A regulatory balancing act: Recent US guidance

Welcome to Cross-Border Tax Talks, where we discuss the latest trends in international taxation. From US tax regulations to the OECD's latest developments. I'm Doug McConey, PWC's International Tax Services Global Leader. PWC's Pillar Two engine, powered by Beacon, is a game changer for Pillar 2 compliance, provision, and modeling calculations.

Built on a graph system utilizing over 20 years of international tax technology. This cloud-based centralized rules engine is developed by a team of Pillar 2 tax experts from around the globe. PWC's Pillar 2 engine is currently available as a service and is also available to license. On this week's episode of Crossborder Tax Talks, we're back in PWC's Policy on Demand studio in Washington, D.C., where I'm excited to welcome Wade Sutton back to the podcast.

Wade is the international tax leader of PWC's Washington National Tax Services Office and guest host of the Cross Border Tax Talks Podcast. Wade, welcome back to the podcast.

Yeah, thanks for having me again.

I'm excited to introduce you as the guest host. I think it's been three. We were trying to add this up. Yep. ChatGPT said two, but I think we've confirmed that it's it's three. All of those are public, and you've been a guest now at least a half a dozen times. Um so maybe can you share with listeners the the challenges of being a host versus a guest?

I mean, which one do you like? What what's been what's your experience been like, Wade?

Yeah, great question. I I actually think being a host is a lot easier because you go into this knowing what you're gonna say. So for the listeners who don't know this, Doug does not hand you a list of questions he's planning to ask you. He wants you on your toes. And I kind of understand the theory. You've never actually told me, but my my guess is that you want people, you know, natural, just sort of reacting on the fly, not doing canned remarks.

So I think it helps the show flow, but as a guest, you're sort of you need to know your stuff and be agile because you never know what questions coming.

Yeah, so there are really two reasons for this. So we haven't talked about this, but there really are, there are two reasons. The the first is that, I mean, I've been a podcast fan for for a long time. And like the being conversational is really, really important. Like you can tell, like when you're talking to somebody, it's a conversation versus some of the other text podcasts that are out there where you can tell people are just reading from scripts.

I don't want to like single anyone out, but there's some that have the flavor of a hostage video. Exactly.

Exactly. And and then the other thing is like I know my guests are experts, and they're that's the reason that we've brought them on. And so, you know, keeping them on their toes, making it dynamic. And then I always say if anything, if we if anybody says anything stupid, we can edit it out. And I will tell you, 220 episodes in, 95%, I might be underestimated of the edits that have stupid things that have been said have been said by me.

Um, including a most recent one where I confused OB3 with uh uh build back better uh for like a five-minute period. So, you know, things happen, but uh um I do I'm with you that I prefer being the host of the guests when I have been the guests on on podcasts. There's a an added level of stress compared to being the host.

Yeah. But I thought you did a fantastic job, and I appreciate you filling in when I was on my uh um sabbatical in August.

Now, in your in your defense, though, what's hard about being a host is you're not an expert in everything you're gonna ask other people about. So you have to kind of quickly get yourself up to speed on things like, you know, this episode I hosted most recently, foreign subsidiary subsidies regulation.

I was happy to misplay, by the way.

Um and and that's fun because it's like a new thing to dig into, but you really have to do that quickly.

Yeah, but you kind of get uh they they kind of let you off the hook that you're not the expert. So you you just have to not be afraid to ask the stupid questions. Yes, yes. And I've gotten over that way a long time ago. So let's test that because I may, and this more isn't my wheelhouse, right? As an international tax practitioner, we're gonna be talking four recent regulation packages, but I I am gonna reserve the right to ask one or two stupid questions, or maybe even more than that.

All right, so but before we dive in, Wade, to the recently proposed regs, I was in London last week as part of our private equity uh client conference, and we received a number of questions from taxpayers about midterm elections and the prospect of a reconciliation bill that could contain tax provisions before year end.

Do you have any thoughts on that?

Yeah, well, it's funny. Earlier in the year, I was actually pretty optimistic about this, but quickly educated about the realities of the election calendar. And, you know, once people after the elections in November, there's that lame duck session. If the House or Senate flips, people will not be interested, I think, in coming back to Washington to get a reconciliation bill through.

