On August 10, 2010, President Obama signed the Education Jobs and Medicaid Assistance Act of 2010 into law. The act contains a number of provisions affecting the U.S. taxation of taxpayers with multinational operations, most notably, provisions that further limit the utilization of foreign tax credits by U.S. taxpayers.

These provisions were originally proposed as revenue raisers for a one-year extension of many taxpayer-favorable provisions (Extenders Legislation), such as the extension of Section 954(c)(6), a provision providing look-through treatment, for subpart-F purposes, for dividends between controlled foreign corporations (CFCs). While the U.S. House of Representatives passed the Extenders Legislation in H.R. 4213, the American Jobs and Closing Tax Loopholes Act of 2010, the U.S. Senate could not reach agreement on a bill and, as a result, the Extenders Legislation has not yet been enacted. The Education Jobs and Medicaid Assistance Act does not contain the extension of any of the taxpayer-favorable provisions contained in the Extenders Legislation, nor does it contain certain amendments to Section 356, which repeals the so-called “boot within gain limitation” for reorganizations, or the proposal to source guarantee fees based on residence of the payor. Carried interest provisions also were not included in the act.

The international tax provisions contained in the act will have a considerable impact on many taxpayers with significant non-U.S. operations. Taxpayers should closely scrutinize the reforms and consider alternatives to mitigate any negative consequences, if possible. The effective dates of the provisions are generally prospective in nature, with most provisions effective either for tax years beginning after December 31, 2010, or for transactions occurring after this date. Thus, taxpayers should consider opportunities to restructure their operations in a manner that limits the impact of the proposals prior to the effective date. Each of the provisions is discussed in detail below.

Covered Asset Acquisitions

The act creates a new Section 901(m) to the Internal Revenue Code, which limits a taxpayer’s ability to claim a foreign tax credit in connection with a “covered asset acquisition.” This provision is estimated to raise $3.645 billion over the next 10 years.

Covered asset acquisitions include certain transactions that result in the creation of additional asset basis for U.S. tax purposes, but that do not create a similar basis increase for non-U.S. purposes as a result of certain elections or characterizations under U.S. tax law. New Section 901(m)(2) describes each of the following as a covered asset acquisition: a qualified stock purchase under Section 338, any transaction that is treated as an asset acquisition (or is disregarded) for U.S. tax purposes and as the acquisition of stock for purposes of the foreign income taxes of the relevant jurisdictions (e.g., the acquisition of the stock of an entity that is disregarded for U.S. tax purposes, but is taxable as an entity in its jurisdiction of organization), and any acquisition of an interest in a partnership that has an election in effect under Section 754. Further, Section 901(m)(2)(D) grants the secretary of the U.S. Department of the Treasury (the Secretary) the authority to identify similar transactions in regulations.

To the extent of any covered asset acquisition occurring after the effective date, Section 901(m) disallows the “disqualified portion” of any foreign taxes paid with respect to such covered asset acquisition for a taxpayer’s computation of its allowable foreign tax credit under Sections 901, 902 and 960. The disqualified portion is the ratio of the aggregate basis differences allocable to such taxable year with respect to all relevant foreign assets, divided by the income on which the foreign income is determined. The aggregate basis differences are generally determined by comparing the adjusted basis in the foreign asset immediately after the covered acquisition to the adjusted basis before the covered asset acquisition (using U.S. tax principles). Thus, Section 901(m) has the effect of denying taxpayers the incremental foreign tax credit benefit created from a transaction that results in a step-up in basis for U.S. tax purposes, but that does not result in a similar basis increase for non-U.S. tax purposes. However, any foreign taxes disallowed under Section 901(m) are allowable as a deduction.

Section 901(m) generally applies to any covered asset acquisition occurring after December 31, 2010. However, a transition rule provides that the provision will not apply to any transaction where the transferor and transferee are unrelated if the acquisition is made pursuant to a written agreement which was binding on January 1, 2011, and at all times thereafter, described in a ruling request submitted to the U.S. Internal Revenue Service (IRS) on or before July 28, 2010, or described on or before January 1, 2011, in a public announcement or in a filing with the U.S. Securities and Exchange Commission.

