Abstract: The IRS recently issued final regs that cover reductions of hybrid deduction accounts under Internal Revenue Code Section 245A(e) and calculation of taxable income for purposes of the foreign tax credit (FTC) limitation. This article looks at some of the most pertinent details, including the Section 904 limitation and the limit on reduction of a hybrid deduction account.
If you are working with EFPR Group and you have controlled foreign corporations (CFCs), rest assured that EFPR is working through these final regulations related to hybrid deduction accounts for FTC purposes. EFPR is also evaluating the impact on the Section 250 deduction under these final regulations.
If you are considering setting up a corporation outside of the U.S., be sure to speak with one of the members of the international tax team at EFPR to review all aspects of applicable U.S. tax law.
Final Regs Cover Hybrid Deduction Accounts, Foreign Tax Credits
The IRS recently issued final regs that cover reductions of hybrid deduction accounts under Internal Revenue Code Section 245A(e) and calculation of taxable income for purposes of the foreign tax credit limitation. Let’s look at some of the more pertinent details.
Sec. 904 Limitation
Under proposed regs issued earlier in 2020, an adjusted subpart F inclusion or adjusted global intangible low-taxed income (GILTI) inclusion with respect to a share of stock is calculated by taking into account foreign income taxes that are likely to give rise to deemed paid credits eligible to be claimed by the domestic corporation with respect to the subpart F inclusion or an adjusted GILTI inclusion. To minimize complexity, the 2020 proposed regs didn’t account for any limitations on foreign tax credits when calculating foreign income taxes that are likely to give rise to deemed paid credits.
The final regs account for the limitation under Sec. 904 for calculating an adjusted GILTI inclusion. Foreign income taxes that, by reason of Sec. 904, don’t currently give rise to deemed paid credits eligible to be claimed with respect to the GILTI inclusion amount aren’t creditable in another year through a carryback or carryover.
Thus, there’s generally no ability for such excess foreign income taxes to reduce the extent that an amount accounted for in income by the domestic corporation is included in income in the United States. The final regs, therefore, provide that such foreign income taxes aren’t accounted for when calculating an adjusted GILTI inclusion.
If the application of this rule results in circularity or ordering rule issues, a taxpayer may apply any reasonable method to calculate the amount of foreign income taxes. The creditability of any such method is limited by Sec. 904, and this can be done solely for purposes of calculating the adjusted GILTI inclusion.
The final regs don’t adopt a similar rule for calculating an adjusted subpart F inclusion. This is because foreign income taxes that don’t currently give rise to deemed paid credits eligible to be claimed with respect to the subpart F inclusion under Sec. 904 may become creditable in another year under Sec. 904(c).
Sec. 250 deduction
Under the 2020 proposed regs, an adjusted GILTI inclusion is calculated by accounting for the portion of the deduction allowed under Sec. 250 because of Code Sec. 250(a)(1)(B) that the domestic corporation is likely to claim with respect to the GILTI inclusion amount. The 2020 proposed regs didn’t account for any limitations on the deduction under Sec. 250(a)(2)(B).
The final regs account for the taxable income limitation under Sec. 250(a)(2). The IRS reasons that accounting for the taxable income limitation results in an adjusted GILTI inclusion that more closely reflects the extent to which the GILTI inclusion amount is included in income in the United States. Thus, the final regs provide a rule to this effect.
A taxpayer may apply any reasonable method to calculate the extent to which the portion of a deduction allowed under Sec. 250 because of Code Sec. 250(a)(1)(B) is limited under Sec. 250(a)(2)(B).
his can be done solely for purposes of calculating an adjusted GILTI inclusion.
Limit on Reduction of a Hybrid Deduction Account
The 2020 proposed regs provided a limit to ensure that an adjusted subpart F inclusion or adjusted GILTI inclusion with respect to a share of stock of a controlled foreign corporation (CFC) doesn’t reduce the hybrid deduction account by an amount greater than the hybrid deductions allocated to the share for the tax year multiplied by a certain fraction. The numerator of this fraction is the subpart F income or tested income of the CFC for the tax year, as applicable. The denominator is the CFC’s taxable income.
In cases in which the CFC’s taxable income is zero or negative, the 2020 proposed regs prevented distortions to the fraction — which would otherwise occur because the fraction would involve dividing by zero or a negative number — by providing that the fraction is considered to be zero.
Distortions to the fraction could also occur if the CFC’s taxable income is greater than zero but less than its subpart F income or tested income (attributable to losses in one category of income) because, absent a rule to address, the fraction would be greater than one. The final regs eliminate these distortions by modifying the fraction so that the numerator and denominator reflect only items of gross income.
The rules under Sec. 245A(e) relating to hybrid deduction accounts are applicable to tax years ending on or after the date that the regs are published in the Federal Register. A taxpayer may apply the final rules under Sec. 245A(e) to a tax year ending before the date of publication in the Federal Register so long as it consistently applies those rules to that tax year and any subsequent tax year ending before the date of publication. The foreign tax credit regs apply to tax years beginning after December 31, 2019.
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