International Tax Developments: Lapse of IRC Section 954(c)(6)
Following is a brief summary of income tax accounting considerations related to the lapse of IRC Section 954(c)(6). It is not intended to be a comprehensive analysis of the items addressed, either from a tax technical or tax accounting perspective.
IRC Section 954(c)(6), Look-Thru Rule for Related Controlled Foreign Corporations (the “look-thru rule”), enacted by the Tax Increase Prevention and Reconciliation Act of 2005 and amended by the Tax Relief and Health Care Act of 2006, the Tax Technical Corrections Act of 2007, and the Tax Extenders and Alternative Minimum Tax Relief Act of 2008, is effective for taxable years of a foreign corporation beginning after December 31, 2005, and before January 1, 2010, and to taxable years of U.S. shareholders with or within which such taxable years of the foreign corporations’ end. For calendar year-end foreign corporations, this provision lapsed on December 31, 2009. While a proposal to extend the look-thru rule retroactively to January 1, 2010, was included in recent House and Senate bills,1 as of March 17, 2010, the extension has not been enacted.
For periods in which it is effective, the look-thru rule generally excludes from U.S. federal income tax certain dividends, interest, rents, and royalties received or accrued by one controlled foreign corporation (“CFC”) of a U.S. multinational enterprise from a related CFC that would otherwise be taxable pursuant to the subpart F regime. For a U.S. company asserting the indefinite reversal exception under ASC 740-30-25-17 for the non-recognition of deferred taxes relating to undistributed foreign earnings, its effective tax rate is generally reduced below the statutory rate for every dollar of earnings that are not subject to current U.S. tax. Accordingly, the look-thru rule operates to reduce the global effective tax rate for certain companies.
Absent any tax planning or restructuring measures,2 and unless and until the proposal to extend the look-thru rule is enacted, U.S. companies that are utilizing the indefinite reversal exception will have to account for tax consequences of the lapse of the look-thru rule. Specifically, in the first quarter of 2010 for a calendar-year end corporation, based on the guidance in ASC 740-270, Income Taxes: Interim Reporting, the U.S. company should include in its estimated annual effective tax rate (“AETR”) the tax expected on the amount of subpart F income that would be recognized for the current year assuming the look-thru rule is not extended. Companies should be prepared to compute the impact of the lapse of the look-thru rule on the estimated AETR to be reflected in the first quarter.
The lapse of the look-thru rule is also expected to impact the ability of some U.S. companies to assert that certain undistributed earnings are subject to the indefinite reversal criteria. For instance, U.S. Company has a CFC (CFC1) which owns a CFC in another jurisdiction (CFC2). U.S. Company asserts that its investment in CFC1 is subject to the indefinite reversal criteria. Absent the look-thru rule, distributions from CFC2 to CFC1 would be subject to U.S. taxation pursuant to subpart F and, accordingly, the position of the company with respect to whether CFC2’s earnings meet the indefinite reversal criteria is relevant to whether the investment in CFC1 can meet the exception. Companies should continue to evaluate their deferred tax position with respect to these basis differences in light of the lapse of the look-thru rule.
If an extension of the look-thru rule is enacted later in 2010, a corporation should account for the enactment in accordance with the guidance set forth under ASC 740-270, Income Taxes: Interim Reporting. Accordingly, for current taxes payable or refundable, the AETR is adjusted to reflect the new tax law in the period that the new tax law is effective. In addition, deferred taxes are adjusted for changes in tax law discretely in the interim period that includes the enactment date. These rules sometimes result in accounting for a change in tax law in more than one quarter. However, if the extension (if and when enacted), is retroactive to January 1, 2010, then the impact on the current year AETR and on the opening deferred taxes will both be reported in the period of enactment.
If the extension of the look-thru rule is not enacted before the balance sheet date, an entity should consider including in the financial report a discussion related to the impact of the lapse, as well as the impact expected if the proposal is later enacted. If the extension of the look-thru rule is enacted after March 31, 2010, but before the first quarter financial report is issued, the entity should disclose its expected revised AETR in the second quarter, the amount of benefit expected from amending prior tax periods to the
extent applicable and any expected change in deferred taxes.
For more information, contact:
Heather J. Jurek
Director, Deloitte Tax LLP
+1 404 220 1510
Partner, Deloitte Tax LLP
+1 202 378 5223
HR 4213, which has been referred to both as the American Workers, State, and Business Relief Act of 2010 and the Tax Extenders Act of 2009.
Different views exist with regard to whether tax planning can be taken into account when establishing the annual effective tax rate prior to implementation.
This material has been prepared by professionals in the member firms of Deloitte Touche Tohmatsu. It is intended as a general guide only, and its application to specific situations will depend on the particular circumstances involved. Accordingly, we recommend that readers seek appropriate professional advice regarding any particular problems that they encounter. This information should not be relied upon as a substitute for such advice. While all reasonable attempts have been made to ensure that the information contained herein is accurate, Deloitte Touche Tohmatsu accepts no responsibility for any errors or omissions it may contain whether caused by negligence or otherwise, or for any losses, however caused, sustained by any person that relies upon it.