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By Lowell D. Yoder, Esq.
McDermott Will & Emery, Chicago, IL
Generally, a loan made by a subsidiary to its parent or to an affiliate is not a taxable event. Subpart F, however, provides a limited exception. When a controlled foreign corporation ("CFC") makes a loan to a related U.S. person, the United States shareholder ("U.S. shareholder") of the CFC includes in its income the average of the amounts of such loans outstanding on the last day of each quarter.1
Treasury and the IRS have provided an exception for short-term loans. A loan to a related U.S. person held by a CFC at the end of a quarter will not trigger an inclusion under Subpart F if the loan is repaid within 30 days from the time it is incurred (i.e., the "30-day exception").2 This exception applies only if the CFC does not hold for 60 or more days during its taxable year any obligations3 of related U.S. persons that (without regard to the 30-day exception) would be subject to §956 ("the 60-day limitation").
The 30-day exception can be used to reduce third-party debt outstanding at the end of a quarter. For example, a U.S. parent may have $100 million of third-party debt and $30 million of cash offshore. For quarterly and annual financial reporting purposes, the $100 million is reported as gross third-party debt, and the company's debt-to-equity ratio is calculated using that amount (i.e., the $30 million of foreign cash is not netted against the $100 million of outside debt). Under the 30-day exception, the CFC can loan the $30 million to the U.S. parent over each quarter-end and at the end of the year (subject to the 60-day limitation), which can then be used to reduce the U.S. parent's $100 million of third-party debt to $70 million. The lower amount of outside debt reflected on the financial statements may result in a better credit rating and lower borrowing costs.4
CCA 201516064 addresses the application of the 60-day limitation on the availability of the 30-day exception. The CCA states that all loans held by a CFC that are subject to §956 must be counted for purposes of determining whether the CFC held loans to related U.S. persons outstanding for 60 or more days during the year, not just the loans qualifying for the 30-day exception.
Under the facts of the CCA, a CFC made two loans to its U.S. parent ("USP"). Let's assume the following dates and amounts, and that the CFC is on a calendar taxable year. On March 25, the CFC loans $20 million to USP. On April 15, USP repays $17.5 million (the remaining $2.5 million of the loan remains outstanding). On September 20, CFC makes another loan to USP in the amount of $30 million, and USP repays the $30 million to CFC on October 10. The $2.5 million amount of the first loan continues outstanding for the remainder of the year.
The taxpayer addressed in the CCA apparently argued that there was only a $2.5 million investment in U.S. property. The amounts of $17.5 million and $30 million were each loaned to USP for less than 30 days. The total number of days both amounts were outstanding was less than 60 days. If the 60-day limitation took into account only loans outstanding for less than 30 days, the limitation would be satisfied. In all events, the $2.5 million that remained outstanding from March 25 through the end of the year would not qualify for the 30-day exception.
The CCA, however, states that all §956 obligations must be counted in calculating the 60-day limitation. This includes loans not outstanding at the end of a quarter and loans that would otherwise qualify for the 30-day exception. Thus, the $2.5 million that remained unpaid on the first loan is counted. Since the CFC had loans to related U.S. persons outstanding for more than 59 days, the 30-day exception did not apply to the $17.5 million loan or the $30 million loan, even though they were both outstanding for less than 30 days.
This 60-day limitation is a "cliff rule." If the CFC has loans outstanding to related U.S. persons for 59 days, the 30-day exception is available, but if the CFC holds §956 loans for 60 days, the 30-day exception is not available for any loan. Also, there is no de minimis rule, nor explicit relief for oversights or inadvertent loans. For example, if a CFC made a 10-day loan during the year to a related U.S. person over a quarter-end for $100 million, and also had one other loan to a related U.S. person during the year in the amount of $50 that was outstanding for 61 days, the $100 million loan literally would not qualify for the exception. It would seem appropriate for the IRS to not rigidly apply the 60-day limitation in order to properly carry out the purpose of providing an exception to §956 for short-term, quarter-end loans.5
Receivables arising from the sale of inventory or the provision of services that qualify for another exception are not counted as obligations for purposes of the 60-day limitation.6 Also, the 60-day limitation does not take into account other types of investments in U.S. property, such as stock in a related U.S. corporation or investments in U.S. tangible property located in the United States.
Under certain circumstances, the IRS has asserted that successive loans should be treated as one continuous loan.7 Such position means that the days between the successive loans are counted and would likely cause the 60-day limitation to be failed. It is generally accepted that successive loans made by a CFC to a related U.S. person that are off for approximately as many days as they are on should not be treated as one continuous loan.8 Accordingly, this step-transaction concept should be easy to avoid because to qualify for the 30-day exception a CFC cannot have loans outstanding during a year for more than 59 days.
The 60-day limitation is applied on a CFC-by-CFC basis consistent with the rules in §956 and the regulations. Therefore, a CFC with loans otherwise satisfying the 30-day and 60-day requirements does not lose the exception if a related CFC has loans outstanding to related U.S. persons for 60 or more days.
