Recognizing that aspects of the international tax regime can be unnecessarily complicated, the Internal Revenue Service (“IRS”) issued Revenue Procedure 2021-26 (the “Rev. Proc.”) providing relief for taxpayers that own 10 percent or more of a Controlled Foreign Corporation (“CFC”).
The pronouncement allows certain U.S. taxpayers to reduce the income tax that they have to report on their tax return from foreign companies (including tax returns already filed). In particular, the tax known as GILTI (“Global Intangible Low-taxed Income”) can be reduced by changing an accounting method used to calculate the value of the property of the foreign corporation.
This Rev. Proc. allows for automatic consent for changing to the Alternative Depreciation System (“ADS”) from another method of depreciation. The relief comes with audit protection and is available for taxable years ending before January 1, 2024.
ADS is required when calculating Earnings and Profits and the Qualified Business Asset Investment (“QBAI”) of a CFC. QBAI is the adjusted basis of depreciable tangible property.
The “designated shareholder” is required to file Form 3115 (“Application for Change in Accounting Method”) on behalf of the CFC. The designated shareholder is usually the controlling shareholder.
The change from either an impermissible or permissible method of depreciation to ADS may result in a negative or positive adjustment to the income tax in the year of the adjustment in order to avoid duplication or omission of income tax items.
Interestingly, use of ADS may decrease the GILTI inclusion because ADS usually results in lower depreciation deductions from its longer recovery periods when compared, for instance, to straight line depreciation. In some instances, this may create a refund opportunity.
The Rev. Proc. provides relief for all taxpayers but is of particular importance for many small and mid-sized businesses, as many of these companies do not usually make adjustments to their book earnings to calculate tax items and thus do not usually calculate GILTI using ADS.
This opportunity should be explored by taxpayers subject to GILTI, especially those who own CFCs with significant investments in depreciable property. Your Friedman LLP advisor can help with any questions on this new opportunity.