Global Tax Alert | 11 September 2013

US IRS publishes final regulations on determining amount of tax paid for purposes of the foreign tax credit

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The Service has issued final regulations (T.D. 9634) providing guidance on determining the amount of taxes paid for purposes of the foreign tax credit (FTC). These final regulations adopt the proposed regulations (REG-126519-11) without substantive changes.

Under Reg. Section 1.901-2(e)(5)(iv) of the final regulations (the 2011 Final Regulations) (T.D. 9535), amounts paid to a foreign taxing authority that are attributable to a “structured passive investment arrangement” (SPIA) are not treated as an amount of tax paid for purposes of the FTC. The 2011 Final Regulations describe six conditions that, if satisfied will result in an arrangement being treated as an SPIA. The first of these conditions is that the arrangement uses an entity that meets two requirements: (1) substantially all of the entity’s gross income, as determined under US 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 (2) there is a foreign tax payment attributable to income of the entity, as determined under the laws of the foreign country to which such foreign payment is made (see EY’s International Tax Alert, Final regulations update 2008 temporary regulations on structured passive investment arrangements, dated 19 July 2011).

The IRS and Treasury became aware that taxpayers could enter into arrangements that could generate duplicative benefits involving foreign withholding taxes imposed on distributions made by an entity to a US party. For example, if the parties undertook a transaction in which interests in an entity are transferred by the US party to a counterparty subject to a repurchase obligation, withholding taxes imposed on distributions from the entity could be claimed as creditable in both jurisdictions. Accordingly, the 2011 Final Regulations eliminated the exception for withholding taxes imposed on distributions or payments to US parties. Further, the temporary regulations introduced a new provision stating that a foreign payment attributable to income of an entity includes a withholding tax imposed on a dividend or other distribution (including distributions made by a pass-through entity or an entity that is disregarded as an entity separate from its owner for US tax purposes) regarding the equity of the entity. These final regulations adopt that language without substantive change.1

Implications

Structured transactions resembling those described in these regulations are no longer commonplace (because of those regulations), but the finalization of these regulations makes clear that the IRS and Treasury Department continue to be concerned about SPIA transactions and believe that it is important to finalize these regulations before the temporary regulations lapse. Taxpayers should continue to monitor their FTC structures in light of these final regulations to ensure that they do not inadvertently violate these rules.

Endnotes

1. The new cite to the final regulations is Reg. Section 1.901-2(e)(5)(iv)(B)(1)(ii).

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services, Washington, DC
  • Peg O’Connor
    +1 202 327 6229
    margaret.oconnor@ey.com
Ernst & Young LLP, International Tax Services — Capital Markets, Washington, DC
  • Matthew Stevens
    +1 202 327 6846
    matthew.stevens@ey.com
  • Hubert Raglan
    +1 202 327 8365
    hubert.raglan@ey.com
Ernst & Young LLP, International Tax Services — Capital Markets, Charlotte, NC
  • Chris J. Housman
    +1 704 350 9156
    chris.housman@ey.com

EYG no. CM3797