International Tax Update

Transcription

1 International Tax Update AMERICAN BAR ASSOCIATION SECTION OF TAXATION 26TH ANNUAL PHILADELPHIA TAX CONFERENCE November 6, :20 a.m. 12:35 p.m.

2 International Tax Update The panel will discuss the most recent developments in international tax. Chair Neil Feinstein, Deloitte Tax LLP, Philadelphia, PA Speakers Joseph Calianno, BDO, Washington, DC Michael DiFronzo, PwC, Washington, DC Gretchen Sierra, Deloitte Tax LLP, Washington, DC

3 Treatment of Foreign Goodwill and Going Concern Value under Sections 367(a) and (d)

4 Treatment of Foreign Goodwill and Going Concern Value under Sections 367(a) and (d) Section 367(a)(1) provides for a general gain recognition rule when a United States person transfers appreciated property to a foreign corporation in certain nonrecognition transactions. There are exceptions to this general gain recognition rule. One exception is for certain assets that are used by the a foreign corporation in the active trade or business outside the United States; however, certain property is ineligible for this exception. See section 367(a)(3) and the regulations under section 367(a) addressing this exception.

5 Treatment of Foreign Goodwill and Going Concern Value under Sections 367(a) and (d) Section 367(d) provides rules for certain outbound transfers of intangible property described in section 936(h)(3)(B). Generally, section 367(d) treats such person as having transferred that property in exchange for annual payments contingent on the productivity or use of the property and such person is required to, over the useful life of the property (not to exceed 20 years but see proposed change to this rule), annually include in gross income an amount that represents an appropriate arms-length charge for the use of the property. See Reg (d)-1T for additional details. Section 367(d)(1) provides that, except as provided in regulations, if a U.S. transferor transfers any intangible property, within the meaning of section 936(h)(3)(B), to a foreign corporation in an exchange described in section 351 or 361, section 367(d) (and not section 367(a)) applies to such transfer.

6 Treatment of Foreign Goodwill and Going Concern Value under Sections 367(a) and (d) Section 936(h)(3)(B) defines intangible property to mean any: (i) patent, invention, formula, process, design, pattern, or know-how; (ii) copyright, literary, musical, or artistic composition; (iii) trademark, trade name, or brand name; (iv) franchise, license, or contract; (v) method, program, system, procedure, campaign, survey, study, forecast, estimate, customer list, or technical data; or (vi) any similar item, which has substantial value independent of the services of any individual (section 936(h)(3)(B) intangible property).

7 Treatment of Foreign Goodwill and Going Concern Value under Sections 367(a) and (d) Treas. Reg (d)-1T(b) generally provides that section 367(d) and Treas. Reg (d)-1T apply to the transfer of any intangible property, but not to the transfer of foreign goodwill or going concern value, as defined in Treas. Reg (a)- 1T(d)(5)(iii). Treas. Reg (a)-1T(d)(5)(i) generally defines intangible property, for purposes of section 367, as knowledge, rights, documents, and any other intangible item within the meaning of section 936(h)(3)(B) that constitutes property for purposes of section 332, 351, 354, 355, 356, or 361, as applicable. Treas. Reg (a)-1T(d)(5)(iii) defines foreign goodwill or going concern value as the residual value of a business operation conducted outside of the United States after all other tangible and intangible assets have been identified and valued and Treas. Reg (a)-1T(d)(5)(iii) also provides that, for purposes of section 367 and the regulations thereunder, the value of a right to use a corporate name in a foreign country is treated as foreign goodwill or going concern value.

8 Legislative History Legislative history supporting exception for foreign goodwill or going concern value: The committee contemplates that, ordinarily, no gain will be recognized on the transfer of goodwill or going concern value for use in an active trade or business. S. Rep. No. 169, 98th Cong., 2d Sess., at 364; H.R. Rep. No. 432, 98th Cong., 2d Sess., at The Senate Finance Committee and the House Committee on Ways and Means each noted, without explanation, that it does not anticipate that the transfer of goodwill or going concern value developed by a foreign branch to a newly organized foreign corporation will result in abuse of the U.S. tax system. S. Rep. No. 169, 98th Cong., 2d Sess., at 362; H.R. Rep. No. 432, 98th Cong., 2d Sess., at 1317.

