The IRS finalized temporary and proposed regulations that are designed to prevent taxpayers from misapplying the Sec. 901(m) statutory disposition rule in certain dispositions of relevant foreign assets (RFAs), including where the gain or loss from the disposition of an RFA is recognized for U.S. income tax purposes but not for foreign income tax purposes, and cases in which no gain or loss is recognized for purposes of U.S. or foreign income tax from the disposition of an RFA (T.D. 9895). The regulations are issued under Sec. 901(m) and Sec. 704.
Sec. 901(m)(1) provides that, in the case of a covered asset acquisition (CAA), the disqualified portion of any foreign income tax determined with respect to the income or gain attributable to RFAs is not taken into account in determining the Sec. 901(a) foreign tax credit, and in the case of foreign income tax paid by a Sec. 902 corporation, is not taken into account for purposes of Sec. 902 or 960. Instead, the disqualified portion of any foreign income tax is allowed as a deduction.
A CAA is (1) a qualified stock purchase (as defined in Sec. 338 (Sec. 338 CAA)); (2) any transaction that is treated as an asset acquisition for U.S. income tax purposes and as the acquisition of stock of a corporation (or is disregarded) for purposes of a foreign income tax; (3) any acquisition of an interest in a partnership that has a Sec. 754 election in effect (Sec. 743(b) CAA); and (4) any other similar transaction the IRS provides.
The regulations are aimed at certain taxpayers that are engaging in transactions shortly after a CAA occurs that are intended to invoke application of the Sec. 901(m)(3)(B)(ii) statutory disposition rule to avoid the purpose of Sec. 901(m). As an example of such a transaction, USP, a domestic corporation, wholly owns FSub, a foreign corporation, and FSub acquires 100% of FT, a foreign corporation, in a Sec. 338 qualified stock purchase. The acquisition of FT’s stock is a Sec. 338 CAA, and FT’s assets are RFAs for that Sec. 338 CAA. Shortly after the acquisition of FT in the Sec. 338 CAA, FT becomes disregarded as an entity separate from its owner. As a result, FT is deemed, solely for U.S. tax purposes, to distribute all of its assets and liabilities to FSub in a deemed liquidation immediately before the closing of the day before the election is effective. Under Secs. 332 and 337, no gain or loss is recognized on the deemed liquidation by either FT or FSub.
Taxpayers have been taking the position that the deemed liquidation constitutes a disposition of the RFAs under Sec. 901(m)(3)(B)(ii) and that, as a result, all of the basis difference from the RFAs is allocated to FT’s final tax year that occurs because of the deemed liquidation and that no basis difference is allocated to any later tax year. The regulations are intended to prevent this and similar practices.
The final regulations identify the transactions that are CAAs and the assets that are RFAs with respect to a CAA. They also provide a general rule for determining the basis difference for an RFA under Sec. 901(m)(3)(C) and a special rule for determining the basis difference for an RFA that arises as a result of an acquisition of an interest in a partnership that has made a Sec. 754 election.
The regulations also provide rules for taking into account a basis difference under the applicable cost recovery method or as a result of a disposition of an RFA and successor rules for applying Sec. 901(m) to subsequent transfers of RFAs that have a basis difference that has not yet been fully taken into account.
The final regulations were revised from the temporary regulations based on comments received. One change was the addition of another de minimis exception from the rules, allowing one if the absolute value of the basis difference with respect to the RFA is less than $20,000. The final regulations also make modifications to the rules contained in the 2016 proposed regulations where necessary due to statutory changes made by the law known as the Tax Cuts and Jobs Act, P.L. 115–97.
The IRS also finalized proposed regulations (REG-129128-14) under Sec. 704 that contain rules for computing the disqualified portion of foreign income taxes under Sec. 901(m), including definitions and rules for determining whether and to what extent basis difference that is assigned to a given tax year is carried over to subsequent tax years. Those regulations were adopted without change.
The regulations generally are applicable to CAAs occurring on or after March 23, 2020, except taxpayers may apply the rules to all CAAs occurring after Dec. 7, 2016 (the date the proposed and temporary regulations were issued), provided they apply the rules consistently.
— Sally P. Schreiber, J.D., (Sally.Schreiber@aicpa-cima.com) is a Tax Adviser senior editor.