Washington Dispatch. In this issue. 2. Congress returned to pending deadlines; Speaker Boehner resigns

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1 Washington Dispatch September 2015, Volume 19, Issue 10 In this issue Legislation 2. Congress returned to pending deadlines; Speaker Boehner resigns IRS news 2. US IRS and Treasury issue regulations under subpart F 3. US IRS issues final regulations on integrated hedging transactions of qualifying debt 3. IRS releases long-awaited final regulations addressing F reorganizations 4. IRS proposed regulations would subject outbound transfers of foreign goodwill or going concern value to tax under Section 367(a) or (d) 5. IRS releases temporary regulations under Section 482 on coordinating transfer pricing rules with other code provisions 6. IRS issues final and temporary regulations on dividend equivalent amounts 6. Cash basis taxpayer may not elect accrual method for claiming foreign tax credits on amended return FATCA news 6. IRS extends certain FATCA transitional rules Courts 7. US Court of Appeals affirms that special 10-year statute of limitations for refund claims attributable to foreign tax credits runs from return due date (excluding extensions) OECD BEPS developments 8. Final BEPS Action Item deliverables set for 5 October release

2 2 Washington Dispatch September 2015 Legislation Congress returned to pending deadlines; Speaker Boehner resigns Congress returned to Washington on 8 September to a number of pending deadlines, including government funding, highway spending authorization and funding, the debt limit, and expired tax extenders. As September closed out, Congress primary focus was on extending government funding beyond the 30 September end of the fiscal year. That goal was achieved when the House and Senate on 30 September approved a continuing resolution to fund the government through 11 December, thereby averting a government shutdown. Early in the month, there was some expectation that Ways and Means Committee Chairman Paul Ryan (R-WI) would release his international tax reform plan in September, with a bill to follow in October for markup. The reform bill reportedly will be based on former Ways and Means Committee Chairman Dave Camp s 2014 reform plan and will include an innovation box proposal. As we go to press, Chairman Ryan s international reform plan has not been released. The House Ways and Means Committee on 17 September approved bills to make permanent five so-called tax extender provisions, including the subpart F active financing exception and the CFC-to-CFC look-through rule. The latest bills to make permanent certain expired tax extender provisions follow on House action earlier this year to approve a series of bills to make permanent other tax extender provisions. Ways and Means Committee Chairman Paul Ryan (R-WI) believes that making certain tax provisions permanent will bring the budget baseline to where it truthfully is, so that, when we write tax reform, we write it to the proper baseline. But the big news in September was the surprise announcement by House Speaker John Boehner (R-OH) that he will resign from Congress on 30 October. The Speaker said he had intended to step down from his leadership post at the end of last year, but stayed on to provide continuity to the Republican Conference and the House. It is currently uncertain whether the election to determine his successor will distract from the current House agenda, or if a change in leadership will affect the prospects for a limited tax reform package in this Congress. House Ways and Means Committee Chairman Paul Ryan (R-WI) released a statement saying, in part, We will miss John, and I am confident our conference will elect leaders who are capable of meeting the challenges our nation faces. Chairman Ryan separately said he would not be running for the Speaker position. IRS news US IRS and Treasury issue regulations under subpart F The IRS and Treasury issued final and temporary regulations (TD 9733) under the subpart F provisions, providing guidance that: The Section 956 anti-abuse rule may apply when a foreign corporation or partnership controlled by a controlled foreign corporation (CFC) is funded by any means (not just by capital contributions or debt), It also clarifies that tax attributes (for example earnings and profits, and foreign taxes) associated with the Section 956 inclusion will be taken into account when determining the application of the anti-abuse rule. Section 956 will apply where a CFC funds a foreign partnership (or guarantees a borrowing by a foreign partnership) in the case where the foreign partnership makes a distribution to a US partner that is related to the funding CFC. Clarifies the application of the active rents and royalties exception to foreign personal holding company income (FPHCI), including providing that a CFC is not a developer unless its own employees and officers perform the required functions. The regulations also provide that employees may be located in more than one country in order to meet the active rents and royalties exceptions. In addition, the temporary regulations clarify that a CFC cannot meet the active rents and royalty exception through cost sharing arrangements and that cost sharing payments will not be treated as active leasing or licensing expenses for purposes of determining whether an organization is substantial. In addition, the IRS and Treasury issued proposed regulations that would further expand the cases where obligations of a partnership will give rise to a Section 956 investment. Specifically: An obligation of a foreign partnership would generally be treated as an obligation of the partners to the extent of each partner s interest in partnership profits, which is to

