RI: Proposed regulation issued on corporate tax treatment of section 965 income

The Rhode Island Division of Taxation recently proposed a regulation to provide guidance on how corporations will report deferred foreign income or section 965 income for the 2017 tax year. The proposed regulation confirms that although there is no statutory Rhode Island dividends-received deduction (DRD) for Subpart F income, the state has historically administratively allowed corporate taxpayers to take a DRD for certain types of foreign source income and Subpart F income. This DRD was equivalent to the DRD provided to domestic corporations under prior federal law. The proposed regulation notes that although prior case law was the impetus for allowing a DRD for foreign source income, Rhode Island is now a combined reporting state. Per the proposed regulation, these changed facts “distinguish the prior case law and urge against Rhode Island providing a DRD for 965 Income amounts included as net income at the Rhode Island level.”

After defining a number of key terms, the draft regulation clarifies that a C-Corporation that receives “Net 965 income” from a foreign corporation subsidiary must generally include such income in Rhode Island income. “Net 965 income” is section 965 income less any federal deduction provided by IRC section 965 (e.g.,  the section 965(c) deduction, which effectively reduces the rate of tax imposed on section 965 income). No DRD will apply if the net 965 income is attributable to a foreign corporation subsidiary whose only income and factors included in the combined report are its U.S source income and factors. Further, includable Net 965 income from a foreign entity included in the combined report (i.e., those foreign entities with greater than 20 percent sales into the U.S.) will be eliminated but only to the extent such Net 965 income is attributable to accumulated deferred foreign income earned by the foreign corporation subsidiary during periods in which it was a combined group member.

The proposed regulation also addresses foreign subsidiaries that are not part of the unitary combined group. Specifically, no DRD applies to Net 965 Income includible in Rhode Island income that is attributable to a so-called “Unitary Foreign Corporation Subsidiary.” This is generally an entity that would be in the unitary group if the water’s-edge rules did not apply. In contrast, if a corporation recognizes Net 965 Income includible in Rhode Island income that is attributable to a so-called “Non-unitary Foreign Corporation Subsidiary,” such Net 965 Income is entitled to a DRD equal to the DRD that would be available under federal income tax law if such subsidiary were a domestic, rather than a foreign entity, and the includible Net 965 Income was a dividend. For apportionment purposes, the proposed regulation clarifies that Net 965 income will be treated like dividend income and examples are provided as to how Net 965 income should be included in the sales factor. A taxpayer that recognizes Net 965 Income must generally include in receipts for apportionment purposes the Net 965 Income amount, as reduced by any DRD allowed. The taxpayer will treat the entirety of such amount as receipts from the taxpayer's activities or transactions outside of Rhode Island and will include such amount in the denominator but not numerator of the sales factor.  The proposed regulation also reminds taxpayers that they must file a RI Schedule 965 with their 2017 Rhode Island return if the return has not yet been filed. If a 2017 Rhode Island return has already been filed, an amended return must be filed that includes RI Schedule 965. The federal “IRC 965 Transition Tax Statement” must be included with the RI Schedule 965. A hearing on the proposed regulation will be held on June 21, 2018. Please stay tuned to TWIST for future updates on reporting section 965 income.