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Summary of final and proposed foreign tax credit regulations

On December 2, 2019, the IRS and Treasury released final and proposed regulations

addressing the foreign tax credit and related provisions. In addition, the regulations finalize

certain portions of the OFL regulations (published in 2012) and proposed section 905(c) and

986(a) regulations (published in 2007).

With respect to the section 905(c) and 986(a) regulations, the Treasury decision finalizes

(1) the currency translation rules (which are moved from Treas. Reg. § 1.905-3T(b) to

Treas. Reg. § 1.986(a)-1)), (2) the definition of foreign tax redetermination in Treas. Reg. §

1.905-3T(c), (3) the rules under Treas. Reg. § 1.905-3T(d)(1) requiring a redetermination

of U.S. tax liability with respect to foreign income taxes other than those that are deemed

paid under section 960, and (4) the rules in Treas. Reg. § 1.905-3T(e) relating to foreign

income taxes imposed on foreign tax refunds.

As a practical matter, the final regulations are approximately 400 pages long and the

proposed regulations over 200 pages long. Below is a summary of the key provisions of the

final and proposed regulations.

Effective Dates and Key Changes

1. Effective Dates

• Final Regulations:

i. Retains effective dates in the proposed regulations (generally effective

beginning in 2018).

ii. OFL regulation changes are effective for tax years ending after the Fed.

Reg. publication date

iii. 905(c) regulation changes apply to foreign tax redeterminations in tax

years ending on or after the Fed. Reg. publication date.

iv. 986(c) regulations apply to tax years ending on or after the Fed. Reg.

publication date and to tax years of foreign corporations which end with or

within a tax year of a US shareholder ending on or after the Fed. Reg.

publication date.

• Proposed Regulations

i. Many of the proposed regulations apply to taxable years that end on or

after the date that the proposed regulations are published in the federal

register. Presumably, this will include the 2019 calendar taxable year.

ii. The changes to the rules regarding the allocation and apportionment of

R&E and the new Treas. Reg. § 1.861-20 (and related changes including

in Treas. Reg. § 1.904-6) apply to taxable years beginning after December

31, 2019.

• Reliance on the proposed regulations rules for the allocation and

apportionment of R&E expense is allowed for taxable years

beginning after December 31, 2019.

iii. The new definition of a financial services entity and ordering rules for

NOLs apply to table years after the publication of final regulations.

iv. The provisions addressing foreign tax redeterminations and Prop. Treas.

Reg. 1.905-3 – 5 apply to redeterminations occurring after the date that

the proposed regulations are published in the federal register. Proposed

Treas. Reg. § 1.905-3 is limited to foreign tax redeterminations that relate

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to a taxable year of a foreign corporation, only if the redetermination

relates to a taxable year of the CFC beginning after December 31, 2017.

Proposed Treas. Reg. § 1.905-5 is limited to foreign tax redeterminations

that relate to taxable years of foreign corporations beginning January 1,

2018.

v. Proposed Treas. Reg. § 1.965-5(b)(2) applies to taxable years of foreign

corporations that end on or after after the date that the proposed

regulations are published in the federal register

vi. Finally, the provisions of 1.1502-4 apply to taxable years for which the

original consolidated Federal income tax return is due (without extension)

after the date that the proposed regulations are published in the federal

register

2. Key Changes in Regulations

• Final Regulations

i. Provide that the E&P bump rule in Treas. Reg. § 1.861-12 applies for

purposes of valuing the stock of lower tier CFCs.

ii. Revise Treas. Reg. § 1.861-9(j)(2)(ii) to allow upper-tier CFCs to take into

account gross tested income (net of interest expense) of lower-tier CFCs.

This change should eliminate distortions in the case of an upper tier

holding company.

iii. Provide a safe harbor option for assigning a portion of the pre-2018

unused foreign taxes to the post-2017 separate category for foreign

branch category income.

iv. Retain disregarded payment rule with respect to the branch basket

v. Provide that all general partners characterize their distributive share of

income from the partnership based on income of the partnership even if

the general partner owns a less than 10 percent interest in the

partnership

vi. The regulations finalize base and timing difference rules without change.

However, very detailed new rules are included in the proposed

regulations.

• Proposed Regulations

i. Provide that stewardship expenses are also allocated to inclusions under

sections 951 and 951A, section 78 dividends, and all amounts included

under the passive foreign investment company provisions.

ii. Provide new rules for the allocation and apportionment of litigation

damages awards, prejudgment interest, settlement payments, and NOLs.

iii. Contain provisions, similar to the SPL rules of the final regulations,

addressing loans by partnerships to their partners.

iv. Provide that guaranteed payments for the use of capital described in

section 707(c) are treated similarly to interest deductions for purposes of

allocating and apportioning deductions under Treas. Reg. §§1.861-8

through 1.861-14 and are treated as income equivalent to interest under

section 954(c)(1)(E).

