Chapter 6 – Options for
Anti-Deferral Tax Regimes
Alternative approaches to
U.S. taxation of U.S. owners & foreign corporate income:
1) Complete
deferral (or territorial?)
2) Partial deferral –
“Subpart F” approach
3) Deferral, but
imposition of an interest charge when income distribution occurs
4) Deferral, but tax
characterization change to ordinary income when gain is received
5) No deferral -
all current income recognition (or
“acceleration”?)
Present/Former U.S.
Anti-Deferral Tax Structures
1) FPHC - current
attribution of investment income (repealed 2004)
2) Controlled
foreign corporation or CFC -Subpart F provisions - partial
current recognition of undistributed income.
3) Foreign investment
companies - (repealed 2004) - characterization of a distribution.
4) Passive foreign
investment company rules - PFIC - interest charge on an excess
distribution or on stock sales proceeds
Purposes for Use of “Base
Country” Corp. p.487
1) Holding stock in
foreign subsidiaries
2) Licensing arrangements
3) Export sales or import
purchases through a “base company”
4) Services provided from
a base company
5) Financing operations
at a foreign base
What is a “base
country”? Tax haven, including no tax on income realized outside the base
country.
The “Subpart F” Provisions
Summarized p.489-490
Code §§ 951-964.
Current income taxation
to U.S. shareholders (even though income not actually received):
1) Must be a “controlled
foreign corporation” (or CFC), i.e. more than 50% U.S. owners.
2) Must be a 10% or
greater shareholder.
3) Limited to certain
types of movable income (not manufacturing income).
PFIC Provisions
Summarized p.490
Code §§1291-1298
(TRA-1986)
“Passive Foreign
Investment Company” (or PFIC) status – passive investment income.
Deferral permitted since no
CFC status, e.g., for offshore investment fund with a large shareholder base.
But, the benefit
of the income tax deferral is recaptured (through an interest
charge) when (1) an “excess distribution” or (2) a stock sale.
PFIC Provisions,
cont. p.491
No stock
ownership percentage test; applicable to U.S. taxpayer owners.
Income must be 75%
passive (or 50% of assets must be those producing passive income).
Options for an interest
charge on deferral benefit:
1) Qualified electing
fund
2) “Mark to market” for
PFIC stock – assuming marketable stock.
“Temporary” Dividends Received
Deduction p.492
Code §965 – temporary
(2004) provision enabling an 85% DRD. Expired, but to be renewed?
Therefore, a tax of 35%
times 15% = 5.25% effective U.S. income tax rate.
Only cash
dividends. Must be extraordinary dividends (i.e., exceeding average
repatriations)
Reinvestment
in U.S. required – must be a dividend reinvestment plan and funds are to
be used for prescribed purposes.
Definition of a “Controlled
Foreign Corporation” p.494
Code §957(a) defines a
“controlled foreign corporation” (CFC) as a foreign corporation where more
than 50 percent of
(i) the vote, or
(ii) the value
of all the outstanding stock is owned (or is considered as owned)
by “United States
shareholders” on any day during the taxable year (determine year by year).
United States shareholder
defined – next slide.
“United States Shareholder”
Defined p.494
Who are “United States
shareholders”? See the §951(b) definition.
U.S. citizens, resident
aliens, corporations, partnerships, trusts or estates owning directly or
indirectly or constructively (under the ownership rules of §958) 10% or
more of the total combined voting power of all classes of stock of a
foreign corporation.
Less than 10%: a
“portfolio interest.”
Subpart F Constructive
Dividends Concept p.496
1. Include a pro rata
share of “Subpart F income” (§951(a)(1)(A)(i)), as determined on the
last day of the year. Objective: Constructive receipt - economic power to
control the income and an immediate accretion to wealth causes gross income
inclusion.
2. Include pro rata
share of investment in “U.S. Property” (§956) - a deemed
repatriation of profits (income type is not
relevant). continued
Subpart F Constructive
Dividends Concept, cont.
3. Income
attributed to the shareholder is treated as ordinary income (i.e.,
capital gain may be transformed into ordinary income). Important to an
individual situation.
Cf., branch treatment.
4. No loss
pass-through to the shareholder.
5. Subsequent
stock disposition gain – ordinary income to the extent of profits allocable to
the stock sold. §1248 (i.e., not capital gain).
Subpart F - Foreign Tax Credit
Availability p.498
Indirect foreign tax
credit is available for U.S. corporate shareholders when current inclusion is
required - similar to §902. See §960.
§78 gross-up by the taxes
deemed paid attributable to the deemed distribution.
§962 – election to an individual
shareholder for the same treatment (i.e., availability of the deemed paid
foreign tax credit & tax at corporate rates).
Subpart F - Adjustment
Mechanisms p.498
§959(a) - actual
distributions from the CFC are sourced first from amounts already taxed under
§951(a). Similar for previously taxed §956 U.S. investment amounts.
§961(a) – an increase in
tax basis is made for shares by the amount included in gross income under
§951(a). Reduction of tax basis is made for untaxed distributions. §961(b).
Subpart F Income Elements -
§952(a) p.499
1) “Foreign base company
income” - diversion of passive (& other) income to a low-tax jurisdiction.
2) Income from insurance
activities
3 International
boycott-related income
4) Illegal bribes and
kickbacks
5) Bad country income
Foreign Base Company
Income - §954(a) p.500
Categories of FBC income:
1) Foreign personal
holding company income (FPHCI)
2) Foreign
base company sales income
3) Foreign
base company services income
4) Foreign base company
oil related income
Not
active business income; formerly, also, foreign base
company shipping income
Limits on Subpart F Income
Inclusion p.502
1) §954(b)(3)(A)&(B)
- de minimis rule (5%) but, also, a 70% full inclusion rule.
2) §952(c)(1) provides
limit on CFC's Subpart F income to “earnings and profits” for that year.
3) §952(b) excludes from
Subpart F income certain U.S. source income - ECI with a U.S. trade or business
(currently subject to U.S. income tax).
