The US IRS on September 2 released temporary and proposed regulations on the application of the section 956 deemed dividend rules to partnership transactions. Regs were also issued providing that a controlled foreign corporation (CFC) must conduct relevant activities itself to take advantage of the foreign personal holding company income (FPHCI) active rent and royalties exception, including in situations where a cost sharing arrangement is involved.
The temporary 956 regulations extend the section 1.956-1T(b)(4) antiabuse rule to cover transactions involving partnerships that are controlled by a CFC. According to the Service, some transactions involving partnerships raise the same concerns as those addressed in the former antiabuse rule, which was applicable only to corporations.
For example, the Service said, a CFC with a principal purpose of avoiding the application of section 956 may contribute cash to a partnership in exchange for an interest in the partnership, which in turn lends the cash to a United States shareholder of the CFC. If an antiabuse rule does not apply, the taxpayer may argue that the CFC is not treated as indirectly holding the entire obligation of the United States shareholder but instead is treated as holding the obligation only to the extent of the CFC’s interest in the partnership under section 1.956-2(a)(3), the Service noted.
The regulations also add an example to the antiabuse rules to illustrate that a CFC’s tax attributes associated with a section 956 inclusion, such as total earnings and profits, previously taxed earnings and profits, and foreign tax credit pools, are taken into account in determining whether a principal purpose of a funding was to avoid the application of section 956 with respect to the funding CFC.
Foreign partnership distributions funded by CFCs
New temporary regulation section 1.956-1T(b)(5) addresses situations where a CFC funds a foreign partnership (or guarantees a borrowing by a foreign partnership) and the foreign partnership makes a distribution to a US partner that is related to the CFC.
In such cases, the regs treat the partnership obligation as an obligation of the distributee partner to the extent of the lesser of the amount of the distribution that would not have been made but for the funding of the partnership or the amount of the foreign partnership obligation.
FPHCI exception for active rents and royalties
The Service also issued temporary regulations regarding when a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes exceptions to the FPHCI rules of section 954.
To provide consistent policy, the new regs provide that to meet the active development test, the CFC lessor or licensor must perform through its own officers or staff of employees the required functions of manufacturing, production, development, or creation of, or, in the case of an acquisition, the addition of substantial value to, the property at issue, the Service said.
The relevant activities may be undertaken by a CFC through its officers or staff of employees in more than one foreign country.
Consistent with these rules, new temporary regulations provide that cost sharing transactions (CSTs) and platform contribution transactions (PCTs) made by a CFC pursuant to a cost sharing agreement will not cause the CFC’s officers and employees to be treated as undertaking the activities of the controlled participant to which the payments are made.
The clarification applies for purposes of the active development tests and the active marketing tests, including for purposes of determining whether an organization that engages in marketing is substantial, the Service said.
Also, new reg. sections 1.954-2T(c)(2)(iii)(E) and (d)(2)(iii)(E) provide that deductions for CST payments and PCT payments are excluded from the definition of active leasing and licensing expenses.
See:
