The IRS issued final, temporary and proposed regulations providing guidance on determining the amount of taxes paid for purposes of determining the foreign tax credit. The regulations are designed to curb certain transactions that the IRS says “produce inappropriate foreign tax credit results.” The final regulations (TD 9535), issued July 13, adopt temporary regulations issued in 2008, with some modifications. Identically worded temporary and proposed regulations (TD 9536 and REG-126519-11), issued July 14, added a paragraph to the regulations clarifying the treatment of withholding taxes.
The final regulations provide that amounts paid to a foreign taxing authority that are attributable to a “structured passive investment arrangement” are not treated as an amount of tax paid for purposes of the foreign tax credit. Structured passive investment arrangements are generally designed to exploit differences between U.S. and foreign tax law by artificially creating a foreign tax liability that allows the U.S. party to claim a U.S. foreign tax credit and a foreign counterparty to claim a duplicative foreign tax benefit. The U.S. and foreign parties share the cost of the purported foreign tax payments through pricing of the arrangement, the IRS said in the preamble to the 2008 temporary regulations (TD 9416).
The new regulations list six conditions that all must be met to qualify an arrangement as a structured passive investment arrangement:
1. The SPV condition. The arrangement uses an entity (a special-purpose vehicle, or SPV) that meets two requirements: (A) Substantially all of the entity’s gross income, as determined under U.S. tax principles, is attributable to passive investment income, and substantially all of the entity’s assets are held to produce such passive investment income; and (B) there is a foreign payment attributable to income of the entity. Although the 2008 temporary regulations had contained an exception for withholding tax, the final regulations removed it, stating that withholding tax imposed on a dividend or other distribution from a foreign entity related to equity of the entity made to a U.S. party is a foreign payment attributable to income of the entity. The new temporary regulations clarified that this rule applies to distributions made by a pass-through entity or other entity disregarded as separate from its owner for U.S. tax purposes.
2. The U.S. party condition. A U.S. party is a person eligible to claim a foreign tax credit under IRC § 901(a), including a credit for taxes deemed paid under section 902 or 960, for all or a portion of foreign tax paid.
3. The direct investment condition. The U.S. party’s share of the foreign payment or payments is (or is expected to be) substantially greater than the amount of credits, if any, that the U.S. party reasonably would expect to be eligible to claim under section 901(a) for foreign taxes attributable to income generated by the U.S. party’s proportionate share of the assets owned by the SPV if the U.S. party directly owned such assets.
4. The foreign tax benefit condition. The arrangement is reasonably expected to result in a tax benefit to a counterparty (or a related person) under the laws of a foreign country.
5. The counterparty condition. The arrangement includes a person that, under the tax laws of a foreign country in which the person is subject to tax on the basis of place of management, place of incorporation or similar criterion or otherwise subject to a net basis tax, directly or indirectly owns or acquires equity interests in, or assets of, the SPV.
6. The inconsistent treatment condition. The United States and an applicable foreign country treat the arrangement inconsistently under their respective tax systems, and the U.S. treatment results in either materially less income or a materially greater amount of foreign tax credits than would be available if the foreign law controlled the U.S. tax treatment.
The final regulations are effective for payments that, if such payments were an amount of tax paid, would be considered paid or accrued on or after July 17, 2011.
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