IRC Section 965 (Treatment of Deferred Foreign Income Upon Transition to Participation Exemption System of Taxation) was part of the TCJA enacted on December 22, 2017. The sections requires a United States shareholder to pay a transition tax on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the United States. IRC 965 applies with respect to the last taxable year of the relevant specified foreign corporation that begins before January 1, 2018, and the amount included in income under IRC 965 is includible in the United States shareholder’s year in which or with which such a specified foreign corporation’s year ends. The majority of IRC 965 liability will arise on taxpayer returns for 2017 and 2018 tax years.
Taxpayers entered 2020 with a possibility that they could be selected for a Section 965 transition tax examination. The possible examinations stem from the IRS Compliance Campaign directed at Section 965.
On July 2, 2018, the IRS introduced a Compliance Campaign directed at Section 965 (Transition Tax) of the Internal Revenue Code (IRC). In its original launch, the Section 965 Campaign stated that certain U.S. shareholders are required to pay a “transition tax” on the untaxed foreign earnings of certain specified foreign corporations as if those earnings had been repatriated to the U.S. Taxpayers could elect to pay the transition tax in installments over an eight-year period. For some Taxpayers, some or all of the tax was due on their 2017 income tax return. A Taxpayer is encouraged to keep adequate records to support the calculation of the transition tax pursuant to section 965.
On November 4, 2019, the IRS updated its commentary on the Compliance Campaign directed at Section 965. The updated commentary states that:
• The goal of this campaign is to promote compliance with IRC 965.
• The treatment stream will include conducting examinations as well as providing technical assistance to teams on IRC 965, with a focus on identifying and addressing taxpayer populations with potential material compliance risk.
• The campaign will start with 2017 returns and generally require looking at both the 2017 and 2018 tax returns.
• It is anticipated that returns selected as part of the 965 campaign will also be risked and, if appropriate, examined for other material issues, especially issues related to Tax Cut and Jobs Act (TCJA) planning.
• The vast majority of IRC 965 liability will arise on Taxpayer returns for 2017 and 2018 tax years.
On January 17, 2020, IRS announced that it is aware of limited circumstances in which it may be appropriate to provide relief from double taxation resulting from application of the repatriation tax under section 965
IRS stated that there could be unique circumstances (example given in IR-2020-16 is where a corporation paid an unusual dividend for business reasons and not because of the enactment of TCJA). In this example, IRS might see “appropriateness” in providing relief from double taxation because when the same earnings and profits of foreign corporations are taxed both as dividends and under section 965; double taxation could result.
IR-2020-16 notes that IRS is open to considering relief from such double taxation where there is no significant reduction in the resulting tax by application of foreign tax credits (meaning, the taxpayer would be required to pay more tax than it would have if the dividend had not been paid).
Furthermore, “taxpayers who have fact patterns that may fit these limited circumstances may raise them with the IRS by contacting the Office of Associate Chief Counsel (International) at 202-317-3800”.
Taxpayers ought to be aware of their income tax obligations under Section 965 and of the possibility of double taxation
U.S. shareholders of a specified foreign corporation must determine:
- if they held an interest in one or more specified foreign corporations
- the amount, if any, of previously untaxed earnings and profits to be included in the tax return
- a possibility of double taxation if profits of foreign corporations are taxed both as dividends and under section 965
Failure to properly comply with the reporting and payment obligations of Section 965 could result in the imposition of interest and/or the assertion of tax penalties and or a possible examination.
Consult your Specialized Tax Advisor.