Definition of “Controlled
Foreign Corporation” p.502
§957 - more than 50% vote
or value of the corp. stock is owned by U.S. shareholders.
§958 specifies direct,
indirect and constructive ownership rules.
§958(a)(2) - indirect
ownership rules.
§958(b) - constructive
ownership rules concerning attribution between family members and between (i)
entities and (ii) their shareholders, partners or beneficiaries. Cf., §318
(Subchapter C) constructive ownership rules.
Problem
1 p.504
CFC Status?
Zeus as Swiss corp has
1,000 shares of a single class of stock outstanding. Jupiter, a widely held
U.S. corporation, owns 460 shares and the remaining 540 are owned equally by
six unrelated U.S. individuals.
Result: None of the
individuals is a “U.S. shareholder” because none owns 10%; therefore, Zeus is
not a CFC.
§957(a) and §951(b).
Problem
2 p.504
More than 10% Individuals
The number of
shareholders is reduced from six to five.
Each individual
shareholder then owns more than 10 percent (10.8%, or 108/1000).
Result: Each individual
would be a “U.S. shareholder.”
Therefore, Zeus would
be a CFC (more than 50% of its stock is owned by “U.S. shareholders”).
Problem
3 p.504
Attribution to Partnership
1) A partnership (one of the
six shareholders each owning 9%) owns 90 shares, and
2) a partner owns 90 shares.
The partner's shares are attributed to the partnership and the partnership,
therefore, holds 180 shares.
Zeus is a CFC (when
including Jupiter’s shares). §958(b) and §318(a)(3)(A). 180 plus 460 (640) is
more than 50 percent.
Is the partner a
U.S. shareholder? No, §318(a)(2) (5% of 90 shares = 4.5 shares).
Problem
4 p.504
Husband & Wife Attribution
Two of the individuals
are husband and wife. Each spouse's shares are attributed to the other under
§958(b) and §318(a)(1)(A)(i).
Each spouse is deemed to
own 180 shares (90 actually and 90 by attribution) and each spouse is a U.S.
shareholder.
Therefore, Zeus is a CFC
(when the 180 shares are combined with the 460 Jupiter shares = 640).
Problem
5 p.504
Nonresident Alien Status
Two of the individual
shareholders are husband and wife. One spouse is a nonresident alien.
No
attribution occurs (under §318(a)(1)(A)) to/from a nonresident alien spouse.
See §958(b)(1).
Therefore, Zeus is not
a CFC.
Problem
6 p.505 Attribution Among Siblings?
Two of the individuals
are brother and sister.
No attribution
occurs between siblings under §318(a)(1)(A).
Therefore, Zeus is not
a CFC.
Cf., §554(a)(2) of the
(former) foreign personal holding company provisions.
Problem
7 p.505
Corp/Shareholder Attribution
One of the individuals
(owning 90 shares) owns 50 percent of the stock of Jupiter corporation (which
owns 46% of Zeus).
All of the individual’s
90 shares are attributed from individual to Jupiter Corp. and
Jupiter then owns 550 shares (460 + 90). §318(a)(3)(C).
Zeus is a CFC.
Cf., attribution to
individual (yes, ½ of 460 shares). §318(a)(2)(C). U.S.
shareholder (230 plus 90 = 320).
Problem
8 p.505
10% Share Ownership
One of the individuals
(owning 90 shares) owns 10% (not 50%) of the stock of Jupiter
corporation (which owns 46% of Zeus) and becomes U.S. shareholder.
The individual’s 90
shares are combined with Jupiter Corp. 460 shares for 550 shares.
§318(a)(2)(C) & §958(b)(3).
Zeus is a CFC.
90 plus 460 = 550 shares.
Problem 9 p.505
5% Share Ownership
One of the individuals
(owning 90 shares) owns five percent of the stock of Jupiter corporation
(which owns 46% of Zeus).
The individual’s 90
shares are not attributed from individual to Jupiter Corp. See §318(a)(2)(C)
& §958(b)(3).
Zeus is not a CFC
since Jupiter is the only “U.S. shareholder” (holding 46%).
Problem 10
p.505
Ownership Thru Foreign Corp.
410 shares of Zeus are
owned by Jupiter Corp, and
90 shares are owned by a
U.S. citizen who (1) also owns 3% of the shares of Juno B.V. (a Dutch
corporation) that (2) owns 500 Zeus shares (i.e., U.S. citizen indirectly
owns 15 additional shares of Zeus or a total 105).
105 shares plus 410
shares means Zeus is a CFC. See §958(a)(2).
Stock Voting Power (or Value?)
Test - 50% plus
CCA,
Inc. p. 505 Old CCA owned all of the issued and outstanding
stock of AG (Swiss).
AG was exporter of CCA
products from the United States. Also, AG had exclusive right to use CCA
trademarks.
AG had manufacturing
plants in other European jurisdictions.
After 1962, an objective
to “decontrol” AG.
Accomplished here. Yes.
Why?
Koehring case p.515
Nominal control irrelevant
KOS, a Panamanian sub,
operating as a wholly owned sub of the U.S. parent corporation. Voting control
transferred to Newton Chambers, an English company, by purchase of cumulative
voting preferred stock having 55% of the vote.
See Reg. §1.957-1(b)(2)
re shifting of formal voting power. But, KOS treated as a CFC. Why?
What impact of the
“clearly erroneous” rule?
Problem 4, p.526
Avoiding CFC Status
Still possible to
decontrol foreign corp.? yes, but preferred stock must have value equal
to at least 50%, and:
1) restrictions re no
transfer to a U.S. person
2) 50 percent of the
Board of Directors as preferred share representatives.
3) no common share right
to redeem preferred
4) no means to resolve
the deadlocks, etc.
Stapled Stock
Corporations p.527
Holdings in (1) the U.S.
and (2) the foreign corporations can only trade as a unit.
“Stapling” to avoid the
applicability of the Subpart F rules for the foreign corp. - & sufficiently
wide distribution of shares of the foreign corporation to not be a CFC.
§269B specifies that the
foreign corporation when stapled is treated as a U.S. corporation. Cf.,
a nonstapled corp.
Corporate
Inversions p.529
Transformation of a U.S.
publicly traded corporation into a subsidiary of a foreign corporation.
Treatment of this change?
After the transaction the
U.S. shareholder ownership of foreign corporation is widely dispersed and
foreign corporation is not a CFC.
Stripping profits from
the U.S. sub to foreign parent would then be enabled.
But, may be treated as a
U.S. corp. See §7874.
Possible Rules for Corporate
Residency p.530
Control the corporate
residency status determination on where the primary corporate officers reside
and regularly work (rather than the place of organization)?
Cf., other foreign
country tests of the place of “management and control” for determining the
situs of a corporation. Different from the place where the corporate business
is conducted?
Mechanics of Subpart F Income
Inclusion p.530
§951(a)(1) - gross income
inclusion for a shareholder if the corporation is a CFC for a 30 day period
during the tax year.
Every person who is a
U.S. shareholder must include his/her/its pro rata share of the Subpart F
income at year-end.
Pro rata share of a
person’s includible Subpart F income is determined by reference only to direct
and indirect CFC ownership (but not to constructive ownership).
Subpart F Mechanics, cont.
p.531
If CFC for only part of
the year - pro rata allocation. §951(a)(2)(A).
Reduction of Subpart F
income amount if dividends were actually received earlier in the same year by a
prior owner. §951(a)(2)(B).
Note: How negotiate a
corporate acquisition transaction with this Subpart F income consideration?
Dividend or no dividend treatment? Consider the FTC situation to the potential
acquirer.
Subpart F Income Inclusion, cont.
p.532
If multiple classes of
stock are outstanding, how allocate the Subpart F income among the several
classes? Allocation is to be based on the E&P amounts allocable to each
class.
How allocate income if
directors have discretionary power to allocate income among the several classes
of stock? Based on the relative values of the shares.
2005 Regulations – T.D.
9222 (8-25-2005).
Subpart F Income Inclusion,
Multiple Tiers p.533
If multiple tiers of
corporations, how determine the shareholder’s Subpart F income amount? Use the
“hop-scotch” method for Subpart F income from lower corps. To the U.S.
shareholder(s).
Eligibility for an
(indirect) foreign tax credit? Yes.
Gross-up the Subpart F
income amount by the allocable deemed paid credit amount under §960.
Shareholder increases tax
basis for above tier corps.
What happens when 1st
tier corporation sells shares of 2nd tier corporation? Tax basis
increase for the holding in the 2nd tier sub. §961.
The Partnership “Blocker”
Transaction p.534
Interpose a domestic
partnership in the middle of a chain of foreign corporations to avoid CFC
status for the foreign corporation(s) below the domestic partnership?
See Notice 2010-41 that
indicates that the U.S. partnership is to be classified as a foreign
partnership for purposes of determining the CFC status of the lower tier corp.
Foreign tax credit
availability p.535
§960 – similar to §902
concerning availability of the indirect FTC to upstream corp. shareholders.
Indirect credit is
available down to the 6th tier foreign corporation if a controlled
foreign corporation. §902(b)(2).
At least 10% corporate
ownership of voting stock must exist at each level.
No indirect FTC below the
6th tier. (but then use a “disregarded entity”?).
Problem
1 p.537
FBC Income Allocation
Two NRAs and a U.S.
corporation organize Irish Foreign Base Company, Inc. (FBC). Two NRAs get
30% each & Widgets gets 40%.
On August 8 NRA Molly gets
a “green card.”
FBC has net income of
$400,000 for year one – 1/2 of this amount being Subpart F income.
FBC paid $80,000 in
foreign income tax on pre-tax foreign net income of $480,000 (16+%
rate). continued
Problem 1, continued
CFC status during mid-year
FBC becomes a CFC on
August 8 when FBC has a 40% & a 30% U.S. shareholder.
For the year $200,000 is
Subpart F income (after foreign taxes) (§954(b)(5)).
Proportionate allocation
of the Subpart F income is to be made to that period during which the
corporation is a CFC - 40% (145/365) of the year, times $200,000 ($80,000),
equals (1) $32,000 inclusion for Widgets (40%) and (2) $24,000 for Molly
(30%). continued
Problem 1, continued
Basis & FTC Treatment?
Molly tax basis
adjustment for her stock: $30,000 cost plus $24,000 Subpart F income –
$54,000.
No indirect FTC
(since an individual), assuming no §962 election by Molly.
Widgets’ tax basis
increase for stock: $40,000 cost, plus $32,000 Subpart F income = $72,000
basis. Widgets gets a §960 deemed paid credit: 32,000/400,000 x 80,000 =
6,400. No tax basis increase for the 6,400 amount (since used as a FTC).
Problem
2 p.537
Actual dividend distribution
Year two distribution of
dividends is made from FBC: $20,000 to Widgets, and $15,000 to Molly and Sam.
FBC breaks even for 2nd year.
Sam (foreigner) is not
subject to U.S. income tax .
Under §959 no tax to
Widgets and Molly since amounts received paid from earnings previously taxed
(under §951). See §959(c) ordering rules.
Under §961(b) the share
basis is then reduced (the prior increase occurred upon the earlier income
inclusion).
Exclusion of U.S. Trade or
Business Income p.537
§952(b) provides an
exclusion from Subpart F for U.S. trade or business income. Assumption of net
basis income taxation in the United States to enable the exclusion from
Subpart F income.
No exclusion from Subpart
F, however, where the trade or business income in the U.S.:
(1) is entitled to an
exclusion from gross income (e.g., no P.E.) under a tax treaty, or
(2) has a reduced rate
of tax under an income tax treaty.
Subpart F Income Is Based on Current
E&P p.538
§952(c)(1)(A) - Subpart F
income is limited to CFC’s current “earnings and profits.”
