[Federal Register Volume 85, Number 142 (Thursday, July 23, 2020)]
[Rules and Regulations]
[Pages 44620-44649]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2020-15351]
[[Page 44619]]
Vol. 85
Thursday,
No. 142
July 23, 2020
Part III
Department of the Treasury
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Internal Revenue Service
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12 CFR Parts 1206, 1225 and 1240
Guidance Under Sections 951A and 954 Regarding Income Subject to a High
Rate of Foreign Tax; Final Rule
26 CFR Part 1
Guidance Under Section 954(b)(4) Regarding Income Subject to a High
Rate of Foreign Tax; Proposed Rule
Federal Register / Vol. 85 , No. 142 / Thursday, July 23, 2020 /
Rules and Regulations
[[Page 44620]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9902]
RIN 1545-BP15
Guidance Under Sections 951A and 954 Regarding Income Subject to
a High Rate of Foreign Tax
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations under the global
intangible low-taxed income and subpart F income provisions of the
Internal Revenue Code regarding the treatment of income that is subject
to a high rate of foreign tax. The final regulations affect United
States shareholders of foreign corporations. This guidance relates to
changes made to the applicable law by the Tax Cuts and Jobs Act, which
was enacted on December 22, 2017.
DATES:
Effective date: These regulations are effective on September 21,
2020.
Applicability dates: For dates of applicability, see Sec. Sec.
1.951A-7(b) and 1.954-1(h)(1) and (3).
FOR FURTHER INFORMATION CONTACT: Jorge M. Oben or Larry R. Pounders at
(202) 317-6934 (not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
Section 951A, which contains the global intangible low-taxed income
(``GILTI'') rules, was added to the Internal Revenue Code (the
``Code'') by the Tax Cuts and Jobs Act, Public Law 115-97, 131 Stat.
2054, 2208 (December 22, 2017) (the ``Act''). On October 10, 2018, the
Department of the Treasury (``Treasury Department'') and the IRS
published proposed regulations (REG-104390-18) under sections 951,
951A, 1502, and 6038 in the Federal Register (83 FR 51072). On June 21,
2019, the Treasury Department and the IRS published final regulations
(T.D. 9866) in the Federal Register (84 FR 29288, as corrected at 84 FR
44693) under sections 951, 951A, 1502, and 6038, and proposed
regulations (REG-101828-19) under sections 951, 951A, 954, 956, 958,
and 1502 in the Federal Register (84 FR 29114, as corrected at 84 FR
37807) (``2019 proposed regulations''). Terms used but not defined in
this preamble have the meaning provided in these final regulations.
The Treasury Department and the IRS received written comments with
respect to the 2019 proposed regulations. A public hearing on the 2019
proposed regulations was not held because there were no requests to
speak.
This rulemaking finalizes the portion of the 2019 proposed
regulations under sections 951A and 954 regarding the treatment of
income subject to a high rate of foreign tax but does not finalize the
portions of the 2019 proposed regulations under sections 951, 956, 958,
and 1502 regarding the treatment of domestic partnerships. The Treasury
Department and the IRS plan to finalize those regulations separately.
Comments outside the scope of this rulemaking are generally not
addressed but may be considered in connection with future guidance
projects. All written comments received in response to the 2019
proposed regulations are available at www.regulations.gov or upon
request.
Summary of Comments and Explanation of Revisions
I. Overview
The 2019 proposed regulations apply the high-tax exclusion set
forth in section 951A(c)(2)(A)(i)(III) (the ``GILTI high-tax
exclusion''), on an elective basis, to certain high-taxed income of a
controlled foreign corporation (as defined in section 957) (``CFC'')
regardless of whether the income would otherwise be foreign base
company income (as defined in section 954) (``FBCI'') or insurance
income (as defined in section 953). See proposed Sec. 1.951A-2(c)(6).
The final regulations retain the basic approach and structure of the
2019 proposed regulations, with certain revisions. This Summary of
Comments and Explanation of Revisions discusses those revisions as well
as comments received.
As discussed in part IV of this Summary of Comments and Explanation
of Revisions, numerous comments recommended that the application of the
GILTI high-tax exclusion be conformed with the high-tax exception of
section 954(b)(4) and Sec. 1.954-1(d)(5) (the ``subpart F high-tax
exception''). The Treasury Department and the IRS agree that the GILTI
high-tax exclusion and the subpart F high-tax exception should be
conformed but have determined that the rules implementing the GILTI
high-tax exclusion better reflect the policies underlying section
954(b)(4) in light of the changes made by the Act. As a result, a
separate notice of proposed rulemaking published in the Proposed Rules
section of this issue of the Federal Register (REG-127732-19) (the
``2020 proposed regulations'') proposes to generally conform the rules
implementing the subpart F high-tax exception to the rules implementing
the GILTI high-tax exclusion set forth in these final regulations, and
provides for a single election under section 954(b)(4) for purposes of
both subpart F income and tested income.
II. Calculation of Effective Foreign Tax Rate
A. QBU-by-QBU Determination
The 2019 proposed regulations apply based on the effective foreign
tax rate imposed on the aggregate of all items of tentative net tested
income of a CFC attributable to a single qualified business unit (as
defined in section 989(a)) (``QBU'') of the CFC that would be in a
single tested income group. See proposed Sec. 1.951A-2(c)(6)(i)(B) and
(c)(6)(ii)(A). The 2019 proposed regulations apply on a QBU-by-QBU
basis to minimize the ``blending'' of income subject to different
foreign tax rates and, as a result, more accurately identify income
subject to a high rate of foreign tax such that low-taxed income
continues to be subject to the GILTI regime in a manner consistent with
its underlying policies.
The Treasury Department and the IRS received several comments
regarding the determination of the effective foreign tax rate on a QBU-
by-QBU basis. One comment supported the QBU-by-QBU determination. Other
comments requested that the effective foreign tax rate test apply on a
CFC-by-CFC basis and asserted that this approach would better align the
GILTI high-tax exclusion with the subpart F high-tax exception. The
comments also stated that a CFC-by-CFC approach would be consistent
with the principles used to determine foreign income taxes deemed paid
under proposed regulations under section 960 and would reduce
complexity and compliance burdens. One comment noted that taxpayers are
not required to conduct this type of QBU-level analysis for any other
U.S. tax purpose and, thus, they may lack the systems, data, or
personnel to do so. Other comments stated that nonconformity with the
subpart F high-tax exception would encourage taxpayers to structure
into the subpart F high-tax exception and questioned the authority to
adopt a QBU-by-QBU approach given the general mechanics of the GILTI
regime, which compute certain items at the CFC level before aggregating
such items at the United States shareholder (as defined in section
951(b)) (``U.S. shareholder'') level.
Some comments suggested that there is not a significant risk of
blending foreign income subject to different tax
[[Page 44621]]
rates and asserted that such blending should not give rise to policy
concerns. Other comments stated that applying the effective foreign tax
rate test on a CFC-by-CFC basis would ameliorate issues caused by
differences between U.S. and foreign tax accounting methods.
Consistent with the rules set forth in the 2019 proposed
regulations, the Treasury Department and the IRS have determined that
calculating the effective foreign tax rate on a CFC-by-CFC basis would
inappropriately allow the blending of high-taxed and low-taxed income
in a manner that is inconsistent with the purpose of section 951A,
which is to limit potential base erosion incentives created by a
participation exemption regime. Such blending would allow low-taxed
income, which poses a significant base-erosion risk, to be excluded
from the GILTI regime. While the legislative history indicates that
high-taxed income does not present base erosion concerns, the policy
rationale underlying that view does not extend to excluding low-taxed
income from GILTI merely because it may be earned by an entity that
also earns high-taxed income. See S. Comm. on the Budget,
Reconciliation Recommendations Pursuant to H. Con. Res. 71, S. Print.
No. 115-20, at 371 (2017) (``The Committee believes that certain items
of income earned by CFCs should be excluded from the GILTI [regime],
either because they should be exempt from U.S. tax--as they are
generally not the type of income that is the source of the base erosion
concerns--or are already taxed currently by the United States. Items of
income excluded from GILTI because they are exempt from U.S. tax under
the bill include foreign oil and gas extraction income (which is
generally immobile) and income subject to high levels of foreign
tax.'').
The QBU-by-QBU approach is also consistent with the legislative
history to section 954(b)(4), which directs the Treasury Department and
the IRS to allow reasonable groupings of items of income that are
substantially taxed at the same rate in a single country. See H.R. Rep.
No. 99-426, at 400-01 (1985) (``Although this rule applies separately
with respect to each `item of income' received by a [CFC], the
committee expects that the Secretary will provide rules permitting
reasonable groupings of items of income that bear substantially equal
effective rates of tax in a given country. For example, all interest
income received by a [CFC] from sources within its country of
incorporation may reasonably be treated as a single item of income for
purposes of this rule, if such interest is subject to uniform taxing
rules in that country.''). Therefore, consistent with this legislative
history, generally only high-taxed income, and not low- or zero-taxed
income, should be excluded from gross tested income. The GILTI high-tax
exclusion carries out this purpose by determining the effective rate of
tax on an item of income at a granular enough level to preclude
inappropriate blending without imposing undue compliance burdens on
taxpayers.
Although greater blending of income subject to different rates of
foreign tax may be permitted within a separate category under section
904, a section 904 separate category is not an appropriate standard for
determining an item of income under section 954(b)(4) because section
904 applies, by its terms, to separate categories of income while
section 954(b)(4) applies to items of income. Moreover, the purposes of
sections 951A and 954(b)(4), which are primarily intended to address
base erosion concerns, differ from the purposes of sections 901 and
904, which are tailored to the avoidance of double taxation of foreign
source income. The ability to credit foreign taxes against a broader
class of income at the U.S. shareholder level does not compel a CFC-by-
CFC effective foreign tax rate computation for purposes of the GILTI
high-tax exclusion. In addition, determining whether an item of income
is high-taxed by grouping similar items at a QBU level has historically
been required for certain passive income under Sec. Sec. 1.904-4(c)
and 1.954-1(c)(1)(iii)(B). Consistent with the 2019 proposed
regulations, Sec. 1.904-4(c) groups passive income items for purposes
of determining whether they are subject to a high rate of tax on a QBU-
by-QBU basis.
Finally, because the GILTI high-tax exclusion applies on an
elective basis, taxpayers may choose not to make the election if the
compliance burdens of the computation outweigh the benefits.
For these reasons, the final regulations do not adopt a CFC-by-CFC
approach. However, the final regulations replace the QBU-by-QBU
approach with a more targeted approach based on ``tested units'' (as
discussed in part III.A of this Summary of Comments and Explanation of
Revisions), permit some additional blending of income under the tested
unit combination rule (as discussed in part III.B of this Summary of
Comments and Explanation of Revisions), and allow taxpayers additional
flexibility by permitting the GILTI high-tax exclusion election to be
made on an annual basis (as discussed in part IV.C of this Summary of
Comments and Explanation of Revisions). Further, as noted in part I of
this Summary of Comments and Explanation of Revisions, the separate
notice of proposed rulemaking published concurrently with these final
regulations conforms the rules implementing the subpart F high-tax
exception with the GILTI high-tax exclusion, thereby eliminating the
disparity between the two elections and the incentive for taxpayers to
structure into the subpart F high-tax exception.
B. CFC-Level Determination of Foreign Taxes
For purposes of the subpart F high-tax exception, the final
regulations under Sec. 1.954-1(d)(3) (before modification by this
Treasury decision) determined, for each U.S. shareholder, the foreign
income taxes paid or accrued with respect to an item of income based on
the amount of foreign income taxes that would be deemed paid under
section 960 if the item of income were included in the gross income of
the U.S. shareholder under section 951(a)(1)(A). The 2019 proposed
regulations modify this determination, for purposes of both the subpart
F high-tax exception and the GILTI high-tax exclusion, by referencing
the amounts of income and taxes at the CFC level, rather than the
amount of taxes that would be deemed paid at the U.S. shareholder
level. See proposed Sec. 1.954-1(d)(3)(i) and proposed Sec. 1.951A-
2(c)(6)(iv). Specifically, foreign income taxes of the CFC for the
current year are allocated and apportioned to the CFC's gross income
based on the rules under Sec. 1.960-1(d), which determine foreign
income taxes ``properly attributable'' to income. The 2019 proposed
regulations modify this calculation because the determination of income
and taxes at the CFC level is more consistent with the text of section
954(b)(4), which refers to items of income (and tax imposed on such
items) of the CFC. In addition, deemed paid credits for taxes properly
attributable to tested income under section 960(d) are determined on an
aggregate basis, which does not provide an accurate basis to determine
the effective foreign tax rate on particular items of income of a CFC
under the GILTI high-tax exclusion provided under section 954(b)(4).
A comment requested that the effective foreign tax rate test be
based on the shareholder's deemed paid credit for taxes properly
attributable to tested income, as defined in section 960(d), over the
shareholder's net CFC tested income, as defined in section 951A(c). The
comment asserted that such an aggregate determination, which would
mirror the calculation of the GILTI
[[Page 44622]]
inclusion, would be consistent with the GILTI legislative history,
would produce more equitable results than those provided under the 2019
proposed regulations, and would significantly reduce compliance and
administrative burdens for taxpayers and the government.
The Treasury Department and the IRS have concluded that this
approach for calculating the effective foreign tax rate would be
inconsistent with section 954(b)(4). Unlike a GILTI inclusion, which is
based on the aggregate amounts of a U.S. shareholder's pro rata shares
of certain items from all the CFCs in which the shareholder is a U.S.
shareholder, section 954(b)(4) applies by its terms to items of income
of a single CFC. That is, section 954(b)(4) applies with respect to
``any item of income received by a CFC'' that is subject to a
sufficiently high rate of foreign tax. Moreover, section
951A(c)(2)(A)(i), which provides exclusions from tested income
including the high-tax exclusion, refers to ``the gross income of such
corporation.'' Nothing in section 954(b)(4), or section
951A(c)(2)(A)(i)(III), suggests that the aggregate approach of the
GILTI regime should or could apply for purposes of determining whether
an item of income received by a CFC is subject to a sufficiently high
level of foreign tax under section 954(b)(4). Thus, the final
regulations do not adopt this comment.
C. Effective Foreign Tax Rate
1. Threshold Rate of Tax
Consistent with section 954(b)(4), the 2019 proposed regulations
apply the GILTI high-tax exclusion by comparing the effective foreign
tax rate with 90 percent of the rate that would apply if the income
were subject to the maximum rate of tax specified in section 11
(currently 18.9 percent, based on a maximum rate of 21 percent). See
proposed Sec. 1.951A-2(c)(6)(i)(B).
Several comments requested that the GILTI high-tax exclusion
instead be applied if the effective foreign tax rate is at least 13.125
percent. One comment requested that it be based on a tax rate of 13.125
percent for taxable years beginning on or before December 31, 2025, and
16.406 percent for taxable years beginning after such date. The
comments asserted that using a 13.125 percent rate would be consistent
with the legislative history indicating that no residual tax should be
due on GILTI subject to an effective foreign tax rate in excess of
13.125 percent, which takes into account the 80 percent foreign tax
credit allowance in section 960(d) and the 50 percent deduction under
section 250, and that the rate should be adjusted for taxable years
beginning after December 31, 2025, to correspond to the reduction in
the amount of deduction allowed with respect to GILTI as provided in
section 250(a)(3)(B).
The Treasury Department and the IRS disagree with these comments.
The GILTI high-tax exclusion is based on section 954(b)(4), which
refers to a tax rate that is greater than 90 percent of the rate that
would apply if the income were subject to the maximum rate of tax
specified in section 11. The rate set forth in section 954(b)(4) does
not vary depending on whether it applies for purposes of determining
FBCI, insurance income, or tested income. Furthermore, the legislative
history describing a 13.125 percent foreign tax rate addresses
situations in which income is included in tested income and,
consequently, subject to GILTI and the associated foreign tax credit
rules under section 960(d).\1\ Those rules do not apply to income
excluded from tested income by reason of the GILTI high-tax exclusion.
Accordingly, the final regulations do not adopt these comments.
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\1\ In addition, the assertion made by certain commenters that
the law categorically provides that no residual U.S. tax is owed
under GILTI at foreign effective tax rates of 13.125% is incorrect.
See Joint Comm. on Tax'n, General Explanation of Public Law 115-97,
at 381 & n.1753.
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2. Safe Harbors
One comment asserted that the ``mechanical snapshot'' rule for
determining the effective foreign tax rate under the 2019 proposed
regulations can produce results that are unreasonable given timing
differences between the U.S. and foreign tax bases. The comment stated
that if an item is accounted for in one period for U.S. tax purposes,
but in another period for foreign tax purposes, the CFC may appear to
have a high effective foreign tax rate in one period, and a low
effective foreign tax rate in the other period, when in fact it is
simply subject to a rate of tax comparable to the U.S. rate on its
foreign tax base over both periods. To address these timing
differences, the comment suggested that the final regulations include
two new methods, in addition to the method set forth in the 2019
proposed regulations, for calculating the effective foreign tax rate,
each of which could be safe harbors applied at the discretion of the
taxpayer.
Under the first suggested method, the GILTI high-tax exclusion
would apply if the foreign statutory income tax rate to which a QBU's
income is subject is sufficiently high and there is no special tax
regime to which a material percentage of the QBU's income is subject.
In such a case, the safe harbor would apply and all the income of the
QBU would be eligible for the GILTI high-tax exclusion. The comment
indicated that the foreign statutory rate could be determined by
reference to publications maintained by the OECD and a special tax
regime could be determined in a manner consistent with the 2016 U.S.
Model Income Tax Treaty.
The second suggested method would allow taxpayers to determine a
QBU's effective foreign tax rate by reference to the average effective
foreign tax rate in the current and preceding four taxable years. The
comment asserted that this approach would smooth out timing differences
and more accurately determine whether the QBU's income was in fact
subject to relatively high rates of tax. The comment also noted that
although the GILTI regime generally operates on an annual basis, the
determination of whether the income of a QBU is subject to a rate of
foreign tax comparable to the U.S. rate may be better determined over a
longer period based on the facts and circumstances.
The Treasury Department and the IRS have concluded that identifying
special tax regimes, or determining the extent to which income would be
subject to special tax regimes, would give rise to considerable
complexity and administrative and compliance burdens for both taxpayers
and the government. Similarly, the Treasury Department and the IRS have
determined that using an average effective foreign tax rate over
multiple taxable years would give rise to additional complexity and
increase the burden on taxpayers and the government due, for example,
to foreign tax redeterminations with respect to a QBU's income, such as
an adjustment for a loss carryback. Such adjustments would not only
affect the year of the redetermination, but also every other year that
took the redetermination year into account in calculating the average
effective foreign tax rate, potentially resulting in multiple amended
returns attributable to a foreign tax redetermination for a single
taxable year. A prior year averaging approach would also lead to
distortive results, such as when the CFC had losses or volatile
earnings. Accordingly, the final regulations do not adopt these safe
harbors. As described in Part III.B. of this Summary of Comments, the
tested unit combination rule should ameliorate some of the concerns
raised by the comment.
[[Page 44623]]
D. Base and Timing Differences
1. In General
The 2019 proposed regulations generally provide that the effective
rate at which taxes are imposed for a taxable year is the U.S. dollar
amount of foreign income taxes paid or accrued with respect to a
tentative net tested income item,\2\ over the sum of the U.S. dollar
amount of the tentative net tested income item and the amount of
foreign income taxes paid or accrued with respect to the tentative net
tested income item. See proposed Sec. 1.951A-2(c)(6)(iii). A tentative
net tested income item is generally determined by taking into account
certain items of gross income (determined under federal income tax
principles) attributable to a QBU, less deductions (also determined
under federal income tax principles) allocated and apportioned to such
gross income. See 1.951A-2(c)(6)(ii)(A) and (B). Thus, the effective
foreign tax rate is based on the amount of foreign income taxes paid or
accrued on income attributable to the QBU as determined for federal
income tax purposes, without regard to how the income is determined for
foreign income tax purposes.
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\2\ The final regulations adopt the term ``tentative tested
income item,'' instead of the term ``tentative net tested income
item.'' See Sec. 1.951A-2(c)(7)(iii).
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The preamble to the 2019 proposed regulations requested comments on
whether additional rules are needed to properly account for cases
(other than disregarded payments) in which the income base upon which
foreign tax is imposed does not match the items of income reflected on
the books and records of the QBU determined for federal income tax
purposes. The preamble cites examples of possible adjustments to
address circumstances in which QBUs are permitted to share losses or
determine tax liability based on combined income for foreign tax
purposes.
2. Disregarded Payments
The proposed regulations generally provide that gross income is
attributable to a QBU if it is properly reflected on the books and
records of the QBU, determined under federal income tax principles,
except that such income is adjusted to account for certain disregarded
payments. See proposed Sec. 1.951A-2(c)(6)(ii)(A)(2). The adjustments
for disregarded payments are made under the principles of Sec. 1.904-
4(f)(2)(vi) (rules attributing gross income to a foreign branch),
without regard to the exclusion for interest described in Sec. 1.904-
4(f)(2)(vi)(C)(1). See id.
One comment suggested that a disregarded payment should not result
in the reallocation of income between QBUs for purposes of computing
the GILTI high-tax exclusion. The Treasury Department and IRS
understand the comment's concern to be the potential inability to claim
the GILTI high-tax exclusion in scenarios where a disregarded payment
was made from a high-taxed CFC to a disregarded entity that paid no
tax.
The Treasury Department and the IRS have determined that, if a
tested unit \3\ makes a disregarded payment to another tested unit,
gross income should be reallocated among the tested units to
appropriately associate the income with the tested unit in which it is
subject to tax. This reallocation promotes conformity between the
income attributed to a tested unit and the income of that tested unit
that is subject to tax in the foreign country, and, therefore, this
rule results in a more accurate grouping of items of income that are
generally subject to the same or similar rates of foreign tax. In
addition, treating disregarded payments in this manner is consistent
with the treatment of regarded payments. For example, if a tested unit
of a CFC were to make a regarded deductible payment that is taken into
account by another tested unit of the CFC (such as a tested unit that
is an interest in a partnership), the payment would be an item of gross
income of the payee tested unit that may qualify for the GILTI high-tax
exclusion based on the foreign taxes attributable to that tested unit.
Moreover, the regarded deduction would be reflected in a reduced
tentative net tested income item (relative to the result in the absence
of adjustment for disregarded payments)--and, consequently, the
denominator of the effective foreign tax rate fraction--with respect to
the payor tested unit for purposes of assessing whether its gross
income is subject to a high rate of foreign tax. For these reasons, the
comment is not adopted.
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\3\ As discussed in part III of this Summary of Comments and
Explanation of Revisions, the final regulations adopt a ``tested
unit'' standard that replaces the QBU standard used in the 2019
proposed regulations.
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The final regulations provide additional rules addressing
disregarded payments, including providing additional detail on how the
principles of Sec. 1.904-4(f)(2)(vi) should be applied. See Sec.
1.951A-2(c)(7)(ii)(B)(2). For example, the final regulations provide
that a disregarded payment of interest is allocated and apportioned
ratably to all of the gross income attributable to the tested unit that
is making the disregarded payment. See Sec. 1.951A-
2(c)(7)(ii)(B)(2)(iv). The final regulations also provide special
ordering rules for reallocations with respect to multiple disregarded
payments. See Sec. 1.951A-2(c)(7)(ii)(B)(2)(iv).
3. Foreign Net Operating Losses and Other Timing Differences
Some comments requested that the final regulations allow taxpayers
to elect to adjust either the numerator or denominator of the effective
foreign tax rate fraction to take into account foreign net operating
loss (``NOL'') carryforwards and other similar items. One comment
asserted that, while the effective foreign tax rate calculation
generally serves as an appropriate test, CFCs with a foreign NOL
carryover may fail the test even though the rate of tax in the foreign
country exceeds 18.9 percent. Another comment indicated that a CFC
could fail the mechanical test in a single year although the same
income is subject to a foreign tax that is substantially higher than
the U.S. corporate tax rate because of timing differences (that is,
differences in when income or deductions are taken into account for
U.S. and foreign tax purposes).
