Adopting or changing a foreign corporation's accounting method.

• Author: Hui, Irene Pik-Wah

Many companies are experiencing decreased cashflow during the present economic downturn and as a result are evaluating options to raise cash to fund ongoing business operations. One option that U.S. multinational corporations may consider is repatriation of earnings from related foreign corporations (FCs).

To the extent of the FC's positive current or accumulated earnings and profits (E&P), the repatriated amount is generally regarded as a dividend under Sec. 316. Dividend treatment may be beneficial, assuming foreign tax credits are triggered to offset the U.S. tax thereon (subject to certain limitations). Thus, the company must determine how to calculate the FC's E&E Since E&P is a U.S. tax concept, determining E&P--including adoption or change of tax accounting methods--should be made in accordance with U.S. tax law.

What Is an Accounting Method?

An accounting method affects when an item of income or deduction is recognized. That is, accounting methods generally result from temporary (not permanent) differences to lifetime income, and these differences reverse in the succeeding tax year or years. Nevertheless, companies should monitor these differences with respect to their FCs because they likely will affect the determination of actual or deemed dividends for repatriations in a particular tax year.

How Does a CFC Adopt or Change a Method of Accounting?

The rules for determining how a controlled foreign corporation (CFC) adopts or changes a method of accounting are provided under Regs. Sec. 1.964-1(c) and more specifically under Temp. Regs. Sec. 1.964-1T(c). It is important to note that the IRS did not finalize these temporary regulations, and they sunset in April 2009 under Sec. 7805. At the time of publication, however, these temporary regulations are expected to be finalized, possibly with only minor modifications. Moreover, much of the analysis presented in this item is also applicable to the rules promulgated in the final regulations under Sec. 964 prior to the publication of the temporary regulations. For these reasons, the item focuses on the temporary regulations even though they are no longer effective.

Temp. Regs. Sec. 1.964-1T(c)(2) provides that for a CFC, the controlling domestic shareholders--i.e., U.S. shareholders who own directly or indirectly, in the aggregate, more than 50% of the total combined voting power of all classes of CFC stock who are entitled to vote and undertake to act on its behalf--may make an election...