Among the many international changes wrought by the TCJA was the addition of a separate Code Sec. 904(d) basket for income attributable to one or more branches of a U.S. person. The final foreign tax credit regulations issued in December 2019 (hereafter, the “Final Regulations”) provide new and definitive guidance on the branch basket. Attribution of income to a foreign branch is a new, but not unprecedented problem in U.S. international tax. Previously, many U.S. outbound taxpayers engaged in similar exercises for purposes of the dual consolidated loss (“DCL”) rules of Code Sec. 1503(d), currency translation rules under Code Sec. 987, and Code Sec. 367 branch loss recapture, among other purposes. The attribution of income to the foreign branch category under Code Sec. 904 will follow a different and equally complex approach to Code Sec. 987. In this regard, the Final Regulations largely follow the 2018 proposed regulations in their treatment of disregarded transactions between the branch and its sole owner, or between branches of the same U.S. taxpayer, with limited relief for certain transfers of IP. To limit cross-crediting, the Final Regulations also exclude not only passive income, but also intercompany financing and other low-taxed income from the branch basket.
Prior to the TCJA, branches with significant foreign tax expense were the exception not the rule for most U.S. multinational corporations. However, after the TCJA, more U.S. corporations have checked the box on their foreign subsidiaries for several reasons, including managing the base erosion antiabuse tax (“BEAT”) on outbound payments or facilitating the movement of IP back to the United States. Corporate taxpayers may also find themselves with foreign branches by having “checked the box” on a newly acquired foreign target company following a qualified stock purchase with a Code Sec. 338(g) election. In addition, foreign operations of partnerships, S corporations and other passthrough entities will often be organized as branches to enable U.S. individual owners to claim direct foreign tax credits under Code Sec. 901. These taxpayers will need to wrestle with computations of branch basket income.
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Originally published in the January – February 2020 issue of the International Tax Journal.