Section 956 applies only to loans made by a CFC to related U.S. persons. Therefore, loans to foreign related persons generally are not subject to §956,9 and accordingly are not counted for purposes of the 60-day limitation. Under certain limited circumstances, however, if a CFC makes a loan or capital contribution to a related foreign corporation which uses the proceeds to make a loan to a related U.S. person, the funding CFC can be considered as holding the loan to the related U.S. person. This anti-abuse rule applies only if there is a principal purpose to avoid the application of §956 to the funding CFC.10 Care should be taken to avoid the application of this indirect investment rule, because it might cause a CFC to fail the 60-day requirement.11
The §956 computational rules provide another short-term loan exception. The amount of the §956 investment is the average of the amounts of loans to related U.S. persons held by a CFC as of the end of each quarter of the CFC's taxable year. Loans outstanding during a quarter but not at the end of a quarter are not counted. Thus, a CFC can make intra-quartile loans to related U.S. persons without a deemed distribution under §956.
Relying on the intra-quartile loan exception eliminates the 60-day limitation (and also the short-term loans can be outstanding for more than 30 days). As mentioned above, successive loans should not be treated as one continuous loan deemed outstanding over a quarter-end provided the loans are off for approximately as long as they are on.
If a U.S. parent desires to obtain the financial reporting benefits of quarter-end loans, a CFC can adopt a fiscal year that closes one month earlier than the fiscal year of its U.S. parent.12This permits a CFC to loan funds over its U.S. parent's quarter-ends but not over the quarter-ends of the CFC.
CCA 201516064 states that the IRS views all §956 loans of a CFC outstanding during a year as being taken into account in determining whether the 60-day limitation is met. In doing so, the IRS again confirmed the continued viability of the 30-day exception for short-term loans outstanding over a CFC's quarter-end.13
This commentary also appears in the October 2015 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Fried and Liss, 6260 T.M., CFCs – Investment of Earnings in United States Property, and in Tax Practice Series, see ¶7150, U.S. Persons -- Worldwide Taxation.
Copyright©2015 by The Bureau of National Affairs, Inc.
1 §951(a)(1)(B), §956. The amount included in the income of the U.S. shareholder is limited to the earnings and profits of the CFC that have not been previously subject to U.S. taxation under Subpart F. See Yoder, Subpart F Inclusions and Dividends: Key Ordering Rules, 41 Tax Mgmt. Int'l J. 570 (Oct. 12, 2012).
2 Notice 88-108, 1988-2 C.B. 445. See GLAM 2007-0016 (confirms that, although Notice 88-108 literally applies to year-end obligations, the 30-day exception will be available for obligations outstanding at the end of each quarter); Yoder, IRS Applies §956 30-Day Exception to Quarters, 36 Tax Mgmt. Int'l J. 664 (Dec. 4, 2007).
6 See §956(c)(2)(C); Reg. §1.956-2(b)(1)(v), §1.956-2T(d)(2)(i)(B). See Yoder, Improving Efficiency of Global Cash Utilization: Accelerated Payments for Inventory, 38 Tax Mgmt. Int'l J. 171 (Mar. 13, 2009). The 60-day rule takes into account only loans that would otherwise be subject to §956.
7 See Rev. Rul. 89-73, 1989-1 C.B. 258; Jacobs Engineering Group Inc. v. U.S., 79 AFTR 2d 97-1673 (C.D. Calif. 1997), aff'd, 168 F.2d 499 (9th Cir. 1999). For a detailed analysis of the Jacobs Engineering case, see Yoder and McGill, Treatment of CFC Loans to U.S. Affiliates: The Sword and Sickle of Subpart F, 26 Tax Mgmt. Int'l J. 454 (Sept. 12, 1997).
9 While the Code limits the application of §956 to loans to related U.S. persons, Treasury and the IRS recently issued Notice 2014-52, 2014-42 I.R.B. 712, stating that regulations would be issued to apply §956 to loans to foreign corporations in certain inverted structures implemented after September 22, 2014. The Notice states that the 30-day exception is not available for such loans. See Yoder, Section 956: IRS Treats Foreign Property as U.S. Property, 44 Tax Mgmt. Int'l J. 157 (Mar. 13, 2015).
11 The cases that have addressed the indirect investment rule have applied it where a CFC parent made a capital contribution to a CFC subsidiary that had no earnings and profits, and the CFC subsidiary invested the funds in U.S. property on a long-term basis. Schering-Plough Corp. v. U.S., 651 F. Supp. 2d 219 (D.N.J. 2009) order denying motion for retrial,Merck & Co v. United States, 2010-1 USTC ¶ 50,373 (D.N.J. 2010), aff'd,Merck & Co., 652 F.3d 475 (3d Cir. 2011); The Limited, Inc. v. Commissioner, 113 T.C. 169 (1999), rev'd on other grounds, 286 F.3d 324 (6th Cir. 2002). None of these opinions addresses whether Reg. §1.956-1T(b)(4) is valid, or whether it exceeds the agency's rulemaking authority. For a discussion of recent IRS guidance applying the indirect investment rule, see Yoder, IRS Applies the §956 Indirect Investment Rule to a Partnership Loan, 43 Tax Mgmt. Int'l J. 630 (Oct. 10, 2014); Yoder, IRS Expands the Application of the Code Sec. 956 Anti-Conduit Rule, 41 Int'l Tax J. 3 (Mar.-Apr. 2015).
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