On February 9, 2015, the U.S. Treasury released final regulations on foreign tax credit (FTC) splitting arrangements (the “2015 Regulations”). The final rules, released the same day that the 2012 temporary and proposed regulations were set to expire, offer some definitional and other clarifications and add useful illustrations. But for the most part, the 2015 Regulations adopt the prior proposed and temporary regulations, including the exclusive list of FTC splitter arrangements. Notably, the final rules fail to address several “mechanical issues” (i.e., issues concerning the tracking of split taxes and related income), which are “still under consideration.”
Section 909 of the Code suspends a taxpayer’s FTCs until the taxpayer takes into account for U.S. tax purposes the related income. An FTC splitting event occurs when the related income is or will be taken into account under the Code by a “covered person” (i.e., a person other than the payor of the taxes). A covered person is any entity in which the payor holds at least a 10% interest, any person which holds at least a 10% interest in the payor, any person related to the payor as described in Section 267(b) or 707(b), and any other person specified by the Treasury. Under the regulations, there are 4 types of FTC splitter arrangements:
- Reverse Hybrid
- Loss-Sharing or Group Relief
- Hybrid Instrument
- Partnership Inter-Branch Payments
Clarifications under the 2015 Regulations included the following:
- The regulations addressed comments regarding the calculation of “related income” where the E&P of a reverse hybrid entity fluctuates due to subsequent losses and added two examples of this fact-pattern.
- Shared losses that can be carried back by a U.S. combined group to prior foreign tax years constitute loss-sharing splitter arrangements. This clarification means that foreign income taxes paid or accrued in prior years may therefore become split taxes on a “retroactive basis.”
- Shared losses that may be carried forward are excluded from the definition of usable shared loss, given the uncertainty that future income could absorb the losses.
- A U.S. equity hybrid instrument splitter arrangement exists—regardless whether payment is made on the instrument—if an accrual under foreign law with respect to the instrument (1) provides a foreign-law deduction for the issuer and (2) results in the imposition of foreign income tax on the owner (3) without giving rise to income under U.S. law. Actual payment of an accrued amount may be treated as a distribution of related income, but does not preclude a hybrid instrument from being a splitter arrangement.
- Split taxes are not allowed as a carryover attribute for inbound Section 381 transactions (continuing the treatment under Reg. Section 1.909-6T(e)(3)). To avoid permanent suspension of credits, taxpayers must effect “distributions” of related income prior to the Section 381 transaction.