New Section 901(m) prevents U.S. taxpayers from tax effecting a basis increase for non-U.S. assets where the basis increase occurs solely for U.S. tax purposes. Thus, the provision disadvantages U.S. purchasers of non-U.S. targets as compared with the period prior to enactment of the act. That is, a U.S. firm would be willing to pay more for a non-U.S. target as a result of its ability to tax effect the basis step-up as a result of a Section 338 election prior to the enactment of Section 901(m), compared to the post-enactment period where that benefit has been eliminated. Further, to the extent there are jurisdictions that would allow a taxpayer to tax effect a similar purchase of the non-U.S. target, U.S. companies are arguably at a disadvantage compared to those companies.

In order to mitigate these effects, to the extent possible, taxpayers should consider taking advantage of the binding commitment provision contained in the effective date provisions of Section 901(m). There also may be opportunities both before and after the effective date of this section that could limit the adverse effects of the provision for taxpayers.

Further, Section 901(m) will likely add significant diligence obligations for U.S. taxpayers who purchase non-U.S. targets where a Section 338 election is made. Specifically, U.S. taxpayers will have to determine the bases of the assets of the non-U.S. target for U.S. tax purposes in order to determine the disqualified portion of any foreign taxes under Section 901(m). To the extent the non-U.S. target is not part of a group controlled by a U.S. parent, it is unlikely the U.S. tax bases would have ever been calculated under prior law. Thus, the U.S. purchaser will have an additional burden of determining the U.S. tax bases of the acquired assets immediately prior to the acquisition.

Finally, there are several aspects of new Section 901(m) that are left unanswered by the statute and could be the subject of future regulations. For example, the statute does not appear to directly address the consequence of multiple covered asset acquisitions or how the effects of a previous covered asset acquisition affect the acquiring corporation in a subsequent covered asset acquisition.

Foreign Tax Credit Splitters

The act creates a new Section 909, which adopts a matching rule to prevent the separation of foreign taxes from the associated foreign income to which those foreign taxes relate. Specifically, the provision provides that upon the occurrence of a “foreign tax credit splitting event” with respect to foreign income taxes paid or accrued by the taxpayer, the foreign income tax is not taken into account before the taxable year in which the related income is taken into account by the taxpayer. This position is estimated to raise $4.25 billion in the next 10 years.

A foreign tax credit splitting event occurs when the income to which the foreign income tax relates is or will be taken into account by a “covered person.” A covered person is an entity in which the payor of the foreign income tax holds, directly or indirectly, at least a 10-percent interest; any person that holds, directly or indirectly, at least a 10-percent interest in the payor; certain related persons to the payor and any other person specified by the Secretary.

When there is a foreign tax credit splitting event, Section 901 taxes are not taken into account until income associated with the taxes is recognized by the U.S. shareholder. With respect to Section 902/960 taxes, the suspension of the foreign taxes continues until the CFC that accrued the foreign taxes recognizes the income or the U.S. shareholder recognizes the income. Any deduction for the foreign taxes is also deferred, including for earnings and profit (E&P) calculation purposes.

The matching rule is designed to address current structures that the IRS views as separating earnings from foreign taxes. Specifically, the provision appears to target foreign consolidated groups (at issue in the Guardian Industries case), reverse hybrid structures and hybrid instruments, all of which can result in the separation of earnings from associated foreign taxes.

The language of Section 909 is both new and potentially quite broad, creating a pressing need for regulatory guidance to ensure the provision does not apply to various everyday transactions. This concern arises due to the substantially different—and more complicated—approach Section 909 takes to foreign tax credit splitters as compared with regulations proposed by the Treasury in 2006, which taxpayers had anticipated would be the regime adopted to address foreign tax credit splitters. For example, under the proposed legislation foreign tax credits were taken into account when the associated income was recognized under foreign law. However, under new Section 909, the trigger for credit utilization is the time when the associated income is recognized under U.S. tax principles, raising the possibility that innocuous differences between U.S. and foreign laws may trigger the provisions. The potential application of this provision to certain hybrid instruments and foreign law loss surrender scenarios is also unclear.

