Federal Register :: Guidance Related to the Allocation and Apportionment of Deductions and Foreign Taxes, Foreign Tax Redeterminations, Foreign Tax Credit Disallowance Under Section 965g, Consolidated Groups, Hybrid Arrangements and Certain Payments Under Section 951A; Correction

The comment noted that the current final regulations at § 1.861–17(a)(2)(iii) mention two digit SIC code categories, or Major Groups in the terminology of the SIC Manual, yet the 2019 FTC proposed regulations omitted references to two digit SIC codes. One comment requested that the final regulations modify § 1.861–8T(d)(2) to permit insurance companies to adjust the amount of income and assets that are exempted in apportioning deductions. By way of background, subchapter L requires a nonlife insurance company to recognize underwriting income, or premiums minus losses and expenses.

This approach is more likely to achieve consistent results in the case of the same or similar final products, and thereby allows for a consistent comparison of value derived from intangible property with respect to each grouping. That is the case regardless of whether the taxpayer chooses to license its intangible property to other persons (including related parties) for purposes of manufacturing final products, or the taxpayer manufactures products itself, and regardless of whether other persons enhance the product with additional value attributable to other intangible property. Therefore, the sales method ensures that differences in supply chain structures do not alter the nature of how R&E allocation and apportionment in us tax expenditures are allocated and apportioned. The 2019 FTC proposed regulations proposed several changes to § 1.861–17, including eliminating the gross income method of apportionment, eliminating the legally-mandated R&E rule, and limiting the class of income to which R&E expenditures could be allocated to gross intangible income reasonably connected with a relevant Standard Industrial Code (SIC) category. In addition, the rule for exclusive apportionment of R&E expenditures was modified by eliminating the possibility of increased exclusive apportionment based on taxpayer-specific facts and circumstances, and by providing that exclusive apportionment applies solely for purposes of section 904.

  1. In particular, the sales method focuses on the gross receipts from sales of a product to final customers.
  2. The amount of foreign income taxes paid or accrued with respect to a separate category (as defined in § 1.904–5(a)(4)(v)) of income (including U.S. source income assigned to the separate category) includes only those foreign income taxes that are allocated and apportioned to the separate category under the rules of § 1.861–20 (as modified by this section).
  3. Furthermore, the Treasury Department and the IRS disagree with the comments suggesting that award payments should be allocated based on the geographic location in which the lawsuit is filed, which could be governed by contractual terms or choice-of-law rules that have little to no factual relationship to the underlying activities to which the lawsuit relates.
  4. While section 267A and the 2020 hybrids final regulations apply only if the D/NI outcome is a result of the use of a hybrid entity or instrument, the conduit financing regulations apply regardless of causation and instead look to whether there is a tax avoidance plan.

Specifically, the 2019 FTC proposed regulations provided that in the case of insurance companies, 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 under section 805(a)(4)(A)(ii) disallowing a portion of the deduction attributable to the policyholder’s share of the dividends or any similar disallowance under section 805(a)(4)(D). Similarly, the regulations provided that the term exempt income includes tax-exempt interest without regard to the proration rules. Finally, several comments disagreed with the approach in the 2019 FTC proposed regulations regarding lawsuits filed by investors against a corporation. These comments argued that it is inappropriate to allocate deductions for such payments to income produced by all of the taxpayer’s assets, because these expenses can have a closer factual connection to the jurisdiction where the litigation occurs or where the events (for example, any negligence, fraud, or malfeasance) at issue in the lawsuit occurred. Some comments advocated for a more flexible rule, noting that certain shareholder claims may have a very narrow geographic scope, whereas other claims may relate to a broader range of activities.

Apportionment and allocation Single-sales factor and three-factor apportionment formulas, and nonbusiness income

The Treasury Department and the IRS considered two options in applying section 905(c) in connection with the high-tax exception. The second option was to provide that section 905(c) applies in connection with the high-tax exceptions under GILTI and subpart F. In the absence of such quantitative estimates, the Treasury Department and the IRS have undertaken a qualitative analysis of the economic effects of the final regulations relative to the no-action baseline and relative to alternative regulatory approaches.

