Regs Make clear Disregarded Funds Involving Non-Department Taxable Models

Reg. part 1.904-4(a)-(q) governs the separate utility of the part 904 overseas tax credit score limitation to classes of earnings. Revealed January 2, T.D. 9959 added steerage to the principles in reg. part 1.904-4(f) that govern the FTC limitation for the overseas department earnings class.

Part 901 permits a credit score for taxes paid to overseas nations. The FTC is restricted by part 904 to a fraction of U.S. tax expense equal to the taxpayer’s foreign-source taxable earnings divided by its complete taxable earnings. Taxpayers should decide 4 separate FTC limitations for 4 classes of earnings listed in part 904(d)(1)(A)-(D):

• world intangible low-taxed earnings inclusions below part 951A;
• overseas department earnings;
• passive class earnings; and
• basic class earnings.

Reg. part 1.904-4(f)(1)-(4) addresses the overseas department earnings class. The steerage consists of:

• a definition of overseas department class earnings;
• an outline of gross earnings attributable to a overseas department;
• 13 definitions; and
• 16 examples.

Reg. part 1.904-4(q)(3) supplies that paragraph (f) of reg. part 1.904-4 applies to tax years that start after December 31, 2019, and finish on or after November 2, 2020. This text focuses on disregarded funds involving non-branch taxable models. Earlier articles addressed disregarded transfers of property between overseas branches and their homeowners (Tax Notes Int’l, Apr. 4, 2022, p. 16) and changes to overseas department earnings for disregarded funds between overseas branches and their homeowners (Tax Notes Int’l, Mar. 28, 2022, p. 1495).

International Department Class Earnings

Reg. part 1.904-4(f)(1)(i)-(iv) describes overseas department class earnings. Reg. part 1.904-4(f)(1)(i)(A)-(C) typically supplies that overseas department class earnings is earnings of a U.S. individual aside from a passthrough entity that’s:

• attributable to the U.S. individual’s overseas branches held instantly or not directly by disregarded entities;
• a distributive share of partnership earnings attributable to overseas branches held by the partnership instantly or not directly by disregarded entities, or held not directly by the partnership by one other partnership or different passthrough entity that holds the overseas branches instantly or not directly by disregarded entities; and
• earnings of different passthrough entities decided below rules like these described above in paragraph (B).

Reg. part 1.904-4(f)(1)(ii)-(iv) supplies exclusions from overseas department class earnings for:

• passive class earnings;
• earnings arising from U.S. actions; and
• earnings arising from inventory of a company.

Earnings Attributable to a International Department

Reg. part 1.904-4(f)(2)(i)-(vi) describes gross earnings attributable to a overseas department (paragraphs (ii) and (iii) are reserved). The steerage consists of:

• a basic rule that gross earnings mirrored on a department’s books and information is attributable to the department;
• an exception for acquire from the department’s disposition of an curiosity in a partnership, passthrough, or disregarded entity;
• an antiavoidance rule; and
• changes to gross earnings for disregarded funds allocable to earnings that will be attributable to a overseas department.

Below reg. part 1.904-4(f)(2)(i), gross earnings is attributable to a overseas department to the extent that it’s mirrored on the separate set of overseas department books and information (as outlined in reg. part 1.989(a)-1(d)(1) and (2)). Gross earnings that’s not attributable to the overseas department and is due to this fact attributable to the overseas department proprietor is earnings in a separate class (aside from the overseas department class).

Reg. part 1.904-4(f)(2)(vi)(A)-(G) requires attribution of gross earnings to which disregarded funds are allocable. The steerage accommodates:

• a basic rule requiring changes to gross earnings when a disregarded cost is allocable to the earnings;
• guidelines for allocating disregarded funds to gross earnings;
• an exclusion of specified disregarded funds from the attribution guidelines;
• the remedy of intangible property transfers;
• guidelines for figuring out the quantity of a disregarded cost;
• the remedy of a number of disregarded funds made in a single tax 12 months; and
• the remedy of disregarded funds made or obtained by non-branch taxable models.

This text focuses on the principles in reg. part 1.904-4(f)(2)(vi)(G) that govern the changes to gross earnings below paragraph (A) and allocation of disregarded funds below paragraph (B) when non-branch taxable models are current.

Changes to Gross Earnings

Reg. part 1.904-4(f)(2)(vi)(A) applies when a overseas department makes a disregarded cost to its proprietor, or a second overseas department, and the disregarded cost is allocable to gross earnings that will be attributable to the overseas department below the principles in reg. part 1.904-4(f)(2)(i)-(v). The taxpayer should regulate gross earnings attributable to the payer overseas department downward (however not beneath zero) to replicate the allocable quantity of the disregarded cost. The taxpayer should additionally regulate the gross earnings attributable to the recipient overseas department proprietor or the second overseas department upward by the identical quantity because the downward adjustment.