The Treasury Department and the IRS have determined that adjusting
the numerator or denominator of the effective foreign tax rate fraction
for foreign NOL carryforwards or other timing differences would result
in considerable complexity and would impose a significant burden on
both taxpayers and the government. It would require the application of
foreign tax accounting rules, and complex coordination rules to
reconcile their application with U.S. tax accounting rules, both in the
current taxable year and other taxable years, to prevent an item of
income, gain, deduction, loss, or credit from being duplicated or
omitted. Accordingly, this comment is not adopted.
III. Adoption of Tested Unit Standard
A. In General
As discussed in part II.A of this Summary of Comments and
Explanation of Revisions, the 2019 proposed regulations propose a QBU-
by-QBU approach to identify the relevant items of income that may be
eligible for the GILTI high-tax exclusion. For this purpose, the
proposed regulations reference the definition of a QBU in section
989(a), which provides that a QBU is any separate and clearly
identifiable unit of a trade or business of a taxpayer that maintains
separate books and records. See proposed 1.951A-2(c)(6)(ii)(A).
Regulations under
[[Page 44624]]
section 989(a) provide guidance as to activities that constitute a
trade or business (based on a facts-and-circumstances analysis) and the
determination of separate books and records. See Sec. 1.989(a)-1(c)
and (d). The preamble to the 2019 proposed regulations requested
comments on whether the definition of a QBU should be modified for
purposes of the GILTI high-tax exclusion, including the requirements to
carry on activities that constitute a trade or business and to maintain
books and records.
One comment asserted that it is unclear whether certain activities
constitute a trade or business under the facts-and-circumstances test
set forth in the regulations under section 989(a) and that making such
determinations would frequently be administratively burdensome. The
comment indicated that in other cases it is also difficult to determine
whether certain interrelated activities constitute a single QBU or
multiple QBUs (for example, different functions performed by separate
divisions operating within a single CFC). In addition, the comment
suggested that taxpayers may engage in affirmative tax planning to
avoid the QBU rule by, for example, breaking up the operations of a
single large QBU of a CFC into smaller components that would not
constitute trades or businesses, or by choosing to no longer maintain
books and records for such sub-lines of business. Another comment
criticized the QBU approach because some taxpayers may track business
activities differently than other taxpayers, which may result in the
inconsistent application of the QBU rules. Finally, a comment noted
that not all companies have sufficient systems in place to accurately
track items at the QBU level.
The 2019 proposed regulations propose the QBU standard as a proxy
for determining the type of entity, or level of activities, that would
likely be subject to tax in a particular foreign country either on an
entity basis or as a taxable presence, and, as a result, would likely
result in items of income attributable to the QBU being subject to a
different rate of foreign tax than that imposed on other income of the
CFC. In response to these comments, the Treasury Department and the IRS
have concluded that a more targeted approach should be applied for
identifying income that is likely to be subject to foreign tax rates
different from those imposed on other income earned by the CFC. This
approach will generally limit the scope of the factual analysis
necessary to apply these rules--for example, it does not depend on
whether activities constitute a trade or business, or whether books and
records are maintained--and thereby addresses many of the concerns
raised in these comments. Accordingly, in lieu of the QBU standard in
the 2019 proposed regulations, the final regulations generally apply
the GILTI high-tax exclusion based on the gross tested income of a CFC
that is attributable to a ``tested unit.'' See Sec. 1.951A-
2(c)(7)(ii). Unlike the QBU standard that serves as a proxy for being
subject to foreign tax, the tested unit approach generally applies to
the extent an entity, or the activities of an entity, are actually
subject to tax, as either a tax resident or a permanent establishment
(or similar taxable presence), under the tax law of a foreign country.
The final regulations provide three categories of a tested unit.
First, and consistent with the 2019 proposed regulations, a tested unit
includes a CFC. See Sec. 1.951A-2(c)(7)(iv)(A)(1). Thus, if a CFC,
which itself is a tested unit, has no other tested units, the GILTI
high-tax exclusion is applied with respect to all the tentative gross
tested income items (determined under Sec. 1.951A-2(c)(7)(ii)) of the
CFC.
Second, and also consistent with the 2019 proposed regulations, a
tested unit generally includes an interest in a pass-through entity
held, directly or indirectly, by a CFC. See Sec. 1.951A-
2(c)(7)(iv)(A)(2). For this purpose, a pass-through entity is defined
to include, for example, a partnership or a disregarded entity. See
Sec. 1.951A-2(c)(7)(ix)(B).
More specifically, a CFC's interest in a pass-through entity is a
tested unit if the pass-through entity meets one of two requirements.
First, the CFC's interest in the pass-through entity is a tested unit
if the pass-through entity is a tax resident of a foreign country
because, in these cases, income earned by the CFC indirectly through
the pass-through entity may be subject to tax at a rate different than
the rate at which income earned by the CFC directly is subject to tax.
See Sec. 1.951A-2(c)(7)(iv)(A)(2)(i). Second, the CFC's interest in
the pass-through entity is a tested unit if the pass-through entity is
not subject to tax as a resident, but is treated as a corporation (or
as another entity that is not fiscally transparent) for purposes of the
CFC's tax law, because in these cases income earned by the CFC
indirectly through the pass-through entity may not be subject to tax in
the foreign country of which the CFC is a tax resident; thus, for
example, an interest in a domestic limited liability company that is a
partnership for federal income tax purposes would typically be a tested
unit. See Sec. 1.951A-2(c)(7)(iv)(A)(2)(ii). A CFC's interest in a
pass-through entity (or the activities of a branch) that is not a
tested unit is a ``transparent interest.'' See Sec. 1.951A-
2(c)(7)(ix)(C); see also the discussion on transparent interests in
part III.C.3 of this Summary of Comments and Explanation of Revisions.
This treatment of interests in pass-through entities in the final
regulations is consistent with a comment suggesting that a pass-through
entity should be treated as a tested unit if the entity is treated as a
separate entity for purposes of a foreign tax law, but not if the
entity is fiscally transparent (and thus not a tax resident) for
purposes of the tax law of a foreign country.
An interest in an entity, rather than the entity itself, is treated
as a tested unit (or a transparent interest) because the entity may
have multiple owners and the characterization of the interest as a
tested unit may depend on each holder's tax treatment with respect to
the interest. As a result, less than the entire entity may be
characterized as a tested unit or a transparent interest. In addition,
different interests in an entity held directly or indirectly by the
same CFC may be characterized differently. The final regulations
include an example that illustrates the application of this rule. See
Sec. 1.951A-2(c)(8)(iii)(D) (Example 4).
Finally, a tested unit includes a branch, or a portion of a branch,
the activities of which are carried on directly or indirectly by a CFC,
provided that either (i) the branch gives rise to a taxable presence in
the country in which the branch is located, or (ii) the branch gives
rise to a taxable presence under the owner's tax law, and the owner's
tax law provides an exclusion, exemption, or other similar relief (such
as a preferential rate) for income attributable to the branch. See
Sec. 1.951A-2(c)(7)(iv)(A)(3). In these cases, the income indirectly
earned by the owner through the branch is likely subject to tax at a
rate different than the rate at which income directly earned by the
owner is subject to tax. The Treasury Department and the IRS have
determined that this branch tested unit rule addresses blending
concerns related to an owner's taxable presence in another country in a
more targeted manner than the ``activities'' QBU standard from the 2019
proposed regulations. In addition, the Treasury Department and the IRS
have determined that the branch tested unit rule will likely reduce
compliance burdens, as compared to the QBU standard from the 2019
proposed regulations, because the tested unit rule
[[Page 44625]]
depends on how activities are treated under foreign tax law, an
analysis of which in most cases would be conducted independently of the
final regulations (for example, to determine whether a tax return must
be filed because activities in that country give rise to a taxable
presence).
For purposes of the tested unit rules, references to the tax law of
a foreign country include statutes, regulations, administrative or
judicial rulings, and treaties of the country. See Sec. 1.951A-
2(c)(7)(iv)(A)(2) and (3) (cross-referencing definitions in regulations
under section 267A that incorporate the definition of the tax law of a
country in Sec. 1.267A-5(a)(21)).
The final regulations make clear that tested units are determined
independently of one another. For example, even though a CFC is itself
a tested unit, the CFC may have other tested units, such as a permanent
establishment or an interest in a disregarded entity that, subject to
the application of the combination rule discussed in part III.B of this
Summary of Comments and Explanation of Revisions, must be treated
separately for purposes of the GILTI high-tax exclusion. See Sec.
1.951A-2(c)(8)(iii)(D) (Example 4).
The final regulations also provide a rule that addresses cases
where the same item is attributable to more than one tested unit in a
tier of tested units. This may occur, for example, if an item is
properly reflected both on the separate set of books and records of one
tested unit, and on the separate set of books and records of a lower-
tier tested that is owned (directly or indirectly) by the first tested
unit, because the books and records of the two tested units were
prepared under different accounting standards. In such a case, the
final regulations provide that the item is considered to be
attributable only to the lowest-tier tested unit. See Sec. 1.951A-
2(c)(7)(iv)(B).
B. Combined Tested Units
The 2019 proposed regulations apply separately to each QBU of a
CFC. See proposed Sec. 1.951A-2(c)(6)(ii)(A)(1). However, the preamble
to the 2019 proposed regulations requested comments as to whether all
of a CFC's QBUs located within a single foreign country should be
combined.
Several comments recommended combining ``same-country'' QBUs, on an
elective basis, noting it would reduce complexity and compliance
burdens. Some comments asserted that a combined same-country QBU
approach would be more consistent with congressional intent for the
GILTI regime to target income in low- and zero-tax countries, would
reduce certain variances (for example, due to business cycle
fluctuations or differences between the U.S. and foreign tax bases),
and would reduce incentives for tax-motivated restructuring. Another
comment recommended that the final regulations include rules that would
allow taxpayers to take into account a fiscal unity or similar grouping
in determining the effective foreign tax rate.
The Treasury Department and the IRS generally agree that a
combination rule would reduce compliance burdens and would be
consistent with the policies underlying the GILTI high-tax exclusion.
Moreover, a combination rule may minimize the effect of timing and
other differences between the U.S. and foreign tax bases. Accordingly,
the final regulations generally provide that tested units of a CFC
(including the CFC tested unit), other than certain nontaxed branch
tested units, are treated as a single tested unit if the tested units
are tax residents of, or located in, the same foreign country. See
Sec. 1.951A-2(c)(7)(iv)(C)(1). In general, a nontaxed branch tested
unit is a branch tested unit that does not give rise to a taxable
presence under the tax law of the foreign country where the branch is
located, but gives rise to a taxable presence under the tax law of the
foreign country where the home office of the branch is a tax resident
and such tax law provides an exclusion, exemption, or similar relief
for purposes of taxing income attributable to the branch. See Sec.
1.951A-2(c)(7)(iv)(A)(3). The tested unit combination rule does not
apply to a nontaxed branch tested unit because such a tested unit
typically would not be subject to tax (or to any meaningful level of
tax) in any foreign country and thus combining it with other tested
units (the income of which may be subject to a meaningful level of tax)
could give rise to inappropriate blending. See Sec. 1.951A-
2(c)(7)(iv)(C)(2).
The combination rule applies without regard to whether the tested
units are subject to the same foreign tax rate because it would be
inconsistent with the purpose of the combination rule to require
taxpayers to determine the effective foreign tax rate imposed on the
tested units separately, and simply comparing the statutory foreign tax
rates may not be meaningful. In addition, the combination rule is not
conditioned on the tested units having the same functional currency
because the effective foreign tax rate is calculated in U.S. dollars
and any differences in functional currency are unlikely to have a
material effect on whether income qualifies for the GILTI high-tax
exclusion. Finally, the combination rule is mandatory, and not
elective, because providing an election would give rise to additional
complexity, and related administrative and compliance burdens.
C. Books and Records
1. In General
Under the 2019 proposed regulations, gross income is attributable
to a QBU if it is properly reflected on the books and records of the
QBU. See proposed Sec. 1.951A-2(c)(6)(ii)(A)(2). For this purpose,
gross income is determined under federal income tax principles with
certain adjustments to reflect disregarded payments. Id.
As discussed in part III.A of this Summary of Comments and
Explanation of Revisions, the final regulations adopt a tested unit
standard, rather than a QBU standard, for purposes of determining a
tentative gross tested income item. Nevertheless, the final regulations
retain the general approach set forth under the 2019 proposed
regulations of relying on a separate set of books and records (as
modified to apply to tested units, rather than QBUs) as the starting
point for determining gross income attributable to a tested unit. The
Treasury Department and the IRS have concluded that applying the books-
and-records approach for tested units is appropriate because it serves
as a reasonable proxy for determining the amount of gross income that
the foreign country of the tested unit is likely to subject to tax. In
addition, relying on a separate set of books and records is consistent
with the approach taken under other provisions and, therefore, should
promote administrability for both taxpayers and the government. See,
for example, Sec. Sec. 1.904-4(f) (foreign branch category rules),
1.987-2(b) (rules for determining items attributable to a QBU branch),
and 1.1503(d)-5(c) (dual consolidated loss rules).
The final regulations generally provide that items of gross income
of a CFC are attributable to a tested unit of the CFC to the extent
they are properly reflected on the separate set of books and records of
the tested unit, or of the entity an interest in which is a tested unit
(for example, in the case of certain partnerships). See Sec. 1.951A-
2(c)(7)(ii)(B). This rule starts with the items of gross income of the
CFC for federal income tax purposes and then attributes those items to
the CFC's tested units to the extent the items are properly reflected
on the separate set of books and records of the tested units (with
certain adjustments, such as to account for disregarded payments). For
[[Page 44626]]
example, if a CFC owns a partnership interest that is a tested unit,
the items of gross income that the CFC derives through the partnership
interest are attributed to the CFC's interest in the partnership to the
extent that the items are properly reflected on the separate set of
books and records of the partnership. Thus, this approach first gives
effect to the rules that determine the items of gross income of the
CFC, such as the rules under section 704 for purposes of determining a
CFC partner's distributive share of items of a partnership, and then
attributes those items to the tested units of the CFC depending on
whether the items are properly reflected on the separate set of books
and records. The final regulations include examples that illustrates
the application of this rule. See Sec. 1.951A-2(c)(8)(D) (Example 4).
2. Separate Set of Books and Records
The Treasury Department and the IRS have determined that a tested
unit, or an entity an interest in which is a tested unit, generally
will maintain a separate set of books and records that would be readily
available for purposes of the final regulations. This is expected to be
the case for a branch tested unit under Sec. 1.951A-2(c)(7)(iv)(A)(3)
(involving a taxable presence), for example, because a separate set of
books and records would ordinarily be required to compute the foreign
tax liability arising in the taxing country (or for not taking into
account items attributable to the taxable presence if determined only
under the owner's tax law). Accordingly, the final regulations retain
the general approach taken in the 2019 proposed regulations by defining
a ``separate set of books and records'' by reference to Sec. 1.989(a)-
1(d). See Sec. 1.951A-2(c)(7)(v)(A).\4\
---------------------------------------------------------------------------
\4\ The 2020 proposed regulations, however, replace the
reference to ``books and records'' with a more specific standard
based on items properly reflected on an ``applicable financial
statement,'' and request comments.
---------------------------------------------------------------------------
3. Booking Rule for Transparent Interests
The final regulations provide a special booking rule that applies
to a transparent interest, which, as noted in part III.A of this
Summary of Comments and Explanation of Revisions, is an interest in a
pass-through entity (or the activities of a branch) that is not a
tested unit. This rule, which is consistent with the rule in Sec.
1.1503(d)-5(c)(3)(ii) (addressing similar interests for purposes of the
dual consolidated loss rules), generally treats items properly
reflected on the separate set of books and records of an entity an
interest in which is a transparent interest as being properly reflected
on the books and records of a tested unit that holds interests
(directly or indirectly through other transparent interests) in the
entity. See Sec. 1.951A-2(c)(7)(v)(C). This treatment is appropriate
because income earned by the tested unit directly, as well as income
earned by the tested unit indirectly through the transparent interest,
is expected to be subject to residence-based tax in only the tested
unit's country of residence (or location) and, as a result, it is
unlikely that blending of income subject to different foreign tax rates
would occur by reason of the tested unit's ownership of the transparent
interest.
4. Tested Units That Fail To Maintain a Set of Books and Records
The final regulations include a rule that applies if a separate set
of books and records is not prepared for a tested unit or transparent
interest. In such a case, items required to apply the GILTI high-tax
exclusion that would be reflected on a separate set of books and
records of the tested unit or transparent interest must be determined
and treated as properly reflected on the separate set of books and
records. See Sec. 1.951A-2(c)(7)(v)(B). This rule is intended to
address cases where a separate set of books and records is not
maintained, and to prevent the avoidance of the rules by choosing to
not maintain a separate set of books and records.
5. Items of Gross Income Not Taken Into Account for Financial
Accounting Purposes
In some cases, items of gross income (determined under federal
income tax principles) may not be properly reflected on a separate set
of books and records because they are not taken into account for
financial accounting purposes. This may occur when items are taken into
account for federal income tax purposes and financial accounting
purposes in different taxable years, or when items are taken into
account for federal income tax purposes but are not taken into account
for financial accounting purposes (for example, due to the mark-to-
market method of accounting). To ensure that these items of gross
income are attributable to a tested unit in a CFC inclusion year, the
final regulations clarify that the items are treated as properly
reflected on a separate set of books and records if they would be so
reflected if they were taken into account for financial accounting
purposes in the CFC inclusion year in which they are taken into account
for federal income tax purposes. See Sec. 1.951A-2(c)(7)(v)(D). No
inference should be drawn from this clarification with respect to other
similar rules that attribute items based on books and records,
including under Sec. 1.904-4(f), Sec. 1.987-2(b), or Sec. 1.1503(d)-
5(c).
D. De Minimis Rules
A comment recommended that the final regulations adopt two de
minimis rules to simplify the application of the QBU-by-QBU approach.
First, the comment suggested that taxpayers should be permitted to
elect to treat all CFCs with income below a specified threshold as a
single QBU. The Treasury Department and the IRS have determined that
aggregating CFCs for this purpose would be inconsistent with section
954(b)(4), which applies with respect to items of income of a single
CFC. Accordingly, this recommendation is not adopted.
Second, the comment suggested that taxpayers should be permitted to
elect to aggregate QBUs within the same CFC that have a small amount of
tested income (measured either in absolute terms or based on a
percentage of the CFC's income). However, it is uncertain whether
aggregating QBUs with small amounts of tested income will result in a
significant amount of simplification because, for example, gross income
would still have to be attributed to each QBU (taking into account
disregarded payments) to determine whether the de minimis rule applies.
The final regulations do not adopt the recommendation, but a de minimis
rule is included in the 2020 proposed regulations to allow an
opportunity for additional notice and comment.
IV. Rules Regarding the Election
A. Consistency Requirement
The 2019 proposed regulations generally provide that if a CFC is a
member of a controlling domestic shareholder group (``CFC group''),\5\
a GILTI high-tax exclusion election (or revocation) is either made with
respect to each member of the CFC group or is not made for any member
of the CFC group. See proposed Sec. 1.951A-2(c)(6)(v)(E)(1) and part
IV.B of this Summary of Comments and Explanation of Revisions. The
preamble to the 2019 proposed regulations requested comments on whether
the consistency rule should be modified or removed, for example, by
allowing the election to be made on an item-by-item or a CFC-by-CFC
basis.
---------------------------------------------------------------------------
\5\ The final regulations adopt the shorter and more descriptive
term ``CFC group,'' instead of the term ``controlling domestic
shareholder group.'' See Sec. 1.951A-2(c)(7)(viii)(E)(2).
---------------------------------------------------------------------------
[[Page 44627]]
Several comments requested that the final regulations eliminate the
consistency requirement such that the GILTI high-tax exclusion election
can be made on a CFC-by-CFC basis, which would conform the exclusion to
the subpart F high-tax exception. Some comments asserted that the
consistency requirement is too restrictive because the GILTI regime
generally applies to both low- and high-taxed income and the
consistency requirement has the effect of applying the GILTI regime
only to low-taxed income since all high-taxed income is excluded.
Comments further asserted that determining whether making the election
for all CFCs is beneficial, especially when involving multiple foreign
countries, is a complex and difficult task and would increase
taxpayers' compliance burden. Some comments stated that the elimination
of the consistency requirement would enable taxpayers to minimize the
unfavorable interaction between the GILTI regime and the rules for
allocating and apportioning deductions. Other comments asserted that
the consistency requirement would encourage taxpayers to implement
structures that would convert tested income into subpart F income,
which is contrary to one of the purposes of the GILTI high-tax
exclusion. Finally, comments suggested that if the consistency
requirement is included in the final regulations, it is likely that
many taxpayers will not make the GILTI high-tax exclusion election.
The Treasury Department and the IRS have determined that the
consistency requirement is necessary due to the collateral effect that
the GILTI high-tax exclusion has on the allocation and apportionment of
deductions. Specifically, allowing CFC-by-CFC or tested unit-by-tested
unit elections would encourage the selective use of the GILTI high-tax
exclusion to inappropriately manipulate the section 904 foreign tax
credit limitation. In this regard, deductions allocated and apportioned
to income excluded under section 954(b)(4) will be subject to section
904(b)(4), as described in Part V.A of this Summary of Comments and
Explanation of Revisions, and thereby disregarded for purposes of
determining a taxpayer's foreign tax credit limitation under section
904. Without a consistency requirement, taxpayers may be able to
include high-taxed income in GILTI to claim foreign tax credits up to
the amount of their section 904 limitation, while electing to exclude
the remainder of such income under the GILTI high-tax exclusion.
Consequently, the taxpayer's section 904 limitation would not take into
account all the deductions attributable to investments generating high-
taxed income, resulting in a distortive application of the foreign tax
credit limitation under section 904. A consistency requirement prevents
this result by ensuring that a taxpayer that seeks to cross-credit the
foreign tax imposed on high-taxed tentative tested income against low-
taxed tentative tested income must take all of its high-taxed tentative
tested income into account along with all of the deductions allocated
and apportioned to that category of income. This concern does not arise
with respect to other types of income that are excluded from tested
income (for example, foreign oil and gas extraction income) because
such items are always excluded (that is, there is no electivity as to
whether they are included in tested income), and the foreign taxes
attributable to that income can never be claimed as a credit against
the U.S. tax imposed on section 951A inclusions.
The Treasury Department and the IRS agree that the GILTI high-tax
exclusion election and the subpart F high-tax exception election should
apply consistently and, as noted in part I of this Summary of Comments
and Explanation of Revisions, have determined that the subpart F high-
tax exception should be conformed to the GILTI high-tax exclusion, as
discussed in the preamble to the 2020 proposed regulations. This is
appropriate, in part, due to changes made by the Act. Before the Act, a
consistency requirement would have had minimal effect because post-1986
earnings and profits (including income excluded from subpart F income
under section 954(b)(4)) could be distributed and would be included in
income of the U.S. shareholder, and foreign taxes would be deemed paid
under section 902, subject to the limitations imposed by section 904,
which is a result consistent with a subpart F inclusion. Further,
before the Act, an amount excluded under section 954(b)(4) largely
resulted only in the deferral of income and deemed paid foreign taxes,
rather than an exclusion of those items from the U.S. tax base, and
deductions allocated and apportioned to such income would limit a
taxpayer's ability to claim foreign tax credits in the future. After
the Act, an election under section 954(b)(4) will result in a permanent
change in the treatment of high-taxed income and the associated foreign
taxes and deductions, increasing the significance, from a policy
perspective, of inconsistent treatment.
