Treasury Proposes Regulations Addressing Certain Hybrid Arrangements
Treasury Proposes Regulations Addressing Certain Hybrid Arrangements
Recently, the Department of the Treasury and the Internal Revenue Service (collectively, Treasury) proposed regulations implementing Sections 245A(e) and 267A regarding hybrid dividends and certain amounts paid or accrued in hybrid transactions or with hybrid entities. The guidance also proposed regulations under Sections 1503(d) and 7701 to prevent the same deduction from being claimed under the tax laws of both the United States and a foreign country. In addition, the guidance proposed regulations under Sections 6038, 6038A and 6038C, to facilitate administration of certain rules in the proposed regulations. The proposed regulations under these sections (the Proposed Regulations) affect taxpayers that would otherwise claim a deduction related to such amounts and certain shareholders of foreign corporations that pay or receive hybrid dividends.
Section 245A(e) denies the dividends received deduction under Section 245A with respect to hybrid dividends, and Section 267A denies certain interest or royalty deductions involving hybrid transactions or hybrid entities. Section 245A(e), applies to distributions made after December 31, 2017, and Section 267A applies to taxable years beginning after December 31, 2017.
1. Section 245A(e) – Hybrid Dividends
The Proposed Regulations under Section 245A(e) address certain dividends involving hybrid arrangements. The Proposed Regulations neutralize the double non-taxation effects of these dividends by either denying the Section 245A(a) dividends received deduction with respect to the dividend or requiring an inclusion under Section 951(a) with respect to the dividend, depending on whether the dividend is received by a domestic corporation or a controlled foreign corporation (CFC as defined in Section 957).
Proposed §1.245A(e)-1(b) provides that if a domestic corporation that is a U.S. shareholder (within the meaning of Section 951(b)) of a CFC receives a hybrid dividend from the CFC, then the U.S. shareholder is not allowed the Section 245A(a) deduction for the hybrid dividend and the rules of Section 245A(d) (denial of foreign tax credits and deductions) apply. The Proposed Regulations provide that in general, a dividend is a hybrid dividend if it satisfies two conditions: (i) but for Section 245A(e), the Section 245A(a) deduction would be allowed and (ii) the dividend is one for which the CFC (or a related person) is or was allowed a deduction or other tax benefit under a “relevant foreign tax law” (such a deduction or other tax benefit a hybrid deduction). The Proposed Regulations take into account certain deductions or other tax benefits allowed to a person related to a CFC (such as a shareholder) because, for example, certain tax benefits allowed to a shareholder of a CFC are economically equivalent to the CFC having been allowed a deduction.
The Proposed Regulations under Section 245A(e) provide guidance regarding:
- The definition of “relevant foreign tax law” (see proposed §1.245A(e)-1(f)(4));
- What deductions or other tax benefits constitute a hybrid deduction and the effect of foreign currency gain or loss to hybrid deductions (see Prop. Reg. §1.245A(e)-1(d) and proposed §1.245A(e)-1(g)(2), Example 2).
- Rules relating to hybrid dividends of tiered corporations (see Prop. Reg. §1.245A(e)-1(c)).
- The interaction of Section 245A(e) with Section 959 (see Prop. Reg. §1.245A(e)-1(c)(2)).
- The interaction of Section 245A(e) with Section 964(e) (see Prop. Reg. §1.245A(e)-1(c)(1) and (4)).
- Rules for hybrid deduction accounts including rules for maintaining such accounts, rules taking into account transfers of CFC stock and rules relating to earnings and profits of a lower-tier CFC that are included in a domestic corporation’s income as a dividend by virtue of Section 1248(c)(2) (see Prop. Reg. §1.245A(e)-1(b), (c), (d), (f)).
- An anti-avoidance rule that makes appropriate adjustments, including adjustments that would disregard a transaction or arrangement, if a transaction or arrangement is engaged with a principal purpose of avoiding the purposes of Prop. Reg. §1.245A(e)-1 (see Prop. Reg. §1.245A(e)-1(e)).
2. Section 267A – Related Party Amounts Involving Hybrid Transactions and Hybrid Entities
The Proposed Regulations under Section 267A address certain payments or accruals of interest or royalties for U.S. tax purposes (the amount of such interest or royalty, a specified payment) that involve hybrid arrangements, or similar arrangements involving branches, that produce deduction/no inclusion (D/NI) outcomes or indirect D/NI outcomes. The Proposed Regulations neutralize the double non-taxation effects of the arrangements by denying a deduction for the specified payment to the extent of the D/NI outcome.