9 Taxpayer Interpretations and IRS Response In general, taxpayers interpret section 367 and the regulations under sections 367(a) and (d) in one of two alternative ways when claiming favorable treatment for foreign goodwill and going concern value. Under one interpretation, taxpayers take the position that goodwill and going concern value are not section 936(h)(3)(B) intangible property and therefore are not subject to section 367(d) because section 367(d) applies only to section 936(h)(3)(B) intangible property. Under this interpretation, taxpayers assert that the foreign goodwill exception has no application. Furthermore, these taxpayers assert that gain realized with respect to the outbound transfer of goodwill or going concern value is not recognized under the general rule of section 367(a)(1) because the goodwill or going concern value is eligible for, and satisfies, the active trade or business exception under section 367(a)(3)(A).

10 Taxpayer Interpretations and IRS Response (Cont d) Under a second interpretation, taxpayers take the position that, although goodwill and going concern value are section 936(h)(3)(B) intangible property, the foreign goodwill exception applies. These taxpayers also assert that section 367(a)(1) does not apply to foreign goodwill or going concern value, either because of section 367(d)(1)(A) (providing that, except as provided in regulations, section 367(d) and not section 367(a) applies to section 936(h)(3)(B) intangible property) or because of the active trade or business exception. The Treasury Department and the IRS have asserted in the preamble to the proposed regulations that, in the context of outbound transfers, some taxpayers attempt to avoid recognizing gain or income attributable to high-value intangible property by asserting that an inappropriately large share (in many cases, the majority) of the value of the property transferred is foreign goodwill or going concern value that is eligible for favorable treatment under section 367.

11 Overview of REG Eliminate the favorable treatment afforded foreign goodwill and going concern value by removing the foreign goodwill and going concern value exception under section 367(d) and limiting the scope of the active trade or business exception under section 367(a) generally to certain tangible property and financial assets Thus, under the proposed regulations, upon an outbound transfer of foreign goodwill and going concern value, a U.S. transferor will either (i) currently recognize gain realized under section 367(a) or (ii) annually include an amount in gross income under section 367(d) Although the proposed regulations do not address whether foreign goodwill and going concern value is a section 936 intangible, to reduce the consequences of the uncertainty, the proposed regulations allow taxpayers taking the position that certain intangible property is not described in section 936(h)(3)(B) and therefore is not subject to section 367(d) to choose to apply section 367(d) to such property rather than recognizing immediate gain with respect to that intangible property under section 367(a)

12 Overview of REG Modify the 1.367(a)-1T regulations to provide that the value of property transferred outbound must be determined under section 482 in the case of controlled transactions Remove the definition of foreign goodwill and going concern value Eliminate the 20-year limitation on useful life for purposes of applying section 367(d) To facilitate the narrowing of the scope of the active trade or business exception and to make the regulations concerning the active trade or business exception more accessible, combine portions of those existing regulations into a single regulation Remove the foreign currency exception to the statutory rule providing that foreign currency and other property denominated in a foreign currency are ineligible for the active trade or business exception Eliminate special rules for outbound transfers to FSCs because FSC rules have been repealed Modify the scope of property subject to a depreciation recapture rule to include section 126 property (as defined in section 1255(a)(2)) Make conforming changes to the information reporting requirements under the section 6038B regulations

13 Overview of REG The proposed regulations would generally apply (i) to transfers occurring on or after September 14, 2015, and (ii) to transfers occurring before September 14, 2015, that result from retroactive entity classification elections filed on or after that date In the case of the removal of the foreign currency exception, the effective date would be prospective based on when the proposed regulations are finalized

14 Temporary Regulations Under Section 482 Clarify that all transfers of value between controlled taxpayers require arm s length compensation, regardless of the form or character of the transfer Clarify that the aggregation principle: encompasses synergies among items transferred and services provided in two or more interrelated transactions, is relevant when transactions are subject to different provisions of the Code or regulations (including an exclusion or nonrecognition provision), and applies even though an aggregate adjustment may need to be allocated for one or more purposes Revise the section 482 regulations to provide more explicit coordination of section 482 and other Code provisions (including clarifying that the realistic alternatives and aggregation principles apply to transfers of value through multiple transactions and/or under multiple Code provisions)

15 Proposed and Temporary Regulations under Section 956

16 Proposed and Temporary Regs under Section 956 Background On September 1, 2015, the IRS and Treasury Department issued proposed and temporary regulations under sections 956 and 954. The proposed regulations address the treatment under section 956 of United States property held by CFCs in transactions involving partnerships. The temporary and final regulations address the treatment under section 956 of certain indirectly held United States property of a CFC and certain foreign partnership distributions funded by CFCs. The temporary and final regulations also provide guidance under section 954 on the active rents and royalties exception.

