By Philip D. Morrison, Esq.
Deloitte Tax LLP, Washington, DC
In two prior commentaries,1 I noted how complex it will be to determine "related income" for purposes of new §909(d)(3), i.e., income the realization of which allows suspended (because of a §909 "splitter" arrangement) foreign taxes to be "unsuspended" and taken into account. The second of these commentaries suggested that Prop. Regs. §1.901-2(f)(2)(i) be finalized and compliance therewith turn off §909. The thought, of course, was that because applying that proposed regulation's rules to foreign consolidation and fiscal unity regimes would be far simpler than applying the §909 concept of tracing related income. The temporary §909 regulations2 (Temporary Splitter Regs.) and final Regs. §1.901-2(f)3 (Final Technical Taxpayer Regs.) adopt this suggestion, though they achieve this desirable result in a somewhat convoluted, though necessary, manner.
Unlike the rules themselves, the Preamble to the Final Technical Taxpayer Regs. is quite straightforward for post-effective-date taxable years:Because failure to allocate appropriately the consolidated tax among the members of the group may result in the separation of foreign income tax from the related income as described in section 909, comments recommended that the proposed rules be finalized in lieu of treating these arrangements as foreign tax credit splitting events under section 909, which would require suspension of split tax until the related income is taken into account. The Treasury Department and the IRS agree with the comments, and accordingly, §1.901-2(f)(3)(i) of the final regulations adopts with minor modifications Prop. §1.901-2(f)(2)(i).
As these regulations are generally effective for foreign taxes paid or accrued during taxable years beginning after February 14, 2012, a foreign tax credit splitting event will not occur with respect to foreign taxes paid or accrued on combined income in such years.
Likewise, for years prior to the effective date of the Temporary Splitter Regs. but after §909's effective date (typically 2011 and 2012), the Preamble to the Final Technical Taxpayer Regs. is also fairly straightforward:… [T]he final regulations permit taxpayers to apply the combined income rules of §1.901-2(f)(3) of the final regulations to taxable years beginning after December 31, 2010, and on or before February 14, 2012. This provision will permit taxpayers to avoid uncertainty regarding the application of section 909 to foreign taxes paid or accrued by foreign consolidated groups in pre-effective date taxable years beginning in 2011 and 2012….To the extent that a taxpayer did not allocate foreign consolidated tax liability among the members of a foreign consolidated group based on each member's share of the consolidated taxable income included in the foreign tax base under the principles of §1.901-2(f)(3), the foreign consolidated group is a foreign tax credit splitting event under section 909. See Section 4.03 of Notice 2010-92 and §1.909-5T.
The means by which the regulations themselves accomplish these feats is somewhat less straightforward than the Preambles' descriptions, though nevertheless clear. With respect to post-reg-effective-date years (typically, 2013 and forward), the Temporary Splitter Regs. accomplish this by failing to define as a foreign tax credit "splitting arrangement" any splitting of foreign taxes from the income on which such taxes were imposed that arises from a foreign consolidated group or fiscal unity regime. If there is no "splitting arrangement," there can be no foreign tax credit "splitting event" and, therefore, no suspended "split taxes." Thus, compliance with the Final Technical Taxpayer Regs. will avoid §909 for foreign consolidated group or fiscal unity regime taxpayers.4
With respect to pre-reg-effective-date years after the effective date of §909 (typically 2011 and 2012), the same analysis holds true but only to the extent the taxpayer complies with the Final Technical Taxpayer Regs. The rules are a bit harder to parse for these years but this result seems clear. Unfortunately, to the extent the taxpayer fails to comply with the Final Technical Taxpayer Regs., the remedy is not to force such compliance (as with 2013 and forward), but to treat the non-compliance as a splitter event and the non-matched taxes as split taxes under §909.
The IRS was compelled to adopt this approach because in Notice 2007-95 they assured taxpayers that "the final regulations relating to the determination of who is considered to pay a foreign tax will be effective for taxable years beginning after the final regulations are published in the Federal Register." That is, having (reasonably) tied their own hands in the Notice, the IRS could not directly force compliance with the Final Technical Taxpayer Regs. for 2011 and 2012, and was left only with the indirect approach of the very large threat of applying §909 itself to those years to the extent a taxpayer failed to apply the Final Technical Taxpayer Regs. Non-compliance, therefore, had to trigger §909; it could not separately be enforced under its own terms. Because most taxpayers will welcome the chance to avoid §909 by applying the Final Technical Taxpayer Regs. to 2011 and 2012, this will not be much of a problem. But even in those cases the IRS has a sizeable hammer to force a conservative view regarding the Final Technical Taxpayer Regs. as non-compliance will cause a §909 issue-a far messier result than simply adjusting how one matches taxes and income under the Final Technical Taxpayer Regs.
