IRS releases Notice 2023-80: Top points for taxpayers

On December 11, 2023, the Internal Revenue Service (IRS) issued Notice 2023-80 (the Notice) announcing that the IRS and the Treasury Department intend to issue proposed regulations providing guidance on the interaction of the Model Global Anti-Base Erosion (GloBe) Rules for Pillar II with the US foreign tax credit (FTC) and dual consolidated loss (DCL) rules.

Notice 2023-80 also extends the temporary FTC relief provided by Notice 2023-55. For additional discussion of the temporary relief provided by Notice 2023-55, please see our prior alert.

Overview of Model GloBe Rules for Pillar II

As part of its Inclusive Framework on Base Erosion Profit Shifting (BEPS), the Organisation for Economic Co-operation and Development (OECD) set out a two-pillar solution for tax multinational enterprises (MNEs): Pillar I, focusing on profit allocation and nexus, and Pillar II, focusing on global minimum taxation.

Pillar II aims to ensure that MNEs with over EUR750 million of annual revenue are subject to a minimum tax of at least 15 percent in each jurisdiction in which they operate.

The Model GloBe Rules for Pillar II are the basis of the Pillar II rules and provide guidance on legislation that implementing jurisdictions should aim to enact into their respective local tax law as part of Pillar II implementation.

The Model GloBe Rules for Pillar II operate so that taxes are imposed in the following order of priority after a local jurisdiction’s ordinary income tax: (1) the Qualified Domestic Minimum Top-up Tax (QDMTT), (2) CFC tax regimes and certain other cross-border taxes, (3) the Income Inclusion Rule (IIR), and (4) the Undertaxed Profits Rule (UTPR).

Below is a brief overview of each of these taxing mechanisms.

• A QDMTT is a minimum tax included in the domestic law of a jurisdiction that allows the source jurisdiction to retain the primary right to tax profits to ensure a 15-percent minimum effective tax rate (ETR). The QDMTT calculates the excess (and undertaxed) profits of constituent entities (CE) located in a jurisdiction and increases the domestic tax liability to the 15-percent minimum ETR on the domestic excess profits. To be a QDMTT, the regime must exclude tax paid or accrued by a domestic CE with respect to the income of foreign CEs under its own CFC regime.
  
  
• CFC taxes are not taken into account for purposes of determining the applicability and amount of a QDMTT in achieving the 15-percent minimum ETR. As relevant for US federal income tax purposes, taxes imposed under a blended CFC tax regime (ie, GILTI and Subpart F) are allocated to low-taxed jurisdictions based on each CFC’s relative income and taxes paid for purposes of determining the applicability and computation of an IIR and UTPR to a CE’s profits.
  
  
• The IIR is similar in operation to the US controlled foreign corporation rules. The IIR is applied where the effective tax rate for a jurisdiction is below the 15-percent minimum ETR after taking into account the QDMTT and CFC tax regimes. Where applicable (ie, where the jurisdiction has a qualifying IIR), the ultimate parent entity (UPE) pays a top-up tax on its proportionate share of the income of any low-taxed CEs in which the UPE has a direct or indirect ownership interest, bringing the overall ETR to 15 percent.
  
  
• Finally, the UTPR acts as a backstop to these provisions. If the QDMTT, CFC Tax Regime, and IIR are unable to achieve the 15-percent minimum ETR on profits in a jurisdiction, the UTPR allows jurisdictions other than the jurisdiction of the UPE to impose a tax on the income up to the 15-percent minimum ETR.

Jurisdictions have enacted legislation implementing the IIR and QDMTT, both generally effective for fiscal years beginning on or after December 31, 2023, and the UTPR effective for fiscal years beginning on or after December 31, 2024. As jurisdictions began enacting legislation implementing these rules, many questions have arisen as to how the US domestic rules will interact with, and take into account, such newly enacted legislation in other jurisdictions.

Notice 2023-80 provides initial and much-needed guidance on the how the Model GloBe Rules for Pillar II interact with the FTC and DCL provisions of the Code. These rules relating to the FTC may generally be relied on by taxpayers for taxable years that end after December 11, 2023, and on or before the date proposed regulations are published.