3 Washington Dispatch September be determined based on all facts and circumstances. This general rule would be superseded by a special rule (the rule in the temporary Section 956 regulations) that increases the amount of the partnership s obligation treated as a separate obligation of a partner when a distribution, exceeding the amount of the obligation that is treated as an obligation of a partner under the general rule, is funded by an obligation of the partnership held by a CFC. A CFC that directly or indirectly guarantees an obligation of a foreign partnership that would be treated as an obligation of a US person will be treated as holding that obligation of a US person. A partnership that guarantees an obligation of a US person will be treated as holding that obligation for purposes of Section 956, causing a CFC partner in that partnership to be treated as holding a portion of that obligation. A CFC partner s share of partnership property, for purposes of Section 956, will be determined in accordance with the CFC partner s liquidation value percentage, which generally equals the cash distribution the partner would receive from the partnership if the partnership sold all its assets for cash, settled its obligations and then liquidated. The rules treating certain receivables acquired by a partnership in a factoring transaction as constituting US property for purposes of Section 956 are expanded. The temporary regulations pertaining to the Section 956 anti-avoidance rule apply to tax years of CFCs ending on or after 1 September 2015 with respect to property acquired on or after 1 September The Section 956 rules relating to obligations of a partnership apply to tax years of CFCs ending on or after 1 September 2015 and to tax years of US shareholders in which or with which such tax years end. The clarifications to the active rents and royalties exception to FPHCI generally apply to rents and royalties received or accrued during tax years of CFCs ending on or after 1 September 2015, and to tax years of US shareholders in which or with which such tax years end. In general, the temporary Section 956 regulations significantly increase the instances in which a CFC may be treated as holding US property (especially an obligation of US person), thus increasing the likelihood of an income inclusion to the US shareholders of the CFC under Section 951(a)(1)(B). These changes were not unexpected, however. Treasury officials had publicly commented on the regulations project during the last several years. When finalized, the proposed regulations treating obligations of a foreign partnership as obligations of its partners would represent a broad expansion of Section 956, likely resulting in inclusions even when partnership obligations are necessary for the going concern of the partnership. US IRS issues final regulations on integrated hedging transactions of qualifying debt The IRS published final regulations (T.D. 9736) under Section 988(d) addressing certain integrated transactions involving a foreign currency denominated debt instrument and two or more associated hedging transactions. Under the final regulations, a taxpayer that has identified multiple positions as being part of a qualified hedging transaction and terminated at least one but not all of the positions constituting the hedge must treat the remaining hedging positions as having been sold for fair market value on the date of the disposition of the terminated hedging position. The final regulations adopt the temporary regulations without substantive change. The IRS had issued the regulations in temporary and proposed form in September 2012 (the temporary regulations). The temporary regulations were meant to address a perceived abuse by taxpayers claiming a foreign currency loss by partially legging-out of an integrated transaction, and applied to leg-outs that occurred on or after 6 September Following the temporary regulations, the final regulations apply to leg-outs (within the meaning of Reg. Section (a)(6)(ii)) that occur on or after 6 September The preamble to the final regulations indicates that the IRS may be considering how to better align the integration regimes of Sections 1275 and 988. Such an alignment would be useful in preventing inconsistent tax treatment under the two regimes. IRS releases long-awaited final regulations addressing F reorganizations The IRS and Treasury have issued final regulations (TD 9739) establishing six requirements for a transaction to qualify as a reorganization under Section 368(a)(1)(F) (an F reorganization). These final regulations clarify four requirements found in regulations proposed in 2004, and add two additional requirements. In addition, these regulations establish