Some CFC current
losses may reduce the CFC’s Subpart F income. However, possible subsequent
recharacterization when an excess of current earnings and profits is realized
over Subpart F income. §952(c)(2). A timing rule.
Accumulated Deficits As
Reducing Subpart F Income
Accumulated deficits do
not reduce Subpart F income for the current year, except as permitted in
§952(c)(1)(B) (i.e., "qualified activity"). P. 539.
Deficits in related
companies cannot be used to reduce Subpart F income except where the same
“qualified activity” is conducted by a "qualified chain member” and
deficits are incurred.
Qualified activities
produce: (1) FBC oil-related income, (2) FBC sales income, (3) FBC services
income, (4) certain insurance co. income, or (5) certain financial co.
income.
Defining Foreign Base Company
Income p.540
Definition of FBCI in
§954(a):
1) Foreign personal
holding company income. Same country exceptions.
2) Foreign base company
sales income.
3) Foreign base company
services income.
4) Foreign base company
oil related income.
FBCI formerly included
foreign base company shipping income.
Defining “Foreign Personal
Holding Company Income”
P. 540. Definition in
§954(c) - Interest, dividends, rents, royalties, annuities and gains from the
sale of stock or securities.
Exception for rents from
unrelated persons when the active conduct of a business -
§954(c)(2)(A).
Exception for “same
country” dividends and same country interest from a related person.
§954(c)(3)(A)(i). Same for “same country” rents and royalties. continued
Defining FPHCI, continued
p. 542-3
The exception for related
party payments is not applicable where payments reduce Subpart F income of
payor. §954(c)(3)(B).
Gain on the sale by a CFC
of another foreign corp stock is treated as a dividend as if §1248 would be
applicable. §964(e). P.544.
Similar treatment if a
§311(b) gain recognition transaction upon distribution of CFC stock by foreign
parent to U.S. shareholder.
Related Person Factoring
Income p.546
Sale of receivable to a
“factor” at a discount.
§864(d)(1) - discount
income from factoring with a related person is treated as “interest”
income from a loan.
Also, a loan to a
purchaser from a related party is treated as a receivable purchase for this
rule. §864(d)(6).
A same country exception
is available in some situations. §864(d)(7).
Other Foreign Personal Holding
Company Income
P. 548. Foreign currency
gains. §954(c)(1)(D). A hedging exception is applicable.
Income from commodity
transactions. §954(c)(1)(C). Hedging exception is available. §954(c)(5)(A).
P. 549. Income derived
from the sale of property producing (1) passive income or (2) no
income. §954(c)(1)(B). Exceptions for certain property sales.
The “Check & Sell” Plan
The Dover case p.551
A CFC’s sale of stock
(including the stock of a 2nd tier foreign subsidiary) produces
capital gain which is FPHC income.
But, the sale of assets
produces no FPHCI but may cause foreign country gains tax.
Option: Use the “check
the box” entity characterization rules (assuming an “eligible entity”) to (1)
cause a deemed liquidation of the foreign corp. and (2) then sell the stock
(which is a sale of assets for U.S. income tax purposes).
Foreign Base Company Sales
Income p.556
§954(d). Income derived
from the purchase and the sale of personal property:
(1) if purchased from or
sold to a related party, and
(2) the property was manufactured
outside the country where the CFC is organized and the property is sold for
ultimate use.
Includes income from
commissions.
“Tax avoidance” purpose
not relevant. Cont.
Foreign Base Company Sales
Income, continued
Exception from FBC sales
income treatment where CFC conducts significant manufacturing of the
product sold:
What is “manufacturing”?
Three alternatives tests: (1) Must be “substantial transformation.” (2) A 20%+
“safe-harbor” is possible for the CFC. Minor assembling is not sufficient
to constitute “manufacturing.” (3) “Substantial contribution” test.
See Dave Fischbein case
(later, Ch. 11, p. 911).
continued
Foreign Base Company Sales
Income, cont. p.558
Possible application of a
“branch rule,” i.e., treating the branch as a separate corporation.
§954(d)(2). Why?
Example: Swiss CFC is
engaged in manufacturing and uses a Cayman Islands branch for its sales
operation. Tax only in Switzerland on the manufacturing income (Swiss
territorial taxation approach). No tax in Cayman Islands on the sales activity
(and income). CI branch treated as a separate sub for FBC sales income
purposes?
Foreign Base Company Services
Income – p.558
§954(e)(1). Services
performed (1) for a related person and (2) performed outside the country where
the CFC is organized. Both a "related person" and a
"geographic" test need to be satisfied.
Consider foreign
construction or drilling companies engaged in offshore activities.
"Substantial
assistance" provided to the foreign subsidiary may cause this rule to
apply. P.559. See exception for financing activities. P.561.
Foreign Base Company Oil Related
Income – p.561
§954(g)(1). “Oil
related” income realized by big producers outside the country of oil & gas
production. E.g., refining, transportation & distribution income from oil
and gas products. See §907(c)(2)&(3).
Applicable only to large
producers (1,000 + barrels per day).
Exception for “in
country” consumption.
Subpart F Definition of a
“Related Person” p.562
§954(d)(3) specifies that
a “related person” is one of following:
1) More than 50% of the
vote or value of a controlled corporation
2) More than 50%
of value of the beneficial interests in a partnership, trust or estate.
Special Rules for
Inclusion/Exclusion p.563
1) De minimis rule (lesser
of 5% of GI or 1 mil.; e.g., for interest received on cash balances).
§954(b)(3)(A). An anti-abuse rule applies.
2) Full inclusion (70%+)
of GI rule. §954(b)(3)(B).
3) Exception for a
high-taxed income item. P.565.
§954(b)(4). At least
a 31.5% (effective, not a nominal) tax rate. No PLR is available.
Blocked earnings
exclusion. §964(b). P.567. But, note re swap and similar arrangements.
Income Earned by CFC Through
Partnership p.568
Consider Subpart F income
realized by a partnership - attribution to the partners, including to a CFC
(sub of a US parent)?
