International Tax Alert - February 2017

February 2017

Recent International Tax Guidance for December 2016 and January 2017

Summary

In December of 2016 and January of 2017, the Department of the Treasury and the Internal Revenue Service (hereinafter, collectively “Treasury”), released guidance and regulations related to:
  1. Passive foreign investment companies (“PFICs”);
  2. Withholding and the Foreign Account Tax Compliance Act (“FATCA”);[1] and
  3. Inversions under section 7874.
Below is a high level overview of certain key items discussed in the guidance and regulations.
 

Key Highlights

  1. PFICs
Recent International Tax Guidance for December 2016 and January 2017
 
Generally, U.S. shareholders in a PFIC are subject to certain reporting requirements and subject to certain tax regimes on PFIC income.[2]
 
Recently, Treasury issued final regulations that provide guidance on determining ownership of a PFIC and on certain annual reporting requirements for shareholders of PFICs to file Form 8621, “Information Return by a Shareholder of a Passive Foreign Investment Company or Qualified Electing Fund.”   In addition, the final regulations provide guidance on an exception to the requirement for certain shareholders of foreign corporations to file Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations.”
 
The final regulations affect U.S. persons that own interests in PFICs and certain U.S. shareholders of foreign corporations.
 
The final regulations adopt the proposed regulations published on December 31, 2013, with certain changes, including implementing the rules described in Notice 2014-28 and Notice 2014-51, and withdraw the corresponding 2013 temporary regulations.  Notice 2014-28 announced that the regulations under section 1291 would provide that a U.S. person that owns stock of a PFIC through a tax exempt organization or account is not treated as a shareholder of the PFIC with respect to the stock.  Notice 2014-51 announced that the regulations under section 1298 would provide guidance concerning U.S. persons that own stock in a PFIC that is marked to market under a provision of chapter 1 of the Internal Revenue Code other than section 1296.
 
For dates of applicability, see Treas. Reg. Secs. 1.1291-1(j)(3), 1.1291-9(k)(3), 1.1298-1(h), 1.6038-2(m), and 1.6046-1(l)(3).
  1. Withholding and FATCA
Recently, Treasury issued two revenue procedures and four sets of regulations dealing with withholding and FATCA.
 
In T.D. 9808, Treasury issued final and temporary regulations regarding withholding of tax on certain U.S. source income paid to foreign persons, information reporting and backup withholding with respect to payments made to certain U.S. persons, and portfolio interest paid to nonresident alien individuals and foreign corporations.  The final regulations finalize certain proposed regulations issued in March 2014 with minor changes, and withdraw corresponding temporary regulations.  In addition, temporary regulations providing additional rules under Chapter 3 of the Code were issued.  The regulations affect persons making payments of U.S. source income to foreign persons.
 
For dates of applicability, see Treas. Reg. Secs. 1.871-14(j), 1.1441-1(f), 1.1441-3(i), 1.1441-4(g), 1.1441-5(g), 1.1441-6(i), 1.1441-7(g), 1.1461-1(i), 1.1461-2(d),1.6041-1(j), 1.6041-4(d), 1.6042-2(f), 1.6042-3(d), 1.6045-1(q), 1.6049-4(h), 1.6049-5(g), 31.3406(g)-1(g), 31.3406(h)-2(i), and 301.6402-3(f).
 
In addition, Treasury released proposed regulations (REG-134247-16) cross referencing the temporary regulations (T.D. 9808) to revise regulations regarding withholding of tax on certain U.S. source income paid to foreign persons as well as requirements for certain claims for refund or credit made by foreign persons.
 
Also, in T.D. 9809, Treasury issued final regulations under FATCA regarding information reporting by foreign financial institutions (“FFIs”) with respect to U.S. accounts and withholding on certain payments to FFIs and other foreign entities.  The Treasury decision finalizes (with changes) certain proposed regulations issued in March 2014 under FATCA, and withdraws corresponding temporary regulations.  The Treasury decision also includes temporary regulations providing additional rules under FATCA.
 
