Proposed GILTI regs. provide useful guidance on certain consolidated return issues

Editor: Michael Dell, CPA   On Sept. 13, 2018, Treasury and the IRS issued proposed regulations (REG-104390-18) under Sec. 951A, which requires U.S. shareholders of controlled foreign corporations (CFCs) to include global intangible low-taxed income (GILTI) in the shareholders’ gross income.

This item describes consolidated return aspects of the proposed regulations. In particular, this item describes (1) sharing tested loss with “income CFCs” owned by other consolidated group members; (2) the allocation of a consolidated group’s GILTI attributes to group members; (3) basis adjustments in consolidated group member stock by reason of offset tested income and used tested loss; and (4) intercompany nonrecognition transactions in which “loss CFC stock” is transferred.

Sharing tested loss with income CFCs owned by other consolidated group members

Unlike Sec. 951(a), which computes the Subpart F income inclusion of a CFC solely by reference to that CFC’s items, the GILTI inclusion under Sec. 951A for a CFC can be affected by the items of other CFCs depending on how the CFCs are owned. As a result, a strict, separate-return application of Sec. 951A to consolidated group members could distort measurement of the group’s consolidated tax liability. This is because the ownership of CFCs within the group could be intentionally or inadvertently segregated in a manner that alters the group’s total GILTI inclusion without otherwise being relevant to the group’s consolidated tax liability. Although the overall computational framework of Sec. 951A applies to consolidated groups, to minimize the impact of where CFCs are owned among consolidated group members, a limited form of single-entity treatment applies by aggregating certain GILTI-related items of members and then allocating the aggregate amounts back to the members. Each member has its own GILTI inclusion amount; to calculate the GILTI inclusion amounts, the proposed regulations aggregate tested loss, qualified business asset investment (QBAI), and specified interest expense, and then allocate these group attributes “back down” to the members based on their respective shares of aggregate tested income.

The proposed regulations effectively treat a consolidated group as a single entity for purposes of determining the sharing of tested loss. As described further below, the sharing of tested loss and the amount of tested income offset by tested loss also affects basis adjustments to the stock of consolidated group members (and the stock of CFCs that those members own). For example, if a consolidated group member, USS1, owns the stock of a CFC with tested income (an income CFC) and a CFC with tested loss (a loss CFC), and another member, USS2, owns the stock of an income CFC, the tested loss of the loss CFC owned by USS1 is shared proportionally with the tested income of both the income CFC owned by USS1 and the income CFC owned by USS2 (i.e., there is no “netting” of tested loss and tested income under USS1 and, thereafter, sharing with USS2 only the resulting net tested loss with CFCs; rather, each member’s income CFCs have equal priority to the tested loss of each member’s loss CFCs). Such sharing is implemented by Prop. Regs. Secs. 1.1502-51(c)(2) and (3), which provide the formula for determining the “used tested loss amount” (i.e., the amount of a loss CFC’s tested loss shared with income CFCs) and the “offset tested income amount” (i.e., the amount of an income CFC’s tested income that is offset by tested loss of loss CFCs).

If the consolidated group tested income (i.e., the aggregate amount of all its income CFCs) exceeds the consolidated group tested loss (i.e., the aggregate amount of all its loss CFCs), then there is positive consolidated net tested income, and the used tested loss amount of every loss CFC is the entire amount of its tested loss. More precisely, the used tested loss amount is calculated for each member’s interest in the loss CFC and would, in this case, equal that member’s entire share of the loss CFC’s tested loss (for ease of discussion, it is assumed that each member wholly owns its CFCs, so its pro rata share of the CFC’s items is 100%, unless otherwise indicated). That the used tested loss amount is composed of the entire tested loss in the situation is intuitive, in that the consolidated group overall is in a net positive tested income position, and thus all of the consolidated group tested loss must be used to offset the consolidated group tested income (i.e., none of the tested loss of any loss CFC is unused). In that case, not all of the consolidated group tested income is offset, and the consolidated tested loss is allocated pro rata for purposes of offsetting the tested income of each income CFC. The pro rata allocation to each income CFC is based on the ratio of: (1) the tested income of that income CFC over (2) the consolidated tested income (i.e., in proportion to the tested income of each income CFC). This proration applies uniformly to all tested income of income CFCs regardless of which member owns the income CFCs and loss CFCs.

Conversely, if the consolidated group tested loss exceeds the consolidated group tested income (i.e., there is consolidated net tested loss), then the offset tested income amount of every income CFC is the entire amount of its tested income. Again, this is intuitive because the consolidated group is in an overall net tested loss position and, therefore, the entire amount of every income CFC’s tested income is offset. In that case, not all of the consolidated group tested loss is used, and the use of the consolidated tested loss is allocated pro rata to the loss CFCs. The pro rata allocation to each loss CFC is based on the ratio of: (1) the tested loss of that loss CFC over (2) the consolidated group tested loss (i.e., in proportion to the tested loss of each loss CFC). Again, this proration applies uniformly to all tested loss of loss CFCs, regardless of which member owns the income CFCs and loss CFCs.

Example 1: USP owns 100% of the stock of each of USS1 and USS2, and each is a member of the USP consolidated group. USS1 owns 100% of the stock of CFC1; USS2 owns 100% of the stock of CFC2; and CFC2 owns 100% of the stock of CFC3. Thus, USS1 is the 10% U.S. shareholder that owns stock under Sec. 958(a) and thus includes income under Secs. 951 and 951A of CFC1; and USS2 is the Sec. 958(a) U.S. shareholder of CFC2 and CFC3. For the year, CFC1 has $100 of tested income; CFC2 has $100 of tested income; and CFC3 has $30 of tested loss.

The USP group is in a net consolidated group tested income position, with aggregate tested income of $170 ($100 of CFC1 tested income, plus $100 of CFC2 tested income, minus $30 of CFC3 tested loss). Thus, CFC3′s used tested loss amount is its entire tested loss of $30. This $30 used tested loss is shared with income CFCs owned by the group in proportion to their respected tested incomes. In this case, because CFC1 and CFC2 each have tested income of $100, CFC3 shares its $30 of tested loss equally — $15 with CFC1 and $15 with CFC2. CFC2 does not have “priority” to CFC3′s tested loss by reason of USS2 being the Sec. 958(a) U.S. shareholder of both CFC2 and CFC3 (i.e., there is no netting of CFC2′s $100 of tested income with CFC3′s $30 of tested loss before sharing any remaining net tested loss (which would be zero) with CFCs owned by other group members). Accordingly, the offset tested income amount of each of CFC1 and CFC2 is $15, and the net CFC tested income amount of each of USS1 and USS2 is $85.

Allocation of consolidated group’s GILTI attributes to group members

Similar to the sharing of tested loss described previously, no priority is given to the member that owns the CFC giving rise to QBAI and specified interest expense; rather, these attributes are allocated to each member in proportion to the member’s share of aggregate tested income (i.e., there is no tracing of the QBAI or interest expense of a CFC owned by one member to affect the GILTI inclusion amount of that member before affecting the GILTI inclusion amounts of other members). This allocation methodology is important because GILTI attributes affect the determination of each member’s GILTI inclusion amount. For example, the amount of consolidated QBAI allocated to each member is multiplied by 10% (resulting in the deemed tangible income return), and then reduced, but not below zero, by certain consolidated specified interest expense allocated to the member (resulting in the net deemed tangible income return), and the resulting amount reduces each member’s net CFC tested income to arrive at the member’s GILTI inclusion amount.

The operative provision implementing this approach is the definition of a member’s “allocable share” in Prop. Regs. Sec. 1.1502-51(e)(3). The allocable share is the amount of the consolidated group’s attributes that is allocated to each member, and is defined as the product of: (1) the amount of consolidated attributes, and (2) the member’s “GILTI allocation ratio.” In turn, the GILTI allocation ratio is the ratio of: (1) the member’s aggregate share of tested income to (2) the consolidated group’s tested income (in each case, only looking at income CFCs, and not loss CFCs). Thus, the consolidated group’s QBAI and specified interest expense are allocated to each member in proportion to the member’s contribution to the consolidated group tested income (taking into account only income CFCs).