4 4 Washington Dispatch September 2015 rules governing outbound F reorganizations with foreign corporations. The final regulations apply to transactions occurring on or after 21 September The final regulations reflect the premise that it is appropriate to treat the resulting corporation in an F reorganization as the functional equivalent of the transferor corporation and to give its corporate enterprise roughly the same freedom of action as would be accorded a corporation that remains within its original corporate shell. As noted earlier, the final regulations list six requirements as being necessary to achieve F reorganization status. A transaction involving the transfer (or deemed transfer) of property from one corporation to another corporation results in a mere change in the identity, form, or place of organization of one corporation only if all of the following requirements are met: 1. Exchange of transferor stock for resulting corporation stock: Immediately after the potential F reorganization, all of the stock of the resulting corporation, including any issued before the potential F reorganization, must have been distributed (or deemed distributed) in exchange for the stock of the transferor corporation. 2. Identity of stock ownership: The same person or persons must own all of the stock of the transferor corporation, determined immediately before the potential F reorganization, and of the resulting corporation, determined immediately after the potential F reorganization, in identical proportions. 3. No prior assets or attributes of resulting corporation: The resulting corporation may not hold any property or have any tax attributes (including those specified in Section 381(c)) immediately before the potential F reorganization. 4. Liquidation of transferor corporation: The transferor corporation must completely liquidate for federal income tax purposes in the potential F reorganization. 5. Resulting corporation is the only acquiring corporation: Immediately after the potential F reorganization, no corporation other than the resulting corporation may hold property that was held by the transferor corporation immediately before the potential F reorganization if the other corporation would, as a result, succeed to and take into account the items of the transferor corporation described in Section 381(c). 6. Transferor corporation is the only acquired corporation: Immediately after the potential F reorganization, the resulting corporation may not hold property acquired from a corporation other than the transferor corporation if the resulting corporation would, as a result, succeed to and take into account the items of the other corporation described in Section 381(c). Requirements one and two reflect the premise that a transaction cannot be a mere change if it shifts the ownership of a corporation; meanwhile, the third and fourth requirement implement the statutory requirement that an F reorganization involves only one corporation. Finally, the fifth and sixth requirements address comments the Service received on the 2004 proposed regulations regarding overlap transactions. Viewed together, the requirements ensure that an F reorganization involves only one continuing corporation and is neither an acquisitive transaction nor a divisive transaction. In an era of deemed corporate liquidations (e.g., through check-the-box elections), the F reorganization probably plays a larger role in tax planning than it did in prior decades. Thus, taxpayers are likely to view the final regulations as helpful. The final regulations represent a significant regulatory development, illustrated by the fact that six revenue rulings were made obsolete in full and two revenue rulings were made obsolete in part by this Treasury Decision. (The obsolete rulings are Revenue Rulings , , , , and 96-29; the rulings made obsolete in part are Revenue Rulings and 88-25). IRS proposed regulations would subject outbound transfers of foreign goodwill or going concern value to tax under Section 367(a) or (d) On 14 September 2015, Treasury and the IRS released proposed regulations under Section 367 (REG ) modifying the application of Section 367(a) and (d) to certain outbound transfers of property. The proposed regulations would eliminate the exception in the current Section 367(d) temporary regulations for the transfer of foreign goodwill and going concern value (FGGCV). The proposed regulations would also permit taxpayers to elect whether the transfer of FGGCV will result in immediate taxation under Section 367(a) or a deemed royalty over

5 Washington Dispatch September the useful life of the intangible under Section 367(d). Additionally, the proposed regulations would eliminate the 20-year limitation for the useful life of intangible property under the Section 367(d) temporary regulations, providing that the useful life of intangible property for purposes of Section 367(d) will be the entire period during which the exploitation of the intangible property is reasonably anticipated to occur, as determined at the time of transfer. The proposed regulations would also narrow the scope of the active trade or business exception of Section 367(a)(3). With a limited exception, the proposed regulations would apply to transfers occurring on or after 14 September 2015, and to transfers occurring before that date resulting from entity classification elections filed on or after 14 September Although the proposed regulations will have an effective date as of 14 September 2015, they are currently only in proposed form. Moreover, the current final and temporary regulations have not been withdrawn and remain in effect. Thus, until the proposed regulations are finalized, taxpayers are faced with uncertainty regarding which set of rules will ultimately apply to their transactions. Given the possible retroactive effect of the proposed regulations on transactions entered on or after 14 September 2015 but prior to the proposed regulations becoming final, taxpayers should evaluate, and potentially take steps to mitigate, the effect of the proposed regulations on any such transactions. [Note: In conjunction with the proposed regulations, the government issued temporary regulations under Section 482 (T.D. 9738), which refine the application of the arm slength standard. The text of the Section 482 regulations also serves as the text to proposed regulations. The concurrent release of the temporary Section 482 and proposed Section 367 regulations is significant. It highlights the interrelation between the activities and transactions covered under these two Code Sections and regulations, and signals an attempt by the IRS to clarify the coordination of the application of the arm s-length standard and the best method rule under Section 482 of the Internal Revenue Code in conjunction with other provisions of the Code. See below an article on the new Section 482 temporary regulations.] IRS releases temporary regulations under Section 482 on coordinating transfer pricing rules with other code provisions On 14 September 2015, the government issued temporary regulations under Section 482 clarifying the application of the arm s-length standard when multiple code sections (e.g., Sections 482 and 367) apply. The temporary regulations apply to tax years ending on or after 14 September The temporary regulations revise Reg. Section (f)(2)(i) and (ii)(b) and are set forth in Reg. Section T(f)(2)(i)(A)-(E) and (j)(7). The temporary regulations are primarily concerned with making the following points: Compensation for a Controlled Transaction under Section 482 is required regardless of whether another Code Section (e.g., Section 367) may also apply to the transfer. The arm s-length values of assets determined under Section 482 should be the same whether or not Section 367 applies. The best method rule may require an analysis of the assets transferred in the aggregate even when some assets are transferred under the purview of Section 351 and other assets are transferred under other provisions of the Code. Absent further action, the provisions of these temporary regulations will expire on 14 September In addition to the release of the temporary Section 482 and proposed Section 367 regulations (see prior article), the IRS has also recently issued Notice , which announced forthcoming regulations under Section 721(c) that will create an exception to the general nonrecognition rule for property contributions to a partnership under Section 721(a). The government also announced their intent to issue modified regulations specific to partnerships under Sections 482 and 6662 to address controlled transactions involving partnerships and the appropriate transfer pricing methods, valuation approaches, periodic adjustment provisions and documentation of those transactions. Taken together, these recent actions by the IRS and Treasury constitute a concerted effort to clarify the application of Section 482 to controlled transactions that occur within regulatory schemes of special application within the

6 6 Washington Dispatch September 2015 Internal Revenue Code, particularly to the extent that those controlled transactions might involve tax-favored transfers of appreciated assets outside the US. These actions also apparently seek to establish the primacy of the Section 482 regulations (particularly the arm s-length standard and best-method analysis) in determining the value of the assets conveyed in such transactions. IRS issues final and temporary regulations on dividend equivalent amounts The IRS and Treasury released final and temporary regulations under Section 871(m) on dividend equivalents on 17 September. The final and temporary guidance applies to nonresident alien individuals and foreign corporations that hold certain financial products providing for payments that are contingent upon or determined by reference to US source dividend payments. The regulations also provide guidance to withholding agents that are responsible for withholding US tax with respect to a dividend equivalent. The final and temporary regulations under Section 871(m) were effective on 18 September As part of the same package, the IRS issued proposed regulations that provide guidance relating to the substantial equivalence test, which is used to determine whether a complex contract is a Section 871(m) transaction. The proposed regulations also provide guidance to qualified derivatives dealers. Cash basis taxpayer may not elect accrual method for claiming foreign tax