For dates of applicability, see Treas. Reg. Secs. 1.1471-1(c), 1.1471-2(c), 1.1471- 3(g), 1.1471-4(j), 1.1471-5(l), 1.1471-6(i), 1.1472-1(h), 1.1473-1(f), 1.1474-1(j), and 1.1474-6(g).
 
In addition, Treasury released proposed regulations (REG-103477-14) under FATCA describing the verification requirements (including certifications of compliance) and events of default for entities that agree to perform the FATCA due diligence, withholding and reporting requirements on behalf of certain FFIs or the FATCA due diligence reporting obligations on behalf of certain non-financial foreign entities.  The proposed regulations also describe the certification requirements and procedures for IRS’s review of certain trustees of trustee-documented trusts and the procedures for IRS’s review of periodic certifications provided by registered deemed compliant FFIs.  In addition, the proposed regulations describe the procedures for future modifications to the requirements for certifications of compliance for participating FFIs.  The proposed regulations also describe the requirements for certifications of compliance for participating FFIs that are members of consolidated compliance groups.
 
Lastly, Treasury recently released Rev. Proc. 2017-15 and 2017-16. Rev. Proc. 2017-15 sets forth the final qualified intermediary (“QI”) withholding agreement.  In general, the QI agreement allows foreign persons to enter into an agreement with the IRS to simplify their obligations as withholding agents.  Rev. Proc. 2017-16 updates guidance on how FFIs should enter into agreement with the IRS to be treated as participating FFIs.  FFI agreement procedures provided in earlier guidance expired on December 31, 2016.  FFI agreement procedures in Rev. Proc. 2017-16 apply beginning January 1, 2017. 
 
  1. Inversions
Recently, Treasury issued final and temporary regulations under section 7874 relating to inversions.  These regulations affect certain domestic corporations and partnerships (and certain parties related thereto) and foreign corporations that acquire substantially all of the properties of such domestic corporations or of the trades or businesses of such domestic partnerships.
 
The final regulations identify certain stock of a foreign corporation that is disregarded in calculating ownership of the foreign corporation for purposes of determining whether it is a surrogate foreign corporation.  Prior temporary regulations under section 7874 included the “disqualified stock rule.”  Under this rule, subject to a de minimis exception, disqualified stock is excluded from the denominator of the section 7874 ownership fraction (i.e., the fraction used to calculate the percent of stock, by vote or value, of the foreign acquiring corporation that is held by former shareholders by reason of holding stock in the domestic corporation).  
 
Disqualified stock generally includes stock of the foreign acquiring corporation that, in a transaction related to the domestic entity acquisition, is transferred to a person other than the domestic entity in exchange for “nonqualified property.”  Nonqualified property means (i) cash or cash equivalents, (ii) marketable securities, (iii) certain obligations, and (iv) any other property acquired with a principal purpose of avoiding the purposes of section 7874, regardless of whether the transaction involves an indirect transfer of property described in clause (i), (ii), or (iii).
 
