KPMG report: Initial impressions of Notice 2019-01 and “ PTEP” guidance
December 17, 2018
The IRS on December 14, 2018, released an advance version of Notice 2019-01 that provides guidance on the treatment of “previously taxed earnings and profits” or PTEP (colloquially referred to as PTI).
Notice 2019-01 [PDF 85 KB] announces that Treasury and the IRS intend to issue proposed regulations under sections 959 and 961 that will take into account various changes made by the new U.S. tax law (Pub. L. No. 115-97), and will withdraw the existing proposed regulations.
Overview
Although the general PTEP rules were not directly modified by Pub. L. No. 115-97, the existing PTEP regulations need to be revised to reflect the additional types of PTEP created under the new law, including PTEP from the mandatory repatriation rules and “global intangible low-tax income” (GILTI) inclusions. In addition, revised guidance on PTEP distributions is needed due to statutory changes—including revisions to the foreign tax credit (FTC) regime—that resulted in different operative rules applying to distributions of different types of PTEP.
Notice 2019-01 does not contain a comprehensive discussion of the rules expected to be included in the forthcoming PTEP regulations. Rather, the notice focuses on a narrow set of issues related to Publ. L. No. 115-97, including guidance on the methodology to determine the order in which PTEP is distributed, and the associated tracking of PTEP required to comply with this methodology.
Section 3.01: Annual accounts and PTEP groups
Section 3.01 of Notice 2019-01 generally describes the rules that taxpayers would need to follow in tracking their PTEP accounts. As set forth in the notice, for each of their separate section 904 separate limitation categories (“baskets”), taxpayers would need to maintain PTEP in an annual account, and segregate the annual account into 16 PTEP groups. The 16 PTEP groups would correspond to the underlying statutory rule that created the PTEP, and would reflect the reclassification of PTEP from section 959(c)(2) to section 959(c)(1) that occurs in connection with section 956.
Read descriptions of the 16 PTEP groups [PDF 118 KB]
Once PTEP is assigned to an annual account and PTEP group in an initial year, it would be maintained in that account as it is distributed or reclassified in subsequent years. In total, there would be nine groups of section 959(c)(1) PTEP and seven groups of section 959(c)(2) PTEP, which include the 10 PTEP groups described in the recently issued proposed FTC regulations (Prop. Reg. section 1.960-3(c)(2)) and six additional groups. A number of these PTEP groups would be relatively uncommon, due to the limited circumstances in which the rule that creates the PTEP would apply or because current law no longer contains the rule that creates the PTEP group.
The forthcoming regulations are expected to include rules that would address the transition from maintaining PTEP under the existing rules, which require the maintenance of fewer PTEP groups, to the new 16 PTEP groups. As described in Notice 2019-01, PTEP assigned to a PTEP group prior to the publication of the regulations generally would remain in that PTEP group, other than PTEP attributable to section 965(a) or section 965(b), which would need to be separately maintained in its relevant PTEP group.
Notice 2019-01 generally discusses the interaction of the PTEP rules described in the notice with the recently issued proposed FTC regulations that provide guidance on the application of the deemed paid FTC rules to PTEP distributions. As noted above, the PTEP groups would be maintained separately for each basket, generally consistent with the proposed FTC regulations. As a result, an annual layer of a particular PTEP group may be maintained in more than one basket. In order to apply the PTEP ordering rules that apply to a PTEP distribution (discussed in the next section of this report), the regulations are expected to include a rule that would treat a distribution of earnings and profits (E&P) from a PTEP group that includes amounts in multiple baskets as a pro rata distribution from each basket. Notice 2019-01 also states that the proposed FTC rules will be coordinated with the PTEP rules, consistent with statements in the preamble to the FTC regulations that acknowledge an intention for the PTEP groups in the proposed FTC regulations to be consistent with the PTEP groups ultimately included in PTEP regulations.
