On October 3, 2008, Treasury and the IRS issued Notice 2008-91 (corrected on October 16, 2008), which provides temporary and limited relief to a particular aspect of section 956, in connection with the current liquidity crisis. Under sections 951 and 956, a U.S. shareholder of a controlled foreign corporation (CFC) is subject to tax on the amount equal to the lesser of (1) the U.S. shareholder’s pro rata share of the average of the amounts of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of the taxable year, less the amount of earnings and profits previously included in the U.S. shareholder’s gross income, or (2) the U.S. shareholder’s pro rata share of the applicable earnings of the CFC. The effect of these provisions is to treat the U.S. shareholders of the CFC as receiving the amount invested in U.S. property as a constructive dividend. Section 956 is consistent with the other provisions of subpart F insofar as it is intended to prevent the tax-free repatriation of earnings.
With certain exceptions, an obligation of a U.S. person is U.S. property for purposes of section 956. In Notice 88-108, Treasury and the IRS excluded from U.S. property obligations held at the end of a CFC’s taxable year if the obligation is collected within 30 days from the time it is incurred. Notice 88-108 provides that this exclusion will not apply if the CFC holds for 60 or more days during the calendar year obligations that, without regard to the 30-day rule, would constitute an investment in U.S. property if held at the end of the CFC’s taxable year.
In 1993, Congress amended section 956 so that a CFC’s investment in U.S. property is measured each quarter, rather than at the end of the CFC’s taxable year. Nevertheless, Congress noted in the legislative history of the amendment that the annual measure previously set forth in Notice 88-108 should remain intact, notwithstanding the amendment to section 956.
Notice 2008-91 liberalizes the exclusion of the Notice 88-108 in recognition of taxpayers’ current difficulty in funding their operations. Specifically, the notice provides that an obligation held by a CFC will not constitute an investment in U.S. property under section 956, provided that the obligation is collected within 60 days from the time it is incurred. However, the exclusion does not apply if the CFC holds for 180 or more calendar days during its taxable year obligations that, without regard to the 60-day rule, would constitute an investment in U.S The rules set forth in Notice 2008-91 are effective for the first two taxable years of a foreign corporation ending after October 3, 2008, but do not apply to the taxable years of a foreign corporation beginning after December 31, 2009. For foreign corporations with calendar tax years, Notice 2008-91 applies to the taxable years ending December 31, 2008, and December 31, 2009.
The Reaction to Notice 2008-91
Several practitioners have called for Treasury and the IRS to clarify certain issues raised by Notice 2008-91. For example, practitioners have noted that Jacobs Engineering Group Inc. v. United States, 79 A.F.T.R. 2d 97-1673 (C.D. Cal., 1997), aff’d, 168 F.3d 499 (9th Cir. 1999) and Revenue Ruling 89-73 are inconsistent with the principle of Notice 2008-91 and Notice 88-103. In Jacobs Engineering, the court treated the twelve back-to-back loans that it borrowed from its CFC as one borrowing that was an obligation for purposes of section 956, even though the loan complied with the technical terms of the regulations that required repayment within one year. In Revenue Ruling 89-73, the IRS ruled that, where a CFC made two loans to its U.S. parent, the loans were, in substance, a single obligation and a repatriation of the CFC’s earnings to the U.S. parent for purposes of section 956. In reaching this conclusion, the IRS focused on the fact that the disinvestment period was brief — 60 days in one case, and 284 days in another. Consequently, practitioners are concerned that a CFC’s making of several loans to its parent within one taxable year could run afoul of Revenue Ruling 89-73 and Jacobs Engineering, even if the loans otherwise comply with the requirements of Notice 2008-91 or Notice 88-103. Practitioners have thus called for a safe harbor disinvestment period or some other clarification that Notice 2008-91 will take precedence over Revenue Ruling 89-73 and Jacobs Engineering.
Additionally, Tax Executives Institute (TEI) has called upon Treasury and the IRS to clarify that the 60-day limitation of Notice 2008-91 does not apply to trade receivables that are excluded from the definition of a U.S. obligation under the section 956 Treasury regulations. TEI noted that trade receivables may remain outstanding for longer than the 60-day limit because of credit limitations. More generally, TEI remarked that further action is warranted, given the severity of the liquidity crisis and the fact that, at the time Notice 2008-91 was issued, a 60-day loan would not be long enough to fund a U.S. parent’s operations through the end of the calendar year.
It is unclear whether Treasury and the IRS will take action to resolve the ambiguity between the IRS notices on the one hand, and Revenue Ruling 89-73 and Jacobs Engineering on the other. Notice 2008-91 may be part of a trend in which Treasury and the IRS have offered ad hoc relief to taxpayers in connection to the overall financial crisis. For example, recently issued Notice 2008-83 suspends the section 382 limitation on the use of built-in losses for certain banks. Time will tell if Treasury and the IRS provide further relief, as well as refinements on existing pronouncements.