Practising Law Institute

Transcription

1 Practising Law Institute Tax Planning For Domestic & Foreign Partnerships, LLCs, Joint Ventures & Other Strategic Alliances 2016 International Joint Venture Issues Paul Oosterhuis Skadden, Arps, Slate, Meagher & Flom LLP Chris Trump Deloitte Tax LLP Jason T. Smyczek Senior Technical Reviewer, Branch 4, Associate Chief Counsel (International), IRS

2 FORMATION AND NOTICE

3 Partnership Contributions In General Section 721(a) allows for the tax deferred transfer of built in gain (or loss) property by a partner to a partnership, without analog to the control requirements imposed on transfers to corporations under section 351. ininteresteconomicspecifictransferor storegardwithoutoperates 721 section, generalin contributed property, thus allowing for mixing bowl effect within partnership. Section 704(c) requires any built in gains and losses existing at the time of the transfer, when recognized, to be allocated to the transferor. However, these requirements may be avoided in part by application of the ceiling rule, which limits such allocations to gain and loss items from the property itself. Treas. Reg (b)(1). gainif( 721(asection turn-off toregulationbyirstheallowedhas( 721(csection, 1997 Since when recognized would be included in the income of a non-u.s. person. Notice , released on August 6, 2015, announced the intent to issue such regulations and provided detailed rules with immediate effect. Notice , although apparently targeting transfers of intellectual property, applies regardless of the nature of the property transferred and irrespective of whether the income from the property is subject to immediate U.S. taxation under subpart F or as effectively connected income. 3

4 Pre-Notice Analysis Facts USP, a U.S. corporation, wholly owns FS, a foreign corporation. USP and FS contribute property to PRS, a partnership. USP contributes Asset A, with a large amount of built-in gain. FS contributes Asset B. Pre-Notice Analysis The contribution of Asset A does not result in gain recognition under section 721(a). PRS could use one of three methods (i.e., traditional method, traditional method with curative allocations, or remedial method), subject to certain anti-abuse rules, to account for the built-in gain of Asset A in allocating items of income, deduction, gain, or loss to its partners. Regardless of the form of consideration received (except in the case of certain partnership interests), the transferor is effectively selling a portion of Asset A. Following the contribution to the partnership, the contributing partner recognizes income attributable to its partnership interest. The timing of recognition of the built-in gain in the asset depends on the section 704(c) method chosen. Asset B USP FS PRS Asset A Value $100M Basis $0 4

5 Notice Notice , issued on August 6, 2015, announces the intent to issue regulations under section 721(c) to ensure that, when a U.S. person transfers certain property to a partnership that has foreign partners related to the transferor, income or gain attributable to the property will be taken into account by the transferor either immediately or periodically (through the remedial section 704(c) method). The new regulations will have two main features: Significant new restrictions will apply if the U.S. partner and related foreign person together own more than 50 percent of the interests in partnership capital, profits, deductions or losses, and the U.S. partner contributes built-in gain property to the partnership. Immediate gain recognition will be required under section 721(c) on the. MethodDeferralGain theadoptspartnershiptheunlesscontribution Section 482 regulations will be issued to specify transfer pricing methods applicable to controlled transactions involving related-party partnerships. These specified methods, which may apply to partnership contributions, partnership distributions, and partnership allocations, will mirror the methods currently prescribed for cost-sharing arrangements andwillincludea periodictrigger featuresimilartothecost-sharing periodic trigger. 5

6 Gain Deferral Method 721(c) The regulations will include an exception to the application of section requirementsfiveextentthetousedbemaywhich( MethodDeferralGain the ) are met. First. The Section 721(c) Partnership adopts the remedial allocation method described in Treas. Reg (d) for Built-in Gain with respect to all Section 721(c) Property contributed to the Section 721(c) Partnership pursuant to the same plan by a U.S. Transferor and all other U.S. Transferors that are Related Persons. 6

7 Gain Deferral Method Second. During any taxable year in which there is remaining Built-In Gain with respect to an item of Section 721(c) Property, the Section 721(c) Partnership allocates all items of section 704(b) income, gain, loss, and deduction with respect to that Section 721(c) Property in the same proportion; Third. Reporting requirements described in Section 4.06 of the Notice are satisfied. Fourth. U.S. Transferor recognizes Built-in Gain with respect to any item of Section 721(c) Property upon an Acceleration Event described in Section 4.05 of the Notice; and Fifth. The Gain Deferral Method is adopted for all Section 721(c) Property subsequently contributed by the U.S. Transferor and related U.S. Transferors until the earlier of: the date when no Built-in Gain remains with respect to any Section 721(c) Property to which the Gain Deferral Method first applied; or 60 months after the initial contribution of Section 721(c) Property to which the Gain Deferral Method first applied. 7

8 Effective Dates The regulations described in the Notice with respect to the application of section 721(c) will apply to transfers occurring on or after August 6, 2015, and to transfers occurring before August 6, 2015, resulting from entity classification elections made under Treas. Reg that are filed on or after August 6, 2015, and that are effective on or before August 6, The section 482 and section 6662 regulations described in the Notice will apply to transactions occurring on or after the date regulations are published. 8

9 Notice : Example 1, USP a domestic corporation, wholly owns FS, a foreign corporation USP (U.S.) USP and FS form a new partnership, PRS FS contributes cash of $1.5M contributes: USP a patent with FMV = $1.2M, basis = $0 a security with FMV = $100k, basis = $20K $1.5M cash FS (Foreign) PRS $1.5M: 1. Patent 2. Security 3. Machine a machine with FMV = $200K, basis = $600K 9

10 Notice : Example 1 (cont d) Analysis The Patent is Section 721(c) Property because it has Built-in Gain (FMV = $1.2M; AB = $0). The security has Built-in Gain, but is Excluded Property. The machine has built-in loss; therefore, it is not Section 721(c) Property. USP. FS is a Related Foreign Person to USP and FS collectively own more than 50% of the interests in the capital, profits, deductions or losses of PRS; therefore, PRS is a Section 721(c) Partnership. USP stoapplynotdoes( 721(aSection contribution of the patent to PRS unless the Gain Deferral Method is applied. $1.5M Cash FS (Foreign) USP (U.S.) PRS $1.5M: 1. Patent 2. Security 3. Machine 10

