New guidance lays the foundation for future rulemaking on the interaction between foreign tax credits and pillar 2 rules, including disallowing credits when the global anti-base-erosion (GLOBE) analysis includes any U.S. income tax liability.
In Notice 2023-80, released December 11, Treasury announced guidance for future rulemaking that will focus on the creditability of foreign taxes that apply the GLOBE rules. The guidance will address a final top-up tax’s creditability. It generally allows a credit unless the final top-up tax accounted for any U.S. federal income tax liability, regardless of whether the income tax liability was considered in the top-up tax computation.
While the guidance includes issues related to the income inclusion rule and qualified domestic minimum top-up taxes (QDMTTs), it didn't cover the undertaxed payments rule. The notice says that “the Treasury Department and the IRS continue to analyze issues related to the UTPR and intend to issue additional guidance.”
John Harrington of Dentons told Tax Notes that omitting UTPR guidance is understandable because members of Congress are concerned about the UTPR's application to U.S. companies. The UTPR is not expected to apply until 2025 or possibly later, so the IRS has time to provide guidance in the proposed regulations that will implement Notice 2023-80, he added.
“Countries will inevitably depart from those model rules, and if implementation and adoption are messy, more detailed guidance will be necessary,” Harrington said.
Pillar 2 establishes a top-up taxation framework through the GLOBE rules, which consist of the IIR and the UTPR. The GLOBE rules apply to multinational enterprises with annual group revenue exceeding €750 million to ensure they pay an effective tax rate of 15 percent in all jurisdictions in which they have operations.
A parent company subject to an IIR must calculate and pay top-up tax on the undertaxed earnings of its constituent entities to the taxing jurisdiction’s tax authority. If the jurisdiction lacks an IIR, the jurisdictions of the constituent entities would have a top-up taxing right on allocated low-taxed earnings if they enforce a UTPR.
The IIR applies before the UTPR, but the GLOBE model rules give countries the option of adopting a domestic minimum top-up tax as long as that tax is peer-reviewed and qualified as being in line with the GLOBE rules.
The United States is among the 140 jurisdictions in the inclusive framework on base erosion and profit shifting that had approved the plan to modernize the international corporate tax system in October 2021.
Several countries will start enforcing the GLOBE rules in 2024, but questions have persisted about the creditability of QDMTTs and GLOBE taxes under the FTC regulations (T.D. 9959).
Brendan Sinnott of Alvarez & Marsal Tax LLC said that the guidance was mostly what everyone expected because “someone is always going to lose, given the circularity of these rules." He added that the rules are “clearly a bit detrimental to U.S. taxpayers when the IIR and the UTPR will largely be uncreditable for U.S. purposes, but this just confirms what a lot of people feared.”
Sinnott said that he was surprised by the section on indirect FTCs because if a company is unable to credit the tax, it is potentially on the hook for the section 78 gross-up inclusion.
The guidance states that “a taxpayer who chooses to credit foreign income taxes would be required to include in gross income under section 78 an amount equal to the amount of a final top-up tax deemed paid by the taxpayer under sections 960(a), (b), and (d), and would not be able to claim a deduction for a final top-up tax under section 275(a)(4).”
Non-Duplication Requirement
The future proposed rules will alter the non-duplication requirement of reg. section 1.903(c)(1)(ii) and clarify that for a foreign tax to qualify as an in-lieu-of-tax, it must only be in substitution for a generally imposed net income tax and not all net income taxes from that country.
The first sentence of the non-duplication requirement will be revised to read: “The generally-imposed net income tax for which the tested foreign tax is imposed in substitution is not also imposed, in addition to the tested foreign tax, on any persons with respect to any portion of the income to which the amounts (such as sales or units of production) that form the base of the tested foreign tax relate (the ‘excluded income’).”
Harrington said the change is a technical issue because the FTC regs are based on a binary approach in which there are two approaches for a credit depending on whether there is an income tax or a section 903 in-lieu-of-an-income-tax. The section 903 tax needs to be a substitute, but because QDMTTs and IIRs do not have direct counterparts, there needed to be a carveout for the GLOBE rules, he noted.
Dual Consolidated Losses
Section 1503(d) prevents double dipping of losses that occur from the same economic loss offsets or that reduce both U.S. income and foreign income subject to that jurisdiction's tax rules. The notice says that “a dual consolidated loss (DCL) is defined as a net operating loss of a dual resident corporation and a net loss of a domestic corporation that is attributable to certain foreign branches or interests in hybrid entities (separate units).”
“The introduction of the pillar 2 rules raises a number of issues relating to the application of the DCL rules, including whether there is a foreign use of a DCL,” Joseph Calianno of Andersen Tax LLC said.
Notice 2023-80 recognizes that because the GLOBE rules follow a jurisdictional blending approach with general aggregation principles, it may cause double-dipping concerns, which it says should be addressed by the DCL rules.
“The notice makes clear that Treasury is aware of these issues and that we can expect future guidance addressing these issues," Calianno said. "However, in the meantime, Treasury is providing some relief to taxpayers as it relates to legacy DCLs (as defined in the notice) by providing that a foreign use would not be considered to occur with respect to a legacy DCL solely because all or a portion of the deductions or losses that comprise the legacy DCL are taken into account in determining the net GLOBE income for a particular jurisdiction.”
The guidance allows taxpayers to rely on the guidance for legacy DCLs “until proposed regulations are published in the Federal Register.”
Relief Extension
The future proposed regs would extend the temporary relief included in Notice 2023-55, 2023-32 IRB 427, which provided relief from some of the more onerous provisions of the 2022 FTC regs, such as the attribution requirement and the significant cost and expenses provision of the cost recovery principle. Notice 2023-55 gave taxpayers the option to apply the rules in place before the 2022 FTC regs, such as former reg. section 1.901-2(a) and (b), to determine whether a foreign tax qualifies as a creditable income tax and allowed the limited return of the predominant character test for determining a tax’s creditability.
The guidance says that it would modify the relief period to “mean taxable years beginning on or after December 28, 2021, and ending before the date that a notice or other guidance withdrawing or modifying the temporary relief is issued (or any later date specified in such notice or other guidance).”
“Taxpayers will welcome the extension of the temporary relief, but it is unclear based on the language of Notice 2023-80 when the relief will end,” Calianno said.
Harrington noted that this presents some problems because “taxpayers have to make long-term plans, and the creditability of foreign taxes can affect that long-term planning. No one wants to sit beneath the sword of Damocles for too long.”