And so I'm learning that there's just a practical aspect of limited time and willingness to get something like that across the finish line.

Okay. Because I think the more theoretical, and I have always advertised myself wait as an outside the beltway kind of guy, even when I, even when I lived here. So I don't know some of the inside baseball to mix metaphors. Um, but you know, obviously the big policy thing that the Republicans have stated is that they need during the next cycle, the next uh uh is is defense spending, a defense spending bill.

So I think there has been some speculation, including on our policy on demand channel, that, you know, if the the Republicans lose control of one or both chambers, which now, based on some of the election math and predictions, seems to be pretty likely, although that election math and predictions have been very wrong in the past.

But if they, if the Republicans lose one or both chambers and and they want to get a big defense spending bill next year, they're going to have to make some concessions to the Democrats. So does that sort of encourage them to try to get a reconciliation bill? And then, of course, for all of our tax listeners, it's just like, well, what provisions, if they need to try to make this budget neutral, like a reconciliation bill over the 10-year window, what provisions do they pull off the shelf to try to pay to pay for something like this?

So I think the odds seem low or remote even, but I'm not going to say zero.

And and just with this is for another podcast to get into the details, but with if folks are interested, what is on the shelf as potential inventory, Ron Estes recently released a proposal with several tax provisions in it that I think people should pay attention to because I think he is interested in kind of being the leader in the House on tax policy.

Yeah, great point. And it's kind of a nice summary of some of the various provisions that have been brought up over the last, what, couple, several decades, even of various, of various provisions. Um, so we're gonna talk about four recently proposed um sets of regulations or sets of proposed regulations related to the one big beautiful bill act, or OB3 is what we're gonna call it.

Um the first one that I want to talk about is is what we refer to often as expense allocation. Um, and some of the rules with OB3 really change these rules with respect to expenses that need to be allocated to guilty, which to remind listeners is now net CFC tested income or NCTI or necktie. Do you have a preference, Wade?

I like NICTI, that's NICT preference. Necktie, not NCTI. I I think we've debated this before. I'm a necktie kind of guy, but I don't really feel that strongly about it. Um and then also what we refer to as the Section 250 deduction, this one I struggle with, which used to be foreign derived and tangible income, and now is foreign.

You're gonna have to help me here.

Foreign derived deduction eligible income.

Foreign derived deduction eligible income. It really is a mouthful fide, though I think we can agree on fide. All right, so first, before we dive into these, maybe what is expense allocation, particularly for some of our non-U.S. listeners, and then what do these proposed rules do with respect to NECTI and FIDE?

Sure. And and for the U.S. technicians who are listening, I apologize because I'm really going to shortcut this. But the United States grants a foreign tax credit to relieve double taxation, uh, where we recognize that another jurisdiction has primary taxing rights. And the the way we do that is by limiting the foreign tax credit to foreign source income, that's net income, within various categories.

So if you imagine, you know, I run a business where uh I have activities in the United States and I derive income and activities abroad, and I derive income, and I have common expenses for both of the businesses, and I need to determine my net income. You might have to allocate and then apportion those expenses across your US and foreign source income.

So you arrive at a net number, and that is the amount that you can claim credits against. So go back to 2017, the TCJA is enacted. People originally thought, or some people had this idea that guilty was like a minimum tax. As long as you paid a certain rate of foreign tax, you weren't subject to any more U.S.

tax, kind of like the way Pillar 2 operates. Yeah. Um what you you were the first one to mention Pillar 2, just for the record. Fair. Um Do I have to drink from that? So people realize though that no, guilty is actually built on this foreign tax credit architecture, and so you did have to take some expenses and allocate them to your guilty to come up with the net number, and that haircut your ability to claim foreign tax credits on the income, even if you're paying tax above the quote-unquote minimum tax rate.

So frequently these were expenses like interest, um, stewardship, you know, certain other litigation awards, things that were allocated across large classes of income. And so there's a Wall Street Journal article about a railroad in Mexico. I think they're paying 30 plus percent tax and still paying U.S.

tax on their guilty, and people thought, how can this be? Right.

So OB3 And just a bunch because that was a highly leveraged business with a ton of interest expense, and because the interest expense was allocated, they still had a U.S. top-up tax despite the fact that they were only really operating in Canada and Mexico above 30 percent.