§702 - provides for
separate characterization.
See Brown Group cases
& §954(d)(3).
§701 anti-abuse
regulations -partnership treated as an “aggregate”.
Notice 96-39 (IRS
disagreement with Brown Group 8th Cir. decision) p. 571
Subsequent regulations
& then §954(c)(4) look-through rules (2004).
Subpart F and the New
Economy p.573
U.S. Treasury Department
Study, 12-2000
Impact of the Subpart F
rules on transactions conducted through Websites and the Internet.
Sourcing issues: Where
is the place of performance or the place of use?
Sales of goods?
Royalties? Services?
Manufacturing within the
CFC, e.g., for software?
Relevance of “branch
rules”? Or, “U.S. trade or business status”?
Problem 1a Matterhorn, S.A.
Swiss sub of USM(US) p.581
Matterhorn (a CFC)
acquires from parent and sublicenses patents for royalties to be received from
independent licensees outside Matterhorn’s place of organization.
Royalties included in
definition of FPHCI.
Unless: (i) same
country-related person exception under §954(c)(3)(A)(ii), or (ii) the active
business - unrelated person exception of §954(c)(2)(A). But, not here – not an
active business.
Problem 1b
Matterhorn
p. 581
Matterhorn patents are
acquired from inventions developed by Matterhorn’s own technicians.
Not FPHC
income since for Matterhorn the royalties are “derived in the active conduct of
a trade or business.”
§954(c)(2)(A); see Reg.
§1.954-2(d).
Problem 1c
Matterhorn
p.581
Matterhorn (Swiss Co.)
receives 200x of dividends and 100x of interest from each of two wholly owned
subs - (i) Belgium & (ii) Switzerland.
Dividend and interest
income normally constitutes FPHCI under §954(c)(1). Consider the same country
related person exception – Swiss sub. §954(c)(3)(A)(i).
But, consider rule that
payment is not permitted to reduce Subpart F income. Interest from Swiss sub
is deductible & would reduce Subpart F income. §954(c)(3)(B).
Problem 1d
Matterhorn
p.581
Sales of gold coins
having numismatic value purchased for investment. Sale is made to an
independent dealer in Switzerland.
This is an investment in
property which “does not give rise to any income”.
Gain on this sale is
FPHCI. §954(c)(1)(B)(iii).
Not FPHCI if purchased by
a dealer (i.e., inventory) (& not foreign currency gain).
Problem 1e
Matterhorn
p.581 Sales Gain re Patents
Sale of all
rights to a group of patents to a Swiss corporation.
Gain will be
FPHCI under §954(c)(1)(B)(i).
No exclusion where not
active trade or business income concerning these royalties (where same country
related party exception of §954(c)(3)(A)(ii) would otherwise be available).
Problem 1f
Matterhorn
p. 581
Sale of golf balls outside
Switzerland.
§954(d) - FBC sales
income.
Purchase of golf balls
and their resale would constitute FBC sales income here.
Purchase from a
related person - although sales to independent distributors outside
Switzerland.
Packaging is not
“manufacturing.”
Problem 1g
Matterhorn
p. 581
Sale of golf balls to
independent distributors in Switzerland (assuming the property is
for actual use in Switzerland).
No FBC sales income
exists here since goods are sold within Switzerland, i.e., no third
country is involved (assuming no subterfuge on destination of purchases!).
Remember the rule: For
FBC sales income – three countries and two related parties.
Problem 1h Matterhorn
p. 581
Purchase of golf balls
(i) from an unrelated person and also sales (ii) to an unrelated person.
No FBC sales income since
no related person is involved in these purchase or sale transactions.
§954(d)(3) – the related
party rule is not invoked in this situation.
Problem 1i
Matterhorn
p. 582
Manufacture by
Matterhorn of golf balls in Switzerland from components purchased from the U.S.
parent corporation.
What constitutes
“manufacturing” for this purpose? (Fischbein case in later chapter).
§954(d)(1), but minor
assembly or repackaging is not sufficient to be manufacturing for
this purpose.
Problem 1j
Matterhorn
p. 582
Manufacture for
Matterhorn under a “contract manufacturing” arrangements with an unrelated
corporation. The manufacturing is outside Switzerland. No significant
Matterhorn employee oversight.
Result:
Problem 1k
Matterhorn
p. 582
Manufacture for
Matterhorn under a “contract manufacturing” arrangements with an unrelated
corporation. The manufacturing is outside Switzerland.
But, Matterhorn’s
employees engage in product design and quality control.
Result:
Problem 1l
Matterhorn
Foreign taxes reduced p.582
Matterhorn (1) purchases
from (a) USM 49% owned German corp. & (b) USM 51% owned Dutch corp. and (2)
resells outside Switzerland.
Issue concerns what is a
“related party” for Subpart F purposes - see §954(d)(3) concerning the
definition of a related party. More than 50% of the vote or value is
required. Germ. Co. is not related & no FBC sales income. Dutch is
related and FBC sales income.
Note: Foreign tax
reduction (& U.S. tax increase).
Problem 1m
Matterhorn
Definition of “related”? P.582
Matterhorn (Swiss Corp)
purchases from a
50 percent owned
German corporation.
The German corporation would
be related (to Matterhorn) and the sales income would be foreign base
company sales income.
See §958(b) &
§318(a)(3)(C) re “related party” attribution of all Matterhorn stock from USM
to German corp.
Problem 1n
Matterhorn
p. 582
Matterhorn acts as a
sales agent, receiving a commission for services, rather than
buying and reselling.
Tax results: inclusion
since (in addition to purchase/resale arrangements) the FBC sales income
definition contemplates sales commission income.
Problem 1o
Matterhorn
page 582
Services are rendered by
Matterhorn to independent customers outside Switzerland:
- not to
a related party
- although performed
outside the country where Matterhorn was organized.
Not FBC services
income – not performed for a related party. See §954(e).