11 Notice : Example 2 USP, a domestic corporation, wholly owns FS, a foreign corporation. USP (U.S.) PRS Interest USP and FS own all of the interests in PRS, which was formed prior to the effective date of Notice USP s management concludes that USP should not hold the PRS interest directly and causes USP to contribute the PRS interest to U.S. Sub in exchange for U.S. Sub Stock. FS (Foreign) 40% 60% PRS (U.S). USP (U.S.) Stock U.S. Sub (U.S.) FS (Foreign) U.S. Sub (U.S.) 40% 60% PRS (U.S.) 11

12 Notice : Example 2 (Cont d) PRS terminates for tax purposes under section 708(b)(1)(B). Deemed Transactions: USP (U.S.) Deemed Transactions PRS contributes its assets to new PRS in exchange for New PRS assumption PRSNewandinterests ofprs liabilities. New PRS liquidates, distributing New PRS interests to FS and to U.S. Sub. Notice Applies? FS (Foreign) New PRS Interest Assets PRS (U.S.) U.S. Sub (U.S.) New PRS Interests New PRS Interest New PRS 12

13 Observations / Open Questions Third Party JVs - Although the Notice appears to be targeted at partnerships between related taxpayers, the rules are broad enough to affect some third-party joint ventures. Deemed Partnerships - It is not always clear whether the economic relationship between taxpayers constitutes a partnership for U.S. federal aininteresttaxpayer sparticularawhetherorpurposestaxincome partnership is debt or equity. With the requirement of immediate gain recognition turning on whether a relationship is a tax partnership and who the partners are, the stakes surrounding these determinations have been raised. 13

14 Observations / Open Questions Technical Terminations - Taxpayers will need to carefully monitor transfers of partnership interests that could result in a technical termination of a partnership in existence before the date of the Notice, which could cause a deemed contribution to a new partnership of built-in gain assets contributed to the old partnership prior to the date of the Notice. 14

15 Observations / Open Questions Proportionate Allocations Requirement The proportionate allocation rule prohibits special allocations of particular section 704(b) items (income, gain, loss, deduction) with respect to an item of Section 721(c) Property. thethatindicatesproperty( 721(cSectionof iteman toreferencethe determination of whether all items with the respect to a Section 721(c) Property are made on a property-by-property basis. Deductions attributable to built-in gain property (e.g., IP development costs incurred as part of a cost share agreement) cannot be specially allocated to USP. In addition, regulatory allocations and allocations of foreign tax credits required under the section 704(b) regulations may require certain items to be shared in different proportions. Presumably regulations will address whether such allocations violate the proportionate allocation rule. 15

16 Observations / Open Questions The concept of Acceleration Events set forth in the notice is very broad. Because the regulations appear to measure built-in gain (and reductions in builtin gain) only at the level of the Section 721(c) Partnership, a distribution of Section 721(c) Property to the U.S. Transferor that contributed such property could be an Acceleration Event, even though the built-in gain is preserved in the hands of the U.S. Transferor. Certain transactions are excepted: Contribution of Section 721(c) Property by a Section 721(c) Partnership to a domestic corporation in a transaction described in section 351(a). Contribution of an interest in a Section 721(c) Partnership to a domestic corporation in a transaction described in section 351(a) or section 381(a); Contribution of Section 721(c) Property by a Section 721(c) Partnership to a foreign corporation in a transaction described in section 351(a), provided the property is treated as being transferred by a U.S. person (other than a domestic partnership) under section

17 Acceleration Rule Facts USP, a U.S. corporation, wholly owns FS, a foreign corporation. USP and FS are partners in PRS, a partnership. In Year 1, USP contributes Asset A to PRS. In Year 9, when Asset A has remaining built-in gain, PRS distributes Asset A to FS. Analysis Section 704(c)(1)(B) (which requires gain recognition in certain circumstances) should not apply because PRS distributed Asset A after 7 years from the date it was contributed to PRS. However, because USP will not recognize any remaining gain with respect to Asset A after the distribution, the distribution is an Acceleration Event. Accordingly, USP is required to recognize any remaining gain of Asset A. USP FS PRS Asset A Value $100M Basis $0 17

18 PARTNERSHIPS AND CONTROLLED FOREIGN CORPORATIONS

19 CFCs Income Inclusion Rule anfor( CFC )corporationforeigncontrolledaiscorporationforeignaif uninterrupted period of 30 days or more during any taxable year, each person who is a U.S. shareholder, as defined in section 951(b), and who thewhichinyearsuchindaylasttheoncorporationsuchinowns stock proshareholder stheincomegrossitsinincludemust, CFCaiscorporation ratashareofthecfc s SubpartF income A U.S.shareholderisa U.S.person, asdefinedinsection 7701(a)(30), that owns, (within the meaning of section 958(a) or (b)), 10 percent or more of the voting stock of a foreign corporation Under section citizensorresidentsincludes person. U.S a,( 7701(a)(30 of the U.S. or domestic partnerships or corporations. USCo, a domestic corporation, is a U.S. person 19

20 U.S. vs. Foreign Partnership Foreign Persons Foreign Persons or <10% US Persons Pship (US) Pship (X) FP FP FP is a CFC FP is a NOT a CFC 20

21 Foreign Personal Holding Includes: Dividends Interest Rents Royalties Excess of gain over loss from: o o o o Exceptions: Sale of stock, Debt instruments, Less-than-25 percent partnership interests, Property that does not give rise to any income Look through from related CFC (section 954(c)(6)) Same country exception (dividend or interest from related CFC organized in same country as recipient and meeting certain other tests) (section 954(c)(3)(A)(i)) Qualified "banking or financing income" of an eligible CFC (section 954(h)) Active rents and royalties from unrelated persons (section 954(c)(2)(A)) Look-through for sale of partnership interest where CFC owns at least 25 percent of the partnership (section 954(c)(4)) 21