Creditability of final top-up taxes

For purposes of assessing the creditability of top-up taxes imposed under the Model GloBe Rules for Pillar II, the IRS created the concept of a “final top-up tax.” As a general matter, no FTC or deduction is allowed under section 901 or section 59(l) for a final top-up tax if any US federal income tax liability of the taxpayer would be taken into account in computing the final top-up tax.

It appears that the final top-up tax concept was created to avoid the circularity taxpayers anticipated in calculating their FTCs under both US federal income tax law and the Model GloBe Rules for Pillar II. However, as a result of the introduction of this rule, taxes imposed as IIRs (and likely UTPRs) will largely not be creditable for US federal income tax purposes.

A final top-up tax is defined as a tax that takes into account (a) the amount of tax imposed on the direct or indirect owners of the entity subject to the tested tax by a country (including the United States) with respect to the income subject to the tested tax, or, (ii) in the case of an entity subject to the tested tax on income attributable to its branch in the foreign country imposing the tested tax, the amount of tax imposed on the entity by its country of residence with respect to such income.

To the extent that the final top-up tax is paid by a partnership or CFC, such final top-up tax is treated as creditable at the partnership or CFC level, with the credit disallowance applying at the partner or US shareholder level.

Notably, a final top-up tax is not taken into account in determining whether the high-tax exceptions to foreign base company income or tested income apply. In computing the effective rate of foreign tax for these exceptions, the final top-up tax is both excluded from the amount of foreign taxes imposed and included in the amount of income. Accordingly, final top-up taxes will make it more difficult for US taxpayers to elect the high-tax exceptions to subpart F and GILTI for CFCs that otherwise incur a high rate of tax due to Pillar II.

With respect to final top-up taxes, the section 78 gross-up rule will require US taxpayers to increase the amount of the section 78 gross-up by the amount of the final top-up tax deemed paid, regardless of whether a foreign tax credit is allowed. Accordingly, the Notice prevents claiming the IIR as a credit as well as disallowing a deduction to reduce future dividend income from a CFC.

Separate levies and QDMTT allocation keys

Guidance is provided for the application of the separate levy requirement under Treas. Reg. § 1.901-2(d). Treasury and the IRS intend to issue guidance clarifying that each of the IIR, UTPR, and QDMTT is a separate levy within the meaning of Treas. Reg. § 1.901-2(d), even if a local country imposes such taxes by adjusting the base of any other levy (eg, increasing its ordinary income tax rate to achieve the 15-percent minimum tax in its jurisdiction).

Rules are provided for determining which taxpayer is considered to have paid a QDMTT when such QDMTT is computed by reference to the income of two or more persons (eg, two CFCs whose income and taxes are combined for purposes of determining any tax liability under a QDMTT). The Notice provides for a QDMTT Allocation Key, which is generally the product of (i) the excess (if any) of the minimum ETR of the foreign jurisdiction over the taxes paid by the person that are taken into account to compute the QDMTT, and (ii) the person’s income or loss that is taken into account in computing the QDMTT. The taxes paid under the QDMTT are allocated to each person by applying the QDMTT Allocation Key to each person.

Finally, Treasury and the IRS intend to amend the non-duplication requirement of Treas. Reg.  § 1.903-1(c)(1)(ii). The proposed amendment would clarify that the IIR, UTPR, and QDMTT do not violate the non-duplication requirement.

DCL guidance

The DCL provisions provide rules to prevent “double dipping” of losses, which can occur when the same economic loss offsets or reduces both income subject to US tax and income subject to a foreign jurisdiction’s tax. A DCL is defined as a net operating loss (NOL) of a dual resident corporation (DRC) and a NOL of a domestic corporation that is attributable to a separate unit (ie, certain foreign branches and interests in hybrid entities of the domestic corporation). As relevant here, the DCL rules provide for a “domestic use election” (DUE), which allows a taxpayer to utilize a DCL against US income so long as the taxpayer certifies that there will be no foreign use of the DCL.

