Editor: Annette B. Smith, CPA
On May 10, 2019, Treasury released a final regulations package (the May final regulations) under Sec. 987, finalizing certain anti-abuse provisions contained in previously issued temporary regulations (T.D. 9857). The temporary regulations were due to expire in December 2019. The finalization of these temporary regulations reflects the commitment of Treasury and the IRS to continue to limit a taxpayer's ability to recognize Sec. 987 losses (and in some cases Sec. 987 gains) resulting from certain terminations of a Sec. 987 qualified business unit (QBU).
Following enactment of the 2017 tax reform legislation in P.L. 115-97, the law known as the Tax Cuts and Jobs Act, certain internal group restructurings commonly may involve the transfer of Sec. 987 QBUs to either domestic or foreign related parties. (A QBU is a separate and clearly identified unit of a taxpayer's trade or business that maintains separate books and records under Sec. 989(a).) In these situations, the May final regulations may defer Sec. 987 gain or loss upon these types of transfers to domestic related parties or between foreign related parties (referred to as a deferral event), while triggering gain and deferring Sec. 987 loss upon outbound transfers to foreign related parties (referred to as an outbound loss event). When transferring Sec. 987 QBUs to related domestic or foreign parties, practitioners should consider the tax implications of the May final regulations, as outlined below, prior to undertaking such internal restructurings.
Overview
On Dec. 7, 2016, Treasury released temporary Sec. 987 regulations (T.D. 9795), which generally had applicability dates that paralleled those for the final regulations. Those applicability dates have been deferred until 2020 (see Notice 2017-57 and Notice 2018-57). However, the applicability date of Temp. Regs. Sec. 1.987-12T was Jan. 6, 2017 (but earlier if a transaction had a principal purpose of recognizing Sec. 987 loss). That is, Temp. Regs. Sec. 1.987-12T was effective within a month of publication and, in certain cases, was immediately effective. While the applicability date of Regs. Secs. 1.987-2(c)(9) and 4(f) are consistent with the applicability date for the final Sec. 987 regulations, the applicability date of Regs. Sec. 1.987-12 is retroactive to Jan. 6, 2017 (but earlier if a transaction had a principal purpose of recognizing Sec. 987 loss).
On Dec. 7, 2016, Treasury also released final, but not yet effective, Sec. 987 regulations (T.D. 9794), providing rules under Regs. Sec. 1.987-8 relating to, inter alia, when a Sec. 987 QBU is considered terminated. The May 2019 final Sec. 987 regulations (T.D. 9857), among other things, finalized the temporary regulations under Temp. Regs. Sec. 1.987-12T with respect to deferring Sec. 987 gains and losses occurring from certain Sec. 987 QBU terminations.
Sec. 987 generally requires the recognition of Sec. 987 gain or loss upon the termination of a Sec. 987 QBU. The May final regulations require the recognition of Sec. 987 gain or loss to be deferred if the termination constitutes a deferral event within the meaning of Regs. Sec. 1.987-12(b). In addition, a combination of rules in the 2016 final, but not yet effective, Sec. 987 regulations and the May final regulations provide that Sec. 987 gain is recognized, but any loss is deferred, if the termination constitutes an outbound loss event within the meaning of Regs. Sec. 1.987-12(d). Regs. Sec. 1.987-12(g) also provides a broad anti-abuse rule for limiting Sec. 987 losses if a transaction or series of transactions has a principal purpose of avoiding the temporary regulations. Importantly, the final regulations do not apply in a tax year when a Sec. 987 QBU's net unrecognized Sec. 987 gain or loss is $5 million or less (Regs. Sec. 1.987-12(a)(3)(ii)).
Below, this item reviews the definition of termination events as applied under the 2016 final, but not yet effective, Sec. 987 regulations and then discusses deferral events and outbound loss events as defined in the May final regulations.
Sec. 987 QBU terminations
The deferral-event or outbound-loss-event rules apply only to certain terminations of a Sec. 987 QBU and do not apply to actual remittances ─ i.e., transfers of cash or property from the Sec. 987 QBU to its owner in excess of contributions to the Sec. 987 QBU. Generally, if a termination occurs, the Sec. 987 QBU is treated as remitting all of its gross assets to its owner immediately before termination, which would result in the recognition of net unrealized Sec. 987 gain or loss under Regs. Sec. 1.987-8(e).
The 2016 final, but not yet effective, Sec. 987 regulations (Regs. Sec. 1.987-8(b)) provide that a QBU termination occurs when: (1) a QBU ceases its trade or business; (2) a QBU transfers substantially all its assets to its owner; (3) a QBU is owned by a controlled foreign corporation (CFC) (as defined in Sec. 957) that ceases to be a CFC under certain circumstances; or (4) the owner of the QBU ceases to exist. Generally, Sec. 332 liquidations and Sec. 368(a)(1) reorganizations are not considered termination events under Regs. Sec. 1.987-8(c), unless the liquidation or reorganization results in a cross-border transfer or the new owner of the Sec. 987 QBU after the transfer has the same functional currency as the Sec. 987 QBU.
