The Internal Revenue Service and the Treasury Department released their final regulations on two major international tax provisions, the Foreign Tax Credit and the Base Erosion and Anti-abuse Tax (BEAT), which was included as part of the Tax Cuts and Jobs Act.
The final regulations on the Foreign Tax Credit relate to a longstanding tax benefit that underwent some major changes from the TCJA. Individuals and businesses have traditionally been able to claim a credit for any income taxes that have been paid to foreign governments, but the TCJA changed several provisions in the Foreign Tax Credit, including repeal of section 902, which allowed deemed-paid credits in connection with dividend distributions based on foreign subsidiaries’ cumulative pools of earnings and foreign taxes. The TCJA also added two separate limitation categories for foreign branch income and amounts that should be includible under the Global Intangible Low-Taxed Income (GILTI) provisions.
On top of that, the TCJA changed how taxable income is figured for purposes of the Foreign Tax Credit limitation by disregarding some expenses and repealing the use of the fair market value method for allocating interest expense.
The TCJA basically overhauled the traditional system of U.S. taxation of international income affecting the Foreign Tax Credit calculation. These systemic changes include the introduction of a participation exemption through a dividends-received deduction for certain dividends in section 245A and the introduction of GILTI, the Global Intangible Low-Taxed Income regime, which subjects to current U.S. taxation foreign earnings that would have been deferred under previous law, albeit at a lower tax rate and subject to extra Foreign Tax Credit restrictions.
Changes to the treatment of Foreign Tax Credits under the TCJA included adding new foreign tax credit limitation categories, providing new foreign tax credit rules related to the enactment of the GILTI regime, and eliminating the fair market value asset valuation method for interest expenses.
The final regulations spell out these changes in detail. They finalize a set of proposed regulations issued last December. Those regulations include a rule treating certain assets as 50 percent exempt for expense allocation purposes, along with rules on applying the new FTC limitation categories. This includes a taxpayer favorable elective transition rule for carryovers of FTCs.
The IRS also issued proposed regulations Monday relating to the allocation and apportionment of deductions and creditable foreign taxes, foreign tax redeterminations, availability of Foreign Tax Credits under the Transition Tax, and the application of the Foreign Tax Credit limitation to consolidated groups. The proposed regulations include rules on the allocation and apportionment of research and experimental deductions that will generally allow taxpayers subject to the GILTI regime to increase their use of foreign tax credits.
In addition to finalizing the regulations on the Foreign Tax Credit, the IRS and the Treasury also issued final regulations and proposed regulations Monday on the Base Erosion and Anti-abuse Tax, or BEAT. Under this recent provision of the tax law, the TCJA added section 59A, imposing a tax equal to the base erosion minimum tax amount for certain taxpayers beginning in tax year 2018. When it’s applicable, this tax comes in addition to the taxpayer’s regular tax liability. The BEAT provision mainly affects corporate taxpayers with annual gross receipts averaging more than $500 million over a three-year period that make deductible payments to foreign related parties.
The BEAT aims to provide a backstop to prevent multinational enterprises from eroding the US tax base by overly reducing their U.S. tax liability. The final regulations released Monday reflect comments received from taxpayers to facilitate compliance with the statute.
They include detailed guidance about which taxpayers will be subject to the BEAT regime, how to determine base erosion payments, the calculation of the base erosion minimum tax amount and the required base erosion and anti-abuse tax resulting from that calculation.
The new proposed regulations offer further guidance on other operational aspects of BEAT. They provide a rule for applying BEAT when taxpayers elect to waive certain deductions, alomng with additional guidance for applying the BEAT to groups of related taxpayers and to partnerships.
“Today’s guidance continues to modernize our tax system, ensure a thoughtful and deliberate transition from a worldwide towards a territorial system, protect the U.S. tax base, and provide taxpayers with the clarity they need to plan and grow their businesses,” said Treasury Secretary Steven T. Mnuchin in a statement.
Updates on the implementation of the TCJA can be found on the Tax Reform page of IRS.gov.
At least one observer would like to see the new regulations go further. “The new BEAT regulations provide some helpful relief, such as for inbound liquidations and reorganizations, as well as several welcome clarifications,” stated David G. Noren, a partner at the law firm McDermott Will & Emery in Washington, D.C. “But Treasury and the IRS declined to adopt most of the more ambitious changes that the business community had requested, such as exceptions for payments that give rise to subpart F income or GILTI.”