v. Clarify what it means for an asset to be connected with indebtedness,

modify the existing example, and add a new example, for the purpose of

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limiting the scope of Treas. Reg. § 1.861-12T(f) (i.e., addressing potential

rules under section 163(l)).

vi. Provide that R&E expenditures are not allocated and apportioned to GILTI

or Subpart F income.

vii. Create a new reg section, Treas. Reg. § 1.861-20 which provide new and

comprehensive rules for the allocation of creditable foreign taxes to

income and to the characterization of income where relevant, including:

• Base Differences: Providing an exclusive list of items that are

excluded from U.S. gross income;

• Distributions: In the case of a distribution from a non-hybrid

corporation that is recognized for both Federal income tax law and

foreign tax law purposes, treats foreign gross income arising from

the distribution as a dividend and as capital gain to the extent of

the portions of the distribution that are, under Federal income tax

law, characterized as a dividend and capital gain, respectively.

• Foreign Law Subpart F: Providing that income arising by reason of

a foreign law regime similar to the subpart F provisions under

sections 951 through 959 (a “foreign law subpart F regime”), is

assigned to the same statutory or residual grouping as the gross

income (determined under the foreign law subpart F regime) of the

foreign law CFC that gave rise to the foreign gross income of the

taxpayer;

• Branch Payments: Provides that certain payments from a foreign

branch are assigned to the statutory and residual groupings by

deeming the payment to be made ratably out of the after-tax

income, computed for Federal income tax purposes, of the foreign

branch, and deeming the branch income to arise in the statutory

and residual groupings in the same ratio as the tax book value of

the assets, including stock, owned by the foreign branch. Provides

that foreign gross income from a disregarded payment made by a

foreign branch owner is assigned to the residual grouping and

assigns an item of foreign gross income attributable to gain

recognized under foreign law with respect to the receipt of a

disregarded payment in exchange for property. This rule also

applies to foreign branches owned by foreign corporations.

• Reverse Hybrid: Provides that the foreign gross income that a

taxpayer recognizes from a reverse hybrid is assigned to the

statutory and residual groupings by treating that foreign gross

income as the income of the reverse hybrid.

viii. Taxes Attributable to Subpart F and Reverse Hybrid Inclusions:

• The regulation reassigns to the section 951A category the foreign

gross income that, if the foreign law CFC or reverse hybrid

recognized the foreign gross income instead of the United States

shareholder, would be assigned to the general category tested

income group of the foreign law CFC or reverse hybrid to which an

inclusion under section 951A is attributable.

Final Regulations

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1. Section 861 Final Regulations

• Allocation and Apportionment to GILTI: Consistent with the proposed regulations, the

final regulations reject comments that no expenses should be allocated and

apportioned to the section 951A category. However, the proposed regulations

provide additional rules that should reduce expenses allocated and apportioned to

the section 951A category.

• Exempt Assets: The final regulations revise Treas. Reg. § 1.861-8(d)(2)(ii)(C)(2) to

reduce the portion of assets treated as exempt by reason of FDII. Unlike the

proposed regulations, which required taxpayers to identify assets that produce gross

income included in FDII for purposes of determining the portion of a taxpayer’s

assets that are treated as exempt by reason of having FDII, the final regulations,

consistent with guidance under section 250 providing that the determination of

FDDEI requires applying Treas. Reg. §§1.861-8 through 1.861-14T and 1.861-17 to

allocate and apportion deductions between gross income derived from sales and

services that are FDDEI (“gross FDDEI”) versus gross income that is not gross

FDDEI, refer to assets that produce gross FDDEI rather than income included

in FDII.

• Specified Partnership Loans:

o The final regulations clarify that the SPL rules should not be applied to create

additional gross income and instead solely to match existing income and

expenses relate to a SPL.

o In addition, the anti-avoidance rule of the proposed regulations are retained

and examples are added to further illustrate the operation of these provisions,

including appropriate adjustments that must be made in cases where the

transaction involves a loan to a CFC.

▪ Additional guidance is also provided in the Proposed FTC regulations,

addressing the treatment of loans made by a partnership to a partner

(“upstream loans”).

• Valuation of Assets for Purposes of Interest Expense Apportionment

o The final regulations decline to modify the transition rule in Treas. Reg. §

1.861-9(g)(2)(i)(A) for transition from FMV to TBV or Alternative TBV

method. Thus, taxpayers must use average of beginning of year or end of

first quarter value and end of year value of assets.

o E&P Bump: The final regulations confirm in Treas. Reg. § 1.861-9(g)(4) that

the E&P bump rule in Treas. Reg. § 1.861-12 applies for purposes of valuing

the stock of lower tier CFCs.

o In addition, the final regulations provide that Treas. Reg. § 1.861-12 applies

for all operative sections, and not solely for section 904.

• Treatment of tested income in allocating and apportioning interest expense of a CFC

under the MGI method

o The final regulations revise Treas. Reg. § 1.861-9(j)(2)(ii) to allow upper-tier

CFCs to take into account gross tested income (net of interest expense) of

lower-tier CFCs. This change should eliminate distortions in the case of an

upper tier holding company and is consistent with the group based approach

of section 951A.

