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IRS finalizes covered asset acquisitions regs

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Tax Hot Topics newsletter The IRS issued final regulations (T.D. 9895) under Section 901(m) on March 20 that remove temporary regulations and largely adopt previously issued proposed regulations with a handful of notable changes.

Section 901(m) limits the ability to claim foreign tax credits associated with certain enumerated transactions referred to as “covered asset acquisitions.” Generally, a covered asset acquisition is a transaction that is treated as an asset acquisition for U.S. federal income tax purposes but is either treated as a stock acquisition or is disregarded for foreign income tax purposes. These types of transactions may result in an increase in tax basis for U.S. federal income tax purposes, but not for foreign tax purposes. The basis differences may generate deductions (e.g., amortization or deprecation) for U.S. federal income tax purposes, which exceed those afforded for foreign tax purposes. The result of this basis difference is often a higher income tax base and higher taxes paid for foreign tax purposes, and thus excess foreign tax credits on income that may never be recognized for U.S. federal tax purposes.

Section 901(m) provides that, in the case of a covered asset acquisition, the disqualified portion of any foreign income tax determined with respect to the income or gain attributable to certain foreign assets will not be taken into account in determining the foreign tax credit allowed under various provisions of the Internal Revenue Code. Instead, the disqualified portion of any foreign income tax is permitted only as a deduction. The statute provides that the term “disqualified portion” means, with respect to any covered asset acquisition, the ratio of the aggregate basis differences allocable to such taxable year divided by the income on which the foreign income tax is determined.

The IRS issued proposed regulations under Section 901(m) in December 2016 that in part cross-referenced temporary regulations. The guidance package also included rules previously provided in Notices 2014-44 and 2014-45. The proposed regulations provided guidance for computing the disqualified portion of foreign income taxes under Section 901(m), set forth numerous definitions and complex operating rules and added several anti-abuse rules. Notable guidance included in the proposed regulations included:

  • The addition of three new categories of transactions to be treated as covered asset acquisitions, which are a supplement to the three categories provided in the statute
  • Simplification of statutory rules regarding the computation of disallowed taxes by allowing combined income taxes.
  • The addition of de minimis rules under which certain basis differences are not taken into consideration for purposes of Section 901(m)
  • The addition of the “foreign basis election,” pursuant to which the basis difference is equal to the U.S. basis in the relevant foreign asset less the foreign basis in the relevant foreign asset immediately after the covered asset acquisition (i.e., prevents the need for re-computing U.S. tax basis immediately prior to the covered asset acquisition on acquired assets).

For more details on the proposed regulations, see [title of prior coverage].

The final regulations largely adopt the proposed rules, but there are a few changes of which taxpayers need to be aware:

  • The final regulations provide an exemption to Section 901(m) where a domestic Section 901(m) payor or a member of its consolidated group recognized the gains or losses or took into account a distributive share of the gains or losses recognized by a U.S. partnership for U.S. tax purposes with respect to the relevant foreign assets as part of the original covered asset acquisition.
  • The proposed regulations provided that a taxpayer is permitted make the foreign basis election retrospectively to covered asset acquisitions occurring on or after Jan. 1, 2011, given that the rest of the proposed regulations were consistently applied. Taxpayers expressed concern to Treasury in comments that they would be denied the choice to retroactively apply the election because a closed year would prevent them from consistently applying the regulations back to Jan. 1, 2011. In response to this concern, the consistency requirement has been modified to apply only to open tax years so as to not prevent taxpayers from obtaining the benefit of a retroactive election, however an additional requirement has been added to take deficiencies into account that would have resulted from the consistent application of the final regulations for a tax year that is closed.
  • The final regulations expand the scope of the de minimis rule for applying Section 901(m) by adding an additional exclusion, such that a basis difference with respect to a relevant foreign asset is not taken into account if the basis is less than $20,000.
  • The final regulations add a priority rule to the regulations to address transactions to which both Sections 901(m) and 909 apply. Under this rule the Section 901(m) calculation would be undertaken before applying Section 909. Further, foreign taxes that are disqualified for foreign tax credit purposes under Section 901(m) but remain eligible to be deducted may still be subject to deferral under Section 909.
  • The final regulations reflect modifications to the rules contained in the 2016 proposed regulations necessary to reflect statutory changes by the Tax Cuts and Jobs Act. For example, references to Section 902 corporations are replaced with references to “applicable foreign corporations” and a definition of “separate category” is added and utilized to address the income groupings required under Section 960.

The final regulations are applicable to covered asset acquisitions occurring on or after March 23. However, they may be applied retroactively subject to certain consistency requirements on any original or amended tax return for each taxable year for which the application of the provisions affects the tax liability and for which the statute of limitations does not preclude assessment or the filing of a claim for refund, as applicable.

Taxpayers may have an opportunity to reduce the amount of foreign tax credits previously disallowed under Section 901(m) by retroactively applying the foreign basis election. However they should be mindful of deficiencies associated with the retroactive application of the regulations. It is recommended that taxpayers model the outcome of making this election.

Contacts:
David Sites
Partner
Washington National Tax Office
T +1 202 861 4104

David Zaiken
Managing Director
Washington National Tax Office
T +1 202 521 1543

Cory Perry
Senior Manager
Washington National Tax Office
T +1 202 521 1509

Mike Del Medico
Manager
Washington National Tax Office
T +1 202 521 1522

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