Daily Tax Update - February 10, 2012: IRS Substantially Modified Position On Application of Section 367 to Section 304 Transactions

IRS SUBSTANTIALLY MODIFIES POSITION ON APPLICATION OF SECTION 367 TO SECTION 304 TRANSACTIONS:  Today, the IRS issued guidance (Notice 2012-15) that applies section 367 to the deemed section 351 transaction and the deemed redemption that occurs in a section 304 transaction.  Previously, in 2006 guidance, the IRS and Treasury took the position that section 367 did not apply to section 304 transactions.  Then, in 2009 guidance, the IRS and Treasury took the position that section 367 did apply, but only to the extent that the distribution received by the exchanging shareholder in redemption of the stock deemed issued by the foreign acquiring corporation is applied against and reduces the basis of stock of the foreign acquiring corporation held by the exchanging shareholder other than the stock deemed issued to the exchanging shareholder in the deemed section 351 exchange.  This new guidance reverses the 2006 guidance, and goes beyond the 2009 guidance, by stating that sections 367(a) and (b) apply fully to section 304 deemed section 351 transactions and deemed redemptions. 

  • If a taxpayer enters into a gain recognition agreement (GRA) with respect to the deemed 351 transaction, the GRA will be triggered by the deemed redemption but, pursuant to the section 367(a) regulations, the deemed redemption will not be treated as a triggering event if the transferor enters into a new GRA with respect to the stock that the transferor continues to own.  The guidance implements these rules by allowing taxpayers to enter into one GRA for the entire section 304 transaction.
  • The guidance is effective for transactions occurring after February 10, 2012.
  • For additional information, contact Philip R. West - pwest@steptoe.com or  Mark J. Silverman - msilverman@steptoe.com

TREASURY, IRS ISSUE REGULATIONS UNDER SECTIONS 901 AND 909:  On February 9, 2012, Treasury and the IRS issued temporary regulations under section 909 and final regulations under section 901.  The temporary regulations (T.D. 9577) provide an exclusive list of arrangements giving rise to foreign tax credit splitting events under section 909, providing taxpayers with much-needed guidance that limits the reach of a broad statute.  The final regulations under section 901 (T.D. 9576) modify the "technical taxpayer" rule, which generally provides that the person considered to have paid a foreign tax is the person who has legal liability for such tax under foreign law.  Both sets of regulations address situations in which foreign income may be "split" from the relevant foreign taxes.