• Characterization of stock of certain foreign corporations under Treas. Reg. § 1.861-

12(c)(3) and -13

o The final regulations decline to adopt a comment that stock of a noncontrolled

10-percent owned foreign corporation owned by a CFC be assigned to the

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specified foreign source general or passive category because a distribution by

the noncontrolled 10-percent owned foreign corporation to a CFC should be

eligible for the section 245A DRD under Treas. Reg. § 1.952-2.

▪ Importantly, the IRS and Treasury again state that future guidance

will provide that any provision expressly limited in its application to

domestic corporation does not apply to CFCs by reason of Treas. Reg.

§ 1.952-2 and that such guidance will address the availability of the

section 245A deduction at the CFC level.

o The final regulations also decline to exempt the gross income or assets of

tested loss CFCs from the expense apportionment rules.

• Section 904(b)(4)

o The final regulations retain the rule assigning stock to a section 245A

subgroup without regard to whether a dividend paid (either in a current or

future year) with respect to the stock may qualify for the section 245A

deduction.

2. FTC Limitation under Section 904

• Treas.Reg. § 1.904-2(j): In response to comments requesting a simplified rule for

assigning a portion of the pre-2018 unused foreign taxes to the post-2017 separate

category for foreign branch category income, final Treas. Reg. § 1.904-2(j)(1)(iii)(B)

provides a safe harbor option.

o Under the safe harbor unused foreign taxes from a particular pre-2017

taxable year are allocated to the post-2018 separate category for foreign

branch category income based on a ratio equal to the amount of foreign

income taxes that were paid or accrued by the taxpayer’s foreign branches

divided by the amount of all foreign income taxes assigned to the general

category that were paid or accrued, or deemed paid by the taxpayer with

respect to the taxable year.

• Treas. Reg. § 1.904(f)-12(j): In response to comments, the regulation is revised to

apply regardless of whether the taxpayer makes an election under Treas. Reg. §

1.904-2(j). The regulation provides a reconstruction approach or safe harbor for

characterizing SLL and OFL accounts and NOLs attributable to pre-2018 years, as

well as rules coordinating Treas. Reg. §§ 1.904(f)-12(j) and 1.904-2(j).

• Treas. Reg. § 1.904-4(f) – Foreign Branch Category Income (“FBI”):

o Generally. The final regulations retain the 2018 proposed rules for attributing

income to a foreign branch, with several clarifications and modifications. The

preamble outlines the policy goals underlying these rules, which are: (i)

attribution of income in a manner commensurate with business activities; (ii)

administrability; (iii) conformity with local country tax law; and (iv) giving

effect to the policies of limiting the deduction under section 250 and the credit

under section 901 by reference to FBI.

o Disregarded Payments. The final regulations retain the disregarded payment

reallocation rules, including the rule preserving the amount, source, and

character of reallocated income, also clarifying that FBI regulations have no

bearing on treaty resourcing analysis. In addition, the regulations decline to

(i) allow netting of disregarded payments or (ii) allow disregarded interest

payments to result in reallocation of income (however, the Treasury and the

IRS are considering future guidance for certain financial institutions that may

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provide for adjustments to FBI by reference to disregarded interest

payments). Finally, the final regulations provide additional (i) ordering rules

for multiple disregarded payments and (ii) guidance related to branch-to-

branch transactions.

o Disregarded Sales of Property. The final regulations provide extensive

additional guidance for applying the disregarded payment rules in cases

where the foreign branch buys or sells inventory or non-inventory property in

a disregarded transaction, i.e., where such payments, if regarded, would give

rise to basis in the property, cost recovery deductions, or COGS.

o Intangible Property Rule. The final regulations retain, with modifications, the

rule for disregarded transfers of IP, which requires the use of section 367(d)

principles to impute disregarded payments, over time, for disregarded

transfers of intangible property (i) from owner to branch, (ii) from branch to

owner, or (iii) from branch to branch. However, as revised, the intangible

property rule does not apply to transfers that occurred before

December 7, 2018. In addition, the rule does not apply to transfers by a

transitory owner of IP, subject to certain limitations.

o Foreign Branch Definition and Books and Records Requirement: The final

regulations replace the presumption in the proposed regulations with a per se

rule that activities conducted outside of the United States that constitute a

permanent establishment under the relevant income tax treaty constitute a

foreign branch. Further, the final regulations provide rules for constructing

hypothetical books and records, where activities otherwise qualify as a foreign

branch but such branch does not have separate books and records, effectively

eliminating the separate books and records requirement from the definition.