New Section 909 is effective for foreign income taxes paid or accrued in a taxable year beginning after December 31, 2010, and for foreign income taxes paid or accrued by a Section 902 corporation in taxable years beginning on or before such date, but only for purposes of applying Sections 902 and 960 with respect to the periods after such date.

Limitation on the Amount of Foreign Taxes Deemed Paid with Respect to Section 956 Inclusions

The Education Jobs and Medicaid Assistance Act amends Section 960 to limit the use of Section 956 to increase a U.S. shareholder’s deemed-paid foreign tax credits. This provision is estimated to raise $704 million over the next 10 years.

The deemed-paid credit is available with respect to any subpart-F income inclusion or inclusion pursuant to the rules of Section 956 and also applies to certain lower tier subsidiaries. Amounts included in the income of a U.S. shareholder are deemed distributed directly to it by the relevant CFC, skipping (or “hopscotching”) any intervening CFC.

Prior to the act’s amendment, U.S. shareholders could use Section 956 affirmatively to access high-taxed earnings of lower tier CFCs and obtain the associated foreign tax credits even though a higher tier CFC had low-taxed earnings. For example, assume the U.S. shareholder owns CFC 1, and CFC 1 owns CFC 2. CFC 1 has earnings of $200 and has paid taxes of $10. CFC 2 also has $200 of earnings, but because it is subject to a higher tax rate, CFC 2 paid $100 of taxes. CFC 2 makes a $100 loan to U.S. shareholder. The Section 956 inclusion is deemed directly from CFC 2 to U.S. shareholder, skipping CFC 1. Under the prior rules, the U.S. shareholder would have a deemed paid credit of $50 (100/200 * 100).

Section 960 was amended to include new subsection (c) which limits the deemed paid credit to the lesser of foreign taxes deemed paid using the prior rules (without regard to new subsection (c) (the “tentative credit”) or to the hypothetical amount of the foreign taxes paid by the U.S. shareholder if the cash in an amount equal to the Section 956 inclusion had been distributed through the chain of ownership (the “hypothetical credit”). This limitation applies whether the U.S. shareholder chooses to claim a credit for the foreign taxes or to deduct the foreign taxes. The hypothetical credit is determined without regard to withholding or income taxes that would be imposed on the cash distributions, and the tentative credit is not increased if the hypothetical credit would have been greater. The Secretary is given authority to issue anti-abuse regulations to “prevent the inappropriate use of the foreign corporation’s foreign income taxes not deemed paid” pursuant to Section 960.

In the example above, under new Section 960(c), the tentative credit ($50) would be compared to the hypothetical credit. In this case, the hypothetical credit would be $20 (100/300 * 60). Under Section 960(c), as amended, the U.S. shareholder’s deemed paid credit would be $20.

Section 960(c) only applies to Section 956 investments in U.S. property and does not apply to deemed paid credits pursuant to other subpart-F inclusions. Additionally, in determining the Section 956 inclusion, amounts will still be deemed to be distributed directly by the relevant CFC.

The effective date for this provision is for acquisitions of U.S. property after December 31, 2010. Accordingly, U.S. shareholders should now evaluate and reorganize their structures to mitigate the effect of this rule.

Additional International Provisions

In addition to the provisions discussed above, the Education Jobs and Medicaid Assistance Act modifies other international tax provisions.

Separate Application of FTC Limitations to Items Resourced under Treaties

The act amends Section 904(d)(6) to provide that if (1) without regard to any treaty obligation of the United States, any item of income would be treated as U.S. source income; (2) under a treaty obligation of the United States, such item would be treated as foreign-source; and (3) the taxpayer chooses the benefits of such treaty obligation, then the foreign tax credit limitations will be applied separately to each item of income. This amendment is effective for taxable years beginning after the act’s date of enactment.

