Daily Tax Update - July 15, 2008

IRS ISSUES TEMPORARY REGULATIONS ON FOREIGN TAX CREDIT GENERATOR TRANSACTIONS:  Today, the IRS issued temporary regulations under section 901 that treat payments of foreign taxes made in connection with so-called “foreign tax credit generator” transactions as noncompulsory payments for which no foreign tax credit may be claimed. The IRS had issued proposed regulations on March 30, 2007 regarding these transactions. The temporary regulations generally retain the substance and mechanics of the proposed regulations, but clarify and modify the proposed regulations in certain respects. 

  • The temporary regulations generally apply to payments accrued or paid by a US or foreign entity in taxable years ending on or after the date the temporary regulations are published in the federal register. Significantly, the IRS rejected comments to adjust the effective date so as to apply the regulation to taxable years beginning after the issuance of the regulations. Rather, the temporary regulations adopt the approach of the proposed regulations, being effective for taxable years ending after the issuance of the regulations. The IRS did, however, modify the effective date of the proposed regulations in several respects: 
    1. The regulations clarify that the taxable year at issue is that of the foreign taxpaying entity.
    2. The regulations generally prevent the regulation from applying to taxes paid or accrued by a foreign corporation in a taxable year of the foreign corporation ending before the effective date of the regulations (e.g., where the taxes were paid years ago, but aren't taken into account under section 902). As such, in the case of payments made by a foreign corporation with a domestic shareholder, the temporary regulations will apply to payments paid or accrued in the foreign corporation's taxable years ending with or within taxable years of its domestic corporation shareholder that end on or after the date the temporary regulations are published in the federal register. 
    3. The regulations were delayed and not finalized in 2007. 
  • As in the proposed regulations, the temporary regulations deny foreign tax credits claimed in connection with a “structured passive investment arrangement”--an arrangement that satisfies six conditions that the IRS believes to be features common to a class of abusive transactions intentionally structured to create a foreign tax liability.
  • One condition is that the arrangement involve a special purpose vehicle (“SPV”). An SPV is defined in part as an entity substantially all of the income of which is attributable to passive investment income and substantially all of the assets of which are held to produce such income. The temporary regulations rejected most all of the comments seeking relaxation of the definition of SPV. In fact, the preamble to the regulations cautions that the IRS and Treasury intend to monitor the use of holding companies to facilitate abusive foreign tax credit arrangements, because they are concerned that taxpayers may continue to seek to enter into tax avoidance transactions by structuring arrangements to fail the SPV definition through use of the holding company exception. The temporary regulations modify the application of the SPV definition to active financing companies in two respects. First, they actually tighten the definition of an SPV as applied to active financing businesses by requiring that they conduct substantial activities through their own employees. Second, they relax the definition of “home country” in the active financing rules incorporated by reference by redefining that term to mean “any foreign country.”
  • The temporary regulations clarify that the foreign payment must be made with respect to a US tax year in which substantially all of the gross income of the entity is attributable to passive investment income and substantially all of the assets of the entity are assets held to produce such passive investment income. 
  • The temporary regulations also modify and clarify the “direct investment” condition requiring that the foreign payment attributable to the SPV be substantially greater than the amount of foreign tax credits a US party would reasonably be expected to claim if such party directly owned a proportionate share of the SPV's assets. The temporary regulations clarify the application of the rules where there is more than one equity owner of the SPV. The temporary regulations also modify the proposed regulations to provide that the US party's proportional share of assets will not include any assets that produce income subject to a gross basis withholding tax as well as a net basis income tax. The temporary regulations also clarify that a dual resident corporation that is an SPV meets the “direct investment” condition.
  • The temporary regulations modify and clarify the conditions providing that a counterparty obtain a foreign tax benefit. To ease administrative burdens, the temporary regulations clarify that, while the foreign tax benefit must be reasonably expected, there is no requirement to show that the benefit be intended or actually realized. Moreover, to avoid covering joint ventures not involving the duplication of tax benefits, the temporary regulations provide that the foreign tax benefit condition is not satisfied unless the benefit corresponds to 10 percent or more of the US party's share of the foreign payment or 10 percent or more of the foreign tax base with respect to which the US party's share of the payment is imposed.
  • The temporary regulations also amend the definition of a counterparty to include certain related persons but not including cases where the US party is a US corporation or individual that owns at least 80 percent of the value of the putative counterparty and cases where at least 80 percent of the value of the US party and putative counterparty are owned by the same US corporation or individual. The temporary regulations also eliminate the percentage ownership thresholds contained in the counterparty definition in the proposed regulations.
  • Finally, the temporary regulations modify the arbitrage condition of the proposed regulations so that the US treatment of the inconsistent aspect of the transaction must now materially increase the amount of the US party's foreign tax credits or materially decrease the US party's income for US tax purposes.
  • For additional information, contact Philip R. West - pwest@steptoe.com
  • The regulations can be accessed via: http://federalregister.gov/OFRUpload/OFRData/2008-16329_PI.pdf  and http://federalregister.gov/OFRUpload/OFRData/2008-16331_PI.pdf

PELOSI CALLS FOR SECOND STIMULUS PACKAGE:  Today, House Speaker Nancy Pelosi said that Congress must enact a second economic stimulus bill. Pelosi said, “We will be proceeding with another stimulus package. . .Even though we believe that the initial public rebates had a positive impact, it is certainly not enough to offset the rising prices in gasoline, in food, in fuel, in health care, in education and other rising costs, while the purchasing power of Americans' income has gone down.” Pelosi said that she hopes to work with President Bush and House Republicans on a proposal.  Pelosi added, “We will have to work with the president on a timetable.”

H.R.6487: To amend the Internal Revenue Code of 1986 to provide for a temporary reduction in the tax imposed on diesel fuel.
Sponsor: Rep Giffords, Gabrielle [AZ-8] (introduced 7/14/2008)      Cosponsors (None)

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