22 Foreign Base Company Sales Income FBCSI Includes: Subject to various exceptions, Foreign Base Company Sales Income under section 954(d) is: o o o o Income derived in connection with the purchase of personal property from a related person and its sale to any person; Income derived from the sale of personal property to any person on behalf of a related person; Income derived from the purchase of personal property from any person and its sale to a related person; OR Income derived from the purchase of personal property from any person on behalf of a related person. Sales income will not constitute FBCSI if: The property is manufactured (by anyone) in the CFC's country of organization, OR The property is sold for use in the CFC's country of organization, OR The property is manufactured or produced by the CFC. EVEN if the property is purchased from, or sold to, a related person. 22

23 Brown Group Regulations Generally, the rules of Subpart F apply at the CFC partner level as if the income were earned directly. Treas. Reg (g) Country of incorporation determinations based on country of CFC incorporation Related party determinations based on CFC/partner relationship to other parties Activities and property to be taken into account at partner level for exceptions generally consider only the activities and property of the partnership 23

24 Application to Subpart F Sales Income Sales of mfg. goods US Co CFC Foreign Co Subpart F Sales Income Generally Results to CFC Under Reg if: Product is purchased from or sold to a related party of CFC; Product is not manufactured by CFC (or by third party in country of CFC incorporation); and Product is sold for use or consumption outside country of CFC incorporation. >50% FJV Mfg. Ops Application to FJV Under Reg (a)(6): Sales (or purchases) by FJV are determined to be to a related person based on CFC, not FJV, relationship FJV treated as manufacturer based only on FJV activities; separate activities of Foreign Co and/or CFC are not taken into account. FJV may be manufacturer as principal in contract manufacturing arrangement if FJV employees make a substantial contribution to the manufacture of the property 24

25 Partnership Payment: 954(c)(6) and (c)(3) Section 954(c)(6): US Co Foreign Co Interest, rents or royalties treated as paid by CFC1 and Foreign Co. for section 954(c)(6) purposes. Therefore, look through rule of section 954(c)(6) is again applicable to payments made to CFC2. CFC 2 CFC1 >50% Section 954(c)(3): Same Country Exception of section 954(c)(3) could also apply to CFC2, to the extent the payments are attributable to CFC1, and assuming the substantial assets test is met. Interest, rents, or royalties FJV How do we treat the interest in FJV for purposes of the substantial assets test? o o o Treas. Reg (b)(4)(x) allows a CFC to look through stock of a subsidiary in determining whether a CFC s assets are located in its country of organization. What about partnership interests? Note section 1297(c). 25

26 Partnership Income: 954(c)(6) and (c)(3) Section 954(c)(6): US Co Foreign Co Payments received by FJV are treated as received or accrued by CFC1 and Foreign Co for purposes of section 954(c)(6). CFC 2 Dividends, interest, rents or royalties CFC1 >50% FJV Therefore, look through rule of section 954(c)(6) is applicable to CFC1. Section 954(c)(3): Same Country Exception of section 954(c)(3) could also apply to CFC1, assuming other requirements are met (including the substantial assets test). 26

27 Section 956 In General Inclusions under section 951(a)(1)(B) Lesser of: o o ( quarter-ends 4 theofaverage )property. U.SinbasisadjustedaverageCFC s less prior section 956 PTI, or priorlessanddividendsyearcurrentlessearningsaccumulatedandcurrent ) earningsapplicable "CFC's section 956 PTI) Section 956 defines U.S. Property to include: tangible property located in the United States; stock of its U.S. shareholder or a domestic corporation which is 25 percent or more owned or treated asbeingownedbythecfc su.s.shareholderaftertheacquisition; an obligation of a United States person; or any right to the use in the United States of o o o o a patent or copyright, an invention, model, or design (whether or not patented), a secret formula or process, or any other similar right, which is acquired or developed by the controlled foreign corporation for use in the United States 27

28 Revenue Ruling : Facts P (U.S.) S (Foreign) Unrelated (Foreign) : Ruling S, a CFC, owned a 25 percent interest in PRS, a partnership The remaining 75 percent of PRS was owned by unrelated parties PRS assetsincludedu.s.realestate which constitutes U.S. property under section 956 FMV = 50 Basis = 10 PRS 25% 75% U.S. Real Estate The U.S. real estate owned by PRS is U.S. property treated as owned by S for purposes of section 956 The amount which constitutes U.S. property is calculated based on the adjusted basis of the U.S. property in the hands of the partnership, limited by the adjusted basis that S has in its PRS partnership interest FMV = 200 Basis = 80 28

29 Treas. Reg (a)(3) CFC1 U.S. Parent CFC2. Treas Reg (a)(3) provides that if a CFC is a partner in a partnership that owns U.S. property, theininterestanholding astreatedbewillcfcthe property equal to its interest in the partnership and such interest will be treated as an interest in United Statesproperty USP Reg., Thus Rev. Rul and Treas. 2(a)(3) generally adopt aggregate type principles for section T(b)(2)(ii)(A) See also Treas. Reg. U.S. Property 29

30 Application of Section 956 Loan to Foreign Partnership Background and( 956(asectionofpurposesforproperty. U.Sis person. U.Saofobligation An a U.S. person includes domestic partnerships. Thus, a loan from a CFC to a domestic partnership results in the CFC holding an obligation of a U.S. person, and therefore U.S. property. This rule treats the partnership as an entity for this purpose rather than an aggregate of its partners. 17, Jan. In the preamble to proposed regulations under section 954(i) published on 2006, the IRS requested comments whether a loan from a CFC to a foreign partnership that has one or more U.S. partners results in the CFC holding an obligation of a U.S. person for purposes of section

31 Application of Section 956 Loan to Foreign Partnership Commentary IRS requested comments on whether CFC should be treated as making a loan to USP, triggering a section 956 inclusion. The NYSBA issued comments in which it argued that because the Subpart F regime treats a domestic partnership as a U.S. person, Subpart F similarly should treat a foreign partnership as a the, Thus. person. U.Sanotthat sentityseparate CFC generally should not be treated as holding an obligation of a U.S. person for purposes of section 956. NYSBA acknowledged, however, that to the extent FP invested the proceeds in U.S. property, including any loan of the proceeds to USP, or distributed the proceeds to USP, and one of the principal purposes of the transaction was the avoidance of section 956, it would be appropriate for the IRS to treat CFC as holding U.S. property. USS USP (U.S.) FP (For) CFC 31