Example 2: Similar to Example 1, USP owns USS1 and USS2; USS1 owns CFC1; USS2 owns CFC2; and CFC2 owns CFC3. CFC1 has $100 of tested income; CFC2 has $100 of tested income; and CFC3 has $30 of tested loss. Additionally, CFC1 has $450 of QBAI; CFC2 has $50 of QBAI; and CFC3 has $20 of specified interest expense that was taken into account in determining its $30 tested loss.

Similar to Example 1, the offset tested income amount of each of CFC1 and CFC2 is $15, and the net CFC tested income amount of each of USS1 and USS2 is $85. However, because this Example 2 includes QBAI and specified interest expense, to arrive at the GILTI inclusion amount of USS1 and USS2, the net tested income of each member is reduced by the member’s net deemed tangible income return.

The consolidated group QBAI is $500 (the sum of CFC1′s $450 of QBAI and CFC2′s $50 of QBAI). If CFC3 had QBAI, that QBAI would not be taken into account by reason of CFC3 being a loss CFC. This $500 consolidated group QBAI is allocated “back down” to members in proportion to the contribution of their income CFCs to the consolidated group tested income. In this case, because CFC1 (owned by USS1) and CFC2 (owned by USS2) each had $100 of tested income (and CFC3 is not taken into account by reason of being a loss CFC), the $500 of consolidated group QBAI is allocated equally — $250 to USS1 and $250 to USS2. Thus, there is no tracing of QBAI to the member owning the CFC with QBAI (i.e., even though CFC1, owned by USS1, had 90% of the QBAI, it is not the case that 90% of the QBAI is allocated to USS1 for purposes of determining USS1′s and USS2′s net CFC tested income; rather, CFC1′s QBAI and CFC2′s QBAI are both allocated in proportion to the tested income of income CFCs of each group member). Thus, each of USS1 and USS2 has a deemed tangible income return of 10% × $250, or $25.

The net deemed tangible income return is the deemed tangible income return, reduced by certain specified interest expense. For a consolidated group member, similar to the aggregation and allocation of QBAI described previously, the specified interest expense of the consolidated group is aggregated and then allocated to each member. In this case, CFC3 has $20 of specified interest expense. This specified interest expense is reflected in the net deemed tangible income return regardless of the fact that CFC3 is a loss CFC. Because CFC3 is the only CFC of the USP consolidated group with specified interest expense, the group’s consolidated specified interest expense is $20, and this amount is allocated to the members in proportion to the amount of tested income earned by the members’ income CFCs (i.e., it is not allocated solely to USS2 by reason of CFC3 being owned indirectly by USS2). In this case, because each of USS1′s income CFC (CFC1) and USS2′s income CFC (CFC2) earned $100 of tested income, the $20 specified interest expense is allocated equally — $10 to USS1 and $10 to USS2. Thus, the net deemed tangible income return of each of USS1 and USS2 is $15, equal to the $25 deemed tangible income return (which is 10% of each member’s $250 QBAI), less the $10 of specified interest expense.

Accordingly, the GILTI inclusion amount of each of USS1 and USS2 is $70, which is (1) the $85 net CFC tested income amounts (the $100 of positive tested income of CFC1 in the case of USS1, and $100 of positive tested income of CFC2 in the case of USS2, reduced by their respective $15 allocable amounts of CFC3′s $30 used tested loss) reduced by (2) the $15 net deemed tangible income return amounts.

Basis adjustments in consolidated group member stock by reason of offset tested income and used tested loss

The proposed regulations amend Regs. Sec. 1.1502-32 to require basis adjustments to: (1) the stock of a member owning a loss CFC that shared tested loss with an income CFC owned by the consolidated group; and (2) the stock of a member owning the income CFC whose tested income was offset by a loss CFC’s tested loss. These amendments are in addition to the general operation of the stock basis adjustment rules, which, without amendment, cause a positive basis adjustment in the stock of each member equal to that member’s taxable GILTI inclusion amount (i.e., the normal requirement to increase basis by the amount of a member’s taxable income and tax-exempt income, together with the likely treatment of a Sec. 250 deduction as simply converting a corresponding portion of the otherwise taxable income into tax-exempt income for these purposes, results in a stock basis increase equal to the gross GILTI inclusion amount of a member without adjustment for the Sec. 250 deduction).

