February 18, 2022
Under the Trump administration, a new tax reform law (Tax Cuts and Jobs Act) was enacted and began to take effect in January 2018, resulting in significant tax changes. The Global Intangible Low Tax Income (GILTI) system, under which the income of a controlled foreign corporation (CFC) is taxed at the U.S. shareholder's combined rate, calculated using a certain calculation method based on U.S. tax law, was also added to the tax code under the Trump administration. In this newsletter, we will discuss the expansion of the automatic change of accounting method for CFCs.
Please note, the explanation below is rather technical, so please read only if you are interested in the technical aspect of taxation.
On May 11, 2021, the IRS allowed certain foreign corporations to obtain automatic consent under Section 168(g) to change their depreciation method under the alternative depreciation system (ADS). This automatic procedure is intended to reduce tax compliance burdens associated with the implementation of the GILTI Final Regulations by making it easier for taxpayers to conform their income, earnings, profits, and GILTI calculations. In addition, the revenue procedure modifies certain special rules applicable to foreign corporations under existing modification procedures.
GILTI and ADSs
A U.S. shareholder of a CFC may be required to include GILTI in its income for the taxable year. In determining GILTI inclusion, the CFC test income will be reduced by 10% of its net deemed tangible income return or qualified business asset investment (QBAI).
For purposes of determining QBAI, the adjusted basis of a specified property, plant, or equipment is determined by using Section 168(g) ADS and allocating the depreciation deduction with respect to such property for the CFC inclusion year proportionately to the number of days in each tax year to which such depreciation relates.
In addition, for purposes of determining the CFC's earnings and profits (E&P), the CFC required to use ADS for depreciable assets property used outside of the U.S. under section 168(g)(1)(A). If there is no material difference between the ADS and non-ADS depreciation methods, the CFC may use the depreciation method used in the accounting books regularly maintained for accounting to shareholders, or a method that complies with U.S. accepted accounting principles ("non-ADS depreciation method").
CFCs that are not required to use ADSs can also convert to ADSs to conform their income, profit, and QBAI calculations。
Expanded Automatic Consent for ADS
CFCs on an impermissible non-ADS depreciation method for income and profit and loss calculations may request to change to straight-line depreciation with ADS, applicable convention and applicable recovery period using the automatic change procedure. However, CFCs using accounting methods other than permitted ADSs are not eligible for an automatic change to use ADSs.
Furthermore, CFCs using the permissible non-ADS method are also provided a time-limited procedure for obtaining automatic consent to change the method of accounting for depreciation of assets to ADS in determining gross income and taxable income. Automatic consent to change the method of accounting for depreciation to ADS can be obtained when determining accumulated foreign income Earnings & Profit (E&P) accumulated since 1987, and certain eligibility limitations are temporarily waived. This procedure reduces the burden on all CFCs to conform their income and E&P calculations to the QBAI calculations.
Code Section 481(a) Adjustments
When there is a change in a CFC's accounting method, the difference between the CFC's income and E&P under the old and new methods must be considered as a Section 481(a) adjustment. It has also been updated to consider the GILTI rules under Section 951A and to account for the elimination of oil-related income as a category of foreign-based enterprise income. the CFC's Section 481(a) adjustment must be considered in determining the CFC's test income or test loss.
Audit Protection
With certain exceptions, taxpayers will receive audit protection for items subject to a change in accounting method if they timely file Form 3115, Application for Change in Accounting Method. Audit protection will not be provided to a CFC or 10/50 corporation if the domestic shareholder of the corporation has a deemed foreign tax liability that exceeds 150% of the shareholder's average foreign tax liability for the previous three tax years in the year preceding the year in which the change in accounting method is filed. The audit protection exception remains unchanged, but it is clarified that the 150% threshold is calculated on the deemed foreign tax liability of the foreign corporation, regardless of the extent to which a foreign tax credit is allowed.
Effective Dates
Taxpayers subject to the GILTI rules should carefully consider whether and when to take advantage of the new guidance, especially if they are changing from a permissible method other than ADS. As mentioned earlier, a change from a permissible non-ADS method can be made using a favorable automatic change procedure, but the period is limited. This automatic change in accounting method procedure is effective for Form 3115 filed on or after May 11, 2021, for CFC taxable years ending on or before January 1, 2024.
CFCs that are not required to use the ADS method will need to file various tax proposals to repeal the QBAI provisions of GILTI, which, if passed, may eliminate the need to use the ADS method and the incentive to make the changes described in the guidance. In such a case, it would be advisable to send the implementation of the change in accounting method to a later date while the prospects for the passage of the various tax proposals become clearer.
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