On February 13, 2018, the Treasury Department and the Internal Revenue Service issued Rev. Proc. 2018-17, which provides modifications to the procedures for changing the accounting period of foreign corporations owned by U.S. shareholders that are subject to the transition tax under the Tax Cuts and Jobs Act. Rev. Proc. 2018-17 basically disallows the accounting period change if such change could result in the avoidance, reduction, or delay of the transition tax.
General rule of accounting period change
Section 442 and §1.442-1(a) provide the general rules for the taxpayers seeking to change its annual accounting period and use a new taxable year, and the procedures to obtain the approval from the Commissioner for the change. In general, under §1.442-1(b)(2), a change in annual accounting period will be approved when a taxpayer agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the change. Section 1.442-1(b)(3) provides that the Commissioner will prescribe the administrative procedures for a taxpayer to be allowed to adopt, change, or retain an annual accounting period. Rev. Proc. 2002-39 provides the general procedures under Section 442 and §1.442-1(b) for obtaining the approval of the Commissioner to adopt, change, or retain an annual accounting period for federal income tax purposes. Rev. Proc. 2006-45, as a successor to Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, provides the exclusive procedures for certain corporations to obtain automatic approval of the Commissioner to change their annual accounting periods.
Tax Cuts and Jobs Act and IRC 965
Section 965(a) provides that for the last taxable year of a deferred foreign income corporation (DFIC) that begins before January 1, 2018, the subpart F income of the corporation (as otherwise determined for such taxable year under Section 952) shall be increased by the greater of the accumulated post-1986 deferred foreign income of such corporation determined as of November 2, 2017, or December 31, 2017.
A Section 965 specified foreign corporation with a taxable year ending on December 31, 2017 could avoid the purposes of Section 965 by changing its taxable year. For example, if a DFIC with the calendar tax year elects to change to November year end effective for its taxable year beginning January 1, 2017, the election could defer by as much as 11 months a U.S. shareholder’s inclusion with respect to the DFIC under Section 965.
The Rev. Proc. specifically provides that Rev. Proc. 2006-45 and Rev. Proc. 2002-39 would not apply if it relates to changing the annual accounting period of specified foreign corporations (as defined in Section 965(e)) and if each of the following conditions is satisfied:
- The specified foreign corporation’s taxable year (determined without regard to the requested change) ends on December 31;
- If the requested change were permitted, the first effective year of the corporation would begin on January 1, 2017, and would end on a date before December 31, 2017; and
- The specified foreign corporation has one or more U.S. shareholders that must include an amount in gross with respect to the specified foreign corporation or any other specified foreign corporation (with such amount determined without regard to the requested change).
The Rev. Proc. applies with respect to any request to change an annual accounting period that ends on December 31, 2017, regardless of when such request is filed.