The net operating losses (NOLs) allowed to be carried back for up to five years under the CARES Act may provide welcome relief to a corporate taxpayer’s cash flow. Many tax benefits exist, such as carrying back NOLs generated at a 21% tax rate in years 2018 through 2020 to years, when income was taxed at 35%.
However, multinational taxpayers have an additional layer of tax rules to consider, due to their global footprint. Specifically, multinational corporations should model out the interplay between the use of NOLs generated by domestic entities and certain international tax rules. This is to ensure the NOL usage is maximized while not reducing other benefits, such as interest expense deductions, foreign tax credits, global intangible low-taxed income (GILTI) and foreign-derived intangible income (FDII) deductions and transition tax installment payments.
The NOL carryback is mandatory for taxpayers, unless the taxpayer elects to waive carryback in its entirety, or elect to waive carryback to tax years with section 965(a) income inclusion (also known as the “transition tax”). Here are some considerations for multinational organizations to maximize benefits.
Consider the following hypothetical:
A small to mid-sized multinational corporate taxpayer with a calendar year-end had taxable income (and thus taxes were paid) from years 2015 through 2018 and a GILTI inclusion in 2018. The taxpayer generated losses in the U.S. in 2013 and 2014 that were already applied and used previously, and in 2017 had a transition tax liability for which it did not make an installment election to pay over eight years. The taxpayer has NOLs in 2019 and expects to have NOLs in 2020. The taxpayer elects to skip 2017 for the NOL carryback under the Revenue Procedure 2020-24, because the taxpayer does not see a benefit. The NOLs generated in 2019 are enough to absorb the entire amount of taxable income in years 2015 and 2016, and a portion of the taxable income in 2018. However, in 2018, a sizable portion of the taxable income was due to the GILTI inclusion, because the foreign subsidiaries had a great year. They applied section 250 deduction to the GILTI inclusion amount, reducing the effective tax rate on GILTI income to 10.5%, without considering the foreign tax credits.
To carryback the NOLs for refunds to years 2015 and 2016, the taxpayer must also carryback the NOLs to the 2018 year. However, the GILTI income is reduced dollar for dollar by the NOLs first, before the section 250 deduction can be applied to reduce the remaining GILTI income by 50%. Thus, the taxpayer would end up using NOLs that normally reduce 21 cents from one dollar of tax for GILTI income that cost 10.5 cents of tax. The foregone section 250 deduction could have been realized had the NOL been carried forward and applied to a tax year in which overall taxable income exceeds the GILTI income by at least the amount of the NOL. Stated differently, these rules reduce not only the value of current-year domestic losses but also carried forward NOLs if they reduce lower-rate GILTI given the 21-cent versus 10.5-cent tax differential.
Also consider whether the GILTI inclusion would be offset by foreign tax credits (FTC), and given that taxes in the GILTI FTC basket cannot be carried forward or back, using NOLs during such a tax period marginalizes any value to those NOLs.
As a planning consideration, taxpayers should review company strategies and opportunities to determine if revenue recognition may be accelerated through operations, restructuring or divestitures.
Additionally, NOLs applied to years 2015 and 2016 may change the tax attributes, such as the foreign tax credit carryover or charitable contribution carryover. The change in tax attributes may reduce the taxpayer’s transition tax liability for 2017, in which case amending the 2017 return may be prudent.
It is also worth noting the tax rate differential between pre- Tax Cuts and Jobs Act of 2017 (TCJA) and post-TCJA tax years that taxpayers may be able to take advantage of. Generally, foreign tax credits (FTCs) carried to pre-TCJA years offset income taxed at 35%, while FTCs utilized in a post-TCJA year will offset income taxed at a maximum 21% rate.
Lastly, the CARES Act includes a technical correction of the TCJA, enacted in December 2017, to allow fiscal-year taxpayers to carry back two years for a refund the NOLs generated in the tax year beginning in 2017 and ending in 2018. The deadline to claim a refund is extended, and will be treated as timely filed if the refund is claimed by the 120th day from March 27, 2020.
BPM’s tax specialists are here to help. To learn more, contact Robert Houston at [email protected], Dmitri Alexeev at [email protected], Javier Salinas at [email protected] or Stacey Kang at [email protected].