International Tax: 2025 Year-End Planning Guide for Private Companies
- HFM CPAs + Business Advisors
- 5 days ago
- 13 min read
International tax planning is becoming both more complex and more important. Major changes to foreign currency and digital content rules will have a significant impact across a broad range of companies and international structures. As important as new guidance is, it may have been eclipsed by legislative developments. The international tax reform in the OBBBA raises novel planning considerations, and ongoing negotiations over Pillar Two could result in meaningful changes for private companies in scope of the rules as we approach year-end.
INTERNATIONAL TAX PLANNING AFTER THE OBBBA
The OBBBA enacted several changes to the global intangible low-taxed income (GILTI), foreign-derived intangible income (FDII), and the base erosion and anti-abuse tax (BEAT) regimes. Combined with changes in certain domestic provisions, such as Section 174 and Section 168, the changes could have a significant impact on multinational taxpayers.
GILTI Changes
GILTI is now known as "net CFC tested income" (NCTI). The effective tax rate on NCTI changes from 10.5% to 12.6% as a result of the change in the Section 250 deduction (from 50% to 40%). The NCTI foreign tax credit (FTC) haircut was reduced from 20% to 10% and now applies to previously taxed earnings and profits (PTEP) distributions. The reduction for qualified business asset investment (QBAI) was repealed, and the FTC expense allocation toward NCTI is limited to those expenses that are "directly allocable," with carveouts for interest and research and experimentation (R&E). In addition, foreign taxes associated with PTEP are no longer treated as deemed paid under the Section 78 gross-up mechanism. Overall, the changes to NCTI could result in taxpayers generating higher NCTI inclusions in the U.S.
FDII Changes
FDII is now known as "foreign-derived deduction-eligible income" (FDDEI). The effective tax rate on FDDEI changes from 13.125% to 14% as a result of the change in the Section 250 deduction (from 37.5% to 33.34%). As with NCTI, QBAI was repealed, and the FTC expense allocation toward FDDEI is limited to those expenses that are "properly allocable," with carveouts for interest and R&E. Additionally, FDDEI excludes income or gain from dispositions of intangible property (IP) (as defined in Section 367(d)) and any other property subject to depreciation, amortization, or depletion by the seller occurring after June 16, 2025. Overall, the changes to FDDEI are taxpayer favorable, making FDDEI more valuable and accessible, particularly for heavy industry. But the deduction is available only to private companies organized as C corporations.
BEAT Changes
The tax rate increased from 10% to 10.5%.
Domestic Changes
The OBBBA made several important domestic tax changes that could affect international planning.
These changes were discussed earlier in the corporate income tax chapter and include:
Permanently restoring full expensing of domestic R&E costs for tax years beginning after December 31, 2024.
Making bonus depreciation permanent at 100% for property acquired after January 19, 2024.
Creating a new category of 100% expensing for real property (buildings) involved in qualified production activities if construction begins after January 19, 2025, and before 2030, and the property is placed in service by the end of 2030.
Permanently removing amortization, depreciation, and depletion from adjusted taxable income for the limit on interest deduction under Section 163(j) for tax years beginning after December 31, 2025.
Effective Dates
Generally, the NCTI, FDDEI, and BEAT changes are effective for tax years beginning after December 31, 2025. As mentioned, 100% bonus depreciation is effective for property acquired and placed in service after January 19, 2025, while businesses can immediately begin deducting domestic R&E expenditures paid or incurred after December 31, 2024.
Planning Considerations
Given the significant changes to NCTI and FDDEI, as well as the changes in the tax rate for BEAT, modeling will be important for multinational taxpayers to effectively plan.
These strategies should be considered, when appropriate:
NCTI
Increase tested income taxes, as more taxpayers are likely to be in an excess limitation position for FTC purposes.
Accelerate income into 2025 and/or defer deductions until 2026 and beyond.
Consider high-tax exclusion election.
FDDEI
Expense apportionment and lack of QBAI opens up potential planning opportunities, particularly for capital-intensive and research-heavy taxpayers.
Consider potentially onshoring IP.
For outbound services, consider increasing inbound income streams if locally deductible.
BEAT
Consider capitalizing interest, Section 174, and other items.
Evaluate the services cost method (SCM) exception.
If subject to Section 1059A, consider increasing cost of goods sold (COGS).