Special Rule for Certain Redemptions by Foreign Subsidiaries

The act amends Section 304(b)(5) to ensure that earnings of foreign subsidiaries of U.S. companies are subject to withholding when intragroup redemptions are used to repatriate these earnings to a foreign parent corporation as a dividend. This provision is estimated to raise $250 million in the next 10 years.

This provision is designed to prevent the hopscotching of a dividend out of the United States. Assume that FP owns 100 percent of USP and USP owns 100 percent of CFC. If CFC purchases shares in USP from FP for cash, Section 304(a)(2) characterizes the transaction as a distribution to FP in redemption of FP’s USP shares. Prior to the act, the dividend resulting from the deemed redemption was treated as received directly by FP from CFC (the acquiring corporation), thereby hopscotching the United States and resulting in no withholding tax out of the United States. Further, to the extent the purchase price equaled CFC’s E&P, there would be no Section 956 consequences for CFC holding the USP shares. However, under the act, none of CFC’s E&P would be taken into account for purposes of characterizing the source of the dividend under Section 304, because more than 50 percent of the dividend is not subject to tax in the United States (100 percent is not taxed in the United States because FP is not subject to U.S. taxation). Accordingly, under the act, the entire dividend is treated as received by FP from USP resulting in withholding tax on the distribution. Further, because CFC’s E&P remains following the transaction, CFC’s ownership of the USP stock would result in a Section 956 inclusion for USP.

This provision is effective for acquisitions after the date of enactment of the act. Accordingly, taxpayers must immediately reconsider their upcoming transfers of U.S. corporations from one foreign entity to another foreign entity. Additionally, although the amended provision does not explicitly provide for regulations, the legislative history states that “[i]t is anticipated that regulations will provide rules to prevent the avoidance of the provisions, including the use of partnerships, options, or other arrangements to cause a foreign corporation to be treated as a CFC.”

Modification of Affiliation Rules for Purposes of Allocating Interest Expense

The act amends Section 864 to provide that if more than 50 percent of a foreign corporation’s gross income is effectively connected income and at least 80 percent of either the vote or value of all outstanding stock of such foreign corporation is owned directly or indirectly by members of the affiliated group, then all of the foreign corporation’s assets and interest expense are taken into account for the purposes of allocating and apportioning the interest expense of the affiliated group. This provision applies to taxable years beginning after the date of enactment.

Termination of Special Rules for Interest and Dividends Received from Persons Meeting the 80/20 Test

The act amends Section 861 to repeal the rule that treats as foreign source all or a portion of any interest paid by a resident alien individual or domestic corporation that meets the 80/20 test. The act also amends Section 871 to repeal the rule that exempts from U.S. withholding tax all or a portion of any dividends paid by a domestic corporation that meets the 80/20 test. These amendments are effective for taxable years beginning after December 31, 2010. The repeal of the interest rules, however, does not apply to payments of interest to persons not related to the 80/20 company on obligations issued before the date of enactment.

Limitation on Extension of Statute of Limitations for Failure to Provide Information on Certain Foreign Transfers

The act makes one taxpayer-favorable clarification to the Hiring Incentives to Restore Employment Act (the HIRE Act), enacted earlier this year. Prior to amendment, the limitation period for assessment of tax did not expire any earlier than three years after all required information about certain cross-border transactions or foreign assets was actually provided to the Secretary. Thus, if a taxpayer inadvertently failed to disclose a single cross-border transaction, however inconsequential, the statute of limitations remained open for the entire return. The new act amends this rule and provides that if a taxpayer can establish reasonable cause, the limitations period is suspended only for the item or items related to the failure to disclose. This provision is effective as if included in the HIRE Act and applies for returns filed after March 18, 2010.


The international tax provisions enacted by the Education Jobs and Medicaid Assistance Act of 2010 will have a significant impact on U.S. taxpayers with multinational operations, most notably by creating further limitations on the utilization of foreign tax credits by such taxpayers. However, taxpayers have the ability to engage in necessary tax planning prior to many of the provisions becoming effective.