17 Temporary Regulations under Section 956 Overview The temporary regulations modify the anti-avoidance rule under existing Temp. Reg T(b)(4). The temporary regulations also add a rule under Temp. Reg T(b)(5) that provides that for purposes of section 956, an obligation of a foreign partnership that is held (or would be treated as held under (c) if the obligation were an obligation of a U.S. person) by a CFC is treated as a separate obligation of a partner when the foreign partnership distributes money or property to the partner that would not have been made but for a funding of the partnership through the obligation, and the distributee partner is related to the CFC within the meaning of section 954(d)(3). Finally, the temporary regulations modify the scope of the active rents and royalty income exceptions under section 954(c)(2)(A) and Treas. Reg (c) and (d).

18 Temporary Regulations under Section 956 Modification of the Anti-Avoidance Rule Existing Temp. Reg T(b)(4) provides that, at the District Director s discretion, a CFC is considered to hold indirectly investments in United States property acquired by any other foreign corporation that is controlled by the CFC if one of the principal purposes for creating, organizing, or funding (through capital contributions or debt) such other foreign corporation is to avoid the application of section 956 with respect to the CFC. For this purpose, control is generally defined by reference to section 267(b). Thus, the current temporary regulations apply only where: United States property is acquired by a foreign corporation, that corporation is funded through capital contributions or debt, and there is an exercise of discretion by the District Director.

19 Temporary Regulations under Section 956 Modification of the Anti-Avoidance Rule The new rule in the temporary regulations treats a CFC as holding indirectly the investments in United States property acquired by a partnership that is controlled by the CFC within the meaning of section 707(b) where a principal purpose of creating, organizing, or funding, by any means (including through capital contributions or debt) the partnership is to avoid the application of section 956 with respect to the CFC. This revised rule expands the scope of funded to include transactions in which the foreign corporation is funded by any means, including through capital contributions or debt. The revised rule applies without requiring the IRS to exercise its discretion. Therefore, the rule is self-executing.

20 Temporary Regulations under Section 956 Modification of the Anti-Avoidance Rule The temporary regulations add an example involving the funding of one CFC by another CFC that controls the funded CFC in order to show that the anti-avoidance rule can apply if there exists a principal purpose to avoid the application of section 956 with respect to the funding CFC, even though there would be a section 956 inclusion with respect to the CFC that received the funding. To determine whether a tax avoidance purpose exists, tax attributes of the funded CFC are taken into account (e.g., foreign tax credit pools, earnings and profits, previously taxed earnings, etc.). The example further demonstrates that if a CFC indirectly holds United States property pursuant to T(b)(4), then the CFC that actually holds the United States property will not also be considered to hold the property for purposes of section 956.

21 Temporary Regulations under Section 956 Indirectly Held U.S. Property Example 1 FS1 sells inventory to FS2 in exchange for trade receivables due in 60 days. A principle purpose of establishing the trade receivables was not to avoid the application of 956 with respect to FS1. FS2 has no earnings and profits and FS1 has substantial accumulated earnings and profits. FS2 makes a loan to P equal to the amount it owes FS1 under the trade receivables. FS2 pays the trade receivables according to their terms. FS1 is not considered to indirectly hold U.S. property under T(b)(4) because the funding of FS2 through the sale of inventory in exchange for the establishment of trade receivables was not undertaken with a principal purpose of avoiding the application of 956 with respect to FS1. 100% FS1 CFC P domestic 100% FS2 CFC FS1 sells inventory to FS2 in exchange for Trade Receivable FS2 makes loan to P

22 Temporary Regulations under Section 956 Indirectly Held U.S. Property Example 2 Same facts as in Example 1, except that, with a principle purpose of avoiding the application of section 956 with respect to FS1, FS1 and FS2 agree to defer FS2 s payment obligation, and FS2 does not timely pay the receivables. FS2 makes a loan to P equal to the amount it owes FS1 under the trade receivables. FS2 pays the trade receivables according to their terms. FS1 is considered to indirectly hold U.S. property under T(b)(4) because there was a funding of FS2, a principal purpose of which was to avoid the application of section 956 with respect to FS1. 100% FS1 CFC P domestic 100% FS2 CFC FS1 sells inventory to FS2 in exchange for Trade Receivable FS2 makes loan to P