32 Application of Sec. 956 to Partnerships Temporary and Proposed Regulations On September 2, 2015, Treasury released temporary and proposed regulations addressing application of section 956 to partnership transactions. The temporary regulations address application of the anti-abuse rule to partnership entities and partnership distributions funded by CFCs. The temporary regulations are effective with respect to taxable years of CFCs ending on or after September 2, The temporary regulations expire in three years if not finalized under the sunset provisions. The proposed regulations address, in part, whether the obligations of a non-u.s. partnership will be treated as U.S. property for purposes of section 956. The proposed regulations are proposed to be effective with respect to taxable years of CFCs ending on or after the date final regulations are published, and taxable years of U.S. shareholders in which or with respect to which such taxable years end. 32

33 Application of Sec. 956 to Partnership Transactions Temporary Regulations The temporary regulations address Treasury and IRS concerns that taxpayers may be using partnerships to structure transactions that are similar to transactions addressed by Treas. Reg T(b)(4) Treas. Reg T(b)(4) is currently applicable to transactions that involve foreign corporations that are controlled by a CFC and requires the IRS to exercise its discretion Treasury and IRS were concerned with the following transactions: CFC funded loans CFC contributes cash to partnership Partnership loans cash to U.S. shareholder of the CFC Taxpayer position: CFC is treated as holding an interest in the obligation only to the extent of the CFC s interest in the partnership CFC funded distributions CFC lends (or guarantees loan) to foreign partnership Foreign partnership distributes proceeds to U.S. partner who is related to CFC Taxpayer position: Section 956 does not apply 33

34 Application of Sec. 956 to Partnership Transactions Temporary Regulations. Treas Reg T(b)(4) expanded to include transactions involving partnerships that are controlled by the CFC U.S. property held indirectly by a CFC includes foreigncontrolledthebycontrolledisthatpartnershipabyacquiredproperty corporation if the property would be United States property if held directly by the controlled foreign corporation, and 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 thecontrolledforeigncorporation. Control CFC controls the foreign partnership if the CFC and the partnership are related within the meaning of 707(b) For purposes of determining whether two corporations are members of the same controlled group, section 267(c) principles apply Rule is self-executing (both with respect to transactions involving corporations and transactions involving partnerships) 34

35 Application of Sec. 956 to Partnership Transactions Temporary Regulations FS1 has substantial e&p FS1 contributes $600 to FP in exchange for a 60% interest USP contributes Non-US real property valued at $400 in exchange for a 40% interest FP lends $100 to USP FS1 is treated as holding U.S. property of $60 pursuant to Treas. Reg (a)(3). If a principal purpose of organizing FP is to avoid section 956 with respect to FS1, FS1 is treated as holding U.S. property of $100 $60 under Treas. Reg (a)(3) $40 under Temp. Treas. Reg (b)(4)(i)(C) and (b)(4)(iii) FS1 $100 Loan 60% USP (U.S.) 40% FP (For) Non-US RP $400 value 35

36 Application of Sec. 956 to Partnership Transactions Temporary Regulations Partnership Distributions General Rule An obligation of a foreign partnership held (or treated as held) by a CFC is treated as a separate obligation of a partner in the partnership if The foreign partnership distributes an amount of money or property to the partner The foreign partnership would not have made the distribution but for a funding of the partnership through the obligation The partner is related to the CFC within the meaning of section 954(d)(3) Amount of obligation The lesser of (a) the amount of the partnership distribution that would not have been made but for such funding or (b) the amount of the obligation of the foreign partnership that is held (or treated as held) by the CFC 36

37 Application of Sec. 956 to Partnership Transactions Temporary Regulations USP wholly owns FS, a CFC USP owns a 70% interest in FP, UTP a domestic corporation, owns the remaining 30% interest in FP USP (U.S.) FP borrows $100 from FS and distributes $80 to USP FS UTP (U.S.) FP would not have made the distribution to USP but for the funding by FS A portion of the obligation that FS holds is treated as an obligation of USP $80 Distribution $100 Loan 70% FP (For) 30% The amount treated as an obligation of USP is the lesser of $80 (the amount of the distribution) or $100 (the amount of the obligation that is held by the CFC) 37

38 Application of Sec. 956 to Partnership Transactions Proposed Regulations Treasury and IRS determined that failing to treat an obligation of a foreign partnership as an obligation of its partners could allow deferral of U.S. taxation of CFC earnings and profits in a manner inconsistent with the purposes of section 956 Areas of concern: Potential ability of U.S. shareholder to access deferred CFC earnings loaned to a foreign partnership in which the U.S. shareholder is a partner without those earnings becoming subject to U.S. tax by causing the partnership to make a distribution Proposed regulations treat an obligation of a foreign partnership as an obligation of its partners, subject to an exception for obligations of foreign partnerships in which neither the lending CFC nor any person related to the lending CFC is a partner 38

39 Application of Sec. 956 to Partnership Transactions Proposed Regulations (b) A partner in a partnership is treated as holding its attributable share of any property held by the partnership (including partnership obligations) liquidationpartner sthewithaccordanceindeterminedisshareattributable value percentage: Liquidation Value - The amount of cash the partner would receive if immediately after the occurrence of the most recent revaluation event or, if none, immediately after the formation of the partnership, the partnership sold all of its assets for cash equal to the fair market value of such assets, satisfied its liabilities (other than certain contingent liabilities), paid an unrelated third party to assume its contingent liabilities in a fully taxable transaction, and then liquidated. Liquidation Percentage partner stheofvalueliquidationtheofratiothe interest in the partnership divided by the aggregate liquidation value of all of thepartners interestsinthepartnership. Special allocations taken into account if the special allocation does not have a principal purpose of avoiding section