The regulations apply the principles in the DCL regulations for this purpose.

o Final regulations do not address comments deemed to be outside the scope

of these regulations, including comments related to the allocation and

apportionment of expenses to foreign branch income, certain consolidated

group issues, operation of section 367(d), etc. However, the Preamble notes

that future guidance projects are being considered, including:

▪ Guidance coordinating the allocation and apportionment of expenses

with the determination of foreign branch category income for regulated

financial institutions (describing two potential options for this

purpose),

▪ Possible additional rules for allocating and apportioning certain

expenses, including R&E expense, to foreign branch category income.

• Treas. Reg. § 1.904-4(n) – Distributive Shares of Partnership Income

o The final regulations revise Treas. Reg. § 1.904-4(n) (and Treas. Reg. §

1.861-9(e)(4)), consistent with prior final Treas. Reg. § 1.904-5(h), to

provide that all general partners characterize their distributive share of

income from the partnership based on income of the partnership even if the

general partner owns a less than 10 percent interest in the partnership.

• Look Through Rules: The final regulations confirm that the look-through rules do not

apply to characterize interest, rents, and royalties paid by a CFC to a US shareholder

as section 951A category income

• Timing Delay in Deductibility: The final regulations clarify that the allocation and

apportionment of interest expense rules in Treas. Reg. § 1.904-5(c)(2) apply in the

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year interest income is taken into account, even if the interest expense is disallowed

under section 163(j).

3. Allocation and Apportionment of Foreign Taxes

• Treatment of Base Differences: Based on the statutory language and cross

references, the final regulations provide that foreign taxes associated with a base

difference are assigned solely to the foreign branch category.

• Base and Timing Differences: The regulations finalize base and timing difference

rules without change, concluding that the regulation generally reflects the

appropriate principles regarding what constitutes a base or timing difference.

However, new rules providing additional guidance are included in proposed

regulations.

4. Translation of Foreign Income Taxes and Foreign Tax Redeterminations

The regulations finalize portions of the 2007 section 905(c) regulations (and move parts of

those regulations to section 986 regulations). The Preamble addresses comments submitted

on the 2007 regulations and makes a number of clarifying changes in response to those

comments. Very generally, the final regulation:

• Treas. Reg. §§1.986(a)-1(a)(2)(i), 1.986(a)-1(c), and 1.905-3(a), clarify that two

years means 24 months and not a potentially shorter length of time due to a short

tax year for section 905(c)(1)(B) which provides that if accrued taxes are not paid

before the date two years after the close of the taxable year to which such taxes

relate, the taxpayer must notify the IRS and redetermine its U.S. tax liability for the

year or years in which it claimed a credit for such taxes.

• Clarifies that the relevant taxable year to which the tax relates is that of the person

that is considered to pay the tax under §1.901-2(f). Thus, in the partnership context

the relevant tax year is that of the partnership rather than the partner.

• Addresses the definition of and translation rules for inflationary currency.

• To minimize compliance burdens for taxpayers, provide that taxpayers may translate

accrued but unpaid taxes (including foreign taxes deemed paid under section 960)

into dollars using the spot rate on the date of payment, in lieu of the provisional

year-end rate, on the original return for the year for which the credit is claimed if

such taxes are paid before the due date (with extensions) of such original return and

such return is timely filed.

• Expands the scope of and provide further guidance on the election under section

986(a)(1)(D) to translate certain foreign taxes at the spot rate when paid.

• Clarifies that a foreign tax redetermination.

o A foreign tax redetermination includes corrections of errors in computing the

foreign tax credit and payments of contested taxes following resolution of the

contest).

o To better coordinate the application of the foreign tax redetermination and

currency translation rules and to ease compliance burdens, the definition of a

foreign tax redetermination has been revised to include “accrued taxes that

are not paid on or before the date 24 months after the close of the taxable

year to which such taxes relate.”

• Provides that if a foreign tax redetermination occurs with respect to direct foreign

taxes and the taxpayer cannot use all of the additional taxes in the year to which

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those taxes relate, amended returns are also required for any year to which the

taxes are carried under section 904(c).

• Clarify that taxes that first accrue after the date 24 months after the close of the

taxable year to which such taxes relate may not be claimed as a credit or added to

PTEP group taxes until they are paid.

5. Deemed Paid Taxes Under Section 960

• Current year taxes (1.960-1(b)(4))

o The preamble to the final regulations reject a comment that under the all

events test, foreign taxes may accrue on a date other than the close of the

foreign tax year.

o The final regulation reject any effort to address mismatches caused by

different US and foreign tax years. Instead, they retains the rule that current

year taxes are foreign taxes that accrue with or within the US tax year.

▪ Accordingly, current year taxes are allocated and apportioned to an

income group based on the income on which they are imposed under

foreign law, even if that income is in part recognized in a different US

tax year due to a difference between US and foreign year ends.

Although, Treasury and the IRS recognize that this may result in taxes

being allocated to a group that has no current year income, they

conclude that a multi-year approach would be inconsistent with the

repeal of section 902.

• In addition, the final regulations confirm that no deemed paid credits are allowed

with respect to a section 956 inclusion.