Notice 2019-01 generally describes an expected rule that would address the application of the basis reduction rules to PTEP distributions. The notice states that the regulations are expected to confirm that a distribution from a PTEP group would reduce a shareholder’s stock basis under section 961(b), regardless of how the basis was created. As an example, Notice 2019-01 states that a distribution from a PTEP group would reduce basis created under section 961(a) even if that PTEP group did not create the basis. Thus, a distribution of section 965(b) PTEP would reduce a shareholder’s stock basis even though there was not an underlying increase in a shareholder’s basis associated with that PTEP.
Notice 2019-01 also describes rules that would apply for purposes of determining foreign currency exchange gain or loss on PTEP distributions. The forthcoming regulations are expected to require each annual PTEP account to be maintained on a separate dollar basis. As a result, the basis pooling rules in Notice 88-71 would no longer apply. Under a transition rule described in Notice 2019-01, shareholders that currently are using the pooling method would be permitted to transition to the annual method by using the blended dollar basis as a single annual PTEP account, assigned to the last tax year before the regulations are applicable. Further, shareholders that maintained aggregate dollar basis pools for section 959(c)(1) PTEP or section 959(c)(2) PTEP would be permitted to assign an average dollar basis to the PTEP in each annual account, provided that the taxpayer maintained annual accounts for section 959(c)(1) PTEP and section 959(c)(2) PTEP.
Notice 2019-01 generally describes the requirement to maintain, for each basket, 16 PTEP groups in annual accounts as necessary to precisely apply the FTC and section 986 foreign currency rules, but also acknowledges the complexity associated with the maintenance of so many PTEP groups. Notice 2019-01 states that Treasury and the IRS are weighing the administrative and compliance concerns raised by the complexity against the need for precise compliance with the rules, and have requested comments on simplifying the rules including by consolidating PTEP groups, or grouping accounts into multi-year accounts.
Section 3.02: Ordering rules
Notice 2019-01 provides that the forthcoming regulations will clarify that a controlled foreign corporation (CFC) can distribute PTEP only to the extent it has current or accumulated E&P. Thus, a CFC that does not have current or accumulated E&P that otherwise would support a section 316 dividend would not be able to distribute PTEP, even if it has PTEP accounts. This rule would address an issue that existed prior to the change in law, but that is amplified under the new law because of the greater potential for PTEP accounts to exceed E&P.
Notice 2019-01 describes ordering rules that would apply when a CFC with E&P distributes PTEP, which determine the PTEP group from which the PTEP is distributed. Subject to a special priority rule, a “last in, first out” (LIFO) approach would apply to PTEP distributions, first to section 959(c)(1), and then to section 959(c)(2) PTEP. As a result, subject to the special priority rule, current year section 959(c)(1) PTEP would be distributed first, followed by prior year section 959(c)(1) PTEP, beginning with the most recent prior year. Next, subject to the special priority rule, current year section 959(c)(2) PTI would be distributed, followed by prior year section 959(c)(2) PTEP, beginning with the most recent prior year.
As described in Notice 2019-01, a special priority rule would apply to distributions of PTEP attributable to a section 965(a) inclusion and PTEP created under section 965(b), which are each maintained in separate PTEP groups within section 959(c)(1) PTEP and section 959(c)(2) PTEP. Under this rule, in applying the ordering rules to distributions of section 959(c)(1) PTEP, distributions would be treated as first coming from the section 965(a) PTEP group, followed by the section 965(b) PTEP group. After these PTEP groups are exhausted, the LIFO approach would apply on a pro rata basis to the PTEP groups in each annual layer of section 959(c)(1) PTEP. Next, the same approach would apply to section 959(c)(2) PTEP. After all of the section 959(c)(2) is distributed, then section 959(c)(3) E&P would be distributed.
The special priority rule and LIFO rules also would apply when PTEP is reclassified from section 959(c)(2) PTEP to section 959(c)(1) PTEP. As a result—with respect to each of section 959(c)(1) PTEP and section 959(c)(2) PTEP—PTEP related to section 965 would be distributed first, regardless of whether there are more current annual layers of PTEP. Notice 2019-01 justifies the special priority rule as reducing the administrative burden of maintaining PTEP accounts because it would result in a quicker reduction in the number of PTEP accounts by exhausting the section 965 PTEP groups sooner than under a LIFO approach.