Deferral events
Generally, a deferral event under Regs. Sec. 1.987-12(b)(2) occurs upon the termination of a Sec. 987 QBU when there is a transfer of substantially all its assets to a related party and those assets are reflected on the books and records of a successor QBU. A deferral event also includes (1) a disposition of part of an interest in a Sec. 987 aggregate partnership, as defined in Regs. Sec. 1.987-1(b)(5); (2) a disposition of part of a disregarded entity through which a Sec. 987 QBU is owned; or (3) any contribution by another person to such a partnership or disregarded entity of assets that, immediately after the contribution, are not considered to be included on the books and records of an eligible QBU, provided that the contribution gives rise to a deemed transfer from the Sec. 987 QBU to the owner. Also, immediately after any of these transactions or series of transactions, assets of the Sec. 987 QBU must be reflected on the books of a successor QBU.
A deferral event, however, does not include (1) a termination described in Regs. Sec. 1.987-8(b)(3) (CFC owner of a Sec. 987 QBU ceases to be a CFC under certain circumstances); (2) a termination described in Regs. Sec. 1.987-8(c) (certain Sec. 381 transactions); or (3) a termination described solely in Regs. Sec. 1.987-8(b)(1) (the trade or business of the Sec. 987 QBU ceases).
The May final regulations (Regs. Sec. 1.987-12(b)(4)) define a successor QBU as a Sec. 987 QBU that, immediately after a termination, disposition, or contribution of a Sec. 987 QBU that is a deferral event, satisfies the following conditions: (1) It reflects assets on its books and records that immediately before the deferral event, were reflected on the books of the original QBU; (2) the owners of the original QBU immediately before the deferral event and the successor QBU are members of the same controlled group (i.e., persons with a relationship to each other described in Sec. 267(b) or 707(b)); and (3) in the case of a termination of a QBU, in which the owner of the terminated QBU immediately before the deferral event was a U.S. person, the successor QBU is owned by a U.S. person.
If a deferral event occurs, the May final regulations (Regs. Sec. 1.987-12(c)(1)) require that the owner of the Sec. 987 QBU (deferral QBU owner) not recognize Sec. 987 gain or loss realized upon the termination of the Sec. 987 QBU. Regs. Sec. 1.987-12(c)(2) provides, however, that a deferral QBU owner recognizes deferred Sec. 987 gain or loss in the tax year of the deferral event or subsequent tax years upon a remittance by a successor QBU to its new owner. The amount of the deferred Sec. 987 gain or loss taken into account by the deferral QBU owner generally is the deferred amount of Sec. 987 gain or loss multiplied by the remittance proportion of the successor QBU owner with respect to the remittance made by the successor QBU.
Many common intercompany transfers are deferral events, such as a Sec. 351 transfer of all the assets of a Sec. 987 QBU to a member of the controlled group. In particular, the 2016 final, but not yet effective, Sec. 987 regulations provide that such a transfer would be a termination event resulting in the recognition of any net unrecognized Sec. 987 gain or loss. However, the May final regulations would defer that Sec. 987 gain or loss until a subsequent remittance by the successor QBU.
Note: An outbound transfer of a Sec. 987 QBU is not a deferral event but instead would be subject to the outbound-loss-event rules described below.
Outbound loss events
The May final regulations (Regs. Sec. 1.987-12(d)(2)) provide that an outbound loss event may occur in any of the following situations: (1) a termination of a Sec. 987 QBU in connection with a transfer by a U.S. person to a related foreign person; (2) a termination of a Sec. 987 QBU in connection with a transfer by a U.S. person to a newly created related foreign person (e.g., a Sec. 987 QBU elects to be classified as a foreign corporation for U.S. federal income tax purposes); (3) a transfer by a U.S. person of part of a Sec. 987 aggregate partnership interest or part of a disregarded entity through which the U.S. person owns the Sec. 987 QBU to a related foreign person that has the same functional currency as the Sec. 987 QBU; or (4) a contribution by a related foreign person to a Sec. 987 aggregate partnership or disregarded entity that owns a Sec. 987 QBU, and the contributed assets are not considered to be included on the books and records of the Sec. 987 QBU, provided the transfer would result in the recognition of Sec. 987 loss.
As noted in the preamble to the May final regulations, the rules applicable to an outbound loss event apply Sec. 367 concepts by requiring recognition of Sec. 987 gain, but not loss, upon a transfer of a Sec. 987 QBU to a foreign related party. In particular, Regs. Sec. 1.987-12(d)(4) provides that if the outbound loss event arises as a result of either a Sec. 351 or Sec. 361 exchange, the Sec. 987 loss not recognized under the outbound-loss-event rules increases the basis of the stock that is received in the transaction.
This may result in the conversion of a Sec. 987 loss to a capital loss, unless the stock is sold or exchanged within two years of the outbound loss event. In this regard, the final and effective regulations (Regs. Sec. 1.987-12(e)(2)) provide that if a loss is recognized on the sale or exchange of that stock within two years of the outbound loss event, the source and character of the loss recognized on the sale or exchange (to the extent of the Sec. 987 loss subject to the outbound loss event) would be determined as if the Sec. 987 loss were recognized on the date of the outbound loss event.
Current status and future considerations
With the finalization of the anti-abuse rules in the May final regulations complete, Treasury can now turn its attention to the revision of the final, but not yet effective, Sec. 987 regulations pursuant to Executive Order 13789 and Notice 2017-57. In the meantime, practitioners should be aware of these anti-abuse rules as they advise on their clients' restructurings.
EditorNotes
Annette B. Smith, CPA, is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, D.C.
For additional information about these items, contact Ms. Smith at 202-414-1048 or annette.smith@pwc.com.
Contributors are members of or associated with PricewaterhouseCoopers LLP.
