In depth

In December of 2017, the Tax Cuts and Jobs Act (TCJA) introduced GILTI and its determining formula, which is based on certain items of each CFC that the shareholder owns, including tested income, tested loss, and qualified business asset investment (QBAI). Determining each of these items required a series of new definitions, operating rules, and examples to be added to the Code and regulations. Reviewing each of these new provisions is not necessary for the purpose of this article. For further information, please see the previous Tax News and Developments articles on the final and proposed GILTI regulations. Rev. Proc. 2021-26 addresses section 951A(d)(3)’s requirement that the adjusted basis in any property for purposes of calculating QBAI must be determined by using ADS. As with many of the TCJA provisions, Treasury and the IRS moved quickly to release implementing regulations. Under proposed GILTI regulations, ADS generally would have applied to determine the basis of property for purposes of QBAI, irrespective of when the property was placed in service or whether the basis of the property was determined using another method for computing depreciation for other purposes of the Code. See Prop. Reg. §1.951A-3(e)(1)-(3). While section 168(g)(1)(A) requires US shareholders of CFCs to use ADS to depreciate tangible property predominantly used outside of the United States, CFCs computing their earnings and profits (E&P) may instead apply a depreciation method used for their financial accounting purposes or a method consistent with US generally accepted accounting principles, provided that the adjustments required to conform to ADS are not material. See Reg. §1.952- 2(c)(2), Reg. §1.964-1(a)(2).

Because taxpayers commented on compliance burdens associated with the proposed regulations, the final regulations provide some relief. For example, the final regulations allow for a taxpayer election out of applying ADS for property placed in service before the first taxable year beginning after 22 December 2017. See Reg. §1.951A-3(e)(3)(ii)).

Automatic Accounting Method Change: Treasury and the IRS also promised relief in a future revenue procedure that would expand the availability of automatic consent for accounting method changes to ADS for CFCs, not otherwise required to use ADS for purposes of computing their income and E&P, that want to conform their income, E&P, and QBAI computations.

Generally section 446 requires a taxpayer to get the IRS’s consent to change its depreciation method. While CFCs using an impermissible non-ADS method of accounting generally were allowed to use the automatic accounting method change procedures to do just this, those using a permissible method were not. See Rev. Proc. 2015-13, Rev. Proc. 2019-43. Rev. Proc. 2021-26 temporarily expands the automatic consent procedures of Rev. Proc. 2019-43 to CFCs using a permissible method non-ADS method.

Take Note: The guidance also allows for limited retroactive relief. Eligible taxpayers may convert a Form 3115 properly filed under the non-automatic procedures of Rev. Proc. 2015-13 for a limited time. To be eligible for conversion, the Form 3115:

• must have been filed before 11 May 2021.
•  must have been pending with the national office on 11 May 2021.

In addition, the designated shareholder must notify the national office contact person for the Form 3115 of the CFCs intent to make the change in method of accounting under the automatic change procedures before the issuance of a letter ruling granting or denying consent for the non-automatic change. See Rev. Proc. 2021-26 (modifying Rev. Proc. 2019-43, §6.22). The taxpayer then attaches an acknowledgement sent from the national office with a newly submitted Form 3115 by the earlier of:

• the 30th calendar day after the date of the national office's letter acknowledging the request to convert, or
• the date the designated shareholder is required to file the original Form 3115 under section 6.03(1)(a) of Rev. Proc. 2015-13.

Additional Guidance Under Rev. Proc. 2021-26: Rev. Proc. 2021-26 also requires a section 481 adjustment for any automatic accounting method change sought under the guidance. Rev. Proc. 2015-13, §7.07 includes the terms and conditions for a section 481 adjustment reflecting the difference between the CFCs income and E&P under the two methods. Because this provision predated section 951A, Rev. Proc. 2021-26 updates this provision to take section 951A into account in the section 481 computation.

Finally, Rev. Proc. 2021-26 continues to deny audit protection to CFCs for a tax year before the requested year of change in which one or more of its US shareholders computes foreign taxes deemed paid under sections 902 and 960 regarding the CFC that exceeds 150 percent of the average amount of foreign taxes deemed paid by the shareholder regarding the CFC in the US shareholder’s three prior tax years. Rev. Proc. 2021-26 modifies the rule in Rev. Proc. 2015-13, §8.02, however, to clarify that the 150 percent threshold is determined using the amount of the foreign corporation’s foreign taxes deemed paid, regardless of the extent to which a foreign tax credit is allowed.

Relief Available: The temporary automatic consent procedures of Rev. Proc. 2021-26 are effective for a Form 3115 filed on or after 11 May 2021 for a taxable year of a CFC ending before 1 January 2024.

Takeaway: Taxpayers and their representatives have an opportunity to suggest streamlined and cost-effective tax administration procedures and request corrections or clarification regarding outdated guidance during a comment period. Even when the comments are rejected, the Treasury and IRS may provide insight into their views on the issue. Alexandra Minkovich recently noted that “Given the significant number of guidance projects that are in the works at any given time, identifying areas where a lack of guidance is causing current challenges for taxpayers helps Treasury and the IRS focus on items that will have an immediate impact.” Alexandra Minkovich, Treasury and IRS Ease Taxpayer Burdens By Allowing an Automatic Method Change to Claim 30-Year ADS Depreciation and the Filing of Amended Partnership Returns, 37 Real Est. J. No. 7 (21 July 2021).

This alert is part of the Tax News and Developments newsletter. See the other articles below:

Part 1 - North America: Residual Profits and Market Jurisdictions

Part 2 - International: G20 supports latest Pillar One and Pillar Two proposals

Part 3 - United States: Eleventh Circuit agrees that the Federal Circuit effectively has control over all overpayment interest suits

Part 4 - United States: Ninth Circuit reverses Tax Court’s use of substance-over-form doctrine in Mazzei

Part 5 - North America: NOL carryback period waiver applies to certain specified liability losses

Part 6 - North America: Maryland Court of Appeals rules that Travelocity is not liable for Maryland sales and use tax prior to enactment of Maryland’s accommodations intermediary law