40 Application of Sec. 956 to Partnership Transactions Proposed Regulations (b) USP owns 100% of FS, a foreign corporation that is a CFC FS owns an interest in FP, a foreign partnership; an unrelated third party owns the rest of the interest in FP FP owns non-depreciable property with a basis of $100 the property would be U.S. property if held by FS directly USP (U.S.) FS 100% UTP Non-U.S. valueliquidation FS, quartertheofclosetheat percentage is 25% FS is treated as holding its attributable share of the property with an adjusted basis equal to its attributable shareoffp sadjustedbasisintheproperty FS liquidation value percentage is 25% $25 isbasisadjustedfp sofshareattributablefs FS is treated as holding US property with an adjusted basis of $25 FP (For) Non-depreciable property A/B = $100 40

41 Application of Sec. 956 to Partnership Transactions Proposed Regulations (b) USP owns 100% of FS, a foreign corporation that is a CFC FS owns an interest in FP, a foreign partnership; an unrelated third party owns the rest of the interest in FP FP owns non-depreciable property with a basis of $100 the property would be U.S. property if held by FS directly USP (U.S.) FS 100% UTP Non-U.S. Income with respect to U.S. property is specially allocated to FS The special allocation does not have a principal purpose of avoiding section 956 itswithaccordanceindeterminedisshareattributablefs s special allocation isproperty. U.SforpercentageallocationspecialFS s inbasisadjustedfp sofshareattributableitsand 80% the property is $80 FS is treated as holding U.S. property with a basis of $80 FP (For) Non-depreciable property A/B = $100 41

42 Application of Sec. 956 to Partnership Transactions Proposed Regulations (b) USP owns 100% of FS, a foreign corporation that is a CFC FS owns an interest in FP, a foreign partnership; USP owns the rest of the interest in FP FP owns property with an adjusted basis of $100; the property would be U.S. property if held by FS directly FP is anticipated to appreciate in value, but to generate relatively little income The partnership agreement specially allocates 80% of the income with respect to the property to USP and 80% of the gain with respect to the disposition of the property to FS. The allocation does not have a principal purpose of avoiding the purposes of section 956 accordanceindeterminedaresharesattributable partnersthe with the special allocation itsand 80% ispropertyfp sofshareattributablefs s ispropertytheinbasisadjustedfp sofshareattributable $80 FS is treated has holding U.S. property with a basis of $80 100% FS USP (U.S.) FP (For) Property A/B = $100 42

43 Obligations of a Foreign Partnership Proposed Regulations (c) An obligation of a foreign partnership is treated as a separate obligation of each of theofsharepartner seachofextentthetopartnershiptheinpartnersthe obligation indeterminedobligationpartnershipofsharepartner s accordance with the partner s interest in partnership profits Preamble notes that the approach is consistent with the observation that, to the extent the proceeds are used by the partnership to invest in profit-generating activities, partners (including service partners) will benefit from the obligation to the extent of their interest in partnership profits Share CFC stheofquartereachofclosetheofasdeterminedobligationof taxable year Exceptions Foregoing rules do not apply if neither the CFC, nor any person related to the CFC, is a partner in the partnership 43

44 Application of Sec. 956 to Partnership Obligations Proposed Regulations (c) USP owns 100% of FS, a foreign corporation that is a CFC USP also owns a 90% interest in the partnership profits of FP UTP X owns a 10% interest in the profits of FP FP borrows $100 from FS; FS basis in the obligation is $100 The $100 obligation is treated as the obligation of USP and UTP X to the extent of their respective interests in partnership profits because $90 isobligationtheofshareusp s its share of profits is 90% $100 Loan 100% FS USP (U.S.) FP (For) 90% Profits 10% Profits UTP X Non-U.S. $90 of the obligation held by FS is treated as an obligation of USP and is US property On the date the loan is made, FS is treated as holding $90 of U.S. property 44

45 Application of Sec. 956 to Partnership Obligations Proposed Regulations (c) USP owns 40% of FS, a foreign corporation that is a CFC Unrelated third party Z, a U.S. person, owns the remaining 60% of FS UTP Z (U.S.) USP (U.S.) USP also owns a 90% interest in the partnership profits of FP UTP X owns a 10% interest in the profits of FP FP borrows $100 from FS; FS basis in the obligation is $100 Unrelated lender exception applies Neither FS nor any person related to FS (within the meaning of section 954(d)(3)) is a partner in the partnership $100 Loan 60% FS 40% FP (For) 90% Profits 10% Profits UTP X Non-U.S. The obligation is treated as an obligation of a foreign partnership, not of a U.S. person FS is not treated as holding U.S. property 45

46 Application of Sec. 956 to Partnership Obligations Proposed Regulations (c) USP owns 100% of FS, a foreign corporation that is a CFC USP also owns a 60% interest in the partnership profits of FP FS has a 30% interest in the partnership profits of FP, USC a U.S. corporation, has a 10% interest in the profits of FP FP borrows $100 from an unrelated person FS guarantees the obligation The $100 obligation is treated as the obligation of USP, FS and USC to the extent of their respective interests in partnership profits Unrelated lender exception does not applyusp sshare of the obligation is $60 because its share of profits is itsbecause $30 isobligationtheofsharefs s; 60% share of profits is 30%; USC share of the obligation is $10 because its share of profits is 10% FS, as guarantor, is treated as holding the obligations of USP and USC that it guarantee Guarantees FP debt FS 30% Profits USP (U.S.) FP (For) 60% Profits $100 Loan 10% Profits USC (U.S.) UTP Z 46

47 Application of Sec. 956 to Partnership Obligations Proposed Regulations (c) USP owns 100% of FS, a foreign corporation that is a CFC USP also owns a 70% interest in the partnership profits of FP UTP X has a 30% interest in the partnership profits of FP FP borrows $100 from FS and makes a distribution of $80 to USP FP would not have made the distribution to USP but for the funding of FP by FS Unrelated lender exception does not apply with respect to USP An obligation of USP held by FS would be U.S. property $70 isobligationtheofshareattributableusp s its( i )ofgreatertheisobligationtheofshareusp s share of the obligation ($70), or (ii) the lesser of (a) the distribution ($80), or (b) the amount of the obligation ($100). Thus, on the date of the loan, FS is treated as holding US property of $80 FS $100 Loan USP (U.S.) FP (For) 70% Profits $80 Distribution UTP X (U.S.) 30% Profits 47

