Final regulations provide guidance on determining the amount of taxes paid for purposes of determining the foreign tax credit (T.D. 9535). The regulations are designed to curb certain transactions that, the IRS says, “produce inappropriate foreign tax credit results.” The final regulations adopt proposed regulations issued in 2008, with some modifications.
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 create a foreign tax liability, allowing the U.S. party to claim a foreign tax credit and the foreign counterparty to claim a foreign tax benefit.
The regulations list six conditions that qualify an arrangement as a structured passive investment arrangement.
- The SPV condition: The arrangement utilizes an entity (a special-purpose vehicle, or SPV) that meets two requirements: (a) substantially all the entity’s gross income, as determined under U.S. tax principles, is attributable to passive investment income, and substantially all 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;
- The U.S. party condition: A U.S. party is a person who is eligible to claim a credit under Sec. 901(a), including a credit for taxes deemed paid under Sec. 902 or Sec. 960, for all or a portion of the foreign payment if the foreign payment was an amount of tax paid;
- 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 Sec. 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;
- 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;
- 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; and
- 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.