Daily Tax Update - January 13, 2012: Guidance Issued on Allocation, Apportionment of Interest Expense

IRS ISSUES TEMPORARY REGULATIONS ON ALLOCATION AND APPORTIONMENT OF INTEREST EXPENSE TO ADDRESS PLANNING TRANSACTIONS: The IRS has issued temporary (T.D. 9571) and identical proposed regulations (REG-113903-10) on the allocation and apportionment of interest expense by corporations owning a 10 percent or greater interest in a partnership, and on the allocation and apportionment of interest using the fair market value method of interest apportionment.

  • The existing temporary regulations adopt an aggregate, or look-through, approach to apportioning a partner’s distributive share of interest expense incurred by the partnership. They require that a corporate partner whose direct or indirect interest in the partnership is 10 percent or more apportion its distributive share of partnership interest expense by reference to the partner’s assets, including the partner’s pro rata share of the partnership’s assets.
  • The new temporary regulations modify the existing temporary rules to clarify that a corporate partner with a 10 percent or greater interest in a partnership must allocate its direct interest expense to all of its assets, including its proportionate share of partnership assets.
    • The new temporary regulations also specify that when a corporate partner with a 10 percent or greater interest in a partnership uses the tax book value or alternative tax book value method—thereby requiring the use of the partnership’s inside basis in its assets when allocating interest expense—the partnership’s inside basis includes any section 734(b) adjustments and any section 743(b) adjustments of the corporate partner for this purpose.
    • An analogous rule is added for individual partners who are general partners or limited partners with a 10 percent or greater interest in the partnership.
  • Under section 864(e)(2), the allocation and apportionment of interest expense must be made on the basis of assets and not gross income (the asset method), with interest expense apportioned between (or among) statutory and residual groupings of gross income in proportion to the average total values of assets within each such grouping for the tax year. For this purpose, taxpayers may choose to value assets based on their fair market value (the FMV method), tax book value, or alternative tax book value.
    • Since some taxpayers have taken positions under existing regulations concerning the relative values of assets assigned to each statutory grouping, the new temporary regulations amend the existing rules to reflect the fact that related party debt is an asset that must be taken into account whether held by the taxpayer or a related person.
    • The new temporary regulations also add a paragraph to provide for the valuation of related party debt so that related party debt obligation held by a taxpayer or another person related to the taxpayer has a value equal to the amount of the liability of the obligor related person.
    • The revised regulations also clarify that the value of stock in a related person includes the taxpayer’s pro rata share of related party debt held by the related person.
    • No inference is intended regarding the interpretation of prior regulations as a result of these modifications.
  • The new temporary regulations also revise the interest allocation regulations to comply with statutory changes made by the Education Jobs and Medicaid Assistance Act (EJMAA), which affects the affiliation of certain foreign corporations for purposes of section 864(e).
    • Under section 864(e)(1), the interest expense of each member of an "affiliated group" is allocated and apportioned as if all members of the group were a single corporation. Generally, foreign corporations are excluded.
    • As amended by the EJMAA, section 864(e)(5)(A) provides that a foreign corporation will be treated as a member of an affiliated group for interest allocation and apportionment purposes if (1) more than 50 percent of the gross income of the foreign corporation for the tax year is effectively connected income, and (2) at least 80 percent of either the vote or value of all outstanding stock of the foreign corporation is owned directly or indirectly by members of the affiliated group.
      • In these situations, all of the qualifying foreign corporation’s assets and interest expense are taken into account for purposes of applying the affiliated group interest apportionment rules.
      • Prior to its amendment by the EJMAA, section 864(e)(5)(A) treated a foreign corporation as a member of an affiliated group for interest allocation and apportionment purposes if (1) at least 80 percent of either the vote or value of the corporation’s outstanding stock was owned directly or indirectly by members of an affiliated group, and (2) more than 50 percent of the corporation’s gross income for the taxable year was effectively connected with the conduct of a trade or business in the United States.
  • The temporary regulations concerning corporate partners (whose interest in the partnership is 10 percent or more) and individual partners (who are general partners or who are limited partners with an interest in the partnership of 10 percent or more) apply for taxable years beginning after January 17, 2012.
  • The temporary regulations concerning the valuing of related party debt and stock in related persons apply for taxable years ending on or after January 17, 2012.
  • The rule concerning whether a foreign corporation will be treated as a member of an affiliated group applies to taxable years beginning after August 10, 2010.
  • The regulations can be accessed here and here.
  • For additional information, contact Philip R. West - pwest@steptoe.com 

IRS PROVIDES TRANSITIONAL RELIEF FROM SECTION 6045B INFORMATION REPORTING REQUIREMENT:  Today, the IRS issued Notice 2012-11, which provides transitional relief from the section 6045B information reporting requirements that apply to stock issuers with respect to organizational actions that affect stock basis.

  • Section 6045B provides that, for organizational actions beginning in 2011, a stock issuer must file a return (Form 8937, Report of Organizational Actions Affecting Basis of Securities) with the IRS to describe any organizational action (e.g., a stock split, merger, or acquisition) that affects the basis of a specified security (for 2011, a specified security is limited to stock in a corporation).
    • The issuer generally must file the return within 45 days after the organizational action and furnish a corresponding statement to nominees or stockholders by January 15th of the year following the calendar year of the organizational action.
    • For organizational actions occurring in 2011, issuers are permitted to file Form 8937 by January 17, 2012, the same deadline for issuers to furnish the required statements to stockholders or nominees.
  • Notice 2012-11 provides that posting either Form 8937 or the required information in a readily accessible format to an issuer’s primary public website will satisfy an issuer’s requirement to file and furnish Form 8937 for organizational actions occurring in 2011.
    • The IRS will treat the issuer as having filed Form 8937 and furnished issuer statements to stockholders or nominees on such posting date.
  • The Notice states that the IRS will not impose penalties for reporting incorrect information under sections 6721 and 6722 if issuers make good-faith efforts to timely post Form 8937 or the required information on their primary public websites or file accurate Forms 8937 and furnish the corresponding issuer statements.
  • The transitional relief provided in the Notice is limited to reporting organizational actions occurring in 2011 and does not apply to issuers that are regulated investment companies, which are not subject to the issuer reporting requirements for 2011 organizational actions.
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com

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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