credits on amended return In IRS Chief Counsel Advice (CCA) , the Service concluded that the relation back doctrine codified in Section 905(c) does not apply to cash basis taxpayers that pay additional taxes in a subsequent year that relate to a prior year s taxable income. Additionally, the Service took the position that a taxpayer that credits its foreign taxes on a cash basis may not retroactively elect to credit its foreign taxes on an accrual basis by filing an amended US federal income tax return for a prior year. Under Section 905(a), a cash basis taxpayer may make an irrevocable election to claim foreign taxes as a credit in the year in which the taxes accrue, rather than in the year in which such taxes are paid. Once this election is made, credits for all subsequent years must be taken on the accrual basis. Generally, creditable foreign taxes accrue in the year the all-events test is satisfied; that is, in the tax year in which all the events, other than payment, have occurred that establish the fact of the liability and permit the amount of the liability to be determined with reasonable accuracy. The courts, and the Service in a series of revenue rulings, have developed what is commonly referred to as the relation back doctrine. Under the relation back doctrine, foreign taxes that accrue subsequent to the year to which they relate are treated as if they accrued in the year to which such taxes relate. That is, they spring back to the year to which they relate when they accrue under normal accrual principles. CCA is a reminder that cash basis taxpayers that do not make a timely election to claim foreign tax credits in the year the tax accrues are at risk for possible double taxation due to mismatching between the year foreign income taxes may be taken as a credit and the year the income subject to such taxes was taken into account for US federal income tax purposes. Because the Service does not permit cash basis taxpayers to elect to credit their foreign income taxes on an accrual basis on an amended return, cash method taxpayers should carefully consider making a timely election to credit foreign taxes on an accrual basis to avoid this potential mismatch. FATCA news IRS extends certain FATCA transitional rules The IRS on 18 September issued Notice , announcing that the Service will amend regulations under Sections to extend the time that certain FATCA transitional rules will apply. Key amendments generally will extend: The date for when withholding on gross proceeds and foreign passthru payments will begin until sales or other dispositions that occur on or after 1 January 2019, and to the later of 1 January 2019 or the date of publication of final regulations defining the term foreign passthru payments, respectively. The use of limited branches and limited foreign financial institutions until 31 December 2016.

7 Washington Dispatch September The deadline for a sponsoring entity to register its sponsored entities and re-document such entities with withholding agents to 31 December 2016 The deadline for certain Model 1 Intergovernmental Agreement (IGA) countries to exchange information with the US with respect to 2014, until 30 September In addition, in order to reduce compliance burdens on withholding agents that hold collateral as a secured party, the notice announces that Treasury and the IRS intend to amend the FATCA regulations to modify the rules for grandfathered obligations in relation to collateral. While the announcement provides some relief for US withholding agents and foreign financial institutions, there are still significant burdens in the implementation of account documentation, due diligence and reporting by the current deadlines (e.g., account holder due diligence for preexisting accounts must be completed by 30 June 2016). Taxpayers may rely on Notice until the regulations are amended. In other FATCA news, the US government in September announced the signing of the first two competent authority (CA) agreements under FATCA IGAs, with Australia and the UK. The CA agreements provide procedures for implementing the IGAs. The IRS plans to sign other similar agreements with additional countries in the future. UK government sets out views on US limited liability companies The UK government on 25 September released Brief 15/2015, which sets out HMRC s view how it will treat US limited liability companies (LLCs) following the recent UK Supreme Court decision in George Anson v HMRC (2015) UKSC 44. The Brief confirms that it considers the Anson decision to be specific to the facts found in the case, and that where US LLCs have been treated as companies within a group structure HMRC will continue to treat the US LLCs as companies, and where a US LLC has itself been treated as carrying on a trade or business, HMRC will continue to treat the US LLC as carrying on a trade or business. The Brief is silent, however, on what HMRC s approach will be to future claims by groups in relation to LLCs. The Brief can be found here. Denial of discretionary treaty benefits subject to judicial review The US District Court for the District of Columbia on 21 September 2015 held in Starr International Co. v. United States that that the US government s denial of discretionary treaty