6. PTEP Groups in Annual PTEP Accounts/Deemed Paid Taxes on PTEP Distributions

• The final regulations reduce the number of separate PTEP groups to be tracked from

16 to 10.

• In addition, the final regulations confirm that taxes not deemed paid under section

965 by reason of section 965(b)(4) cannot be treated as taxes deemed paid with

respect to a PTEP distribution. In addition, the Treasury and IRS reject the argument

that they have authority to fix a section 78 statutory “glitch” by regulation and

instead confirm that a section 78 gross-up is required for taxes deemed paid on a

PTEP distribution.

Proposed Regulations

Allocation and Apportionment of Deductions and the Calculation of Taxable

Income for Purposes of Section 904(a)

1. In General

• Treatment of Stewardship Expenses: The proposed regulations provide that that

stewardship expenses are allocated to dividends and inclusions received or accrued,

or to be received or accrued, from related corporations. Unlike the current

regulations, the proposed regulations provide that stewardship expenses are also

allocated to inclusions under sections 951 and 951A, section 78 dividends, and all

amounts included under the passive foreign investment company provisions.

o For this purpose, the proposed regulations provide that stewardship expenses

are apportioned based upon the relative values of a taxpayer’s stock assets,

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as determined and characterized under Treas. Reg. § 1.861-9T(g) (and, as

relevant, Treas. Reg. §§ 1.861-12 and 1.861-13) for purposes of allocating

and apportioning the taxpayer’s interest expense.

o The proposed regulations extend the treatment of stewardship expenses to

cover expenses incurred with respect to a partnership.

• Litigation damages awards, prejudgment interest, and settlement payments:

o The proposed regulations provide that deductions for damages awards,

prejudgment interest, and settlement payments arising from product liability

and similar or related claims are allocated to the class or classes of gross

income produced by the specific sales of products or services that gave rise to

the claims for damage or injury.

o Damages, prejudgment interest, and settlement payments related to events

incident to the production of goods or provision of services, such as damages

for injuries caused by industrial accidents, are allocated to the class of gross

income produced by the assets involved in the event and, if necessary,

apportioned between groupings based on the relative value of the assets in

such groupings.

o In the case of claims made by investors that arise from corporate negligence,

fraud, or other malfeasance, the proposed regulations provide that damages,

prejudgment interest, and settlement payments paid by the corporation are

allocated and apportioned based on the value of all the corporation’s assets.

• NOL Deduction: The proposed regulations provide that a net operating loss is

assigned to the statutory and residual groupings by reference to the losses in each

statutory or residual grouping (determined without regard to adjustments made

under section 904(b)) that are not allocated to reduce income in a different grouping

in the taxable year of the loss.

• Application of the exempt income/asset rule to insurance companies in connection

with certain dividends and tax-exempt interest

o The proposed regulations provide that in the case of insurance companies, the

term exempt income includes dividends for which a deduction is provided by

sections 243(a)(1) and (2) and 245, without regard to the proration rules

disallowing a portion of the deduction. Similarly, the term exempt income

includes tax exempt interest without regard to the proration rules.

2. Loans between Partners and Partnerships

• Upstream Loans: The proposed regulations contain provisions addressing loans by

partnerships to their partners. Under these provisions, to the extent the borrower in

an upstream partnership loan transaction takes into account both interest expense

and interest income with respect to the same loan, the interest income is assigned to

the same statutory and residual groupings as those groupings from which the

matching amount of interest expense is deducted, as determined under the

allocation and apportionment rules in Treas. Reg. §§ 1.861-9 through 1.861-13.

o Like the provisions of the final regulations, for purposes of applying the

allocation and apportionment rules, the borrower does not take into account

as an asset its proportionate share of the loan, as otherwise provided under

Treas. Reg. § 1.861-9(e)(2) and (3).

o Further, these provisions apply to transactions that are not loans but that give

rise to deductions that are allocated and apportioned in the same manner as

interest expense and also contain anti abuse rules.

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• Treatment of Guaranteed Payments: The proposed regulations revise Treas. Reg. §

1.861-9(b) and Treas. Reg. § 1.954-2(h)(2)(i) explicitly to provide that guaranteed

payments for the use of capital described in section 707(c) are treated similarly to

interest deductions for purposes of allocating and apportioning deductions under

Treas. Reg. §§1.861-8 through 1.861-14 and are treated as income equivalent to

interest under section 954(c)(1)(E).

3. Treatment of assets connected with capitalized, deferred, or disallowed interest

• The proposed regulations clarify what it means for an asset to be connected with

indebtedness, modify the existing example, and add a new example, with the

purpose of limiting the scope of this provision.

4. Treatment of section 818(f) expenses

• The proposed regulations adopt the separate entity method for allocating and

apportioning section 818(f) expenses. Under this method, the allocation and

apportionment of section 818(f) expenses is done on a separate company basis.

