determining the shareholder’s net CFC tested income for the taxable year to the extent the interest income attributable to such expense is not taken into account in determining such shareholder’s net CFC tested income. Section 951A(b)(2).
[3] See Prop. Reg. §1.951A-1(d)(2)(i).
[4] See Prop. Reg. §1.951A-1(d)(3)(i).
[5] See Prop. Reg. §1.951A-1(d)(3)(ii).
[6] For illustration, see Prop. Reg. §1.951A-1(d)(3)(iii), Examples 1 and 2.
[7] See Prop. Reg. §1.951A-2(c)(4).
[8] See Prop. Reg. §1.951A-2(c)(3).
[9] See Prop. Reg. §1.951A-3(g)(3).
[10] See Prop. Reg. §1.951A-3(g)(2).
[11] See Prop. Reg. §1.951A-3(h)(1).
[12] See Prop. Reg. §1.951A-3(h)(2).
[13] See Prop. Reg. §1.951A-1(c)(3)(iii).
[14] See Prop. Reg. §1.951A-4(b)(1) and (2).
[15] See Prop. Reg. §1.951A-5(b).
[16] See Prop. Reg. §1.951A-5(c).
[17] See Prop. Reg. §1.951A-5(f).
[18] See Prop. Reg. §1.951A-6(b)(1).
[19] See Section 959(a)(2) and (f)(1).
[20] See Prop. Reg. §1.951A-6(c)(1).
[21] See Prop. Reg. §1.951A-6(c)(2).
[22] See Prop. Reg. §1.951A-6(e)(1)(ii).
[23] See Prop. Reg. §1.1502-51(e).