The use of the Final Technical Taxpayer Regs. to allow relief from the complexity of §909, while most welcome, is not without some of its own uncertainties, however. For example, under Regs. §1.901-2(f)(4)(ii), when there is a change of ownership of a disregarded entity (DE) during the DE's foreign taxable year (and such year does not close), foreign tax paid or accrued in that year must be allocated between the transferor and the transferee. When interests in a DE are sold, this is easy. But what about when the DE itself checks the box to become a regarded controlled foreign corporation (CFC)? Is that a change of ownership "of a DE" that results in an allocation of tax between the prior U.S. shareholder and the new CFC the DE has become? It is unclear based on the language of the regulation but, reportedly, the IRS draftsperson has stated publicly that that is what ought to happen.
As noted already, the decision to use the Final Technical Taxpayer Regs. to allow relief from the complexity of §909 and its problematic identification of related income is the good news regarding these two regulations packages. The not-so-good news is too voluminous to cover in a few paragraphs, but it is worthwhile to at least note that the complex "loss-sharing regime" rules will present a challenge to many taxpayers.
Although compliance with the Final Technical Taxpayer Regs. calls off §909 for a consolidation or fiscal unity regime, compliance with the Final Technical Taxpayer Regs. does not call off §909 for a group relief regime where losses are surrendered to same-country affiliates. A loss-sharing splitter arrangement exists, however, only where, under a foreign group relief or other loss-sharing regime, a "shared loss" of a "U.S. combined income group" could have been used to offset income of that group ("usable shared loss") but is used instead to offset income of another U.S. combined income group. A "shared loss" means a loss, for foreign tax purposes, of one entity (including a branch) that is taken into account by one or more other entities. A "U.S. combined income group" is an individual or corporation and any and all other entities (including disregarded entities and branches) that combine their income for U.S. tax purposes. It is important to note that a "U.S. combined income group" does not mean that there is a U.S. person in the group-only that income and losses of the group are combined for U.S. tax purposes. Thus, a DE and its owner CFC will constitute a "U.S. combined income group."
The split taxes from a loss-sharing splitter arrangement are the foreign income taxes paid or accrued by a member of the U.S. combined group that would have been offset by the usable shared loss had it not been used to offset income of another U.S. combined income group. The related income (with respect to the split taxes) is the income of the other U.S. combined income group that is offset by the usable shared loss.
The "could have been used" standard for identifying a "usable shared loss" presents one of several challenges with respect to applying this rule with confidence. For example, if one U.S. combined income group shares a loss with another U.S. combined income group in 2013, but could have carried that loss back to its own 2012 year, is that a loss-sharing splitter arrangement? What about carryforwards? While the carryback situation may have been intended to be caught, one hopes the carryforward case was not-how can one be expected to know whether or not a U.S. combined income group will have income against which the loss could be used in a future year?
Hybrid partnerships also create challenges. The hybrid partnership is treated as simultaneously being in two U.S. combined income groups. Consider a situation in which the hybrid partnership has a loss, but is owned by two U.S. combined income groups with income. Would the regulation prohibit the loss from being surrendered to either group?
In summary, the IRS is to be congratulated for using the Final Technical Taxpayer Regs. to limit the application of §909. It should be forewarned, however, that the loss-sharing splitter arrangement rules will need some added clarity and will likely result in sizeable administrative headaches both for the IRS and for taxpayers.
This commentary also will appear in the June 2012 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see DuPuy and Dolan, 901 T.M., The Creditability of Foreign Taxes - General Issues, and in Tax Practice Series, see ¶7150, U.S. Persons - Worldwide Taxation.
1 "Section 909 - Foreign Tax Credit Splitting Events and `Related Income,'" 39 Tax Mgmt. Int'l J. 679 (11/12/10); "Section 909 - Part 2," 40 Tax Mgmt. Int'l J. 108 (2/11/11).
2 T.D. 9577, 77 Fed. Reg. 8127 (2/14/12).
3 T.D. 9576, 77 Fed. Reg. 8120 (2/14/12).
4 Non-compliance will also avoid §909. The remedy for failing to match foreign taxes with related income in foreign consolidation regimes is not to suspend foreign taxes, as §909 would, but to currently match the tax and related income under the Final Technical Taxpayer Regs.
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