48 Application of Sec. 956 to Partnership Transactions Proposed Regulations Pledges and Guarantees Current Rule An obligation of a U.S. person with respect to which a CFC is a pledgor or guarantor is considered for purposes of section 956 to be U.S. property held by the CFC Proposed Regulations Any obligation of a U.S. person with respect to which a CFC or a partnership is a pledgor or guarantor (directly or indirectly) is considered for purposes of section 956 to be U.S. property held by the CFC, or the partnership, as the case may be. CFC that is a partner in the pledgor partnership is not itself treated as a pledgor solely as a result of its ownership of an interest in the partnership How does one treat the pledge of a partnership interest by a U.S. person that has a related CFC partner? Existing Pledges and Guarantees The proposed regulations are proposed to be effective with respect to pledges and guarantees entered into on or after the date published in the federal register A pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification of an obligation with respect to which it is a pledgor or guarantor on or after the date the regulations are published in the federal register 48

49 Application of Sec. 956 to Partnerships Proposed Regulations Pledges and Guarantees USP owns 90% of FP, a foreign partnership, and 70% of FS, a foreign corporation that is a CFC profitsfp sininterest 90% ahasusp, Z an unrelated third party loans $100 to FP FS pledges its assets as security for the loan (c) Under Prop. Treas. Reg. iszutptoobligation $100 FP sof $90 treated as an obligation of USP for purposes of section Reg. Under Prop. Treas. 2(c)(1), FS is considered to hold an obligation of USP in the amount of $90 and is treated as holding US property in the amount of $90 UTP X (Non- U.S.) 30% 70% FS Pledge Assets as Security for Loan USP (U.S.) FP (For) 90% $100 Loan 10% UTP Y (Non- U.S.) UTP Z 49

50 DISPOSITION

51 Exit Strategies Sale of partnership assets or interests source/character Buy out other partner. Note Rev. Rul and the Administration s 2016 Budget proposal to codify the ruling Partnership redeems out a partner consider section 736, source, and character Liquidate partnership sections 731, 704(c), 751(b), etc. Incorporate partnership - Note section 367 issues Partnership division 51

52 Section 1248 and Partnerships: Sale of Interest in Partnership Holding CFC Stock Foreign Co 40% 60% FJV (Foreign) CFC US Co FMV: 360 FMV: 600 Basis: 100 E&P: 300 Sale of FJV Partnership Interest IRS position appears to be no FTCs and no QDI; see 1248(g)(2). Section 751(c) treats stock of a CFC held through a partnership as a zero-basis unrealized receivable in an amount equal to the potential section 1248 dividend amount CFC FMV 600 Partnership Basis in CFC 100 Gain on Sale 500 Potential Section 1248 Dividend Amt. 300 A domestic partner of the partnership recognizes ordinary income to the extent of its share of any gain that would have been treated as a dividend under section 1248 had the partnership sold the CFC stock directly FMV Partnership Interest 360 Basis in Partnership Interest 60 Gain on Sale 300 Section 751(c) Ordinary Income (Allocable Share of Potential Section 1248 Amount) 180 Section 741 Capital Gain 120

53 Section 1248: Sale of Partnership Interest and Section 338 Election Foreign Co US Co sell 100% of partnership interests Buyer 40% 60% FJV (Foreign) DE CFC E&P: 300 deemed asset sale New CFC Purchase of 100% of partnership interests is treated as a purchase of PS assets under Rev. Rul. 99-6, enabling Buyer to make a 338 election for CFC, wiping out E&P If 751(c) and IRS view of 1248(g)(2) applies here, who takes E&P and associated FTCs into account?

54 Section 1248 and Partnerships: Sale of Interest in Partnership Holding CFC Stock Foreign Co 40% 60% FJV (Foreign) CFC2 US Co CFC1 Disposition Subpart F: Section 954(c)(4) treats as a sale by CFC1 of its proportionate share of assets of Foreign Partnership (i.e., CFC2 stock) But: Treated as a sale of CFC2 stock by CFC1 for purposes of section 964(e)? purposesforonly says( 954(c)(4 ; No of this section Deemed dividend to CFC1? No Availability of FTCs? No See section 1248(g)(2)

55 Section 1248 and Partnerships: Sale of CFC by Domestic Partnership Foreign Co 40% 60% JV (U.S) CFC US Co Disposition E&P: 300 CFC FMV 600 Partnership Basis in CFC 100 Disposition treated as a sale of CFC stock by a U.S. person to which section 1248 applies Each partner allocated its respective share of section 1248 dividend income and capital gain Credits allowable to domestic partners under Rev. Rul and section 902(c)(7) QDI Gain on Sale 500 Section 1248: 300 Capital Gain: 200

56 Section 1248 and Partnerships: Sale of CFC by Foreign Partnership Foreign Co US Co Partners of Foreign Partnership treated as selling or exchanging their proportionate share of the stock of CFC. Treas. Reg (a)(4) 40% 60% Results are not different from previous slide, but mechanics are FJV (Foreign) CFC E&P: 300 Disposition CFC 600 Partnership Basis in CFC 100 Gain on Sale 500 Gain Allocable to Domestic Partners (60% x 500) 300 See Treas. Reg (a)(5), Ex. 4. E&P Allocable to Domestic Partners (60% x 300) 180 Section Capital Gain 120

57 PARTNERSHIPS AND SECTION 7874

58 Section 7874: Acquisition of U.S. P/S by Foreign Corporation Section 7874 applies to a foreign corporation acquiring a trade or business of a U.S. partnership if: after the transaction partners in U.S. partnership own 60% (or 80%) or more of a foreign corporation by reason of their ownership of interests in the U.S. partnership, the foreign corporation directly or indirectly acquires substantially all the properties constituting a trade or business of the U.S. partnership, and The foreign corporation and its subsidiaries do not have substantial business activities in the country in which the foreign corporation is incorporated o Temp Regulations (June 2012) adopt 3-part 25% test assets, employees, gross income

59 Anti-Inversion Legislation: Partnerships US Non-Corporates USP EU-1 DE EU-2 DE EU-3 DE EU-4 DE EU-5 DE Does section 7874 apply to wholly foreign operations of USP? Dissolution of USP /conversion to FP subject to anti-avoidance rule? 59

