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TAX MATTERS

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NOVEMBER 2010

FOREIGN TAX CREDIT RESTRICTIONS ENACTED

New restrictions on the use of foreign tax credits (FTCs), along with other revenue-raising international tax provisions, were enacted Aug. 10, 2010, as part of the so-called Education Jobs Act (PL 111-226).

 

The legislation adds IRC § 909, which provides generally that in the case of an “FTC splitting event,” taxpayers may not claim an FTC until the tax year in which they take related income into account for U.S. taxation. An FTC splitting event is one where the related income is or will be taken into account by a “covered person,” defined as (1) any entity in which the person that pays or accrues a foreign income tax (the “payor”) holds, directly or indirectly, at least a 10% ownership interest, (2) any person that holds, directly or indirectly, at least a 10% ownership interest in the payor, or (3) a person related (as defined in section 267(b) or 707(b)) to the payor. The legislation also provides a similar matching rule for “section 902 corporations”—generally, foreign corporations and domestic corporations that own 10% or more of the voting stock of a foreign corporation from which they receive dividends.

 

Other changes under the act include:

 

  • Corporations that engage in covered asset acquisitions (as defined in the act), such as qualified stock purchases under section 338(d)(3), may not take the disqualified portion of any foreign income tax determined with respect to the income or gain attributable to the relevant foreign asset into account in determining their foreign tax credits.
  • The amount of foreign taxes deemed paid with respect to section 956 inclusions is limited. If a domestic corporation includes in income an amount attributable to the earnings of a foreign corporation that is a member of the domestic corporation’s qualified group (under section 902(b)), the inclusion amount is limited to the amount of foreign income taxes that would have been deemed paid if cash in the amount of the inclusion had been distributed through the chain of ownership starting with the foreign corporation and ending with the domestic corporation. Formerly, under what is known as the “hopscotch rule,” the amount of a tax credit from a section 956 inclusion was based on the amount deemed paid by the controlled foreign corporation.
  • Corporate acquisitions by stock redemptions under section 304 where the acquiring corporation is a foreign corporation are subject to a special rule concerning the taxability of dividends arising from the acquisition.
  • A prior-law exclusion from treatment as U.S.-source income of interest received from corporations meeting the 80% foreign business requirements under section 861(a) (“80/20 corporations”) is repealed. An exemption under section 871(i) from the 30% withholding tax on the income of nonresident aliens for the percentage of dividends paid by 80/20 corporations equal to the percentage of the corporations’ gross income that is income from outside the United States is modified. Under the new law, for existing 80/20 corporations, the exemption from withholding applies to the “active foreign business percentage” of any dividends and interest paid by the corporations to nonresident aliens.

 

These changes are effective with tax years beginning after Dec. 31, 2010.

 

In addition, the act repealed the advance earned income credit, also effective for tax years beginning after Dec. 31, 2010.

 

 

PAYMENT CARD FINAL REGS RELEASED

The IRS issued final regulations (TD 9496) on Aug. 13, 2010, regarding the new information reporting requirement under IRC § 6050W for payment card and third-party network transactions. Under the provision, banks and similar transaction settlement entities must file annual information returns for each participating merchant or other payee reporting aggregate gross receipts for the calendar year from credit and debit card sales or third-party network transactions. The requirement is effective for returns for calendar years after 2010; in other words, the first new 1099-K reporting forms will be filed in early 2012 for the 2011 calendar year. The final regulations adopted with several modifications proposed regulations issued in November 2009 (REG-139255-08).

 

The final regulations provided implementation guidance and amended existing regulations under sections 6041 and 6041A to provide relief from duplicate reporting for certain transactions. They also amended regulations under sections 6721 and 6722 to reflect penalties applying to failures to file correct information returns and payee statements required by section 6050W. In addition, the final regulations adopted without change proposed amended regulations under section 3406 to provide that amounts reportable under section 6050W are subject to backup withholding (effective for amounts paid after Dec. 31, 2011).