Yeah. Now, some people manage that with a high tax election, but let's set that aside. So, what is OB3 doing? It's trying to fix that issue and make NICTI now, or necktie, whatever you want to call it, uh behave more like a minimum tax. And the way they've done that is specified that only certain expenses are allocable to NICTI, and then everything else uh does not burden the category.

So, what are those expenses? Well, it's the 250 deduction, which for the non-U.S. listeners, what is that? You get a special deduction on certain types of income, like you know, foreign export sales, we we refer to that as fiday, or nICTI inclusions from your CFCs. And it's basically like a rate adjustment.

It takes you from the 21% rate to an effective rate when you take into account foreign taxes of about 14. Uh that gets allocated to the category, obviously.

Yeah, that's the mechanism to your point of how they get to 14. Because I think a lot of people just assume you multiply that percentage by the earnings at the CFC level, and that's not the case, that's all included, and then you have this so-called Section 250 deduction.

Yeah. And, you know, state and local taxes, fine, that that makes a lot of sense. They also tell us that interest and research and experimentation cost you do not allocate to NICT. And then there's this catch-all provision in the bill that says, and the only other expenses you allocate are directly allocable expenses.

The interesting thing about that is there's not really a clear definition anywhere of that term, and it's used inconsistently throughout the code, right? So Treasury, I think, had a tough job, treasuring the IRS, in crafting regulations here. They had comments all over the map about this. I'm sure. Um, and I think they wanted to be principled about what the better meaning of the statute is uh here.

And so where they landed is effectively uh expenses that could be allocable based on all of your gross income or assets. So think of these as things you might formulaically apportion, those are not directly allocable expenses. So think of, in addition to interest, which is mentioned in the statute, things like stewardship, litigation awards, supportive expenses.

There's a long laundry list of other expenses that are indirectly allocable. What that leaves, like what is in the directly allocable category, is a really narrow uh number of things.

So for example, if you were in NICD PTEP and you distribute it, so previously taxed income, it's not even subject to tax, yeah.

Uh and you distribute that amount, but there have been foreign exchange changes between when you earn the income and when it's distributed, you can recognize gain or loss on that distribution. And if you have a foreign currency loss on a distribution of the previously taxed earnings, that is kind of obviously directly allocable to the NICTI category.

Once you go beyond that, I was like you got any other examples, but they are hyper-technical, and I will lose all the audience, so I'm not gonna even go into them. But but I think the punchline here is um it's it's really hard to identify broad categories of expenses. And so NICTI now really is gonna behave more like a minimum tax, where as long as you're paying that threshold rate of 14%, you're you're not gonna have a top-up tax, more than likely.

Yeah, and and just to state again that I mean this was a hugely taxpayer-friendly kind of change that that came in with OB3, right? Because to the great example from that Wall Street Journal article, I mean, that feels like decades ago. But with the railroad taxpayer, um, this really solves that issue.

Um, RNE research and experimental expenditures were also something that needed to be allocated. Um, those no longer um so really a taxpayer-friendly, but then kind of the open question of well, what else needs to potentially be allocated?

And we should pause on the research and experimentation code. That's right, yeah. Because um that was actually fixed during the TCGA process. I say fixed, but addressed. Um, those were not allocable to NICTI, and uh we won't get into why, but there's kind of a theory laid out for that. That's important because if an expense would have otherwise been allocable to NICTI, but it's not because of this new provision, there's a special rule that says you allocate that to U.S.

source income. So that rule applies to interest expense, right? Because you might have allocated that, but for this rule, it doesn't apply to RE because the regulation's already excluded it. What's interesting about that, and this is a little bit of a gotcha, and it's technical, so apologies. Um if you have enough U.S.

expenses that you have for this purpose a loss in U.S. source income.

Overall domestic loss.

And overall domestic loss, that's right. Um, you can actually end up having limitation back in your foreign tax credit categories and ending up paying a top-up tax where you thought you didn't. Right. And and this, some people refer to it as a boomerang or whatever you want to call it, um is kind of the big gotcha coming out of this provision that a lot of taxpayers are frustrated by and obviously lobbying the government to try and change.

Um I from the treasury's perspective and IRS, in the preamble, they said we we acknowledge what the statute says, we are going to allocate the expenses, and if it creates an ODL, that will apply to all of the foreign tax credit baskets. So you're back in the top-up tax.