Equally, if a overseas department proprietor makes a disregarded cost to its overseas department and the disregarded cost is allocable to gross earnings attributable to the overseas department proprietor, the taxpayer adjusts gross earnings attributable to the payer overseas department proprietor downward (however not beneath zero) and the gross earnings attributable to the recipient overseas department upward by the identical quantity because the downward adjustment.

An adjustment to the quantity of attributable gross earnings below reg. part 1.904-4(f)(2)(vi) doesn’t change the entire quantity, character, or supply of a U.S. individual’s gross earnings; doesn’t change the quantity of a U.S. individual’s earnings in any separate class aside from the overseas department and basic classes (or a specified separate class related to the overseas department and basic classes); and has no bearing on the evaluation of whether or not an merchandise of gross earnings is eligible to be re-sourced below an earnings tax treaty.

Allocation of Disregarded Funds

Reg. part 1.904-4(f)(2)(vi)(B)(1)-(3) governs the willpower of whether or not a disregarded cost is allocable to gross earnings. A disregarded cost is allocable to gross earnings attributable to a overseas department or gross earnings attributable to its proprietor. The supply and separate classes of the gross earnings to which the disregarded cost is allocable are decided below guidelines in reg. part 1.904-4(f)(2)(vi)(B)(1)(i) and (ii) that distinguish between funds from an proprietor to its department and funds from a department to its proprietor.

Disregarded funds from a overseas department proprietor to its overseas department are allocable to gross earnings attributable to the overseas department proprietor to the extent {that a} deduction for that cost or any disregarded price restoration deduction regarding that cost, if regarded, could be allotted and apportioned to gross earnings attributable to the overseas department proprietor below reg. part 1.861-8 by -14T and -17 (with out regard to unique apportionment). Taxpayers should deal with foreign-source gross earnings and U.S.-source gross earnings in every separate class as a statutory grouping.

Disregarded funds from a overseas department to its overseas department proprietor or to a different overseas department are allocable to gross earnings attributable to the payer overseas department to the extent {that a} deduction for that cost or any disregarded price restoration deduction regarding that cost, if regarded, could be allotted and apportioned to gross earnings attributable to the payer overseas department below reg. part 1.861-8 by -14T and -17 (with out regard to unique apportionment). Once more, taxpayers should deal with foreign-source gross earnings and U.S.-source gross earnings in every separate class as a statutory grouping.

Reg. part 1.904-4(f)(2)(vi)(B)(3)(i) and (ii) addresses the timing of gross earnings reattribution.

The gross earnings attributable to the overseas department is usually adjusted solely within the tax 12 months {that a} disregarded cost, if regarded, could be allowed as a deduction (together with a disregarded price restoration deduction), or in any other case could be taken under consideration as a rise to price of products bought.

The gross earnings attributable to a overseas department property disposition is adjusted solely within the tax 12 months wherein acquire is acknowledged by the disposition of property with an adjusted disregarded foundation in a transaction that’s regarded below U.S. tax legislation.

Non-Department Taxable Models

Reg. part 1.904-4(f)(2)(vi)(G)(1)-(3) supplies steerage on figuring out the quantity, supply, and character of gross earnings attributable to a overseas department and its proprietor below reg. part 1.904-4(f)(2) when a non-branch taxable unit is current. “Non-branch taxable unit” is outlined in reg. part 1.904-4(f)(3)(xi) by cross-reference to reg. part 1.904-6(b)(2)(i)(B).

The regs in part 1.904-6 govern allocation and apportionment of overseas earnings tax expense to earnings classes. Reg. part 1.904-6(a) typically supplies that overseas earnings taxes assigned to a separate earnings class embody solely these overseas earnings taxes which might be allotted and apportioned to the separate class below the principles of reg. part 1.861-20. Reg. part 1.904-6(b)(1) and (2) supplies steerage on assigning overseas gross earnings to separate classes in circumstances wherein the earnings is attributable to a base distinction or a disregarded cost.

Reg. part 1.904-6(b)(2) applies when a taxpayer that’s a person or a home company consists of an merchandise of overseas gross earnings upon receipt of a disregarded cost by a overseas department or overseas department proprietor (as outlined in reg. part 1.904-4(f)(3)), or by a non-branch taxable unit. In that case, the overseas gross earnings merchandise is assigned to a separate class below reg. part 1.861-20(d)(3)(v), which accommodates guidelines for assigning overseas gross earnings from receipt of a disregarded cost to statutory and residual groupings.

