The term PTEP refers to earnings and profits (E&P) of a foreign corporation attributable to amounts which are, or have been, included in the gross income of a U.S. shareholder under Sec. 951(a) or under Sec. 1248(a).
Sec. 959(a)(1): Distributions of PTEP are excluded from the U.S. shareholder’s gross income, or the gross income of any other U.S. person who acquires the U.S. shareholder’s interest (or a portion thereof) in the foreign corporation (such U.S. person, a successor in interest).
Sec. 959(a)(2): further excludes PTEP from a U.S. shareholder’s gross income if such E&P would be included in the gross income of the U.S. shareholder or successor in interest under Sec. 951(a)(1)(B) as an amount determined under Sec. 956. Distributions of PTEP to a U.S. shareholder or successor in interest generally are not treated as dividends except that such distributions immediately reduce the E&P of the foreign corporation.
Sec. 959(c): ensures that distributions from a foreign corporation are first attributable to PTEP described in Sec. 959(c)(1) (Sec. 959(c)(1) PTEP) and then to PTEP described in Sec. 959(c)(2) (Sec. 959(c)(2) PTEP), and finally to non-previously taxed E&P (Sec. 959(c)(3) E&P).
Sec. 959(f): ensures that, in determining the amount of any inclusion under Sec. 951(a)(1)(B) and 956 with respect to a foreign corporation, PTEP attributable to Sec. 951(a)(1)(A) inclusions remaining after any distributions during the year are taken into account before non-previously taxed E&P described in Sec. 959(c)(3).
Notice 2019-01: provides that Treasury intends to withdraw existing proposed regulations and issue new proposed regulations under Sec.s 959 and 961 that provide rules regarding (1) annual accounts and groups of PTEP, (2) ordering of E&P upon distributions and reclassifications and (3) adjustments due to an income inclusion in excess of current E&P.
Example: Assume that U.S. Corp, a U.S. corporation, owns 100% of the interests in CFC1, a controlled foreign corporation. At the end of Year 2, CFC1 distributes $100 to U.S. Corp, and CFC1 has $150 of E&P that consists entirely of PTEP. CFC1 did not have Code Sec. 956 income inclusions and thus does not have PTEP described in Code Sec. 959(c)(1). For all years, the PTEP of CFC1 in each PTEP group and Code Sec. 959(c)(3) E&P are described in a single Code Sec. 904 basket. The $150 of PTEP consists of the following PTEP types and amounts:
- $70 of Code Sec. 965(a) PTEP;
- $20 of Code Sec. 951A PTEP attributable to GILTI inclusion in Year 2;
- $30 of Code Sec. 951A PTEP attributable to GILTI inclusion in Year 1; and
- $30 of Code Sec. 951(a)(1)(A) PTEP attributable to Subpart F inclusion in Year 1.
Under the framework, the Special Priority Rule applies before the LIFO approach. Accordingly, $70 of the distribution will be sourced from Code Sec. 965(a) PTEP. After the Special Priority Rule, under the LIFO approach, $20 of the distribution will be sourced from the Code Sec. 951A PTEP attributable to GILTI inclusion in Year 2. The remaining $10 of the distribution will be sourced from both (i) the Code Sec. 951A PTEP attributable to the Year 1 GILTI inclusion and (ii) the Subpart F PTEP attributable to the Year 1 inclusion proportionately, i.e., $5 is from the Year 1 Code Sec. 951A PTEP, and another $5 is from the Year 1 Subpart F PTEP.
The new regulations are expected to:
- Provide that an annual account must be maintained for PTEP and that account must be segregated, potentially, into 16 different baskets
- Provide that the dollar basis must be tracked for each annual PTEP account and, to the extent applicable, separately for each PTEP basket within an annual account
- Provide transition rules for annual PTEP accounts maintained before the applicability date of the regulations
- Require a “last in, first out” approach to the sourcing of distributions from annual PTEP accounts for purposes of calculating PTI exchange gain or loss, subject to application of Sec. 965
In addition, the notice:
- Indicates that global intangible low-taxed income (GILTI) inclusions based on U.S. taxable income principles rather than earnings and profits (E&P) in excess of current year PTEP can create deficits in Sec. 959(c)(3) E&P
- Addresses the new ordering rules and coordination among PTEP accounts that are expected to be included in the forthcoming regulations
The guidance is expected to apply to tax years ending after Dec. 14, 2018, for U.S. shareholders and to taxable years ending with or within such tax years of U.S. shareholders for foreign corporations. U.S. shareholders may rely on the ordering rules described in the notice until the proposed regulations are released if the shareholder and each person related to the shareholder applies the rules consistently with respect to PTEP of all foreign corporations in which the shareholder or related shareholder owns stock. This rule is in effect for all taxable years beginning with the shareholder’s or the related shareholder’s taxable year that includes the taxable year-end of any such foreign corporation to which Sec. 965 applies.