That potentially that that whips off, so to speak.

Right.

Um, what about uh the expense allocation for the FDDEI for the FIDE?

So this one is easier because you don't have this directly allocable issue. Instead, it just says there are two categories of expenses you never allocate to DEI, deduction eligible income. That's the first part of your calculation before you then figure out your FIDE eligible income. Um and that's research and experimentation cost and interest.

So pretty simple. Um the one thing there was a lot of healthy debates about this before we saw Reg. So here's one. If I capitalize an RE expense, say under we have a section 59E, and it allows you to capitalize the expense and amortize it over time. Well, technically you have basis and an asset. So does that mean that I'm now not I don't have an RE expense anymore?

I'm now having asset amortization or depreciation, so I'm not eligible for the exclusion. Treasury, I thought very sensibly said, no, it's it's the same thing. We're gonna treat it as if you could currently deduct it, same treatment. So that was nice. Um we did not, however, get any real real detail on what a research and experimentation cost is.

And that's been an area of controversy, particularly with contract RE. We're expecting some guidance later this year on that, so you know, watch out for that. But there are a few taxpayers that are already arguing with the IRS about this.

All right. So let's let's stick with Fiday and move to our next regulation package. Um so tell us about the the changes to FIDE that have nothing to do with expense allocation.

Sure. So um what I I would say OB3, there was a little bit of a flavor of America first, right? So one of the things changes to Fidae that I thought was consonant with that was you no longer got uh a Q by deduction, right? So arguably you're no longer penalized for having tangible assets in the US. And then you could not claim the deduction for offshoring certain property to a foreign person.

So for example, if I sell IP offshore, which happens all the time, right? When you cost your IP and you have recently acquired a target, you'll often sell the IP to the foreign participant. That's no longer today eligible. It used to be. And that includes deemed sales like 367D. And then there's another category for property that is of a type that was depreciable or amortizable in the hands of the seller.

So one of the important issues the regulations answered here, which was also addressed in notice, is well, what happened? You said of a type that's eligible for depreciation. You know, some I have lots of property. Some of it I hold in inventory and I sell to my customers, some of it I hold on to and use in my business.

Does that mean everything is now tainted? The iris in in this uh proposed reg package said no. Like it's only the stuff that you have actually been amortizing or depreciating. One bit that was not helpful or taxpayers had asked for and did not get in the proposed regulations is well, what happens if I refurbish property that I'd been depreciating and then I put it into inventory?

Shouldn't I get some relief for that? And I think the proposed regs take a very simple approach. They say we're not gonna get into you know recapture provisions for previous depreciation or anything like that. Like it if it was never depreciated or amortized, you can claim the benefit. Otherwise, you can't.

Um this one is a little bit in the weeds. The last thing to mention DEI, deduction eligible income, that's your starting point to figure out how much of your income is eligible for the deduction. That depends on a fraction based on foreign use. But a lot of people don't appreciate that if you're losing money on the domestic side of your business, your DEI is a small number.

So you can, or a smaller number than it would be if you only had foreign income. And so that can actually haircut your deduction. And and I think people are used to thinking about, you know, that there's a taxable income limitation that also haircuts the deduction. And so they don't realize that there's arguably in the statute a second limitation sitting there, and that was confirmed in the regulations.

Yeah, so maybe just a couple of things to remind listeners is that, you know, first of all, when when these provisions first came out in the Tax Cuts and Jobs Act, um, there they're the the QBI that you mentioned, which is the qualified business asset investment investments, right? Thank you. Um generally kind of penalized, that's probably too too strong of a word, but generally penalize taxpayers from having investing in a bunch of assets and that would otherwise reduce the amount of income that it would otherwise qualify for this reduced amount of tax.

Um and then there were also these other provisions, which, you know, from a policy perspective, maybe some thought were a little puzzling, that if US of the US taxpayer would take that intellectual property and then transfer it offshore and what would otherwise be a tax-free transaction, there's special rules that say, oh, well, if that's certain types of intangibles, it's a there's a deemed royalty that comes back.

And then that royalty before these changes in OB3 were also could also benefit from this lower rate of tax. So arguably encouraging IP to move offshore. So I could understand with OB3 why they said, no, no, no, no. If you're moving this stuff offshore, it's not going to qualify. So instead, just leave the IP in the US, license it, and that royalty would be subject to this.