Problem 1p
Matterhorn
page 582
Services are rendered for
a related party (brother-sister corp). See §954(d)(3).
But, the services are
performed in the country (Switzerland) where Matterhorn is organized.
Consequently, not
FBC services income (the geographic element of the FBC services income test is
not met).
See §954(e).
Problem 1q Matterhorn
p.582
Only 4% of the income is
FBC Services income and, therefore, all this income is within the
protection of the “de minimis” rule (i.e., no FBC income taint).
This is a gross income
test. See §954(b)(3)(A).
Planning: generate a
large amount of active operation gross income (20 mil.) to protect a limited
(no more than 5%) passive income amount (up to 1 mil.).
Problem 1r
Matterhorn
Full Inclusion Rule p.583
75 percent of the
Matterhorn income is foreign base company sales income.
Therefore, all
the Matterhorn income (including 25% non-tainted income) is
treated as foreign base company sales income under the §954(b)(3)(B) “full
inclusion” (more than 70%) rule.
Problem 1s
Matterhorn
High Foreign Tax Rule p.583
Services income is
subject to an effective rate of Swiss and other foreign income taxes of 32
percent.
Problem
1q facts: No FBC income.
Problem
1r facts: Services income is excluded from FBC services income if
the proper high-taxed income election is made. Effective tax rate is to
be greater than 31.5% (90% of 35%).
Problem 1t
Matterhorn
Partnership & p.583
Matterhorn as a 60%
partner in a Belgium partnership and the partnership receives interest income
that would be FPHCI if received directly by Matterhorn.
Make a classification
decision concerning the income as if the income is being received directly
by the partner? Is an entity or aggregate analysis applicable? See Reg.
§1.954-1(g)(1) & Brown case (Tax Court).
Problem
2 p.583
Factoring Income?
Sale by a US seller to a
Swiss sub of installment notes received by the US seller.
Price paid is less than
the unpaid balance on the obligations. Swiss sub either (1) collects on the
debt or (2) sells it at profit to an unrelated party.
Income (when) realized is
(1) related party factoring income & interest (§864(d)(1)) and, therefore, (2)
FPHCI (assuming not active banking income).
Problem 3
p. 583
Loan to Parent’s Customers
Matterhorn loans funds directly
to unrelated foreign customers who use these borrowed funds to buy USM goods.
The income (i) would be
interest income, and (ii) therefore would be FPHC income. §864(d)(6).
Also, a §956 problem
(U.S. investment, later).
Problem
4 p.583
Sale of good or service?
Eastlaw (US) on-line
legal research database.
Foreign Base Co. (sub)
purchases access to database & sells access to unrelated customers in other
foreign countries.
Foreign base company
income to sub?
1) Is this sales income?
- then FBC sales income.
2) Is this services
income? Not FBC services income (not performed for related person?) – unless
the “substantial assistance” rule applies.
Problem
5 p.583
In-Country Services (Sales)?
US Corp sells computers
on Internet.
Tax haven sub processes
customer orders and arranges delivery into third countries.
Tax haven sub receives a
fees for its services.
Foreign base company services
income? Not if services are rendered in tax haven; if outside the
tax haven, FBC services income.
§954(e). But, FBC sales
income (sale of personal property on behalf of a related person)? Doubtful.
Earnings Invested in U.S.
Property - §956 p.584
Concept of deemed
repatriation of foreign earnings (any income type - not
limited to “tax-haven” type income realized by CFC).
For determining this
amount “invested in U.S. property” – i.e., the lesser of:
1) the current
year investment, or
2) the
shareholder’s pro rata share of "applicable earnings".
Limit of the required
inclusion is the adjusted tax basis of property acquired (less debt).
§956
Ancillary Effects
p.585
2nd inclusion is avoided
if prior Subpart F inclusion has occurred - §959.
§960 provides for foreign
tax credit availability if inclusion under §951(a)(1)(B).
Exploiting §956
applicability: Cause a constructive dividend under §956 –
1) FTC is
available for U.S. income tax purposes.
2) No
foreign withholding tax at source on the deemed dividend (occurring for
U.S. tax purposes).
Result: possibly
reducing the foreign tax rate.
Defining Investment in “U.S.
Property” p.587
1) Tangible
property located in the United States - §956(c)(1)(A).
2) Stock of a U.S.
corporation, if related (25% ownership connection). §956(c)(1)(B).
3) Debt obligations
of related U.S. persons.
§956(c)(1)(C) (as of end
of each quarter)
Special exception in
2009-2010 – why? Next slide.
4) Rights to use
U.S. patents, know-how, copyrights or similar U.S. use property.
Short-term Loans to Related
Party p.588
Certain short-term loans
disregarded.
A series of short-term
loans might be integrated for §956 purposes.
Notice 2008-91: “60-180”
obligation.
repay loan with
59 days & total loan days cannot exceed 180 days. Two year rule.
Notice 2009-10: extend to
3 years availability
Notice 2010-12: rule
applies through 2010.
Anti-abuse rule: e.g.,
dropping cash into CFC sub to make loan & sub has no E&P.
Exclusions from “United States
Property” §956(c)(2)
Examples:
1) U.S. Treasury
obligations and bank deposits - but consider The Limited 6th Cir.
case (p. 588) situation of purchase of CDs from related (credit card) bank by
CFC. Held: bank deposits. But, see §956(c)(2)(A) (2004), as revised, re a
“real bank.”
2) Stock issued by an
unrelated corporation.
3) Transportation
equipment outside U.S.
Pledges & Guarantees
Indirect Repatriations p.590
See §956(d) concerning
deemed repatriation treatment for pledges & guarantees.
Possible alternative
situations:
1) CFC guarantees the
financial obligation of the U.S. corp.
2) U.S. corporation
pledges the stock of the CFC to secure financing.
Ludwig case
p.590
Pledging Stock of CFC
Stock of CFC (Oceanic, a
Panamanian corporation) pledged by Ludwig as collateral for a loan to enable
Union Oil stock acquisition by Ludwig.