23 Temporary Regulations under Section 956 Indirectly Held U.S. Property Example 3 Neither FS1 nor FS2 has E&P described in section 959(c)(1) or 959(c)(2). FS2 loans $100x to FS1. FS1 then loans $100x to P. An income inclusion by P of $100x under sections 951(a)(1)(B) and 956 with respect to FS1 would result in foreign income taxes deemed paid by P under section 960. A principal purpose of funding FS1 through the loan from FS2 is to avoid the application of section 956 with respect to FS2. Then FS1 loans $100x to P 100% P domestic 100% Under T(b)(4)(i)(B), FS2 is considered to indirectly hold the $100x obligation of P that is held by FS1. As a result, P has an income inclusion of $100x under sections 951(a)(1)(B) and 956 with respect to FS2, and the foreign income taxes deemed paid by P under section 960 is $0. P does not have an income inclusion under sections 951(a)(1)(B) and 956 with respect to FS1 related to the $100x loan from FS1 to P. FS1 CFC FS1 has: $100x E&P $100x foreign taxes $0 cash First, FS2 loans $100x to FS1 FS2 CFC FS2 has: $100x E&P $0x foreign taxes substantial cash

24 Temporary Regulations under Section 956 Indirectly Held U.S. Property Example 4 FS1 has substantial earnings and profits. P and FS1 are the only partners in FPRS. There are no special allocations in the FPRS partnership agreement. FPRS lends $100x to P. Under (a)(3), FS1 is treated as holding U.S. property of $60x (60% x $100x) as a result of the FPRS loan to P. A principal purpose of creating, organizing, or funding FPRS is to avoid the application of section 956 with respect to FS1. FS1 contributes $600x cash in exchange for 60% interest P contributes foreign real estate (FMV=$400x) in exchange for 40% interest

25 Temporary Regulations under Section 956 Indirectly Held U.S. Property Example 4 (cont d) Before taking into account T(b)(4)(iii), because FS1 controls FPRS and a principal purpose of creating, organizing, or funding FPRS was to avoid application of section 956 with respect to FS1, under T(b)(4)(i)(C) FS1 is considered to indirectly hold P s $100x obligation that would be U.S. property if held directly by FS1. Under T(b)(4)(iii), FS1 is treated as holding U.S. property under T(b)(4)(i)(C) only to the extent the amount held indirectly under T(b)(4)(i)(C) exceeds the amount of U.S. property that FS1 is treated as holding under (a)(3). The amount of U.S. property that FS1 is treated as indirectly holding under T(b)(4)(i)(C) ($100x) exceeds the amount determined under (a)(3) ($60x) by $40x. Thus, FS1 is considered to hold U.S. property within the meaning of section 956(c) in the amount of $100x ($60x under (a)(3) and $40x under T(b)(4)(i)(C) and (b)(4)(iii)). 100% P domestic 100% FS1 CFC FS2 CFC FPRS foreign P contributes foreign real estate (FMV=$400x) in exchange for 40% interest

26 Temporary Regulations under Section 956 Foreign Partnership Distributions Funded by CFCs New Temp. Reg T(b)(5) provides that an obligation of a foreign partnership that s held by a CFC (or would be treated as held by CFC under (c) if it were an obligation of a United States person) is treated as a separate obligation of a partner when the foreign partnership distributes money or property to the partner that would not have been made but for a funding of the partnership through the obligation, and the distributee partner is related to the CFC within the meaning of section 954(d)(3). The amount treated as an obligation of the distributee partner is the lesser of: (i) the amount of the distribution that would not have been made but for the funding of the partnership, or (ii) the amount of the obligation that s held by the CFC (or that would be treated as held by the CFC under (c) if the obligation were an obligation of a United States person). The preamble to the temporary regulations states that T(b)(5) will be withdrawn once the proposed section 956 regulations are finalized. Due to difference in effective dates, however, new T(b)(5) applies to transactions entered into on or after September 1, 2015 and before the proposed section 956 regulations are finalized.