CLASSIFYING AND SOURCING DIGITAL CONTENT AND CLOUD TRANSACTIONS
The IRS on January 10, 2025, released final regulations on the classification of digital content and cloud transactions. The regulations are generally effective for tax years beginning on or after January 14, 2025, with the option to elect to apply to tax years beginning on or after August 14, 2019, and all subsequent tax years.
The IRS also released proposed regulations to determine how income from cloud transactions is to be sourced for U.S. federal tax purposes, and a notice requesting comment on the potential implications of applying the characterization rules for digital content and cloud transactions to all provisions of the Internal Revenue Code.
A Closer Look
The final regulations modify Reg. §1.861-18 to expand its scope to include the transfer of all manner of digital content so that it is no longer limited to computer programs. Digital content is defined as a computer program or any other content, such as books, movies, and music, in digital format that is protected by copyright law or not protected by copyright law solely due to the passage of time or because the creator dedicated the content to the public domain.
Reg. §1.861-18 classifies transfers of digital content into one of four categories:
A transfer of a copyright right in the digital content;
A transfer of a copy of the digital content (a copyrighted article);
The provision of services for the development or modification of the digital content; or
The provision of know-how relating to development of digital content.
The final regulations replace the de minimis transaction rule with a predominant character rule for the characterization of digital content and cloud transactions. Under the new predominant character rule, a transaction that has multiple elements is classified in its entirety as digital content or a cloud transaction if the predominant character is digital content or a cloud transaction.
If a copyright is transferred, the transaction will generally be classified as a sale or license of intangible property. If a copyrighted article is transferred, the transaction will generally be classified as a sale or lease of tangible property.
New sourcing rules provide that when a copyrighted article is sold and transferred through an electronic medium, the sale is deemed to have occurred at the location of the purchasers' billing address for purposes of Reg. §1.861-7(c). Reg. §1.861-19 provides rules that generally classify all cloud transactions as services income, eliminating a delineation made in the 2019 proposed regulations between lease and services income. A cloud transaction is defined as a transaction through which a person obtains on-demand network access to computer hardware, digital content (as defined in Reg. §1.861-18(a)(2)), or other similar resources. A cloud transaction does not include network access to download digital content for storage and use on a person's computer or other electronic device.
The addition of numerous examples in Reg. §1.861-18 help illuminate the rules, particularly surrounding the classification of digital content transactions in various industries, including online gaming and streaming of other types of content. The examples emphasize that providers will need to pay careful attention to contracting with customers, including the method and terms of delivery for digital content to achieve a preferred tax outcome. One specific example of this concept is the clarification of rules related to the distribution of "software as a service" or "SaaS."
Sourcing of Cloud Transactions
The proposed regulations (mostly designated as Reg. §1.861-19(d)) classify cloud transactions (such as SaaS, on-demand platform access) as services and follow Sections 861(a)(3) and 862(a)(3) and some court cases in generally sourcing income to where services are performed. However, the preamble to the proposed regulations recognizes that such general sourcing rules were designed with more traditional operating models in mind. Thus, the proposed regulations attempt to consider the distinctive attributes of cloud transactions. The proposed regulations provide a mechanical formula that is based on the location of intangible assets, employee functions, and tangible property pertaining to the provision of the cloud transaction, and results in a fraction that is applied to the gross income from the cloud transaction to determine source.
One of the most important aspects of the proposed regulations is that the above factors are applied exclusively on a taxpayer-by-taxpayer basis. Therefore, if the cloud transactions involve multiple related parties, the factors and activities of the related parties are not considered for purposes of the sourcing rules. However, attention should be paid to any related parties acting as agents for the taxpayer, as such factors/attributes presumably may be imputed to the taxpayer.
Planning Considerations
Today, most business interactions with customers occur in some form of digital or cloud environment. Until now, there have been no final regulations specifically addressing the treatment of digital content and cloud transactions for federal income tax purposes. Both the characterization and sourcing of income from these transactions are important because they impact the application of various international tax provisions of the Code, including the determination of U.S. withholding tax and other income tax reporting obligations. These regulations will apply to any taxpayer that engages in digital content and cloud transactions across various industries and in a cross-border context.
OBBBA REPLACES DOWNWARD ATTRIBUTION PROHIBITION WITH NEW RULES
The restoration of Section 958(b)(4) under the OBBBA represents a significant change in the determination of controlled foreign corporation (CFC) and U.S. shareholder status.
Prior to the enactment of the TCJA, Section 958(b)(4) prohibited the downward attribution of stock ownership from a foreign person to a U.S. person, which limited the number of foreign corporations classified as CFCs and reduced filing obligations for constructive U.S. shareholders. The TCJA's repeal of this provision resulted in many foreign corporations being treated as CFCs, triggering new reporting requirements for U.S. shareholders.
