On December 11, 2023, the IRS released Notice 2023-80 (the Notice) announcing that the U.S. Department of the Treasury (Treasury) will issue proposed regulations addressing the interaction of foreign tax credits (FTCs) and dual consolidated losses (DCLs) with other taxes implemented by the Global Anti-Base Erosion (GloBE) rules implemented by the worldwide initiative of Pillar Two. In addition to addressing concerns with the taxes imposed under Pillar Two, Treasury also extended the temporary relief afforded under Notice 2023-55 with respect to the 2022 FTC final regulations. The Pillar Two rules developed by the Organisation for Economic Co-operation and Development propose a system of global taxation based on financial accounts applied using a minimum rate of 15% (which is set to rise to 17% by 2026) on a country-by-country basis. These rules are designed to target multinational enterprise groups (MNE groups) with average annual global revenues of at least EUR 750 million. By design, the Pillar Two rules are expected to raise worldwide effective tax rates (ETRs) by utilizing charging provisions like:
- Qualified Domestic Minimum Top-Up Tax (QDMTT), which is a minimum tax imposed by the domestic law of a jurisdiction that computes its own top-up tax following the Pillar Two rules;
- Income Inclusion Rule (IIR), a minimum that imposes top-up tax at the highest level of an MNE group concerning low-taxed income at its constituent entities; and
- Undertaxed Profits Rule (UTPR), a rule that allows a jurisdiction to deny deductions in its own jurisdiction to top up any low-taxed jurisdictions of an MNE group not brought into charge under the IIR or QDMTT.
As of the current date, multiple jurisdictions have already enacted Pillar Two legislation or have agreed to enact Pillar Two legislation within the next following months.
Interaction With the U.S. Foreign Tax Credit Regime & High-Tax Exclusion for GILTI & Subpart F
The proposed regulations noted in the Notice will provide that any top-up tax imposed under Pillar Two, which considers the U.S. tax liability of a U.S. shareholder with respect to income that will be taxed under the Pillar Two rules will not be creditable under Section 901 or §960 of the Internal Revenue Code (the Code). The Notice also addresses interaction with the treatment of Pillar Two top-up taxes and the high-tax exclusion elections under §954(b)(4) for Subpart F income and Treasury Regulation 1.951A-2(c)(7) for tested income by specifying that a non-creditable top-up tax will not be considered for purposes of these elections. In so doing, the Notice includes extensive examples elaborating on the creditability of these top-up taxes in the U.S. and how they are to be analyzed specifically with respect to QDMTTs and IIRs but does not address any UTPR implications that are set to go into effect in 2025.
The proposed rules under the Notice appear to confirm that top-up taxes paid under the IIR imposed by Pillar Two will not be creditable since the IIR, by design of the GloBE rules, is generally expected to consider U.S. tax liabilities as a covered tax in the top-up tax computations. In addition, while the UTPR is not addressed in the Notice, similar considerations can be ascertained considering that the UTPR is a backstop to the IIR, which by design will consider U.S. tax liabilities in its base unless otherwise specified.
Furthermore, to the extent QDMTTs are to consider U.S. tax liabilities in the base of the local country top-up tax, such top-up taxes will not be creditable. Based on the language provided in the Notice, it appears that a QDMTT that considers a U.S. tax liability in its base will be completely non-creditable under §901 or §960 as opposed to non-creditable only with respect to the portion of the QDMTT that considers the U.S. tax liability. To the extent Treasury wishes to only disallow the portion of a QDMTT that considers the U.S. tax liability, the proposed regulations will likely need to clarify this point when released. Similar to the 2022 FTC final regulations, which have been temporarily suspended under Notice 2023-55, the imposition of these proposed regulations addressing Pillar Two will generally require U.S. taxpayers to understand how the foreign tax laws associated with QDMTTs function in order to ascertain whether such top-up taxes are to be creditable under §901 or §960.
Interaction With DCL Rules
The Notice provides clarification with respect to how the GloBE rules will interact with DCLs in the proposed regulations that are set to be released. With respect to DCLs incurred in tax years beginning before January 1, 2024 and ending after December 31, 2023, the proposed regulations will provide that application of the GloBE rules will not initiate a foreign use and thus not implicate any of the DCL triggering rules contemplated in the §1503 regulations of the Code. This stipulation is intended to apply only to the extent a U.S. taxpayer’s tax year aligns with the same dates as the fiscal year of the MNE group in question. It further provides that to the extent a DCL is incurred or increased with an intention to reduce the jurisdictional top-up tax, the proposed regulations will include provisions deeming such as a foreign use subject to the triggering rules. Finally, the Notice does not address the interaction of DCLs created in future years where the GloBE rules will be implemented but does note that Treasury is studying and analyzing whether the GloBE rules may create a “foreign use” and how to address this matter going forward with other aspects in the Code.
The guidance provided with respect to DCLs incurred before January 1, 2024 is helpful as it clarifies the absence of additional administrative burden for affected taxpayers with DCLs. Without the clarification in the Notice, affected taxpayers would have had to analyze whether additional U.S. tax could be triggered by application of the GloBE rules and whether additional disclosures are necessary for the 2024 U.S. compliance and reporting deadlines. While this guidance is certainly helpful, the Notice’s absence of guidance with respect to DCLs created in future years when the GloBE rules are implemented presents further uncertainty. For affected taxpayers, it will be critical to monitor subsequent Treasury developments to determine whether potential U.S. tax and/or additional reporting obligations may ensue in future years.
Extension of Relief Period Included in Notice 2023-55
In July 2023, responding to numerous complaints by taxpayers regarding application, the IRS issued Notice 2023-55 temporarily suspending the application of the 2022 final FTC regulations and allowed taxpayers to use the former §901 and §903 regulations for a relief period that includes taxable years beginning on or after December 28, 2021 and ending on or before December 31, 2023. The 2022 final FTC regulations substantially revised the requirements to claim an FTC for foreign taxes paid in the United States. Specifically, the regulations required detailed analysis of foreign local country law to determine if foreign taxes were imposed on a tax base that substantially conformed with U.S. tax principles. In addition, these final regulations added a new “attribution” requirement to the net gain component by noting that foreign taxes must be attributable to the activities within the foreign country. The Notice extends the relief period to tax years ending before the date that a notice or other guidance modifying the temporary relief is issued.
The extension of the temporary relief period is a much-welcomed update as it provides further certainty to taxpayers for the foreseeable future with respect to the creditability of foreign income taxes.
The Notice is significant because it formalizes many of the assumptions that the tax community had already been expecting with respect to Pillar Two’s interaction with the U.S. tax regime and provides more certainty with respect to the creditability of FTCs for the foreseeable future while Treasury studies how the creditability of FTCs will be determined in the future. This Notice further provides additional clarity with respect to Pillar Two’s effect on U.S. fiscal budgetary concerns addressed in the Joint Committee on Taxation’s budget projection released earlier this year. While the impact to Treasury remains uncertain at this point in time, it is largely expected that the global enactment of Pillar Two will result in more administrative costs to MNE groups with average annual global revenues of at least EUR 750 million. To comply with the Pillar Two rules, affected taxpayers should consider contacting their tax advisors to help evaluate whether local country QDMTTs will be creditable and assess the impact of any DCLs incurred prior to 2024 to evaluate whether a “foreign use” can be implicated. In addition, affected taxpayers may want to consider adopting internal protocols to evaluate their internal tax function to help determine whether Pillar Two provision and compliance requirements can be met. For more information regarding how FORVIS can assist you with your Pillar Two needs, please reach out to a professional at FORVIS.