27 Temporary Regulations under Section 956 Foreign Partnership Distributions Funded by CFCs Example FPRS borrows $100x from FS and distributes $80x to P. FPRS would not have made the distribution to P but for the funding by FS. A portion of the obligation of FPRS that FS holds is treated as an obligation of P, which constitutes U.S. property, because FPRS made a distribution to P that FPRS would not have made but for the funding of FPRS through the obligation held by FS. The amount that is treated as an obligation of P is the lesser of the amount of the distribution, $80x, or the amount of the entire obligation of FPRS held by FS, $100x. For purposes of section 956, therefore, on the date the loan to FPRS is made, FS is considered to hold U.S. property of $80x. P domestic 100% FS CFC $100x loan FPRS foreign X domestic 70% 30%

28 Temporary Regulations under Section 954 Active Rents and Royalty Income Exceptions The temporary regulations modify the scope of the active rents and royalty income exceptions under section 954(c)(2)(A) and Treas. Reg (c) and (d). The active rents and royalty income exceptions can be satisfied through one of several tests under current law: One test is the active development test, which requires the CFC to be regularly engaged either in manufacture or production of, or in acquisition of and addition of substantial value to, certain property ( (c)(1)(i), applicable to rents); or in development, creation or production of, or in acquisition of and addition of substantial value to, certain property ( (d)(1)(i), applicable to royalties) (collectively, the active development tests ). The active marketing tests under (c)(1)(iv) and (d)(1)(ii) apply with respect to property which is leased or licensed as a result of the performance of marketing functions if the lessor or licensor, through its own officers or staff of employees located in a foreign country, maintains and operates an organization in such country which is regularly engaged in the business of marketing, or of marketing and servicing, the leased or licensed property and which is substantial in relation to the amount of rents or royalties derived from the leasing or licensing of such property.

29 Temporary Regulations under Section 954 Active Rents and Royalty Income Exceptions With respect to the active development tests, the temporary regulations provide that the CFC lessor or licensor must perform the required functions through its own officers or staff of employees. In determining whether a CFC conducts activities through its own officers or staff of employees, cost sharing transaction ( CST ) payments and platform contribution transaction ( PCT ) payments (within the meaning of ) will not cause the CFC to be treated as conducting the activities performed by the controlled participant to which payments are made. With respect to the active marketing tests, the temporary regulations provide that the tests can be satisfied by officers or staff of employees located in one or more foreign countries by organizations maintained and operated in one or more foreign countries. In determining whether those marketing activities are substantial, CST and PCT payments are not considered active leasing or licensing expenses.

30 Temporary Regulations under Section 956 Effective Dates Temporary regulations under T(b)(4) and (5) apply to taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, with respect to property acquired, including property treated as acquired as the result of a deemed exchange of property pursuant to section 1001, on or after September 1, Temporary regulations regarding the active development tests apply to rents or royalties received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, but only with respect to property manufactured, produced, developed, created, or acquired and to which substantial value has been added on or after September 1, Temporary regulations regarding the active marketing tests apply to rents or royalties received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of U.S. shareholders in which or with which such taxable years end, to the extent that such rents or royalties are received or accrued on or after September 1, The preamble to the temporary regulations provides that no inference is intended as to the application of the provisions amended by the new temporary regulations under current law.

31 Proposed Regulations under Section 954 Overview United States Property Owned through Partnerships: the proposed regulations provide rules for determining the amount of United States property that a CFC partner is treated as holding through a partnership. The proposed regulations treat a CFC partner as holding its share of partnership property based on the partner s liquidation value percentage. Obligations of Foreign Partnerships: the proposed regulations address when CFC loans to foreign partnerships constitute United States property within the meaning of section 956. Specifically, the proposed regulations address when a foreign partnership s obligation is treated as an obligation of a United States person. Pledges and Guarantees of a United States Person s Obligation: proposed regulations expand the pledges and guarantees rules that give rise to United States property to transactions involving partnerships.

