CCH Tax Day Report
The IRS has issued final regulations under Code Sec. 956 addressing U.S. property held by controlled foreign corporations (CFCs) in transactions involving partnerships, along with related proposed regulations, and has partially withdrawal some earlier proposed regulations. Code Sec. 956 determines the amount that a U.S. shareholder (as defined in Code Sec. 951(b)) of a CFC must include in gross income with respect to the CFC under Code Sec. 951(a)(1)(B). Code Sec. 956(e) authorizes regulations to prevent the avoidance of Code Sec. 956 through reorganizations or otherwise. The final regulations provide rules for determining whether a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining foreign personal holding company income (FPHCI), as well as rules for determining whether a CFC holds U.S. property as a result of certain related party factoring transactions.
The final regulations retain the basic approach and structure of 2015 proposed regulations (NPRM REG-155164-09, I.R.B. 2015-41, 560) and the portion of 1988 proposed regulations (NPRM REG-209001-86) that relates to Reg. §1.956-3, with certain revisions.
Several of the key areas addressed by the IRS under the final and proposed regulations, or in the preambles to those regulations, are discussed below.
Section 1.956-1(b) Anti-Avoidance Rule
Before 2015, temporary regulations provided that a CFC would be considered to indirectly hold investments in U.S. property acquired by any other foreign corporation that is controlled by the foreign corporation if one of the principal purposes for creating, organizing, or funding (through capital contributions or debt) the other foreign corporation is to avoid the application of Code Sec. 956 with respect to the CFC. The 2015 temporary regulations modified the anti-avoidance rule in Temporary Reg. §1.956-1T(b)(4) so that the rule could also apply when a foreign corporation controlled by a CFC is funded other than through capital contributions or debt and expanded the rule to apply to transactions involving partnerships that are controlled by a CFC.
The final regulations add new examples addressing common transactions to illustrate the distinction between funding transactions that are subject to the anti-avoidance rule and common business transactions to which the anti-avoidance rule does not apply.
Partnership Property Indirectly Held by a CFC Partner
Rev. Rul. 90-112, 1990-2 CB 186, addressed the treatment under Code Sec. 956 of U.S. property held by a CFC indirectly through a partnership. The revenue ruling includes an outside basis limitation—a limitation on the measurement of U.S. property—that is not included in the final or proposed regulations. Specifically, the revenue ruling provides that the amount of U.S. property taken into account for purposes of Code Sec. 956 when a CFC partner indirectly owns property through a partnership is limited by the CFC’s adjusted basis in the partnership. The IRS has determined, however, that an outside basis limitation should not be incorporated into the rule in final Reg. §1.956-4(b)(1).
Time for Determining the Liquidation Value Percentage
The IRS’s position is that the liquidation value percentage should be redetermined upon a revaluation event, which may result in a significant change in the partners’ relative economic interests in a partnership. The final regulations provide that a partner’s liquidation value percentage must be redetermined in certain additional circumstances even absent a revaluation event. Specifically, if the liquidation value percentage determined for any partner on the first day of the partnership’s tax year would differ from the most recently determined liquidation value percentage of that partner by more than 10 percentage points, then the liquidation value percentage must be redetermined on that day even in the absence of a revaluation event.
Under Proposed Rules, Partner’s Attributable Share Determined without Regard to Special Allocations
Proposed Reg. §1.956-4(b)(2)(ii) defines a special allocation as an allocation of income (or, where appropriate, gain) from partnership property to a partner under a partnership agreement that differs from the partner’s liquidation value percentage in a particular tax year.
However, the IRS has determined that special allocations with respect to a partnership controlled by a U.S. multinational group (a controlled partnership) and its CFCs are unlikely to have economic significance for the group as a whole and can lead to improper tax planning. As a result, the IRS has proposed a new rule under which a partner’s attributable share of property of a controlled partnership is determined solely in accordance with the partner’s liquidation value percentage, without regard to any special allocations (NPRM REG-114734-16).
Obligations of Foreign Partnerships
The general rule in Reg. §1.956-4(c)(1) adopts an aggregate approach, treating an obligation of a foreign partnership as a separate obligation of each partner in proportion to the partners’ interest in partnership profits.
The IRS has determined that the liquidation value percentage method should be used to determine a partner’s share of a foreign partnership’s obligation. As a result, the final regulations provide that an obligation of a foreign partnership is treated as an obligation of its partners in proportion to the partners’ liquidation value percentage with respect to the partnership.
The IRS has withdrawn portions of NPRM REG-209001-86 that relate to stock redemptions through related corporations, the application of Code Sec. 956 to U.S. property indirectly held by a CFC, and certain related party factoring transactions, as well as the definition of the term “obligation” for purposes of Code Sec. 956.
T.D. 9792, 2016FED ¶47,052
Proposed Regulations, NPRM REG-122387-16, 2016FED ¶49,719
Proposed Regulations, NPRM REG-114734-16, 2016FED ¶49,720
Code Sec. 956
CCH Reference – 2016FED ¶28,535B
CCH Reference – 2016FED ¶28,571
CCH Reference – 2016FED ¶28,572
CCH Reference – 2016FED ¶28,573
CCH Reference – 2016FED ¶28,574D
CCH Reference – 2016FED ¶28,575D
CCH Reference – 2016FED ¶28,575DB
Tax Research Consultant
CCH Reference – TRC INTLOUT: 9,254