A non-branch taxable unit is an individual or an curiosity described in reg. part 1.904-6(b)(2)(i)(B)(1) or (2), respectively.

A non-branch taxable unit is an individual:

• that’s not in any other case a overseas department proprietor and is a U.S. particular person, a home company, or a overseas or home partnership (or different passthrough entity as outlined in reg. part 1.904-5(a)(4)); and
• an curiosity wherein is owned instantly or not directly (by partnerships or different passthrough entities) by a U.S. particular person or a home company.

A non-branch taxable unit can also be an curiosity of a overseas department proprietor or an curiosity of an individual described above that’s:

• not in any other case a overseas department; and
• both a disregarded entity or a department as outlined in reg. part 1.267A-5(a)(2), together with a department described in reg. part 1.951A-2(c)(7)(iv)(A)(3) (modified by substituting “individual” for “managed overseas company”).

Reg. part 1.267A-5(a)(2) defines the time period “department” as a taxable presence of a tax resident in a rustic aside from its nation of residence, as decided below both the tax resident’s tax legislation or the opposite nation’s tax legislation. Reg. part 1.951A-2(c)(7)(iv)(A)(3) refers to a department as described in reg. part 1.267A-5(a)(2), the actions of that are carried on instantly or not directly (by a number of passthrough entities) by a CFC.

Below reg. part 1.904-4(f)(2)(vi)(G)(1), reg. part 1.904-4(f)(2) applies to deal with a non-branch taxable unit as if it had been a overseas department or a overseas department proprietor, as applicable. That is required to attribute gross earnings to the non-branch taxable unit and to then additional attribute the earnings of a non-branch taxable unit to a number of overseas branches or to a overseas department proprietor (see Instance 16). Particular guidelines in reg. part 1.904-4(f)(2)(vi)(G)(2) and (3) apply to overseas department group earnings and overseas department proprietor group earnings.

The earnings of a overseas department group is attributed to the overseas department that owns the group. The earnings of a overseas department group is the mixture of the U.S. gross earnings that’s attributed to every member of the overseas department group, decided after accounting for all disregarded funds made and obtained by every member of the overseas department group.

The earnings of a overseas department proprietor group is attributed to the overseas department proprietor that owns the group. The earnings of a overseas department proprietor group is the mixture of the U.S. gross earnings that’s attributed to every member of the overseas department proprietor group, decided after accounting for all disregarded funds made and obtained by every member of the overseas department proprietor group.

Definitions

Reg. part 1.904-4(f)(3)(i)-(xiii) accommodates definitions in impact for the principles in reg. part 1.904-4(f), together with the definitions of non-branch taxable unit (described above), overseas department group, overseas department proprietor, and overseas department proprietor group.

International department group is a overseas department and a number of non-branch taxable models (aside from a person or a home company), to the extent that the overseas department owns the non-branch taxable unit instantly or not directly by a number of different non-branch taxable models.

International department proprietor is the individual (together with a overseas or home partnership or different passthrough entity) that owns the overseas department both instantly or not directly by a number of disregarded entities. International department proprietor doesn’t embody the overseas department or one other overseas department of the individual that owns the overseas department.

International department proprietor group means a overseas department proprietor and a number of non-branch taxable models (aside from a person or a home company), to the extent that the overseas department proprietor owns the non-branch taxable unit instantly or not directly by a number of different non-branch taxable models.

Examples

The examples in reg. part 1.904-4(f)(4) illustrate the applying of the reg. part 1.904-4(f) definitions and earnings changes. Examples 13-16 accompany the principles for non-branch taxable models in reg. part 1.904-4(f)(2)(vi)(G).

Instance 13 illustrates a disregarded cost from a home company to its personal overseas department and varieties the idea for examples 14-16. Home company P owns FDE, a disregarded entity that may be a overseas department having the U.S. greenback as its useful forex.

In 12 months 1 P accrues, information on its books, and information below U.S. tax legislation $400 of U.S.-source gross earnings from the license of mental property to unrelated events that’s not passive class earnings. P additionally accrues $600 of foreign-source passive class curiosity earnings.

P compensates FDE for providers that FDE performs out of the country with an arm’s-length cost of $350 recorded on FDE’s books and information. The transaction is disregarded below U.S. tax legislation.

