NCTI almost works the way GILTI was advertised: Treasury and IRS propose new rules on expense allocation to the Section 951A category

On September 10, 2026, the Department of the Treasury (Treasury) and the Internal Revenue Service (IRS) published proposed regulations, REG-117273-25 (Proposed Regulations), regarding the allocation and apportionment of deductions to foreign source section 951A category income (now net CFC taxable income (NCTI), and previously global intangible low-taxed income (GILTI)) for foreign tax credit (FTC) limitation purposes and for calculating foreign derived deduction eligible income (FDDEI) with respect to which a deduction is allowed under section 250(a)(1)(A).¹

The Proposed Regulations implement changes made by the One Big Beautiful Bill Act (OBBBA) providing special rules that (1) limit allocation and apportionment of deductions to foreign source section 951A category income for FTC limitation purposes (thereby generally increasing the FTCs that may be claimed by taxpayers with respect to such income) and (2) exclude interest expense and research and experimental (R&E) expenditures from deductions that reduce FDDEI (thereby generally increasing taxpayers’ related deduction available under section 250). The Proposed Regulations would apply to taxable years beginning after December 31, 2025, and taxpayers may rely on the Proposed Regulations before finalization if applied consistently and in their entirety.

Background

The Tax Cuts and Jobs Act, enacted in 2017, added section 951A to the Code, along with the related deduction and FTC provisions in section 250(a)(1)(B) and section 960(d), respectively. Together, these provisions required United States shareholders, as defined in section 951(b) (US shareholder), of controlled foreign corporations (CFCs) to include GILTI in income, but permitted a deduction equal to 50% of the amount of such inclusion (and any associated gross-up under section 78) and a deemed paid credit for 80% of certain foreign income taxes paid by the CFCs. Viewed in isolation, these provisions would have functioned as a minimum tax on certain low-taxed foreign earnings that would not produce residual US tax if a US shareholder’s CFCs paid local tax at an average rate of at least 13.125%. To illustrate, if a corporate US shareholder included GILTI and related section 78 gross-up of $100, its US tax on such inclusion, after taking into account the section 250 deduction, would be $10.50 ($100 - $50 section 250 deduction = $50 net taxable income x 21% = $10.50). This tax would be fully offset by FTCs if the CFCs had paid $13.125 of related foreign income taxes for which the US shareholder received an 80% deemed paid FTC (80% x $13.125 = $10.50). 

However, these provisions did not operate in isolation. Section 904(a) limits a taxpayer’s FTC to the amount of US tax imposed on the taxpayer’s foreign source income. Section 904(d) applies this limitation separately to each separate category of income, including net section 951A category income (prior to OBBBA, the GILTI basket). To determine a taxpayer’s net foreign source section 951A category income, a taxpayer is required to determine the amount of deductions that are allocated and apportioned to foreign source section 951A category income.

In practice, the allocation and apportionment of expenses, particularly interest expense, to the GILTI basket limited the ability of US shareholders to claim FTCs in respect of GILTI, meaning they often had residual US tax in cases where CFCs paid tax at rates well in excess of 13.125%. Using the above example, if the US shareholder had $40 of interest expense apportioned to the GILTI basket, its FTC limitation for that basket would have been reduced to $2.10 ($50 net taxable income calculated above - $40 apportioned interest expense = $10 net foreign source income into the GILTI basket x 21% = $2.10). The US shareholder would therefore have to pay $11.125 more in US tax than it would have paid if its interest expense had not been apportioned to the GILTI basket. Importantly, GILTI FTCs may not be carried forward, so any such credits not used in the current year, including as a result of expense apportionment, were lost. The net result was that what had been characterized as a minimum tax increased the tax bill of US corporate taxpayers even if they were already paying an average effective foreign tax rate on their GILTI significantly in excess of 13.125%

Expense Allocation Rules for Section 951A 

As compared to 2025, OBBBA changed the section 951A landscape by reducing the available section 250(a)(1)(B) deduction from 50% to 40% and by increasing the related deemed paid credit from 80% to 90% of the related foreign taxes. As a result, the nominal break-even average effective foreign tax rate increased from 13.125% to 14%.

Notwithstanding this increase in the break-even rate, the OBBBA generally reduced the cost of section 951A inclusions for taxpayers. This is because new section 904(b)(5) provides favorable special rules for allocating and apportioning deductions for purposes of applying section 904(a) with respect to section 951A category income.

Most significantly, section 904(b)(5)(B) provides that no amount of interest expense or R&E expenditures is allocated and apportioned to the section 951A category, eliminating the interest expense apportionment issue illustrated above.

Section 904(b)(5)(A) provides that any section 250(a)(1)(B) deduction (reduced to 40% by the OBBBA) and any deduction under section 164(a)(3) for state and local income taxes attributable to the section 951A inclusion and related gross-up are allocated and apportioned to the section 951A category. The Proposed Regulations clarify that the section 164(a)(3) reference does not include foreign income taxes, because foreign income taxes imposed on a US shareholder are generally not expected to be imposed with respect to its NCTI.

Section 904(b)(5)(C) provides that any deduction is allocated and apportioned to the section 951A category income only if the deduction is “directly allocable” to such income.

Deductions that would have been allocated or apportioned to the section 951A category but for the application of section 904(b)(4)(B) (interest expense and R&E expenditures) and (C) (other deductions that are not “directly allocable”) are reallocated to US source income.

