Insights & News

Tax Insights, September 9, 2015
Tracking Tax News You Need to Know

September 09, 2015
Final Regulations Issued Regarding Loss Consequences of Legging Out of Integrated Hedging Transactions
Final regulations have been issued providing guidance regarding certain integrated transactions that involve a foreign currency-denominated debt instrument and multiple associated hedging transactions. The regulations apply to “leg-outs” under Treasury Regulation Section 1.988-5(a)(6)(ii) occurring on or after Sept. 6, 2012. Taxpayers who dispose of all or part of a qualifying debt instrument or hedge before maturity of the transaction, or change a material term of the qualifying debt instrument or hedge, are viewed as “legging out” of integrated treatment. The regulations state that if a taxpayer has identified multiple hedges as being part of a qualified hedging transaction and the taxpayer has terminated at least one but fewer than all of the hedges, including a portion of one or more of the hedges, the taxpayer must treat the remaining hedges as having been sold for fair market value on the date of disposition of the terminated hedge. The regulations adopt temporary regulations issued in 2012 without substantive change.

IRS Announces Penalty Relief for Educational Institutions
The IRS announced that for 2012 through 2014, educational institutions will not face information return penalties for filing Forms 1098-T (Tuition Statement) with missing or incorrect taxpayer information numbers (TINs). Legislation enacted earlier in 2015 had provided prospective penalty relief only. An educational institution that was previously assessed penalties for 2012 will receive a letter from the IRS advising of the penalty waiver. The IRS is not assessing penalties for incorrect or missing TINs for tax years 2013 and 2014.

Educational institutions must provide a return to IRS and a statement to the student (Form 1098-T) stating, in part, the amount paid by or billed to the student for qualified tuition and related expenses for the tax year. The form requires the educational institution to include the student’s TIN. The form is used by a taxpayer in connection with claiming education-related tax credits (e.g., the American Opportunity Tax Credit and the Lifetime Learning Credit) or an above-the-line deduction for tax years beginning before Jan. 1 for qualified tuition and related expenses. Section 6721 (section references are to the Internal Revenue Code of 1986, as amended) imposes penalties for not properly and completely preparing correct information returns, including Form 1098-T.

Effective for returns required to be made and statements required to be furnished after Dec. 31, the Trade Preference Extension Act of 2015 (TPEA) waives the penalty for educational institutions that fail to file Forms 1098-T with accurate TINs of students attending the educational institution if the institution certifies, under penalty of perjury, that it properly requested TINs from the students. However, the penalty relief provided for under TPEA did not provide educational institutions with penalty relief for earlier years.

IRS Reallocates CFC Income and Expenses
In Legal Advice Issued by Field Attorneys (LAFA) 20153301F, the IRS characterized the entire amount of an intercompany referral fee derived by certain controlled foreign corporations (CFCs) as subpart F income; specifically, foreign-based company sales income. Under the facts of the LAFA, the intercompany referral fee was paid by one CFC to another CFC because salespersons at one CFC arranged for sales to its customer through salespersons at another CFC. Under applicable Treasury regulations, a taxpayer is required to allocate deductions to a class of gross income and then, if necessary, to make the determination required by the operative section of the Internal Revenue Code to apportion deductions within the class of gross income between the statutory grouping of gross income (or among the statutory groupings) and the residual grouping of gross income. Except for deductions, if any, which are not definitely related to a class of gross income and which therefore are ratably apportioned to all gross income, all deductions of the taxpayer must be so allocated and apportioned. Allocations and apportionments are made on the basis of the factual relationship of deductions to gross income. The IRS found that the taxpayer erred in treating any portion of the fee as arising from post-sale services and further allocated the intercompany referral fee (an expense in the hands of certain CFCs) entirely against the non-subpart F sales income of the CFCs.

