In a recent notice published by the US Department of Treasury and Internal Revenue Service, the agencies provide additional guidance on the proposed regulations under Internal Revenue Code Section 965, including on stock basis adjustment elections, single entity treatment for certain consolidated group foreign cash position calculations, and relief for certain taxpayers affected by Hurricane Florence.
The US Department of Treasury (Treasury) and the Internal Revenue Service (IRS) published Notice 2018-78 (the Notice) on October 1, announcing follow-up guidance relating to the proposed Section 965 regulations released in August (the Proposed Regulations). (See our White Paper, IRS Proposed Regulations Under Internal Revenue Code Section 965, for more in-depth coverage.) The Notice covers three topics: (i) the timing and requirements for making stock basis adjustment elections under Internal Revenue Code Section 965(b)(4) and Proposed Treasury Regulations § 1.965-2(f)(2); (ii) prescribing “single entity” treatment for certain foreign cash position calculations for consolidated groups; and (iii) reporting and filing relief for certain taxpayers affected by Hurricane Florence.
Election to Make Stock Basis Adjustments to DFIC and E&P Deficit Company Stock
Section 965(b)(4) treats an earnings and profits (E&P) deficit of an E&P deficit corporation absorbed by a deferred foreign income corporation (DFIC) as previously taxed subpart F income. The statute and the TCJA Conference Report reflect Congress’s intention to allow an upward adjustment to the stock basis of the DFIC equal to the amount of previously taxed earnings, but say very little as to whether the stock basis of the E&P deficit corporation that surrendered the deficit must also be reduced; preliminary Section 965 guidance was silent in this regard.
Proposed Treasury Regulations § 1.965-2(f)(2) answered this question: an elective upward basis adjustment to the stock of a DFIC is allowed only if a corresponding downward adjustment is made to the stock of the E&P deficit corporation (the Basis Election). Absent a Basis Election by the taxpayer, no basis adjustments are allowed to the stock of either the DFIC or the E&P deficit corporation.
As previously discussed, a Basis Election can be helpful in some circumstances, but unfavorable in others. That is, although taxpayers will generally welcome an upward basis adjustment to DFIC stock, a corresponding downward basis adjustment that exceeds the basis in the E&P deficit corporation stock can result in gain recognition under Section 961(b)(2). Accordingly, taxpayers will need to carefully weigh the pros and cons of making a Basis Election.
The Proposed Regulations provide that a Basis Election must be made no later than the due date (taking into account extensions) for a US shareholder’s return for the first taxable year that includes the last day of the last taxable year of the DFIC or the E&P deficit corporation that begins before January 1, 2018. In cases where such date occurred before September 10, 2018, the Proposed Regulations require the Basis Election to be made by October 9, 2018 (the Transition Rule).
The Notice announces that the Transition Rule will apply to returns due (taking into account extensions) before the date that is 90 days after final regulations under Section 965 are published (the Publication Date); the Basis Election must be made no later than 90 days after the Publication Date. Importantly, Basis Elections made on or before the Publication Date may be revoked, provided that the revocation is made within 90 days after the Publication Date.
This new guidance is generally taxpayer favorable, as it will allow US shareholders additional time and flexibility to consider the potential benefits (or detriments) of making a Basis Election. The Notice appears to acknowledge as much, explaining that “requiring taxpayers to make a binding basis election before the proposed regulations are finalized would be too onerous for taxpayers.”
Consolidated Groups Single-Entity Treatment—Foreign Case
To avoid double-counting of cash and cash equivalents, the Proposed Regulations allow for certain payables and obligations between related specified foreign corporations (SFCs) to be disregarded for purposes of calculating a US shareholder’s aggregate cash position; however, such treatment is available only to the extent of the lower of the US shareholder’s percentage ownership in the two corporations. In addition, the Proposed Regulations permit a US shareholder of an SFC to reduce its cash position with respect to the SFC to the extent the US shareholder can demonstrate that such amount is taken into account or otherwise reflected in the cash position of another SFC of the US shareholder (collectively, the Double-Counting Rules).
Separately, the Proposed Regulations provide that members of a consolidated group that are US shareholders of an SFC are treated as a single corporation for certain specifically enumerated purposes and provisions within the Internal Revenue Code; the Double-Counting Rules, however, are not among the specifically enumerated provisions.
The Notice announces that all members of a consolidated group that are US shareholders with respect to an SFC are treated as a single corporation for purposes of applying the Double-Counting Rules. This treatment more closely aligns the proposed foreign cash position rules with the general treatment of members of a consolidated group under the Proposed Regulations.
Hurricane Florence Relief
The IRS has announced that certain individuals and business taxpayers affected by Hurricane Florence will have until January 31, 2019, to file certain tax returns and make certain tax payments; the announcement did not specifically address whether this relief applies to elections available under Section 965 or to certain transfer agreements required to be filed under the Proposed Regulations.
The Notice provides that an affected person whose Section 965 elections or transfer agreements are due on or after September 7, 2018, but before January 31, 2019, shall be granted additional time until January 31, 2019, to make those filings. An “affected person” is any taxpayer whose principal residence or place of business was located in a Hurricane Florence covered disaster area, or whose records necessary to meet reporting and filing obligations under Section 965 were located in such a disaster area.
Summary and Observations
Although Treasury and the IRS have issued the Proposed Regulations, the guidance in the Notice demonstrates that they continue to study Section 965. Importantly, they appear willing to issue additional guidance where appropriate to alleviate the compliance and administrative burdens being placed upon taxpayers who are simply trying to understand the implications of the Proposed Regulations while at the same time properly report their Section 965 obligations.