In general, Prop. Regs. Secs. 1.1502-32(b)(3)(ii)(E), (F), and (iii)(C)cause:

1. A reduction in the basis in the stock of a member owning a loss CFC by the amount of tested loss that the member’s loss CFC shared with the consolidated group members’ income CFCs (i.e., to the extent the tested loss is used).

2. A reversal of this basis reduction (but not below zero, i.e., not resulting in a net overall basis increase) to the extent that the tested income of such member’s income CFCs is offset by tested loss of loss CFCs owned by the consolidated group (i.e., to the extent the tested income is not included by the U.S. shareholder in its taxable GILTI inclusion).

3. An increase in the basis of the stock of a member owning an income CFC for part or all of any remaining offset tested income of the income CFC, immediately before a recognition event with respect to the stock of the member (i.e., any offset tested income that did not previously reverse the basis reduction in 1 by reason of the adjustments in 2 that only eliminates the negative basis adjustments in 1 and does not create net positive basis adjustments).

The portion of the remaining offset tested income resulting in this increase equals the amount of the remaining offset tested income that, if distributed by the underlying CFC to the member, would have given rise to a 100% Sec. 245A dividends-received deduction but would not have been subject to Sec. 1059.

Said differently, before any recognition event for member stock, the used tested loss of a member’s loss CFCs reduces the basis in the member’s stock without limitation, whereas the offset tested income of the member’s income CFCs increases the basis in the member’s stock only to the extent that the increase offsets the reduction to stock basis from used tested loss. Thus, while there can be a net basis decrease to member stock, there can be no net basis increase to member stock by reason of both shared tested loss and offset tested income before a recognition event.

By contrast, a recognition event for member stock can result in a net basis increase to reflect any remaining offset tested income not previously used to reverse negative basis adjustments from shared tested loss, but only to the extent of the amount that could have been distributed by the underlying CFC to the member without causing taxable income to the member or causing the member to reduce its basis in the CFC’s stock.

The reduction in member stock basis for the used tested loss of the member’s loss CFCs contrasts with the deferred basis reduction required by the proposed regulations to the underlying loss CFC stock owned by the member. The basis of the loss CFC’s stock is not reduced until immediately before a taxable transfer of the loss CFC stock. Consideration should be given to the effects of this different mechanism during the periods before a disposition (e.g., whether and how Sec. 861 expense allocation is affected). The net positive adjustment in member stock immediately before a recognition event for the stock also differs from the treatment of underlying income CFC stock basis owned by the member. Income CFC stock basis is not increased by the amount of offset tested income, because the operation of Secs. 1248 and 245A generally makes the amount of gain on income CFC stock attributable to that offset tested income effectively tax-free, thus making basis increases in income CFC stock generally unnecessary.

If certain requirements are met (e.g., a holding period of greater than 365 days during which time the recipient has been a U.S. shareholder of the foreign corporation), Sec. 1248 recharacterizes gain on the sale of income CFC stock as a dividend to the extent of the income CFC’s earnings and profits attributable to the selling shareholder’s stock, and Sec. 245A allows a 100% dividends-received deduction on the foreign-source portion of dividends received from the income CFC (and other 10%-owned foreign corporations); although unclear, Sec. 1059 might not apply to the Sec. 245A dividends-received deduction with respect to dividend treatment arising under Sec. 1248. In contrast, gain from the sale of member stock is not subject to Sec. 1248 or Sec. 245A, and thus the basis in member stock needs to be increased by the amount of offset tested income of that member’s income CFCs to avoid the consolidated group being indirectly taxed on income that was generally intended to be tax-free through the operation of Secs. 1248 and 245A.

