The IRS has released guidance (Rev. Proc. 2021-26
) that provides new automatic consent method change procedures for certain foreign corporations to conform to the alternative depreciation system (ADS). The revenue procedure also prescribes terms and conditions to make sure that Section 481(a) adjustments are properly included in the computation of tested income and loss, and clarifies the current rule limiting audit protection.
Section 951A determines a U.S. shareholder’s GILTI inclusion through a computation based on certain controlled foreign corporation (CFC) attributes, including tested income or loss and qualified business asset investment (QBAI). With some exceptions, CFCs are generally required to use ADS under Section 168(g) to compute depreciation for tested income and QBAI. Prior to the Tax Cuts and Jobs Act, many CFCs used book depreciation because it was not materially different from ADS for purposes of computing E&P, and continued to do so under the GILTI regime for computing tested income. However, doing so may cause a disconnect between tested income and QBAI computations.
Prior to the release of this procedure, some CFCs may have been eligible to use the existing automatic procedures to change their depreciation method to properly use ADS for purposes of tested income. Rev. Proc. 2021-26 adds Section 6.22 to Rev. Proc. 2019-43 to temporarily allow all CFCs, regardless of their present method, to make an automatic change to use ADS. The procedure waives the normal scope limitations that may preclude taxpayers from being allowed to use an automatic procedure and provides for a Section 481(a) adjustment and the potential for audit protection.
Rev. Proc. 2015-13 includes a 150% rule that may limit audit protection for certain CFCs. This guidance modifies the rule by clarifying that the 150% limit is based solely on a foreign corporation’s foreign taxes deemed paid, regardless of the foreign tax credit amount allowed to a domestic shareholder.
When it makes a change in a method of accounting, a CFC must generally compute and include a Section 481(a) adjustment to prevent omission or duplication of differences between previously reported income and earnings and profits. The guidance under Rev. Proc. 2015-13 for determining the treatment of the adjustment pre-dated the final regulations regarding Section 951A. Rev. Proc. 2021-26 updates the rules and prescribes terms and conditions for accounting method changes made on behalf of CFCs to ensure that any resulting Section 481(a) adjustments will adjust tested income or tested loss unless the adjustment constitutes a gross income exclusion under Section 951A(c)(2)(A). The rules also require that a taxpayer apply the de minimis and full inclusion rules after Section 481(a) adjustment is determined to be positive or negative, if applicable.
The updates to Rev. Proc. 2015-13 are effective for any Form 3115 filed on or after May 11, 2021. The temporary automatic procedures added in Section 6.22 of Rev. Proc. 2019-43 will only apply to CFCs with taxable years ending before Jan 1, 2024.
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