32 Proposed Regulations under Section 956 U.S. Property Owned Through Partnerships Liquidation Value Percentage Existing rules under (a)(3) provide that a CFC partner in a partnership holding property that would be United States property if held directly by the CFC partner is treated as holding an interest in that property based on the partner s interest in the partnership. There is no specific rule for measuring a CFC partner s interest in the partnership. The proposed regulations provide that for purposes of section 956, a partner is treated as holding its attributable share of property held by the partnership, which is determined in accordance with the partner s liquidation value percentage. liquidation value = cash partner would receive with respect to its interest if partnership sold all assets for section 704(b) book value, satisfied its liabilities, and liquidated. The preamble to the proposed regulations states that it is reasonable to use liquidation value percentage prior to the finalization of the proposed regulations.

33 Proposed Regulations under Section 956 U.S. Property Owned Through Partnerships Liquidation Value Percentage Special Allocation Rule If there are special allocations that differ from the partner s liquidation value percentage in a particular tax year, the proposed regulations provide that partner s attributable share of that property is determined solely in reference to the partner s special allocation with respect to the property, provided the special allocation does not have a principal purpose of avoiding the purposes of section 956.

34 Proposed Regulations under Section 956 U.S. Property Owned Through Partnerships Example 1 FPRS holds non-depreciable property that would be U.S. property if held by FS directly with an adjusted basis of $100x. At the close of quarter 1 of year 1, the liquidation value percentage for FS with respect to FPRS is 25%. There are no special allocations in the FPRS partnership agreement. Under the proposed regulations, FS s attributable share of property held by FPRS is 25% (its liquidation value percentage), and its attributable share of FPRS s basis in the property is $25x. Accordingly, for purposes of determining the amount of U.S. property held by FS as of the close of quarter 1 of year 1, FS is treated as holding U.S. property with an adjusted basis of $25x. AB = $100x

35 Proposed Regulations under Section 956 U.S. Property Owned Through Partnerships Example 2 Same facts as Example 1, except the FPRS partnership agreement, which satisfies the requirements of section 704(b), specially allocates 80% of the income with respect to U.S. property to FS. The special allocation does not have a principal purpose of avoiding the purposes of section 956. Because of the special allocation, FS s attributable share of U.S. property is determined in accordance with its special allocation. FS s special allocation percentage for U.S. property is 80%, and thus FS s attributable share of U.S. property held by FPRS is 80% and its attributable share of FPRS s basis in U.S. property is $80x. Accordingly, for purposes of determining the amount of U.S. property held by FS as of the close of quarter 1 of year 1, FS is treated as holding U.S. property with an adjusted basis of $80x.

36 Proposed Regulations under Section 956 U.S. Property Owned Through Partnerships Example 3 FPRS property is anticipated to appreciate in value but generates relatively little income. FPRS partnership agreement, which satisfies the requirements of section 704(b), specially allocates 80% of income with respect to FPRS property to USP and 80% of gain with respect to disposition of FPRS property to FS. The special allocation does not have a principal purpose of avoiding the purposes of section 956. FS CFC USP domestic The partners attributable shares of the FPRS property are determined in accordance with the special allocations of gain. Accordingly, for purposes of determining the amount of U.S. property held by FS in each year that FPRS holds FPRS property, FS s attributable share of the FPRS property is 80% and its attributable share of FPRS s basis in U.S. property is $80x. Special allocation Of 80% of gain from property FPRS foreign US Property AB = $100x Special allocation of 80% of income from property Thus, FS is treated as holding U.S. property with an adjusted basis of $80x.

37 Proposed Regulations under Section 956 Obligations of Foreign Partnerships - Generally The proposed regulations treat an obligation of a foreign partnership as an obligation of its partners for purposes of section 956. Specifically, Prop. Reg (c)(1) treats an obligation of a foreign partnership as an obligation of the partners to the extent of each partner s share of the obligation, as determined in accordance with the partner s interest in partnership profits. IRS and Treasury requested comments as to whether another method is more appropriate for determining a partner s share of a foreign partnership s obligation. Alternative methods include a liquidation value method, an approach that traces the proceeds, an approach that looks to a partner s share of the obligation under section 752, and others? For purposes of applying section 956 with respect to a CFC, the general rule of Prop. Reg (c)(1) does not apply to an obligation of foreign partnerships in which neither the CFC nor any person related to the CFC within the meaning of section 954(d)(3) is a partner; such obligations are treated as obligations of the foreign partnership under Prop. Reg (c)(2).