In effect, the proposed regulations provide for a basis increase in member stock in order to create parity with taxable transfers of underlying income CFC stock, determining the amount of the basis increase based on the amount that, if distributed, would have given rise to a Sec. 245A dividends-received deduction but would not have been subject to a Sec. 1059 basis reduction. Thus, to benefit from a net basis increase immediately before a recognition event for member stock, the member would need to own the stock of the income CFC for more than 365 days, and the hypothetical distribution by the income CFC to the member could not have been an extraordinary dividend under Sec. 1059 (e.g., because the member owned the CFC stock for more than two years, or the amount of the distribution is less than 10% of the member’s basis in CFC stock).

Example 3: Similar to Example 1, USP owns USS1 and USS2; USS1 owns CFC1; USS2 owns CFC2; and CFC2 owns CFC3. For year 1, CFC1 has $100 of tested income; CFC2 has $100 of tested income; and CFC3 has $30 of tested loss, resulting in an $85 GILTI inclusion for each of USS1 and USS2 — with $15 of offset tested income in each of CFC1 and CFC2, and $30 of used tested loss in CFC3. In year 2, CFC1 has $10 of tested loss, and CFC3 has $10 of tested income. In year 3, CFC1 has $50 of tested loss, and CFC3 has $50 of tested income. In year 4, USP sells all of the stock ofUSS2.

With respect to the taxable GILTI inclusion amounts, USP increases its basis in the stock of each of USS1 and USS2 by $85 in year 1. This result is provided by current law (treating the Sec. 250 deduction as resulting in a portion of the $85 being tax-exempt income).

Under the proposed regulations, in addition to the foregoing year 1 basis increase, by reason of CFC3′s $30 of used tested loss, USP reduces its basis in USS2 stock in year 1 by $30, under Prop. Regs. Sec. 1.1502-32(b)(3)(iii)(C). That reduction to USP’s basis in USS2 stock should be offset in year 1, in part, by reason of CFC2′s $15 of offset tested income, under Prop. Regs. Sec. 1.1502-32(b)(3)(ii)(E) (as noted earlier, $15 of CFC3′s tested loss is allocated to each of CFC1 and CFC2, notwithstanding that CFC2 and CFC3 are owned by USS2, whereas CFC1 is owned by USS1). Thus, USP should reduce its basis in USS2 stock in year 1 by only $15 ($30 negative for shared tested loss, “reversed” by $15 offset tested income), resulting in USP having a $70 net increase to CFC2 stock basis in year 1 when combined with the foregoing $85 increase for the taxable GILTI inclusion. By contrast, USP’s basis in USS1 stock remains increased by $85 for the taxable GILTI inclusion, because its $15 of offset tested income attributable to CFC1 is not a reversal of any negative basis adjustment to USS1 stock from shared tested losses of USS1′s CFCs (i.e., CFC1 has only had tested income thus far), and there has been no recognition event for the USS1 stock that could give rise to a net positive basis adjustment in USS1 stock for CFC1′s $15 of offset tested income. Thus, for year 1, the results of the foregoing adjustments are that USP increases its basis in USS1 by $85 and increases its basis in USS2 by $70.

In year 2, there is no taxable GILTI inclusion, so any basis adjustments arise solely from shared loss and offset tested income. CFC3′s $10 of tested income is offset by CFC1′s $10 of tested loss. This year 2 offset tested income of a CFC owned by USS2 reverses $10 of the $15 USS2 negative basis adjustment made in year 1. As described previously, there was a $15 net negative basis adjustment in USS2 stock in year 1 by reason of the shared loss ($30 used tested loss of CFC3, reversed to the extent of $15 offset tested income of CFC2), and, thus, $15 remains available for CFC3′s year 2 offset tested income to reverse. CFC3 has $10 of year 2 offset tested income, causing a $10 basis increase in USS2 stock (reducing the overall adjustment in USS2 stock basis by reason of shared loss from a $15 reduction to a $5 reduction). Thus, for year 2, the result of the foregoing adjustments is that USP increases its basis in USS2 by $10 (combined with year 1 for a cumulative increase of $80).

