IRS issues foreign-targeted bond guidance

BY PAUL BONNER

The IRS issued interim guidance Thursday (Notice 2012-20) on registration of foreign-targeted bonds and provided transitional relief for withholding agents on the related portfolio interest exception.

The IRS said it had received questions about these and other implications of the repeal of the foreign-targeted bond rules under Sec. 163(f)(2)(B) by the Hiring Incentives to Restore Employment (HIRE) Act of 2010, P.L. 111-147.

Generally, the Sec. 163 deduction for interest paid is denied and capital gain treatment and loss recognition disallowed under Secs. 1287 and 165(j), respectively, with respect to obligations that are required to be in registered form but are not. An excise tax may also be imposed under Sec. 4701 on such bonds.

Secs. 871(h) and 881(c) provide an exception from tax for U.S.-source portfolio interest received by a nonresident alien or foreign corporation. This portfolio interest exception is generally not available for interest paid on debt that is not issued in registered form (bearer debt).

The foregoing rules generally did not apply to bearer debt that complied with the foreign-targeting rules of Sec. 163(f)(2)(B); however, the HIRE Act generally eliminated the various exceptions for foreign-targeted bearer debt, effective for obligations issued after March 18, 2012. Therefore, after March 18, the portfolio interest exception will be available only for obligations issued in registered form.

Notice 2012-20 provides guidance on when obligations will be considered to be in registered form. It also provides interim guidance regarding the application of the portfolio interest exception to certain obligations in registered form issued after March 18, 2012, and before Jan. 1, 2014.

The notice also addresses the continued availability of the existing exception from reporting of interest or original-issue discount under Sec. 6049 for certain foreign-targeted short-term obligations. Finally, the notice provides procedures to use to comply with the foreign-targeting rules of Sec. 4701(b) as amended by Section 502 of the HIRE Act.

Registered form

The IRS said in the notice that an obligation will be treated as in registered form under the existing rules of Regs. Sec. 5f.103-1, that is, if (1) it is registered with the issuer or agent with respect to both principal and stated interest and may be transferred only by surrender and reissuance to a new holder, and/or (2) its right to principal and stated interest may be transferred only through a “book entry system” record of ownership maintained by the issuer or agent. The notice also addresses application of the book entry system rules to certain obligations “immobilized” in a clearing system and those for which holders may obtain physical certificates in nonregistered (bearer) form.

Portfolio interest exception extended

The IRS said it has received comments stating that, where bond issuers have relied on the foreign-targeting rules, withholding agents may have difficulty obtaining Forms W-8 or similar statements. Therefore, for obligations issued in registered form after March 18, 2012, and before Jan. 1, 2014, withholding agents may rely on the foreign-targeted registered obligation rules of Regs. Sec. 1.871-14(e), if the obligations meet the requirements of those rules.

Short-term debt information reporting

The notice also clarifies that repeal of the foreign-targeting rules does not eliminate an exception for certain foreign-targeted short-term obligations from information reporting of interest and original-issue discount under Sec. 6049. Such obligations are defined in Regs. Sec. 1.6049-5(b)(10) partly by reference to the now-repealed Sec. 163(f)(2)(B). The IRS said that the information-reporting exception will continue to be available after March 18, 2012, and that it intends to issue regulations incorporating the foreign-targeting rules into the regulations under Sec. 6049 in place of the existing reference to Sec. 163(f)(2)(B).

Excise tax exception

Similarly, the IRS said it will issue regulations providing guidance on a HIRE Act provision applying the foreign-targeting rules to the Sec. 4701(b) excise tax on unregistered obligations that are required to be in registered form.

Paul Bonner ( pbonner@aicpa.org ) is a JofA senior editor.

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