 

The final regulations included explanations and examples of several common types of payment cards and related instruments that were asked about by commenters but do not meet statutory requirements for reporting, the IRS said. For example, purchases made with a payment card issued by a retail merchant that may be used only with that merchant are not reportable, nor are ATM withdrawals or similar transactions. The IRS noted that reportable payment card transactions must involve use of a card that is accepted as payment (section 6050W(c)(2)) by a network of unrelated persons (section 6050W(d)(2)(B)).

 

The final regulations adopted proposed rules to avoid duplicate reporting of transactions by providing relief from the expanded information reporting requirements under section 6041 as amended by the Patient Protection and Affordable Care Act, PL 111-148. Under the expanded section 6041 rules, payments by a trade or business aggregating $600 or more to any single vendor during any calendar year beginning after Dec. 31, 2011, must be reported to the vendor and to the IRS on an information return, such as Form 1099. The final regulations specify that transactions that are reportable under both sections 6041 and 6050W must be reported under section 6050W and not under section 6041. In response to “numerous” requests, the IRS in the final regulations also extended this relief to third-party network transactions. Solely for purposes of determining whether a payor is eligible for this relief, the de minimis threshold for reportable third-party network transactions under section 6050W (more than 200 transactions to a payee aggregating more than $20,000 per calendar year) is disregarded.

 

The final regulations also addressed how transactions that incorporate “chargebacks” or other adjustments should be handled. The IRS did not adopt suggestions to report net sales as being more likely to match amounts reported on tax returns, noting that the statute requires reporting of gross amounts (section 6050W(a)(2)). “The information reported on the return required under these regulations is not intended to be an exact match of the net, taxable, or even the gross income of a payee,” the IRS said in a preamble.

 

 

COD INCOME DEFERRAL REGS ISSUED

The IRS issued temporary and proposed regulations Aug. 13, 2010, relating to taxpayer elections to defer recognition of cancellation of debt (COD) income.

 

The American Recovery and Reinvestment Act of 2009 (ARRA, PL 111-5) enacted IRC § 108(i), providing an election to defer COD income arising from the forgiveness or reacquisition of certain debt instruments occurring between Jan. 1, 2009, and Dec. 31, 2010. A taxpayer making the election may include COD income in gross income ratably over a five-year period beginning with the fourth or fifth tax year after the reacquisition occurred (in 2010 or 2009 tax years, respectively). See also “Tax Practice Corner: Deferring COD Income: Burden May Outweigh Benefit,” page 60 in this issue. If a taxpayer making a section 108(i) deferral election dies or ceases business, or substantially all the assets of the taxpayer are liquidated or sold, any remaining deferred COD income or OID deductions must be included in gross income or taken in the tax year in which any of those events occurred. In a Title 11 bankruptcy case, the deferred COD income is taken into account on the day before the petition is filed (section 108(i)(5)(D)).

 

In the new guidance, the IRS clarified various contexts in which these events accelerate deferrals of COD income. Treasury Decision 9497 and REG-142800-09 provided temporary and proposed regulations, respectively, addressing situations where taxpayer corporations transfer substantially all their assets in reorganization exchanges. A literal reading of the statute could require a deferral acceleration, contrary to the purposes of section 108(i) as enacted, the IRS said in a preamble. Consequently, the temporary regulations require acceleration of deferred COD income by corporations where the corporation:

  • Changes its tax status;
  • Ceases its corporate existence in a transaction to which section 381(a) (corporate acquisition rules) does not apply; or
  • Engages in a transaction that impairs its ability to pay the tax liability associated with the deferred COD income.

 

In Treasury Decision 9498 and REG-144762-09, the IRS issued temporary and proposed regulations, respectively, regarding the application of section 108(i) to partnerships and S corporations. Since “applicable debt instruments” for which the election may be made are defined in the statute as those issued by a C corporation or other person in connection with a trade or business, the IRS addressed situations where partnerships or S corporations may be considered issuers of applicable debt instruments.