Plus, we're going to create this added benefit of Q Bye, of the any investment, any assets that you're investing related to that won't otherwise reduce that. So again, very, I think, taxpayer-friendly.

Yeah.

Um, all right. So let's move on to then um, you know, this is something that's near and dear to my heart. I think we we've talked about it on some podcasts over the course of the last few years, but um, the CFC Pro Radishare rule. So maybe if you can explain briefly, I've asked you to do this on the podcast.

Um you usually do a magnificent job. We're gonna test you again here, Wade. But what is the CFC Pro Ratish share rule and what guidance did we recently get that changes those rules that I will point out have been in place for 60 years since the advent of

The Kennedy administration. The Kennedy administration. Which which, okay, quick tangent, but if you ever go back, they actually did hearings back then on like with where business would show up as witnesses and talk about, and everyone was decrying the anti-competitive effects. If you do this, we'll never be able to compete.

Subpart of subpart F. That turned out not to be true. But um Yeah, so 1962, Subpart F income had what we refer to as the hot potato rule. And what that meant is if you were the owner of the stock of a foreign corporation on the last day in its taxable year that it was a CFC, then you were allocated, subject to an exception we're going to talk about, all of its subpart F income for the year.

That's different than just about every other flow-through provision in the code, right? So you think about partnerships. If I own an interest in a partnership and I sell it to you midway through the year, there's a provision. It's Section 706, and it allocates me some of the income and it allocates you some of the income.

Consolidated return rules have similar concepts. S corporations, everyone else sort of tries to prorate the income based on when it was earned and who owned the shares at that time. I don't know why Subpart F didn't do that back in the 60s, because they certainly had partnerships back then.

I I mean I would need to go back and check that legislative history. I did write an article on this particular provision about 20 years ago, um, well before I really knew what I was talking about. If you want to, or if you can't even argue that I know what I'm talking about at this point. But the Subpart F is a concept that was determined at the on the last day of the CFC.

And my guess is from a simplicity perspective, it's just like, well, if there, if there was a deal, and we're going to talk more about this, and you've somebody sold their CFC, one US shareholder to another U.S. shareholder, well, how are you going to do that kind of pro-RATA split? We we now actually have regs that tell us how to do that.

But I I am guessing it was an administrative ease at that point. I mean, 60 years ago, things were not quite as complex, it wasn't quite as global of the vibe. Exactly. But I I I don't know. And I don't I don't believe that's in the legislative history, but I would need to go back and look. But all right, keep going.

Well, the the other provision that that changed to no B3 is under the prior law, if if a person who held the shares at the end of the year had acquired them from someone else and that other person had received a dividend, then you reduce the subpart F inclusion, right? This was 951A2 cap B. And there's been a lot of controversy and you know, planning and litigation all around that provision.

Um the theory behind that provision, you know, if if the prior owner had gotten a dividend of cash, well, it's unfair necessarily to tax that person on income where there's no cash to pay the tax liability.

And that was back when dividends were subject to tax at the 35% rate. Yeah.

And yeah, maybe that or the person was taxed on the dividend. So um, but after TCJ, particularly with our participation exemption under Section 245 CAP A, uh, it's been an issue, right? And so I think Congress just wanted to walk away from that entirely. And so they've gotten rid of that rule and the hot potato rule, and it's now been replaced with basically a pro-RAT share rule that allocates income to the owners of the shares throughout the year, right?

So go back to my example of I sell you a partnership. Well, let's now make that a CFC. If I, you know, before OB3 had sold you the CFC, you would have been allocated all the subpartif income for the year. Now I'm gonna be allocated some based on my ownership throughout the year, and you're gonna be allocated some based on your ownership.

So one of the hard questions these proposed regulations answered was, how do you determine your pro-RATA share? That's what the statute says. And there were a lot of comments that came in on this that basically said, You, you know, look at the partnership rules or 1502 consolidated return rules. All of these try to take certain extraordinary items or closing of the books approaches and try to make sure that income is allocated when it was earned to the people that own those shares.