Effective for tax years beginning after December 31, 2025, the OBBBA reinstates this downward attribution prohibition, potentially simplifying reporting obligations for certain taxpayers.
In conjunction with the restoration of Section 958(b)(4), the OBBBA introduces Section 951B, which extends the CFC inclusion rules to foreign controlled U.S. shareholders (FCUSS) of foreign controlled foreign corporations (FCFC). Under these new rules, an FCUSS would generally be required to include Subpart F income or net CFC tested income (NCTI) of an FCFC only if it owns a direct or indirect interest, under Section 958(a), in the FCFC. This approach narrows the scope of income inclusions for FCUSSs, focusing on direct and indirect ownership rather than constructive ownership through downward attribution.
Planning Considerations
Guidance is expected to clarify the reporting requirements for FCUSSs and FCFCs, as well as the impact on the passive foreign investment company (PFIC) rules. Taxpayers affected by the prior repeal of Section 958(b)(4) should carefully review these new provisions and forthcoming regulations, particularly regarding reporting for FCUSSs and FCFCs, pro rata share rules, and potential overlap with the PFIC rules.
The restoration of Section 958(b)(4) and introduction of Section 951B may simplify compliance for some taxpayers, but also introduce new complexities and areas requiring regulatory guidance.
SECTION 987 REGULATIONS ON FOREIGN CURRENCY GAIN OR LOSSES
The IRS has issued final and proposed regulations under Section 987, which are effective for tax years beginning after December 31, 2024. This marks the end of years of uncertainty, during which the IRS continually deferred proposed rules and were willing to accept "reasonable methods" based on a slew of proposed regulations — a period that earned the regime the nickname "the Wild West."
Section 987 governs the recognition of foreign currency gain or loss for qualified business units (QBUs) with a different functional currency than its taxpayer. Partnerships and S corporations generally remain outside the scope of the final regulations. Nevertheless, certain applicable provisions may apply (e.g., character and sourcing rules, suspended or deferred losses, and treatment of QBU terminations).
The proposed regulations include an election intended to reduce the compliance burden of accounting for certain disregarded transactions between a QBU and its owner.
Transition Rules
The owner of a QBU must adopt the Section 987 regulations as of the transition date — January 1, 2025 — for calendar year taxpayers (or the day of a termination event after November 9, 2023). Pretransition gain or loss must be computed as if each QBU were terminated the day before the transition date. The method for computing the pretransition gain or loss depends on whether the taxpayer has applied an eligible method for computing Section 987 gains and losses in prior years.
Pretransition Gain or Loss - Eligible Method
The pretransition gain or loss amount, in general, is the amount of Section 987 gain or loss that would have been recognized by the owner under the eligible method if the Section 987 QBU terminated on the transition date and transferred all of its assets and liabilities to the owner.
Pretransition Gain or Loss – No Eligible Method
The pretransition gain or loss amount, in general, is the amount of the "annual unrecognized Section 987 gain or loss" computed each year that the owner held the QBU after September 7, 2006, and before the transition date (the "transition period"). This total amount is adjusted for the amount of Section 987 gain or loss recognized by the owner of such QBU for all those years.
The annual unrecognized Section 987 gain or loss is the amount of Section 987 gain or loss computed as though a current rate election was in effect for each year of the transition period. A current rate election is an election to treat all balance sheet items as a marked item which is translated at the end of year spot rate rather than a historic rate.
The Section 987 regulations provide an alternative method for computing QBU net value for purposes of Reg. §1.987-4(d), but only when a current rate election is made. Thus, this alternative approach may be applied for purposes of computing pretransition gain or loss when an eligible method has not been previously applied, as a current rate election is deemed made for the transition period.
Definition of "Eligible Pretransition Method"
The Section 987 regulations provide that an eligible method includes an earnings and capital method, which is defined as a method that requires Section 987 gain or loss to be determined and recognized with respect to both the earnings of the Section 987 QBU and capital contributed to the Section 987 QBU.
The Section 987 regulations further provide that another reasonable method could also qualify as an eligible method if it produces the same total amount of income over the life of the owner of a Section 987 QBU as the earnings and capital method described above.
Recognition of Pretransition Gain or Loss
Pretransition gain is treated as net accumulated unrecognized Section 987 gain, which will be recognized in future years as remittances are made from the Section 987 QBU. Alternatively, taxpayers may elect to recognize pretransition gain ratably over 10 years.
