CHANGES IN SECTION 965 SPECIFIED FOREIGN CORPORATIONS’ TAX YEARS
On February 13, 2018, the Department of the Treasury and the Internal Revenue Service (collectively, “Treasury”) issued Rev. Proc. 2018-17 (the “Rev. Proc.”). The Rev. Proc. provides additional guidance under Section 965, Treatment of deferred foreign income upon transition to participation exemption system of taxation, as amended by the “Tax Cut and Jobs Act,” which was enacted on December 22, 2017. In particular, the Rev. Proc. provides guidance regarding certain changes in Section 965 specified foreign corporations’ tax years.
Section 442 and §1.442-1(a) generally provide that a taxpayer seeking to change its annual accounting period and use a new taxable year must obtain the approval of the Commissioner. In general, under §1.442-1(b)(2), a change in annual accounting period will be approved when a taxpayer agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the change. Section 1.442-1(b)(3) provides that the Commissioner will prescribe the administrative procedures for a taxpayer to be allowed to adopt, change, or retain an annual accounting period. Rev. Proc. 2002-39 provides the general procedures under Section 442 and §1.442-1(b) for obtaining the approval of the Commissioner to adopt, change, or retain an annual accounting period for federal income tax purposes. Rev. Proc. 2006-45, as a successor to Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, provides the exclusive procedures for certain corporations to obtain automatic approval of the Commissioner to change their annual accounting periods.
Section 965(a) provides that for the last taxable year of a deferred foreign income corporation (DFIC) that begins before January 1, 2018, the subpart F income of the corporation (as otherwise determined for such taxable year under Section 952) shall be increased by the greater of the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or December 31, 2017 (each such date, a “measurement date”).
Section 965(o) provides that the Secretary shall prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of Section 965, including regulations or other guidance to prevent the avoidance of the purposes of such section, including through a reduction in earnings and profits, through changes in entity classification or accounting methods, or otherwise. The Conference Report accompanying the Tax Cut and Jobs Act states, “The conferees are also aware that certain taxpayers may have engaged in tax strategies designed to reduce the amount of post-1986 earnings and profits in order to decrease the amount of the inclusion required under this provision. Such tax strategies may include a change in entity classification, accounting method, and taxable year . . . .” H.R. Rep. No. 115-466, at 619 (2017) (emphasis added).
A Section 965 specified foreign corporation with a taxable year ending on December 31, 2017, could avoid the purposes of Section 965 by changing its taxable year. For example, if a DFIC with the calendar year as its taxable year elected, effective for its taxable year beginning January 1, 2017, a taxable year closing on November 30, the election could defer by as much as 11 months a U.S. shareholder’s inclusion with respect to the DFIC under Section 965. Further, the election could, depending on the facts, reduce the amount of the tax liability of a U.S. shareholder of the DFIC by reason of Section 965, including through the reduction of the post-1986 earnings and profits of the DFIC.
The Rev. Proc. applies to a Section 965 specified foreign corporation seeking to change its taxable year that ends on December 31, 2017. For purposes of applying the Rev. Proc., a 52-53-week taxable year is deemed to begin on the first day of the calendar month nearest to the first day of the 52-53-week taxable year, and is deemed to end or close on the last day of the calendar month nearest to the last day of the 52-53-week taxable year, as the case may be. See §1.441-2(c).
In particular, the Rev. Proc. provides for the inapplicability of Rev. Proc. 2006-45 and Rev. Proc. 2002-39 as it relates to changing the annual accounting period of specified foreign corporations (as defined in Section 965(e)) if each of the following conditions is satisfied:
- The specified foreign corporation’s taxable year (determined without regard to the requested change) ends on December 31;
- If the requested change were permitted, the first effective year of the corporation would begin on January 1, 2017, and would end on a date before December 31, 2017; and
- The specified foreign corporation has one or more U.S. shareholders that must include an amount in gross income under Section 951(a)(1) by reason of Section 965 with respect to the specified foreign corporation or any other specified foreign corporation (with such amount determined without regard to the requested change).”
The Rev. Proc. applies with respect to any request to change an annual accounting period that ends on December 31, 2017, regardless of when such request was filed.
The release of the rules contained in the Rev. Proc. is not surprising given the broad language in Section 965(o) and Conference Report accompanying the Tax Cuts and Jobs Act. We can assist clients with calculating their income tax liability under Section 965 and help with understanding the complexities with various international tax reform provisions, including Section 965 and the rules discussed in the Rev. Proc.
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