And and this is kind of interesting because the proposed reg said the statute doesn't allow us to do that, right? It says pro rata share of an annual amount. This is what you just said, right? Like subpart F income, you don't know what it is until the end of the year. And so that amount's just allocated pro rata based on number of days, right?

Now there are a bunch of special rules where you have multiple classes of stock. We're probably going to skip that discussion. But there should be dividends and but that but that means um you know that subpart F income is gonna be allocated simply. It's really easy to administer, but it's not accurate, right?

So for this is something people should pay attention to in MA. If someone is buying or selling a foreign target, then income that's earned after the transaction closes might still be allocated to the seller. That's always technically been true, but um it's really heightened now, particularly where you do the calculation uh based on number of shares, you might be able to close the books in certain circumstances, not always.

So it's something to watch out for and draft around.

Yeah, and I mean the drafting just becomes very important. And um, particularly like with pillar two, right? Now some of the data that's required, information that's required, weird results that can happen with Popes and MOPES, and now with the pro rata share rule, like I just feel like the international tax provisions now that we're seeing seeing in deals is it's just really important to get right because you know it it can change the economics, right?

And it becomes critically important to filing the returns as well. So just something else to add to that list.

Well, since we're talking MA, just one we should talk about the closing of the tax years too. But um, one other thing to watch out for, I think this gets fixed hopefully quickly, but um the current rules on previously taxed earnings give people basis adjustments in the shares of the CFC stock. That prevents double tax.

So back to my example where I sell you a CFC, um I should get a basis adjustment in my shares for the subpart F that gets allocated to me. Otherwise, I end up double taxed on that gain. Well, the current regulations on the basis adjustments don't give me the adjustment until the last day of the CFC's tax year on which it's a CFC.

So if we're all calendar year here, that'd be December 31, even if my sale happens in January, right? That's you know, people are gonna have to figure out how to deal with that. I'm I'm sure if it all happens within a single tax year for everyone, that's easy. But you know, there can be circumstances where I might have a different tax year than the CFC.

And and what do I do then? Do I have to sort of write file an amended return and then claim more basis that I got in a subsequent year? Sort of an esoteric question, but it's again something you need to think through in another.

Yeah, yeah, for sure.

Um the the last MA thing, spin-offs, we're seeing this quite a bit. If you are spinning off a business and it owns CFCs, um that entity is gonna be the owner throughout the entire year. And even if it's tax share closes, right? Because like when you leave a consolidated group or you join one, you'll get a tax share close, subpart F income is still gonna be allocable to that one person, and it all hits in the second short taxable year.

And so all of the tax attributes will go there as well. And this is something, you know, there is an election for certain people in certain transactions to electively close a tax year, but you can't do that in these transactions where you have the same owner throughout the entire tax year, even if that owner has multiple short taxable years.

Okay. All right, so the elections, we should talk about this.

Okay.

Yeah, so our fourth reg package. Oh no, no, sorry. The Oh, the elections for the ProRATA rule. Sorry. Sorry, yeah. Um we mentioned ProRATA is kind of inaccurate, it's simple and administrable. So if you want to do something more accurate, it would be better to close your tax year of the CFC because then anything earned in the pre-transfer period gets allocated to that owner and vice versa to the acquire.

Um it's a limited election, though. It only is available if there's a greater than 50% decrease in ownership by a U.S. shareholder. So easily that will apply if I'm selling you 100% of the shares of a CFC, but if I'm a minority holder and I'm only selling you 40%, that election's not available. But I think that's going to be an important tool for folks as they negotiate their deals.

There's also a mandatory closing of the books where CFC status changes. So if I'm buying a foreign company and it's not a CFC before I acquire it, its year closes as of the date of the acquisition. Same thing going reverse, right? If I'm selling a foreign company and it's a CFC in my hands, but not in the acquirer's hands, mandatory closing of the tax year.

And that's kind of interesting because that means any gain or income that's accrued outside of the U.S. tax net stays outside of the U.S. tax net, which I think is helpful.

Okay. All right, so let's move to the last provision or the last uh proposed regs, is the, and I think we talked actually about this this notice. So we don't need this in a ton of detail, but um what does the repeal of the one-month deferral rule mean for CFCs and what guidance do we get regarding how foreign tax credits are allocated between those years?

