Treasury and IRS Unveil Proposed Dual Consolidated Loss Regulations Impacting Global Tax Compliance

On August 06, 2024, the Department of the Treasury and the IRS unveiled proposed regulations (REG-105128-23) addressing the dual consolidated loss (DCL) rules and their interplay with the OCED’s Pillar Two global tax regime. These proposed regulations offer significant updates and clarifications on calculating DCLs, including a new rule for disregarded payment losses. They aim to address uncertainties, refine computations, and prevent inappropriate tax planning under current income tax law.

Before discussing the proposed Regulations’ main points, let’s understand the concept of a Dual Consolidated Loss (DCL) and the Domestic Use Exception (DUE).

A DCL occurs when a corporation experiences a tax loss in both the United States and another country. The DCL rules are in place to prevent a corporation from benefiting from the same loss in both countries, known as “double dipping.”

The DCL rules primarily apply to dual resident corporations (DRCs) and groups filing U.S. consolidated tax returns. A DRC is a domestic corporation subject to foreign income tax on its worldwide income or a foreign insurance company that elects to be taxed as a domestic corporation and is a member of an affiliated group.

For DCL purposes, a separate unit can be a foreign branch or hybrid entity owned by a domestic corporation. These taxpayers must follow DCL rules when they seek to claim a loss that could reduce taxable income in both countries.

Having a DCL means a company cannot benefit twice from the same loss. It involves initial and annual certification requirements, increased tax liability, and reporting obligations. S corporations are not subject to the DCL rules, and domestic corporations are considered to indirectly own a separate unit owned by a partnership or grantor trust.

The Domestic Use Election (DUE) is an option for a company to use its DCL to reduce U.S. taxable income. By choosing DUE, the company agrees not to use the loss to reduce taxes in any other country. Non-compliance means adding the loss back to U.S. income, resulting in higher taxes owed.

The critical summary points for the proposed DCL regulations are as follows:

• The regulations clarify that a domestic corporation’s DCL cannot reduce the taxable income of a domestic affiliate unless specific exceptions apply.
• The proposed rules emphasize that items arising from intercompany transactions should be treated consistently to prevent tax avoidance. The matching rule under Treas. Reg. § 1.1502-13(c) is highlighted to ensure that the attributes of intercompany items are redetermined to reflect transactions as if they occurred between divisions of a single corporation.
• The regulations extend the definition of foreign income tax to include taxes intended to ensure a minimum level of income taxation, such as the GloBE Model Rules’ Qualified Domestic Minimum Top-up Tax (QDMTT) and Income Inclusion Rule (IIR). See “OECD’s Pillar 2” for more information.
• New rules are introduced to address losses arising from disregarded payments deductible for foreign tax purposes but disregarded for U.S. income tax purposes. These rules require domestic corporations to include any disregarded payment loss in gross income if a triggering event occurs.
• Taxpayers must certify that no foreign use of the disregarded payment loss (“DPL”) has occurred during a specified certification period. Failure to comply with these requirements triggers the inclusion of the disregarded payment loss in gross income.
• The regulations confirm that the DCL rules apply to taxes based on the OECD’s GloBE Model Rules, addressing concerns about double-deduction outcomes.
• A foreign use exception is provided for jurisdictions that qualify for the Transitional CbCR Safe Harbour, ensuring that no foreign use occurs solely because a DCL is taken into account under the GloBE Model Rules.
• The proposed regulations include an anti-avoidance rule to address transactions or structures designed to circumvent the DCL rules. This rule allows for adjustments to disregard or modify transactions that aim to reduce or eliminate a dual consolidated loss while putting an item of deduction or loss to a foreign use.
• Provides clarification of the 1502 consolidated return regs as applicable to DCLs, stating in pertinent part that if the DCL rules impact an item of income or loss at the foreign branch level, such impact does not apply to the related counterparty (e.g., interest expense disallowed by a foreign branch under the DCL rules does not impact interest income inclusion by a related U.S. corporate entity filing a consolidated return).
• Provides clarification under Treas. Reg. 1.1503(d)-5 that items of income or loss that do not (and will not) appear on the foreign branch’s books and records may not be used in calculating a DCL (contrary to the position taken by some taxpayers).

The proposed DCL regulations are expected to take effect for tax years ending on or after August 6, 2024. However, the intercompany transaction regulations modifying Section 1502 would apply to tax years for which the original U.S. income tax return is due without extensions after the final DCL regulations are published in the Federal Register. If the final regulations are published by April 15, 2025, they will apply to the calendar year 2024. Deemed consent under the DPL rules would apply to tax years ending on or after August 6, 2025. Deemed consent would be given under Treas. Reg. 301.7701-3(c) by making an entity classification (“CTB”) election on a foreign entity to treat it as disregarded (“FDE”).

The proposed DCL regulations mark a significant shift in global tax compliance. By aligning DCL calculations with the OECD’s Pillar Two global tax regime and introducing stringent rules to prevent inappropriate tax planning, these regulations aim to close existing loopholes and ensure a fairer taxation system. Key clarifications on treating disregarded payment losses, intercompany transactions, and foreign income taxes enhance the regulatory framework. As businesses navigate these changes, compliance with the new certification and reporting requirements will be crucial to avoid increased tax liabilities. Once finalized, these regulations will necessitate careful consideration and potential retroactive application to ensure consistency and compliance in tax years moving forward.