Thus, the Treasury Department and the IRS have determined that the
policy underlying section 954(b)(4) is best furthered through a single
election to exclude all high-taxed income from GILTI (and, subject to
finalization of the 2020 proposed regulations, subpart F income)
because that income does not pose a base erosion concern and is
therefore not the type of income that Congress intended to include in
tested income. However, because the application of section 954(b)(4),
and the additional administrative burden associated with identifying
high-taxed items of income, has always been elective, the Treasury
Department and the IRS have determined that the exclusion of such
income (and to the extent possible any additional burden associated
with identifying such income) should continue to be limited to cases
where a taxpayer elects the application of section 954(b)(4).
The Treasury Department and the IRS have determined that it would
be inappropriate to allow a taxpayer to selectively exclude and include
income, once it makes an election under section 954(b)(4). Section 951A
generally does not permit electivity in the determination of tested
income. For example, a taxpayer cannot choose to include in tested
income amounts that would be subpart F income but for the application
of section 954(b)(4) (regardless of whether the election is made), nor
may a taxpayer choose to include foreign oil and gas extraction income
in tested income. Further, contrary to some comments, the Treasury
Department and the IRS anticipate that the additional electivity is
more likely to increase, rather than reduce, compliance burden as a
result of the need for more numerous calculations. As a result, the
Treasury Department and the IRS have concluded that the consistency
rule should be retained; accordingly, this recommendation is not
adopted.
B. Definition of CFC Group
The 2019 proposed regulations define a CFC group based on two
tests. Under the first test, a CFC group means two or more CFCs if more
than 50 percent of the total combined voting power of the stock of each
CFC is owned (within the meaning of section 958(a)) by the same
controlling domestic shareholder (as defined in Sec. 1.964-1(c)(5)).
See proposed Sec. 1.951A-2(c)(6)(v)(E)(2). The second test applies
only if no single controlling domestic shareholder satisfies the first
test. Under the second test, the 2019 proposed regulations provide that
a CFC group means two or more CFCs if more than 50 percent of the total
combined voting power of the stock of each CFC is owned (within the
[[Page 44628]]
meaning of section 958(a)) by the same controlling domestic
shareholders and each such shareholder owns (within the meaning of
section 958(a)) the same percentage of stock in each CFC. See id. For
purposes of both tests, a controlling domestic corporate shareholder
includes a related person (within the meaning of section 267(b) or
707(b)(1)) (the ``related party rule''). See id.
One comment raised several issues with the definition of a CFC
group. For example, the comment stated that the application of the
related party rule is circular because it requires the already-
determined existence of a controlling domestic shareholder to apply the
rule that a controlling domestic shareholder includes persons related
to the controlling domestic shareholder. In addition, the comment
requested clarification as to whether, for purposes of determining the
CFC group, section 958(a) ownership is limited to ownership by U.S.
persons. The comment also raised several issues related to changes in
ownership of CFCs, including issues arising in connection with
simultaneous acquisitions of CFCs and acquisitions of controlling
domestic shareholders.
In response to these comments, the final regulations revise the
definition of a CFC group. Under the final regulations, a CFC group is
an affiliated group, as defined in section 1504(a), with certain
modifications that broaden the definition. See Sec. 1.951A-
2(c)(7)(viii)(E)(2)(i). First, the affiliated group rules in section
1504(a) apply without regard to section 1504(b)(1) through (6) (which
exclude certain corporations, such as foreign corporations, from the
definition of an ``includible corporation''). See id. Second, for
purposes of determining whether a CFC is a member of a CFC group, the
final regulations incorporate a ``more than 50 percent'' threshold
instead of the ``at least 80 percent'' threshold in section 1504(a).
See id. Stock ownership for this purpose is determined by applying the
constructive ownership rules of section 318(a), with certain
modifications. See id. These constructive ownership rules would, for
example, cause two corporations owned directly by the same U.S.
individual to be part of a CFC group.
The final regulations provide that the determination of whether a
CFC is included in a CFC group is made as of the close of the CFC
inclusion year of the CFC that ends with or within the taxable years of
the controlling domestic shareholders. See Sec. 1.951A-
2(c)(7)(viii)(E)(2)(ii). This rule is intended to address certain
changes in ownership of CFCs, such as acquisitions and dispositions.
The final regulations also provide that a CFC may be a member of only
one CFC group and include a special tie-breaker rule for situations in
which a CFC would be a member of more than one CFC group. See Sec.
1.951A-2(c)(7)(viii)(E)(2)(iii).
The final regulations also clarify that if a CFC is not a member of
a CFC group, a high-tax election is made (or revoked) only with respect
to the CFC and the rules regarding the election apply by reference to
the CFC. See Sec. 1.951A-2(c)(7)(viii)(A). If, however, a CFC is a
member of a CFC group, a high-tax election is made (or revoked) with
respect to all members of the CFC group and the rules regarding the
election apply by reference to the CFC group. See Sec. 1.951A-
2(c)(7)(viii)(E)(1).
C. Duration of Election
The 2019 proposed regulations generally provide that the GILTI
high-tax exclusion election is effective for the CFC inclusion year for
which it is made and all subsequent CFC inclusion years, unless the
election is revoked. See proposed Sec. 1.951A-2(c)(6)(v)(C). The 2019
proposed regulations further provide that, subject to a ``change of
control'' exception, if an election is revoked, then the CFC cannot
make a new election for any CFC inclusion year that begins within 60
months following the close of the CFC inclusion year for which the
previous election was revoked (``60-month restriction''). See proposed
Sec. 1.951A-2(c)(6)(v)(D)(2). The preamble to the 2019 proposed
regulations requested comments on whether the 60-month restriction
should be modified or removed.
Several comments requested that the 60-month restriction be
eliminated such that taxpayers would be permitted to make the GILTI
high-tax exclusion election on an annual basis. Some comments reasoned
that this change would be consistent with the subpart F high-tax
exception, which is an annual election. Another comment asserted that
taxpayers should be permitted to make the election annually to take
into account significant fluctuations in foreign income that taxpayers
generate from year to year, or the likely possibility that taxpayers
may be subject to differing foreign tax rates from year to year as a
result of economic factors and conditions beyond their control.
Finally, a comment stated that taxpayers with a mix of high-taxed and
low-taxed income attributable to their QBUs must evaluate various
factors to determine whether an election should be made and, as those
factors change from year to year, the 60-month restriction may force
taxpayers to pay additional tax under the GILTI regime if future
projections are incorrect.
The Treasury Department and the IRS agree with these comments and
have determined that, given that the final regulations adopt a tested
unit-by-tested unit approach (in lieu of the QBU-by-QBU approach) and
retain the consistency requirement set forth in the 2019 proposed
regulations, the 60-month restriction is not necessary to prevent
abuse. Accordingly, the final regulations do not include the 60-month
restriction and, subject to the consistency requirement, taxpayers may
elect the GILTI high-tax exclusion on an annual basis.
Because the final regulations eliminate the 60-month restriction,
comments requesting that the restriction be clarified in certain
respects are moot and therefore not discussed.
D. Effect on Non-Controlling U.S. Shareholders
One comment requested that the final regulations include a notice
of election and revocation requirement, which would require any U.S.
shareholder that makes or revokes an election to notify the CFC of such
action and require any CFC that receives an election or revocation
notice from a U.S. shareholder for a taxable year to notify its other
U.S. shareholders of the action taken by the U.S. shareholder and its
ownership percentage.
The Treasury Department and the IRS agree that U.S. shareholders
that are not controlling domestic shareholders of a CFC should be
informed by the controlling domestic shareholders of the CFC if they
make (or revoke) a GILTI high-tax exclusion election with respect to
the CFC. Therefore, the final regulations clarify that the controlling
domestic shareholders must provide notice of elections (or
revocations), as required by Sec. 1.964-1(c)(3)(iii), to each U.S.
shareholder that is not a controlling domestic shareholder. See Sec.
1.951A-2(c)(7)(viii)(A)(1)(ii), (C) and (D).
E. Treatment of Domestic Partnerships as Controlling Domestic
Shareholders
The proposed regulations under section 958 in the 2019 proposed
regulations provide, as a general rule, that for purposes of sections
951 and 951A (and certain related provisions) a domestic partnership is
not treated as owning stock of a foreign corporation within the meaning
of section 958(a). See proposed Sec. 1.958-1(d)(1). Under an exception
to this general rule, a domestic partnership is treated as owning stock
of a foreign corporation within the meaning of section 958(a) for
purposes of determining whether any
[[Page 44629]]
U.S. shareholder is a controlling domestic shareholder. See proposed
Sec. 1.958-1(d)(2). The preamble to the 2019 proposed regulations
requested comments on this exception. The Treasury Department and the
IRS intend to address comments received in response to this request in
connection with finalizing the proposed regulations under sections 951,
956, 958, and 1502.\6\
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\6\ Under currently applicable Sec. 1.951A-1(e)(2), a domestic
partnership can be a controlling domestic shareholder--for example,
for purposes of determining which party elects the GILTI high-tax
exclusion under Sec. 1.951A-7(c)(7)(viii)(A), including potentially
for taxable years beginning after December 31, 2017, under Sec.
1.951A-7(b), as discussed in part VIII of this Summary of Comments
and Explanation of Revisions.
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F. Elections Made or Revoked on Amended Tax Returns
The 2019 proposed regulations generally allow a taxpayer to make
(or revoke) the GILTI high-tax exclusion election with an amended
income tax return. See proposed Sec. 1.951A-2(c)(6)(v)(A)(1) and
(c)(6)(v)(D)(1). One comment indicated that it was unclear how the
binding effect of the election on all U.S. shareholders of a CFC
operates when the controlling domestic shareholder makes (or revokes)
the election on an amended return. In particular, the comment stated
that it was unclear whether a U.S. shareholder, other than a
controlling domestic shareholder, would be required to file an amended
return reflecting the election (or revocation). The comment further
raised concerns about the possibility that the assessment statute of
limitations may limit the government's ability to assess any additional
tax due as a result of such election (or revocation). The comment
recommended that the final regulations clarify whether U.S.
shareholders are required to file amended income tax returns when an
election is made (or revoked) on an amended return.
In general, the Treasury Department and the IRS agree with the
comment that allowing the controlling domestic shareholders to make (or
revoke) the GILTI high-tax exclusion election on an amended income tax
return may change the amount of U.S. tax due with respect to U.S.
shareholders other than the controlling domestic shareholders. Further,
the election or revocation may change the amount of U.S. tax due with
respect to all U.S. shareholders in intervening tax years. If the
election were made (or revoked) on an amended return after some or all
of these taxable years are no longer open for assessment under section
6501, it may result in the issuance of refunds for certain taxable
years of shareholders when corresponding deficiencies could not be
assessed or collected. As a result, the final regulations provide that
the election may be made (or revoked) on an amended federal income tax
return only if all U.S. shareholders of the CFC file amended federal
income tax returns (unless an original return has not yet been filed,
in which case the original federal income tax return may be filed
consistently with the election (or revocation)) for the taxable year
(and for any other taxable year in which their U.S. tax liabilities
would be increased by reason of that election (or revocation)) (or in
the case of a partnership if any item reported by the partnership or
any partnership-related item would change as a result of the election
(or revocation)), within 24 months of the unextended due date of the
original federal income tax return of the controlling domestic
shareholder's inclusion year with or within which the CFC inclusion
year, for which the election is made (or revoked), ends. See Sec.
1.951A-2(c)(7)(viii)(A)(2) and (c)(7)(viii)(C). For administrative
purposes, the final regulations also provide that amended federal
income tax returns for all U.S. shareholders of the CFC for the CFC
inclusion year must be filed within a single 6-month period (within the
24-month period). See Sec. 1.951A-2(c)(7)(viii)(A)(2)(ii). The
requirement that all amended federal income tax returns be filed within
a 6-month period is to allow the IRS to timely evaluate refund claims
or make additional assessments.
The final regulations also clarify how these rules operate in the
case of a U.S. shareholder that is a domestic partnership. See Sec.
1.951A-2(c)(7)(viii)(A)(3) and (4). For example, the final regulations
provide that in the case of a U.S. shareholder that is a partnership,
the election may be made (or revoked) with an amended Form 1065 or an
administrative adjustment request (as described in Sec. 301.6227-1),
as applicable. See Sec. 1.951A-2(c)(7)(viii)(A)(3). The final
regulations further provide that if a partnership files an
administrative adjustment request, a partner that is a U.S. shareholder
in the CFC is treated as having complied with these requirements (with
respect to the portion of the interest held through the partnership) if
the partner and the partnership timely comply with their obligations
under section 6227 with respect to that administrative adjustment
request. See Sec. 1.951A-2(c)(7)(viii)(A)(4).
V. Foreign Tax Credit Rules
A. Allocation and Apportionment of Deductions With Respect to CFC Stock
One comment requested that the final regulations confirm that U.S.
shareholder deductions properly allocated and apportioned to income
excluded under the GILTI high-tax exclusion should not be taken into
account for purposes of section 904 per the application of section
904(b)(4)(B). Section 904(b)(4) applies with respect to deductions
properly allocated and apportioned to income (other than amounts
includible under section 951(a)(1) or 951A(a)) with respect to stock of
a specified 10-percent owned foreign corporation (as defined in section
245A(b)) or to such stock to the extent income with respect to such
stock is other than amounts includible under section 951(a)(1) or
951A(a). Accordingly, section 904(b)(4) applies to any deduction
allocated and apportioned to dividend income for which a deduction is
allowed under section 245A. See Sec. 1.904(b)-3(a)(1)(ii). Similarly,
section 904(b)(4) applies to any deduction allocated and apportioned to
stock of specified 10-percent owned foreign corporations in the section
245A subgroup. See Sec. 1.904(b)-3(a)(1)(iii). For purposes of
characterizing stock of a CFC under Sec. 1.861-13, income excluded
under the GILTI high-tax exclusion should be treated as any other
foreign or U.S. source gross income described in Sec. 1.861-
13(a)(1)(i)(A)(9) and (10). The portion of the value of the stock of
the CFC relating to such income will be assigned to the section 245A
subgroup under Sec. 1.861-13(a)(5)(ii) through (iv). As a result, the
Treasury Department and the IRS have determined that the regulations
are clear regarding the interaction of U.S. shareholder deductions
allocated and apportioned to income excluded under the GILTI high-tax
exclusion and section 904(b)(4), and no further rules are necessary.
Another comment suggested that the final regulations turn off the
application of section 904(b)(4) for deductions allocated and
apportioned to income or stock that relates to earnings and profits
arising from CFC income that is excluded by reason of the GILTI high-
tax exclusion. This comment indicated that allowing the application of
section 904(b)(4) could incentivize taxpayers to inappropriately locate
deductions related to high-taxed income in the United States. The
Treasury Department and the IRS do not agree that taxpayers will have a
material incentive to relocate deductions relating to high-taxed income
to the United States as a
[[Page 44630]]
result of the application of section 904(b)(4) because the foreign tax
rates required to qualify for the GILTI high-tax exclusion must
generally be comparable to or higher than the U.S. corporate tax rate,
and, thus, taxpayers will generally benefit from locating such
deductions in the foreign country. In effect, the GILTI high-tax
exclusion reduces the effect of federal income taxes on taxpayers'
locational decisions with respect to investment and deductions, thereby
increasing the likelihood that such decisions will be based on non-tax
business considerations. Furthermore, section 904(b)(4) by its terms
applies to income that is not includible under section 951(a)(1) or
section 951A(a), and income excluded under the GILTI high-tax exclusion
is not includible under either of those provisions. Accordingly, the
comment is not adopted.
B. Determination of Taxes Paid or Accrued
One comment asserted that the 2019 proposed regulations are unclear
as to the determination of the foreign taxes paid or accrued and
requested that the final regulations clarify that foreign income taxes
include taxes imposed by a country (or countries) on the net item, as
provided under current Sec. 1.954-1(d)(3)(i). The comment specifically
notes, as an example, instances where two foreign countries tax the
same income.
The rules provided in Sec. 1.951A-2(c)(7)(iii) and (vii) are
comparable to those provided in current Sec. 1.954-1(d)(3)(i); both
sets of rules generally apply Sec. 1.904-6 to allocate and apportion
foreign taxes to income. Although the GILTI high-tax exclusion requires
that foreign taxes be associated with income on a narrower basis--the
tested unit rather than the CFC--taxes imposed on the CFC that relate
to income of the tested unit will generally be associated with the
appropriate income under the rules in Sec. 1.904-6, regardless of
whether such tax is imposed by one or more countries. The 2020 proposed
regulations propose further conformity of the rules applicable for the
computation of the effective foreign tax rate for both subpart F income
and tested income.
Further, in response to this comment, as well as similar comments
received in response to the 2019 proposed regulations, the final
regulations (T.D. 9882) relating to foreign tax credits published in
the Federal Register (84 FR 69022) (``the 2019 Final FTC Regulations'')
and these final regulations clarify the rules for associating foreign
taxes with income. In particular, these final regulations clarify that
the amount of foreign income taxes paid or accrued by a CFC with
respect to a tentative tested income item is the U.S. dollar amount of
the controlled foreign corporation's current year taxes that are
allocated and apportioned to the related tentative gross tested income.
See Sec. 1.951A-2(c)(7)(vii). The final regulations provide that the
deductions for current year taxes are allocated and apportioned to a
tentative gross tested income item under the principles of Sec. 1.960-
1(d)(3), by treating each tentative gross tested income item as
assigned to a separate tested income group. See Sec. 1.951A-
2(c)(7)(iii)(A). As a result, the principles of Sec. 1.904-6(a)(1)
generally apply to allocate and apportion foreign income taxes to a
tentative gross tested income item. However, the principles of Sec.
1.904-6(a)(2) are applied, in lieu of the principles of Sec. 1.904-
6(a)(1), to associate foreign taxes with income in the case of
disregarded payments between tested units. See Sec. 1.960-1(d)(3) and
Sec. 1.951A-2(c)(7)(iii)(B). The final regulations provide additional
rules for how the principles of Sec. 1.904-6(a)(2) should be applied
for purposes of the high-tax exception. See id. In addition, a new
example illustrates how foreign income taxes are associated with income
in the case of disregarded payments. See Sec. 1.951A-2(c)(8)(iii)(B)
(Example 2). The Treasury Department and the IRS also published
proposed regulations (REG-105495-19) relating to foreign tax credits in
the Federal Register (84 FR 69124) that contain more detailed rules for
associating foreign taxes with income, including in the case of
disregarded payments.
C. Annual Accounting Periods and Foreign Tax Accruals
The proposed regulations generally provide that the amount of
foreign income taxes paid or accrued with respect to a tentative net
tested income item are the CFC's current year taxes (as defined in
Sec. 1.960-1(b)(4)) that would be allocated and apportioned under the
principles of Sec. 1.960-1(d)(3)(ii) to the tentative net tested
income item by treating the item as in a separate tested income group.
See proposed Sec. 1.951A-2(c)(6)(iv). Taxes accrue, and are taken into
account in determining foreign taxes deemed paid under section 960(d),
when all the events have occurred that establish the fact of the
liability and the amount of the liability can be determined with
reasonable accuracy. See Sec. 1.960-1(b)(4). Therefore, withholding
taxes accrue when the payment from which the tax is withheld is made,
and net basis taxes on income recognized during a taxable period accrue
on the last day of the taxable period. Id.
Comments suggested that the final regulations provide special rules
to address distortions that can arise from a mismatch between the U.S.
and foreign taxable years. One comment recommended a ``closing of the
books election'' whereby a taxpayer could elect to allocate and
apportion its foreign taxes accrued in one U.S. taxable year across
multiple U.S. taxable years, in proportion to the income accrued in
each U.S. taxable year. Other comments recommended that taxpayers be
permitted to adopt various alternative methods of accounting, including
the use of the foreign taxable year to determine whether income is
subject to a high rate of tax, or methods of accounting required under
foreign law, such as mark-to-market.
The Treasury Department and the IRS have determined that foreign
taxes should be associated with U.S. income consistently for all
federal income tax purposes, and that deviating from established
principles for determining when income and foreign taxes are taken into
account for purposes of the GILTI high-tax exclusion would be
inappropriate. Allowing foreign taxes to be taken into account in
applying the GILTI high-tax exclusion in a different year than the year
in which the foreign taxes accrue could lead to double counting, or
double-non-counting, of the foreign taxes. This could occur, for
example, if a foreign tax that accrued in one year both caused a prior
year tentative tested income item to be excluded as high-taxed and was
creditable in the later year under section 960(d). While some comments
also recommended changes to how foreign taxes are taken into account
more generally, changes to the foreign tax credit regime are beyond the
scope of this rulemaking. In addition, the Treasury Department and the
IRS responded to similar comments in Part V of the Summary of Comments
and Explanation of Revisions in the preamble to the 2019 Final FTC
Regulations.
Similar considerations would apply with respect to the adoption of
alternative methods of accounting for tentative tested income items,
such as the adoption of a foreign fiscal year as the testing period or
mark-to-market accounting. The use of these methods would lead to
potential double counting of items of income, gain, deduction, or loss
in different U.S. taxable years for different purposes, or would
require complex coordination rules with material changes to established
rules
[[Page 44631]]
relating to when such items accrue for federal income tax purposes.
Such changes are beyond the scope of this rulemaking and, accordingly,
are not adopted.
VI. Removal of Examples in Sec. 1.954-1(d)(7)
Current Sec. 1.954-1(d)(7) provides examples that illustrate the
application of the rules set forth in Sec. 1.954-1(c) and (d). The
Treasury Department and the IRS have determined that these examples
need to be updated to properly reflect changes to current Sec. 1.954-1
made in the final regulations, and to other provisions referenced in
the examples. Therefore, the final regulations remove the examples in
current Sec. 1.954-1(d)(7). No inference is intended as to the removal
of these examples. Additional examples will be considered in connection
with the Treasury decision adopting the 2020 proposed regulations as
final regulations in the Federal Register.
VII. Authority
The Treasury Department and the IRS are aware that questions have
been raised regarding the statutory authority for the GILTI high-tax
exclusion. As described in detail in the preamble to the 2019 proposed
regulations (see 84 FR 29114), the Treasury Department and the IRS have
determined that the GILTI high-tax exclusion is a valid interpretation
of ambiguous statutory text in section 951A(c)(2)(A)(i)(III) and, after
considering assertions to the contrary, concluded that this rationale
provides authority to finalize the GILTI high-tax exclusion. See
Michigan v. Environmental Protection Agency, 135 S.Ct. 2699, 2707
(2015) (observing that a court must ``accept an agency's reasonable
resolution of an ambiguity in a statute that the agency administers,''
provided that such interpretation ``operate[s] within the bounds of
reasonable interpretation.''). Specifically, the regulation interprets
the words ``by reason of'' in that provision as denoting independently
sufficient causation. The assertion by some commenters to the contrary
that the words ``by reason of'' unambiguously require ``but for''
causation is not supported by the case law. Terms such as ``by reason
of'' have been equated with other causal terms, such as ``because of''
or ``as a result of,'' and have been interpreted flexibly based on the
underlying context and purposes of the applicable provision. Several
recent decisions have interpreted such terms as encompassing
independently sufficient causation based on dicta in the Supreme
Court's recent opinion in Burrage v. United States, 134 S.Ct. 881, 890
(2014). See, e.g., United States v. Ewing, 749 Fed.Appx. 317, 327-28
(6th Cir. 2018); United States v. Seals, 915 F.3d 1203, 1206-07 (8th
Cir. 2019); United States v. Feldman, 936 F.3d 1288, 1317-18 (11th Cir.
2019).
In addition, commenters have suggested that, based on the statutory
structure of sections 954(b)(4) and 951A(c)(2)(A)(i)(III), the
provisions can only apply to income that would otherwise qualify as
FBCI or insurance income. The Treasury Department and the IRS disagree
with this assertion because it would require that income both qualify
as FBCI or insurance income and be excluded from such categories of
income for purposes of the same provision. Moreover, neither section
954(b)(4) nor 951A(c)(2)(A)(i)(III) contains any limitation on the
category of income to which the provisions can apply, instead referring
broadly to ``any item of income'' and ``any gross income,''
respectively.
Accordingly, the GILTI high-tax exclusion is a valid interpretation
of section 951A(c)(2)(A)(i)(III) based on the statutory text and the
legislative purposes and history underlying section 951A, each of which
is described in detail in the preamble to the 2019 proposed
regulations.
VIII. Applicability Dates
Consistent with the applicability date in the 2019 proposed
regulations, the final regulations provide that the GILTI high-tax
exclusion applies to taxable years of foreign corporations beginning on
or after July 23, 2020, and to taxable years of U.S. shareholders in
which or with which such taxable years of foreign corporations end. See
Sec. 1.951A-7(b).\7\
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\7\ Although this applicability date applies to Sec. 1.954-
1(c)(1)(iv) (clarifying the treatment of deductions and loss
attributable to disqualified basis in determining a net item of
foreign base company income or insurance income), the rules in Sec.
1.951A-2(c)(5) (requiring deductions or loss attributable to
disqualified basis to be allocated and apportioned solely to
residual gross income) apply 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 end. See Sec. 1.951A-7(a). See also proposed
Sec. 1.951A-2(c)(6) (requiring deductions related to disqualified
payments to be allocated and apportioned solely to residual CFC
gross income), as proposed to be amended at 85 FR 19858 (April 8,
2020), which would apply to taxable years of foreign corporations
ending on or after April 7, 2020, and to taxable years of U.S.
shareholders in which or with which such taxable years end. See
proposed Sec. 1.951A-7(d).
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Several comments requested that taxpayers be permitted to apply the
GILTI high-tax exclusion earlier than the proposed regulations would
have allowed (for example, to taxable years beginning after December
31, 2017). In response to the comments, the final regulations permit
taxpayers to choose to apply the GILTI high-tax exclusion to taxable
years of foreign corporations that begin after December 31, 2017, and
before July 23, 2020, and to taxable years of U.S. shareholders in
which or with which such taxable years of the foreign corporations end.
See Sec. 1.951A-7(b). Any taxpayer that applies the GILTI high-tax
exclusion retroactively must consistently apply the rules in this
Treasury decision to each taxable year in which the taxpayer applies
the GILTI high-tax exclusion. See id.
Special Analyses
I. Regulatory Planning and Review--Economic Analysis
Executive Orders 13771, 13563, and 12866 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits (including potential economic, environmental, public
health and safety effects, distributive impacts, and equity). Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, of reducing costs, of harmonizing rules, and of promoting
flexibility. For purposes of Executive Order 13771, this final rule is
regulatory.
The Office of Management and Budget's Office of Information and
Regulatory Affairs (OIRA) has designated these regulations as subject
to review under Executive Order 12866 pursuant to the Memorandum of
Agreement (April 11, 2018) between the Treasury Department and the
Office of Management and Budget (OMB) regarding review of tax
regulations. The Office of Information and Regulatory Affairs (OIRA)
has designated the final rulemaking as significant under section 1(c)
of the Memorandum of Agreement. Accordingly, OMB has reviewed the final
regulations.
A. Background
The Tax Cuts and Jobs Act (the ``Act'') established a system under
which certain earnings of a foreign corporation can be repatriated to a
corporate U.S. shareholder without federal income tax. However,
Congress recognized that, without any anti-base erosion measures, this
system could incentivize taxpayers to allocate income--in particular,
mobile income from intangible property that would otherwise be subject
to U.S. tax--to controlled foreign corporations (``CFCs'') operating in
low- or zero-tax
[[Page 44632]]
jurisdictions. See Senate Committee on the Budget, 115th Cong.,
Reconciliation Recommendations Pursuant to H. Con. Res. 71, at 365 (the
``Senate Explanation''). Therefore, Congress enacted section 951A in
order to subject intangible income earned by a CFC to U.S. tax on a
current basis, similar to the treatment of a CFC's subpart F income
under section 951(a)(1)(A). However, in order to protect the
competitive position of U.S. corporations relative to their foreign
peers, the global intangible low tax income (``GILTI'') of a corporate
U.S. shareholder is effectively taxed at a reduced rate by reason of
the deduction under section 250 (with the resulting federal income tax
further reduced by a portion of foreign tax credits under section
960(d)). Id.
The Treasury Department and the IRS previously issued final and
proposed regulations under section 951A on June 21, 2019 (``2019
proposed regulations'').
B. Need for Regulations
The final regulations are needed to provide a framework for
taxpayers to elect to apply the statutory high-tax exception of section
954(b)(4) and exclude certain high-taxed income from taxation under
section 951A.
C. Overview of Regulations
The final regulations provide that the GILTI high-tax exclusion in
section 951A(c)(2)(A)(i)(III) applies to high-taxed income of a CFC
that is excluded from foreign base company income (``FBCI'') or
insurance income under section 954(b)(4) regardless if the income would
otherwise be FBCI or insurance income.
The final regulations provide rules to determine the effective rate
of tax on foreign items of income for the purposes of applying the
GILTI high-tax exclusion. The final regulations provide that the
effective foreign tax rate is determined on a tested unit basis. They
also provide rules to determine the net amount of income (in other
words, the tentative tested income item) and the foreign taxes paid or
accrued with respect to such net amount of income that are used to
compute the effective rate of tax. In addition, the final regulations
indicate how to make a GILTI high-tax exclusion election. The final
regulations provide that the election, if made, must be made
consistently for certain related CFCs. The final regulations also
provide that taxpayers can make the election annually.
D. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the final regulations relative to a no-action baseline
reflecting anticipated federal income tax-related behavior in the
absence of these regulations.
2. Summary of Economic Effects
The final regulations provide certainty and clarity to taxpayers in
applying section 954(b)(4) to certain high-tax income. In the absence
of this clarity, there is a higher likelihood that taxpayers will
interpret the rules regarding the high-tax exclusion differently. For
example, when taxpayers hold varying interpretations of statutory
language, one taxpayer may undertake an investment in a particular
country while another taxpayer may decline to make this investment with
this difference based solely on different interpretations of how income
from that investment will be treated under section 951A and related
provisions. If the investment would have been more productive if
undertaken by the second taxpayer, this difference in beliefs about tax
treatment is economically costly. The final regulations help to
minimize this outcome. Clarity and certainty over tax treatment also
reduce compliance costs and the costs of tax administration.
The final regulations also work to apply the GILTI high-tax
exclusion in a way that treats income similarly across all
international business activity and without favoring one type of income
over another. In general, such equitable treatment of income-generating
activities can be expected to improve U.S. economic performance.
The Treasury Department and the IRS project that the final
regulations will have annual economic effects greater than $100 million
($2020). This determination is based on the fact that many of the
taxpayers potentially affected by these regulations are large
multinational enterprises. Because of their substantial size, even
modest changes in the treatment of their foreign-source income,
relative to the no-action baseline, can lead to changes in patterns of
economic activity that amount to at least $100 million per year.
The Treasury Department and the IRS project that the final
regulations may increase U.S. taxpayers' foreign investment in high-tax
jurisdictions, since the final regulations may decrease the effective
tax rate on high-tax foreign-source income for some U.S. taxpayers
relative to the no-action baseline. The Treasury Department and the IRS
have not undertaken more precise estimates of the economic effects of
the regulations. We do not have readily available data or models to
predict with reasonable precision the business decisions that taxpayers
would make under the final regulations, such as the amount and location
of their foreign business activities, versus alternative regulatory
approaches, including the no-action baseline.
In the absence of quantitative estimates, the Treasury Department
and the IRS have undertaken a qualitative analysis of the economic
effects of the final regulations relative to the no-action baseline and
relative to alternative regulatory approaches.
3. Economic Analysis of Specific Provisions
a. Scope of the GILTI High-Tax Exclusion
The GILTI high-tax exclusion in section 951A permits U.S.
shareholders of CFCs to elect to exclude certain high-taxed income from
gross tested income. The final regulations provide guidance on which
types of high-taxed income are eligible for the high-tax exclusion.
The Treasury Department and the IRS considered a number of options
for defining income that is eligible for the GILTI high-tax exclusion.
The options were (i) to exclude from gross tested income only income
that would be subpart F income solely but for the high-tax exception of
section 954(b)(4) applying to such income; (ii) in addition to
excluding the aforementioned income, to exclude from gross tested
income on an elective basis an item of gross income that is excluded by
reason of another exception to FBCI or insurance income, if such income
is subject to an effective foreign tax rate above the statutory
threshold; \8\ or (iii) to exclude from gross tested income on an
elective basis any item of gross income subject to an effective foreign
tax rate above the statutory threshold.
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\8\ The statutory threshold is 90 percent of the maximum U.S.
corporate tax rate (18.9 percent based on the current U.S. corporate
tax rate of 21 percent).
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The first option excludes from gross tested income only income that
would be FBCI or insurance income but for the high-tax exception of
section 954(b)(4), which is the interpretation of the scope of the
GILTI high-tax exclusion in the final 951A regulations. This approach
is consistent with current regulations under section 954, which permit
an election under section 954(b)(4) only with respect to income that is
not excluded from subpart F income by reason of another exception (for
[[Page 44633]]
example, section 954(c)(6) or 954(h)). However, under this approach,
taxpayers with high-taxed gross tested income would have an incentive
to structure their foreign operations in order to ensure that income
that would otherwise qualify as gross tested income would instead
qualify as subpart F income, to a greater degree than other regulatory
approaches that provide a broader GILTI high-tax exclusion, such as the
third option considered. For instance, under this option, a taxpayer
could structure its operations to have a CFC purchase personal property
from, or sell personal property to, a related person in order to
generate foreign base company sales income described under section
954(d) (assuming certain other exceptions are not satisfied). The
result would be that the CFC's income from the disposition of the
property meets the definition of FBCI and hence is eligible for the
high-tax exception. Because businesses are largely not currently
structured in this way, such an organization would entail
restructuring, which would potentially be costly and only available to
certain taxpayers yet would not provide any general economic benefit.
In other words, such reorganization to realize a specific tax treatment
would suggest that tax instead of business considerations are
determining business structures and operations. This outcome may lead
to higher compliance costs and less efficient patterns of business
activity relative to a regulatory approach that provides a broader
GILTI high-tax exclusion.
The second option broadens the application of the GILTI high-tax
exclusion, relative to the first option, to allow taxpayers to elect to
exclude items of gross income that are subject to an effective foreign
tax rate above the statutory threshold, if such income was also
excluded from FBCI or insurance income by reason of another exception
to subpart F. Under this interpretation, income such as active
financing income that is excluded from subpart F income under section
954(h), active rents or royalties that are excluded from subpart F
income under 954(c)(2)(A), and related party payments that are excluded
from subpart F income under section 954(c)(6) could also be excluded
from gross tested income under the GILTI high-tax exclusion if such
items of income are high taxed within the meaning of section 954(b)(4).
Under this approach, however, taxpayers would have the ability to
exclude their CFCs' high-taxed income that would be subpart F income
but for an exception (for example, active financing income), while they
would not be able to exclude their CFCs' high-taxed income that is not
subpart F income in the first instance (for example, active business
income). This may result in differential treatment of economically
similar income, which generally leads to economically inefficient
decision-making. Furthermore, taxpayers with items of high-taxed income
that are not subpart F income would still be incentivized to
restructure their foreign operations in order to convert their high-
taxed gross tested income into subpart F income, which poses the same
compliance costs and inefficiencies as the first option.
The third option, which was adopted in the proposed regulations and
which these regulations finalize, provides an election to broaden the
scope of the high-tax exception relative to the other two options
considered. Under this option, the high-tax exception under section
954(b)(4) for purposes of the GILTI high-tax exclusion applies to any
item of income that is subject to an effective foreign tax rate greater
than 90 percent of the maximum corporate tax rate (currently, 18.9
percent based on a 21 percent corporate rate). The final regulations
permit controlling domestic shareholders of CFCs to elect to apply the
high-tax exception under section 954(b)(4) to items of gross income
that would not otherwise be FBCI or insurance income. If this high-tax
exception is elected, the GILTI high-tax exclusion will exclude the
item of gross income from gross tested income. Under the election, an
item of gross income is subject to a high rate of foreign tax if, after
taking into account properly allocable expenses, the net item of income
is subject to an effective foreign tax rate above the statutory
threshold.
Contrary to the first two options, this approach permits similarly
situated taxpayers with CFCs subject to a high rate of foreign tax to
make the election to exclude such income from gross tested income and
reduces the incentive for taxpayers to restructure their operations or
structures to convert their high-taxed gross tested income into FBCI or
insurance income for federal income tax purposes.
For taxpayers that make the election, this approach will lower U.S.
tax on certain foreign income by reducing U.S. tax on a broader scope
of the income of high-taxed tested units compared to the no-action
baseline. If a taxpayer elects the high-tax exclusion, U.S. tax on
other foreign income may increase due to complex interactions with
other provisions in the corporate tax system, such as the expense
allocation and foreign tax credit rules, although taxpayers will
generally only make the election if this increase in tax on other
foreign income is less than the decrease in tax on high-taxed income.
Thus, this approach may reduce the taxpayers' cost of capital on high-
taxed foreign investment, and at the margin, the lower cost of capital
may increase foreign investment in high-tax jurisdictions by U.S.-
parented firms relative to the baseline.
The Treasury Department and the IRS have not undertaken estimation
of these effects, relative to the no-action baseline, because we do not
have readily available data or models to estimate with any reasonable
precision: (i) The number and attributes of the taxpayers that will
find it advantageous to make the election; (ii) the relationship
between the marginal effective foreign tax rate at the tested unit
level and foreign investment by U.S. taxpayers; and (iii) the range of
marginal effective foreign tax rates at the tested unit level that
taxpayers are likely to have under the final regulations versus the
baseline or other regulatory approaches.
b. Aggregation of Income for Determination of the Effective Foreign Tax
Rate
The statute provides an exclusion from tested income for high-taxed
income but does not provide sufficient detail for determining how
income should be aggregated for determining the effective foreign tax
rate that applies to that income, such that that income would be
excluded. The Treasury Department and the IRS considered four options
to address this issue: (i) Apply the determination of whether income is
high-taxed on an item-by-item basis; (ii) apply the determination on a
CFC-by-CFC basis; (iii) apply the determination on a qualified business
unit (``QBU'')-by-QBU basis; and (iv) apply the determination on a
tested unit-by-tested unit basis.
The first option is to determine whether income is high-taxed
income on an item-by-item basis, based on the item-by-item
determination that is generally applicable under the current
regulations that implement the high-tax exception of section 954(b)(4)
for purposes of subpart F income. However, this would entail high
compliance costs for taxpayers and be difficult to administer because
it would require taxpayers to analyze each item of income to determine
whether, under federal tax principles, the item is subject to a
sufficiently high effective foreign tax rate. The Treasury Department
and the IRS have not estimated the higher compliance costs that might
have been
[[Page 44634]]
incurred under this regulatory option, relative to the final
regulations.
The second option, to apply the determination based on all the
items of income of the CFC, would minimize complexity and would be
relatively easy to administer. On the other hand, this approach could
permit inappropriate tax planning, such as combining operations subject
to different rates of tax into a single CFC. This would have the effect
of ``blending'' the rates of foreign tax imposed on the income, which
could result in low- or non-taxed income being excluded as high-taxed
income by being blended with much higher-taxed income. The low-taxed
income in this scenario is precisely the sort of base erosion-type
income that the legislative history describes section 951A as intending
to tax, and such tax motivated planning behavior is economically
inefficient.
The third option, which was proposed in the proposed regulations,
is to apply the high-tax exception based on the items of gross income
of a QBU of the CFC. Under this approach, the net income that is taxed
by the foreign jurisdiction in each QBU must be determined and the
blending of different tax rates within a CFC would be minimized. While
this approach would more accurately separate high-taxed and low-taxed
income, compared to applying the high-tax exception on the basis of a
CFC, there were several comments to the proposed regulations that noted
the difficulties in compliance and administration that would arise if
the QBU standard were used, such as the difficulty in determining
whether a set of activities constituted a trade or business and hence a
QBU.
The fourth option, which is adopted in the final regulations, is to
apply the high-tax exception on the basis of the items of gross income
of a tested unit of a CFC. The tested unit standard is a more targeted
measure than the QBU standard and will be more easily applied to the
GILTI high-tax exclusion than the QBU standard. Moreover, the tested
unit standard, similarly to the QBU standard, will minimize the
blending of different tax rates within a CFC. For example, if a CFC
earned $100x of tested income through a tested unit in Country A and
was taxed at a 30 percent rate and earned $100x of tested income
through another tested unit in Country B and was taxed at 0 percent,
the blended rate of tax on all of the CFC's tested income is 15
percent. However, if the high-tax exception applies to each of a CFC's
tested units based on the income earned by that tested unit, then the
two tax rates would not be blended together. Although applying the
high-tax exception on the basis of a tested unit, rather than the CFC
as a whole, may be more complex and administratively burdensome under
certain circumstances and may entail somewhat higher compliance costs
(although most of the data the taxpayer would use for this purpose will
likely be readily available to the taxpayer and will often overlap with
data necessary to meet other compliance requirements), it more
accurately pinpoints income subject to a high rate of foreign tax and
therefore continues to subject to tax the low-taxed base erosion-type
income that the legislative history describes section 951A as intending
to tax. Accordingly, the final regulations apply the high-tax exception
of section 954(b)(4) based on the items of net income of each tested
unit of the CFC.
The Treasury Department and the IRS have not estimated these
effects, relative to the no-action baseline, because we do not have
readily available data or models to estimate with any reasonable
precision the compliance costs or restructuring costs affected by these
provisions relative to the no-action baseline or other regulatory
alternatives.
c. Grouping of Tested Units in Same Country
The statute does not specify how items of income in the same
country should be treated for the purpose of applying the GILTI high-
tax exclusion. To address this issue, the final regulations provide
guidance on how a CFC's tested units in the same country should be
treated in order to determine if income is high-taxed.
Under the proposed regulations, effective foreign tax rates are
determined separately for each QBU, even if other QBUs of the same CFC
are located in the same county. Testing each QBU separately would limit
the blending of income taxed at different rates and thus limit the
likelihood that that no-taxed or low-taxed income would qualify for the
high-tax exclusion through aggregation with higher-taxed income. This
approach is consistent with the intent to subject low-taxed base
erosion-type income to tax under section 951A, as described in the
legislative history. However, comments noted that separate testing for
each QBU would result in high compliance burdens for taxpayers and
could result in tax rate calculations that do not reflect the rate of
foreign tax on QBU income, especially in circumstances in which
separate QBUs are able to share tax attributes through a fiscal unity,
consolidation or similar means. If tax rate calculations do not
properly reflect the rate of foreign tax on QBU, taxpayers may
undertake inefficient business decisions when evaluated against the
intent and purpose of the statute.
In the final regulations, all tested units of a CFC in the same
country are generally grouped together to determine the effective
foreign tax rate for the purpose of applying the high-tax exclusion.
Under this approach, low-taxed and high-taxed income are unlikely to be
blended, since tested units in the same country are likely to be
subject to the same statutory tax rate. Relative to the approach in the
proposed regulations, this approach will lower compliance burdens for
taxpayers because taxpayers will less frequently have to allocate and
apportion taxes paid by one tested unit to another tested unit. In
addition, this approach may also reduce the effect of fluctuations in
effective foreign tax rates observed in individual tested units
relative to the regulatory alternative in the proposed regulations.
Since multiple tested units are grouped together, outlying effective
foreign tax rates due to timing and base differences between the U.S.
and foreign tax rules will counterbalance each other. Finally, this
averaging of tax rates will decrease the incentives taxpayers face to
undertake inefficient planning activities to achieve certain tax rates
in individual tested units relative to a regulatory approach in which
effective foreign tax rates were determined separately for tested units
in the same country.
The Treasury Department and the IRS have not undertaken estimation
of these effects, relative to the no-action baseline, because data or
models are not readily available to estimate with any reasonable
precision the compliance costs or patterns of business activity
affected by these provisions relative to the no-action baseline or
other regulatory alternatives.
d. Foreign Net Operating Losses
The statute provides an exclusion from tested income for income
that is high-taxed but does not specify whether or how foreign net
operating loss (``NOL'') carryovers should be accounted for in the
computation of the effective foreign tax rate. To address this issue,
the final regulations provide rules governing how foreign net operating
loss carryforwards should be accounted for in the computation of the
effective foreign tax rate.
The proposed regulations generally provided that the effective
foreign tax rate that determines whether a tested unit's income is
considered high-taxed is computed using the amount of income as
determined for federal income tax purposes, without regard for how the
income is determined for
[[Page 44635]]
foreign tax purposes. Thus, under this approach, foreign NOL
carryforwards do not factor into the effective foreign tax rate
calculation, since foreign NOL carryforwards are not accounted for in
the federal tax base under federal tax accounting principles. Some
comments suggested that taxpayers should be able to make adjustments to
the effective foreign tax rate calculation to account for foreign NOL
carryforwards. These comments noted that NOLs carried forward to
subsequent profitable tax years of a tested unit could lead to income
subject to a high statutory foreign tax rate not being classified as
high-taxed for the purposes of the GILTI high-tax exclusion. The
effective foreign tax rate--calculated using the federal tax base--
could be lower than the statutory threshold, even if the smaller
foreign base is taxed at a higher rate.
The Treasury Department and the IRS decided to maintain the
approach of the proposed regulations and to not provide rules that
account for the use of foreign NOL carryforwards. The Treasury and IRS
determined that carried forward NOLs are an example of timing
differences between foreign and federal tax bases. Since there may be
differences between when certain items are recognized for federal and
foreign tax purposes, the effective foreign tax rate of a given tested
unit calculated for the purpose of applying the high-tax exclusion may
change from year to year even if the tax rate on its foreign base
remains constant. Accounting for these differences would require
complex rules akin to the deferred tax asset and tax liability rules
used in financial accounting. Taxpayers would need to apply rules that
reconcile foreign and federal tax accounting rules over multiple years.
The Treasury Department and the IRS determined that these rules would
add undue complexity and impose a substantial compliance burden on
taxpayers and administrative burden on the government relative to the
regulatory approach of the final regulations. The Treasury Department
and the IRS have not attempted to estimate the compliance burden under
this alternative regulatory approach relative to the final regulations.
e. Election Period
The statute provides for an election to exclude high-taxed income
from gross tested income but does not specify the length of the
election period. To address this issue, proposed regulations provided
that the election into the high-tax exclusion would be generally made
or revoked for a five-year period. The five-year election period was
intended to prevent taxpayers from manipulating the timing of income,
expenses, and foreign income taxes in order to achieve inappropriate
results. As a simple example, under a shorter election period, a
taxpayer could accelerate certain expenses that are allocable to the
income of a high-taxed tested unit into a year when the taxpayer elects
into the high-tax exclusion. The following year, the taxpayer could
revoke its election. Thereby, in the second year, the taxpayer would be
able to use the foreign income taxes paid by the high-taxed tested unit
as creditable taxes against income included under section 951A without
the accelerated expenses reducing the amount of the foreign tax credit
that could be claimed. In order to achieve tax savings through this
manipulation, taxpayers would need to manipulate a large number of
items annually, and the manipulation of these items would be costly
without any corresponding increase in productive economic activity.
Comments noted that the extended election period would require
taxpayers to make five-year projections of a large number of variables
on a tested unit-by-tested unit basis in order to determine whether to
elect into the high-tax exclusion. The complexity of these projections
would result in a large burden on taxpayers. Moreover, even with a
shorter election period, taxpayers would likely face difficulty in
engaging in tax planning by changing their election status. Existing
rules limit taxpayers' discretion over the timing of recognition of
income and expenses. The complexity of manipulating the timing of
different items across all of a taxpayer's tested units, which is
necessary under the final regulations because the election into the
high-tax exclusion must be made for all related CFCs, would also create
obstacles to using frequent changes in election status as part of tax
reduction strategies. Therefore, the Treasury Department and IRS
determined that the reduction in taxpayer compliance burdens
significantly outweighed concerns about potential tax planning, and the
Treasury Department and IRS adopted a one-year election period in the
final regulations.
The Treasury Department and the IRS have not undertaken estimation
of these effects, relative to the no-action baseline, because data or
models are not readily available to estimate with any reasonable
precision the compliance costs or patterns of business activity
affected by these provisions relative to the no-action baseline or
other regulatory alternatives.
4. Profile of Affected Taxpayers
The proposed regulations potentially affect those taxpayers that
have at least one CFC with at least one tested unit (including,
potentially, the CFC itself) that has high-taxed income. Taxpayers with
CFCs that have only low-taxed income are not eligible to apply the
high-tax exception and hence are unaffected by the proposed
regulations.
The Treasury Department and the IRS estimate that there are
approximately 4,000 business entities (corporations, S corporations,
and partnerships) with at least one CFC that pays an effective foreign
tax rate above 18.9 percent, the current high-tax statutory threshold.
The Treasury Department and the IRS further estimate that, for the
partnerships with at least one CFC that pays an effective foreign tax
rate greater than 18.9 percent, there are approximately 1,500 partners
that have a large enough share to potentially qualify as a 10 percent
U.S. shareholder of the CFC.\9\ The 4,000 business entities and the
1,500 partners provide an estimate of the number of taxpayers that
could potentially be affected by guidance governing the election into
the high-tax exception. The figure is approximate because the tax rate
at the CFC-level will not necessarily correspond to the tax rate at the
tested unit-level if there are multiple tested units within a CFC.
---------------------------------------------------------------------------
\9\ Data are from IRS's Research, Applied Analytics, and
Statistics division based on E-file data available in the Compliance
Data Warehouse for tax years 2015 and 2016. The counts include
Category 4 and Category 5 IRS Form 5471 filers. Category 4 filers
are U.S. persons who had control of a foreign corporation during the
annual accounting period of the foreign corporation. Category 5
filers are U.S. shareholders who own stock in a foreign corporation
that is a CFC and who owned that stock on the last day in the tax
year of the foreign corporation in that year in which it was a CFC.
For full definitions, see https://www.irs.gov/pub/irs-pdf/i5471.pdf.
---------------------------------------------------------------------------
The Treasury Department and the IRS do not have readily available
data to determine how many of these taxpayers would elect the high-tax
exception as provided in these proposed regulations. Under the proposed
regulations, a taxpayer that has both high-taxed and low-taxed tested
units will need to evaluate the benefit of eliminating any tax under
section 951 and section 951A with respect to high-taxed income against
the costs of forgoing the use of foreign tax credits and, with respect
to section 951A, the use of tangible assets in the computation of
qualified business asset investment (QBAI).
Tabulations from the IRS Statistics of Income 2014 Form 5471 file
\10\ further
[[Page 44636]]
indicate that approximately 85 percent of earnings and profits are
reported by CFCs incorporated in jurisdictions where the average
effective foreign tax rate is less than or equal to 18.9 percent. The
data indicate several examples of jurisdictions where CFCs have average
effective foreign tax rates above 18.9 percent, such as France, Italy,
and Japan. However, information is not readily available to determine
how many tested units are part of the same CFC and what the effective
foreign tax rates are with respect to such tested units. Taxpayers
potentially more likely to elect the high-tax exception are those
taxpayers with CFCs that only operate in high-tax jurisdictions. Data
on the number or types of CFCs that operate only in high-tax
jurisdictions are not readily available.
---------------------------------------------------------------------------
\10\ The IRS Statistics of Income Tax Stats report on Controlled
Foreign Corporations can be accessed here: https://www.irs.gov/statistics/soi-tax-stats-controlled-foreign-corporations.
---------------------------------------------------------------------------
II. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (``PRA'')
generally requires that a federal agency obtain the approval of the OMB
before collecting information from the public, whether such collection
of information is mandatory, voluntary, or required to obtain or retain
a benefit.
The final regulations include collections of information in Sec.
1.951A-2(c)(7)(viii)(A)(1) and (2), and Sec. 1.951A-2(c)(7)(viii)(C).
The collection of information in Sec. 1.951A-2(c)(7)(viii)(A)(1)
requires that each controlling domestic shareholder of a CFC file an
election to exclude gross income of a CFC from tested income under the
high-tax exception of section 954(b)(4), with a timely original federal
income tax return or Form 1065, or, subject to certain time limitations
and other requirements, with an amended federal income tax return,
administrative adjustment request, or amended Form 1065, as applicable.
This collection of information in the final regulations generally
retains the collection of information in the proposed regulations. The
final regulations clarify that a controlling domestic shareholder must
make this election by filing the statement required under Sec. 1.964-
1(c)(3)(ii). The collection of information in Sec. 1.951A-
2(c)(7)(viii)(A)(1)(ii) requires that each controlling domestic
shareholder of a CFC that files an election to exclude gross income of
a CFC from tested income under the high-tax exception of section
954(b)(4) provide any notices required under Sec. 1.964-1(c)(3)(iii).
The collection of information in Sec. 1.951A-2(c)(7)(viii)(C) requires
each controlling domestic shareholder that revokes an election on an
amended return to provide the statement and notice described in Sec.
1.951A-2(c)(7)(viii)(A)(1)(i) and (ii), respectively.
As shown in Table 1, the Treasury Department and the IRS estimate
that the number of persons potentially subject to the collections of
information in Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii), and Sec.
1.951A-2(c)(7)(viii)(C) is between 25,000 and 35,000. The estimate in
Table 1 is based on the number of taxpayers that filed a tax return
that included a Form 5471, ``Information Return of U.S. Persons With
Respect to Certain Foreign Corporations.'' The collections of
information in Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii), and Sec.
1.951A-2(c)(7)(viii)(C) can only apply to taxpayers that are U.S.
shareholders (as defined in section 951(b)) and U.S. shareholders are
required to file a Form 5471.
Table 1--Table of Tax Forms Impacted
------------------------------------------------------------------------
Tax Forms Impacted
-------------------------------------------------------------------------
Number of Forms to which the
Collections of information respondents information may be
(estimated) attached
------------------------------------------------------------------------
Sec. 1.951A- 25,000-35,000 Form 990 series, Form
2(c)(7)(viii)(A)(1)(i) and 1120 series, Form
(ii), and Sec. 1.951A- 1040 series, Form
2(c)(7)(viii)(C). 1041 series, and
Form 1065 series
------------------------------------------------------------------------
Source: MeF, DCS, and IRS's Compliance Data Warehouse.
The reporting burdens associated with the collections of
information in Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec.
1.951A-2(c)(7)(viii)(C) will be reflected in the Form 14029, Paperwork
Reduction Act Submission, that the Treasury Department and the IRS will
submit to OMB for tax returns in the Form 990 series, Forms 1120, Forms
1040, Forms 1041, and Forms 1065. In particular, the reporting burden
associated with the information collection in Sec. 1.951A-
2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-2(c)(7)(viii)(C) will
be included in the burden estimates for OMB control numbers 1545-0123,
1545-0074, 1545-0092, and 1545-0047. OMB control number 1545-0123
represents a total estimated burden time for all forms and schedules
for corporations of 3.344 billion hours and total estimated monetized
costs of $61.558 billion ($2019). OMB control number 1545-0074
represents a total estimated burden time, including all other related
forms and schedules for individuals, of 1.717 billion hours and total
estimated monetized costs of $33.267 billion ($2019). OMB control
number 1545-0092 represents a total estimated burden time, including
all other related forms and schedules for trusts and estates, of
307,844,800 hours and total estimated monetized costs of $9.950 billion
($2016). OMB control number 1545-0047 represents a total estimated
burden time, including all other related forms and schedules for tax-
exempt organizations, of 52.450 million hours and total estimated
monetized costs of $1,496,500,000 ($2020). Table 2 summarizes the
status of the Paperwork Reduction Act submissions of the Treasury
Department and the IRS related to forms in the Form 990 series, Forms
1120, Forms 1040, Forms 1041, and Forms 1065.
The overall burden estimates provided by the Treasury Department
and the IRS to OMB in the Paperwork Reduction Act submissions for OMB
control numbers 1545-0123, 1545-0074, 1545-0092, and 1545-0047 are
aggregate amounts related to the U.S. Business Income Tax Return, the
U.S. Individual Income Tax Return, and the U.S. Income Tax Return for
Estates and Trusts, along with any associated forms. The burdens
included in these Paperwork Reduction Act submissions, however, do not
account for any burden imposed by Sec. 1.951A-2(c)(7)(viii)(A)(1)(i)
and (ii) and Sec. 1.951A-2(c)(7)(viii)(C). The Treasury Department and
the IRS have not
[[Page 44637]]
identified the estimated burdens for the collections of information in
Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C) because there are no burden estimates specific to
Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C) currently available. The burden estimates in the
Paperwork Reduction Act submissions that the Treasury Department and
the IRS will submit to the OMB will in the future include, but not
isolate, the estimated burden related to the tax forms that will be
revised for the collection of information in Sec. 1.951A-
2(c)(7)(viii)(A)(1) and (ii) and Sec. 1.951A-2(c)(7)(viii)(C).
The Treasury Department and the IRS have included the burdens
related to the Paperwork Reduction Act submissions for OMB control
numbers 1545-0123, 1545-0074, 1545-0092, and 1545-0047 in the PRA
analysis for other regulations issued by the Treasury Department and
the IRS related to the taxation of cross-border income. The Treasury
Department and the IRS encourage users of this information to take
measures to avoid overestimating the burden that the collections of
information in Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec.
1.951A-2(c)(7)(viii)(C), together with other international tax
provisions, impose. Moreover, the Treasury Department and the IRS also
note that the Treasury Department and the IRS estimate PRA burdens on a
taxpayer-type basis rather than a provision-specific basis because an
estimate based on the taxpayer-type most accurately reflects taxpayers'
interactions with the forms.
The Treasury Department and the IRS request comments on all aspects
of information collection burdens related to the final regulations,
including estimates for how much time it would take to comply with the
paperwork burdens described above for each relevant form and ways for
the IRS to minimize the paperwork burden. Proposed revisions (if any)
to these forms that reflect the information collections contained in
Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C) will be made available for public comment at https://apps.irs.gov/app/picklist/list/draftTaxForms.html and will not be
finalized until after these forms have been approved by OMB under the
PRA.
Table 2--Summary of Information Collection Request Submissions Related to Form 990 Series, Forms 1120, Forms
1040, Forms 1041, and Forms 1065
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No.(s) Status
----------------------------------------------------------------------------------------------------------------
Forms 990.............................. Tax exempt entities (NEW 1545-0047 Approved by OIRA 2/12/2020
Model). until 2/28/2021.
------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201912-1545-014 014.
----------------------------------------------------------------------------------------------------------------
Form 1040.............................. Individual (NEW Model)... 1545-0074 Approved by OIRA 1/30/2020
until 1/31/2021.
------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201909-1545-021 021.
----------------------------------------------------------------------------------------------------------------
Form 1041.............................. Trusts and estates....... 1545-0092 Approved by OIRA 5/08/2019
until 5/31/2022.
------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201806-1545-014 014.
----------------------------------------------------------------------------------------------------------------
Form 1065 and 1120..................... Business (NEW Model)..... 1545-0123 Approved by OIRA 1/30/2020
until 1/31/2021.
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Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201907-1545-001 001.
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III. Regulatory Flexibility Act
It is hereby certified that these final regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(5 U.S.C. chapter 6).
Section 951A generally affects U.S. shareholders of CFCs. The
reporting burdens in Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and
Sec. 1.951A-2(c)(7)(viii)(C), affect controlling domestic shareholders
of a CFC that elect to apply the high-tax exception of section
954(b)(4) to gross income of a CFC. Controlling domestic shareholders
are generally U.S. shareholders who, in the aggregate, own more than 50
percent of the total combined voting power of all classes of stock of
the foreign corporation entitled to vote. As an initial matter, foreign
corporations are not considered small entities. Nor are U.S. taxpayers
considered small entities to the extent the taxpayers are natural
persons or entities other than small entities. Thus, Sec. 1.951A-
2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-2(c)(7)(viii)(C)
generally only affect small entities if a U.S. taxpayer that is a U.S.
shareholder of a CFC is a small entity.
Examining the gross receipts of the e-filed Forms 5471 that is the
basis of the 25,000--35,000 respondent estimates, the Treasury
Department and the IRS have determined that the tax revenue from
section 951A estimated by the Joint Committee on Taxation for
businesses of all sizes is less than 0.3 percent of gross receipts as
shown in the table below. Based on data for 2015 and 2016, total gross
receipts for all businesses with gross receipts under $25 million is
$60 billion while those over $25 million is $49.1 trillion. Given that
tax on GILTI inclusion amounts is correlated with gross receipts, this
results in businesses with less than $25 million in gross receipts
accounting for approximately 0.01 percent of the tax revenue. Data are
not readily available to determine the sectoral breakdown of these
entities. Based on this analysis, smaller businesses are not
significantly impacted by these proposed regulations. The Small
Business Administration's small business size standards (13 CFR part
121) identify as small entities several industries with annual revenues
above $25 million or because of the number of employees.
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2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
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JCT tax revenue (billion $)................................... 7.7 12.5 9.6 9.5 9.3 9.0 9.2 9.3 15.1 21.2
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[[Page 44638]]
Total gross receipts (billion $).......................... 30727 53870 566676 59644 62684 65865 69201 72710 76348 80094
Percent....................................................... 0.03 0.02 0.02 0.02 0.01 0.01 0.01 0.01 0.02 0.03
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Source: Research, Applied Analytics and Statistics division (IRS), Compliance Data Warehouse (IRS) (E-filed Form 5471, category 4 or 5, C and S
corporations and partnerships); Conference Report, at 689.
The data to assess the number of small entities potentially
affected by Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec.
1.951A-2(c)(7)(viii)(C) are not readily available. However, businesses
that are U.S. shareholders of CFCs are generally not small businesses
because the ownership of sufficient stock in a CFC in order to be a
U.S. shareholder generally entails significant resources and
investment. The Treasury Department and the IRS welcome comments on
whether the proposed regulations would affect a substantial number of
small entities in any particular industry.
Regardless of the number of small entities potentially affected by
Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C), the Treasury Department and the IRS have concluded
that there is no significant economic impact on such entities as a
result of Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec.
1.951A-2(c)(7)(viii)(C). Furthermore, the requirements in Sec. 1.951A-
2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-2(c)(7)(viii)(C) apply
only if a taxpayer chooses to make an election to apply a favorable
rule. Consequently, the Treasury Department and the IRS have determined
that Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C) will not have a significant economic impact on a
substantial number of small entities. Accordingly, it is hereby
certified that the collection of information requirements of Sec.
1.951A-2(c)(7)(viii)(A)(1)(i) and (ii) and Sec. 1.951A-
2(c)(7)(viii)(C) would not have a significant economic impact on a
substantial number of small entities. Notwithstanding this
certification, the Treasury Department and the IRS invite comments from
the public on the impact of Sec. 1.951A-2(c)(7)(viii)(A)(1)(i) and
(ii) and Sec. 1.951A-2(c)(7)(viii)(C) on small entities.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (2 U.S.C.
1532) requires that agencies assess anticipated costs and benefits and
take certain other actions before issuing a final rule that includes
any federal mandate that may result in expenditures in any one year by
a state, local, or tribal government, in the aggregate, or by the
private sector, of $100 million in 1995 dollars, updated annually for
inflation. This rule does not include any federal mandate that may
result in expenditures by state, local, or tribal governments, or by
the private sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive Order. This final rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt state law
within the meaning of the Executive Order.
VI. Congressional Review Act
The Administrator of the Office of Information and Regulatory
Affairs of the OMB has determined that this Treasury decision is a
major rule for purposes of the Congressional Review Act (5 U.S.C. 801
et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule
generally takes effect 60 days after the rule is published in the
Federal Register. Accordingly, the Treasury Department and IRS are
adopting these final regulations with the delayed effective date
generally prescribed under the Congressional Review Act.
Drafting Information
The principal authors of these regulations are Jorge M. Oben and
Larry R. Pounders of the Office of Associate Chief Counsel
(International). However, other personnel from the Treasury Department
and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805.
Sec. 1.951A-0 [Removed]
0
Par. 2. Section 1.951A-0 is removed.
0
Par. 3. Section 1.951A-2 is amended by revising paragraph (c)(1)(iii),
redesignating the text of paragraph (c)(3) as paragraph (c)(3)(i),
adding a subject heading to newly redesignated (c)(3)(i), and adding
paragraph (c)(3)(ii), a reserved paragraph (c)(6), and paragraphs
(c)(7) and (8) to read as follows:
Sec. 1.951A-2 Tested income and tested loss.
* * * * *
(c) * * *
(1) * * *
(iii) Gross income excluded from the foreign base company income
(as defined in section 954) or the insurance income (as defined in
section 953) of the corporation by reason of the exception described in
section 954(b)(4) pursuant to an election under Sec. 1.954-1(d)(5), or
a tentative gross tested income item of the corporation that qualifies
for the exception described in section 954(b)(4) pursuant to an
election under paragraph (c)(7) of this section,
* * * * *
(3) * * *
(i) In general. * * *
(ii) Coordination with the high-tax exclusion--(A) In general. In
the case of a taxpayer that has made an election under paragraph (c)(7)
of this section, in allocating and apportioning deductions under this
paragraph (c)(3), the taxpayer must apply the rules of sections 861
through 865 and 904(d) (taking into account the rules of section
954(b)(5) and Sec. 1.954-1(c)) in a manner that achieves results
consistent with those under paragraph (c)(7) of this section.
(B) Application of consistency rule to deductions allocated and
apportioned to the residual grouping in applying the high-tax
exclusion. Deductions that are allocated and apportioned to the
residual income group under paragraph (c)(7)(iii)(A) of this section
for purposes of applying the high-tax exclusion to a controlled foreign
corporation's tentative gross tested income items are
[[Page 44639]]
allocated and apportioned for purposes of determining the controlled
foreign corporation's net income in each relevant statutory grouping
using a method that provides for a consistent allocation and
apportionment of deductions to gross income in the relevant groupings.
See Sec. Sec. 1.954-1(c) and 1.960-1(d)(3) for rules relating to the
allocation and apportionment of expenses for purposes of determining
subpart F income, which is included in the residual grouping for
purposes of applying the high-tax exclusion of sections
951A(c)(2)(A)(i)(III) and 954(b)(4) and paragraph (c)(7) of this
section. Therefore, for example, interest expense that is apportioned
under the modified gross income method to a tentative gross tested
income item of a lower-tier corporation under paragraph
(c)(7)(iii)(A)(1) of this section may be allocated and apportioned to
the tested income of the upper-tier corporation or to the residual
grouping, depending on whether the lower-tier corporation's tentative
gross tested income item is an item of gross tested income or is
excluded from gross tested income under the high-tax exclusion. See
paragraph (c)(8)(iii)(C) (Example 3) of this section for an example
illustrating the rules of this paragraph (c)(3).
* * * * *
(6) [Reserved]
(7) Election to apply high-tax exception of section 954(b)(4)--(i)
In general. For purposes of section 951A(c)(2)(A)(i)(III) and paragraph
(c)(1)(iii) of this section, a tentative gross tested income item of a
controlled foreign corporation for a CFC inclusion year qualifies for
the exception described in section 954(b)(4) only if--
(A) An election made under paragraph (c)(7)(viii) of this section
is effective with respect to the controlled foreign corporation for the
CFC inclusion year; and
(B) The tentative tested income item with respect to the tentative
gross tested income item was subject to an effective rate of foreign
tax, as determined under paragraph (c)(7)(vi) of this section, that is
greater than 90 percent of the maximum rate of tax specified in section
11.
(ii) Calculation of tentative gross tested income item--(A) In
general. A tentative gross tested income item with respect to a
controlled foreign corporation for a CFC inclusion year is the
aggregate of all items of gross income of the controlled foreign
corporation attributable to a tested unit (as defined in paragraph
(c)(7)(iv) of this section) of the controlled foreign corporation in
the CFC inclusion year that would be gross tested income without regard
to this paragraph (c)(7) and would be in a single tested income group
(as defined in Sec. 1.960-1(d)(2)(ii)(C)). A controlled foreign
corporation may have multiple tentative gross tested income items. See
paragraphs (c)(8)(iii)(A)(2)(i) (Example 1) and (c)(8)(iii)(B)(2)(i)
(Example 2) of this section for illustrations of the application of the
rule set forth in this paragraph (c)(7)(ii)(A).
(B) Gross income attributable to a tested unit--(1) Items properly
reflected on separate set of books and records. Items of gross income
of a controlled foreign corporation are attributable to a tested unit
of the controlled foreign corporation to the extent they are properly
reflected on the separate set of books and records of the tested unit,
as modified under paragraph (c)(7)(ii)(B)(2) of this section. Each item
of gross income of a controlled foreign corporation is attributable to
a tested unit (and not to more than one tested unit) of the controlled
foreign corporation. See paragraphs (c)(8)(iii)(D)(2) and
(c)(8)(iii)(D)(5) (Example 4) of this section for illustrations of the
application of the rule set forth in this paragraph (c)(7)(ii)(B).
(2) Gross income determined under federal income tax principles, as
adjusted for disregarded payments. For purposes of paragraph
(c)(7)(ii)(B)(1) of this section, gross income must be determined under
federal income tax principles, except that the principles of Sec.
1.904-4(f)(2)(vi) apply to adjust gross income of the tested unit, to
the extent thereof, to reflect disregarded payments. For purposes of
this paragraph (c)(7)(ii)(B)(2), the principles of Sec. 1.904-
4(f)(2)(vi) are applied taking into account the rules in paragraphs
(c)(7)(ii)(B)(2)(i) through (v) of this section.
(i) The controlled foreign corporation is treated as the foreign
branch owner and any other tested units of the controlled foreign
corporation are treated as foreign branches.
(ii) The principles of the rules in Sec. 1.904-4(f)(2)(vi)(A)
apply in the case of disregarded payments between a foreign branch and
another foreign branch without regard to whether either foreign branch
makes a disregarded payment to, or receives a disregarded payment from,
the foreign branch owner.
(iii) The exclusion for interest and interest equivalents described
in Sec. 1.904-4(f)(2)(vi)(C)(1) does not apply to the extent of the
amount of a disregarded payment that is deductible in the country of
tax residence (or location, in the case of a branch) of the tested unit
that is the payor.
(iv) In the case of an amount described in paragraph
(c)(7)(ii)(B)(2)(iii) of this section, the rules for determining how a
disregarded payment is allocated to gross income of a foreign branch or
foreign branch owner in Sec. 1.904-4(f)(2)(vi)(B) are applied by
treating the disregarded payment as allocated and apportioned ratably
to all of the gross income attributable to the tested unit that is
making the disregarded payment. If a tested unit is both a payor and
payee of an amount described in paragraph (c)(7)(ii)(B)(2)(iii) of this
section, gross income to which the disregarded payments are allocable
include gross income allocated to the payor tested unit as a result of
the receipt of amounts described in paragraph (c)(7)(ii)(B)(2)(iii) of
this section, to the extent thereof. If a tested unit makes and
receives payments described in paragraph (c)(7)(ii)(B)(2)(iii) of this
section to and from the same tested unit, the payments are netted so
that paragraph (c)(7)(ii)(B)(2)(iii) of this section and the principles
of Sec. 1.904-4(f)(2)(vi) apply only to the net amount of such
payments between the two tested units.
(v) In the case of multiple disregarded payments, in lieu of Sec.
1.904-4(f)(2)(vi)(F), disregarded payments are taken into account under
paragraph (c)(7)(ii)(B)(2) of this section and the principles of Sec.
