Foreign Tax Credit “Splitter” Arrangements: IRS Issues Initial Guidance on Section 909Sullivan & Cromwell LLP - December 14, 2010
On December 6, 2010, the Internal Revenue Service (the “IRS”) issued Notice 2010-92 (the “Notice”), which provides guidance on aspects of Section 909, a provision that was added to the Internal Revenue Code in August 2010. Section 909 defers the creditability of foreign taxes that are paid in connection with so-called “foreign tax credit splitter” arrangements: that is, structures that separate the person liable for the foreign tax from the person entitled to the related income and, under pre-Section 909 law, might allow a credit for the foreign tax in a year prior to the year, if any, in which the related income is taken into account for U.S. federal income tax purposes.
In general, Section 909 is not retroactive and does not apply to foreign taxes that were paid or accrued in taxable years beginning on or before December 31, 2010 (“Pre-Effective Taxable Years”). However, Section 909 applies to foreign taxes that were accrued or paid in earlier periods (taxes that are paid or accrued in an earlier period, hereafter “Legacy Taxes”; and those Legacy Taxes that are subject to Section 909, hereafter, “Suspended Legacy Taxes”) to the extent that a corporate 10% U.S. shareholder of a foreign corporation claims an “indirect” foreign tax credit for Legacy Taxes of the corporation in a taxable year beginning after December 31, 2010 (a “Post-Effective Taxable Year”). In other words, beginning with the foreign corporation’s first Post-Effective Taxable Year, the provision generally applies to the “pool” of foreign taxes for which a corporate U.S. shareholder may claim a foreign tax credit even if those foreign taxes were paid or accrued in a Pre-Effective Taxable Year. Because of this potential retrospective effect, a taxpayer with an arrangement that may be affected by the Notice should review the foreign taxes of any entities that could potentially be subject to Section 909 before the end of its final Pre-Effective Taxable Year.
The Notice identifies four types of “Pre-2011 Splitter Arrangements” that will be the sole arrangements giving rise to Suspended Legacy Taxes:
- Certain structures involving “reverse hybrids” (i.e., entities that are fiscally transparent for local non-U.S. tax purposes, but treated as corporations for U.S. federal income tax purposes);
- Foreign consolidated groups in which foreign taxes were not, for U.S. federal income tax purposes, apportioned by taxpayers among the members in accordance with their shares of the foreign income of the group;
- Arrangements involving certain “disregarded debt instruments” (i.e., obligations that have no effect for U.S. federal income tax purposes, but are treated as indebtedness under local law); and
- Certain structures involving hybrid instruments (i.e., instruments that are characterized as equity for U.S. federal income tax purposes, but as indebtedness under local non-U.S. tax law, or vice versa).
In addition to creating Suspended Legacy Taxes, these four structures will, according to the Notice, be foreign tax credit splitting events in Post-Effective Taxable Years. Future guidance may also treat other arrangements as splitting events with respect to foreign taxes paid or accrued in Post-Effective Taxable Years. The Notice also provides that Legacy Taxes paid or accrued by a foreign corporation in a taxable year beginning before January 1, 1997 will not be treated as Suspended Legacy Taxes. Accordingly, a taxpayer claiming indirect foreign tax credits will need to review taxes paid by a foreign subsidiary since the beginning of that subsidiary’s first taxable year that started in 1997, but will not need to go back further.
The Notice describes detailed rules that will govern the treatment of Suspended Legacy Taxes, including:
- A determination that Legacy Taxes that exceed a taxpayer’s foreign tax credit limitation in a separate category and are carried forward under Section 904(c) will not be subject to Section 909;
- Initial rules that specify how Suspended Foreign Taxes and related income will be accounted for under Section 909 (including rules governing how partnerships and trusts will need to apply Section 909); and
- Preliminary rules governing the application of Section 909 to other parts of the Internal Revenue Code (e.g., the deductibility of foreign taxes, statute of limitations provisions and provisions governing redeterminations of foreign tax amounts).