16 September 2016
International Tax Alert
US Treasury plans
regulations to treat
certain transactions or
restructurings relating
to foreign-initiated tax
payments as Section 909
foreign tax credit splitters
EY Global Tax Alert Library
Access both online and pdf versions
of all EY Global Tax Alerts.
Copy into your web browser:
www.ey.com/taxalerts
Executive summary
In Notice 2016-52 (the Notice), the US Department of the Treasury and the
Internal Revenue Service (together, Treasury) have described regulations that
they intend to issue under Internal Revenue Code1 Section 909 identifying as
foreign tax credit splitter arrangements certain transactions or restructurings
undertaken by Section 902 corporations in anticipation of foreign-initiated
income tax adjustments. The forthcoming regulations would apply to foreign
income taxes paid on or after 15 September 2016.
Detailed discussion
Background
Section 909 was enacted in 2010 to prevent the separation of creditable
foreign taxes from related income generally by deferring the right to claim
the credits until the related income is included in US taxable income. Current
regulations set forth an exclusive list of “splitter arrangements” that are subject
to Section 909. Notice 2016-52 provides notice of two types of transactions
or restructurings (each in connection to foreign-initiated tax adjustments) that
Treasury intends to treat as splitter arrangements in future amendments to the
Section 909 regulations.
2
International Tax Alert
Under Section 905(c), certain foreign income taxes paid by
a “Section 902 corporation” after the tax year to which the
taxes relate generally are taken into account by adjusting
Section 902 pools of post-1986 foreign income taxes in the
tax year in which the taxes are paid, rather than accounting
for the taxes in the prior tax year to which the taxes relate.
A Section 902 corporation, defined in Section 909(d)(5),
is any foreign corporation for which one or more domestic
corporations meets the ownership requirements of
Section 902(a) or (b).
Under certain circumstances, Section 909 is intended to
suspend foreign income taxes until those taxes are “matched”
with the income to which they relate (related income).
Specifically, Section 909(a) provides that, if there is a
“foreign tax credit splitting event” with respect to a foreign
income tax paid or accrued by a taxpayer, then the foreign
income tax will not be taken into account before the tax year
in which the taxpayer takes the related income into account.
Section 909(b) provides that, if there is a foreign tax credit
splitting event with respect to a Section 902 corporation,
foreign income taxes paid or accrued are not taken into
account for purposes of Section 902 or 960, or for purposes
of determining earnings and profits, before the tax year
in which the related income is taken into account by the
Section 902 corporation or a domestic corporation satisfying
the ownership requirements of Section 902(a) or (b) with
respect to the Section 902 corporation.
Need for regulations
The Notice states that, in anticipation of large foreign-initiated
tax adjustments (adjustments that result in additional tax
liability greater than US$10 million) relating to a prior tax year,
some taxpayers may take steps to separate the additional
payment of foreign income tax from the income to which it
relates. The Notice describes situations in which, through
certain transactions or restructurings, taxpayers may
attempt to change their ownership structure or cause
the Section 902 corporation to make an extraordinary
distribution so that the subsequent tax payment creates a
high-tax pool of post-1986 undistributed earnings. Those
undistributed earnings can then be used to generate
substantial amounts of foreign taxes deemed paid, without
repatriating and including in US taxable income the earnings
and profits to which the taxes relate.
Planned regulations
To address the transactions or restructurings described above,
Notice 2016-52 defines two new splitter arrangements that
Treasury intends to include in future regulations: (1) splitter
arrangements arising from the application of Section 905(c)
to successor entities, and (2) splitter arrangements arising
from distributions made before the payment of additional tax
pursuant to foreign-initiated adjustments.
Splitter arrangements arising from application of
Section 905(c) to successor entities
Under the planned regulations, certain changes in ownership
structures in connection with a foreign-initiated adjustment
will result in a foreign tax credit splitting event. In particular,
this splitter arrangement covers certain transactions or
restructurings that result in taxes being paid by a payor
Section 902 corporation that would not have been the payor
of the taxes if such taxes had been paid or accrued in the
relation-back year. As an example, the Notice described an
arrangement in which US Parent wholly owns controlled
foreign corporation (CFC)1, which, in turn, wholly owns
CFC2. CFC1 and CFC2 are both located in Country X. CFC1
also owns DE, which is treated as a disregarded entity
for US tax purposes and as a corporation for Country X
purposes. In Years 1 through 5, DE earns earnings and profits
with respect to which it accrues and pays no foreign tax. These
earnings and profits constitute CFC1’s pool of post-1986
undistributed earnings. In Year 6, CFC1 transfers all of its
interest in DE to CFC2 in exchange for stock. In Year 8, DE pays
foreign income taxes to Country X to settle a foreign-initiated
adjustment with respect to Years 1 through 5. Under the
planned regulations, CFC1’s transfer of its interest in DE
to CFC2 and the subsequent payment of foreign income
taxes by CFC2 (through DE) will generally give rise to a
splitter arrangement. Two exceptions are available. One
exception covers transactions or restructurings in which the
earnings and profits of the predecessor entity is transferred
to the payor pursuant to Section 381(c)(2). The other
exception covers cases in which the taxpayer demonstrates
by clear and convincing evidence that the transactions
or restructurings were not structured with a principal
purpose of separating covered taxes from the post-1986
undistributed earnings of the predecessor entity.