The final regulations finalize the disqualified stock rule in the temporary regulations with certain modifications and clarifications.  Some of the key modifications and clarifications are summarized below:
  1. The final regulations exclude from the definition of nonqualified property an obligation owed by a member of the expanded affiliated group (“EAG”) if the holder of the obligation immediately before the domestic entity acquisition and any related transaction (or its successor), is a member of the EAG after the domestic entity acquisition and all related transactions.[3]
  2. The final regulations include a de minimis rule to exclude from the definition of nonqualified property, an obligation owed by a person that is only a de minimis former domestic entity shareholder or former domestic entity partner.  The final regulations also exclude from the definition of nonqualified property, an obligation owed by a person that, before and after the domestic entity acquisition, owns no more than a de minimis interest in any member of the EAG.[4]  Nevertheless, the anti-abuse rule in section 7874(c)(4) may still apply to disregard transfers of stock in exchange for such obligations.
  3. The final regulations provide that an obligation for purposes of the disqualified stock rule includes any fixed or contingent obligation to make payment or provide value (such as through providing goods or services).[5]  No inference is intended regarding the treatment, under Treas. Reg. Sec. 1.752-1(a)(4)(ii) or the temporary regulations, of a contractual agreement by a person to provide goods or services.
  4. Under the “associated obligation rule,” disqualified stock also generally includes stock of the foreign acquiring corporation that is transferred by a person (the transferor) to another person (the transferee) in exchange for property (the exchanged property) if, pursuant to the same plan (or series of related transactions), the transferee subsequently transfers the stock in exchange for the satisfaction or assumption of one or more obligations associated with the exchanged property.  The final regulations make certain modifications to this associated obligation rule.[6]  In addition, the final regulations generally limit the amount of disqualified stock arising under the associated obligation rule to the proportionate share of obligations associated with the exchanged property that, pursuant to the same plan (or series of related transactions), is not assumed by the foreign acquiring corporation.[7]  
  5. The final regulations make certain modifications to the de minimis exception in Treas. Reg. Sec. 1.7874-4(d)(1)(ii) to address certain practical difficulties noted in the comments to the temporary regulations.
  6. The final regulations clarify that stock of the foreign acquiring corporation included in the numerator of the section 7874 ownership fraction is in all cases also included in the denominator of the fraction.
  7. The final regulations clarify that an interest in a partnership is nonqualified property only to the extent it is a marketable security or avoidance property (i.e., any property, other than specified nonqualified property, acquired with a principal purpose of avoiding the purposes of section 7874).
The final regulations also provide guidance on the effect of transfers of stock of a foreign corporation after the foreign corporation has acquired substantially all of the properties of a domestic corporation or of a trade or business of a domestic partnership.  The prior temporary regulations provided a rule (the “subsequent transfer rule”) pursuant to which stock of a foreign corporation that is described in section 7874(a)(2)(B)(ii) (that is, by reason of stock) does not cease to be so described as a result of any subsequent transfer of the stock by the former domestic entity shareholder or former domestic entity partner that received such stock, even if the subsequent transfer is related to the domestic entity acquisition.  The final regulations adopt the subsequent transfer rule as final without modification.
 
For dates of applicability, see Treas. Reg. Secs. 1.7874-4(k), 1.7874-5(e), 1.7874-7T(h), and 1.7874-10T(i).
 

BDO Insights

 
The above discussion is a high level overview of certain key international tax issues from recent Treasury regulations and guidance.  The rules discussed in this tax alert are complex with various exceptions and applicability dates.  BDO can assist with understanding the complexities of the above discussed rules and also advise on how these rules may impact taxpayers.  Please reach out to your BDO international tax services contact if you have questions on the above.
 

For more information, please contact one of the following practice leaders:
 
Robert Pedersen
Partner and International Tax Practice Leader
         Chip Morgan    Partner 

 
Joe Calianno
Partner and International Tax Technical Practice Leader 
  Brad Rode
Partner 
 

 
William F. Roth III
Partner, National Tax Office
  Jerry Seade
Principal 

 
Scott Hendon
Partner 
  Monika Loving
Partner 

 
Annie Lee
Partner
  Sean Dokko
Senior Manager 
 
[1] Sections 1471 through 1474 and the Treasury Regulations promulgated thereunder.
[2] See sections 1291 through 1298 and the Treasury Regulations promulgated thereunder.
[3] Treas. Reg. Sec. 1.7874-4(i)(2)(iii)(A).
[4] See Treas. Reg. Secs. 1.7874-4(i)(2)(iii)(B) and (C) (providing a de minimis rule for a less than five-percent ownership interest).
[5] Treas. Reg. Sec. 1.7874-4(i)(3).
[6] See, Treas. Reg. Sec. 1.7874-4(c)(1)(ii)(A). 
[7] See Treas. Reg. Sec. 1.7874-4(c)(1)(ii)(B).