On August 1, 2018, the United States Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) released proposed regulations providing clarification to Section 965, the “transition tax”, which was enacted as part of the Tax Cuts and Jobs Act of 2017, as the United States tax system moves to a modified territorial tax regime in 2018. The 249 pages of proposed regulations follow and incorporate three previously issued IRS Notices that addressed taxpayers’ frequently asked questions, and address comments received from taxpayers in the interim. 
Section 965 uses the deemed repatriation mechanics of Subpart F (Section 951) to impose a one-time tax on post-1986 undistributed foreign Earnings & Profits (“E&P”) of certain foreign corporations (“deferred foreign income corporations”), as of a measurement date in late 2017, which have not been previously taxed in the United States. The E&P is taxed at preferential rates. For C Corporation U.S. Shareholders, the rate of 15.5% applies to E&P represented by cash and cash equivalents, and the rate of 8% applies to the E&P represented by other trade or business assets. The corresponding rates for individual U.S. Shareholders are 17.534% and 9.062%. Individuals may elect, under Section 962, to have the corporate rates apply instead, although the Section 962 election might not always be beneficial, depending on the facts in each case.
The proposed regulations further define the items of Section 965 E&P inclusion, basis impacts, foreign tax credit availability, available elections and payments, affiliated groups and anti-tax avoidance. The proposed regulations generally apply to the last taxable year of a deferred foreign income corporation that begins before January 1, 2018.
Highlights noted include:
- The Treasury and the IRS have determined that an increase to the basis of stock of deferred foreign income corporations is appropriate only if there is a corollary reduction to the basis of the stock of E&P deficit foreign corporations. Accordingly, one proposed new regulation allows taxpayers to elect to make the relevant basis adjustments, in which case such adjustments must be consistently made with respect to all stock of specified foreign corporations owned by a U.S. Shareholder and related persons.
• Where a controlled foreign corporation (“CFC”) incurs a loss after the applicable measurement date, creating a Section 965 inclusion amount in excess of its year-end untaxed E&P, the Section 965 inclusion is treated as previously taxed income and a deficit in E&P is created or increased.
• If a CFC incurs Subpart F income during the year of inclusion, only the Subpart F income earned as of the measurement date is taken into account for computing deferred foreign earnings.
• Changes in accounting methods, entity elections, and certain transactions occurring between E&P measurement dates that can reduce the amount of Section 965 inclusions can be disregarded by the IRS if the Secretary of the Treasury determines that a principal purpose of any transaction was to reduce the amount of a Section 965 inclusion of the U.S. shareholder.
- No deduction or credit is allowed for the applicable percentage of any withholding taxes imposed on a U.S. Shareholder by the jurisdiction of residence of the distributing foreign corporation with respect to a distribution of Section 965 previously taxed earnings and profits.
• Where installment payments over an eight-year period are elected, certain “acceleration events” may occur and the unpaid portion of all remaining installments of the taxpayer’s Section 965(h) net tax liability generally will be accelerated and due on the date of the event.
Proposed Treasury Regulation Section 1.986(c) provides that when Section 965(a) previously taxed E&P are distributed to a U.S. shareholder, foreign currency gain or loss with respect to such distributions is determined based on movements in the exchange rate between December 31, 2017 and the date on which such E&P are actually distributed.
These highlights are only a first impression of the intricate Section 965 proposed regulations. FGMK will continue to monitor progress by the IRS or Treasury and will advise as new information becomes available.
If you have any additional inquiries about Section 965, or any other cross-border tax matters, please contact FGMK.
Fuad Saba Scott Simpson
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
 P.L. 115-97 (2017).
 See Notice 2018-07, 2018-4 I.R.B. 317; Notice 2018-13, 2018-6 I.R.B. 341; and Notice 2018-26, 2018-16 I.R.B. 480; see also Rev. Proc. 2018-17, 2018-9 I.R.B. 384.
 Where capitalized U.S. Shareholder refers to the term as defined by Section 951(b) as modified by the Tax Cuts and Jobs Act of 2017.