Example: USP, a domestic corporation, owns all of the stock of foreign corporations CFC1 and CFC2. USP, CFC1, and CFC2 are calendar year taxpayers. On all measurement dates, CFC1 has accumulated post-1986 deferred foreign earnings of $100, and CFC2 has an E&P deficit of $20. USP in aggregate will have an $80 Sec. 965(a) inclusion amount ($100 from CFC1 less CFC2’s $20 deficit allocated to CFC1 under Sec. 965(b)).
CFC1’s PTEP account will increase by $100 ($80 for the Sec. 965(a) inclusion amount and $20 for the Sec. 965(b) deficit allocated to CFC1). CFC2 will have $0 of PTEP, and its E&P will increase by the $20 of deficit taken into account under Sec. 965(b).
On October 20, 2022, the Treasury and IRS published in the Federal Register a “withdrawal of notice of proposed rulemaking” regarding the exclusion from gross income of previously taxed earnings and profits (“PTEP”) under Sec. 959 and related basis adjustments under Sec. 961.
The above Notice stated that the 2006 Proposed Regulations “were never finalized, never went into effect, and did not indicate that taxpayers could rely on them.” The Withdrawal Notice states that the government is withdrawing the 2006 Proposed Regulations to “help prevent possible abuse or misuse of them–such as inappropriate basis adjustments in certain stock acquisitions to which Sec. 304(a)(1) applies–while the Treasury Department and the IRS continue to develop the new proposed regulations.” The Withdrawal Notice goes on to state that the IRS may, where appropriate, challenge taxpayer positions giving rise to “inappropriate results.”
Taxpayers that relied on the 2006 Proposed Regulations for PTEP and basis sharing are on notice that the IRS may challenge these transactions.
Tax Forms and Schedules for PTEP Computation:
Schedule P of Form 5471 is used to report PTEP of the U.S. shareholder of a controlled foreign currency (“CFC”) in the CFC’s functional currency.
Provide that an annual account must be maintained for PTEP and that account must be
segregated, potentially, into 16 different baskets
Provide that the dollar basis must be tracked for each annual PTEP account and, to the
extent applicable, separately for each PTEP basket within an annual account
Provide transition rules for annual PTEP accounts maintained before the applicability date of
the regulations
Require a “last in, first out” approach to the sourcing of distributions from annual PTEP
accounts for purposes of calculating PTI exchange gain or loss, subject to the application of Sec.
965
In addition, the notice:
Indicates that global intangible low-taxed income (GILTI) inclusions based on U.S. taxable
income principles rather than earnings and profits (E&P) in excess of current year PTEP can
create deficits in Sec. 959(c)(3) E&P
Addresses the new ordering rules and coordination among PTEP accounts that are expected
to be included in the forthcoming regulations
The guidance is expected to apply to tax years ending after Dec. 14, 2018, for U.S. shareholders and
to taxable years ending with or within such tax years of U.S. shareholders for foreign corporations.
U.S. shareholders may rely on the ordering rules described in the notice until the proposed
regulations are released if the shareholder and each person related to the shareholder applies the
rules consistently with respect to PTEP of all foreign corporations in which the shareholder or related
shareholder owns stock. This rule is in effect for all taxable years beginning with the shareholder’s or
the related shareholder’s taxable year that includes the taxable year-end of any such foreign
corporation to which Sec. 965 applies.
Example: USP, a domestic corporation, owns all of the stock of foreign corporations CFC1
and CFC2. USP, CFC1, and CFC2 are calendar-year taxpayers. On all measurement dates,
CFC1 has accumulated post-1986 deferred foreign earnings of $100, and CFC2 has an E&P
deficit of $20. USP in aggregate will have an $80 Sec. 965(a) inclusion amount ($100 from
CFC1 less CFC2’s $20 deficit allocated to CFC1 under Sec. 965(b)).
CFC1’s PTEP account will increase by $100 ($80 for the Sec. 965(a) inclusion amount and $20
for the Sec. 965(b) deficit allocated to CFC1). CFC2 will have $0 of PTEP, and its E&P will
increase by the $20 of deficit taken into account under Sec. 965(b).
On October 20, 2022, the Treasury and IRS published in the Federal Register a “withdrawal of notice
of proposed rulemaking” regarding the exclusion from gross income of previously taxed earnings and
profits (“PTEP”) under Sec. 959 and related basis adjustments under Sec. 961.
The above Notice stated that the 2006 Proposed Regulations “were never finalized, never went into
effect, and did not indicate that taxpayers could rely on them.” The Withdrawal Notice states that
the government is withdrawing the 2006 Proposed Regulations to “help prevent possible abuse or
misuse of them–such as inappropriate basis adjustments in certain stock acquisitions to which Sec.
304(a)(1) applies–while the Treasury Department and the IRS continue to develop the new proposed
regulations.” The Withdrawal Notice goes on to state that the IRS may, where appropriate, challenge
taxpayer positions giving rise to “inappropriate results.”
Taxpayers that relied on the 2006 Proposed Regulations for PTEP and basis sharing are on notice
that the IRS may challenge these transactions.
Tax Forms and Schedules for PTEP Computation:
Schedule P of Form 5471 is used to report PTEP of the U.S. shareholder of a controlled foreign
currency (“CFC”) in the CFC’s functional currency.
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