Use of U.S. GAAP to calculate the earnings and profits of foreign corporations

Tax Executive, The, March-April, 1991 by Fred T. Goldberg, Jr.

III. Election to Use U.S. GAAP

E&P Method

The use of U.S. GAAP principles to compute the E&P of foreign corporations should be conditioned on an election by the taxpayer. An election regime would be especially important if the Institute's recommendations (as discussed in Part IV) concerning the adjustment of two items (certain basis adjustments and leasing transactions) were not adopted.

An election to use the U.S. GAAP E&P method would constitute a method of accounting under section 446, which could not be revoked without the consent of the Commissioner. TEI recommends that the IRS develop a revenue procedure under which taxpayers would be given automatic consent to adopt the method. The revenue procedure should also address the extent to which a section 481(a) adjustment will be required (or permitted) in respect of electing taxpayers. In general, section 481 adjustments for differences between U.S. GAAP and tax accounting rules should be required only if they are material.

The revenue procedure should provide that taxpayers may make the election on their return. Because use of the U.S. GAAP E&P method would be elective, we assume that the proposal would be applied on a prospective-only basis. A retroactive application of the U.S. GAAP E&P proposal that would require the recalculation of deemed paid foreign tax credits claimed in prior years would produce tremendous compliance and auditing burdens.

IV. Differences Between U.S.

GAAP and Current Tax

Rules that Should Be

Retained in Computing E&P

Although the effect of timing differences between financial and tax accounting rules will tend to dissipate over time through the pooling of E&P, there are two differences between U.S. GAAP and the corresponding tax rules that could cause substantial distortion in the deemed paid foreign tax credit. We believe the following adjustments required by the tax rules should be retained as E&P adjustments. These differences are:

1. Corporate Reorganizations, Mergers, and Divestitures. Using U.S. GAAP income in computing E&P is not appropriate where basis differentials arise from corporate reorganizations, mergers, and acquisitions. TEI believes that the following basis adjustments should be retained under the U.S. GAAP E&P proposal.

* Section 338(g) Elections. Under

section 338(g) of the Code, a

purchasing corporation may

elect to treat certain stock acquisitions

as asset acquisitions,

thereby receiving a step-up in

the basis of the target corporation's

assets. A taxpayer making

such an election is required

to maintain tax books which

may include different asset values

from those reflected on its

U.S. GAAP books. Any such differences

would also produce depreciation

differences. This, in

turn, could distort the taxpayer's

foreign tax credit.

* Section 304 Transactions. A

section 304 transaction is treated

as the payment of a dividend

for tax purposes, but is normally

treated under U.S. GAAP as

a intercompany transaction

with no gain or loss. The selling

company would normally

have substantially more income