Section 3.03: Inclusions in excess of earnings and profits
Under the new law, PTEP for a current year can exceed current year E&P. For example, the amount of GILTI PTEP can exceed E&P because a U.S. shareholder’s GILTI inclusion allocated to a CFC is not limited by the CFC’s E&P. In addition, the amount of PTEP from a subpart F inclusion can exceed E&P under a GILTI-subpart F coordination rule that increases the E&P of a tested loss CFC for purposes of applying the current year E&P limitation rule in calculating a CFC’s subpart F income.
Notice 2019-01 states that section 959(c)(1) PTEP, section 959(c)(2) PTEP, and section 959(c)(3) E&P must equal the CFC’s E&P. Under the rules described in the notice, to the extent that a CFC has PTEP in a year that exceeds E&P, the excess amount would reduce section 959(c)(3) E&P, including below zero. In addition, a current year E&P deficit would reduce only section 959(c)(3) E&P. As a result, under the forthcoming regulations, a CFC could have a negative section 959(c)(3) E&P amount, which is generally consistent with Rev. Rul. 86-131.
Section 4: Applicability date
The rules described in Notice 2019-01 are expected to apply to tax years of U.S. shareholders that end after December 14, 2018. Prior to issuance of the regulations, shareholders can rely on the rules described in Notice 2019-01, provided the shareholder and all related persons consistently apply the rules to all foreign corporations, beginning with the tax year that includes the tax year end of any foreign corporation to which section 965 applied.
Section 5: Request for comments
Notice 2019-01 includes a separate section that requests comments on a number of specific issues, which are due by February 12, 2019. Included in this section is a request for guidance on the application of section 961(c) basis for purposes of determining tested income for GILTI purposes, as well as a request relating to an election that would allow for multi-year GILTI PTEP accounts.
For more information, contact a tax professional in KPMG’s Washington National Tax practice:
Barbara Rasch | +1 (213) 533-3382 | brasch@kpmg.com
List of 16 PTEP groups
1. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 965(a) (“reclassified section 965(a) PTEP”)
2. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 965(b)(4)(A) (“reclassified section 965(b) PTEP”)
3. E&P described in section 959(c)(1)(A) by reason of section 951(a)(1)(B) and not by reason of section 959(a)(2) (“section 951(a)(1)(B) PTEP”)
4. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 951A(f)(2) (“reclassified section 951A PTEP”)
5. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 245A(e)(2) (“reclassified section 245A(e)(2) PTEP”)
6. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 959(e) (“reclassified section 959(e) PTEP”)
7. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 964(e)(4) (“reclassified section 964(e)(4) PTEP”)
8. E&P described in section 959(c)(1)(A) that were initially described in section 959(c)(2) by reason of section 951(a)(1)(A) (other than E&P that were initially described in (10) through (15) of this list) (“reclassified section 951(a)(1)(A) PTEP”)
9. E&P described in section 959(c)(1)(B), including by reason of section 959(a)(3) (before its repeal) (“section 956A PTEP”)
10. E&P described in section 959(c)(2) by reason of section 965(a) (“section 965(a) PTEP”)
11. E&P described in section 959(c)(2) by reason of section 965(b)(4)(A) (“section 965(b) PTEP”)
12. E&P described in section 959(c)(2) by reason of section 951A(f)(2) (“section 951A PTEP”)
13. E&P described in section 959(c)(2) by reason of section 245A(e)(2) (“section 245A(e)(2) PTEP”)
14. E&P described in section 959(c)(2) by reason of section 959(e) (“section 959(e) PTEP”)
15. E&P described in section 959(c)(2) by reason of section 964(e)(4) (“section 964(e) PTEP”)
16. E&P described in section 959(c)(2) by reason of section 951(a)(1)(A) not otherwise described in (10) through (15) of this list (“section 951(a)(1)(A) PTEP”)