International Tax Alert
Splitter arrangements arising from distributions
made before payment of additional tax pursuant to
foreign-initiated adjustments
Treasury also plans for the regulations to address another
arrangement that could achieve a similar result. In this
arrangement, a taxpayer uses distributions to, in effect, move
post-1986 undistributed earnings from one Section 902
corporation to another Section 902 corporation before the
first Section 902 corporation makes a tax payment relating
to a specified foreign-initiated adjustment. In such an
arrangement, the payor of the taxes first takes into account
the earnings to which the tax payment relates. However, as
a result of the distributions, the earnings are then taken into
account by a covered person that is a Section 902 corporation
before the first Section 902 corporation pays the tax. The
planned regulations would treat the transaction as a splitter
arrangement if the distribution were made with a principal
purpose of reducing the payor’s undistributed earnings to which
the taxes relate in advance of the payment of such taxes. The
Notice sets forth further rules providing when such principal
purpose will be assumed and how it may be rebutted with
clear and convincing evidence. The Notice includes examples
illustrating such arrangements in further detail.
3
Treasury also specifically requests comments on whether
an objective test, rather than a subjective test based on
taxpayer intent, should be used to determine whether the
described transactions or restructurings should be treated as
splitter arrangements. And, if so, what type of objective test
could be used for this purpose.
Comments are due 14 December 2016.
Implications
The rules set forth in the Notice limit foreign tax credit planning
that may be undertaken in conjunction with foreign-initiated
tax adjustments. Taxpayers should be mindful of how such
rules could affect the availability of foreign tax credits as they
undertake transactions or restructurings involving entities
with respect to which such foreign-initiated tax adjustments
are anticipated.
Request for comments, alternative approaches
In a request for comments, Treasury specifically asks whether
the described transactions or restructurings would be more
appropriately addressed in rules under Section 905(c),
providing that additional payments of tax be accounted
for through adjustments to the pools of post-1986 foreign
income taxes and post-1986 undistributed earnings of
Section 902 corporations that are not the same entity as the
payor of the tax.
Endnote
1. All “Section” references are to the Internal Revenue Code of 1986, and the regulations promulgated thereunder.
4
International Tax Alert
For additional information with respect to this Alert, please contact the following:
Ernst & Young LLP, International Tax Services, Washington, DC
• Natan J. Leyva • Sean Hailey
+202 327 6798
+202 327 7470
[email protected]
[email protected]
International Tax Services
Global ITS, Alex Postma, Tokyo
ITS Director, Americas, Jeffrey Michalak, Detroit
ITS Markets Leader, Americas, Stephen O’Neil, New York
Ernst & Young LLP, National Director of ITS Technical Services, Jose Murillo, Washington
Member firm contacts, Ernst & Young LLP (US)
Northeast
Johnny Lindroos, McLean, VA
Israel – Kost Forer Gabbay & Kasierer (Israel)
Sharon Shulman, Tel Aviv
Financial Services
Chris J Housman, New York
Mexico – Mancera, S.C. (Mexico)
Koen Van ‘t Hek, Mexico City
Central
Mark Mukhtar, Detroit
Central America – Ernst & Young, S.A.
Juan C Chavarria Pozuelo, San José
Southeast
Scott Shell, Charlotte, NC
South America – Ernst & Young Serviços Tributários S.S.
Gil F. Mendes, São Paulo
Southwest
Amy Ritchie, Austin
West
Beth Carr, San Jose, CA
Canada – Ernst & Young LLP (Canada)
Albert Anelli, Montreal
EY | Assurance | Tax | Transactions | Advisory
About EY
EY is a global leader in assurance, tax, transaction
and advisory services. The insights and quality
services we deliver help build trust and confidence
in the capital markets and in economies the world
over. We develop outstanding leaders who team to
deliver on our promises to all of our stakeholders.
In so doing, we play a critical role in building a better
working world for our people, for our clients and for
our communities.
EY refers to the global organization, and may refer to
one or more, of the member firms of Ernst & Young
Global Limited, each of which is a separate legal entity.
Ernst & Young Global Limited, a UK company limited
by guarantee, does not provide services to clients.
For more information about our organization, please
visit ey.com.
About Ernst & Young’s International Tax
Services practices
Our dedicated international tax professionals assist
our clients with their cross-border tax structuring,
planning, reporting and risk management. We work
with you to build proactive and truly integrated global
tax strategies that address the tax risks of today’s
businesses and achieve sustainable growth. It’s how
Ernst & Young makes a difference.
International Tax Services
© 2016 EYGM Limited.
All Rights Reserved.
EYG no. 02896-161US
1508-1600216 NY
ED None
This material has been prepared for general informational
purposes only and is not intended to be relied upon as
accounting, tax, or other professional advice. Please refer
to your advisors for specific advice.
ey.com