5. Allocation and Apportionment of R&E Expenses

• In general, the Treasury Department and the IRS agree with the comments that the

rules under Treas. Reg. § 1.861-17 should be modified to reflect the fact that R&E

expenditures that are deductible or amortizable under section 174 or section 59(e)

generally give rise to intangible property, and that under the rules in sections 367(d)

and 482, the person incurring such R&E expenditures must be compensated properly

when such intangible property gives rise to income.

• Accordingly, R&E expenditures ordinarily are considered deductions that are

definitely related to all gross intangible income reasonably connected with the

relevant Standard Industrial Classification Manual code (“SIC code”) category (or

categories) of the taxpayer and so are allocable to all items of gross intangible

income related to the SIC code category (or categories) as a class.

o Gross intangible income is defined as all gross income earned by a taxpayer

that is attributable, in whole or in part, to intangible property derived from

R&E expenditures and does not include dividends or any amounts

included under section 951, 951A, or 1293. The proposed regulations do

not directly address but may significantly increase the amount of R&E

expense apportioned to gross FDDEI and gross non-FDDEI.

• The proposed regulations also:

o Eliminate the optional gross income method and require R&E expenditures in

excess of the amount exclusively apportioned under Treas. Reg. § 1.861-

17(b) to be apportioned among the statutory and residual groupings within

the class of gross intangible income on the basis of the relative amounts of

gross receipts from sales and services in each grouping. Gross receipts are

assigned to the grouping to which the gross intangible income related to the

sale, lease, or service is assigned.

o Clarify the rules relating to goods or property that are described in the SIC

code category for “wholesale trade” or “retail trade.

o Eliminate the legally mandated R&E rule.

o Eliminate the increased exclusive apportionment rule.

o Clarifies that the exclusive apportionment rule applies only to section 904 as

the operative section.

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o Clarify the treatment of CSA under section 482 in two respects.

▪ First, the taxpayer’s R&E expenditures allocated and apportioned

under §1.861-17 do not include any amounts that are not deductible

by reason of the second sentence under §1.482-7(j)(3)(i).

▪ Second, the proposed regulations clarify that the exclusion of the

controlled party’s gross receipts applies only for purposes of

apportioning those R&E expenditures that are intangible development

costs with respect to the CSA.

o Modify the special rules for partnerships’ gross receipts

6. Application of section 904(b) to net operating losses

• The 2018 FTC proposed regulations did not coordinate any of the adjustments

required under section 904(b) with the net operating loss provisions. Therefore, the

proposed regulations include a coordination rule. Under this coordination rule, for

purposes of determining the source and separate category of a net operating loss,

the separate limitation loss and overall foreign loss rules of section 904(f) and the

overall domestic loss rules of section 904(g) are applied without taking into account

the adjustments required under section 904(b).

Foreign Tax Credit Limitation Under Section 904

1. Financial Services Entities:

• Proposed Treas. Reg. § 1.904-4(e)(2) modifies the definition of an FSE by adopting a

definition of “predominantly engaged in the active conduct of a banking, insurance,

financing, or similar business” and “income derived in the active conduct of a

banking, insurance, financing, or similar business” that is generally consistent with

sections 954(h), 1297(b)(2)(B), and 953(e). A significant difference between the

current final section 904 regulation definition of active financing income and the

definition in section 954(h) (and the 1998 legislative history as there are no

regulations under section 954(h)) is that section 954(h) requires all income to be

derived from dealings with customers. Adopting the section 954(h) definition thus

may result in fewer entities qualifying as FSEs under section 904.

2. Allocation and Apportionment of Foreign Taxes

• The proposed regulations move the general rules in §1.904-6 (which address

allocating and apportioning taxes to separate categories) to new proposed Treas.

Reg. § 1.861-20 and include provision that apply for purposes of allocating and

apportioning foreign income taxes to statutory and residual groupings. Rules specific

to the allocation and apportionment of foreign income taxes to separate categories

remain in proposed §1.904-6.

• Proposed Treas. Reg. § 1.861-20 adopts the principles of §1.904-6 but provides

more detailed guidance on how to apply those principles, which are illustrated by

several examples.

• In addition, Prop. Treas. Reg. § 1.861-20(c) provides that foreign tax expense is

allocated and apportioned among the statutory and residual groupings by first

assigning the items of gross income under foreign law (“foreign gross income”) on

which a foreign tax is imposed to a grouping, then allocating and apportioning

deductions under foreign law to that income, and finally allocating and apportioning

the foreign tax among the groupings

o Proposed Treas. Reg. § 1.861-20(d)(1) provides a general rule for assigning

foreign gross income to a statutory or residual grouping

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▪ Under this rule, a foreign gross income item is assigned to a grouping

by characterizing the item under Federal income tax law. If an item of

gross income or loss arises under Federal income tax law from the

same transaction or realization event from which the foreign gross

income item arose (a “corresponding U.S. item”), the foreign gross

income item is assigned to the same statutory or residual grouping as

the corresponding U.S. item.