1.904-4(f)(2)(vi) under the rules provided in this paragraph
(c)(7)(ii)(B)(2)(v). Adjustments are made with respect to a disregarded
payment received by a tested unit before payments made by that tested
unit. Except as provided in paragraph (c)(7)(ii)(B)(2)(iv) of this
section, if a tested unit both makes and receives disregarded payments,
adjustments are first made with respect to disregarded payments that
would be definitely related to a single class of gross income under the
principles of Sec. 1.861-8; second, adjustments are made with respect
to disregarded payments that would be definitely related to multiple
classes of gross income under the principles of Sec. 1.861-8, but that
are not definitely related to all gross income of the tested unit;
third, adjustments are made with respect to disregarded payments (other
than interest described in paragraph (c)(7)(ii)(B)(2)(iii) of this
section) that would be definitely related to all gross income under the
principles of Sec. 1.861-8; and fourth, adjustments are made with
respect to interest described in paragraph (c)(7)(ii)(B)(2)(iii) and
disregarded payments that would not be
[[Page 44640]]
definitely related to any gross income under the principles of Sec.
1.861-8.
(iii) Calculation of tentative tested income item--(A) In general.
A tentative tested income item with respect to the tentative gross
tested income item described in paragraph (c)(7)(ii)(A) of this section
is determined by allocating and apportioning deductions for the CFC
inclusion year (including expense for current year taxes (as defined in
Sec. 1.960-1(b)(4)), and not including any items described in Sec.
1.951A-2(c)(5) or (c)(6)) to the tentative gross tested income item
under the principles of Sec. 1.960-1(d)(3). For purposes of this
paragraph (c)(7)(iii), each tentative gross tested income item (if any)
is treated as assigned to a separate tested income group, as that term
is described in Sec. 1.960-1(d)(2)(ii)(C), and all other income is
treated as assigned to a residual income group. For purposes of
applying Sec. Sec. 1.861-9 and 1.861-9T under the principles of Sec.
1.960-1(d)(3), the amount of interest deductions that are allocated and
apportioned to the assets (or gross income, in the case of a taxpayer
that has elected the modified gross income method) of a lower-tier
corporation, such as a corporation the stock of which is owned by the
controlled foreign corporation indirectly through the tested unit, are
allocated and apportioned to the residual income category and not to
any tentative gross tested income item of the controlled foreign
corporation. See paragraphs (c)(8)(iii)(A)(2)(iii) (Example 1),
(c)(8)(iii)(B)(2)(iv) (Example 2), and (c)(8)(iii)(C)(2)(iv) (Example
3) of this section for illustrations of the application of the rules
set forth in this paragraph (c)(7)(iii)(A).
(B) Allocation and apportionment of current year taxes imposed by
reason of disregarded payments. The principles of Sec. 1.904-6(a)(2)
apply to allocate and apportion the expense for current year taxes
imposed by reason of disregarded payments to a tentative gross tested
income item. For purposes of this paragraph (c)(7)(iii)(B), the
principles of Sec. 1.904-6(a)(2) apply by--
(1) Treating the CFC as the foreign branch owner and any other
tested unit as a foreign branch;
(2) In the case of payments to a tested unit that is treated as a
foreign branch under paragraph (c)(7)(vi)(B)(1) of this section,
applying the principles of Sec. 1.904-6(a)(2)(ii) and (iii) as if the
tested unit receiving the payment were a foreign branch owner; and
(3) Treating any portion of a disregarded payment between
individual tested units that does not result in a reallocation of gross
income under paragraph (c)(7)(ii)(B)(2) of this section (because the
amount of the payment exceeds the gross income of the individual tested
unit making the payment) as a payment that is described in Sec. 1.904-
4(f)(2)(vi)(C)(4) (to which Sec. 1.904-6(a)(2)(iii) applies). See
paragraph (c)(8)(iii)(B)(2)(iii) (Example 2) of this section for
illustrations of the application of the rules set forth in this
paragraph (c)(7)(iii)(B).
(C) Effect of potential and actual changes in taxes paid or
accrued. Except as otherwise provided in this paragraph (c)(7)(iii)(C),
the amount of current year taxes paid or accrued by a controlled
foreign corporation for purposes of this paragraph (c)(7) does not take
into account any potential reduction in foreign income taxes that may
occur by reason of a future distribution to shareholders of all or part
of such income. However, to the extent the foreign income taxes paid or
accrued by the controlled foreign corporation are reasonably certain to
be returned to a shareholder by the foreign country imposing such
taxes, directly or indirectly, through any means (including, but not
limited to, a refund, credit, payment, discharge of an obligation, or
any other method) on a subsequent distribution to such shareholder, the
foreign income taxes are not treated as paid or accrued for purposes of
this paragraph (c)(7). In addition, foreign income taxes that have not
been paid or accrued because they are contingent on a future
distribution of earnings (or other similar transaction, such as a loan
to a shareholder) are not taken into account for purposes of this
paragraph (c)(7). If, pursuant to section 905(c) and Sec. 1.905-3, a
redetermination of U.S. tax liability is required to account for the
effect of a foreign tax redetermination (as defined in Sec. 1.905-
3(a)), this paragraph (c)(7) is applied in the adjusted year taking
into account the adjusted amount of the redetermined foreign tax.
(iv) Tested unit rules--(A) In general. Subject to the combination
rule in paragraph (c)(7)(iv)(C) of this section, the term tested unit
means any corporation, interest, or branch described in paragraphs
(c)(7)(iv)(A)(1) through (3) of this section. See paragraph
(c)(8)(iii)(D) (Example 4) of this section for an example that
illustrates the application of the tested unit rules set forth in this
paragraph (c)(7)(iv).
(1) A controlled foreign corporation (as defined in section
957(a)).
(2) An interest held directly or indirectly by a controlled foreign
corporation in a pass-through entity that is--
(i) A tax resident (as described in Sec. 1.267A-5(a)(23)(i)) of
any foreign country; or
(ii) Not treated as fiscally transparent (as determined under the
principles of Sec. 1.267A-5(a)(8)) for purposes of the tax law of the
foreign country of which the controlled foreign corporation is a tax
resident or, in the case of an interest in a pass-through entity held
by a controlled foreign corporation indirectly through one or more
other tested units, for purposes of the tax law of the foreign country
of which the tested unit that directly (or indirectly through the
fewest number of transparent interests) owns the interest is a tax
resident.
(3) A branch (as described in Sec. 1.267A-5(a)(2)) the activities
of which are carried on directly or indirectly (through one or more
pass-through entities) by a controlled foreign corporation. However, in
the case of a branch that does not give rise to a taxable presence
under the tax law of the foreign country where the branch is located,
the branch is a tested unit only if, under the tax law of the foreign
country of which the controlled foreign corporation is a tax resident
(or, if applicable, under the tax law of a foreign country of which the
tested unit that directly (or indirectly, through the fewest number of
transparent interests) carries on the activities of the branch is a tax
resident), an exclusion, exemption, or other similar relief (such as a
preferential rate) applies with respect to income attributable to the
branch. For purposes of this paragraph (c)(7)(iv)(A)(3), similar relief
does not include a credit (for example, a foreign tax credit) against
the tax imposed under such tax law. If a controlled foreign corporation
carries on directly or indirectly (through one or more pass-through
entities) less than all of the activities of a branch (for example, if
the activities are carried on indirectly through an interest in a
partnership), then the rules in this paragraph apply separately with
respect to the portion (or portions, if carried on indirectly through
more than one chain of pass-through entities) of the activities carried
on by the controlled foreign corporation. See paragraphs
(c)(8)(iii)(D)(3) and (c)(8)(iii)(D)(4) (Example 4) of this section for
illustrations of the application of the rules set forth in this
paragraph (c)(7)(iv)(A)(3).
(B) Items attributable to only one tested unit. For purposes of
paragraph (c)(7) of this section, if an item is attributable to more
than one tested unit in a tier of tested units, the item is considered
attributable only to the lowest-tier tested unit. Thus, for example, if
a controlled foreign
[[Page 44641]]
corporation directly owns a branch tested unit described in paragraph
(c)(7)(iv)(A)(3) of this section, and an item of gross income is (under
the rules of paragraph (c)(7)(ii)(B) of this section) attributable to
both the branch tested unit and the controlled foreign corporation
tested unit, then the item is considered attributable only to the
branch tested unit.
(C) Combination rule--(1) In general. Except as provided in
paragraph (c)(7)(iv)(C)(2) of this section, tested units of a
controlled foreign corporation (including the controlled foreign
corporation tested unit) are treated as a single tested unit if the
tested units are tax residents of, or located in (in the case of a
tested unit that is a branch, or a portion of the activities of a
branch, that gives rise to a taxable presence under the tax law of a
foreign country), the same foreign country. For purposes of this
paragraph (c)(7)(iv)(C)(1), in the case of a tested unit that is an
interest in a pass-through entity or a portion of the activities of a
branch, a reference to the tax residency or location of the tested unit
means the tax residency of the entity the interest in which is the
tested unit or the location of the branch, as applicable. See
paragraphs (c)(8)(iii)(D)(2) and (c)(8)(iii)(D)(5) (Example 4) of this
section for illustrations of the application of the rule set forth in
this paragraph (c)(7)(iv)(C)(1).
(2) Exception for nontaxed branches. The rule in paragraph
(c)(7)(iv)(C)(1) of this section does not apply to a tested unit that
is described in paragraph (c)(7)(iv)(A)(3) of this section if the
branch described in paragraph (c)(7)(iv)(A)(3) of this section does not
give rise to a taxable presence under the tax law of the foreign
country where the branch is located. See paragraph (c)(8)(iii)(D)(4)
(Example 4) of this section for an illustration of the application of
the rule set forth in this paragraph (c)(7)(v)(C)(2).
(3) Effect of combination rule. If, pursuant to paragraph
(c)(7)(iv)(C)(1) of this section, tested units are treated as a single
tested unit, then, solely for purposes of paragraph (c)(7) of this
section, items of gross income attributable to such tested units, and
items of deduction and foreign taxes allocated and apportioned to such
gross income, are aggregated for purposes of determining the combined
tested unit's tentative gross tested income item, tentative tested
income item, and foreign income taxes paid or accrued with respect to
such tentative tested income item.
(v) Separate set of books and records--(A) In general. For purposes
of this paragraph (c)(7), the term separate set of books and records
has the meaning set forth in Sec. 1.989(a)-1(d). In addition, for
purposes of this paragraph (c)(7), in the case of a tested unit or a
transparent interest that is an interest in a pass-through entity or a
portion of the activities of a branch, a reference to the separate set
of books and records of the tested unit or the transparent interest
means the separate set of books and records of the entity or the
branch, as applicable.
(B) Failure to maintain separate set of books and records. If a
separate set of books and records is not maintained for a tested unit
or transparent interest, the items of gross income, disregarded
payments, and any other items required to apply paragraph (c)(7) of
this section that would be reflected on a separate set of books and
records of the tested unit or transparent interest must be determined.
Such items are treated as properly reflected on the separate set of
books and records of the tested unit or transparent interest for
purposes of applying paragraph (c)(7) of this section.
(C) Transparent interests. If a tested unit of a controlled foreign
corporation or an entity an interest in which is a tested unit of a
controlled foreign corporation holds a transparent interest, either
directly or indirectly through one or more other transparent interests,
then, for purposes of paragraph (c)(7) of this section (and subject to
the rule of paragraph (c)(7)(iv)(C) of this section), items of the
controlled foreign corporation properly reflected on the separate set
of books and records of the transparent interest are treated as being
properly reflected on the separate set of books and records of the
tested unit, as modified under paragraph (c)(7)(ii)(B)(2) of this
section. See paragraph (c)(8)(iii)(D)(6) (Example 4) of this section
for an illustration of the application of the rule set forth in this
paragraph (c)(7)(v)(C).
(D) Items not taken into account for financial accounting purposes.
For purposes of this paragraph (c)(7), an item of gross income in a CFC
inclusion year that is not taken into account in such year for
financial accounting purposes, and therefore not properly reflected on
a separate set of books and records of a tested unit or a transparent
interest, or an entity an interest in which is a tested unit or a
transparent interest, is treated as properly reflected on a separate
set of books and records to the extent it would have been so reflected
if the item were taken into account for financial accounting purposes
in such CFC inclusion year.
(vi) Effective rate at which foreign taxes are imposed. For a CFC
inclusion year of a controlled foreign corporation, the effective rate
of foreign tax with respect to the tentative tested income items of the
controlled foreign corporation is determined separately for each such
item. See paragraphs (c)(8)(iii)(A)(2)(v) (Example 1),
(c)(8)(iii)(B)(2)(vi) (Example 2), and (c)(8)(iii)(C)(2)(vi) (Example
3) of this section for illustrations of the application of the rules
set forth in this paragraph (c)(7)(vi). The effective rate at which
foreign income taxes are imposed on a tentative tested income item is--
(A) The U.S. dollar amount of foreign income taxes paid or accrued
with respect to the tentative tested income item, determined by
applying paragraph (c)(7)(vii) of this section; divided by
(B) The U.S. dollar amount of the tentative tested income item,
increased by the amount of foreign income taxes referred to in
paragraph (c)(7)(vi)(A) of this section.
(vii) Foreign income taxes paid or accrued with respect to a
tentative tested income item. For a CFC inclusion year, the amount of
foreign income taxes paid or accrued by a controlled foreign
corporation with respect to a tentative tested income item of the
controlled foreign corporation for purposes of this paragraph (c)(7) is
the U.S. dollar amount of the controlled foreign corporation's current
year taxes (as defined in Sec. 1.960-1(b)(4)) that are allocated and
apportioned to the related tentative gross tested income item under the
rules of paragraph (c)(7)(iii) of this section. See paragraphs
(c)(8)(iii)(A)(2)(iv) (Example 1), (c)(8)(iii)(B)(2)(v) (Example 2),
and (c)(8)(iii)(C)(2)(v) (Example 3) of this section for illustrations
of the application of the rule set forth in this paragraph (c)(7)(vii).
(viii) Rules regarding the high-tax election--(A) Manner--(1) An
election is made under this paragraph (c)(7)(viii) by the controlling
domestic shareholders (as defined in Sec. 1.964-1(c)(5)) with respect
to a controlled foreign corporation for a CFC inclusion year (a high-
tax election) in accordance with the rules provided in forms or
instructions and by--
(i) Filing the statement required under Sec. 1.964-1(c)(3)(ii)
with a timely filed original federal income tax return, or with an
amended federal income tax return in accordance with paragraph
(c)(7)(viii)(A)(2) of this section, for the U.S. shareholder inclusion
year of each controlling domestic shareholder in which or with which
such CFC inclusion year ends;
(ii) Providing any notices required under Sec. 1.964-1(c)(3)(iii);
and
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(iii) Providing any additional information required by applicable
administrative pronouncements.
(2) In the case of an election (or revocation) made with an amended
federal income tax return--
(i) The election (or revocation) must be made on an amended federal
income tax return duly filed within 24 months of the unextended due
date of the original federal income tax return for the U.S. shareholder
inclusion year with or within which the CFC inclusion year ends;
(ii) Each United States shareholder in the controlled foreign
corporation as of the end of the CFC's taxable year to which the
election relates must file amended federal income tax returns (or
timely original federal income tax returns if a return has not yet been
filed) reflecting the effect of such election (or revocation) for the
U.S. shareholder inclusion year with or within which the CFC inclusion
year ends as well as for any other taxable year in which the U.S. tax
liability of the United States shareholder would be increased by reason
of the election (or revocation) (or in the case of a partnership if any
item reported by the partnership or any partnership-related item would
change as a result of the election (or revocation)) within a single
period no greater than six months within the 24-month period described
in paragraph (c)(7)(viii)(A)(2)(i) of this section; and
(iii) Each United States shareholder in the controlled foreign
corporation as of the end of the controlled foreign corporation's
taxable year to which the election relates must pay any tax due as a
result of such adjustments within a single period no greater than six
months within the 24-month period described in paragraph
(c)(7)(viii)(A)(2)(i) of this section.
(3) In the case of a United States shareholder that is a
partnership, paragraphs (c)(7)(viii)(A)(1) and (2) and (c)(7)(viii)(C)
of this section are applied by substituting ``Form 1065 (or successor
form)'' for ``federal income tax return'' and by substituting ``amended
Form 1065 (or successor form) or administrative adjustment request (as
described in Sec. 301.6227-1), as applicable,'' for ``amended federal
income tax return'', each place that it appears.
(4) A United States shareholder that is a partner in a partnership
that is also a United States shareholder in the controlled foreign
corporation must generally file an amended return, as required under
paragraph (c)(7)(viii)(B)(2) of this section, and must generally pay
any additional tax owed as required under paragraph (c)(7)(viii)(B)(3).
However, in the case of a United States shareholder that is a partner
in a partnership that duly files an administrative adjustment request
under paragraph (c)(7)(viii)(A)(2) of this section, the partner is
treated as having satisfied the requirements of paragraphs
(c)(7)(viii)(A)(2)(ii) and (iii) of this section with respect to the
interest held through that partnership if:
(i) The partnership timely files an administrative adjustment
request described in paragraph (c)(7)(viii)(A)(1)(i) or (ii) of this
section, as applicable; and,
(ii) Both the partnership and its partners timely comply with the
requirements of section 6227 with respect to the administrative
adjustment request. See Sec. Sec. 301.6227-1 through -3 for rules
relating to administrative adjustment requests.
(B) Scope. A high-tax election applies with respect to each
tentative gross tested income item of the controlled foreign
corporation for the CFC inclusion year and is binding on all United
States shareholders of the controlled foreign corporation.
(C) Revocation. A high-tax election may be revoked by the
controlling domestic shareholders of the controlled foreign corporation
in the same manner as prescribed for an election made on an amended
return as described in paragraph (c)(7)(viii)(A) of this section.
(D) Failure to satisfy election requirements. A high-tax election
(or revocation) is valid only if all of the requirements in paragraph
(c)(7)(viii)(A) of this section, including the requirement to provide
notice under paragraph (c)(7)(viii)(A)(1)(ii) of this section, are
satisfied.
(E) Rules applicable to CFC groups--(1) In general. In the case of
a controlled foreign corporation that is a member of a CFC group, a
high-tax election is made under paragraph (c)(7)(viii)(A) of this
section, or revoked under paragraph (c)(7)(viii)(C) of this section,
with respect to all controlled foreign corporations that are members of
the CFC group and the rules in paragraphs (c)(7)(viii)(A) through (D)
of this section apply by reference to the CFC group.
(2) Determination of the CFC group--(i) Definition. Subject to the
rules in paragraphs (c)(7)(viii)(E)(2)(ii) and (iii) of this section,
the term CFC group means an affiliated group as defined in section
1504(a) without regard to section 1504(b)(1) through (6), except that
section 1504(a) is applied by substituting ``more than 50 percent'' for
``at least 80 percent'' each place it appears, and section
1504(a)(2)(A) is applied by substituting ``or'' for ``and.'' For
purposes of this paragraph (c)(7)(viii)(E)(2)(i), stock ownership is
determined by applying the constructive ownership rules of section
318(a), other than section 318(a)(3)(A) and (B), by applying section
318(a)(4) only to options (as defined in Sec. 1.1504-4(d)) that are
reasonably certain to be exercised as described in Sec. 1.1504-4(g),
and by substituting in section 318(a)(2)(C) ``5 percent'' for ``50
percent.
(ii) Member of a CFC group. The determination of whether a
controlled foreign corporation is included in a CFC group is made as of
the close of the CFC inclusion year of the controlled foreign
corporation that ends with or within the taxable years of the
controlling domestic shareholders. One or more controlled foreign
corporations are members of a CFC group if the requirements of
paragraph (c)(7)(viii)(E)(2) of this section are satisfied as of the
end of the CFC inclusion year of at least one of the controlled foreign
corporations, even if the requirements are not satisfied as of the end
of the CFC inclusion year of all controlled foreign corporations. If
the controlling domestic shareholders do not have the same taxable
year, the determination of whether a controlled foreign corporation is
a member of a CFC group is made with respect to the CFC inclusion year
that ends with or within the taxable year of the majority of the
controlling domestic shareholders (determined based on voting power)
or, if no such majority taxable year exists, the calendar year. See
paragraph (c)(8)(iii)(E) (Example 5) of this section for an example
that illustrates the application of the rule set forth in this
paragraph (c)(7)(viii)(E)(2)(ii).
(iii) Controlled foreign corporations included in only one CFC
group. A controlled foreign corporation cannot be a member of more than
one CFC group. If a controlled foreign corporation would be a member of
more than one CFC group under paragraph (c)(7)(viii)(E)(2) of this
section, then ownership of stock of the controlled foreign corporation
is determined by applying paragraph (c)(7)(viii)(E)(2) of this section
without regard to section 1504(a)(2)(B) or, if applicable, by reference
to the ownership existing as of the end of the first CFC inclusion year
of a controlled foreign corporations that would cause a CFC group to
exist.
(ix) Definitions. The following definitions apply for purposes of
this paragraph (c)(7).
(A) Indirectly. The term indirectly, when used in reference to
ownership, means ownership through one or more pass-through entities.
(B) Pass-through entity. The term pass-through entity means a
partnership, a disregarded entity, or any
[[Page 44643]]
other person (whether domestic or foreign) other than a corporation to
the extent that income, gain, deduction or loss of the person is taken
into account in determining the income or loss of a controlled foreign
corporation that owns, directly or indirectly, interests in the person.
(C) Transparent interest. The term transparent interest means an
interest in a pass-through entity (or the activities of a branch) that
is not a tested unit.
(8) Examples--(i) Scope. This paragraph (c)(8) provides examples
illustrating the application of the rules in paragraph (c)(7) of this
section.
(ii) Presumed facts. For purposes of the examples in paragraph
(c)(8)(iii) of this section, except as otherwise stated, the following
facts are presumed:
(A) USP is a domestic corporation.
(B) CFC1X and CFC2X are controlled foreign corporations organized
in, and tax residents of, Country X.
(C) CFC3Z is a controlled foreign corporation organized in, and tax
resident of, Country Z.
(D) FDEX is a disregarded entity that is a tax resident of Country
X.
(E) FDE1Y and FDE2Y are disregarded entities that are tax residents
of Country Y.
(F) FPSY is an entity that is organized in, and a tax resident of,
Country Y but is classified as a partnership for federal income tax
purposes.
(G) CFC1X, CFC2X, CFC3Z, and the interests in FDEX, FDE1Y, FDE2Y,
and FPSY are tested units (the CFC1X tested unit, CFC2X tested unit,
CFC3Z tested unit, FDEX tested unit, FDE1Y tested unit, FDE2Y tested
unit, and FPSY tested unit, respectively).
(H) CFC1X, CFC2X, CFC3Z, FDEX, FDE1Y, and FDE2Y conduct activities
in the foreign country in which they are tax resident, and properly
reflect items of income, gain, deduction, and loss on separate sets of
books and records.
(I) All entities have calendar taxable years (for both federal
income tax purposes and for purposes of the relevant foreign country)
and use the Euro ([euro]) as their functional currency. At all relevant
times [euro]1 = $1.
(J) The maximum rate of tax specified in section 11 for the CFC
inclusion year is 21 percent.
(K) Neither CFC1X, CFC2X, nor CFC3Z directly or indirectly earns
income described in section 952(b), has any items of income, gain,
deduction, or loss, or makes or receives disregarded payments. In
addition, no tested unit of CFC1X, CFC2X, or CFC3Z makes or receives
disregarded payments.
(L) An election made under section 954(b)(4) and paragraph
(c)(7)(viii) of this section is effective with respect to CFC1X and
CFC2X, as applicable, for the CFC inclusion year.
(iii) Examples--(A) Example 1: Effect of disregarded interest--(1)
Facts--(i) Ownership. USP owns all of the stock of CFC1X, and CFC1X
owns all of the interests of FDE1Y.