And to remind folks, this is we we had for decades had the ability for to elect a CFC for a county or taxpayer, for example, to be 1130 year-end. I feel like that became particularly in vogue. I mean this is like 20 years ago. Wait, it doesn't really feel like that long, but when we had CFC look through, right?

And we wanted, and we, and that was just one of those provisions that was never permanent, it was always expiring, and this gave us the ability to have an extra 11 months for calendar year CFCs to take advantage of look through, in other words, dividends, interest, rents, and royalties that could be paid between CFCs without running a foul of subpart F income.

And then that just kind of stuck with us. We had TCJA. Um, we ended up with this so-called donut hole period, which we talked about on the and some of the litigation related to that with some of these mismas provisions. Quite a bit of quite a bit of litigation, which we talked about on the on the last uh on the last podcast.

Um, but but what did the proposed regs tell us? Because there was also this question of well, where do the credits end up when you've got these, when you're effectively having to conform to the parents year at.

Yeah, so this is another example of a very old rule whose purpose was not that was not fit for purpose in a post-TCJ world. So the new rule is the CFC has to conform its tax year to that of its controlling domestic shareholders. So if I am a calendar year owner of 100% of a CFC, it can no longer use an 1130 year end.

It has to conform to me uh and have a calendar year end. But how do you do that mechanically? Well, in 2025, it's gonna have a short taxable year that starts on December 1st and ends on December 31st. And one of the issues immediately that jumped out with the statute was um you're gonna accrue 12 months worth of taxes in that one-month tax year, and that more often than not would result in you losing the taxes because you had negative income in the CFC once you deduct the taxes.

So uh we we got um a notice that filled us in on some of the details. A lot of good comment letters came in asking for certain issues uh or relief. To me, um the really remarkable thing about the proposed regulation package is how responsive it was to comments. Because basically, anytime there was a valid substantive concern about, you know, the rule you've written does not quite fit this fact pattern, we've gotten an election where taxpayers can elect into a regime that is better suited to their facts.

So one example of that is um the the rules in the notice allocated foreign taxes based on foreign taxable income, and it didn't really differentiate by foreign tax credit categories. And so the classic example of where you can run into an issue here is if in your short taxable year you had a very large passive item, like I sold a passive category asset for a large gain, that might attract a bunch of foreign tax.

But what the notice would do is it would push some of that tax into the subsequent tax year, so 2026. That's useless to you if you don't have other passive income. So there's now an election where instead of looking to the entire year's income without differentiating by categories, you can now break it up into categories and allocate that way.

That's helpful. Uh there's a special rule to allow you to close a partnership's tax year in order to um allocate taxes to a CFC owner. That's helpful. Um there's an election not to allocate any taxes, which I think is particularly helpful for certain um CFCs with March taxable year in so it's typically India.

Um Japan, I think, too. Yeah, just very very responsive to taxpayer comments. I think I I thought it would, you know, this is a one-time issue. It's not gonna be with us forever. It's kind of like 965 in that way. Um, but it's the regulation package is not trying to pick fights, it's just trying to get to the right answer.

Yeah, which is very encouraging. So maybe a couple of things just administratively. I think all of these different packages have different effective dates, even some some, so I would encourage, you know, we're not gonna go through those. And then remind me, these are proposed regs, so we have there's comment periods.

I think most of these comment periods are are still open, but we're what's is it? What's the comment period?

So I it's funny, I'm I'm actually looking at the Pro Red S share rules right now. Theirs is mid-October. Okay. Um, and and most of the regulations that are out are this month or next. Comments are going to be due. And I think one of the reasons for that is the government's going to try to finalize these rules by January 4th, 2027.

Many of the rules. Why is that? Well, it has to do with retroactivity, and there's a special provision in the code that says a regulation can be retroactive to the date of enactment of a statute if issued within 18 months. So the bill was passed July 4th. That's a very memorable date. So 18 months from that, January 4th.

So that's kind giving rise to the somewhat compressed timeline. So I think Ferrari Share, I believe, has a 60-day comment period. Um, and there's quite a bit to think about there. But folks are working on comment letters, getting them in. Um, we'll see where the final regulations land.

All right, maybe kind of sticking with in that theme, kind of big picture kind of policy. Um, have you seen a different approach to these regulations post the Supreme Court's Loper Bright decision? Because we talked a lot about some of the donut hole regulations in our prior podcast, but these are more kind of weighed like blocking and tackling, kind of, you know, how do we do the calcs kind of regs?

