The New York State Bar Association Tax Section has submitted a report on the rules governing previously taxed earnings and profits (PTI) under section 959 and the related basis adjustments under section 961, primarily focusing on tax code changes under the Tax Cuts and Jobs Act (P.L. 115-97).

The tax section first notes that the section 965 transition tax raises a variety of PTI issues and is discussed as a building block for the framework for analyzing these issues more broadly. Regarding “traditional” subpart F income, the retention of section 956, and the addition of section 951A on global intangible low-taxed income by the TCJA, PTI issues extend well beyond income included under section 965.

Section members address and make recommendations on several issues, including whether and how PTI attributes can be shared within a consolidated group as provided by the 2006 proposed regulations (REG-121509-00). The group says this requires a different calculus after the TCJA and requires consideration of the ability to take foreign tax credits and the complexities of section 1059.

The tax section advises that the limited gain reduction rule in Notice 2018-7 and the proposed section 965 regulations (REG-104226-18) might be read as a way for Treasury to leave open the possibility that section 961 basis reductions and gain occur before basis increases. Section members say that instead of leaving the issue open and providing a helpful (but limited) gain reduction rule that only applies to distributions of section 965(a) and 965(b) PTI during the transition year, Treasury should resolve the issue by clarifying that for purposes of determining section 961(b)(2) gain, basis decreases in controlled foreign corporation stock under section 961(b), and gain under section 961(b)(2), do not occur before giving effect to basis increases under section 961(a).

Absent that clarification, section members urge Treasury to allow distributions during the transition year to be treated as being made first out of section 965(a) PTI and 965(b) PTI (before other types of PTI), so that such distributions, if necessary, would be eligible for the gain reduction rule in Notice 2018-7 and Notice 2018-13 and the proposed section 965 regs.

Section members also recommend that Treasury and the IRS issue regulations on several topics. Members suggest regs providing that there should be no gain recognition (or basis reduction) because of PTI distributions that exceed basis in cases in which the upper-tier CFC did not previously increase its basis in lower-tier CFC stock under section 961(a) and (c). Other regs should provide that section 961(c) basis adjustments in lower-tier CFC stock apply not only for purposes of calculating the subpart F income of upper-tier CFCs, but also for purposes of calculating GILTI tested income of upper-tier CFCs. Members add that Treasury and the IRS should consider issuing regs providing that a section 959(c)(3) deficit is not netted with the amount of PTI; rather, both amounts can coexist as disaggregated components of a CFC’s E&P. Another recommended reg would provide that a distribution under section 301(c)(2) does not reduce PTI; rather, that PTI should only be reduced by the amount of a distribution that otherwise would have been included in gross income by a U.S. shareholder.

NYSBA Tax Section Report Addresses Rules on Previously Taxed E&P