Dual Consolidated Loss Proposal May Put Extra Burden on Taxpayers

• Crowe experts say new proposal isn’t very taxpayer-friendly
• Rules do offer more certainty on intercompany transactions

The Department of the Treasury and the IRS’ proposed regulations on dual consolidated losses—which prevent domestic corporations from using net operating losses in both the US and a foreign jurisdiction—are a mixed bag for taxpayers.

Overall, the proposed rules are likely to dramatically reduce taxpayers’ ability to opt for a domestic use election in jurisdictions that have adopted minimum taxes under the OECD Pillar Two Global Anti-Base Erosion Rules. The proposed regulations layer a new loss recapture mechanism in addition to the DCL rules.

However, the most onerous aspect for taxpayers might be the burden of learning and complying with each country’s tax law, juggling multiple tax systems in a single jurisdiction, tracking losses, identifying triggering events, and computing recaptures—not the economic impact on US taxes. This exercise is likely to require significant human and digital resources that will cost taxpayers more than the additional tax generated.

While not generally taxpayer-friendly, the proposed regulations include some provisions most taxpayers will welcome. The primary advantage is greater certainty on the treatment of intercompany transactions. Though the operative treatment isn’t necessarily favorable or unfavorable, taxpayers will spend less time and energy on DCL calculation.

The proposed regulations also expand the relief contained in Notice 2023-80, providing that qualified domestic minimum top-up taxes and taxes computed under the income inclusion rule—two tax systems under the global minimum tax rules within the Organization for Economic Cooperation and Development’s Pillar Two initiative—won’t be considered for DCL purposes for years beginning before the proposed regulations are finalized.

Finally, the proposed regulations provide a very narrow foreign use exception to the transitional country-by-country reporting safe harbor to the extent that the loss qualifying as DCL isn’t duplicated in the computation of tax under the safe harbor.

However, most of the operative rules under the proposed regulations break against taxpayers. Gains on stock sales, dividends (including deemed inclusions by reasons of Subpart F, GILTI, and Section 1248 of the tax code), and associated deductions would be excluded for purposes of computing income or DCL of a separate unit. Disregarding these items of income will result in more DCLs.

The preamble clarifies that the general requirement to conform to US tax principles when computing a DCL isn’t a license to ignore operative provisions. The proposed regulations also add an anti-avoidance catch-all provision designed to reverse the impact on a taxpayer’s DCL of any transaction undertaken with the intent to avoid the rules’ application.

The proposed regulations create new hurdles for taxpayers with the provision that QDMTTs and IIRs, as well as taxes computed under the transitional CbCR safe harbor, are considered income taxes. These taxes are based aggregation of financial statement income of all entities within a jurisdiction, which by definition creates a forbidden foreign use—even when the relevant separate unit isn’t participating in a consolidated group or other form of group relief under local tax law.

As a result, these Pillar Two taxes will be treated as a foreign use preventing domestic use elections or triggering recapture of prior DCLs. The proposed regulations don’t address the interaction between the undertaxed profits rule (a third tax system under the OECD’s Pillar Two initiative), and the DCL rules in this iteration.

The proposed regulations also include a new disregarded payment loss system that operates independently from, and in addition to, the DCL rules. Under the proposed rules of the system, if disregarded payments to a US owner are deductible and create a loss under local tax law, that loss must be tracked and added back to the US owner’s taxable income upon a triggering event, resulting in an increase to taxable income for the US owner.

The insertion of Pillar Two taxes into the DCL mix, and the introduction of a new loss recapture based on losses under foreign tax principles, will require taxpayers to learn the intricacies of foreign law. Bear in mind that the OECD’s guidance on Pillar Two taxes is just that. Each country will enact its own enabling legislation.

The burden of learning each jurisdiction’s laws, tracking multiple tax bases in multiple jurisdictions, and the hypothetical nature of a “foreign use” under the DCL rules could create astronomical compliance costs for the taxpayer relative to the actual US taxes generated by the change in DCL use.