The IRS is preparing to finalize several regulations this summer implementing the international provisions of the 2017 tax overhaul—a welcome development for companies seeking clarity on a host of issues.
Agency officials said final rules meant to ensure companies pay a minimum levy on offshore profits in low-tax countries could be out by June 22, but three others are in the pipeline awaiting action—a full 18 months after the tax law was signed.
Tax practitioners say they need answers on numerous issues, such as determining how they should calculate liabilities under a new income category, verify eligibility for a new export deduction, and categorize payments between related businesses. Without these answers, companies can’t go ahead with tax planning with any certainty, they said.
“The timing of finalization of the 2017 tax act regulations may be more important in signaling to multinational companies when they can safely begin to implement significant changes to their cross-border operations and organizational structures without worrying that they have miscalculated how the law ends up,” said John P. Warner, a shareholder at Buchanan Ingersoll & Rooney PC in Washington and a member of the Bloomberg Tax International Advisory Board.
Only the transition tax rules (T.D. 9846) under tax code Section 965 have been made final so far. The rules impose a one-time tax on assets U.S. corporations and individuals held overseas dating back to 1986. Final Section 965 regulations for the tax were issued after companies filed their returns for 2017 using guidelines in proposed regulations.
As they await agency action, companies are making conservative estimates based on proposed rules that indicate the IRS’s intent. Here is where the regulations stand now.
Anti-Base Erosion Tax
U.S. multinationals are still waiting on final rules for the base erosion and anti-abuse (BEAT) tax, which is meant to prevent companies from shifting profits offshore. Proposed regulations (REG-104259-18) were released Dec. 17.
A major contention under the BEAT is the kinds of payments that should be kept off the table. A company becomes subject to the BEAT when 3% or more of its deductible payments are considered base-erosion payments. When that happens, the company is slapped with a 10% tax. The BEAT, under new tax code Section 59A, increases to 12.5% after 2025.
For instance, tax executives have asked Treasury to exclude nonrecognition payments, or transactions that can’t be claimed as a gain or loss, as a BEAT payment because it can have an adverse effect on business activity following mergers and acquisitions, according to a comment letter earlier this year from the Tax Executives Institute.
“By applying the BEAT to such transactions, the Proposed Regulations place U.S. companies at a competitive disadvantage by increasing the costs of the post-merger integration and potentially hindering growth and operational efficiency, especially considering that a foreign acquirer would not need to restructure to consolidate operations,” the letter said.
And, depending on the calculation method, all or none of the payments made between foreign banks and their U.S. branches could be deemed base-erosion payments, the Institute of International Bankers said in a May letter to the Treasury Department.
GILTI and Tax Credits
The IRS issued proposed rules (REG-104390-18) Sept. 13 under tax code Section 951A for income that U.S. shareholders earn from controlled foreign corporations—those that are more than 50% owned by U.S. shareholders who own 10% or more of the total stock in the CFC.
Companies would pay a tax on a new income category, global intangible low-taxed income, earned after Dec. 31, 2017. The levy ensures companies pay a minimum amount of tax on overseas profits earned in countries with low tax rates.The White House’s Office of Management and Budget is reviewing final GILTI rules it received May 16.
Companies can claim foreign tax credits that amount to 80% of their GILTI income. Expenses, including research and development, interest, and stewardship spending in the U.S. can reduce taxable income but also reduce the availability of foreign tax credits.
But since proposed foreign tax credit rules (REG-105600-18) don’t address how the credits would interact with the new GILTI income category, final GILTI regulations could leave taxpayers wondering about their foreign tax credits.
“To the extent the U.S. shareholder is trying to mitigate the GILTI inclusion through foreign tax credits, that’s the piece that we’re still uncertain about until we have the final regulation,” said Layla J. Asali, a member and vice chair of the tax department at Miller & Chevalier Chartered in Washington.
The IRS has said that providing guidance on allocation of expenses is a priority due to the number of comments it received from tax executives and practitioners.
Foreign-Derived Income Deduction
The IRS on March 4 issued proposed rules (REG-104464-18) on the Section 250 deduction, which gives companies an effective tax rate of 13%, rather than 21%, on income from some exports. That benefit is scheduled to drop to a 16% effective tax rate by 2026.
The IRS has scheduled a hearing on the new export deduction on July 10.
The foreign-derived intangible income (FDII) provision is a counterpart to GILTI, aimed at ultimately neutralizing a company’s decision on where to locate its headquarters. Companies that want the FDII deduction on such income must prove that the property or services they sell is for foreign use.
The proposed rules include guidance on how companies can document their foreign sales, like ensuring contracts have language guaranteeing such use or obtaining signed documents from purchasers. But companies that don’t already document the location and use of buyers have asked Treasury for additional methods to prove foreign use to avoid having to alter business operations in order to claim the deduction.
Treasury recently indicated that it was considering giving companies more options for proving they are qualified for the FDII deduction.
Comments like those from officials suggest that the final rules may make substantial changes to the documentation rules. The proposed regulations set the bar high, and the issue remains a big one for taxpayers aiming to benefit from the deduction, said David Sites, national managing partner of international tax services and partner in Grant Thornton LLP’s Washington National Tax Office.
Hybrid Mismatch Rules
The IRS issued proposed rules (REG-104352-18) on “hybrid mismatch” arrangements—an abusive cross-border method of doubling up on tax deductions—that went beyond what the Organization for Economic Cooperation and Development recommended.
The rules are aimed at stopping companies from taking tax benefits on the same transaction from two different jurisdictions.
The rules do rein in the effectiveness of many hybrid strategies. But, the treatment of other structures isn’t so clear, Sites said. For example, companies facing potential limits on royalties or interest under tax code Section 267A are evaluating the impact and considering their options, he said. The code section disallows tax deductions for interest or royalties paid or accrued to a related party in a hybrid transaction.
“The landscape will continue to evolve and I expect that what’s possible will continue to be narrowed in this space,” Sites said.
—With assistance from Sony Kassam.