benefits in the US-Switzerland tax treaty is subject to judicial review. The company filed a $38 million refund suit after it was denied discretionary relief under the treaty to apply the lower dividend withholding rate. The court noted the treaty does not reflect an unambiguous intent to foreclose judicial review. Courts US Court of Appeals affirms that special 10- year statute of limitations for refund claims attributable to foreign tax credits runs from return due date (excluding extensions) In Albemarle Corporation v. United States, Albemarle Corporation and subsidiaries appealed to the US Court of Appeals for the Federal Circuit a 2014 decision of the US Court of Federal Claims sustaining an IRS disallowance of certain refund claims Albemarle had based on credits for disputed Belgian taxes. In its opinion, the appellate court affirmed the lower court s decision, ruling that the 10-year limitations period in Section 6511(d)(3)(A) began to run on the due date (excluding extensions) for Albemarle s tax returns for the tax years to which the Belgian taxes related, and not on the subsequent date on which Albemarle and the Belgian tax authority settled the dispute. The case provides a detailed summary of the legislative history and purpose of Section 6511(d)(3)(A) and the application of the relation-back doctrine in the foreign tax credit context. In doing so, the case clearly establishes that the tax year to which a refund claim relates for purposes of Section 6511(d)(3) is the year the taxes originated, even for contested foreign taxes actually paid at a later date. Note that the 10-year statute of limitations for claiming a refund for contested foreign taxes allowed as a credit under Section 901 begins as of the due date (without extension) for filing the return for the tax year to which those foreign taxes relate, and not the year in which the contest is concluded. Therefore taxpayers that have resolved contested foreign

8 8 Washington Dispatch September 2015 tax liabilities, but have yet to file a claim for refund, should review the time by which they will need to file a claim to ensure that they are not barred from doing so by the statute of limitations under Section 6511(d). Further, taxpayers with on-going foreign tax disputes should consider filing protective refund claims. OECD BEPS developments Final BEPS Action Item deliverables set for 5 October release The OECD has confirmed that it will release the final Base Erosion and Profit Shifting Action Item deliverables and reports on 5 October. The OECD will deliver the final BEPS deliverables and legal instruments to the G-20 Finance Ministers in Lima on 8 October After review by the finance ministers, the BEPS package will go to the G-20 leaders for their approval at a summit meeting scheduled for November. The OECD is also expected to announce in October that specific aspects of the BEPS project will continue into Meanwhile, the G-20 Finance Ministers and central bank governors in September issued a communique addressing BEPS, stating that the effectiveness of the BEPS project will be determined by widespread and consistent implementation. The group said they will continue to monitor the BEPS project s outcome, particularly noting the exchange of information on cross-border tax rulings. The communique also called on the OECD to prepare a BEPS framework by early 2016 that includes involvement by interested non-g20 countries, particularly developing countries. It will next be up to individual countries to decide how to proceed with respect to the implementation of tax measures recommended in the BEPS reports. Treasury and IRS officials have indicated that the IRS will issue guidance relating to country-by-country reporting by the end of the year.

9 Washington Dispatch September Ernst & Young LLP, International Tax Services, Washington, DC Jose Murillo Barbara Angus Stephen Bates David Canale Doug Chestnut Ken Christman Tom Coony Arlene Fitzpatrick David Golden Sean Hailey Liz Hale Lilo Hester Stephen Jackson Karen Kirwan Kyle Klein Richard Larkins Natan Leyva Richard McAlonan John Morris Alan Munro Peg O Connor Chris Ocasal Al Paul Karen Petrosino Craig Sharon Matthew Stevens John Turro Tim Wichman Tyler Arbogast Matthew Berger Norman Hannawa Petya Kirilova Tammy LeGrys Andreia Leite Verissimo Katherine Loda Carlos Mallo Maria Martinez Ben Orenstein Dave Peppelman Loren Ponds Hubert Raglan Allen Stenger fax number International Tax Services Global ITS, Alex Postma, Tokyo ITS Director, Americas, Jeffrey Michalak, Detroit Ernst & Young LLP National Director of ITS, Jose Murillo, Washington Member Firm Contacts, Ernst & Young LLP (US) Northeast Johnny Lindroos, McLean, VA Financial Services Phil Green, New York Central Mark Muktar, Detroit Southeast Scott Shell, Charlotte, NC Southwest Amy Ritchie, Austin Canada - Ernst & Young LLP (Canada) Albert Anelli, Montreal Israel - Kost Forer Gabbay & Kasierer (Israel) Sharon Shulman, Tel Aviv Mexico - Mancera, S.C. (Mexico) Koen Van t Hek, Mexico City Central America - Ernst & Young, S.A. Rafael Sayagues, San José South America - Ernst & Young Serviços Tributários S.S. Gil F. Mendes, São Paulo West Beth Carr, San Jose, CA

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