CFC1′s year 2 items should not cause an overall change to USP’s basis in USS1 stock. CFC1′s $10 of used tested loss causes a $10 basis reduction in USS1 stock, but this amount is offset by an equal $10 basis increase in USS1 stock for its year 1 offset tested income of $15 (limited to $10, the amount necessary to offset the year 2 shared loss). Because this basis increase takes into account all relevant years, it should not be relevant that CFC1′s offset tested income occurred in a year before its used tested loss; the earlier offset tested income nonetheless operates to reverse negative basis adjustments from later used tested loss. Thus, there is no net adjustment in USS1 stock in year 2. USS1 retains $5 of offset tested loss that can be used to reverse negative basis adjustments from future shared losses. The result of the foregoing adjustments is that USP does not change its basis in USS1 (combined with year 1 for a cumulative increase of $85).

In year 3, again there is no taxable GILTI inclusion, so the basis adjustments arise solely from shared loss and offset tested income. The same mechanics described earlier result in a $5 basis increase in USS2 stock. There was $5 remaining of CFC3′s $30 used tested loss ($15 of it was reversed in year 1 through CFC2′s offset tested income, and $10 of it was reversed in year 2 through CFC3′s offset tested income). The remaining $45 of CFC3′s year 3 offset tested income does not create a current basis increase in USS2 stock because a net increase in member stock basis (i.e., in excess of reversing negative adjustments) only results immediately before a recognition event for the stock. The result of the foregoing adjustments is that USP increases its basis in USS2 by $5 (combined with years 1 and 2 for a cumulative increase of $85).

The same mechanics described previously result in a $45 reduction in USP’s basis in USS1 stock in year 3. There is a $50 negative adjustment for CFC1′s $50 used tested loss. This $50 reduction is reversed to the extent of CFC1′s $5 remaining offset tested income from year 1 (the original $15 of CFC1′s year 1 offset tested income was used in part to eliminate CFC1′s year 2 $10 used tested loss, resulting in $5 of remaining offset tested income, which can reverse $5 of CFC1′s $50 used tested loss in year 3). The result of the foregoing adjustment is that USP reduces its basis in USS1 by $45 (combined with years 1 and 2 for a cumulative increase of $40).

In year 4, USP’s sale of USS2 stock provides an opportunity for a net basis increase in USS2 stock equal to the $45 of remaining offset tested income of USS2 (the sum of the $15 of offset tested income of CFC2 in year 1, the $10 of offset tested income of CFC3 in year 2, and the $50 of offset tested income of CFC3 in year 3, reduced by the $30 shared loss of CFC3 in year 1, results in $45 of net offset tested income that has not caused a basis increase to USS2 stock). USP’s basis in USS2 stock increases to the extent that, if the $45 of offset tested income were distributed by CFC2 to USS2, the dividend would be eligible for Sec. 245A but would not be subject to Sec. 1059. Given the holding period of greater than two years, and a pro rata distribution, nothing in the facts of Example 3 indicates that Sec. 245A would be unavailable or that Sec. 1059 would apply. Thus, it appears that USP can increase its basis in USS2 stock by the full $45 of remaining offset tested income (combined with the years 1 through 3 adjustments, for a cumulative increase of $130) immediately before disposing of the USS2stock.

Intercompany nonrecognition transactions in which loss CFC stock is transferred

A special rule for certain intercompany nonrecognition transactions is provided by Prop. Regs. Sec. 1.1502-51(c)(5). If a consolidated group member transfers stock of a CFC that has a net used tested loss to another member in an intercompany, nonrecognition transaction (e.g., in exchange for transferee member stock in a Sec. 351 exchange, or in exchange for acquiring member stock in a Sec. 361 exchange), then the basis of the nonrecognition property received in the transaction (i.e., the stock of the transferee member or acquiring member) is reduced by the amount of the used tested loss.

