Editor: Mark Heroux, J.D.
On May 11, 2021, the IRS issued Rev. Proc. 2021-26, which contains procedures for certain foreign corporations to obtain automatic consent to change their methods of accounting for depreciation to the alternative depreciation system (ADS). The automatic procedures are intended to reduce the tax-compliance burden associated with implementing the global intangible low-taxed income (GILTI) final regulations by enabling taxpayers to more easily conform their income, earnings and profits (E&P), and GILTI computations. The revenue procedure also modifies certain special rules applicable to foreign corporations under existing method change procedures.
The GILTI provisions, found in Sec. 951A, apply to 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.
Sec. 951A requires a U.S. shareholder of any controlled foreign corporation (CFC) that owns the CFC's stock for any tax year to include the shareholder's GILTI in gross income for such tax year. (Definitions of relevant terms are found in Sec. 951(b), Sec. 957(a), and Sec. 958(a).)
A U.S. shareholder determines GILTI using a formula based on certain items of each CFC that the shareholder owns, including tested income, tested loss, and qualified business asset investment (QBAI), if any.
Sec. 951A(d)(3) provides that the adjusted basis in any property for purposes of calculating QBAI shall be determined by using ADS under Sec. 168(g).
In the preamble of the final GILTI regulations (T.D. 9866) issued on June 21, 2019, the IRS noted that CFCs not otherwise required to compute income and E&P using ADS depreciation methods may want to change to the ADS method, given the requirement to use the ADS method to determine QBAI. The IRS further stated its intention to issue guidance expanding the availability of automatic consent procedures to facilitate such depreciation changes.
Rev. Proc. 2021-26, the focus here, provides the procedural guidance for automatic method changes discussed in the preamble to the final GILTI regulations.
New temporary automatic ADS method change for CFCs
Rev. Proc. 2021-26 provides a new automatic change, for a limited period, permitting a CFC on an impermissible non-ADS method as well as a CFC on a permissible non-ADS method to obtain automatic consent to change its method of accounting to the ADS method for certain tangible property used predominantly outside the United States.
Highlighted below are key provisions of Rev. Proc. 2021-26:
Eligible changes: The change permits a CFC to change its method of accounting for depreciation for property described in Sec. 168(g)(1)(A) and not excluded under Sec. 168(f) to the ADS method, convention, and recovery period under Sec. 168(g) for purposes of determining the CFC's gross and taxable income and E&P. The CFC must own the property at the beginning of the year of change. As noted, the change applies regardless of whether the present depreciation methods are impermissible or permissible tax methods of accounting.
One-year property: Rev. Proc. 2021-26 favorably allows taxpayers changing from an impermissible non-ADS method for property placed in service in the tax year immediately preceding the year of change (one-year property) the option of filing a Form 3115, Application for Change in Accounting Method, with a Sec. 481(a) adjustment or, alternatively, amending the prior-year income tax return. The amended return must be filed prior to the date of filing the federal income tax return for the following tax year.
Note: Taxpayers changing from a permissible non-ADS depreciation method for one-year property must file Form 3115. Changes from permissible non-ADS methods may not be made on an amended tax return.
Change available for limited period: Form 3115 for the new automatic change may only be filed on or after May 11, 2021, for a tax year of a CFC ending before Jan. 1, 2024. Temporary transition relief, discussed below, is provided for method change applications filed prior to May 11, 2021. Forms 3115 filed after the Jan. 1, 2024, cutoff date may be filed under the existing automatic change procedures in Section 6.01 of Rev. Proc. 2019-43, provided the eligibility rules and the terms and conditions for that automatic change are met. However, this automatic change only applies to a change from an impermissible depreciation method (not a change from a permissible method). Consequently, a Form 3115 filed to change from a permissible non-ADS method filed after the cutoff date in Rev. Proc. 2021-26 must be filed under the more costly and onerous advance consent procedures. Affected taxpayers should therefore act timely to take advantage of the favorable automatic change provisions.
