Daily Tax Update - May 21, 2008

HOUSE PASSES TAX EXTENDERS BILL -- ADMINISTRATION ISSUES VETO THREAT:  Today, the House approved a $57 billion renewable energy and tax extenders bill. The Administration issued a Statement of Administration Policy (SAP) threatening to veto the bill in its current form. The statement said, “Overall, the Administration does not believe that efforts to avoid tax increases on Americans need to be coupled with provisions to increase revenue.” The SAP said the Administration “strongly opposes” the bill's tax changes to the treatment of deferred compensation paid by managers of offshore hedge funds, and its nine-year delay of the implementation of the worldwide interest allocation rule.

• The SAP can be accessed here.

IRS PUBLISHES FINAL REGULATIONS UNDER SECTION 7874 ON AFFILIATE-OWNED STOCK:  The IRS has published final regulations concerning the treatment of “affiliate-owned stock” in determining whether a corporation is a surrogate foreign corporation under section 7874, relating to inversions involving certain US corporations and partnerships. The preamble to the final regulations also announces the IRS position on three planning techniques taxpayers have been using to avoid section 7874, and announces an IRS decision not to change the treatment of plain vanilla preferred stock in determining whether the 60% or 80% ownership thresholds have been crossed (with the effect that such stock is excluded from the determination of whether an affiliated group constitutes an “expanded affiliated group” but is otherwise counted for purposes of determining whether such thresholds have been crossed). The final regulations generally adopt temporary and proposed regulations published on December 28, 2005. 

• An expatriated entity is a domestic corporation or partnership with respect to which a foreign corporation is a surrogate foreign corporation. A foreign corporation is a surrogate foreign corporation if, in addition to satisfying other conditions, at least 60 percent of the stock (by vote or value) is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation or, in the case of a domestic partnership, by former partners of the domestic partnership by reason of holding a capital or profits interest in the domestic partnership. Section 7874(c)(2)(A) provides that stock held by members of the expanded affiliated group which includes the foreign corporation (“affiliate-owned stock”) will not be taken into account in determining whether the 60 percent ownership threshold has been satisfied. The final regulations contain rules relating to the extent to which affiliated-owned stock will be disregarded for purposes of section 7874. 
• The final regulations provide that affiliate-owned stock is generally excluded from both the numerator and the denominator of the ownership fraction used to determine whether a foreign corporation will be treated as a surrogate foreign corporation. Such stock is included in the denominator, but not the numerator, in two instances: (1) certain transactions occurring as part of an internal group restructuring involving a domestic entity (the “internal group exception”) and (2) certain acquisitive business transactions between unrelated parties where the former shareholders or partners of the domestic entity have a minority interest in the acquired properties after the acquisition. The final regulations modify the mechanics of the internal group exception.
• The final regulations also clarify that so-called “hook stock” (i.e, stock of an acquiring foreign corporation that is held by an entity that is at least 50 percent owned directly or indirectly by the acquiring foreign corporation) is excluded from the determination of whether both exceptions to the general rule apply.   
• The final regulations do not incorporate comments requesting that plain vanilla preferred stock (described in section 1504(a)(4)) be excluded from both the numerator and denominator of the ownership fraction. The Preamble notes that Treasury and the IRS will continue to monitor the use of plain vanilla preferred stock and its treatment under section 7874. 
• The Preamble to the final regulations identifies three positions that Treasury and the IRS understand that taxpayers may be taking to avoid the application of section 7874. The Preamble states that Treasury and the IRS view each of these positions as being inconsistent with the purposes of section 7874. Furthermore, as stated in the Preamble, Treasury and the IRS may issue guidance addressing these positions in connection with forthcoming final regulations under section 7874, and that such guidance may be effective as of May 20, 2008. 
• One of the three transactions involves acquisition of a domestic corporation by a foreign corporation in a title 11 or similar case. In such case, taxpayers have been taking the position that former creditors of the domestic corporation are not equity owners for purposes of section 7874.
• Another of the transactions involves the acquisition by a foreign corporation of two or more domestic corporations pursuant to a plan. In such a case, taxpayers have been taking the position that the ownership fractions are calculated separately for each domestic corporation so that, for example, if two domestic corporations of equal value are acquired by a foreign corporation, the former shareholders of each domestic corporation own only 50% of the value of the foreign corporation.
• The third transaction involves the use of a partnership. In this transaction shareholders of a domestic corporation transfer the stock of that corporation to a domestic partnership which is formed by a foreign acquiring corporation and an affiliate and which owns at least 60% of the foreign acquiring corporation. This position relies on treating the partnership as an entity (rather than as an aggregate of its partners) to conclude that there is no ownership of the domestic corporation by its former shareholders.
• The final regulations generally apply to acquisitions completed on or after May 20, 2008, subject to a binding contract exception. Taxpayers may elect to apply the final regulations to prior acquisitions, however, but only if the taxpayer applies the final regulations consistently to all acquisitions within its scope. 
• For additional information, contact Philip R. West - pwest@steptoe.com
• The regulations can be accessed here.
  

TAX BILL INTRODUCED MAY 20TH:
H.R.6101: To amend the Internal Revenue Code of 1986 to improve the ability of medical professionals to practice medicine and provide quality care to patients by providing a tax deduction for patient bad debt.
Sponsor: Rep Thornberry, Mac [TX-13] (introduced 5/20/2008)      Cosponsors (None)

INTERNAL REVENUE SERVICE - CIRCULAR 230 DISCLOSURE:
As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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