CCH Tax Day Report
The Treasury and IRS intend to issue regulations under Code Sec. 909 that will address the separation of related income from foreign taxes paid by a Code Sec. 902 corporation pursuant to a foreign-initiated adjustment. The regulations are in response to concerns that, prior to the payment pursuant to a foreign-initiated adjustment, such as an adjustment under European Union (EU) State aid law, a taxpayer may change its ownership structure or cause a Code Sec. 902 corporation to make an extraordinary distribution. The subsequent tax payment can then create a high-tax pool of post-1986 undistributed earnings that generate substantial amounts of foreign taxes deemed paid, without U.S. taxation of the earnings and profits to which the taxes relate. The regulations will identify two new splitter arrangements-a splitter arrangement for ownership changes and a splitter arrangement for distributions. The regulations will apply similar rules to taxpayers that take the position that taxes paid by a U.S. person pursuant to a foreign-initiated adjustment to the tax liability of a Code Sec. 902 credit are eligible for the direct foreign tax credit under Code Sec. 901.
The regulations will apply to foreign income taxes paid on or after September 15, 2016. No inference is intended from Notice 2016-52, describing the regulations, as to the treatment of transactions described under current law. No inference is also intended as to whether (1) payments pursuant to a foreign-initiated adjustment qualify as payments of creditable tax, or (2) taxes paid by a U.S. person pursuant to a foreign-initiated adjustment to the tax liability of a Code Sec. 902 corporation are eligible for a Code Sec. 901 foreign tax credit.
Code Sec. 905(c) requires taxpayers to notify the IRS when the foreign tax liability in a prior year changes so that the IRS can redetermine the amount of U.S. tax for the year. With respect to foreign income taxes deemed paid under Code Sec. 902 or Code Sec. 960, the IRS can adjust pools of post-1986 foreign income taxes and post-1986 undistributed earnings in lieu of redetermining the U.S. shareholder’s income tax. Accrued foreign taxes of a Code Sec. 902 corporation paid more than two years after the close of the tax year to which they relate, are taken into account in the tax year in which they are paid. Neither Code Sec. 905(c) or its regulations address how to account for payments of additional foreign taxes with respect to the earnings of a Code Sec. 902 corporation if, as a result of a liquidation, reorganization, or other corporate transaction, the person making the additional payment of foreign taxes as a result of a foreign-initiated adjustment is other than the Code Sec. 902 corporation that would have paid the tax, if the additional tax were paid in the year to which the tax relates.
In general, Code Sec. 909(a) provides that if there is a foreign tax credit splitting event, with respect to foreign income tax paid or accrued, the tax will not be taken into account before the tax year in which the related income is taken into account by the taxpayer. If there is a foreign tax credit splitting event with respect to foreign income tax paid or accrued by a Code Sec. 902 corporation, Code Sec. 909(b) provides that the tax is not taken into account for purposes of Code Sec. 902 or Code Sec. 960, or for purposes of determining earnings or profits under Code Sec. 964(a), before the tax year in which the related income is taken into account by the Code Sec. 902 corporation or the domestic corporation that meets the ownership requirements of Code Sec. 902(a) or Code Sec. 902(b).
Splitter Arrangements Arising from Application of Code Sec. 905(c) to Successor Entities
In this foreign-initiated adjustment splitter arrangement, changes in ownership structures result in a foreign tax credit splitting event. The regulations will provide that a splitter arrangement arises when, as a result of a “covered transaction” a Code Sec. 902 corporation pays “covered taxes” during the tax or splitter year.
Covered taxes are foreign income taxes taken into account through adjustment of post-1986 pools of undistributed earnings and foreign income taxes underCode Sec. 905(c). The taxes must result from a “specified foreign-initiated adjustment” to foreign income tax accrued in prior tax years or “relation-back years.” A specified foreign-initiated adjustment is an adjustment (or series of related adjustments to more than one tax year) that result in a foreign income tax liability greater than $10 million.
A covered transaction is generally a transaction (or series of transactions) that results in covered taxes being paid by a payor that is a Code Sec. 902 and that is not the Code Sec. 902 corporation that would have been the payor of the covered taxes (the predecessor entity) if those taxes had been paid or accrued in the relation-back year. Additionally, the predecessor entity or its successor must have been a covered person with respect to the payor immediately before the transaction. If the payor entity did not exist immediately before the transaction, the predecessor entity or its successor must have been a covered person with respect to the payor entity immediately after the transaction.
A transaction will not be a covered transaction if: (1) the transaction results in a transfer of earnings and profits of the predecessor entity to the payor underCode Sec. 381(2), or (2) it is demonstrated that the transaction was not structured with the principal purpose of separating covered taxes and post-1986 undistributed earnings of the predecessor entity that include the earnings to which the covered taxes relate.
An example is provided to illustrate these rules.
Splitter Arrangements Arising from Distributions Made Before the Payments of Additional Tax Pursuant to Foreign-Initiated Adjustments
In this foreign-initiated splitter adjustment, distributions are used to move post-1986 undistributed earnings from one Code Sec. 902 corporation to another Code Sec. 902 corporation before the first Code Sec. 902 corporation makes a tax payment pursuant to a foreign-initiated adjustment. As a result, the earnings to which the tax payment relate are taken into account by the payor, but then are taken into account by a covered person that is a Code Sec. 902 corporation before the first Code Sec. 902 corporation pays the tax. The regulations will provide that a splitter arrangement exists when a payor that is a Code Sec. 902 corporation pays covered taxes during a tax year and the payor or its predecessor has made a “covered distribution.”
A covered distribution is any distribution with respect to the payor’s stock to the extent that the distribution: (1) occurred in a tax year of the payor to which the covered taxes relate or an subsequent tax years, up to and including the tax year immediately before the tax year in which the covered taxes are paid, (2) resulted in a distribution or allocation of the payor’s post-1986 undistributed earnings to a Code Sec. 902 person, and (3) was made with the principal purpose of reducing the payor’s post-1986 undistributed earnings that included the earnings to which the covered taxes relate in advance of the payment of covered taxes.
Examples are provided to illustrate these rules.
The Treasury and IRS are soliciting comments on the rules in Notice. In particular comments are requested on whether the transactions would more appropriately be addressed under the rules of Code Sec. 905(c) and whether an objective rather than subjective test should be used to determine when the transactions are treated as splitter arrangements.
Written or electronic comments must be submitted by December 14, 2016, to the Office of Associate Chief Counsel (International), Attention: Jeffrey Parry, Internal Revenue Service, IR-4554, 1111 Constitution Avenue, NW, Washington, D.C. 20224 or to Notice.firstname.lastname@example.org.
Notice 2016-52, 2016FED ¶46,405
Code Sec. 902
CCH Reference – 2016FED ¶27,843,152
Code Sec. 905
CCH Reference – 2016FED ¶27,907.183
Code Sec. 909
CCH Reference – 2016FED ¶27,975.10
Tax Research Consultant
CCH Reference – TRC INTLOUT: 3,300