Um, but any themes from Treasury that that you can tell or anything different?

Yeah, I mean, so I think all of this stems from the Loper Bright decision, which it was an administrative law. It did not have to do with tax, but but it overturned Chevron, which was a decision that gave a lot of deference to the agency, and replaced it with a standard where the court is in charge of determining what a statute means.

And whatever the best reading is, that's the end of it. I, you know, I was at the government for a bit. I was at the Treasury Department, and you know, when I was there, we've I felt like if the statute was ambiguous, you know, like the camel's nose was in the tent, you had a lot of leeway to sort of then import your policy into a statute.

I think that's gone, right? And and I think you're actually seeing Treasury acknowledging that with the reg packages. So for example, I think if you cornered anybody at Treasury or the IRS and said, hey, is this daily proration approach really the best approach economically? They say, no, we should have done the consolidated return rules too with extraordinary items.

That's my guess. But I think they felt constrained by the statutory text. And the preamble actually says that. It it more or less says this is the required reading of the statute. You're seeing the same thing, I think, with the directly alcohol expenses rule, right? Um the granted, that was a highly ambiguous uh provision, but I think what they got to was what was Congress trying to do here, right?

And and I think JCT also had some thoughts there as well. So it is constraining a little bit this new system we're operating in, where I Treasury doesn't have as much flexibility to fix problems, but um they're just sort of implementing the statute and filling in details where there is clear regulatory grants.

So it it may be harder to close loopholes or gotchas or double tax issues. Um, but it is a lot more predictable because I don't foresee that we're gonna end up like we were after TCGA, where you had, gosh, we're almost a decade of litigation over some of those regulations.

All right. So then the the last question, what other OB3 regulatory guidance can we expect in the in the near future here? Okay, so it's a long list, so maybe it's just a two.

There, yeah, there are two. So that that I'm keeping an eye on. One is um there's a provision for foreign sales branches, right? So after TCGA, there was a rule that said if you manufacture inventory in the United States for export sale, you source that income based on where the production happened, right?

But there were other fact managers that applied too, but as well, but but that's the paradigm that I think Congress was focused on here, because I think it dawned on people, hey, this is actually disincentivizing U.S. manufacturing. And so, you know, if you think of OB3 as an America first bill, that's the last thing they wanted to do is ship manufacturing jobs offshore.

And so what the new provision says is if there's a foreign sales branch that participates in the export sale, then the income attributable to the foreign sales branch can be foreign sourced. So that's good because you can claim more foreign tax credits now on that income, subject to a 50% cap. That's a provision we're looking for uh guidance on, because I think there are a lot of questions about what it means for income to be attributable.

Right. Um there's a cross-reference to some inbound tax rules dealing with ECI, but you know, debates about what that might mean. Uh the other one is uh I'm gonna use a code section, sorry, 951 CAP B. And and this is for foreign-controlled CFCs, it's sort of a new category of CFC that doesn't meet the old 1962 definition where a US person directly or indirectly controlled more than 50% of the stock.

This is an entity that is a CFC solely by virtue of certain attribution through related people. So, you know, typically this is like a decontrolled structure that you might have seen after a foreign acquisition of a US multinational. Um a lot to watch there. There are a lot of cross-reference, there are a lot of references in the code to CFC.

We'll see if that is now going to include a foreign-controlled CFC or FCFC, excuse me.

So this could be very relevant for our inbound listeners. But of course, when these regs come out, we'll uh talk about them here on the cross-border tax talks podcast. So, Wade, thanks for coming on.

Yeah, thanks for having me.

So thanks for tuning in to this week's episode of Crossborder Tax Talks. Thank you, Wade Sutton, international tax leader of PWC's Washington National Tax Services Practice. I'm Doug McConey, PWC's International Tax Services Global Leader. Stay tuned for another exciting edition of the Cross Border Tax Talks Podcast.

This podcast is brought to you by PWC, all rights reserved. PWC refers to the U.S. member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PWC network. Each member firm is a separate legal entity. Please see www.pwc.com slash structure for further details. This podcast is for general information purposes only and should not be used as a substitute for consultation with professional advisors.

A regulatory balancing act: Recent US guidance

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