Temporary transition relief: For a Form 3115 filed prior to May 11, 2021, under Section 6.01 of Rev. Proc. 2019-43 (impermissible to permissible depreciation change), Rev. Proc. 2021-26 provides that the taxpayer may file the original Form 3115 under Section 6.01 of Rev. Proc. 2019-43, provided the duplicate Form 3115 was filed prior to May 11, 2021. Such a taxpayer is not required to refile the Form 3115 under Rev. Proc. 2021-26.
Eligibility rules waived: Rev. Proc. 2021-26 favorably waives the eligibility restrictions that preclude filing an automatic change in certain circumstances (e.g., liquidation or final year of the trade or business, or a change made for the overall method or for the same method within the five prior tax years with or without a Form 3115).
Sec. 481(a) adjustment special rules: A Sec. 481(a) adjustment is required, and, if the method change covers multiple properties, a separate Sec. 481(a) adjustment must be provided for each property. A single net Sec. 481(a) adjustment for multiple properties is not permitted. Notably, requiring a Sec. 481(a) adjustment for a change from a permissible depreciation method is a departure from the existing automatic change under Section 6.02 of Rev. Proc. 2019-43, which must be implemented on a cutoff basis. Furthermore, Rev. Proc. 2021-26 modifies the terms and conditions for taking the Sec. 481(a) adjustment into account for purposes of computing the CFC's tested income or tested loss, gross income, taxable income, and E&P. These modified terms and conditions revise the existing provisions for foreign corporations under Rev. Proc. 2015-13 to incorporate amendments under the law known as the Tax Cuts and Jobs Act, P.L. 115-97 (e.g., enactment of Sec. 951A discussed in the background section above). Rev. Proc. 2021-26 contains an example illustrating the required treatment of the Sec. 481(a) adjustment in gross and taxable income and E&P under the modified terms and conditions.
CFC audit protection limitations retained: Unfortunately, Rev. Proc. 2021-26 does not waive the existing audit protection limitations applicable to method changes made for CFCs. However, in an attempt to address taxpayer confusion and misapplication of the rules, the IRS does provide guidance in Rev. Proc. 2021-26, clarifying how to apply the 150% threshold provisions described in the existing method change procedures under Rev. Proc. 2015-13. Under these provisions, a CFC does not receive audit protection for tax years before the requested year of change in which any of the CFC's corporate U.S. shareholders computed an amount of foreign taxes deemed paid that exceeded 150% of the average amount of foreign taxes deemed paid in the shareholder's three prior tax years. Rev. Proc. 2021-26 clarifies that the 150% threshold is computed with respect to the amount of the CFC's foreign taxes deemed paid, regardless of the extent to which a foreign tax credit is allowed. The IRS indicated recently that it continues to study the contentious issue of audit protection for CFC method changes and may reconsider its positions in the future to enable foreign corporations to obtain audit protection for voluntary method changes more easily.
Taxpayers subject to the GILTI rules should carefully consider whether and when to take advantage of the new guidance, particularly if they are changing from permissible non-ADS methods.
As noted, changes from permissible non-ADS methods may now be made using favorable automatic change procedures, but for a limited period. Form 3115 for the new automatic change may only be filed on or after May 11, 2021, for a tax year of a CFC ending before Jan. 1, 2024.
CFCs that are not otherwise required to use ADS methods should monitor the various tax proposals to repeal the QBAI provision under GILTI that, if passed, could eliminate the need to use ADS methods and the incentive to make changes described in the guidance. Such taxpayers are advised to delay implementing accounting method changes under Rev. Proc. 2021-26 until the prospects for enactment of the various tax proposals become clearer.
Mark Heroux, J.D., is a tax principal in the Tax Advocacy and Controversy Services practice at Baker Tilly US, LLP in Chicago.
For additional information about these items, contact Mr. Heroux at 312-729-8005 or email@example.com.
Unless otherwise noted, contributors are members of or associated with Baker Tilly US, LLP.