With out the adjustment guidelines in reg. part 1.904-4(f)(2)(vi), the $400 of gross earnings P earned from the license could be basic class earnings not attributable to FDE. If the $350 disregarded cost from P to FDE had been regarded below U.S. tax legislation, the deduction for the cost could be allotted and apportioned fully to P’s $400 U.S.-source basic class gross licensing earnings below reg. part 1.861-8 and -8T (treating U.S.-source basic class gross earnings and foreign-source passive class gross earnings every as a statutory grouping). P and FDE incur no different bills.

The $350 disregarded cost from P, a U.S. individual, to FDE, its overseas department, will not be recorded on FDE’s separate books and information below reg. part 1.904-4(f)(2)(i) as a result of it’s disregarded below U.S. tax legislation. The disregarded cost is allocable to gross earnings attributable to P as a result of a deduction for the cost, if it had been regarded, could be allotted and apportioned to the $400 of P’s U.S.-source licensing earnings.

Due to this fact, below the adjustment guidelines in reg. part 1.904-4(f)(2)(vi)(A) and the timing guidelines in reg. part 1.904-4(f)(2)(vi)(B)(3), the quantity of gross earnings attributable to the FDE overseas department (and the gross earnings attributable to P) is adjusted in 12 months 1 to account for the disregarded cost. The $350 of P’s $400 U.S.-source basic class gross earnings from the license is attributable to the FDE overseas department; and so $350 of the U.S.-source gross earnings that P earned from its license in 12 months 1 is assigned to the overseas department class. The remaining $50 stays U.S.-source basic class earnings. P’s $600 of foreign-source passive class curiosity earnings is unchanged.

Instance 14 illustrates a regarded cost from a nonconsolidated home company to a overseas department circuitously owned by the payer company. The information are the identical as in Instance 13, besides P wholly owns USS, and USS (fairly than P) owns FDE. P and USS don’t file a consolidated return. USS has no gross earnings aside from the $350 foreign-source providers earnings from the $350 cost it receives from P (by FDE).

The $350 providers cost from P, a U.S. individual, to FDE, a overseas department of USS, will not be a disregarded cost as a result of the transaction is regarded below U.S. tax legislation. Below reg. part 1.861-8 and -8T, P’s $350 deduction for the providers cost is allotted and apportioned to its U.S.-source basic class gross earnings.

The cost of $350 from P to USS by FDE is providers earnings attributable to FDE and overseas department class earnings of USS below reg. part 1.904-4(f)(2)(i). Due to this fact, USS has $350 of foreign-source overseas department class gross earnings. P has $600 of foreign-source passive class earnings and $400 of U.S.-source basic class gross earnings offset by a $350 deduction for the providers cost. The web result’s $50 of U.S.-source basic class taxable earnings to P.

Instance 15 is described within the regs’ preamble as illustrating the matching rule in reg. part 1.1502-13 to a regarded intercompany cost from a member of an affiliated group to a overseas department owned by a unique member of the group. Reg. part 1.1502-13(a)-(m) supplies guidelines for figuring out earnings, acquire, deduction, and lack of consolidated group members from intercompany transactions. Its goal is to replicate taxable earnings and tax legal responsibility of a bunch as a complete by stopping intercompany transactions from creating, accelerating, avoiding, or deferring consolidated taxable earnings or tax legal responsibility.

The information in Instance 15 are the identical as in Instance 14, besides that P and USS are members of an affiliated group that recordsdata a consolidated return below part 1502.

Intercompany Transaction

Reg. part 1.1502-13(b)(1) defines an intercompany transaction as a transaction between companies which might be members of the identical consolidated group instantly after the transaction. Due to this fact, the $350 providers cost from P to FDE, a overseas department of USS, is an intercompany transaction between P and USS. USS is the promoting member, and P is the shopping for member. P has a $350 deduction for the providers cost that may be a corresponding merchandise, and USS has $350 of earnings that’s an intercompany merchandise. The cost will not be a disregarded cost as a result of the transaction is regarded below U.S. tax legislation.

Timing and Attributes

Reg. part 1.1502-13(a)(2) supplies that the promoting member and the shopping for member are handled both as separate entities or as divisions of a single company, relying on the willpower at concern. The quantity and site of vendor and purchaser’s intercompany objects are decided on a separate-entity foundation. The timing and attributes (like character and supply) of the intercompany objects are initially decided on a separate-entity foundation however are then redetermined to provide the impact of transactions between divisions of a single company.

Below a separate-entity evaluation, the consequence is identical as in Instance 14, wherein P has $600 of foreign-source passive class earnings and $50 of U.S.-source basic class earnings, whereas USS has $350 of foreign-source overseas department class earnings.

