IRS Plans Regs. on Sec. 909 Foreign Tax Credit Splitter Arrangements

By Sean Hailey, CPA, and Natan Leyva, J.D., Washington

Editor: Michael Dell, CPA

In Notice 2016-52, the IRS describes regulations it intends to issue under Sec. 909 identifying as foreign tax credit splitter arrangements certain transactions or restructurings undertaken by Sec. 902 corporations in anticipation of foreign-initiated income tax adjustments. The regulations the IRS is planning to issue would apply to foreign income taxes paid on or after Sept. 15, 2016. The notice mentioned that the impetus for the new rules is the recent development of foreign-initiated adjustments in European Union (EU) state-aid cases, and the notice was issued after it was announced that the EU had ordered Apple Inc. to repay $14.5 billion in Irish tax breaks.


Sec. 909 was enacted in 2010 to prevent the separation of creditable foreign taxes from related income, generally by deferring the right to claim the credits until the related income is included in U.S. taxable income. Current regulations set forth an exclusive list of "splitter arrangements" that are subject to Sec. 909. Notice 2016-52 adds two types of transactions or restructurings (each in connection with foreign-initiated tax adjustments) that Treasury intends to treat as splitter arrangements in future amendments to the Sec. 909 regulations.

Under Sec. 905(c), certain foreign income taxes paid by a "Section 902 corporation" after the tax year to which the taxes relate generally are taken into account by adjusting Sec. 902 pools of post-1986 foreign income taxes in the tax year in which the taxes are paid, rather than accounting for the taxes in the prior tax year to which the taxes relate. A Sec. 902 corporation, defined in Sec. 909(d)(5), is any foreign corporation for which one or more domestic corporations meet the ownership requirements of Sec. 902(a) or (b) (a foreign corporation at least 10% of the voting stock of which is owned by a domestic corporation).

Under certain circumstances, Sec. 909 is intended to suspend foreign income taxes until those taxes are "matched" with the income to which they relate (related income). Specifically, Sec. 909(a) provides that, if there is a "foreign tax credit splitting event" for a foreign income tax paid or accrued by a taxpayer, then the foreign income tax will not be taken into account before the tax year in which the taxpayer takes the related income into account. Sec. 909(b) provides that, if there is a foreign tax credit splitting event for a Sec. 902 corporation, foreign income taxes paid or accrued are not taken into account for purposes of Sec. 902 or 960, or for purposes of determining earnings and profits, before the tax year in which the related income is taken into account by the Sec. 902 corporation or a domestic corporation satisfying the ownership requirements of Sec. 902(a) or (b) for the Sec. 902 corporation.

Need for Regulations

Notice 2016-52 states that, in anticipation of large foreign-initiated tax adjustments (adjustments that result in additional tax liability greater than $10 million) relating to a prior tax year, some taxpayers may take steps to separate the additional payment of foreign income tax from the income to which it relates. The notice describes situations in which, through certain transactions or restructurings, taxpayers may attempt to change their ownership structure or cause the Sec. 902 corporation to make an extraordinary distribution so that the subsequent tax payment creates a high-tax pool of post-1986 undistributed earnings. Those undistributed earnings can then be used to generate substantial amounts of foreign taxes deemed paid, without repatriating and including in U.S. taxable income the earnings and profits to which the taxes relate.

Planned Regulations

To address the transactions or restructurings described above, Notice 2016-52 defines two new splitter arrangements that Treasury intends to include in future regulations: (1) splitter arrangements arising from the application of Sec. 905(c) to successor entities, and (2) splitter arrangements arising from distributions made before the payment of additional tax under foreign-initiated adjustments.

Splitter arrangements arising from application of Sec. 905(c) to successor entities: Under the planned regulations, certain changes in ownership structures in connection with a foreign-initiated adjustment will result in a foreign tax credit splitting event. In particular, this splitter arrangement covers certain transactions or restructurings that result in taxes being paid by a payer Sec. 902 corporation that would not have been the payer of the taxes if the taxes had been paid or accrued in the relation-back year. As an example, the notice described the following arrangement:

Example: U.S. Parent wholly owns CFC1, which, in turn, wholly owns CFC2. CFC1 and CFC2 are both located in Country X. CFC1 also owns DE, which is treated as a disregarded entity for U.S. tax purposes and as a corporation for Country X purposes. In years 1 through 5, DE has earnings and profits for which it accrues and pays no foreign tax. These earnings and profits constitute CFC1's pool of post-1986 undistributed earnings. In year 6, CFC1 transfers all of its interest in DE to CFC2 in exchange for stock. In year 8, DE pays foreign income taxes to Country X to settle a foreign-initiated adjustment for years 1 through 5.

Under the planned regulations, CFC1's transfer of its interest in DE to CFC2 and the subsequent payment of foreign income taxes by CFC2 (through DE) will generally give rise to a splitter arrangement. Two exceptions are available. One exception covers transactions or restructurings in which the earnings and profits of the predecessor entity are transferred to the payer under Sec. 381(c)(2). The other exception covers cases in which the taxpayer demonstrates by clear and convincing evidence that the transactions or restructurings were not structured with a principal purpose of separating covered taxes from the post-1986 undistributed earnings of the predecessor entity.

Splitter arrangements arising from distributions made before payment of additional tax under foreign-initiated adjustments: Treasury also plans for the regulations to address another arrangement that could achieve a similar result. In this arrangement, a taxpayer uses distributions to, in effect, move post-1986 undistributed earnings from one Sec. 902 corporation to another Sec. 902 corporation before the first Sec. 902 corporation makes a tax payment relating to a specified foreign-initiated adjustment. In that arrangement, the payer of the taxes first takes into account the earnings to which the tax payment relates. As a result of the distributions, however, the earnings are then taken into account by a covered person (a person having a 10% or more ownership interest in the payer or that is a related party) that is a Sec. 902 corporation before the first Sec. 902 corporation pays the tax.

The planned regulations would treat the transaction as a splitter arrangement if the distribution were made with a principal purpose of reducing the payer's undistributed earnings to which the taxes relate in advance of paying those taxes. Notice 2016-52 provides further rules providing when that principal purpose will be assumed and how it may be rebutted with clear and convincing evidence. The notice includes examples illustrating the arrangements in further detail.

Request for Comments, Alternative Approaches

In a request for comments, Treasury specifically asked whether the described transactions or restructurings would be more appropriately addressed in rules under Sec. 905(c),providing that additional payments of tax be accounted for through adjustments to the pools of post-1986 foreign income taxes and post-1986 undistributed earnings of Sec. 902 corporations that are not the same entity as the payer of the tax.

Treasury also specifically requested comments on whether an objective test, rather than a subjective test based on taxpayer intent, should be used to determine whether the described transactions or restructurings should be treated as splitter arrangements. And, if so, it asked what type of objective test could be used for this purpose. The comment period ended Dec. 14, 2016.


The rules set forth in Notice 2016-52 limit foreign tax credit planning that may be undertaken in conjunction with foreign-initiated tax adjustments. Taxpayers should be mindful of how those rules could affect the availability of foreign tax credits as they undertake transactions or restructurings involving entities for which foreign-initiated tax adjustments are anticipated.


Michael Dell is a partner at Ernst & Young LLP in Washington.

For additional information about these items, contact Mr. Dell at 202-327-8788 or

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.

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