The Tax Times: IRS & Treasury Issue Proposed Regulations Implementing IRC Section 965 Transition Tax

The Internal Revenue Service and the Department of the Treasury on August 1, 2018 issued proposed regulations on Section 965 of the Internal Revenue Code. The proposed regulations affect United States shareholders, as defined under section 951(b) of the Code, with direct or indirect ownership in certain specified foreign corporations, as defined under section 965(e) of the Code.

Section 965, enacted in December 2017, levies a transition tax on post-1986 untaxed foreign earnings of specified foreign corporations owned by United States shareholders by deeming those earnings to be repatriated. For domestic corporations, foreign earnings held in the form of cash and cash equivalents are generally intended to be taxed at a 15.5 percent rate for 2017 calendar years, and the remaining earnings are intended to be taxed at an 8 percent rate for 2017 calendar years.

The lower effective tax rates applicable to section 965 income inclusions are achieved by way of a participation deduction set out in section 965(c) of the Code. A reduced foreign tax credit also applies with respect to the inclusion under section 965(g) of the Code.

Taxpayers may generally elect to pay the transition tax in installments over an eight-year period under section 965(h) of the Code. The proposed regulations contain detailed information on the calculation and reporting of a United States shareholder’s section 965(a) inclusion amount, as well as information for making the elections available to taxpayers under section 965.

The proposed regulations are generally consistent with prior guidance and contain many technical details.
Key aspects include:

Unfavorable rules that may inflate cash positions above actual cash and require double counting, including: (i) a hybrid approach for measuring the cash position of consolidated groups; and (ii) rules addressing groups with multiple year ends;
Rules allowing certain intercompany receivables to be disregarded for purposes of determining cash positions (including certain cash pools run through third-party banks if treated as intercompany transactions under general tax principles);
Treasury's decision not to expand the definition of "accounts payable" to include other short-term ordinary expenses;
Foreign tax credits for both income and withholding taxes reduced in proportion to the reduced transition tax rate;
Anti-avoidance rules disregarding: (i) certain transactions that change the amount of the income inclusion, cash position, or creditable foreign taxes (whether or not such change affects a taxpayer's total tax liability or is material in amount) that are undertaken on or after November 2, 2017 (in whole or in part) with a principal purpose of effecting such change (with materiality of the change relevant in determining whether there was a purpose); and (ii) certain accounting method changes and entity classification elections with similar effects (even if effective before November 2, 2017, and including changes from impermissible to permissible methods);
Instructions for electing to pay the tax in installments and permitting an acquirer to assume a target's installment obligation;
An election to transfer basis between foreign subsidiaries to better align with foreign subsidiary earnings to facilitate repatriation;
Rules for reducing an inclusion by deficits from other foreign subsidiaries, including an unfavorable rule reducing deficits by the amount of certain previously taxed earnings;
Clarification that individual owners of pass-through entities may elect to be subject to tax at corporate rates under section 962 if they are "U.S. shareholders" with respect to foreign corporations;
Application of the normal FX rules only to certain distributions of subsidiary earnings; and
Strict filing requirements without late filing relief available for many of the statements and elections.

Written or electronic comments and requests for a public hearing on this proposed regulation must be received within 60 days of publication in the Federal Register, which is forthcoming.

More information regarding the Tax Cuts and Jobs Act, as well as Section 965, can be found at the Tax Reform page.

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