This special rule appears designed to reflect the fact that, as described earlier, basis reductions in loss CFC stock for that loss CFC’s used tested loss do not occur until immediately before a taxable transfer of the loss CFC stock, whereas basis reductions in the stock of a member that owns loss CFC stock occur in the year of the used tested loss. Thus, in a transaction in which the not-yet-reduced basis of loss CFC stock determines the basis in member stock (i.e., because under Sec. 358, the basis in the transferee member stock received by the transferor member in a Sec. 351 exchange equals the transferor member’s basis in the loss CFC stock surrendered), then, without this special rule, the transferee member stock would not reflect the used tested loss. In contrast, if the transferee member had held the loss CFC stock during the relevant time, the stock in the transferee member would reflect reductions for the loss CFC’s used tested loss as previously described. Possibly to create parity with the latter fact pattern, this special rule requires the transferor member to reduce its Sec. 358 basis in transferee member stock received by the amount of the loss CFC’s used tested loss.

The application of this special rule is most clear in the case of a Sec. 351 exchange. It also applies to an internal Sec. 368(a)(1) asset reorganization, but the intent and appropriateness of this rule in this context is unclear. The potentially anomalous results of the special rule are illustrated in the case of an intragroup “all cash D” reorganization under Regs. Sec. 1.368-2(l), through an enhanced example of the fact pattern in Prop. Regs. Sec. 1.1502-13(f)(7), Example 4(c).

The special rule applies its basis reduction before the deemed issuance and redemption of acquiring member stock provided by Regs. Sec. 1.1502-13(f)(3) for boot in intercompany reorganizations. However, it is unclear that the new example actually applies before all of the Regs. Sec. 1.1502-13(f)(3) fictions, or that the special rule is appropriate when the basis of acquirer stock will ultimately be determined under Sec. 358 by reference to the basis of the target member’s stock that should have already been reduced for the loss CFC’s used tested loss as described earlier. As a result, the example illustrates the lack of clarity as to why the special rule does not result in a duplicative basis reduction for the same used tested loss. Hopefully, Treasury will clarify the mechanics and purpose for the special rule in final regulations.

Effective date

Generally, the proposed regulations, when adopted as final regulations, are effective for tax years of foreign corporations beginning after Dec. 31, 2017, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

Implications

The consolidated return aspects of the proposed regulations provide useful guidance on many questions that had been raised by new Sec. 951A. While the regulations adopt a single-entity view of a consolidated group in some respects, notably, the group is not treated as a single U.S. shareholder; rather, the proposed regulatory framework is that each member of the group that is a U.S. shareholder determines its own GILTI inclusion. In this respect, the GILTI inclusions of a consolidated group member are treated similarly to other Subpart F determinations. However, the proposed regulations provide additional rules to aggregate certain GILTI “items” of CFCs owned by all members and then allocate these items back to members that are U.S. shareholders for the purpose of eliminating incentives/traps associated with consolidated group ownership of CFCs.

As with any regulation package of this scope, it will take time to understand the full impact of the proposed rules in a consolidated group setting. For example, as noted, new proposed rules adjust member stock basis to reflect the offset tested income and used tested loss of underlying CFCs, and it is unclear how those generally applicable adjustments are meant to interact with a special stock basis reduction rule for intercompany nonrecognition transfers of CFC stock (e.g., when a CFC is transferred in a Sec. 361 exchange between members of the group). Moreover, as noted, a net basis increase to member stock might be available in connection with recognition events for member stock, based on the member’s tax benefit from a hypothetical dividend stripping of the underlying income CFC. Also, it is unclear why a dividend-strip model was adopted in the case of the recognition event being the sale of member stock rather than a comparable, hypothetical sale by the member of its underlying income CFC, which could have different implications for the relevance of Sec. 1059.

Finally, the government took an expansive view of a 1934 Supreme Court case involving a duplicated loss in a consolidated return setting — Charles Ilfeld Co. v. Hernandez,292 U.S. 62 (1934) — as support for its proposed rule to generally require a U.S. shareholder to reduce its basis in the stock of a loss CFC generating used tested loss, though the applicability of this case outside the consolidated return context is unclear. More generally, it is not clear why the government took a dramatically different approach to CFC stock basis in the proposed regulations as compared to its approach in proposed regulations under Sec. 965 (REG-104226-18).

EditorNotes

Michael Dell is a partner at Ernst & Young LLP in Washington.

For additional information about these items, contact Mr. Dell at 202-327-8788 or michael.dell@ey.com.

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP. Ernst & Young previously published versions of these items as Tax Alerts.