Holding: CFC (Oceanic)
was not a guarantor of Ludwig’s obligation. No undertakings by CFC to
pay Ludwig’s debt to bank. Remedy is a sale of the pledged stock (not Oceanic
liquidation).
Sequels to the Ludwig case
p. 600
Reg. §1.956-2(c)(2)
concerning indirect pledges. Why a 66 2/3% requirement (and accompanying
“negative covenants”)?
What authority for the
IRS to promulgate this §956 regulation?
What result if back-to-back
(or parallel) borrowing arrangements for the foreign sub and the U.S. parent
with an independent bank?
What if two loans with
pledges of 35% and 65% of the stock of the CFC to two separate lenders?
Indirect Ownership of U.S.
Property (thru Partnership)
Rev. Rul.
90-112 p.601
CFC is a minority
partner in a foreign partnership which owns real property in U.S.
The partnership is
foreign country based.
Code §956(c)(1) includes
this (indirectly owned) as being U.S. real property interest and within the
concept of U.S. property.
Use of an “aggregate”
partnership approach deemed appropriate. Is this a U.S. tax planning device?
What about a Pledge of a U.S.
LLC Interest?
Assume (1) U.S. parent
corp. pledges its interest in a U.S. LLC, and
(2) U.S. LLC itself owns
stock in a CFC (and an interest in a U.S. business).
Should the LLC be treated
as disregarded for applicability of §956? Probably.
Further §956 Questions
re Pledges
1) What if a pledge of
an asset worth less than the amount of the loan? Inclusion to the amount of
the loan or lesser value of asset?
2) Guarantee by CFC, but
value of CFC is less than the loan?
3) Pledge of partnership
interest when the partnership holds CFC stock?
4) Loan by CFC to
foreign partnership owner where US partner holds majority/minority interest in
the partnership?
Problem
1 p.602
Delft, N.V., a CFC
Dutch corporation owned
by U.S. corp; Dutch corp. is engaged in manufacturing.
Assume no FBC income.
Dutch corp's surplus earnings are loaned to U.S. parent corporation. Loan
to a related person is treated as an investment in U.S. property under
§951(a)(1)(B) and §956.
Similar treatment for
purchase of U.S. patent, but not for investment in stock
of unrelated a NYSE listed company.
Problem
2 p.603
Sale or Loan to CFC
1) Amount paid by
Matterhorn from its earnings to USM is an investment in U.S. property to the
extent of the U.S. obligations. §956(c)(3) and §864(d).
2) Loan to unrelated
foreign customers of USM is not an investment in U.S. property since not
acquiring a trade or business receivable from a related U.S. person.
§956(c)(3)(A).
Previously Taxed Income and
Ordering Rules p.603
Three levels
of possible income recognition:
1) Subpart F
2) §956 -
investment in U.S. property
3) Actual dividend
distribution.
See §959(c) re order of
distributions
(§956 income first,
then Subpart F income).
If previously taxed,
nontaxable distributions not carrying out foreign tax credits.
Previously Taxed Income and
Ordering Rules, cont.
Consider an upstream
dividend from a 2nd tier subsidiary (CFC) to a first tier subsidiary
(CFC). Subpart F (FPHC) income to the first tier subsidiary?
Yes, unless previously
included in shareholder income under §951(a). See §959(b). P.604
Treatment of Stock Sale Gain
as Ordinary Income
Gain realized on the
disposition of the CFC stock investment is (partly) treated as dividend
income.
§1248 transforms cap
gain into a dividend distribution to the extent of 10% shareholder's
allocable E&P, limited to amount of stock gain.
Is §1248 treatment
preferred? Yes, for a corporate shareholder, since the deemed paid FTC is
available. Reg. §1.1248-1(d).
And, no foreign
withholding tax if a stock sale (rather than if an actual dividend
distribution)?
Avoiding §1248 by
individual – hold until
death. continued
Treatment of Stock Sale Gain
as Ordinary Income
§1248(b) limits the tax
attributable to the deemed dividend.
Deemed dividend under
§1248 does not reduce the CFC’s E&P.
§959(e) treats §1248
deemed dividend as previously taxed E&P and, therefore, not subject to tax
on a later distribution.
E&P reduced when a
subsequent nontaxable distribution is actually made. §959(e).
Previously Taxed Income and
Ordering Rules
Consider (1) a sale
of CFC stock and (2) CFC income previously included as Subpart F income in
seller’s income (or includible under §956.
Inclusion in gross income
again? No, §959(a).
Problem - §1248 p.608
Corp. Partial Stock Sale
Corp. shareholder sells
20% interest in FC for 300x; basis is 50x. 250x cap gain? No.
Prior 40x (20% of 200k)
included as Subpart F income, and tax of $4,000 (20% of 20x).
No prior actual dividends
assumed.
Stock sale gain is 300k
less 50x basis = 250x.
§1248 amount: 1.2 mil
less 120x tax = 1.08 mil. earnings times 20% = 216x less 40x prior deemed
distribution = (i) 176x ordinary income (§1248) and (ii) 74x cap gain &
FTC.
Problem - §1248 p.608
Individual Stock Sale
Individual sells 100%
interest in FC for 300k; basis is 50x. 250x cap gain? No.
Prior 40x (20% of 200x)
included as Subpart F income, and tax of $4,000 (20% of 20x).
No prior actual dividends
assumed.
Stock sale gain is 300x
less 50x basis = 250x.
§1248 amount: 1.2 mil
less 120x tax = 1.08 mil. earnings times 20% = 216x less 40x prior deemed
distribution = (i) 176x ordinary income (§1248) & (ii) 74x cap gain. No
FTC.
Sale or Exchange of a Patent to
a CFC p.610
§1249 transforms capital
gain into ordinary income when a patent is sold to a foreign corporation by a
U.S. transferor which owns more than 50% of the voting power of the purchaser
foreign corporation.
To preclude capital gains
sales to CFC which then sublicenses (receiving ordinary, deferred income; but
FPHC income?)
