New IRS rules aim to prevent avoidance of transition tax on foreign subsidiary earnings

The US IRS today published rules designed to prevent US companies from avoiding the new transition tax on untaxed foreign subsidiary earnings, added last December in the Tax Cuts and Jobs Act.

The guidance, Notice 2018-26, also clarifies rules on special elections under section 965, on the reporting and payment of the transition tax, and other issues under section 965. It also provides relief to taxpayers from certain estimated tax requirements and penalties arising from the enactment of the transition tax and clarifies the change to existing stock attribution rules in the Tax Cuts and Jobs Act.

The new antiavoidance rule provides that transactions, accounting method changes, and entity classification elections under reg. section 301.7701-3 occurring after November 2, 2017, will be disregarded if undertaken with a principal purpose of reducing the section 965 tax liability and if the tax liability would, in fact, be reduced if it was not for this new rule.

The guidance states that some transactions are presumed to be undertaken for a principal purpose of reducing the section 965 tax, which can be rebutted only if the facts and circumstances clearly show otherwise. These transactions are cash reduction transactions, earnings and profits reduction transactions, and pro-rata share transactions.

Further, the Service said that regulations will be issued providing that any accounting method change made for a taxable year of a specified foreign corporation that ends in 2017 or 2018 will be disregarded for purposes of determining the section 965 tax if the accounting method change reduces the tax. These rules will not apply to method changes requested prior to November 2, 2017.

Similarly, any Section 301.7701-3 entity classification election under filed on or after November 2, 2017, will be disregarded for purposes of the tax if applying the election would reduce the tax, the Service said.

The new rules will be incorporated into tax regulations but can be relied upon now, the Service said.

Comments are requested on the new notice. The IRS and Treasury also seek feedback on what additional guidance is needed to assist taxpayers in computing the transition tax.