▪ In the case of a corresponding U.S. item that is an item of loss (or

zero), the foreign gross income is assigned to the same grouping to

which an item of gain would be assigned had the transaction or

realization event given rise to an item of gain under Federal income

tax law.

o Proposed Treas. Reg. § 1.861-20(d)(2) sets forth rules for assigning a foreign

gross income item to a grouping if there is no corresponding U.S. item in the

U.S. taxable year in which the taxpayer paid or accrued the foreign income

tax imposed on foreign taxable income that includes the foreign gross income

item.

o Proposed §1.861-20(d)(2)(ii) provides guidance regarding the treatment of

foreign gross income items that are either excluded from gross income under

Federal income tax law or attributable to base differences.

▪ Proposed §1.861-20(d)(2)(ii)(B) provides an exclusive list of items

that are excluded from U.S. gross income and that, if taxable

under foreign law, are treated as base differences. The items are death

benefits described in section 101, gifts and inheritances described in

section 102, contributions to capital described in section 118 and the

receipt of property in exchange for stock described in section 1032,

the receipt of property in exchange for a partnership interest described

in section 721, returns of capital described in section 301(c)(2), and

distributions to partners described in section 733.

o Proposed §1.861-20(d)(3) sets forth special rules that apply for purposes of

assigning certain items of foreign gross income to a grouping, including rules

for distributions that both Federal income tax law and foreign law recognize,

certain foreign law distributions such as consent dividends, inclusions under

foreign law CFC regimes, disregarded payments, inclusions from reverse

hybrids, and gain on the sale of a disregarded entity.

▪ In the case of a distribution from a non-hybrid corporation that is

recognized for both Federal income tax law and foreign tax law

purposes, Prop. Treas. Reg. §1.861-20(d)(3)(i)(B) treats foreign gross

income arising from the distribution as a dividend and as capital gain

to the extent of the portions of the distribution that are, under Federal

income tax law, characterized as a dividend and capital gain,

respectively. The foreign gross income is assigned to the same

statutory and residual groupings as the corresponding amounts of

dividend and capital gain as computed for U.S. tax purposes. Foreign

gross income arising from the portion of the distribution that is a

return of capital under Federal income tax law is treated as a base

difference.

▪ If a taxpayer (including an upper-tier CFC) includes an item of foreign

gross income by reason of a foreign law regime similar to the subpart

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F provisions under sections 951 through 959 (a “foreign law subpart F

regime”), Prop. Treas. Reg. § 1.861-20(d)(3)(i)(D) assigns that item

to the same statutory or residual grouping as the gross income

(determined under the foreign law subpart F regime) of the foreign law

CFC that gave rise to the foreign gross income of the taxpayer.

o Proposed Treas. Reg. § 1.861-20(d)(3)(ii) addresses the assignment of

foreign gross income arising from disregarded payments between a foreign

branch (as defined in §1.904-4(f)(3)) and its owner.

▪ If the foreign gross income item arises from a payment made by a

foreign branch to its owner, Prop. Treas. Reg. § 1.861-20(d)(3)(ii)(A)

generally assigns the item to the statutory and residual groupings by

deeming the payment to be made ratably out of the after-tax income,

computed for Federal income tax purposes, of the foreign branch, and

deeming the branch income to arise in the statutory and residual

groupings in the same ratio as the tax book value of the assets,

including stock, owned by the foreign branch.

▪ If the item of foreign gross income arises from a disregarded payment

to a foreign branch from its owner, Prop. Treas. Reg. § 1.861-

20(d)(3)(ii)(B) generally assigns the item to the residual grouping.

However, Prop. Treas. Reg. § 1.861-20(d)(3)(ii)(C) assigns an item of

foreign gross income attributable to gain recognized under foreign law

with respect to the receipt of a disregarded payment in exchange for

property under the rule in Prop. Treas. Reg. § 1.861-20(d)(2)(i).

▪ In addition, proposed §1.904-6(b)(2) includes special rules assigning

foreign gross income items arising from certain disregarded payments

for purposes of applying section 904 as the operative section.

o Prop. Treas. Reg. § 1.861-20(d)(3)(iii) addresses the assignment to a

statutory or residual grouping of foreign gross income that a taxpayer

includes by reason of its ownership of a reverse hybrid.

▪ Under this rule, the foreign gross income that a taxpayer recognizes

from a reverse hybrid is assigned to the statutory and residual

groupings by treating that foreign gross income as the income of the

reverse hybrid and applying the general rules of Prop. Treas. Reg. §

1.861-20(d).

▪ However, Treas. Reg. § 1.904-6(f) includes a special rule assigning

certain items of foreign gross income recognized by a United States

shareholder of a controlled foreign corporation that is a reverse hybrid

to the section 951A category for purposes of applying section 904 as

the operative section. The Treasury Department and the IRS request

comments on whether additional rules are needed to address other

fact patterns in which the U.S. and a foreign country tax different

persons on the same item of income, for example, in the case of a

sale-repurchase agreement.

o Finally, Prop. Treas. Reg. § 1.861-20(d)(3)(iv), provides that if a taxpayer

recognizes an item of foreign gross income that is gain from the sale of a

disregarded entity, and Federal income tax law characterizes the transaction

as a sale of the assets of the disregarded entity, the foreign gross income is

assigned to the statutory and residual groupings in the same proportion as

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the gain that the taxpayer would have recognized if foreign law also treated

the transaction as a sale of assets.