 

The regulations provide five safe harbors in this respect (see Temp. Treas. Reg. § 1.108(i)-2T(d)(1)). Other regulations establish a method by which partnerships and S corporations may allocate differing amounts of deferred COD income among partners or S corporation shareholders and rules for adjustment of basis and share of liabilities and other partner and shareholder items.

 

The regulations also address deductions by issuers of new debt instruments featuring original issue discount (OID) in place of those that are reacquired or forgiven and for which the debtor has made a section 108(i) election to defer COD income. Any deduction taken for OID by issuers of such debt instruments must also be deferred, but where the COD income deferral is subject to acceleration, an OID deduction may also be accelerated.

 

The rules for acceleration of deferrals apply to events occurring on or after Aug. 13, 2010. The regulations also provide transitional rules that allow electing corporations to use provisions in the acceleration rules in a timely manner. The applicability of certain other rules is retroactive to reacquisitions of debt instruments occurring after Dec. 31, 2008.

 

 

NEW ORLEANS LANDMARK GETS RECONSIDERATION

The Fifth Circuit Court of Appeals (docket no. 09-60085) vacated and remanded for reconsideration the Tax Court’s reduction of a claimed charitable deduction for a conservation easement involving the historic Maison Blanche and the adjoining Kress building in New Orleans. For the Tax Court proceedings, see Whitehouse Hotel Limited Partnership v. Commissioner, 131 TC 112, discussed in “Tax Matters: IRS, Historic Hotel Face Off Over Facade,” JofA, April 2009, page 67.

 

Whitehouse Hotel Limited Partnership transferred to the Preservation Alliance of New Orleans a qualified conservation contribution of an easement guaranteeing to maintain the historic appearance of the building and improve and maintain its ornate facade. Whitehouse claimed on its 1997 federal income tax return a charitable contribution deduction for $7.44 million, the amount its appraiser determined to be the property’s reduction in value by the easement. Whitehouse based its valuation on a “highest and best use” of the property as a Ritz-Carlton luxury hotel, which was subsequently developed on the site along with two other smaller hotels. The IRS determined that the allowable deduction should have been $1.15 million and proposed that the property’s highest and best use was as a nonluxury hotel. The Tax Court rejected aspects of both sides’ analyses and calculated its own value for a deduction of nearly $1.8 million.

 

In remanding the case, the Fifth Circuit said the Tax Court erred in not considering the effect of the pending consolidation of the two buildings into one hotel and the easement’s prohibition of building additional hotel rooms on top of the Kress building. As part of its reconsideration, the Tax Court should also clarify the highest-and-best-use issue, the Fifth Circuit said.

 

 

11TH CIRCUIT AFFIRMS OCMULGEE FIELDS

The Eleventh Circuit Court of Appeals affirmed (docket no. 09-13395) the Tax Court’s holding in Ocmulgee Fields Inc. v. Commissioner that use of a qualified intermediary (QI) in a section 1031 exchange of like-kind property is not a remedy for a transaction between related parties (132 TC 105, discussed in “Tax Matters: QI No Cure for Related-Party Deal,” JofA, July 2009, page 78).

 

Ocmulgee Fields sold a shopping center, purchased replacement property through a QI, and reported the transaction as a section 1031 exchange in which it did not recognize gain. The IRS, however, required inclusion of gain because the replacement property was held by a company owned by two of the three owners of Ocmulgee Fields. Although section 1031(f) denies like-kind exchange treatment for transactions between related parties, there is an exception for related-party exchanges that do not have tax avoidance as a principal purpose, which the taxpayer claimed was the case.

 

The Eleventh Circuit said the taxpayer’s arguments that the transaction also imposed future adverse tax consequences were “at best, speculative and unquantified,” and neither they nor arguments that Ocmulgee Fields had legitimate business purposes for the exchange established any clear error by the Tax Court.

 

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