(ii) Gross income and deductions (other than for foreign income
taxes). In Year 1, CFC1X generates [euro]100x of gross income from
services to unrelated parties that would be gross tested income without
regard to paragraph (c)(7) of this section and that is properly
reflected on the books and records of FDE1Y. The [euro]100x of services
income is general category income under Sec. 1.904-4(d). In Year 1,
FDE1Y accrues and pays [euro]20x of interest to CFC1X that is
deductible for Country Y tax purposes but is disregarded for federal
income tax purposes. The [euro]20x of disregarded interest income
received by CFC1X from FDE1Y is properly reflected on CFC1X's books and
records, and the [euro]20x of disregarded interest expense paid from
FDE1Y to CFC1X is properly reflected on FDE1Y's books and records.
(iii) Foreign income taxes. Country X imposes no tax on net income,
and Country Y imposes a 25% tax on net income. For Country Y tax
purposes, FDE1Y (which is not disregarded under Country Y tax law) has
[euro]80x of taxable income ([euro]100x of services income from the
unrelated parties, less a [euro]20x deduction for the interest paid to
CFC1X). Accordingly, FDE1Y incurs a Country Y income tax liability with
respect to Year 1 of [euro]20x ([euro]80x x 25%), the U.S. dollar
amount of which is $20x.
(2) Analysis--(i) Tentative gross tested income items. Under
paragraph (c)(7)(ii)(A) of this section, the tentative gross tested
income item with respect to each of the CFC1X tested unit and the FDE1Y
tested unit is the aggregate of the gross income of CFC1X that is
attributable to the tested unit, that would be gross tested income
(without regard to this paragraph (c)(7)), and that would be in a
single tested income group. Under paragraphs (c)(7)(ii)(B)(1) and (2)
of this section, items of gross income of CFC1X are attributable to the
CFC1X tested unit, or the FDE1Y tested unit, to the extent properly
reflected on its separate set of books and records, as determined under
federal income tax principles and adjusted to take into account
disregarded payments. Without regard to the [euro]20x disregarded
interest payment from FDE1Y to CFC1X, gross income attributable to the
CFC1X tested unit would be [euro]0 (that is, the [euro]20x of interest
income reflected on the books and records of CFC1X would be reduced by
[euro]20x, the amount attributable to the payment that is disregarded
for federal income tax purposes). Similarly, without regard to the
[euro]20x disregarded interest payment from FDE1Y to CFC1X, gross
income attributable to the FDE1Y tested unit would be [euro]100x (that
is, [euro]100x of services income reflected on the books and records of
FDE1Y, unreduced by the [euro]20x disregarded interest payment from
FDE1Y to CFC1X). However, under paragraph (c)(7)(ii)(B)(2) of this
section, the gross income attributable to each of the CFC1X tested unit
and the FDE1Y tested unit is adjusted by [euro]20x, the amount of the
disregarded interest payment from FDE1Y to CFC1X that is deductible for
Country Y tax purposes. Accordingly, the tentative gross tested income
item attributable to the CFC1X tested unit (the ``CFC1X tentative gross
tested income item'') is [euro]20x ([euro]0 + [euro]20x), and the
tentative gross tested income item attributable to the FDE1Y tested
unit (the ``FDE1Y tentative gross tested income item'') is [euro]80x
([euro]100x - [euro]20x).
(ii) Foreign income tax deduction. Under paragraph (c)(7)(iii)(A)
of this section, CFC1X's tentative tested income items are computed by
treating the CFC1X tentative gross tested income item and the FDE1Y
tentative gross tested income item each as income in a separate tested
income group (the ``CFC1X income group'' and the ``FDE1Y income
group'') and by allocating and apportioning CFC1X's deductions for
current year taxes under the principles of Sec. 1.960-1(d)(3)(ii)
(CFC1X has no other deductions to allocate and apportion). Under
paragraph (c)(7)(iii)(A) of this section, the [euro]20x deduction for
Country Y income taxes is allocated and apportioned solely to the FDE1Y
income group (the ``FDE1Y group tax''). None of the Country Y taxes are
allocated and apportioned to the CFC1X income group under paragraph
(c)(7)(iii)(B) of this section and the principles of Sec. 1.904-
6(a)(2)(ii)(A), because none of the Country Y tax is imposed solely by
reason of the disregarded interest payment.
(iii) Tentative tested income items. Under paragraph (c)(7)(iii) of
this section, the tentative tested income item with respect to the
CFC1X income group (the ``CFC1X tentative tested item''), is [euro]20x.
The tentative tested income item with respect to the FDE1Y income group
(the ``CFC1X tentative tested item'') is [euro]60x (the FDE1Y tentative
gross tested income item of [euro]80x, less the [euro]20x deduction for
the FDE1Y group tax).
(iv) Foreign income tax paid or accrued with respect to a tentative
tested income item. Under paragraph (c)(7)(vii) of this section, the
foreign income taxes paid or accrued with
[[Page 44644]]
respect to a tentative tested income item is the U.S. dollar amount of
the current year taxes that are allocated and apportioned to the
related tentative gross tested income item under the rules of paragraph
(c)(7)(iii) of this section. Therefore, the foreign income taxes paid
or accrued with respect to the FDE1Y tentative tested income item is
$20x, the U.S. dollar amount of the FDE1Y group tax. The foreign income
tax paid or accrued with respect to the CFC1X tentative tested income
item is $0, the U.S. dollar amount of the foreign tax allocated and
apportioned to the CFC1X tentative gross tested income item under
paragraph (c)(7)(iii) of this section.
(v) Effective foreign tax rate. The effective foreign tax rate is
determined under paragraph (c)(7)(vi) of this section by dividing the
U.S. dollar amount of foreign income taxes paid or accrued with respect
to each respective tentative tested income item by the U.S. dollar
amount of the tentative tested income item increased by the U.S. dollar
amount of the relevant foreign income taxes. Therefore, the effective
foreign tax rate with respect to the FDE1Y tentative tested income item
is 25%, computed by dividing $20x (the U.S. dollar amount of the
foreign income taxes paid or accrued with respect to the FDE1Y
tentative tested income item under paragraph (c)(7)(vii) of this
section) by $80x (the sum of $60x, the U.S. dollar amount of the FDE1Y
tentative tested income item, and $20x, the U.S. dollar amount of the
foreign income taxes paid or accrued with respect to the FDE1Y
tentative tested income item). The CFC1X tentative tested income item
is not subject to any foreign income tax, so is subject to an effective
foreign tax rate of 0%, calculated as $0 (the U.S. dollar amount of the
foreign income taxes paid or accrued with respect to the CFC1X
tentative tested income item) divided by $20x (the U.S. dollar amount
of the CFC1X tentative tested income item).
(vi) Gross income items excluded under sections 954(b)(4) and
951A(c)(2)(A)(i)(III). The FDE1Y tentative tested income item is
subject to an effective foreign tax rate (25%) that is greater than
18.9% (90% of the maximum rate of tax specified in section 11).
Therefore, the requirement of paragraph (c)(7)(i)(B) of this section is
satisfied, and the FDE1Y tentative gross tested income item qualifies
under paragraph (c)(7)(i) of this section for the high-tax exception of
section 954(b)(4) and is excluded from tested income under sections
951A(c)(2)(A)(i)(III) and 954(b)(4) and paragraph (c)(1)(iii) of this
section. The CFC1X tentative tested income item is subject to an
effective foreign tax rate of 0%. Therefore, the CFC1X tentative tested
income item does not satisfy the requirement of paragraph (c)(7)(i)(B)
of this section, and the CFC1X tentative gross tested income item does
not qualify under paragraph (c)(7)(i) of this section for the high-tax
exception of section 954(b)(4) and is not excluded from tested income
under sections 951A(c)(2)(A)(i)(III) and 954(b)(4) and paragraph
(c)(1)(iii) of this section.
(B) Example 2: Disregarded payment for services--(1) Facts--(i)
Ownership. USP owns all of the stock of CFC1X. CFC1X owns all of the
interests of FDE1Y. FDE1Y is a tax resident of Country Y, but is
treated as fiscally transparent for Country X tax purposes, so that
FDE1Y is subject to tax in Country Y and CFC1X is subject to tax in
Country X with respect to FDE1Y's activities.
(ii) Gross income, deductions (other than for foreign income
taxes), and disregarded payments. In Year 1, CFC1X generates
[euro]1,000x of gross income from services to unrelated parties that
would be gross tested income without regard to paragraph (c)(7) of this
section and that is properly reflected on the books and records of
CFC1X. In Year 1, CFC1X accrues and pays [euro]480x of deductible
expenses to unrelated parties, [euro]280x of which is properly
reflected on CFC1X's books and records and is definitely related solely
to CFC1X's gross income reflected on its books and records, and
[euro]200x of which is properly reflected on FDE1Y's books and records
and is definitely related solely to FDE1Y's gross income reflected on
its books and records. Country X law does not provide rules for the
allocation or apportionment of these deductions to particular items of
gross income. In Year 1, CFC1X also accrues and pays [euro]325x to
FDE1Y for support services performed by FDE1Y in Country Y; the payment
is disregarded for federal income tax purposes. The [euro]325x of
disregarded support services income received by FDE1Y from CFC1X is
properly reflected on FDE1Y's books and records, and the [euro]325x of
disregarded support services expense paid from CFC1X to FDE1Y is
properly reflected on CFC1X's books and records.
(iii) Foreign income taxes. Country X imposes a 10% tax on net
income, and Country Y imposes a 16% tax on net income. Country X allows
a deduction, but not a credit, for foreign income taxes paid or accrued
to another country (such as Country Y). For Country Y tax purposes,
FDE1Y (which is not disregarded under Country Y tax law) has [euro]125x
of taxable income ([euro]325x of support services income received from
CFC1X, less a [euro]200x deduction for expenses paid to unrelated
parties). Accordingly, FDE1Y incurs a Country Y income tax liability
with respect to Year 1 of [euro]20x ([euro]125x x 16%), the U.S. dollar
amount of which is $20x. For Country X tax purposes, CFC1X has
[euro]500x of taxable income ([euro]1,000x of gross income for
services, less a [euro]480x deduction for expenses paid to unrelated
parties by CFC1X and FDE1Y and a [euro]20x deduction for Country Y
taxes; Country X does not allow CFC1X a deduction for the [euro]325x
paid to FDE1Y for support services because the [euro]325x payment is
disregarded for Country X tax purposes). Accordingly, CFC1X incurs a
Country X income tax liability with respect to Year 1 of [euro]50x
([euro]500x x 10%), the U.S. dollar amount of which is $50x.
(2) Analysis--(i) Tentative gross tested income item. Under
paragraph (c)(7)(ii) of this section, CFC1X has two tentative gross
tested income items, one item with respect to CFC1X (the ``CFC1X
tentative gross tested income item'') and one item with respect to
CFC1X's interest in FDE1Y (the ``FDE1Y tentative gross tested income
item''). The gross income attributable to each tested unit comprises
the gross income properly reflected on the books and records of each
tested unit under paragraph (c)(7)(ii)(B)(1) of this section, as
adjusted under paragraph (c)(7)(ii)(B)(2) of this section. Without
regard to the [euro]325x payment for support services from CFC1X to
FDE1Y, the gross income attributable to the FDE1Y tested unit would be
[euro]0 (that is, the [euro]325x of services income properly reflected
on the books and records of FDE1Y, reduced by the [euro]325x payment
from CFC1X to FDE1Y that is disregarded for federal income tax
purposes). Similarly, without regard to the [euro]325x payment for
support services from CFC1X to FDE1Y, the gross income attributable to
the CFC1X tested unit would be [euro]1,000x (that is, [euro]1,000x of
services income reflected on the books and records of CFC1X, unreduced
by the [euro]325x disregarded payment). However, under paragraph
(c)(7)(ii)(B)(2) of this section, the gross income attributable to each
of the CFC1X tested unit and the FDE1Y tested unit is adjusted by
[euro]325x, the amount of the disregarded services payment from CFC1X
to FDE1Y. Accordingly, the FDE1Y tentative gross tested income item is
[euro]325x ([euro]0 + [euro]325x), and the CFC1X tentative gross tested
income item is [euro]675x ([euro]1,000x - [euro]325x).
(ii) Deductions (other than for foreign income taxes). Under
paragraph (c)(7)(iii) of this section, CFC1X's tentative tested income
items are computed by applying the principles of Sec. 1.960-1(d)(3),
treating the CFC1X
[[Page 44645]]
tentative gross tested income item and the FDE1Y tentative gross tested
income item each as income in a separate tested income group (the
``CFC1X income group'' and the ``FDE1Y income group'') and by
allocating and apportioning CFC1X's deductions among the income groups
under federal income tax principles. For Year 1, CFC1X has deductible
expense (other than foreign income tax) of [euro]480x. This amount
includes [euro]280x of deductible expense that is definitely related
solely the services activity of the CFC1X tested unit, and another
[euro]200x of deductible expense (other than foreign income tax) that
is definitely related solely to the services provided by the FDE1Y
tested unit. Therefore, [euro]280x of deductible expense (other than
foreign income tax) is allocated and apportioned to the CFC1X income
group, and [euro]200x of deductible expense (other than foreign income
tax) is allocated and apportioned to the FDE1Y income group.
(iii) Foreign income tax deduction. CFC1X accrues foreign income
tax in Year 1 of [euro]70x ([euro]50x imposed by Country X and
[euro]20x imposed by Country Y). Under paragraph (c)(7)(iii) of this
section, the deductions for foreign income taxes are allocated and
apportioned under the principles of Sec. 1.960-1(d)(3)(ii) to the
FDE1Y income group and the CFC1X income group. Under paragraph
(c)(7)(iii)(A) of this section and Sec. 1.960-1(d)(3)(ii), the
principles of Sec. 1.904-6(a)(1) generally apply to determine the
amount of the foreign income tax paid or accrued with respect to each
income group. However, under paragraph (c)(7)(iii)(B) of this section,
foreign income taxes imposed by reason of the receipt of a disregarded
payment are allocated and apportioned under the principles of Sec.
1.904-6(a)(2). The Country Y tax of [euro]20x is imposed solely by
reason of FDE1Y's receipt of a [euro]325x disregarded payment. As a
result, the entire [euro]20x of Country Y tax is allocated and
apportioned to the FDE1Y income group under the principles of Sec.
1.904-6(a)(2)(ii)(A). If Country X had allowed a deduction for the
disregarded payment from CFC1X to FDE1Y and not otherwise imposed tax
on CFC1X with respect to income of FDE1Y, the foreign tax imposed by
Country X would relate only to the CFC1X tested income group, and no
portion of it would be allocated and apportioned to the FDE1Y income
group because the FDE1Y income would not be included in the Country X
tax base. However, because gross income subject to tax in Country X
includes gross income that for federal income tax purposes is
attributable to both the FDE1Y tested unit and the CFC1X tested unit,
the [euro]50x of foreign income tax imposed by Country X is related to
both the FDE1Y income group and to the CFC1X income group and must be
allocated and apportioned under the principles of Sec. 1.904-
6(a)(1)(i). Because Country X does not provide specific rules for the
allocation or apportionment of the [euro]500x of deductible expenses,
Sec. 1.904-6(a)(1)(ii) applies the principles of Sec. Sec. 1.861-8
through 1.861-14T to determine the foreign law net income subject to
Country X tax for purposes of apportioning the [euro]50x of Country X
tax between the income groups. CFC1X has [euro]1,000x of gross income
and [euro]500x of deductible expenses under the tax laws of Country X,
resulting in [euro]500x of net foreign law income. Of the [euro]1,000x
of foreign law gross income, [euro]325x corresponds to the gross income
in the FDE1Y income group, and [euro]675x corresponds to the gross
income in the CFC1X income group. Applying federal income tax
principles to allocate and apportion the foreign law deductions to
foreign law gross income, [euro]220x of the [euro]500x foreign law
deductions is allocated and apportioned to the FDE1Y income group and
[euro]280x is allocated and apportioned to the CFC1X income group. Of
the total [euro]500x of net foreign law income, [euro]105x ([euro]325x
Country X gross income corresponding to the FDE1Y income group, less
[euro]220x allocable Country X expenses) corresponds to the FDE1Y
income group and [euro]395x ([euro]675x Country X gross income
corresponding to the CFC1X income group, less [euro]280x allocable
Country X expenses) corresponds to the CFC1X income group. Therefore,
[euro]10.5x ([euro]50x x [euro]105x/[euro]500x) of Country X tax is
allocated and apportioned to the FDE1Y income group, and [euro]39.5x
([euro]50x x [euro]395x/[euro]500x) is allocated and apportioned to the
CFC1X income group. In total, [euro]30.5x of foreign tax ([euro]10.5x
of Country X tax and [euro]20x of Country Y tax) is allocated and
apportioned to the FDE1Y income group (the ``FDE1Y group tax''), and
[euro]39.5x of foreign tax (all of which is Country X tax) is allocated
and apportioned to the CFC1X tested income group (the ``CFC1X group
tax'').
(iv) Tentative tested income items. Under paragraph (c)(7)(iii) of
this section, the tentative tested income item attributable to FDE1Y
(the ``FDE1Y tentative tested income item'') is [euro]94.5x (the FDE1Y
gross tested income item of [euro]325x, less the allocated and
apportioned deductions of [euro]230.5x (the sum of deductions (other
than for foreign income tax) of [euro]200x, Country Y tax of [euro]20x,
and Country X tax of [euro]10.5x)). The tentative tested income item
attributable to CFC1X (the ``CFC1X tentative tested income item'') is
[euro]355.5x (the CFC1X gross tentative tested income item of
[euro]675x, less the allocated and apportioned deductions of
[euro]319.5x (the sum of deductions (other than for foreign income tax)
of [euro]280x and Country X tax of [euro]39.5x)).
(v) Foreign income taxes paid or accrued with respect to a
tentative tested income item. Under paragraph (c)(7)(vii) of this
section, the foreign income taxes paid or accrued with respect to a
tentative tested income item is the U.S. dollar amount of the current
year taxes that are allocated and apportioned to the related tentative
gross tested income item under the rules of paragraph (c)(7)(iii) of
this section. Therefore, the foreign income taxes paid or accrued with
respect to the FDE1Y tentative tested income item is $30.5x, the U.S.
dollar amount of the FDE1Y group tax, and the foreign income taxes paid
or accrued with respect to the CFC1X tentative tested income item is
$39.5x, the U.S. dollar amount of the CFC1X group tax.
(vi) Effective foreign tax rate. The effective foreign tax rate is
determined under paragraph (c)(7)(vi) of this section by dividing the
U.S. dollar amount of foreign income taxes paid or accrued with respect
to each respective tentative tested income item by the U.S. dollar
amount of the tentative tested income item increased by the U.S. dollar
amount of the relevant foreign income taxes. Therefore, the effective
foreign tax rate for the FDE1Y tentative tested income item is 24.4%,
computed by dividing $30.5x (the U.S. dollar amount of the foreign
income taxes paid or accrued with respect to the FDE1Y tentative tested
income item), by $125x (the sum of $94.5x, the U.S. dollar amount of
the FDE1Y tentative tested income item, and $30.5x, the U.S. dollar
amount of the foreign income taxes paid or accrued with respect to the
FDE1Y tentative tested income item). Similarly, the effective foreign
tax rate for the CFC1X tentative tested income item is 10%, computed by
dividing $39.5x (the U.S. dollar amount of the foreign income taxes
paid or accrued with respect to the CFC1X tentative tested income item)
by $395x (the sum of $355.5x, the U.S. dollar amount of the CFC1X
tentative tested income item, and $39.5x, the U.S. dollar amount of the
foreign taxes paid or accrued with respect to the CFC1X tentative
tested income item).
(vii) Gross income items excluded under sections 954(b)(4) and
[[Page 44646]]
951A(c)(2)(A)(i)(III). The FDE1Y tentative tested income item has an
effective foreign tax rate (24.4%) that is greater than 18.9% (90% of
the maximum rate of tax specified in section 11). Therefore, the
requirement of paragraph (c)(7)(i)(B) of this section is satisfied, and
the FDE1Y tentative gross tested income item qualifies under paragraph
(c)(7)(i) of this section for the high-tax exception of section
954(b)(4) and is excluded from tested income under sections
951A(c)(2)(A)(i)(III) and 954(b)(4) and paragraph (c)(1)(iii) of this
section. The CFC1X tentative tested income item has an effective
foreign tax rate (10%) that is not greater than 90% of the maximum rate
of tax specified in section 11. Therefore, the CFC1X tentative gross
tested income item does not qualify under paragraph (c)(7)(i) of this
section for the high-tax exception of section 954(b)(4) and is not
excluded from tested income under sections 951A(c)(2)(A)(i)(III) and
954(b)(4) and paragraph (c)(1)(iii) of this section.
(C) Example 3: Interest expense allocated and apportioned with
respect to the income of a lower-tier CFC--(1) Facts--(i) Ownership.
USP owns all of the stock of CFC1X. CFC1X directly owns all the
interests of FDE1Y. FDE1Y owns all of the stock of CFC3Z. Pursuant to
Sec. 1.861-9(j) and Sec. 1.861-9T(j), CFC1X uses the modified gross
income method to allocate and apportion its interest expense.
(ii) Gross income and deductions (including for foreign income
taxes). During Year 1, CFC1X generates [euro]4,000x of gross income
from services that would be gross tested income without regard to
paragraph (c)(7) of this section, [euro]3,000x of which is properly
reflected on the books and records of the CFC1X tested unit and
[euro]1,000x of which is properly reflected on the books and records of
the FDE1Y tested unit. CFC1X also accrues [euro]1,000x of interest
expense to an unrelated person. Country X imposes [euro]200x of income
taxes with respect to the [euro]3,000x of gross income properly
reflected on the books and records of the CFC1X tested unit, and
Country Y imposes [euro]200x of income taxes with respect to the
[euro]1,000x of gross income properly reflected on the books and
records of the FDE1Y tested unit. CFC3Z generates [euro]1,000x of gross
income from services that would be gross tested income without regard
to paragraph (c)(7) of this section, and such gross income is properly
reflected on the books and records of the CFC3Z tested unit. CFC3Z
accrues no expenses, and Country Z imposes [euro]100x of income taxes
with respect to the [euro]1,000x of gross income generated by CFC3Z.
(2) Analysis--(i) Tentative gross tested income items. Under
paragraph (c)(7)(ii) of this section, the [euro]3,000x of gross income
that is reflected on the books and records of the CFC1X tested unit,
and the [euro]1,000x of gross income that is reflected on the books and
records of the FDE1Y tested unit, are attributable to the CFC1X tested
unit and the FDE1Y tested unit, respectively. Under paragraph
(c)(7)(ii) of this section, each of these amounts is a separate
tentative gross tested income item of CFC1X (the ``CFC1X tentative
gross tested income item'' and the ``FDE1Y tentative gross tested
income item,'' respectively). Under paragraph (c)(7)(ii) of this
section, the [euro]1,000x item of tentative gross tested income that is
properly reflected on the books and records of the CFC3Z tested unit is
attributable to the CFC3Z tested unit. Under paragraph (c)(7)(ii) of
this section, the amount attributable to the CFC3Z tested unit is a
tentative gross tested income item of CFC3Z (the ``CFC3Z tentative
gross tested income item'').
(ii) Allocation and apportionment of interest expense. To compute
CFC1X's tentative tested income items, the principles of Sec. 1.960-
1(d)(3) apply by treating each of CFC1X's tentative gross tested income
items as income in a separate tested income group (the ``CFC1X income
group'' and the ``FDE1Y income group'') and allocate and apportion its
deductions among those income groups under federal income tax
principles. Because CFC1X uses the modified gross income method under
Sec. 1.861-9(j) and Sec. 1.861-9T(j) to allocate and apportion
interest expense, it must allocate and apportion its interest expense
between the CFC1X income group and the FDE1Y income group based on a
combined gross income amount that includes both the gross income of
CFC1X (including the gross income attributable to both the CFC1X tested
unit and the FDE1Y tested unit) and the gross income of CFC3Z, adjusted
as provided under Sec. 1.861-9(j) and Sec. 1.861-9T(j). Under Sec.
