|Sean Foley||Landon McGrew|
Section 901(m) denies a foreign tax credit for the "disqualified portion" of any foreign income tax determined with respect to the income or gain attributable to assets acquired in a CAA. In general, a CAA is a transaction that results in an asset basis step-up for US tax purposes, without a corresponding step-up for foreign tax purposes. For the purposes of section 901(m), the "disqualified portion" of a foreign income tax for a taxable year is computed based on the ratio of the aggregate basis differences allocable to that taxable year (as allocated under applicable US cost recovery rules) over the income on which the foreign income tax is determined.
Section 901(m) also provides a special disposition rule in the event that an asset is disposed of before the end of its applicable cost recovery period. Under section 901(m)(3)(B), if there is a disposition of an asset acquired in a CAA, any unallocated basis difference is allocated entirely to the year of disposition and no basis difference is allocated to any taxable year thereafter.
The notice states that the IRS and Treasury have become aware that certain taxpayers are engaging in transactions intended to inappropriately trigger the application of the disposition rule to avoid the purposes of section 901(m). The notice provides the following example:
USP wholly owns FSub, which acquires 100% of the stock of FT in a qualified stock purchase (as defined in section 338(d)(3)) for which an election under section 338(g) is made. Accordingly, the acquisition of FT is a CAA. Shortly after the CAA, FT elects to be treated as a disregarded entity for US tax purposes under reg. section 301.7701-3. As a result, FT is deemed to distribute all of its assets to USP in a tax-free liquidation for US tax purposes.
The notice states that taxpayers have taken the position that the deemed liquidation constitutes a disposition for purposes of section 901(m)(3)(B). As a result, taxpayers claim that all of the basis difference attributable to the CAA is allocated to the final taxable year of FT, and that no basis difference is allocated to any later taxable year. The notice states that this position is inappropriate because (i) the basis difference in the assets of FT for purposes of US income tax and foreign income tax continues to exist after the deemed liquidation and (ii) no gain is recognised for foreign income tax purposes as a result of the deemed liquidation.
To address this situation, the notice limits the definition of a disposition for purposes of section 901(m) to an event that results in gain or loss recognition for US or foreign tax purposes, or both. Accordingly, the tax-free deemed liquidation in the example described above would not result in a disposition for purposes of section 901(m) under the notice because no gain or loss is recognised for US or foreign purposes. The notice further provides that if a transaction results in a disposition that is not fully taxable for US and foreign purposes, a portion of the basis difference may carry over to the new owner. In addition, the notice provides a number of additional rules, including a definition of the "disposition amount", special rules for assets acquired in a section 743(a) CAA, and successor rules.
As noted above, the future regulations will apply to dispositions occurring on or after July 21 2014. Shortly after the release of the notice, the IRS issued Notice 2014-45 to clarify that the notice also applies to check-the-box elections filed on or after July 29 2014, with an effective date on or before July 21 2014.
The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.
This article represents the views of the authors only, and does not necessarily represent the views or professional advice of KPMG LLP.