38 Proposed Regulations under Section 956 Obligations of Foreign Partnerships Distribution Rule There is a special rule for determining a partner s share of a foreign partnership s obligation under section 956 when: (1) the foreign partnership distributes money or property to a partner that s related to the CFC within the meaning of section 954(d)(3); (2) the foreign partnership s obligation would be United States property if held (or treated as held) by the CFC; and (3) the distribution would not have been made but for a funding of the partnership through an obligation held (or treated as held) by a CFC. When this rule applies, the partner s share of the foreign partnership s obligation is the greater of -- the partner s share of the partnership obligation under the proposed regulations; or the lesser of: (1) the amount of the distribution that would not have been made but for the funding of the partnership or (2) the amount of the obligation (as determined under section (e)).

39 Proposed Regulations under Section 956 Obligations of Foreign Partnerships Example 1 FPRS borrows $100x from FS. FS s basis in the FPRS obligation is $100x. For purposes of section 956, the obligation of FPRS is treated as obligations of its partners, USP and X, to the extent of each partner s interest in the partnership profits of FPRS. Because USP, a partner in FPRS, is related to FS within the meaning of section 954(d)(3), the exception in the proposed regulations does not apply. Based on its interest in FPRS s profits, USP s attributable share of the FPRS obligation is $90x under the proposed regulations. Accordingly, $90x of the FPRS obligation held by FS is treated as an obligation of USP and is U.S. property within the meaning of section 956(c). Therefore, on the date the loan is made, FS is treated as holding U.S. property of $90x. FS CFC $100x Loan 100% USP domestic FPRS foreign 90% interest in FPRS profits FPRS s AB in $100x obligation = $100x X unrelated foreign 10% interest in FPRS profits

40 Proposed Regulations under Section 956 Obligations of Foreign Partnerships Example 2 Facts are the same as in Example 1, except that UPS owns 40% of FS stock and is not a related person (under section 954(f)(3)) with respect to FS. Y is a U.S. person unrelated to USP or X. Because neither FS nor any person related to FS within the meaning of section 954(d)(3) is a partner in FPRS, the exception in Prop. Regs (c)(2) applies to treat the FPRS obligation as an obligation of a foreign partnership. Accordingly, Prop. Regs (c)(1) does not apply and FS is not treated as holding U.S. property. Y unrelated US person 60% FS CFC $100x Loan 40% USP domestic FPRS foreign 90% interest in FPRS profits X unrelated foreign 10% interest in FPRS profits FPRS s AB in $100x obligation = $100x

41 Proposed Regulations under Section 956 Obligations of Foreign Partnerships Example 3 For purposes of section 956, the obligation of FPRS is treated as obligations of its partners to extent of each partner s interest in partnership profits. Because USP is related to FS and FS is a partner in FPRS, the exception in (c)(2) does not apply. USP s attributable share of FPRS obligation is $60x and USC s share is $10x. Thus, $60x of FPRS obligation is treated as an obligation of USP, and $10x is treated as an obligation of USC. Under (c)(1), FS is treated as holding the obligations of USP and USC that FS guaranteed. All exceptions to the definition of U.S. property in section 956 and apply to determine whether the obligations of USP and USC treated as held by FS constitute U.S. property. Accordingly, the obligation of USC is not U.S. property under section 956(c)(2)(F) and (b)(1)(viii). The obligation of USP is U.S. property under section 956(c). Therefore, on the date the guarantee is made, FS is treated as holding U.S. property of $60x. FS guarantees the obligation of FPRS Unrelated lender $100x Loan 100% FS CFC 30% interest in profits USP domestic FPRS foreign 60% interest in profits USC unrelated 10% interest in profits

42 Proposed Regulations under Section 956 Obligations of Foreign Partnerships Example 4 FPRS would not have made the distribution to USP but for the funding of FPRS by FS. Because USP is related to FS (within the meaning of section 954(d)(3)), the exception in (c)(2) does not apply. Moreover, an obligation of USP held by FS would be U.S. property. USP s attributable share of the obligation is $70x (determined in accordance with profits interest). Under (c)(3), USP s share of the obligation is greater of (i) USP s $70x attributable share of the obligation or (ii) lesser of the $80x distribution or the $100x amount of the obligation. Thus, for purposes of section 956, $80x of the FPRS obligation is treated as an obligation of USP and is U.S. property. On the date the loan is made, FS is treated as holding U.S. property of $80x. FS CFC $100x Loan 100% USP domestic FPRS foreign 70% profits interest USC unrelated 30% profits interest $80x distribution

