In the realm of overseas investment earnings, the Internal Revenue Code — specifically Section 956(c) — defines “U.S. property” to include an obligation of a “related U.S. person” held by a controlled foreign corporation (CFC). In general, an investment in U.S. property by a CFC produces dividend income for the CFC’s U.S. shareholders in an amount equal to the amount of the investment.1
For this purpose, a related U.S. person includes a “U.S. shareholder” of the CFC, as well as any domestic corporation whose voting stock is at least 25% owned (directly, indirectly, and constructively) by the U.S. shareholder.2
In October 2008, the Internal Revenue Service issued guidance (Notice 2008-91, 2008-43 I.R.B. 1000) explaining that a CFC may exclude from the term “obligation,” the commitments of a related U.S. person that is collected within 60 days of the time it is incurred. This exclusion, however, does not apply under certain circumstances. Notably, 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 exculpatory rule — would constitute investments in U.S. property.
By February of this year, the IRS followed-up with new guidance (Notice 2009-10, 2009-5 I.R.B. 419) that extends the application of last October’s guidance to the third consecutive taxable year of a foreign corporation, if any, that ends after October 3, 2008, and that ends on or before December 31, 2009.
“The legal memorandum also reminds us that transactions that seek to avoid IRS rules do not qualify for exemptions.” — Robert Willens
Then last month, the IRS’s chief counsel’s office weighed in with related guidance (AM 2009-013) that attempts to resolve some of the thorniest issues raised by the October 2008 guidance, including how to handle involvement by two CFCs.
The legal guidance states that if more than one CFC holds one or more obligations of a related U.S. person during the same taxable year, each CFC may separately qualify — and choose to apply Notice 2008-91. Because each CFC may meet the less-than-180-day requirement during different days of the taxable year, obligations of the same related U.S. person may qualify for the exclusion if a condition is met. Specifically, the obligations must be held by more than one CFC that, in the aggregate, remains outstanding for 180 or more days during the taxable year.
The legal memorandum from the IRS also concludes that if a CFC fails to meet the conditions of Notice 2008-91, an obligation of a related U.S. person will be considered U.S. property as of its origination date.3
The legal memorandum also reminds us that transactions that seek to avoid IRS rules do not qualify for exemptions. For example, consider a situation in which a CFC of a related U.S. person is acquired by another foreign corporation that is controlled by the CFC. In that case, the CFC indirectly holds an obligation if one of the principal purposes for creating, organizing, or funding the other foreign corporation is to avoid the application of the tax code — specifically Section 956 — with respect to the CFC. This rule must be taken into account in assessing a taxpayer’s entitlement to the benefits of Notice 2008-91.