Daily Tax Update - August 9, 2006

TREASURY AND IRS ISSUE FINAL REGULATIONS GOVERNING TAX ATTRIBUTES IN INBOUND AND FOREIGN-TO-FOREIGN SUBCHAPTER C TRANSACTIONS:
This week, Treasury and the IRS finalized regulations proposed in November 2000 governing the treatment of earnings and profits and taxes in both inbound and foreign-to-foreign subchapter C transactions. The rules are effective August 8, 2006, defer the treatment of previously taxed income under section 959 for later consideration (after a PTI reg project is completed), and defer consideration of attributes in an outbound section 355 transaction to a later project on outbound spin-offs.

  • In general, the final regulations retain most of the potentially harsh anti-attribute trafficking features of the proposed regulations. For example, over the objections of commentators, the final regulations retain the rules that:
    • limit the carryover of E&P in inbound transactions to those that are effectively connected with a U.S. trade or business or effectively connected with a U.S. permanent establishment
    • apply the hovering deficit rules on a basket-by-basket basis, with the potential that hovering deficits can trap taxes in baskets of combining corporations with overall positive E&P and can support dividends even where corporations have overall deficits in E&P,
    • apply the hovering deficit rule for purposes of computing deemed paid credits under section 902, and
    • apply the "zipping" rule to permanently eliminate earnings from look-through status if the corporation changes from a look-through corporation to a non-look-through corporation, even if the entity subsequently reverts to look-through status. (The zipping rule is, however, now moot to the extent that it would have applied to CFCs, due to the statutory change allowing look-through treatment for distributions by a CFC out of any E&P accumulated while it was a CFC.)
  • The final regulations do contain a number of favorable changes from the proposed regulations, including:
    • elimination of the non-look-through 10/50 category, a simplification measure dictated by the statutory elimination of the 10/50 basket,
    • relaxation of the rule requiring that foreign taxes associated with a hovering deficit do not enter the pool until the entire deficit has been offset against post-transaction E&P (the final regulations allow the taxes to enter the pool pro rata as the hovering deficit is absorbed)
    • clarification that pretransaction deficits are not taken into account for purposes of calculating the E&P limitation for purposes of the subpart F qualified deficit rule of section 952(c)(1)(B), and
    • elimination of the anti-abuse rule from the proposed regulations.
  • In addition, the final regulations modify the rule of the proposed regulations that suspended application of the hovering deficit rule in the case of F reorgs and similar transactions. The rule is broadened to cover more transactions in which one of the corporations has no more than nominal property or attributes, but is narrowed so that it does not apply if more than one corporation has more than nominal property or attributes.
  • For additional information, contact Philip R. West - pwest@steptoe.com
  • The regulations can be accessed here.

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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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