Insights and Resources
IRS issues guidance for changing CFC depreciation methods
TAX ALERT |
Authored by RSM US LLP
The IRS recently published Rev. Proc. 2021-26, providing an automatic method change for certain foreign corporations – controlled foreign corporations (CFCs) and 10/50 corporations - to change their methods of accounting to the alternative depreciation system (ADS) under section 168(g). Importantly this method change covers both impermissible to permissible and permissible to permissible depreciation changes. The revenue procedure also prescribes additional terms and conditions related to the cumulative catch-up (section 481(a)) adjustment and its impact on other global intangible low-taxed income (GILTI) calculations. Finally, the IRS clarified existing rules that limit audit protection with respect to certain foreign corporations.
Automatic method change
For a limited period, a CFC can file an automatic change in method of accounting for depreciation of property used predominately outside of the United States. This change is applicable to items of property owned by the CFC at the beginning of the year of change to the permissible depreciation method, convention and recovery period. This change can be applied regardless of whether the current depreciation method is permissible or impermissible. Before Rev. Proc. 2021-26, a permissible to permissible change to use ADS was a non-automatic change.
Special rules are in place for assets placed into service in the preceding year to the method change. The method of accounting for these assets, or ‘one-year property’, can be changed if the designated shareholder files a Form 3115 and the section 481(a) adjustment attributable to the one-year property is included on the Form 3115. Alternatively, if the prior method was impermissible for one-year property all U.S. shareholders of the CFC may file an amended federal income tax return for the placed-in-service year to move to ADS, provided such amended return is filed prior to the date the shareholder files the federal income tax return for the succeeding taxable year.
Like other depreciation changes, the method of accounting is determined at each item of property, and a taxpayer may file concurrent automatic changes for multiple items of property on a single Form 3115. Unlike other depreciation changes though, the section 481(a) adjustment may not be netted, and a separate section 481(a) adjustment is required for each item of property being changed.
Companies may have pending non-automatic changes for permissible to permissible methods of depreciation. For example, a company may have desired conformity in depreciation methods for qualified business asset investment (QBAI), earnings and profits (E&P) and CFC income and filed a non-automatic change to get conformity. For a company that has a pending non-automatic change, there is the ability to convert to an automatic change if two conditions are met: (1) the CFC is otherwise eligible to use the automatic change procedures and (2) the Form 3115 was filed before May 11, 2021 and is pending with the national office on May 11, 2021. The designated shareholder must notify the national office contact person for the Form 3115 of their intent to convert their non-automatic change to the new automatic change. If this is done timely and properly, the designated shareholder will receive a letter acknowledging the request with a return of the fee submitted with the Form 3115.
The designated shareholder must then resubmit a Form 3115 that conforms to the automatic change procedures, with a copy of the national office letter sent acknowledging the request to convert, by the earlier of (1) the 30th calendar day after the date of the national office’s letter acknowledging the request to convert or (2) the date the designated shareholder is required to file the original Form 3115.
Terms and Conditions
If the above change is being made on behalf of a CFC or a noncontrolled 10% owned foreign corporation (10/50 corporation) the following additional terms and conditions apply:
- If the functional currency of the foreign corporation is not the U.S. dollar, the section 481(a) adjustment must be stated in the functional currency of the foreign corporation and not in U.S. dollars.
- Section 954(b)(3)(A) de minimis or section 954(b)(3)(B) full inclusion rules apply after the characterization of the positive or negative section 481(a) adjustments.
For each taxable year of the section 481(a) adjustment period beginning with the year of change, the appropriate amount of the section 481(a) adjustment must generally be taken into account in determining the CFC’s tested income or tested loss (either as gross tested income if the section 481(a) adjustment is positive, or as a deduction properly allocable to the CFC’s gross tested income if the section 481(a) adjustment is negative). In addition, the section 481(a) adjustment must be taken into account in determining the foreign corporation’s gross and taxable income under section 1.952-2 as well as its E&P under sections 964 and 986(b) and the regulations thereunder.
In the case of a change in method of accounting made on behalf of a CFC or 10/50 corporation, the IRS may change the method of accounting for the same item that is the subject of a Form 3115 filed under this revenue procedure for taxable years prior to the requested year of change in which any of the CFC’s or 10/50 corporation’s domestic corporate shareholders computed an amount of foreign taxes deemed paid under sections 902 and 960 with respect to the CFC or 10/50 corporation that exceeds 150% of the average amount of foreign taxes deemed paid under sections 902 and 960 by the domestic corporate shareholder with respect to the CFC or 10/50 corporation in the shareholder’s three prior taxable years.
Generally, taxpayers that voluntarily change to a permissible method of accounting receive audit protection preventing the issue from being raised by examination for prior years. However, Rev. Proc. 2021-26 clarifies the pre-existing CFC or 10/50 corporation audit protection rules and states that the deemed paid determination is made without regard to the amount of the domestic corporate shareholder’s allowable foreign tax credit in the taxable year the foreign taxes are deemed paid or in any other taxable year.
A covered taxpayer should discuss with their tax advisor the impact of these changes and whether it may be beneficial to file a permissible to permissible accounting method change to conform income, E&P and QBAI depreciation methods.
Call us at +1 213.873.1700, email us at firstname.lastname@example.org or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Christian Wood, Ryan Corcoran , Lori Anne Johnston, Cameron Thomas and originally appeared on 2021-05-12.
2020 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Vasquez & Company LLP is a proud member of the RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Vasquez & Company LLP can assist you, please call +1 213.873.1700.