Daily Tax Update - June 10, 2009

IRS AND TREASURY ISSUE FINAL REGULATIONS REGARDING THE APPLICATION OF THE SEPARATE FOREIGN TAX CREDIT LIMITATIONS TO DIVIDENDS RECEIVED FROM NONCONTROLLED SECTION 902 CORPORATIONS: The temporary regulations provided that unused foreign taxes attributable to dividends from a noncontrolled section 902 corporation with respect to which the taxpayer was no longer a qualifying shareholder after the noncontrolled corporations’ first post 2002 taxable year are allocated among the taxpayer’ separate categories in the same percentages as the earnings in the noncontrolled 902 corporation’s non-look through pool or pre-1987 accumulated profits would have been assigned had they been distributed in the last taxable year in which the taxpayer was a domestic shareholder in such corporation. The final regulations clarify that such taxes will be allocated as if look-through treatment applied in the year of the hypothetical distribution.

  • The final regulations revise the inadequate substantiation rule in the temporary regulations to provide that the Commissioner will allocate the undistributed earnings and taxes in the non-look-through pools to the foreign corporation’s passive category only if the Commissioner determines the look-through characterization of such earnings and taxes cannot reasonably be determined based on the available information.
  • The final regulations provide that the safe harbor contained in the temporary regulations with respect to reconstructing a taxpayer’s non-look-through pools may be elected by the taxpayer retroactively, either on a timely filed amended tax return or during an audit. In addition, the final regulations clarify that the safe harbor is only available as a transition rule for taxpayers who were required to characterize the stock of the foreign corporation for purposes of apportioning interest expense in the taxpayer’s first taxable year ending after the first day of the foreign corporation’s first post-2002 taxable year.
  • The final regulations provide that the section 952(c)(2) recapture amounts maintained by a controlled foreign corporation with respect to dividends received from a noncontrolled 902 corporation that were subject to the earnings and profits limitation of section 952(c)(1) are allocated to separate categories in the same manner as the associated post-1986 undistributed earnings.
  • The final regulations simplify the procedures by which controlling domestic shareholders may make an election or adopt or change a method of accounting or taxable year on behalf of a foreign corporation. The final regulations also clarify that the adjustments to the appropriate separate category of earnings and profits and income of the foreign corporation shall be required under section 481 to prevent any duplication or omission of amounts attributable to previous years that would otherwise result from any change in method of accounting. The preamble to the final regulations indicates that the details concerning the section 481 adjustment are addressed in applicable revenue procedures, including Rev. Proc. 2008-52, 2008-36 IRB 587.
  • For additional information, contact Philip R. West - pwest@steptoe.com

TREASURY AND IRS ISSUE REGULATIONS ON INVERSION TRANSACTIONS:  Treasury and the IRS have issued final and temporary regulations under section 7874 concerning the determination of whether a foreign corporation is treated as a surrogate foreign corporation. The regulations primarily affect domestic corporations or partnerships, and certain foreign corporations that acquire substantially all of the properties of such domestic corporations or partnerships (so-called “inversion” transactions). The regulations replace temporary regulations on surrogate foreign corporations published in 2006 and that recently sunset on June 6. The text of the new temporary regulations also serves as the text for simultaneously issued proposed regulations. 

  • The temporary regulations do not retain the safe harbor contained in the 2006 temporary regulations for determining whether the substantial business activities condition in section 7874(a)(2)(B)(iii) is satisfied. The regulations also do not retain the examples in the 2006 temporary regulations that apply a general rule based on all the facts and circumstances.
  • The temporary regulations modify the scope of Treas. Reg. § 1.7874-1(e), so that stock held by a partnership is considered as held proportionately by the partners of the partnership only for the purpose of determining whether the ownership condition of section 7874(a)(2)(B)(ii) is satisfied (i.e., the 60% ownership test).
  • The temporary regulations retain the rules from the 2006 temporary regulations identifying certain indirect acquisitions of properties held by a domestic corporation, and state that the identified transactions do not represent an exclusive list of transactions that constitute indirect acquisitions.
  • The temporary regulations provide a number of rules designed to prevent transactions that are viewed as avoiding section 7874. These include transactions involving (i) two or more foreign corporations that, in the aggregate, complete an acquisition, and (ii) a single corporation completing more than one acquisition as part of the same plan. The temporary regulations also address transactions intended to avoid section 7874 by using certain interests that are structured to be substantially equivalent to an equity interest in the foreign corporation.
  • The temporary regulations clarify that the “by reason of’ standard in the 60% ownership test is satisfied if stock of a foreign corporation is received in exchange for, or with respect to, stock in a domestic corporation. The temporary regulations also clarify that, subject to section 7874(c) and general tax principles, the “by reason of” standard is not affected by a relationship between stock of the domestic corporation (or an interest in the domestic partnership) and any other property exchanged for the stock of the foreign corporation.
  • The temporary regulations modify and clarify the rules on publicly traded foreign partnerships, including an example on the scope of the public offering rule of section 7874(c)(2)(B). The temporary regulations also revise the rules in the 2006 temporary regulations on options and similar interests. Treasury and the IRS request comments on the rules concerning options.
  • The temporary regulations generally provide that any claim by a creditor against an insolvent domestic corporation is treated as stock of the domestic corporation. A similar rule applies with respect to a domestic or foreign partnership. 
  • Although the temporary regulations state that they are effective June 12, 2009, the regulations provide that they apply to acquisitions completed on or after June 9, 2009. However, taxpayers may apply the temporary regulations to acquisitions completed before June 9, 2009, if the temporary regulations are applied consistently to all acquisitions completed prior to this date.
  • The regulations can be accessed via:
  • http://www.steptoe.com/publications/2009-13770_PI.pdf
  • http://www.steptoe.com/publications/2009-13769_PI.pdf
  • For additional information, contact Philip R. West - pwest@steptoe.com

H.R.2779: To amend the Internal Revenue Code of 1986 to provide transparency with respect to fees and expenses charged to participant-directed defined contribution plans, and to improve participant communication.
Sponsor: Rep Neal, Richard E. [MA-2] (introduced 6/9/2009)      Cosponsors (4)

S.1213: A bill to amend title XI of the Social Security Act to provide for the conduct of comparative effectiveness research and to amend the Internal Revenue Code of 1986 to establish a Patient-Centered Outcomes Research Trust Fund, and for other purposes.
Sponsor: Sen Baucus, Max [MT] (introduced 6/9/2009)      Cosponsors (1)

S.1222: A bill to amend the Internal Revenue Code of 1986 to extend and expand the benefits for business operating in empowerment zones, enterprise communities, or renewal communities, and for other purposes.
Sponsor: Sen Lincoln, Blanche L. [AR] (introduced 6/9/2009)      Cosponsors (8)  

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.

Steptoe & Johnson LLP has one of the largest and most diverse law firm tax practices in the country. The practice covers the entire spectrum of federal taxation, including representation of businesses before the Congress, Treasury and the national office of the IRS; transactional planning for domestic and multinational corporations; complex audit and controversy work for corporations and other business interests contesting IRS adjustments; litigation before the Tax Court, Court of Federal Claims, district courts, courts of appeals and the Supreme Court. The firm's tax practice also encompasses all aspects of employee benefits (ERISA), executive compensation, tax-exempt organizations and charitable giving. Steptoe has an extensive state and local tax practice, representing an array of business clients on complex sales and use tax, corporate income tax and property tax matters, both advising those clients and handling audits, administrative appeals, and litigation for them. Read more information on Steptoe's tax practice.