The US IRS on May 11 released guidance that aims to make it easier for controlled foreign corporations to make certain accounting method changes for purposes of conforming income and earnings & profits calculations with qualified business asset investment (QBAI) calculations.
The guidance, Revenue Procedure 2021-26, also clarifies how certain adjustments are taken into account following a method change and how to determine the application of a certain exception to audit protection for method changes.
Automatic consent to change to alternative depreciation system
For tax years beginning before 2024, the guidance expands the availability of automatic IRS consent for controlled foreign corporations to change their method of accounting for depreciation to the “alternative depreciation system” under Internal Revenue Code Section 168(g).
The QBAI calculation is used in determining a US shareholder’s global intangible low-taxed income (GILTI) inclusion. Because the GILTI rules require that QBAI to be determined using the alternative depreciation system, the change enables controlled foreign corporations to change their income and earnings & profits to the alternative depreciation system if they do not already use it.
The change is effective for applications for a change in accounting method filed on or after May 11, 2021, for controlled foreign corporation tax years beginning before January 1, 2024.
Adjustments following a method change
The guidance also includes terms and conditions for accounting method changes made on behalf of controlled foreign corporations with respect to “Section 481(a) adjustments.” Section 481(a) adjustments are made following the change in a controlled foreign corporation’s method of accounting to address differences in income and earnings & profits between the old and new method.
The guidance aims to ensure that Section 481(a) adjustments resulting from controlled foreign corporation method changes are properly included in calculations of tested income and tested loss. To this end, it includes certain clarification about how the adjustment is taken into account.
Audit protection
The guidance clarifies the “150 percent rule” that limits audit protection with respect to certain controlled foreign corporations and “10/50 corporations” (i.e., foreign corporations owned at least 10 percent but not more than 50 percent by a US corporation).
Although audit protection generally applies to certain items subject to accounting method changes, there is an exception for certain method changes made on behalf of a controlled foreign corporation or 10/50 corporation. The exception applies to tax years before the requested year of method change when certain foreign taxes deemed paid exceeds 150 percent of the average amount of such foreign taxes deemed paid in the three prior tax years.
The guidance clarifies that the 150 percent rule is calculated with respect to the amount of the foreign corporation’s foreign taxes deemed paid, regardless of the extent to which a foreign tax credit is allowed.
The change is intended to address questions that have arisen regarding whether the effect of various limitations on a domestic corporate shareholder’s ability to claim a current tax benefit for foreign taxes deemed paid should affect the application of the 150 percent rule.
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