Apportioning tax benefits among members of a controlled group

As demonstrated in Vectren and British Land, the key to succeeding in asserting entitlement to alternative apportionment is to provide the state with documentation and support for both prongs of the alternative apportionment statutory requirements. The taxpayer must clearly establish the unfairness of the statutory apportionment formula and must also prove that the proposed alternative method is reasonable. By identifying when a state’s statutory apportionment methodology does not accurately represent a company’s presence in the state, identifying a reasonable and acceptable alternative method of apportionment, and knowing the requirements and burdens of proof necessary to use the alternative method, taxpayers may obtain significant tax savings. Some situations in which a business may be able to demonstrate entitlement to an alternative apportionment method involve expanding operations, new revenue from acquired entities, or substantial gain realized from the sale of assets or business interests. A foreign branch group contribution is a contribution (as defined in § 1.861–20(d)(3)(v)(E)) made by a member of a foreign branch owner group to a member of a foreign branch group that the payor owns, made by a member of a foreign branch group to another member of that group that the payor owns, or made by a member of a foreign branch group to a member of a different foreign branch group that the payor owns.

No attorney-client or confidential relationship is formed by the transmission of information between you and the National Law Review website or any of the law firms, attorneys or other professionals or organizations who include content on the National Law Review website. If you require legal or professional advice, kindly contact an attorney or other suitable professional advisor. Treasury’s pivot to the tracing approach in the 2020 Proposed Regulations may, in many instances, yield a more favorable result than the 2019 Proposed Regulations. That said, the complexity of the provisions in the 2020 Proposed Regulations, and the expansive record-keeping requirements arising therefrom, no doubt add to the growing list of taxpayer administrative burdens deriving from the Tax Cuts and Jobs Act. Selection of an appropriate allocation method will significantly affect the performance and efficiency of the system. Allocation method provides a way in which the disk will be utilized and the files will be accessed.

Application of Section 904(b) to Net Operating Losses

However, because tax-exempt income is not considered in the apportionment of deductions within a gross income class, the gross income of the two domestic companies must be reduced to reflect the DRD. In the apportionment formula, the dividends are $100 each from the three foreign companies and $20 each from the domestic companies, for a total of $340. Reattribution payments generally mean disregarded payments to the extent they result in the reattribution of income from one “taxable unit” to another. Generally, a disregarded payment causes gross income to be attributed from one taxable unit to another to the extent that a deduction for the payment, if regarded, would be allocated against the payor tested unit’s US gross income. Apportionment is the assignment of a portion of a corporation’s income to a particular state for the purposes of determining the corporation’s income tax in that state.

These rules were intended to prevent the use of guaranteed payments to avoid the rules under §§ 1.861–9(e)(8) and 1.954–2(h) that apply to partnership debt. A comment also recommended that the final regulations clarify whether the computation of an adjusted subpart F inclusion takes into account an amount that the domestic corporation includes in gross income by reason of section 964(e)(4). As noted in the comment, an amount that the domestic corporation includes in gross income by reason of section 964(e)(4) is in many cases offset by a 100 percent dividends received deduction under section 245A(a), and thus no portion of the amount is included in income in the United States (that is, taken into account in income and not offset by a deduction or credit particular to the inclusion). The final regulations clarify that the computation of an adjusted subpart F inclusion does not take into account an amount that a domestic corporation includes in gross income by reason of section 964(e)(4), to the extent that a deduction under section 245A(a) is allowed for the amount. Section 245A(e) and the 2020 hybrids final regulations neutralize the double non-taxation effects of a hybrid dividend or tiered hybrid dividend by either denying the section 245A(a) dividends received deduction with respect to the dividend or requiring an inclusion under section 951(a)(1)(A) with respect to the dividend, depending on whether the dividend is received by a domestic corporation or a CFC. The 2020 hybrids final regulations require that certain shareholders of a CFC maintain a hybrid deduction account with respect to each share of stock of the CFC that the shareholder owns, and provide that a dividend received by the shareholder from the CFC is a hybrid dividend or tiered hybrid dividend to the extent of the sum of those accounts.

According to the comment, after exclusive apportionment (as applicable), the 2019 FTC proposed regulations would apportion entirely to foreign branch category income the remaining R&E expense, which should instead be apportioned to the general category income originally attributable to the GII of the foreign branch that was reassigned by reason of the disregarded royalty. First, the final regulations specify under what circumstances the sales or services of uncontrolled or controlled parties are taken into account. Second, the final regulations revise § 1.861–17(d)(4) to refer to sales by controlled parties (which is defined as any person that is related to the taxpayer)), rather than controlled corporations, to clarify that, for example, sales made by a controlled partnership that is reasonably expected to license intangible property from the taxpayer are fully taken into account under the sales method.

