On December 11, the Treasury Department and the Internal Revenue Service (IRS) issued Notice 2023-80. This notice details forthcoming proposed regulations concerning the interaction between the US tax system and Pillar Two. It takes into consideration whether Pillar Two could stimulate a recapture of “legacy” dual consolidated losses and to what extent US taxpayers will be eligible for a foreign tax credit for certain Pillar Two top-up taxes.
In a recent development, Notice 2023-55 has been indefinitely extended. It previously offered taxpayers respite from the application of contentious January 2022 modifications to enduring foreign tax credit regulations. While this notice is clear on some pivotal issues, it abstains from explaining the policy rationale or the technical basis for the proposed rules.
The matter of whether Pillar Two taxes should be excluded from US exceptions for high-taxed income, according to existing laws, remains uncertain. It’s likewise unclear how a Pillar Two tax could be deemed ineligible for the US foreign tax credit but result in a deemed dividend inclusion.
As of January 1, top-up taxes in alignment with the OECD’s Pillar Two work will come into effect in more than two dozen countries. The creditability for each US taxpayer will be determined by the foreign tax’s status as a final top-up tax after considering any of the taxpayer’s US tax liability. Factors such as whether a tax is a Qualified Domestic Minimum Top-up Tax (QDMTT) or an Income Inclusion Rule (IIR) tax contribute to the scenario.
This hangs in the balance as the proposed approach conforms to the Pillar Two ordering rules which prioritize taxes levied by a controlled foreign corporation (CFC) imposed by the parent entity before any IIR tax imposed by an intermediate parent entity.
Concerns remain regarding potential conflicts with the policy of excluding income from the scope of Subpart F and GILTI where the income was not exported abroad for the purpose of US tax reduction. The agreement reached by the Treasury Department at the Organization for Economic Cooperation and Development regarding CFC taxes has not been incorporated into the domestic law, which raises questions about the technical basis under the federal tax code.
Various industry experts, such as the New York State Bar Association, have proposed the procedure for disallowing the credit aligns with the treatment of IIR taxes as a new form of soak-up tax.
Lastly, there’s growing concern over the notion that the rules denying a foreign tax credit are inconsistent with those requiring a deemed dividend under Section 78 when translated into proposed regulations. The continued rulemaking process aims to elucidate these issues further.