60 Anti-Inversion Acquisition o Service Partners/SHs U.S. Public Shareholders Foreign Parent (Bermuda) Injected cash from IPO of Bermuda Co disregarded in testing ownership fraction received for U.S. partnership under section 7874(c)(2)(B) Treas. Reg T (Jan. 2014) expanded rule to certain private transactions (see Notice ) On April 4, 2016, Treas. Reg T was amended to reflect Notice , Notice and the new 2016 temporary regulations

61 Limitations on Go-Private Transactions As in the Notices, Treas. Reg T excludes from the denominator of the ownership fraction, stock issued by the foreign acquirer in exchange for nonqualified property Theterm nonqualifiedproperty isdefinedas Cash and cash equivalents, Marketable securities, Disqualified obligations (not previously included in Notice ), or Any other property acquired in a transaction with a principal purpose of avoiding the purposes of section 7874, regardless of whether the transaction involves an indirect transfer of nonqualified property However, subject to an anti-abuse rule, a marketable interest in a corporation or benotwilleagacquirer sforeigntheofmemberabecomesthatpartnership treated as nonqualified property This is the exception that allows stock issued by the foreign acquirer in exchange for the publicly traded stock of a non-u.s. target to be counted in the denominator of the ownership fraction

62 Disregard of Stock Transferred for Passive Property Third Party Foreign Assets Individual A USCo Partners PRS Cash Pre-Transaction Structure Individual A 25% 75% (deemed 100%) FA USCo Partners FJV Post-Transaction Structure cash purchase assets Foreign Assets Individual A transfers USCo to FA in exchange for 75 FA shares. FJV transfers cash (nonqualified property) to FA in exchange for 25 FA shares. FA uses cash to purchase foreign assets The FJV transfer of cash is disregarded; Individual A deemed to own 100% of FA. 62

63 Disregard of Stock Transferred for Avoidance Property Third Party Foreign Assets Individual A USCo cash assets Partners FJV Pre-Transaction Structure Individual A 75% (?) USCo 25% (?) Partners FA FJV Post-Transaction Structure Foreign Assets assets Individual A transfers USCo to FA in exchange for 75 FA shares. FJV buys foreign assets that are not nonqualified property, transfers assets to FA in exchange for 25 FA shares. Answer depends on whether the FJV transfer of assets has as a principal purpose the avoidance of section

64 Limitations on Go-Private Transactions Treas. Reg T contains a de minimis exception whereby the exclusion rule for disqualified stock does not apply if: The ownership continuity percentage is less than 5 percent (as measured by vote and value and ignoring the diet dividend rule in Treas. Reg T and the cash box rule in Treas. Reg T ), and After the acquisition and all transactions related to the acquisition, the former shareholders or partners of the acquired U.S. entity own less than 5 percent (as measured by vote and value) of the foreign acquirer or any member of the EAG Ownership is determined with attribution under section 318, as modified by section 304(c)(3)(B) The de minimis exception likely to apply when there is a cash purchase of a domestic target with limited management rollover

65 Anti-Inversion Legislation: Acquisition by Foreign Partnership Regulations also apply to an acquisition of a U.S. corporation or partnership by a publicly traded foreign partnership Section 7874(g) provided specific regulatory authority to prevent avoidance of provision through, among other things, the use of pass-through entities Regulation can treat publicly traded foreign partnerships which are not treated as corporations under section 7704(c) as foreign corporations to be tested under section 7874 o foreign thethen, testcontinuity 80% the,. e.g If the other tests are satisfied,, notif; 7874 sectionundercorporationdomesticaastreatedbecan corporation remains a partnership

66 THE FOREIGN TAX CREDIT

67 Direct vs. Indirect Credit Partnership: Direct Credit Corporation: Indirect Credit Partnership: Indirect Credit US Co Foreign Co US Co Foreign Co US Co Foreign Co FJV 100 Income 50 Tax To avoid double taxation, a foreign tax credit (FTC) is provided under section 901, which reduces the US tax liability dollar-for-dollar (subject to the FTC limitation) Subject to the section 904 limitation, the 50 Tax is creditable under section 901. Section 704(b) governs how the 50 of creditable foreign tax expense (CFTE) is allocated between the partners Dividen d FJV Co 100 E&P 50 Tax Generally, when US Co includes FJV Co s earnings in US Co s income, US Co may claim FJV Co s taxes as an FTC under Section 902 When FJV Co s earnings are distributed (or treated as distributed) back to US Co, then US Co may claim an FTC Thus, a 100 distribution (dividend) from FJV Co would entitle US Co to claim a 50 FTC (100% * 50) Dividen d FJV CFC 100 Income 50 Tax Section 902(c)(7) provides that for purposes of claiming an indirect credit, stock owned, directly or indirectly, by a partnership is treated as proportionately owned by its partners 67

68 Section 704(b) Regulations and FTCs notdo( CFTEs )ExpendituresTaxForeignCreditableofAllocations bemust, thereforeand( SEE ) have Substantial Economic Effect PartnershiptheinInterestPartner sthewithaccordanceinallocated ( PIP ) Safe harbor An allocation of CFTE is deemed to be in accordance with PIP if: (1) the CFTE is allocated (whether or not pursuant to an express provision in the partnership agreement) and reported on the partnership return in proportion to the distributive shares of income to which the CFTE relates, and (2) allocations of all other partnership items that materially affect the CFTEs allocated to a partner are valid. (Treas. Reg (b)(4)(viii)(a)) 68

69 Section 704(b) Regulations and FTCs Simple Case U.S. Co Foreign Co Net Income Tax Split DRE1 $500 $ DRE2 $500 $ DRE1 FJV DRE2 DRE1: 500 Net Income; 100 Tax DRE2: 500 Net Income; 50 Tax US Co: DRE1: $375; $75 Tax DRE2: $250; $25 Tax Foreign Co: DRE1: $125; $25 Tax DRE2: $250; $25 Tax 69