The Notice also provides guidance for the treatment of DCLs under the Model GloBe Rules for Pillar II. The Model GloBe Rules for Pillar II use a jurisdictional blending approach under which all income and loss of entities in the same jurisdiction are generally aggregated (ie, country-by-country aggregation). In the view of the IRS, this aggregation can be viewed as giving rise to the same double dipping concerns that the DCL rules were promulgated to address. For example, if a loss that gives rise to a DCL is aggregated with other items of income of CEs located in the same jurisdiction for purposes of determining GLoBe income, this raises a concern as to whether, under US federal income tax principles, the loss would be available to reduce both US tax (if a DUE were permitted) and the Jurisdictional Top-Up Tax.

Treasury and the IRS are studying the extent to which DCL rules should apply with respect to the Model GloBe Rules for Pillar II, including the extent to which such aggregation results in a foreign use of the DCL, which could impact US taxpayers’ ability to make a DUE.

In advance of promulgating administrative guidance in the form of regulations, the Notice provides interim guidance for “legacy DCLs” which were incurred (i) in taxable years ending on or before December 31, 2023, or, (ii) provided the taxpayer’s taxable year begins and ends on the same dates as the fiscal year of the MNE Group that could take into account as an expense any portion of a deduction or loss comprising such a DCL, taxable years beginning before January 1, 2024 and ending after December 31, 2023.

Under this rule, a legacy DCL will not be considered to have a foreign use solely because a portion or all of the deductions or losses that comprise the legacy DCL are taken into account in determining the net GloBe income for a particular jurisdiction (eg, the legacy DCL created a local deferred tax asset that is then used to determine covered taxes in a future year). However, the rule will not apply to any DCL that was incurred or increased with a view to reducing the Jurisdictional Top-Up Tax or qualifying for this proposed rule. Taxpayers may rely on this rule until proposed regulations are published.

The Notice solicits comments on this topic, and such comments should be submitted by February 9, 2024.

Extension and modification of temporary FTC relief under Notice 2023-55

As indicated in our prior alert, Notice 2023-55 provided temporary relief from the new FTC rules that were released on January 4, 2022 and allowed taxpayers to rely on the pre-existing FTC rules, provided that taxpayers did so consistently.

Notice 2023-80 extends the relief period until further guidance described in the Notice is issued, with the applicable period now ending before the date that a notice or other guidance withdrawing or modifying the temporary relief is issued. This provides relief to calendar year taxpayers, but importantly gives relief to fiscal year taxpayers that were not covered by Notice 2023-55 with respect to their current fiscal taxable year (ie, beginning in 2023).

Additionally, Treasury and the IRS had received questions regarding whether the relief provided in Notice 2023-55 applied to partnerships and whether the partnership or its partners would apply the temporary relief. Notice 2023-80 clarifies that, with respect to foreign taxes paid or otherwise required to be reported by a partnership, which could include foreign taxes paid by a controlled foreign corporation, the partnership itself is eligible for temporary relief.

However, if a partnership did not apply the temporary relief before December 11, 2023 for a partnership’s relief year ending on or before December 31, 2022, a partner may apply the temporary relief to its share of the partnership’s foreign taxes for a partnership 2022 tax year. Analogous to other taxpayers, partnerships and partners are subject to the consistent application requirement contained in Notice 2023-55.

Going forward

Notice 2023-80 provides important clarifications and temporary administrative guidance as to the interaction between the Model GloBe Rules for Pillar II and US FTC and DCL rules. As a result of this temporary guidance on Pillar II taxes and their US treatment, we anticipate that taxpayers will need to conduct extensive modeling to determine the impact of the Notice on their overall FTC position.

The practical outcome of this guidance is that the IIR (and likely the UTPR) will largely not be a creditable tax for US federal income tax purposes. This means that foreign earned income of in-scope US corporate groups will be subject to incremental (albeit not double) taxation, arguably at odds with the overriding purpose of the FTC rules – namely to relieve double taxation. However, Notice 2023-80 provides welcome relief to taxpayers by extending the temporary relief period established by Notice 2023-55 until further guidance withdrawing or modifying the temporary relief is issued.

For more information, please contact the authors.

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