After numerous promises and delays, the IRS and Treasury have finally issued Proposed Regulations addressing Previously Taxed Earnings and Profits (PTEP) of foreign corporations and the related basis adjustments.
The proposed regulations are a follow-up of Notice 2019-01, which was issued in response to 2017’s Tax Cuts and Jobs Act (the “TCJA”). This notice provided a preview on how previously taxed income should be tracked and allocated when distributed. The current proposed regulations present a framework for tracking and managing PTEP to ensure that US shareholders in controlled foreign corporations (CFCs) are not taxed twice on the same earnings.
US Shareholders in CFCs are subject to a handful of tax regimes which require them to recognize “phantom income,” or income attributed from the foreign corporation, without even having received a distribution of cash or property. These regimes include Subpart F, Global Intangible Low Taxed Income (GILTI) and the one-time Section 965 Transition tax, ca. 2017.
When an actual distribution of cash or property is made, these earnings could be subject to US tax for a second time. The PTEP rules provide that these earnings, previously taxed under one of the above-mentioned regimes, should be excluded from income when distributed, preventing double taxation.
The latter two regimes, GILTI and Section 965, were codified as part of the 2017 TCJA and resulted in a tremendous increase in the number of US taxpayers that were recognizing phantom income and in the amounts of PTEP that were in the system. Hence, the increased urgency for guidance on the practical application of the PTEP rules.
The 350-page proposal does not make for light reading, and experts claim it doesn’t cover many issues that still need to be addressed.
Below are some key points:
- PTEP Accounting and Tracking – The regulations require tracking of PTEP at both the U.S. shareholder and foreign corporation levels.
- Categorized, annual PTET accounts – Taxpayers must maintain annual PTEP accounts categorized by the different types of income inclusions (e.g., Subpart F income, Global Intangible Low-Taxed Income [GILTI], Section 965 inclusions).
- Share-by-Share Basis Adjustments – This approach entails applying basis adjustments to specific shares or property, which prevents improper shifts and ensures accurate gains or losses upon sale.
- Tiered structures present challenges because they involve multiple layers of ownership. Under Subpart F/GILTI/Section 965 rules, lower tier foreign corporation income can bypass intermediate holding companies and be allocated directly to the US shareholder, making it difficult to accurately account for PTEP.
- Adjustments to basis are generally made at the beginning of the taxable year in which the inclusion or distribution occurs.
- Foreign Currency Dollar Basis Pools – Taxpayers are required to maintain U.S. dollar basis pools to compute foreign currency gain or loss under Section 986(c).
- Foreign Tax Credits Allocation and Apportionment – The proposal includes rules for allocating and apportioning foreign taxes to PTEP distributions.
- The proposed regulations are set to apply only for future tax years of foreign corporations, starting on or after the date when the regulations are officially finalized. They are not retroactive.
- Taxpayers have the option to apply the regulations retroactively to open tax years.
The proposed regulations are welcome and will be helpful for taxpayers who have had recognized Subpart F, GILTI or other phantom inclusions from CFCs. However, accounting for US investments in foreign corporations and keeping updated about the new ordering rules, basis adjustments, and distribution classifications is not for an amateur. Taxpayers should work closely with tax professionals who can help them update their tracking systems, accurately categorize PTEP pools, and strategize to avoid double taxation and address compliance issues.
This material has been prepared for informational purposes only, and is not intended to provide or be relied upon for legal or tax advice. If you have any specific legal or tax questions regarding this content or related issues, please consult with your professional legal or tax advisor.
