International Tax Developments: Lapse of IRC Section 954(h)
Following is a brief summary of income tax accounting considerations related to the lapse of IRC Section 954(h). 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(h), Special Rule for Income Derived in the Active Conduct of Banking, Financing, or Similar Businesses (the “active financing exception”), enacted by the Tax and Trade Relief Extension Act of 1998,1 is effective for taxable years of foreign corporations beginning after December 31, 1997, and before January 1, 2010 and for taxable years of U.S. shareholders with or within which such taxable years of the foreign corporations’ end. For calendar year-end corporations, this provision lapsed on December 31, 2009. While a proposal to extend the active financing exception with retroactive effect to January 1, 2010, was included in recent House and Senate bills,2 as of March 25, 2010, the extension has not been enacted.
For periods in which it is effective, the active financing exception generally excludes from U.S. federal income tax qualified banking or financing income of an eligible controlled foreign corporation (“CFC”) that would otherwise be taxable income 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 relatively low taxed earnings that are not subject to current U.S. tax. Accordingly, the active financing exception operates to reduce the global effective tax rate for certain companies by reducing the amount of subpart F income that would otherwise be subject to U.S. taxation.
Absent any tax planning or restructuring measures,3 and unless and until the proposal to extend the active financing exception is enacted, U.S. companies will have to account for tax consequences of the lapse of the active financing exception. Specifically, in the first quarter of 2010 for a calendar-year end CFC, based on the guidance in ASC 740-270, Income Taxes: Interim Reporting, the U.S. shareholder of the CFC (as defined in section 951(b)) should include in its estimated annual effective tax rate (“AETR”) the projected residual U.S. income tax liability on the amount of subpart F income that would be recognized for the current year assuming the active financing exception is not extended. Companies should be prepared to compute the estimated AETR without the benefit of the active financing exception until that provision is re-enacted, beginning with the first quarter of 2010.
If an extension of the active financing exception 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. 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 will be reported in the period of enactment.
If the extension of the active financing exception is not enacted before the end of the first quarter, an entity should consider including in the financial report an explanation of the impact of the lapse reflected in the first quarter financial report. Furthermore, an entity should consider disclosing what the expected impact would be if the proposal is later enacted.
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- Section 954(h) was amended by the Tax Relief Act of 1999, the Job Creation and Workers Assistance Act of 2002, the American Jobs Creation Act of 2004, the Tax Increase Prevention and Reconciliation Act of 2005 and the 2008 Tax Extenders and Alternative Minimum Tax Relief Act
- H.R. 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 of a restructuring nature can be taken into account when establishing the annual effective tax rate (versus accounting for the effects of the restructuring when implemented).
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.