  • With respect to foreign income taxes paid or accrued by section 902 corporations in taxable years beginning on or before December 31, 2010, the temporary regulations (Treas. Reg. § 1.909-6T) adopt the guidance previously described in Notice 2010-92, including providing an exclusive list of "pre-2011 splitter arrangements." 
  • The temporary regulations also provide an exclusive list of arrangements that will be treated as giving rise to foreign tax credit splitting events with respect to foreign income taxes paid or accrued in (a) a taxable year beginning on or after January 1, 2011 and before January 1, 2012 and (b) taxable years beginning on or after January 1, 2012. 
    • For taxes paid or accrued in taxable years beginning on or after January 1, 2012, Treas. Reg. § 1.909-2T provides that the following are "splitter arrangements": (a) reverse hybrid splitter arrangements; (b) loss-sharing splitter arrangements; (c) hybrid instrument splitter arrangements; and (d) partnership inter-branch payment splitter arrangements.  Foreign taxes paid or accrued in connection with such arrangements are, to the extent provided in the regulations, "split taxes" that may not be taken into account until the related income is taken into account by the payor or, in the case of split taxes paid or accrued by a section 902 corporation, by a section 902 shareholder of such corporation.
      • A reverse hybrid splitter arrangement is an arrangement where a payor pays or accrues foreign income taxes with respect to income of an entity treated as a flow-through for foreign tax purposes and a corporation for US tax purposes. 
      • A loss-sharing splitter arrangement is an arrangement involving a foreign group relief or similar regime to the extent that a shared loss of a US combined group could have been used to offset income of that group but is instead used to offset income of another US combined group.  The regulations define a US combined group as an individual or a corporation and all entities that for US tax purposes combine income, deductions, or gains and losses, such as a CFC that owns a foreign entity disregarded for US tax purposes. 
      • A hybrid instrument splitter arrangement includes both "US equity hybrid instrument splitter arrangements" and "US debt hybrid instrument splitter arrangements."  A US equity hybrid instrument splitter arrangement arises where payments or accruals with respect to an instrument treated as equity for US tax purposes and debt for foreign tax purposes (a) give rise to foreign taxes paid or accrued by the instrument’s owner, (b) are deductible by the issuer under foreign law, and (c) do not give rise to income for US tax purposes.  A US debt instrument hybrid instrument splitter arrangement arises where foreign income taxes are paid or accrued by the issuer of an instrument treated as debt for US tax purposes and equity for foreign tax purposes with respect to income in an amount equal to the interest on the instrument that is deductible for US, but not foreign, tax purposes.
      • A partnership inter-branch payment splitter arrangement arises in certain cases where the allocation of a tax with respect to an inter-branch payment (as defined in Treas. Reg. § 1.704-1(b)(4)(viii)(d)(3)) results in foreign income taxes being allocated to a different partner than the related income. 
  • For taxes paid or accrued in taxable years beginning on or after January 1, 2011 and before January 1, 2012, Treas. Reg. § 1.909-5T provides that income taxes paid or accrued in connection with the following give rise to split taxes: (a) pre-2011 splitter arrangements (to the same extent that such taxes would have been treated as pre-2011 split taxes if paid or accrued by a section 902 corporation in taxable years before December 31, 2010) and (b) a partnership inter-branch splitter arrangement.  Foreign taxes paid or accrued in a taxable year beginning on or after January 1, 2012 and on or before February 9, 2012 in connection with a foreign consolidated group splitter arrangement are also split taxes to the extent that such taxes would have been treated as pre-2011 split taxes if paid or accrued by a section 902 corporation in a pre-2011 taxable year.  As the preamble to the temporary regulations explains, "[t]his rule ensures that section 909 applies to suspend foreign income tax on income of foreign consolidated groups paid or accrued in post-2010 taxable years to the extent the tax is not apportioned amount the members of the group in accordance with the principles of Treas. Reg. § 1.901-2(f)(3)," i.e., the final legal liability regulations described below.
  • The preamble to the temporary regulations states that Treasury and the IRS will continue to study other potential splitting arrangements, such as certain asset transfers and distributions, as well as the interaction of section 909 and recently enacted section 901(m) (discussed below).  Treasury and the IRS also intend to provide additional guidance on the amount of related income and split taxes attributable to a foreign tax credit splitting event.
  • The final regulations issued under section 901 (generally effective for foreign taxes paid or accrued in taxable years beginning after February 9, 2012, with certain transition rules) address when a taxpayer is considered legally liable for a foreign tax. 
    • The final regulations partially adopt 2006 proposed regulations, with one notable modification being the elimination of the rules addressing reverse hybrids (which are instead covered by the section 909 temporary regulations). 
    • Similar to the 2006 proposed regulations, the final regulations provide that, if a foreign tax is imposed on the combined income of two or more persons, foreign law is considered to impose legal liability on each such person for the amount of the tax that is attributable to such person’s portion of the tax base.  A foreign tax is considered imposed on the combined income of two or more persons even if foreign law attributes all of the combined income to one person (such as the foreign parent of a foreign consolidated group, as in Guardian).  Like the proposed regulations, the final regulations provide that foreign tax is not considered imposed on the combined income of two more persons solely because foreign law provides for group relief, requires a shareholder to include in income amounts attributable to a corporation pursuant to an integrated tax system, or requires an income inclusion pursuant to an anti-deferral regime. The final regulations also add three other situations under which foreign law is not considered to impose tax on combined income—where income is reallocated under foreign transfer pricing rules, where foreign law requires that a person take into account a distributive share of income of a fiscally transparent entity, or where foreign law requires that a person take into account income of a reverse hybrid.  
    • The final regulations also provide rules addressing the treatment of taxes imposed on partnerships and disregarded entities. 
    • The preamble to the final regulations states that Treasury and the IRS "are continuing to consider whether and to what extent to revise or clarify the general rule that tax is considered paid by the person who has legal liability under foreign law," including the issue of whether "it is appropriate to provide a special rule for determining who has legal liability in the case of a withholding tax imposed on an amount of income that is considered received by different persons for US and foreign tax purposes."
  • The regs can be accessed here, here and here.
  • For additional information, contact Philip R. West - pwest@steptoe.com or  Amanda Varma - avarma@steptoe.com