In distinction, below a single-entity evaluation, the consequence is identical as in Instance 13, wherein P has $600 of foreign-source passive class earnings, $50 of U.S.-source basic class earnings, and $350 of U.S.-source overseas department class earnings.

The Matching Rule

Below the matching rule in reg. part 1.1502-13(c)(1), the timing, character, supply, and different attributes of USS’s $350 intercompany merchandise and P’s $350 corresponding merchandise are redetermined to provide the impact of transactions between divisions of a single company, as if the providers cost had been made to a overseas department of that company. Accordingly, all of USS’s foreign-source earnings of $350 is redetermined to be U.S.-source (not foreign-source) earnings.

Due to this fact, below reg. part 1.1502-4(c)(1) (governing calculation of a bunch’s FTC limitation), the P group has $600 of overseas passive class earnings, $50 of U.S.-source basic class earnings, and $350 of U.S.-source overseas department class earnings.

Instance 16 illustrates a disregarded cost made by a non-branch taxable unit. The information are the identical as these in Instance 13, besides that P additionally wholly owns FDE1, a disregarded entity that may be a non-branch taxable unit. FDE1 (fairly than P) accrues and information on its books and information the $400 of U.S.-source basic class earnings from the license of IP and the $600 of foreign-source passive class curiosity earnings. Furthermore, FDE1 (fairly than P) is the entity that makes the $350 cost to FDE for providers, which is disregarded below U.S. tax legislation.

Below reg. part 1.904-4(f)(2)(vi)(G), the principles of reg. part 1.904-4(f)(2) apply to attribute gross earnings to FDE1, a non-branch taxable unit, as if FDE1 had been a overseas department. Below these guidelines, the $400 of licensing earnings and the $600 of curiosity earnings are initially attributable to FDE1. This earnings is adjusted in 12 months 1 to account for the $350 disregarded cost, which is allocable to the $400 of licensing earnings of FDE1.

Accordingly, $50 of the $400 of U.S.-source basic class licensing earnings is attributable to FDE1, and $350 of this earnings is attributable to the FDE overseas department. To find out the earnings that’s attributable to P, the overseas department proprietor, and FDE, the overseas department, the earnings that’s attributed to FDE1, after bearing in mind all of the disregarded funds that it makes and receives, should be additional attributed to a number of overseas branches or a overseas department proprietor below reg. part 1.904-4(f)(2)(vi)(G).

Below reg. part 1.904-4(f)(2)(vi)(G), the earnings of FDE1 is attributed to the overseas department group or overseas department proprietor group of which it’s a member. As a result of FDE1 is wholly owned by P, FDE is a member solely of the overseas department proprietor group that’s owned by P (see definition of overseas department proprietor group in reg. part 1.904-4(f)(3)).

All of the earnings that’s attributed to FDE1 below reg. part 1.904-4(f)(2) — specifically, the $50 of U.S.-source basic class licensing earnings and the $600 of foreign-source passive class curiosity earnings — is additional attributed to P below reg. part 1.904-4(f)(2)(vi)(G)(3). Due to this fact, the consequence is identical as in Instance 13.

Preamble

Whereas the ultimate regs’ preamble accommodates little or no commentary on the principles for non-branch taxable models, the preamble to the proposed regs finalized in T.D. 9959 (REG-101657-20) explains their rationale and operation. The reallocation guidelines apply to disregarded funds made to and from non-branch taxable models outlined typically as individuals and pursuits that don’t meet the definition of a overseas department or overseas department proprietor. For instance, disregarded funds could happen amongst overseas branches, overseas department homeowners, and disregarded entities that haven’t any commerce or enterprise and are due to this fact not overseas branches.

Disregarded funds to and from non-branch taxable models should be reattributed to the identical extent as disregarded funds to and from overseas branches and overseas department homeowners. Due to this fact, the gross earnings attributed to a non-branch taxable unit should be additional attributed to a overseas department (if the non-branch taxable unit is a part of a overseas department group) or a overseas department proprietor (if the non-branch taxable unit is a part of a overseas department proprietor group). Reattribution is finished after accounting for all disregarded funds that the non-branch taxable unit makes and receives.

A non-branch taxable unit is a part of both a overseas department group or a overseas department proprietor group to the extent that it’s owned (together with not directly by different non-branch taxable models) by a overseas department or a overseas department proprietor. Gross earnings attributed to the members of a overseas department group is attributed to the overseas department that owns the group. Gross earnings attributed to the members of a overseas department proprietor group is attributed to the overseas department proprietor that owns the group.