Proration rules reduce losses by the “applicable percentage” of income from tax exempt interest and deductible dividends. For a life insurance company, the proration rules reduce the closing balance of reserve items by the “policyholder’s share” of tax-exempt interest. The policyholder’s share is a fixed percentage intended to represent the portion of the company’s tax-exempt investment income that funds its obligation to policyholders.

Furthermore, the Treasury Department and the IRS disagree with the comments suggesting that award payments should be allocated based on the geographic location in which the lawsuit is filed, which could be governed by contractual terms or choice-of-law rules that have little to no factual relationship to the underlying activities to which the lawsuit relates. Treasury and the IRS have requested comments on exceptions to the general rules for allocation and apportionment of stewardship expenses when the expenses seem definitely related to a more limited class of gross income; for example, when ownership of a particular asset requires the expense because https://accounting-services.net/ an entity’s jurisdiction has unique compliance requirements. As for apportionment, the proposed regs contain an explicit rule providing that stewardship expenses should be apportioned based on the relative values of a taxpayer’s stock. The proposed regs now require taxpayers to characterize and value their stock assets using the same method for allocating and apportioning both their interest and stewardship expenses, and also some damages payments. To apportion the $540 in stewardship expenses, the FTC limitation statutory groupings are foreign-source general category income, foreign-source passive category income, and foreign-source GILTI income.

As a result, the prior conduit financing regulations would not apply to an equity instrument in the absence of such attributes, and the U.S.-source payment might be entitled to a lower rate of U.S. withholding tax. The 2019 FTC proposed regulations provided that, with respect to § 1.861–17, taxpayers that use the sales method for taxable years beginning after December 31, 2017, and before January 1, 2020 (or taxpayers that use the sales method only for their last taxable year that begins before January 1, 2020), may rely on proposed § 1.861–17 if they apply it consistently with respect to such taxable year and any subsequent year. Therefore, a taxpayer using the sales method for its taxable year beginning in 2018 may rely on proposed § 1.861–17 but must also apply the sales method (relying on proposed § 1.861–17) for its taxable year beginning in 2019. Finally, a comment requested that § 1.905–4(b)(1)(ii) be amended to allow a taxpayer that avails itself of special procedures under Revenue Procedure 94–69 to notify the IRS of a foreign tax redetermination when the taxpayer makes a Revenue Procedure 94–69 disclosure during an audit for the taxable year for which U.S. tax liability is increased by reason of the foreign tax redetermination. One comment recommended that the Treasury Department and the IRS reconsider the elimination of the “legally mandated R&E” rule from the 2019 FTC proposed regulations, noting that the rule seemed to be required by section 864(g)(1)(A). As explained in the preamble to the 2019 FTC proposed regulations, the legally mandated R&E rule was eliminated in light of changes to the international business environment and to simplify the regulations, and the comment does not argue the change is inappropriate.

Sections 862(b) and 863(a) have similar guidance for converting U.S.- or foreign-source gross income into taxable income. Section 861 and the section 861 regulations provide that a taxpayer allocates a deduction to a class of gross income, and then, if necessary, apportions that deduction between the statutory and residual groupings of gross income within that class. The taxpayer must determine the factual relationship of the deduction to income for the taxpayer to properly allocate and apportion the deduction. The taxpayer must allocate the deduction to the relevant class, and must apportion the deduction between the relevant groupings, even if there is no gross income in the class/groupings in the taxable year in which the deduction arises.

Thus, dividends received as reported on Form 5471 are an upper bound on the amount of hybrid arrangements by these taxpayers. One option for addressing the current disparate treatment would be to not change the conduit financing regulations, which currently treat equity as a financing transaction only if it has specific redemption-type features; this is the no-action baseline. This option is not adopted by the Treasury Department and the IRS, since it is inconsistent with the Treasury Department’s and the IRS’s ongoing efforts to address financing transactions that use hybrid instruments, as discussed in the 2008 proposed regulations. These provisions of the final regulations will further enhance U.S. economic performance by helping to ensure that similar economic arrangements face similar tax treatments. Disparate tax treatment of similar economic transactions may create economic inefficiencies by leading taxpayers to undertake less productive economic activities.

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