Temporary Regulations Issued Expanding Application of Section 956 Anti-avoidance Rule to Partnerships
Temporary regulations were issued expanding the anti-avoidance rule in Treasury Regulations Section 1.956-1T(b)(4) to treat property indirectly held by a controlled foreign corporation (CFC) in connection with certain transactions involving partnerships as “U.S. property.” The temporary regulations also provide guidance on when a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining foreign personal holding company income (FPHCI). Additionally, the IRS made a number of changes to final regulations to coordinate the application of the temporary regulations.

The temporary regulations modify the existing anti-avoidance rule by (a) expanding the reach of the anti-avoidance rule so that it can now apply when a foreign corporation controlled by a CFC is funded other than through capital contributions or debt; (b) making the rule self-executing so that it applies without requiring IRS to exercise its discretion; and (c) expanding the rule to include transactions involving partnerships that are controlled by the CFC versus only foreign corporations that are controlled by the CFC. The rules apply to tax years of CFCs ending on or after Sept. 1 and to tax years of U.S. shareholders in which or with which such tax years end, with respect to property acquired, including property treated as acquired as the result of a deemed exchange of property pursuant to Section 1001 on or after Sept. 1.

The temporary regulations add a new rule relating to foreign partnership distributions funded by CFCs. The IRS has become aware that CFCs are engaging in transactions in which (a) a CFC lends funds to a foreign partnership, which then distributes the proceeds from the borrowing to a U.S. partner who is related to the CFC and whose obligation would be U.S. property if it were held (or treated as held) by the CFC; or (b) the CFC guarantees a loan to a foreign partnership, which then distributes the loan proceeds to a related U.S. partner. Taxpayers take the position that Section 956 does not apply to these transactions even though the CFC’s earnings are repatriated to a related U.S. partner. The temporary regulations treat the partnership obligation as an obligation of the distributee partner (and, therefore, as U.S. property) to the extent of the lesser of (a) the amount of the distribution that would not have been made but for the funding of the partnership or (b) the amount of the foreign partnership obligation. This rule also applies to tax years of CFCs ending on or after Sept. 1 and to tax years of U.S. shareholders in which or with which such tax years end, in the case of distributions made on or after Sept. 1.

The temporary regulations also modify and clarify the active rents and royalties exception. The active rents and royalties exception is used to distinguish between a CFC that passively receives investment income and a CFC that derives income from the active conduct of a trade or business.

Proposed Regulations Issued Regarding When Partnership Transactions Result in U.S. Property for CFC
The IRS also has issued proposed regulations that, if adopted, would provide rules on the treatment as U.S. property of property held by a CFC in connection with certain transactions involving partnerships. The text of contemporaneously issued temporary regulations, described above, serves as the text of certain provisions of the proposed regulations.

IRS Disallows Deduction for Partially Worthless Debts – Charge-off Requirement Not Met
In LAFA 20153501F, the IRS concluded that a taxpayer could not deduct partially worthless debts because it failed to charge off the amounts on its books during the tax year. The taxpayer described in the LAFA participated in, directly originated or otherwise extended credit under loans. The debt instruments underlying the loans were secured by real estate (and in certain circumstances, with rent rolls and/or other financial collateral related to the real properties).

IRS Releases Practice Units on International Tax Issues
The IRS released practice units on transfer pricing concepts and foreign-to-foreign transactions. The practice units are training aids that describe for IRS agents specific international and transfer pricing issues and transactions.

IRS Updates FATCA FAQs Clarifying Branch and Disregarded Entity Registration Requirements
The IRS updated its list of frequently asked questions (FAQs) to clarify branch and disregarded entity registration requirements under the Foreign Account Tax Compliance Act (FATCA). In general, unless a specific exception applies, a branch must register as a branch of its owner rather than as a separate entity. A new FAQ also provides instructions to branches that are registered as separate entities on how to correct their registration.

Information contained in this publication should not be construed as legal advice or opinion or as a substitute for the advice of counsel. The articles by these authors may have first appeared in other publications. The content provided is for educational and informational purposes for the use of clients and others who may be interested in the subject matter. We recommend that readers seek specific advice from counsel about particular matters of interest.

Copyright © 2015 Stradley Ronon Stevens & Young, LLP. All rights reserved.

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