The IRS Has Released a New Guidance on Accounting Method Changes That Impact Certain Foreign Corporations
August 10, 2021
On May 11, the IRS issued Rev. Proc. 2021-26, which provides guidance for certain foreign corporations to obtain the IRS’s automatic consent to change their method of accounting for depreciation to the alternative depreciation system (ADS). The guidance allows a window to comply with the regulations and provide additional terms and conditions applicable with respect to Section 481(a) adjustments and clarifies an existing rule that limits audit protection for certain foreign corporations.
Specific Method Change
Section 951A requires a US shareholder of any controlled foreign corporation (CFC) to include the shareholder’s global intangible low-taxed income (GILTI) in gross income. GILTI is the excess of the shareholder’s net tested income over its net deemed intangible return for the tax year. Very generally, the net deemed intangible return is the excess of 10% of the shareholder’s qualified business asset investment (QBAI) over its pro-rata shares of certain interest expense from all its CFCs. QBAI is determined by reference to CFCs’ adjusted bases in specified tangible property as determined by using ADS under Section 168(g).
When computing tested income and earnings and profits (E&P), taxpayers may use depreciation methods other than ADS. Given the requirement to use ADS to determine the adjusted basis for purposes of calculating QBAI, CFCs not otherwise required to use ADS to compute their income, and E&P may want to change to ADS for tangible property to conform their income, E&P, and QBAI computations.
In the guidance specified in 2021-26, the IRS modifies existing rules, including waiving certain eligibility requirements, to allow, for a limited period of time, a CFC on either an impermissible or permissible non-ADS method to obtain the automatic consent to change its method of depreciation to ADS for purposes of calculating income, as well as E&P.
When Is This Change Effective?
This change is effective for a Form 3115 filed on or after May 11, 2021, for a CFC’s tax year ending before January 1, 2024. An automatic Form 3115 filed under the new method change procedure must be filed in duplicate. Specifically, the automatic change procedural rules of Section 6.03 of Revenue Procedure 2015-13 require the following:
- The original completed Form 3115 (or an electronic version of the Form 3115) must be attached to the taxpayer’s timely filed (including extensions) original federal income tax return implementing the requested automatic change for the requested year of change.
- A signed copy of the original Form 3115 must be filed with the IRS in Ogden, UT (Ogden copy) no earlier than the first day of the requested year of change and no later than the date the taxpayer files the original Form 3115 with the federal income tax return for the requested year of change.
Section 481(a) adjustment
When a CFC changes its method of accounting, the difference between the CFC’s income under the old and new methods is generally taken into account as a Section 481(a) adjustment as part of the CFC’s computation of income and E&P. To account for the recently enacted GILTI rules, as well as the repeal of foreign base company oil-related income as part of the Subpart F regime, Rev. Proc. 2021-26 clarifies that a CFC’s Section 481(a) adjustment as a result of a change in accounting method (including as a result of an automatic change in method of depreciation to ADS, as described above) is generally required to be taken into account for purposes of computing the CFC’s tested income or loss for GILTI purposes unless the adjustment relates to an item of gross income, or a deduction attributable to an item of gross income, excluded from the computation of tested income or loss (such as Subpart F). Rev. Proc. 2021-26 further clarifies that such Section 481(a) adjustment to tested income or loss for GILTI purposes will also include any Section 481(a) adjustment relating to the repealed foreign base company oil-related income, as well as any Section 481(a) adjustment that relates to an item of income or expense arising before the effective date of Section 951A.
Revenue Procedure, 2015-13, denies audit protection for an accounting method change made on behalf of a CFC or a 10/50 corporation if the 150% threshold is met. The threshold is met for a particular tax year if the foreign taxes deemed paid under Sections 902 and 960 by a CFC or 10/50 corporation exceed 150% of the average amount of foreign taxes deemed paid by its shareholder under Sections 902 and 960 for the three prior tax years.
Rev. Proc. 2021-26 retains these limitations.
How AbitOs Can Help
Understanding how to leverage the changes allocable by IRS Rev. Proc. 2021-26 and if changing your accounting method makes sense for your particular operation can be a bit complicated.
Any international tax planning should be considered fully before applying this guidance. The experts at AbitOs would be happy to help!
AbitOs specializes in the unique accounting needs of high net-worth individuals with international lifestyles as well as for entities doing business in LATAM and across the globe. Leveraging the new guidance that can be found in IRS Rev. Proc. 2021-26 can be quite complex. If you would like to benefit from our expertise in these areas or if you have further questions on this Alert, do not hesitate to contact us.