IRS provides new guidance on accounting method changes for CFCs.

• Author: Ngai, Nicole
• Position: Controlled foreign corporations

Nonautomatic accounting method changes are inconvenient and troublesome for taxpayers. When global intangible low-taxed income (GILTI) was introduced by the enactment of the law known as the Tax Cuts and Jobs Act (TCJA), P.L. 115-97, numerous taxpayers wanted to change the accounting methods of their controlled foreign corporations (CFCs) to more easily comply with GILTI calculations. In particular, many desired to conform their CFCs' depreciation method to the alternative depreciation system (ADS). The IRS acknowledged taxpayers' burden and provided new guidance under Rev. Proc. 2021-26 in May 2021. Under Rev. Proc. 2021-26, for a limited time, the IRS is allowing automatic change procedures for CFCs changing to the ADS method and has clarified the process and certain aspects of audit protection.

Background: ADS depreciation (Sec. 168(g))

Under Sec. 168(g)(1)(A), ADS must be employed for depreciable tangible property mainly used outside the United States. As a result, it is expected that foreign corporations that operate overseas, including CFCs, use the ADS method when computing depreciation for earnings and profits (E&P), tested income, and other items when complying with U.S. tax laws. However, if the adjustments necessary to conform to ADS are not material, a foreign corporation may use a non-ADS depreciation method when calculating E&P (Regs. Secs. 1.952-2(c)(2) and 1.964-1(a)(2)). Non-ADS methods include the depreciation method maintained in its book accounting for shareholders or other methods allowed under U.S. GAAP (Regs. Secs. 1.952-2(c)(2)(i) and (ii)).

A change in depreciation method, recovery period, or convention is considered a change in accounting method per Regs. Sec. 1.446-1(e)(2)(ii)(d)(2)(i). Therefore, changing the CFC's depreciation method to ADS would be considered a change in the method of accounting under Sec. 446 and will require following the appropriate procedures to obtain IRS consent (Sec. 446(e)).

Prior to Rev. Proc. 2021-26, automatic approval by the IRS for this change in accounting method depended on whether the CFC was using an impermissible non-ADS method or a permissible one. Under Rev. Proc. 2015-13 and Rev. Proc. 2019-43, a CFC using an impermissible non-ADS method and requesting a change to ADS was permitted to use the automatic change procedures. However, a CFC using a permissible non-ADS method and desiring a change to ADS was not entitled to automatic consent until Rev. Proc. 2021-26 was issued.

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