Pretransition loss is generally treated as suspended Section 987 loss, which means that such loss will be recognized in future years to the extent the QBU generates Section 987 gain. If a current-rate election is in effect on the transition date, then the pretransition loss becomes unrecognized Section 987 loss that will be recognized upon remittances in future years. Alternatively, taxpayers may elect to recognize pretransition loss ratably over 10 years.
Planning Considerations
Taxpayers have waited a long time for final Section 987 guidance and although clarity in the area is welcome, many issues will need attention. As year-end approaches, taxpayers should inventory their QBUs, quantify pretransition amounts, model election strategies, and coordinate choices across the enterprise. The more immediate concerns are the transition to the new regulations and the computation of pretransition gain or loss. Taxpayers will then need to focus on gathering the required data to compute Section 987 gains and losses as well as evaluating the many elections that are available under the final regulations beginning with the 2025 tax year, modeling the overall impact of the regulations with and without the new elections.
U.S. WITHDRAWS FROM GLOBAL TAX AGREEMENT, LEAVING PILLAR TWO IN LIMBO
President Donald Trump on January 20, 2025 — his first day in office — issued a memorandum to clarify that the "Global Tax Deal" has no force or effect in the U.S., and directing the Secretary of the Treasury and the U.S. permanent representative to the OECD to notify the global organization that any commitments made by the Biden administration regarding the global tax deal have no force or effect in the U.S. absent an act by Congress adopting the relevant provisions of the deal.
The global tax deal referenced in the memorandum alludes to Pillar Two of the OECD's two-pillar framework for addressing the tax challenges arising from the digitalization of the economy and may be directed at aspects of Pillar One as well. The global anti-base erosion (GloBE) model rules issued under Pillar Two — which introduced the undertaxed profits rule (UTPR) and the income inclusion rule (IIR) — are designed to ensure that large multinational companies pay a minimum tax of 15% on taxable profit in each jurisdiction in which they operate. While more than 56 jurisdictions have enacted domestic legislation implementing Pillar Two, including all EU member states, the U.S. has not.
On June 28, Treasury released a statement by the G-7 nations asserting that "there is a shared understanding that a side-by-side system could preserve important gains made by jurisdictions in the Inclusive Framework in tackling base erosion and profit shifting and provide greater stability and certainty in the international tax system moving forward."
The side-by-side system would be based on four principles:
It would fully exclude U.S.-parented groups from the UTPR and the IIR in respect of both their domestic and foreign profits.
It would include a commitment to ensure that any risks of base erosion and profit shifting are addressed to preserve the common policy objectives of the side-by-side system.
Work to deliver a side-by-side system would be undertaken alongside material simplifications being delivered to the overall Pillar Two administration and compliance framework.
Work to deliver a side-by-side system would be undertaken alongside considering changes to the Pillar Two treatment of substance-based nonrefundable tax credits.
A statement from House Ways and Means Committee Chairman Jason Smith (R-MO) and Senate Finance Committee Chairman Mike Crapo (R-ID) indicated that the side-by-side agreement had been predicated on the removal of proposed Section 899 from the OBBBA. Section 899 would have imposed a retaliatory tax on some non-U.S. corporations and individuals if their home jurisdiction had adopted taxes on U.S. taxpayers deemed to be discriminatory or extraterritorial.
The U.S. is now actively negotiating with the OECD to try to reach agreement on a "side-by-side "framework by the end of the year. It has recently been reported that the OECD circulated a 30-page draft proposing targeted changes to the global minimum tax to address how the regime applies to U.S. multinationals.
Reportedly, the draft provides that companies based in a jurisdiction that qualifies as "side-by-side" would not be subject to the IIR and the UTPR.
Planning Considerations
Several OECD countries have fully implemented the UTPR in their domestic tax laws and many more have indicated their intention to do so. Therefore, a looming conflict between U.S. tax law and the OECD Pillar Two regime would need to be addressed during 2025 to avoid a conflict of laws applicable to U.S.-parented multinationals.
Private companies in multinational groups that are within the scope of Pillar Two should carefully consider these international tax developments with their advisors and monitor developments for any impact on tax planning and tax compliance.
Additional 2025 Year-End Tax Guides for Private Companies
Questions?
Contact HFM CPAs for questions on how this change may affect your specific situation. Our team stays current with evolving tax and related legislation to help you navigate new opportunities and requirements.
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