70 Inter-Branch Payments U.S. Co Foreign Co FJV is engaged in Business A operations in Country X and business B operations Country Y that are conducted through DRE1 and DRE2, respectively 75% of income DRE1 50% of income from DRE2 50% 50% 25% of income from DRE1 50% of income from DRE2 The partnership agreement provides for different allocations of the net income attributable to business A and the B business FJV DRE1 earns $100,000 and makes a $75,000 payment to DRE2 that is deductible in computing the Country X Tax DRE1 US Income: $100,000 X Income: $25,000 Tax: $10,000 $75,000 Interest DRE2 US Income: $50,000 Y Income: $125,000 Tax: $25,000 DRE2 earns $50,000 and also receives the $75,000 payment from DRE1 DRE1 pays $10,000 of Country X Tax DRE2 pays $25,000 of Country Y Tax 70

71 Inter-Branch Payments (cont d) 75% of income DRE1 50% of income from DRE2 U.S. Co DRE1 50% US Income: $100,000 X Income: $25,000 Tax: $10,000 FJV $75,000 Interest 50% Foreign Co DRE2 25% of income from DRE1 50% of income from DRE2 US Income: $50,000 Y Income: $125,000 Tax: $25,000 aretaxesxcountrydre1 sof $10,000 The attributable to the Business A operations (net of the interest payment) and the $10,000 of Country Y taxes are attributable to the Business B operations (without regard to the disregarded interest payment) The additional $15,000 of Country Y taxes are imposed on the inter-branch interest payment Provided the additional $15,000 of Country Y taxes imposed on the inter-branch payment are allocated to the same partner as the $75,000 of income attributable to the disregarded payment, the allocations will satisfy the section 704(b) safe harbor This can be accomplished by: (i) allocating the Country Y taxes imposed on the inter-branch payment in the same manner as the DRE1 income or (ii) allocating $75,000 of the DRE1 income in the same manner as the DRE2 income 71

72 Section 704(c) Example IP FMV 15,000 AB 0 US Co 50% 50% Bus A FJV Foreign Co Bus B Non-Depreciable Operating Business FMV 15,000 AB 15,000 Business A: 500 Net Income; 100 Tax Business B: 500 Net Income; 50 Tax US Co contributes property with a value of 15,000 and an adjusted basis of 0 Foreign Co a non-depreciable operating business with contributes a value of 15,000 and a basis of 15,000 Revenues exceed expenses by 1,000 a year In each year, the IP generates 1,000 of book depreciation and 0 of tax depreciation The parties anticipate the royalty income will have substantially the same effect on their tax liabilitiesasincomefromfjv scontributedip The IP is sold at the end of year 15 for 15,000 At the end of year 15, the fair market values Co sforeignandco s of each of US. interests in FJV are 22,500 72

73 Section 704(c) Effect on Allocations of CFTEs A partner s distributive share for purposes of the section 704(b) safe harbor is the partner s distributive share of taxable income (not section 704(b) book income), and is calculated by taking section 704(c) into account Items of built-in gain or loss must be allocated to the contributing partner using one of three methods set out in the regulations As a trap for the unwary, a foreign partner may be ignorant of section 704(c), and may negotiate its economic deal without taking section 704(c) into account 73

74 Gross Basis Withholding Taxes Corp A Corp B Corp C FJV is engaged in DREX operations in Country X, DREY operations in Country Y and DREZ operations in County Z, respectively. The partnership agreement provides for different allocations of the net income attributable to business A and the B business DREX $100,000 <$90,000> US:$100,000 X:$10,000 X Tax:$3,000 FJV DREY $90,000 <$80,000> US: $0 Y:$10,000 X:$90,000 X Tax:$9,000 DREZ $80,000 US: $0 X:$80,000 Tax:$0 DREX earns $100,000 royalty income from unrelated payors, on which no withholding tax is imposed. Country X imposes a 30 percent net income tax on DREX income. DREX makes a royalty payment of $90,000 to DREY that is deductible for Country X purposes and subject to a 10 percent Country X withholding tax. DREY earns no other income and Country Y does not tax any of the DREY income. DREY makes a royalty payment of $80,000 to DREZ. DREZ earns no other income and Country Z does not tax any of the DREZ income. 74

75 Gross Basis Withholding Taxes Corp A Corp B Corp C All partnership items from business X, excluding CFTEs, are allocated 80 percent to Corp A and 10 percent to Corp B and Corp C. DREX $100,000 <$90,000> FJV DREY $90,000 <$80,000> DREZ $80,000 All partnership items from business Y, excluding CFTEs, are allocated 80 percent to Corp B and 10 percent to Corp A and Corp C. All partnership items from business Z, excluding CFTEs, are allocated 80% to Corp C and 10 percent to Corp A and Corp B. US: $100,000 X: $10,000 X Tax:$3,000 US: $0 Y:$10,000 X:$90,000 X Tax:$9,000 US: $0 X:$80,000 Tax:$0 75

76 Gross Basis Withholding Taxes Net Income Tax Split Corp A Corp B Corp C DREX DREY $100,000 $0 $12,000 80/10/10 $0 10/80/10 DREZ $0 $0 10/10/80 FJV Corp A: DREX: $80,000; $9600 Tax DREX $100,000 <$90,000> DREY $90,000 <$80,000> DREZ $80,000 Corp B: DREX: $10,000; $120 Tax US: $100,000 X: $10,000 X Tax:$3,000 US: $0 Y: $10,000 X: $90,000 X Tax:$9,000 US: $0 X: $80,000 Tax:$0 Corp C: DREX: $10,000; $120 Tax 76

77 INBOUND INVESTMENT

78 Corporate USTOB vs. Partnership USTOB Foreign USTOB Partnership USTOB Foreign Co US Co Foreign Co US Co FJV Co FJV USTOB USTOB Income effectively connected with the USTOB of FJV Co will be taxable on a net basis to FJV Co at US statutory rates Foreign Co will not be deemed to be engaged in a US trade or business or to have a US permanent establishment If FJV Co is a USRPHC, the sale of stock in FJV Co by Foreign Co may result in gains being treated as U.S. source ECI Foreign Co will be deemed to engage in a business conducted by a partnership of which it is a partner. See section 875 If the partnership has a U.S. permanent establishment, any partner will be deemed to have a PE activitycommercial ainengagespartnershiptheif within the meaning of section 892, any partner will be treated as engaging in a commercial activity 78