This article applies to Controlled Foreign Corporations (CFCs) and in some cases, other foreign corporations. This article outlines recent IRS guidance relating to accounting method changes with regard to automatic consent, Section 481a adjustment and audit protection exceptions.
In a recently issued Revenue Procedure, the IRS provided guidance regarding accounting method changes made on behalf of controlled foreign corporations and, in some cases, other foreign corporations. This article examines the three primary areas addressed: automatic consent, Section 481(a) adjustment and audit protection exceptions.
Accounting Method Changes by Foreign Corporations
In the recently issued Revenue Procedure 2021-26, the IRS provided guidance regarding accounting method changes made on behalf of controlled foreign corporations (CFCs) and, in some cases, other foreign corporations. Included in the guidance is an expansion, for a limited period, in the availability of automatic consent for CFCs to change their methods of accounting for depreciation to the alternative depreciation system (ADS) under the Internal Revenue Code (IRC).
The guidance sets forth temporary procedures for a CFC using an impermissible non-ADS method, as well as a CFC using a permissible non-ADS method, to obtain automatic IRS consent to change its accounting method for depreciation of property described in IRC Section 168(g)(1)(A). The automatic consent doesn’t apply to property excluded from the application of Sec. 168 because of Sec. 168(f) to the ADS in determining the CFC’s gross and taxable income under applicable regulations. Nor does it apply to earnings and profits (E&P) under Sec. 964 and Sec. 986(b) and the regs under them.
These procedures also temporarily waive certain eligibility restrictions to make it easier for such CFCs to obtain automatic consent to change their accounting methods for depreciation to the ADS. The changes are effective for a Form 3115 (“Application for Change in Accounting Method”) filed on or after May 11, 2021, for a tax year of a CFC ending before January 1, 2024.
The IRS notes that these procedures will ease the burden on all such CFCs in conforming their income and E&P calculations with their calculations for qualified business asset investment.
Section 481(a) Adjustment
The new guidance updates and revises previous guidance to account for both the enactment of Sec. 951A and the repeal of Sec. 954(g), which eliminated foreign base company oil-related income as a category of foreign base company income under the Tax Cuts and Jobs Act.
More specifically, the guidance clarifies that a CFC’s Sec. 481(a) adjustment must be accounted for in determining the foreign corporation’s tested income or tested loss. An exception exists to the extent the adjustment prevents the duplication or omission of an item of gross income that’s described in, or that’s a deduction properly allocable to, an item of gross income as described under the tax code.
Audit Protection Exceptions
The IRS is aware that questions have arisen whether the effect of various limitations on a domestic corporate shareholder’s ability to claim a current tax benefit for foreign taxes deemed paid should affect the application of the 150% threshold.
Under Sec. 960(a) and Sec. 960(d), foreign income taxes of a foreign corporation that are properly attributable to amounts included in a domestic corporate shareholder’s income are deemed paid regardless of whether the shareholder elects to deduct or credit foreign income taxes in the year of the inclusion. They’re also deemed paid regardless of the extent to which Sec. 904(d) or other limitations affect the allowable amount of the foreign tax credit in the inclusion year or other years.
In the guidance, the IRS notes that the purpose of the 150% threshold is to deny audit protection for an improper mthod of accounting that affects the calculation of the foreign corporation’s income for federal tax purposes. Thus, the threshold may improperly inflate the amount of foreign taxes deemed paid with respect to an income inclusion from that corporation.
Under Sec. 901(a) and Sec. 904(c), taxpayers are allowed 10 years to:
- Elect to credit foreign income taxes, and
- Carry excess foreign tax credits with respect to subpart F income to other tax years
Therefore, in the view of the IRS, the 150% threshold is appropriately applied on the basis of the amount of foreign taxes deemed paid and not on the allowable amount of the associated foreign tax credit. As a result, the new guidance clarifies that the 150% threshold is calculated with respect to the amount of the foreign corporation’s foreign taxes deemed paid, regardless of the extent to which a foreign tax credit is allowed.
CFCs and other foreign corporations face daunting tax compliance challenges. Contact your tax advisor for further information on the latest IRS guidance.