Foreign taxes on PTEP can provide additional foreign tax credits.

• Author: Alajbegu, Jim
• Position: Previously taxed earnings and profits

As the world eagerly awaits the issuance of regulations addressing previously taxed earnings and profits (PTEP) by Treasury and the IRS,this third installment of the authors' ongoing series covering international earnings and profits (E&P) rules focuses on the potential increase in the Sec. 904(a) foreign tax credit limitation when PTEP is distributed by a controlled foreign corporation (CFC) to its corporate "U.S. shareholder." A U.S. shareholder who is an individual and has made a Sec. 962 election may also be eligible to increase his or her Sec. 904 foreign tax credit limitation in this scenario.

Simplified example

In two previous articles (Alajbegu and Brown, "Tax Clinic: Foreign Income Taxes Deemed Paid and the PTEP Rules," 51 The Tax Adviser 633 (October 2020) and "Tax Clinic: Demystifying the New International E&P Rules," 50 The Tax Adviser 690 (October 2019), the authors explained the application of the U.S. international PTEP rules by way of modifying an example contained in the applicable Treasury regulations (Regs. Sec. 1.960-3(e), Example (1)). As illustrated in the diagram, "Distribution From CFC to USP" (below), a domestic corporation (USP) owns all of the stock of CFC and therefore is the U.S. shareholder in this example. Both entities have calendar year ends, and one unit of CFC's functional currency "u" is equal to $1 at all relevant times. In year 1, USP has 1,000u Subpart F income and 500u of global intangible low-taxed income (GILTI) inclusion from CFC. Assume that USP does not have any Sec. 965(a) or Sec. 965(b) PTEP related to CFC and that CFC's year 1 income giving rise to the Subpart F and GILTI inclusions is not subject to foreign tax. Also assume that the Subpart F inclusion is allocated and apportioned to the Sec. 951(a)(1)(A) PTEP group in the passive category and the GILTI inclusion is Sec. 951A PTEP in the 951A category. Finally, in year 2, CFC makes a Sec. 959(a) PTEP distribution of the 1,500u to USP, and the distribution suffers 450u of foreign withholding taxes.

As detailed in the authors' previous article, after the distribution, CFC has no PTEP. Further, because CFC had PTEP groups in more than one Sec. 904 category in the same year and did not have any Sec. 965(a) or Sec. 965(b) PTEP, it is anticipated the forthcoming PTEP regulations will provide that the distribution would be made pro rata out of the E&P in each Sec. 904 category. (See Alajbegu and Brown, "Tax Clinic: Demystifying the New International...