Treasury and IRS Issue Accounting Method Change Guidance for Foreign Corporations

Treasury and IRS issued Revenue Procedure 2021-26 regarding accounting method changes made on behalf of controlled foreign corporations (CFCs). The guidance expands on final regulations issued in 2019 implementing Internal Revenue Code Sec. 951A, regarding global intangible low-taxed income (GILTI) inclusions and reporting. GILTI was established under the Tax Cuts and Jobs Act (TCJA) and applies to tax years beginning after December 31, 2017.

The revenue procedure extends to tax years beginning before 2024 the availability of automatic consent for CFCs to change their methods of accounting for depreciation to the alternative depreciation system (ADS) for determining income and earnings and profits (E&P). It also updates prior guidance (Rev. Proc. 2015-13) for making a Sec. 481(a) change in accounting method adjustment to account for GILTI under Sec. 951A and the TCJA’s repeal of Sec. 954(g), which eliminated foreign base company oil related income as a category of foreign base company income.

Tested Income and Accounting Method Changes

Tested income is a new concept that led to uncertainties as it relates to accounting methods. The final GILTI regulations clarified that a taxpayer must use the same accounting methods for GILTI tested income that it does for computing E&P. In particular, this impacts taxpayers who have not historically been using ADS depreciation for E&P purposes. It can also implicate other methods of accounting for CFCs. The same general procedures that apply to make a change in method of accounting for a CFC for E&P purposes also apply for making a change in method of accounting for a U.S. taxpayer. Form 3115, Application for Change in Accounting Method must be filed to secure the Commissioner’s consent. In the case of a CFC, the U.S. taxpayer files Form 3115 on behalf of the CFC under the automatic procedure, if applicable, or otherwise the non-automatic procedure.

Changes in Methods of Accounting for Depreciation

A method for depreciation is adopted when the asset is placed in service. A method change may be necessary to change the treatment of assets placed in service in prior years. A proper ADS method can be adopted by using the ADS method for assets placed in service on a current year tax return.

Under Sec. 446, a taxpayer needs to receive IRS consent before changing its depreciation method. Revenue Procedure 2015-13 provides the procedures under which a taxpayer can obtain automatic consent. However, under Rev. Proc. 2015-13, a CFC using a permissible non-ADS method could not make an automatic change to use ADS. In 2019, Treasury and IRS expressed intent to publish a new revenue procedure to expand the availability of automatic consent for depreciation changes and update the terms and conditions of Rev. Proc. 2015-13, Section 7.07.

Revenue Procedure 2021-26 allows automatic consent for changing depreciation to ADS in determining income and E&P for Forms 3115 filed on or after May 11, 2021 for CFC tax years ending before 2024. Additionally, Rev. Proc. 2021-26 permits a CFC using a permissible non-ADS method to make an automatic change to use ADS.

Section 481(a) Adjustments for GILTI Tested Income

Section 481(a) adjustments prevent duplication or omission of income and deductions after a change in accounting methods. Revenue Procedure 2015-13 requires a Sec. 481(a) change in accounting method adjustment to be allocated to income that had the same source, separate limitation classification, character and subpart F treatment. Revenue Procedure 2021-26 updates Rev. Proc. 2015-13 to account for the computation of GILTI under Sec. 951A. Under Rev. Proc. 2021-26, a CFC will account for its adjustment in determining tested income or loss unless it is an adjustment to an item excluded from gross income under Sec. 951A(c)(2)(A)(i). Revenue Procedure 2021-26 also reflects the repeal of Sec. 954(g) under the TCJA, which eliminated foreign base company oil related income as a category of foreign base company income.

Audit Protection

Special rules for back-year audit protection for CFCs and 10/50 companies contained within Rev. Proc. 2015-13 (see Section 8.02(5)) may prevent back-year audit protection from applying to an accounting method change for a CFC for the Sec. 965 inclusion year (or potentially other years). Specifically, the exception from back-year audit protection applies if foreign taxes deemed paid exceed 150% of the average amount of foreign taxes deemed paid in the prior three taxable years. In many cases, the Sec. 965 inclusion generates foreign taxes deemed paid that are significantly higher than the foreign taxes deemed paid in the prior three years, which may trigger this exception.

Questions had been raised as to whether limitations on claiming benefits from foreign taxes deemed paid should affect the 150% threshold. However, Rev. Proc. 2021-26 stated that “The purpose of the 150 percent threshold is to deny audit protection for an improper method of accounting that affects the calculation of the foreign corporation’s income for United States tax purposes and so may improperly inflate the amount of foreign taxes deemed paid with respect to an income inclusion from that corporation.” Accordingly, Rev. Proc. 2021-26 modifies Section 8.02(5) of Rev. Proc. 2015-13 to clarify that the 150% threshold is computed 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.

Given the mechanics of the formula for the special 150% rule, taxpayers who had been subject to the rule due to the Sec. 965 year being part of the prior three-year average may not exceed the 150% threshold for 2021 or future years. Taxpayers contemplating an accounting method change should consider audit protection in determining the year to file the accounting method change.

The Takeaway

Revenue Procedure 2021-26 offers welcome relief to taxpayers with CFCs by making automatic consent procedures available to them for a change in their depreciation accounting method. It also updates prior guidance (Rev. Proc. 2015-13) for making a Sec. 481(a) change in accounting method adjustment to account for GILTI under Sec. 951A. Contact an Andersen advisor to understand how Rev. Proc. 2021-26 applies to your business.