ENZI INTRODUCES INTERNATIONAL TAX REFORM BILL:  Yesterday,  Senator Mike Enzi (R-WY) introduced the "United States Job Creation and International Tax Reform Act of 2012," which would "allow U.S.-based company earnings currently sitting offshore to be brought back to America at a reduced tax rate; provide an exemption from US tax for foreign earnings already subject to taxes in a foreign country; and reduce the US tax burden on certain income derived from ideas and inventions."  Enzi said, "This bill would modernize the United States tax code, giving US companies incentives to create jobs and invest back in the United States. American companies would be competing on a level playing field with their foreign counterparts under this bill."

  • The bill:
    • Provides a 95 percent exemption from US tax for foreign earnings that have already been subject to tax in a foreign country.
    • Allows for foreign earnings currently held overseas to be brought back to America at a reduced tax rate.
    • Imposes a reduced US tax rate on certain income generated by domestic companies from ideas and inventions.
  • For the legislative text of the United States Job Creation and International Tax Reform Act of 2012, click here.
  • For a one-page summary of the bill, click here.
  • For a detailed technical explanation of the proposed tax changes, click here.

TAX BILLS INTRODUCED FEBRUARY 9TH:

1. [112nd] H.R.3997 : To amend the Internal Revenue Code of 1986 to extend the deduction for expensing of environmental remediation costs.
Sponsor: Rep Barrow, John [GA-12] (introduced 2/9/2012)      Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 2/9/2012 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

2. [112nd] H.R.3998 : To amend the Internal Revenue Code of 1986 to extend the deduction for certain expenses of elementary and secondary school teachers.
Sponsor: Rep Barrow, John [GA-12] (introduced 2/9/2012)      Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 2/9/2012 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

3. [112nd] H.R.3999 : To amend the Internal Revenue Code of 1986 to extend the deduction for mortgage insurance.
Sponsor: Rep Barrow, John [GA-12] (introduced 2/9/2012)      Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 2/9/2012 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

4. [112nd] H.R.4001 : To amend the Internal Revenue Code of 1986 to allow partnerships invested in infrastructure property to be treated as publicly traded partnerships, to reduce the depreciation recovery periods for such property, and for other purposes.
Sponsor: Rep Campbell, John [CA-48] (introduced 2/9/2012)      Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 2/9/2012 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

5. [112nd] S.2083 : A bill to amend the Internal Revenue Code of 1986 to prohibit the Secretary of the Treasury from requiring that taxpayers reconcile amounts with respect to reportable payment transactions to amounts related to gross receipts and sales.
Sponsor: Sen Thune, John [SD] (introduced 2/9/2012)      Cosponsors (1)
Committees: Senate Finance
Latest Major Action: 2/9/2012 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

6. [112nd] S.2088 : A bill to amend the Internal Revenue Code of 1986 to permanently double the amount of start-up expenses entrepreneurs can deduct from their taxes.
Sponsor: Sen Rockefeller, John D., IV [WV] (introduced 2/9/2012)      Cosponsors (None)
Committees: Senate Finance
Latest Major Action: 2/9/2012 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

7. [112nd] S.2091 : A bill to amend the Internal Revenue Code of 1986 to reform the international tax system of the United States, and for other purposes.
Sponsor: Sen Enzi, Michael B. [WY] (introduced 2/9/2012)      Cosponsors (None)
Committees: Senate Finance
Latest Major Action: 2/9/2012 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

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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