The “Directly Allocable” Standard

The term “directly allocable” is not defined in the Code. The Proposed Regulations interpret the term as requiring a closer and more direct factual relationship between a deduction and the section 951A category income than is required under the “properly allocable” standard that otherwise governs the allocation and apportionment of deductions under the section 861 regulations.

The Proposed Regulations adopt a narrow construction of “directly allocable,” providing that a deduction is not directly allocable to section 951A category income if it is of a type that, under the applicable allocation and apportionment rules, would be subject to apportionment on the basis of relative asset values or gross income amounts. In other words, deductions that the section 861 regulations apportion formulaically cannot be “directly allocable” to the section 951A basket.

Applying this standard, the Proposed Regulations specify certain deductions that are and are not treated as directly allocable to the section 951A category, as summarized in the table below. 

Deductions not directly allocable to the section 951A category	Deductions that are directly allocable to the section 951A category
stewardship expenses;  legal and accounting fees;  damages and settlement payments;  and supportive expenses, including general overhead, general and administrative expenses, and supervisory expenses	section 986(c) foreign currency losses on distributions of previously taxed section 951A category earnings and profits; and net operating loss (NOL) deductions that are allocated to the section 951A category income under existing rules.

 

Eversheds Sutherland Observation: The Proposed Regulations’ interpretation of “directly allocable” is broadly favorable to taxpayers. By excluding stewardship expenses, legal and accounting fees, and other overhead from the section 951A category, the regulations further mitigate the factors that previously eroded FTC limitations for taxpayers with GILTI/NCTI inclusions. US shareholders with NCTI inclusions in respect of CFCs paying local tax at rates above the US rate are now less likely to face material residual US tax on their NCTI inclusions.

 

Eversheds Sutherland Observation: Expenses apportioned to the section 245A category (based on the value of foreign subsidiary stock related to earnings eligible for the section 245A dividends received deduction) continue to restrict NCTI basket FTCs. Under section 904(b)(4), these expenses are not taken into account for purposes of determining a domestic corporation’s foreign tax credit limitation, which has the effect of apportioning the expenses pro rata over net taxable income in each category, thereby reducing the corporation’s FTC limitation in each basket, including NCTI.

 

Reallocation of Excluded Deductions to US Source Income

To determine the amount of deductions reallocated to US source income, the Proposed Regulations would first allocate and apportion deductions to foreign source section 951A category income using existing rules.

The Proposed Regulations provide that the reallocation of these deductions to US source income applies for all purposes of section 904, including for purposes of determining US source losses, which ratably reduce the FTC limitation in baskets with positive foreign source income. To the extent a US source loss offsets foreign source income, it is referred to as an overall domestic loss (ODL). Example 2 in the Proposed Regulations illustrates this effect: a taxpayer with $50x of deductions reallocated from the section 951A category to US source income ends up with a $20x ODL, $15x of which is allocated to NCTI under the rules of section 904(f), reducing the taxpayer’s NCTI FTC limitation. The $20x ODL ($15x of which relates to the NCTI basket) is then subject to the recapture mechanism under section 904(g), which may increase the taxpayer’s NCTI FTC limitation in subsequent taxable years. 

Eversheds Sutherland Observation: Because NCTI basket FTCs cannot be carried forward, increasing the taxpayer’s NCTI basket FTC limitation in future years may not provide the benefit intended by the ODL recapture rules. Such recapture will only allow the taxpayer to claim additional FTCs if it pays sufficiently high foreign taxes related to its NCTI inclusion in the year of recapture. Thus, while the reallocation of expenses away from the section 951A category is favorable, taxpayers should be aware that the resulting increase in US source deductions can result in continuing constraints on the ability to use NCTI basket FTCs due to an ODL.

 

Eversheds Sutherland Observation: For taxpayers that have enough US source income that reallocation of NCTI basket deductions to US source income does not result in an ODL, maximizing the initial apportionment of expenses such as interest to the NCTI basket is beneficial, because it draws these expenses away from the other FTC baskets (thereby increasing the FTC limitation in those baskets) and reallocates those expenses to US source income. For taxpayers that have an average effective foreign tax rate on NCTI of at least 14%, it is likely even beneficial to increase the NCTI inclusion (e.g., by not making the NCTI high-tax exclusion election) to achieve this result.

 

The Proposed Regulations also include rules detailing how new section 904(b)(5) interacts with the existing NOL, overall foreign loss, and ODL rules.

Changes to the FDDEI Calculation

The Proposed Regulations would provide that FDDEI continues to be reduced by all deductions, other than interest expense and R&E expenditures, allocated and apportioned to FDDEI under existing rules. Interest expense would be defined as any expense that is deductible under section 163, including original issue discount. R&E expenditures would be defined as any expenditure that is deducted (including as an amortization deduction) under section 174, section 174A, or section 59(e)(2)(B).

Comment Period and Effective Dates

Comments on the Proposed Regulations are due by November 10, 2026. Taxpayers may rely on the Proposed Regulations before finalization, provided that they apply the Proposed Regulations consistently and in their entirety.

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If you have any questions about this Legal Briefing, please feel free to contact any of the attorneys listed or the Eversheds Sutherland attorney with whom you regularly work.

_{1 Unless otherwise stated, all section references are to the Internal Revenue Code of 1986, as amended (Code), and all “Treas. Reg. §” references are to the regulations promulgated thereunder by the Treasury as in effect as of the date of this client alert, as relevant. REG-117273-25, RIN 1545-BR90, published at 91 Fed. Reg. 57,832 (Sept. 11, 2026).}