43 Proposed Regulations under Section 956 Pledges and Guarantees by CFCs and Partnerships Prop. Reg (c)(1) clarifies that any obligation of a United States person with respect to which a CFC or a partnership is a pledgor or guarantor is considered to be held by the CFC or the partnership for purposes of section 956. Under the indirect pledge or guarantee rule of Prop. Reg (c)(2), if the assets of a CFC or a partnership serve at any time, even though indirectly, as security for the performance of an obligation of a United States person, then the CFC or partnership is considered a pledgor or guarantor of the obligation under Prop. Reg (c)(1). Prop. Reg (c)(2) further provides, however, that if a partnership is considered a pledgor or guarantor of an obligation, a CFC partner in the partnership will not also be treated as a pledgor or guarantor of the obligation solely as a result of its ownership of an interest in the partnership. Thus, if a CFC directly or indirectly guarantees an obligation of a foreign partnership that is treated as an obligation of a United States person under Prop. Reg (c)(1), then under the Proposed Regs, the CFC is treated as holding an obligation of a United States person by virtue of its guarantee.

44 Proposed Regulations under Section 956 Pledges and Guarantees by CFCs and Partnerships For purposes of the pledgor or guarantor rules under Prop. Reg (c), Prop. Reg (d) provides that a CFC partner is not considered a pledgor or guarantor of the portion of a partnership obligation attributed to its partners that are United States persons under the general rule of Prop. Reg (c) solely as a result of attribution of a portion of the partnership s assets to the CFC under the rules in Prop. Reg (b).

45 Proposed Regulations under Section 956 Pledges and Guarantees by CFCs and Partnerships Example There are no special allocations in FPRS partnership agreement. FPRS borrows $100x from Z, an unrelated lender. FS pledges its assets as security for FPRS s performance of its obligation to repay the $100x loan. USP s share of the $100x FPRS obligation, determined in accordance with its interest in profits, is $90x. Under (c), $90x of FPRS obligation is treated as an obligation of USP for purposes of section 956. For purposes of section 956, under Prop. Reg (c)(1), FS is considered to hold an obligation of USP in the amount of $90x. Thus, FS is treated as holding U.S. property in the amount of $90x. Pledges assets as security for FPRS s $100x loan from Z Z Bank X unrelated foreign 30% $100x Loan FS CFC 70% USP domestic 90% FPRS foreign Y unrelated foreign 10%

46 Proposed Regulations under Section 956 Additional Issues Addressed Obligations of domestic partnerships are treated as an obligation of a United States person for purposes of section 956 under Prop. Reg (e). In addition, the exception from the treatment of such an obligation as United States property under section 956(c)(2)(L) applies. For purposes of section 956, an obligation of a disregarded entity is treated as an obligation of the owner of the disregarded entity under Prop. Reg (a)(3). The proposed regulations also contain rules regarding certain trade or service receivables acquired from United States persons under Prop. Reg (b)(2)(ii).

47 Proposed Regulations under Section 956 Effective Dates The proposed regulations are effective for taxable years of CFCs ending on or after the date that the proposed regulations become final regulations, and taxable years of U.S. shareholders in which or with which such taxable years end. Most of the rules are proposed to apply to property acquired, or pledges or guarantees entered into, on or after September 1, 2015, including property considered acquired, or pledges or guarantees considered entered into on or after September 1, 2015 as a result of a deemed exchange pursuant to section Two rules dealing with obligations of disregarded entities and domestic partnerships, however, are proposed to apply to obligations held on or after the date of publication in the Federal Register of the Treasury decision adopting the proposed rules as final regulations. Finally, Prop. Reg (b), which deals with partnership property indirectly held by a CFC, is proposed to apply to property acquired on or after the date of publication in the Federal Register of the Treasury decision adopting the proposed rules as final regulations. The preamble to the proposed regulations provides that no inference is intended as to the application of the provisions to be amended by the proposed regulations under current law, including transactions involving obligations of foreign partnerships.

48 Additional Recent Developments Altera Corporation v. Comm r, 145 T.C. No. 3 (July 27, 2015) 721(c) Notice (Notice ) 368(a)(1)(F) Regulations (T.D. 9739) OECD BEPS/EU State Aid AIG/BNYM cases 2 nd. Cir. FTC economic substance