• Proposed Treas. Reg. § 1.904-6(b)(2)(i) generally provides that if a foreign branch

makes a disregarded payment to another foreign branch or to its owner that causes

the taxpayer’s gross income under Federal income tax law that is otherwise

attributable to the foreign branch to be attributed to another foreign branch or to the

foreign branch owner under §1.904-4(f)(2)(vi)(A) or §1.904-4(f)(2)(vi)(D), the

foreign gross income that arises by reason of the disregarded payment is assigned to

the same category as the reattributed U.S. gross income.

o Items of foreign gross income that a taxpayer includes solely by reason of the

receipt by a foreign branch of a disregarded payment from its foreign branch

owner that is a United States person are generally assigned to the foreign

branch category (or, in the case of a foreign branch owner that is a

partnership, to the partnership’s general category income that is attributable

to the foreign branch).

o Items of foreign gross income attributable to gain recognized under foreign

law with respect to the receipt of a disregarded payment in exchange for

property are characterized and assigned under the rules of Prop. Treas. Reg.

§1.861-20(d)(2)(i).

o If a taxable disposition of property acquired in a disregarded sale results in

the recognition of U.S. gross income that is reattributed to or from a foreign

branch under §1.904-4(f)(2)(vi)(A) or §1.904-4(f)(2)(vi)(D), any foreign

gross income arising from that disposition of property under foreign law is

assigned to the same separate category as the corresponding U.S. item of

gain under Treas. Reg. § 1.861-20(d)(1) without regard to the reattribution of

U.S. gross income.

• Proposed Treas. Reg. § 1.904-6(f) addresses the circumstance in which a United

States shareholder pays or accrues foreign income tax with respect to foreign gross

income that it recognizes because it owns a foreign law CFC or a reverse hybrid.

o The foreign income tax is allocated and apportioned to a category by treating

the foreign gross income of the United States shareholder as the foreign gross

income of the foreign law CFC or reverse hybrid.

o Accordingly, the regulation reassigns to the section 951A category the foreign

gross income that, if the foreign law CFC or reverse hybrid recognized the

foreign gross income instead of the United States shareholder, would be

assigned to the general category tested income group of the foreign law CFC

or reverse hybrid to which an inclusion under section 951A is attributable. The

amount of the foreign gross income that is reassigned is based upon the

inclusion percentage of the United States shareholder.

OFL Recapture on Property Dispositions

The proposed regulations address comments on proposed section 904(f) and 904(g)

regulations published in 2012.

• One comment recommended that additional income required to be recognized on a

disposition under the branch loss recapture and dual consolidated loss (“DCL”)

recapture rules not be subject to the OFL recapture rules. Prop. Reg. § 1.904(g)-3

rejects this comment but clarifies the ordering rules for applying the new branch loss

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recapture rule in section 91, the DCL recapture rules, and the OFL and ODL

recapture rules.

Section 905(c) Foreign Tax Redeterminations

The proposed regulations include new guidance under section 905(c), replacing proposed

regulations published in 2007. The regulations:

• Require a U.S. tax redetermination (i.e., an amended return) to account for any

foreign tax redetermination at the U.S. level or foreign corporation level.

• Clarify that a foreign tax redetermination results in adjustments to earnings and

profits and inclusions under section 951 and 951A in the year to which the

redetermined foreign taxes relate. In addition, the regulations provide that the high

tax exception is applied taking into account the redetermined foreign tax and

resulting E&P adjustments in the year to which the redetermined foreign taxes

relate.

• Provide that a foreign tax redetermination is required even if there is no impact on

the U.S. taxpayers foreign tax credit for the year to which the redetermined foreign

taxes relate.

• Provides that the required redetermination of U.S. tax liability is made as if the

foreign tax redetermination occurred in the hands of the original taxpayer. It is not

clear how this rule would apply where the current taxpayer is unrelated to the

original taxpayer.

• Reproposes with modifications the notification requirements in the 2007 temporary

regulations.

• Addresses the application of the notification requirements to partners and

partnerships, including partnerships subject to the centralized partnership audit

regime.

• Provides for penalties if the taxpayer fails to comply with the section 905(c)

regulations notification requirements.

• The Treasury Department and the IRS request comments on whether an alternative

adjustment to account for post-2017 foreign tax redeterminations with respect to

pre-2018 taxable years of foreign corporations, such as an adjustment to the foreign

corporation’s taxable income and earnings and profits, post-1986 undistributed

earnings, and post-1986 foreign income taxes as of the foreign corporation’s last

taxable year beginning before January 1, 2018, may provide for a simplified and

reasonably accurate alternative.

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