Cf., §367(d) re
contribution of intangibles to foreign corporation.
Note §174 re prior
R&D deduction.
PFIC - Passive Foreign
Investment Co. p.611
PFIC provisions -
§§1291-1298
Applicable to all
U.S. shareholders.
Choices of taxation for
U.S. shareholders:
1) Election
for current inclusion (QEF), possible deferral of tax payment, subject to a
later interest charge.
2) Mark to market
election (current income)
3) Not QEF - tax on (i)
distribution from the QEF or (ii) sale of shares (plus interest).
Definition of a PFIC
p.612
(i) 75% of Corp’s gross
income is passive income (an income test, i.e., income that would
be foreign personal holding company income) or
(ii) 50% of its assets
are held for the production of passive income (the asset test, based on
value, subject to election - except for public company - to use tax basis; plus
mandatory requirement for non-public CFCs to use tax basis). §1297(a).
Year-by-year test.
Special PFIC Status Rules
p.614
Leased properties treated
as assets held by PFIC - as part of the active business assets. §1298(d).
& R&D expenses.
Active banking business
exception. §1297(b)(2)(A)
Interest, dividend, rent
and royalty from a related person exception (sourced from business income).
§1297(b)(2)(C).
Look-Through Rule
p. 615
Look thru rule for 25
percent or more owned subsidiaries - §1297(c).
Purpose: To enable
foreign corps having active subs from being treated as PFICs.
Dividends and interest
received from this subsidiary are eliminated from income for purposes of the
income test.
Stock of this subsidiary
is eliminated for purposes of the asset test. §1297(c).
The Starting or Changing
Business Rules p.616
Special rules apply for:
1) the
start-up year for an active business operation, §1298(b)(2), and
2) corporations
changing active businesses.
Corporation not treated
as a PFIC. §1298(b)(3).
Subpart F – PFIC Overlap
P. 617
If both rules would
apply, the Subpart F rules take priority. §1297(e).
This enables deferral
without an interest charge accruing (for non-Subpart F income).
Non “U.S. shareholders”
(e.g., less than 10% ownership) are subject to the PFIC rules.
Excess Distribution from or
Disposition of PFIC p.618
If not a QEF, an interest
charge is imposed on the value of the tax deferral at the time:
1) of the disposition of
PFIC stock at a gain,
or
2) the receipt of an
"excess distribution” from the PFIC (i.e., above 125% of prior dividend
distribution level).
§1291(a)(1) & (2).
PFIC distribution to U.S.
corp. enables deemed paid FTC. See §1291(g).
Qualified Electing Fund
(QEF) p.620
Election by each shareholder
- not by the PFIC.
Information to come from
the corporation.
Current inclusion in
gross income of the shareholder’s prorata share of the PFIC's earnings and
profits. §1293.
Can divide into the
prorata shares of fund's:
(i) net capital
gains, and
(ii) ordinary
income. §1293(a)(1).
QEF & Tax Deferral
When No Distribution p.620
§1294 does permit
the PFIC – QEF election shareholder to elect to defer the tax amount if no
actual distribution has occurred.
No deferral if §951
applies.
Deferral is subject to an
interest charge.
Loan to a shareholder is
treated as a distribution. §1294(f).
Mark-to-Market Election
p. 622
Available for “marketable
stock” of PFIC.
§1296 - U.S. shareholder
includes in (ordinary) income the excess of fair market value of the PFIC stock
at close of year over basis (as previously adjusted).
Treated as ordinary
income.
What if loss? Permitted
to the extent of the “unreversed inclusions.” Treated as ordinary loss.
§1296(a)(2).
Problem
1 p.626
PFIC & CFC Comparison
PFIC provisions apply
even if no CFC status. Apply even to less than 10 percent ownership by U.S.
shareholder in PFIC.
CFC applies to more
income types. PFIC only applies to passive income.
PFIC ends benefits of
deferral for all income of the PFIC, not limited to specified types of gross
income. PFIC has a more complete termination of deferral of income
recognition.
Problem 2a
p.26
CFC Status?
Tax Avoidance is a CFC
under §957(a):
Two “United States
shareholders” holding more than 50%:
US Parent owns 40 shares
&
Sam (US citizen) owns 12
shares; no attribution to Sam from NRA sister - §958(b)(1).
Problem 2b
p.627
PFIC Status?
Tax Avoidance is a PFIC under
§1297(a):
Meets the 50% passive
assets test (based on tax basis ratios).
§1297(a)(2) &
§1297(f)(2)(A).
Problem 2c
p.627
CFC Income?
U.S. shareholders are
U.S. Parent (40%) and Sam (20%).
They have constructive
dividends for pro rata shares of Tax Avoidance’s $6.5 million Subpart F income:
(i) $5.5 million dividends & capital gains (§954(c)(1)(A) & (B)), and
(ii) $1 million FBC sales income (§954(d)).
Problem 2d
p.627
PFIC Applicability?
PFIC provisions apply
without regard to the amount of ownership.
But, not treated as a
PFIC for those persons treated as U.S. shareholders of a CFC. §1297(e).
This is applicable to U.S. Parent & Sam.
Alexandra (indirect
ownership), (ii) USA, Inc., and (iii) John are subject to the PFIC rules.
Options for them: interest charge or QEF. No “mark-to-market” option.
Problem 2e
p.627
Regularly Traded Stock
Stock would constitute
“marketable stock” within the meaning of §1296(e).
Those shareholders
subject to the PFIC rules could make the “mark to market” election under §1296.
Reporting Requirements
p.628
Information returns (IRS
Form 5471):
§6046 –
information on formation of the foreign corporation.
§6038 – annual
information by every person who is in control of a foreign corporation.
Summary
Policy Options p.632
Options for Foreign
Income Taxation:
1. Current full
inclusion
2. Subpart F Structure
3. Foreign corporation
dividend exemption.
See:
JCT 2005 Options Paper
Bush 2005 Tax Panel
Recommendations
2000 U.S. Treasury
Study