1.861-9(j) and Sec. 1.861-9T(j), the adjusted combined gross income of
CFC1X comprises the CFC1X tentative gross tested income item
([euro]3,000x), or 60% of the combined adjusted gross income amount,
the FDE1Y tentative gross tested income item ([euro]1,000x), or 20% of
the combined adjusted gross income amount, and the CFC3Z gross
tentative tested income item ([euro]1,000x), or 20% of the combined
adjusted gross income amount. Under paragraph (c)(7)(iii) of this
section, interest expense of CFC1X that is allocated and apportioned to
the gross income of CFC3Z under Sec. 1.861-9(j) and Sec. 1.861-9T(j)
is not allocated and apportioned to either the CFC1X income group or
the FDE1Y income group. Therefore, [euro]600x of interest expense (60%
of the [euro]1,000x of interest expense) is allocated and apportioned
to the CFC1X income group, and [euro]200x of interest expense (20% of
the [euro]1,000x of interest expense) is allocated and apportioned to
the FDE1Y income group. The [euro]200x of interest expense that is
allocated and apportioned to the [euro]1,000x of gross tentative tested
income of CFC3Z is allocated and apportioned to the residual income
group for purposes of paragraph (c)(7) of this section, but can still
be allocated and apportioned to a statutory grouping of tested income
of CFC1X for purposes of paragraph (c)(3) of this section. See
paragraph (c)(7)(iii) of this section.
(iii) Foreign income tax deduction. Under paragraph (c)(7)(iii) of
this section, deductions for foreign income taxes paid or accrued by
CFC1X are allocated and apportioned under the principles of Sec. Sec.
1.960-1(d)(3)(ii) and Sec. 1.904-6(a)(1) to the CFC1X income group and
the FDE1Y income group. Similarly, foreign income taxes paid or accrued
by CFC3Z are allocated and apportioned under the principles of
Sec. Sec. 1.960-1(d)(3)(ii) and 1.904-6(a)(1) to the tentative gross
tested income item of CFC3Z (the ``CFC3Z income group''). Under these
principles, the [euro]200x of Country X income taxes are allocated and
apportioned to the CFC1X income group (the ``CFC1X group tax''), the
[euro]200x of Country Y income taxes are allocated and apportioned to
the FDE1Y income group (the ``FDE1Y group tax''), and the [euro]100x of
Country Z income taxes are allocated and apportioned to the CFC3Z
income group (the ``CFC3Z group tax'').
(iv) Tentative tested income items. After the allocation and
apportionment of deductions to reduce the tentative gross tested income
in each income group, under paragraph (c)(7)(iii) of this section,
CFC1X has a tentative tested income item with respect to the CFC1X
tested unit of [euro]2,200x ([euro]3,000x, less [euro]600x of interest
expense and [euro]200x of foreign income tax expense, the ``CFC1X
tentative tested income item'') and a tentative tested income item with
respect to the FDE1Y tested unit of [euro]600x ([euro]1,000x, less
[euro]200x of interest expense and [euro]200x of foreign income tax
expense, the ``FDE1Y tentative tested income item''). CFC3Z has a
tentative tested income item of [euro]900x ([euro]1,000x, less
[euro]100x of foreign income tax expense, the ``CFC3Z tentative tested
income item'').
(v) Foreign income taxes paid or accrued with respect to a
tentative
[[Page 44647]]
tested income item. Under paragraph (c)(7)(vii) of this section, the
foreign income taxes paid or accrued with respect to a tentative tested
income item is the U.S. dollar amount of the current year taxes that
are allocated and apportioned to the related tentative gross tested
income item under the rules of paragraph (c)(7)(iii) of this section.
Therefore, the foreign income tax paid or accrued with respect to the
CFC1X tentative tested income item is $200x, the U.S. dollar amount of
the CFC1X group tax. Similarly, the foreign income tax paid or accrued
with respect to the FDE1Y tentative tested income item is $200x, the
U.S. dollar amount of the FDE1Y group tax, and the foreign income tax
paid or accrued with respect to the CFC3Z tentative tested income item
is $100x, the U.S. dollar amount of the CFC3Z group tax.
(vi) Effective foreign tax rate. The effective foreign tax rate is
determined under paragraph (c)(7)(vi) of this section by dividing the
U.S. dollar amount of foreign income taxes paid or accrued with respect
to each respective tentative tested income item by the U.S. dollar
amount of the tentative tested income item increased by the U.S. dollar
amount of the relevant foreign income taxes. Therefore, the effective
foreign tax rate for the CFC1X tentative tested income item is 8.3%,
computed by dividing $200x (the U.S. dollar amount of the foreign
income taxes paid or accrued with respect to the CFC1X tentative tested
income item), by $2,400x (the sum of $2,200x, the U.S. dollar amount of
the CFC1X tentative tested income item and $200x, the U.S. dollar
amount of the foreign taxes paid or accrued with respect to the CFC1X
tentative tested income item). The effective foreign tax rate for the
FDE1Y tentative tested income item is 25%, computed by dividing $200x
(the U.S. dollar amount of the foreign taxes paid or accrued with
respect to the FDE1Y tentative tested income item) by $800x (the sum of
$600x, the U.S. dollar amount of the FDE1Y tentative tested income
item, and $200x, the U.S. dollar amount of the foreign taxes paid or
accrued with respect to the FDE1Y tentative tested income item). The
effective foreign tax rate for the CFC3Z tentative tested income item
is 10%, computed by dividing $100x (the U.S. dollar amount of the
foreign taxes paid or accrued with respect to the CFC3Z tentative
tested income item) by $1,000x (the sum of $900x, the U.S. dollar
amount of the CFC3Z tentative tested income item, and $100x, the U.S.
dollar amount of the foreign taxes paid or accrued with respect to the
CFC3Z tentative tested income item).
(vii) Gross income items excluded under sections 954(b)(4) and
951A(c)(2)(A)(i)(III). The FDE1Y tentative tested income item is
subject to tax at an effective foreign tax rate (25%) that is greater
than 18.9% (90% of the maximum rate of tax specified in section 11).
Therefore, the requirement of paragraph (c)(7)(i)(B) of this section is
satisfied, and the FDE1Y tentative gross tested income item qualifies
under paragraph (c)(7)(i) of this section for the high-tax exception of
section 954(b)(4) and is excluded from tested income under sections
951A(c)(2)(A)(i)(III) and 954(b)(4) and paragraph (c)(1)(iii) of this
section. In computing the tested income of CFC1X under paragraph (c)(3)
of this section, the deductions of CFC1X that were allocated and
apportioned to the FDE1Y tentative gross tested income item (that is,
the [euro]200x of interest expense and the [euro]200x of FDE1Y group
taxes) are allocated and apportioned to this item of tentative gross
tested income. As a result, the [euro]1,000x of tentative gross tested
income excluded from tested income under section 954(b)(4), as well as
the [euro]200x of interest expense and [euro]200x of foreign tax
expense allocable to that gross income, are allocated and apportioned
to the residual category under paragraph (c)(3) of this section for
purposes of determining the tested income of CFC1X. Under Sec. 1.960-
1(d)(3), the $200x of foreign income taxes allocated and apportioned to
the excluded gross income would also be assigned to the residual income
group for purposes of determining CFC1X's tested taxes for purposes of
section 960(d). The CFC1X tentative tested income item and CFC3Z
tentative tested income item each have effective foreign tax rates
(8.3% and 10%, respectively) that are not greater than 90% of the
maximum rate of tax specified in section 11. Therefore, the CFC1X
tentative gross tested income item and the CFC3Z tentative gross tested
income item do not qualify under paragraph (c)(7)(i) of this section
for the high-tax exception of section 954(b)(4), and are not excluded
from tested income under sections 951A(c)(2)(A)(i)(III) and 954(b)(4)
and paragraph (c)(1)(i) of this section. Under paragraph (c)(3) of this
section, the corresponding deductions are allocated and apportioned to
that gross tested income in a manner that achieves a result that is
consistent the result of the allocation and apportionment of those
deductions under paragraph (c)(7) of this section. Accordingly, because
CFC3Z's tentative gross tested income is not excluded from gross tested
income under sections 951A(c)(2)(A)(i)(IIII) and 954(b)(4) and
paragraph (c)(1)(i) of this section, under paragraph (c)(3) of this
section the [euro]200x of CFC1X's interest expense that was apportioned
to tentative gross tested income of CFC3Z under the modified gross
income method in Sec. 1.861-9 is allocated and apportioned to gross
tested income of CFC1X and therefore reduces CFC1X's tested income. In
contrast, if the CFC3Z tentative gross tested item had been excluded
from gross tested income under sections 951A(c)(2)(A)(i)(III) and
954(b)(4) and paragraph (c)(1)(i) of this section, then the [euro]200x
of CFC1X's interest expense that was allocated and apportioned to that
income would be assigned to the residual category.
(D) Example 4: Application of tested unit rules--(1) Facts--(i)
Ownership. USP owns all of the stock of CFC1X. CFC1X directly owns all
the interests of FDEX and FDE1Y. In addition, CFC1X directly carries on
activities in Country Y that constitute a branch (as described in Sec.
1.267A-5(a)(2)) and that give rise to a taxable presence under Country
Y tax law and Country X tax law (such branch, ``FBY'').
(ii) Items reflected on books and records. For the CFC inclusion
year, CFC1X had a [euro]20x item of gross income (Item A), which is
properly reflected on the books and records of FBY, and a [euro]30x
item of gross income (Item B), which is properly reflected on the books
and records of FDEX.
(2) Analysis--(i) Identifying the tested units of CFC1X. Without
regard to the combination rule of paragraph (c)(7)(iv)(C) of this
section, CFC1X, CFC1X's interest in FDEX, CFC1X's interest in FDE1Y,
and FBY would each be a tested unit of CFC1X. See paragraph
(c)(7)(iv)(A) of this section. Pursuant to the combination rule,
however, the FDE1Y tested unit is combined with the FBY tested unit and
treated as a single tested unit because FDE1Y is a tax resident of
Country Y, the same country in which FBY is located (the ``Country Y
tested unit''). See paragraph (c)(7)(iv)(C)(1) of this section. The
CFC1X tested unit (without regard to any items attributable to the
FDEX, FDE1Y, or FBY tested units) is also combined with the FDEX tested
unit and treated as a single tested unit because CFC1X and FDEX are
both tax residents of County X (the ``Country X tested unit''). See
paragraph (c)(7)(iv)(C)(1) of this section.
(ii) Computing the items of CFC1X. Under paragraph (c)(7)(ii)(A) of
this section, a tentative gross tested income item is determined with
respect to each of the Country Y tested unit and the
[[Page 44648]]
Country X tested unit. To determine the tentative gross tested income
item of each tested unit, the item of gross income that is attributable
to the tested unit is determined under paragraph (c)(7)(ii)(B) of this
section. Under paragraph (c)(7)(ii)(B) of this section, only Item A is
attributable to the Country Y tested unit. Item A is not attributable
to the Country X tested unit because it is not reflected on the
separate set of books and records of the CFC1X tested unit or the FDEX
tested unit, and an item of gross income is only attributable to one
tested unit. See paragraph (c)(7)(ii)(B)(1) of this section. Under
paragraph (c)(7)(ii)(B) of this section, only Item B is attributable to
the Country X tested unit.
(3) Alternative facts--branch does not give rise to a taxable
presence in country where located--(i) Facts. The facts are the same as
in paragraph (c)(8)(iii)(D)(1) of this section (the original facts in
this Example 4), except that FBY does not give rise to a taxable
presence under Country Y tax law; moreover, Country X tax law does not
provide an exclusion, exemption, or other similar relief with respect
to income attributable to FBY.
(ii) Analysis. FBY is not a tested unit but is a transparent
interest. See paragraphs (c)(7)(iv)(A)(3) and (c)(7)(ix)(C) of this
section. CFC1X has a tested unit in Country X that includes the CFC1X
tested unit (without regard to any items related to the interest in
FDEX or FDE1Y, but that includes FBY since it is a transparent interest
and not a tested unit) and the interest in FDEX. See paragraph
(c)(7)(iv)(C) of this section. CFC1X has another tested unit in Country
Y, the interest in FDE1Y.
(4) Alternative facts--branch is a tested unit but is not
combined--(i) Facts. The facts are the same as in paragraph
(c)(8)(iii)(D)(1) of this section (the original facts in this Example
4), except that FBY does not give rise to a taxable presence under
Country Y tax law but Country X tax law provides an exclusion,
exemption, or other similar relief (such as a preferential rate) with
respect to income attributable to FBY.
(ii) Analysis. FBY is a tested unit. See paragraph (c)(7)(iv)(A)(3)
of this section. CFC1X has two tested units in Country Y, the interest
in FDE1Y and FBY. The interest in FDE1Y and FBY tested units are not
combined because FBY does not give rise to a taxable presence under the
tax law of Country Y. See paragraph (c)(7)(iv)(C)(2) of this section.
CFC1X also has a tested unit in Country X that includes the activities
of CFC1X (without regard to any items related to the interest in FDEX,
the interest in FDE1Y, or FBY) and the interest in FDEX.
(5) Alternative facts--split ownership of tested unit--(i) Facts.
The facts are the same as in paragraph (c)(8)(iii)(D)(1) of this
section (the original facts in this Example 4), except that USP also
owns CFC2X, CFC1X does not own FDE1Y, and CFC1X and CFC2X own 60% and
40%, respectively, of the interests of FPSY.
(ii) Analysis for CFC1X. Under paragraph (c)(7)(iv)(C)(1) of this
section, FBY and CFC1X's 60% interest in FPSY are combined and treated
as a single tested unit of CFC1X (``CFC1X's Country Y tested unit''),
and CFC1X's interest in FDEX and CFC1X's other activities are combined
and treated as a single tested unit of CFC1X (``CFC1X's Country X
tested unit''). CFC1X's Country Y tested unit is attributed any item of
CFC1X that is derived through its interest in FPSY to the extent the
item is properly reflected on the books and records of FPSY. See
paragraph (c)(7)(ii)(B)(1) of this section.
(iii) Analysis for CFC2X. Under paragraphs (c)(7)(iv)(A)(1) and
(c)(7)(iv)(A)(2)(i) of this section, CFC2X and CFC2X's 40% interest in
FPSY are tested units of CFC2X. CFC2X's interest in FPSY is attributed
any item of CFC2X that is derived through FPSY to the extent that it is
properly reflected on the books and records of FPSY. See paragraph
(c)(7)(ii)(B)(1) of this section.
(iv) Analysis for not combining CFC1X and CFC2X tested units. None
of the tested units of CFC1X are combined with the tested units of
CFC2X under paragraph (c)(7)(iv)(C)(1) of this section because they are
tested units of different controlled foreign corporations, and the
combination rule only combines tested units of the same controlled
foreign corporation.
(6) Alternative facts--split ownership of transparent interest--(i)
Facts. The facts are the same as in paragraph (c)(8)(iii)(D)(1) of this
section (the original facts in this Example 4), except that USP also
owns CFC2X, CFC1X does not own DE1Y, and CFC1X and CFC2X own 60% and
40%, respectively, of the interests in FPSY, but FPSY is not a tax
resident of any foreign country and is fiscally transparent for Country
X tax law purposes.
(ii) Analysis for CFC1X. CFC1X's interest in FPSY is not a tested
unit but is a transparent interest. See paragraphs (c)(7)(iv)(A)(2) and
(c)(7)(ix)(C) of this section. Under paragraph (c)(7)(v)(C) of this
section, any item of CFC1X that is derived through its interest in FPSY
and is properly reflected on the books and records of FPSY is treated
as properly reflected on the books and records of CFC1X.
(iii) Analysis for CFC2X. CFC2X's interest in FPSY is not a tested
unit but is a transparent interest. See paragraphs (c)(7)(iv)(A)(2) and
(c)(7)(ix)(C) of this section. Under paragraph (c)(7)(v)(C) of this
section, any item of CFC2X that is derived through its interest in FPSY
and is properly reflected on the books and records of FPSY is treated
as properly reflected on the books and records of CFC1X.
(E) Example 5: CFC group--Controlled foreign corporations with
different taxable years--(1) Facts. USP owns all the stock of CFC1X and
CFC2X. CFC2X has a taxable year ending November 30. On December 15,
Year 1, USP sells all the stock of CFC2X to an unrelated party for
cash.
(2) Analysis. The determination of whether CFC1X and CFC2X are in a
CFC group is made as of the close of their CFC inclusion years that end
with or within the taxable year ending December 31, Year 1, the taxable
year of USP, the controlling domestic shareholder. See paragraph
(c)(7)(viii)(E)(2)(ii) of this section. Under paragraph
(c)(7)(viii)(E)(2)(i) of this section, USP directly owns more than 50%
of the stock of CFC1X as of December 31, Year 1, the end of CFC1X's CFC
inclusion year. USP also directly owns more than 50% of the stock of
CFC2X as of November 30, Year 1, the end of CFC2X's CFC inclusion year.
Therefore, CFC1X and CFC2X are members of a CFC group, and USP must
consistently make high-tax elections, or revocations, under paragraph
(c)(7)(viii) of this section with respect to CFC1X's taxable year
ending December 31, Year 1, and CFC2X's taxable year ending November
30, Year 1. This is the case notwithstanding that USP does not directly
own more than 50% of the stock of CFC2X as of December 31, Year 1, the
end of CFC1X's CFC inclusion year. See paragraph (c)(7)(viii)(E)(2)(ii)
of this section.
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Par. 4. Section 1.951A-7 is amended by:
0
1. Designating the undesignated text as paragraph (a);
0
2. Adding a subject heading to newly designated paragraph (a);
0
3. Removing the word ``Sections'' and adding in its place ``Except as
otherwise provided in this section, sections'' in newly designated
paragraph (a); and
0
4. Adding paragraph (b).
The additions read as follows:
Sec. 1.951A-7 Applicability dates.
(a) In general. * * *
(b) High-tax exception. Section 1.951A-2(c)(1)(iii), (c)(3)(ii),
and (c)(7)
[[Page 44649]]
and (8) apply to taxable years of foreign corporations beginning on or
after July 23, 2020, and to taxable years of United States shareholders
in which or with which such taxable years of foreign corporations end.
In addition, taxpayers may choose to apply the rules in Sec. 1.951A-
2(c)(1)(iii), (c)(3)(ii), and (c)(7) and (8) to taxable years of
foreign corporations that begin after December 31, 2017, and before
July 23, 2020, and to taxable years of U.S. shareholders in which or
with which such taxable years of the foreign corporations end, provided
that they consistently apply those rules and the rules in Sec. 1.954-
1(c)(1)(iii)(A)(3), Sec. 1.954-1(c)(1)(iv), and the first sentence of
Sec. 1.954-1(d)(3)(i) to such taxable years.
Sec. 1.954-0 [Amended]
0
Par. 5. Section 1.954-0 is amended by removing and reserving paragraph
(b).
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Par. 6. Section 1.954-1 is amended by:
0
1. Adding ``or'' to the end of paragraph (c)(1)(iii)(A)(2)(ii);
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2. Removing and reserving paragraphs (c)(1)(iii)(A)(2)(iii) and (iv);
0
3. Adding paragraphs (c)(1)(iii)(A)(3) and (c)(1)(iv);
0
4. In paragraph (d)(1) introductory text, removing the language
``foreign base company oil related income, as defined in section
954(g), or'' in the second sentence and adding a sentence after the
fourth sentence;
0
5. Removing the language ``imposed by a foreign country or countries''
in paragraph (d)(1)(ii);
0
6. Removing the language ``in a chain of corporations through which a
distribution is made'' in the first sentence in paragraph (d)(2)
introductory text;
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7. Removing the language ``(or deemed paid or accrued)'' in paragraph
(d)(2)(i);
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8. Revising paragraph (d)(3)(i);
0
9. Removing and reserving paragraph (d)(3)(ii);
0
10. Removing paragraph (d)(7);
0
11. Revising paragraph (h)(1); and
0
12. Adding paragraph (h)(3).
The additions and revisions read as follows:
Sec. 1.954-1 Foreign base company income.
* * * * *
(c) * * *
(1) * * *
(iii) * * *
(A) * * *
(3) For purposes of paragraph (c)(1)(iii)(A) of this section, the
aggregate amount from all transactions that falls within a single
separate category (as defined in Sec. 1.904-5(a)(4)(v)) and is
described in paragraph (c)(1)(iii)(A)(1)(i) of this section is a single
item of income. Similarly, the aggregate amount from all transactions
that falls within a single separate category (as defined in Sec.
1.904-5(a)(4)(v)) and is described in each one of paragraphs
(c)(1)(iii)(A)(1)(ii) through (c)(1)(iii)(A)(1)(v) of this section is
in each case a separate single item of income. The same principles
apply for transactions described in each one of paragraphs
(c)(1)(iii)(A)(2)(i) through (v) of this section.
* * * * *
(iv) Treatment of deductions or loss attributable to disqualified
basis. For purposes of paragraph (c)(1)(i) of this section (and in the
case of insurance income, paragraph (a)(6) of this section), in
determining the amount of a net item of foreign base company income or
insurance income, deductions or loss described in Sec. 1.951A-2(c)(5)
or (c)(6) are not allocated and apportioned to gross foreign base
company income or gross insurance income.
(d) * * *
(1) * * * For rules concerning the application of the high-tax
exception of sections 954(b)(4) and 951A(c)(2)(A)(i)(III) to tentative
gross tested income items, see Sec. 1.951A-2(c)(1)(iii), (c)(3)(ii),
and (c)(7) and (8). * * *
* * * * *
(3) * * *
(i) In general. The amount of foreign income taxes paid or accrued
by a controlled foreign corporation with respect to a net item of
income for purposes of section 954(b)(4) and this paragraph (d) is the
U.S. dollar amount of the controlled foreign corporation's current year
taxes (as defined in Sec. 1.960-1(b)(4)) that are allocated and
apportioned under Sec. 1.960-1(d)(3)(ii) to the subpart F income group
(as defined in Sec. 1.960-1(d)(2)(ii)(B)) that corresponds with the
net item of income.
* * * * *
(h) * * *
(1) Paragraph (d)(3) of this section for taxable years ending on or
after December 4, 2018, and before July 23, 2020. For the application
of paragraph (d)(3) of this section to taxable years of controlled
foreign corporations ending on or after December 4, 2018, and before
July 23, 2020, and to taxable years of United States shareholders in
which or with which such taxable years of the controlled foreign
corporations end, see Sec. 1.954-1, as contained in 26 CFR part 1
revised as of April 1, 2020.
* * * * *
(3) Paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this
section for taxable years beginning on or after July 23, 2020.
Paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this section
apply to taxable years of a controlled foreign corporation beginning on
or after July 23, 2020, and to taxable years of United States
shareholders in which or with which such taxable years of foreign
corporations end. In addition, taxpayers may choose to apply the rules
in paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this
section to taxable years of controlled foreign corporations that begin
after December 31, 2017, and before July 23, 2020, and to taxable years
of United States shareholders in which or with which such taxable years
of the controlled foreign corporations end, provided that they
consistently apply those rules and the rules in Sec. 1.951A-
2(c)(1)(iii), (c)(3)(ii), and (c)(7) and (8) to such taxable years.
Sec. 1.1502 [Amended]
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Par. 7. Section 1.1502-51 is amended in paragraph (g)(1) by removing
the language ``Sec. 1.951A-7'' and adding in its place ``Sec. 1.951A-
7(a)'' wherever it appears.
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: July 1, 2020.
David Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2020-15351 Filed 7-20-20; 4:15 pm]
BILLING CODE 4830-01-P