The Proposed Regulations under Section 267A provide guidance regarding:
- What is a “disallowed deduction” (see Prop. Reg. §1.267A-1(b));
- Taxpayers subject to Section 267A (i.e., a specified party) (see Prop. Reg. §1.267A-5(a)(17)).
- How to determine the no-inclusion aspect of a D/NI outcome including rules for timing differences (see Prop. Reg. §1.267A-3(a), and Prop. Reg. §1.267A-6(c), Examples 2 and 7).
- Hybrid and branch arrangements giving rise to disqualified hybrid amounts including rules relating to disregarded payments, deemed branch payments, payments to reverse hybrids and branch mismatch payments (see Prop. Reg. §1.267A-2).
- Rules relating to the link between hybridity and D/NI outcome (see Prop. Reg. §1.267A-2(a)(1)(ii)).
- Rules that generally only consider the tax laws of tax residents or taxable branches that are related to the specified party in determining whether a specified payment is made pursuant to a hybrid or branch mismatch arrangement (see Prop. Reg. §1.267A-2(f)). However, the Proposed Regulations do provide that the tax law of an unrelated tax resident or taxable branch is taken into account for purposes of Section 267A if the tax resident or taxable branch is a party to a structured arrangement (see Prop. Reg. §1.267A-2(f)). The Proposed Regulations set forth a test for when a transaction is a structured arrangement and impute an entity’s participation in a structured arrangement to its investors (see Prop. Reg. §1.267A-5(a)(20));
- Rules that provide that a specified payment is a disqualified hybrid amount if a D/NI outcome occurs as a result of hybridity in any foreign jurisdiction, even if the payment is included in income in another foreign jurisdiction (see Prop. Reg. §1.267A-6(c), Example 1);
- Rules that reduce disqualified hybrid amounts by certain amounts included or includible in a U.S. tax resident’s or U.S. taxable branch’s income (see Prop. Reg. §1.267A-3(b));
- Rules to address “imported” hybrid and branch arrangements to prevent the effects of an “offshore” hybrid arrangement (for example, a hybrid arrangement between two foreign corporations completely outside the U.S. taxing jurisdiction) from being shifted, or “imported,” into the U.S. taxing jurisdiction through the use of a non-hybrid arrangement (see Prop. Reg. §1.267A-4 and Prop. Reg. §1.267A-6(c), Examples 8, 9 and 10);
- The definitions of “interest” and “royalties” (see Prop. Reg. §1.267A-5(a)(12), (16) and (b));
- Rules providing that foreign currency gain or loss recognized with respect to a specified payment is taken into account under Section 267A only to the extent that the specified payment is in respect of accrued interest or an accrued royalty for which a deduction is disallowed under Section 267A (see Prop. Reg. §1.267A-5(b)(2));
- Rules that treat a U.S. taxable branch (which includes a permanent establishment of a foreign person) as a specified party and rules regarding interest or royalties considered paid or accrued by a U.S. taxable branch, solely for purposes of Section 267A (and thus not for other purposes, such as chapter 3 of the Code) (see Prop. Reg. §1.267A-5(b)(3) and Prop. Reg. §1.267A-6(c), Example 4);
- Coordination rules for Section 267A with other provisions of the Code which generally provide that Section 267A applies after the application of other provisions of the Code and regulations (see Prop. Reg. §1.267A-5(b)(4)). These coordination rules also provide that Section 267A applies to interest or royalties after taking into account provisions that could otherwise re-characterize such amounts, such as Reg. §1.894-1(d)(2);
- Rules providing that the disallowance of a deduction under Section 267A does not affect whether or when the amount paid or accrued that gave rise to the deduction reduces earnings and profits of a corporation (see Prop. Reg. §1.267A-5(b)(4));
- A de minimis exception where a specified party is excepted from the application of Section 267A for any taxable year for which the sum of its interest and royalty deductions (plus interest and royalty deductions of any related specified parties) is below $50,000. For purposes of this rule, specified parties that are related are treated as a single specified party (see Prop. Reg. §1.267A-1(c)); and
- The interaction of Section 267A with withholding taxes and income tax treaties, including rules providing that the determination of whether a deduction for a specified payment is disallowed under Section 267A is made without regard to whether the payment is subject to withholding under Section 1441 or 1442 or is eligible for a reduced rate of tax under an income tax treaty.
3. Information Reporting under Sections 6038, 6038A and 6038C
The Proposed Regulations provide that a specified payment for which a deduction is disallowed under Section 267A, as well as hybrid dividends and tiered hybrid dividends under Section 245A, must be reported on the appropriate information reporting form in accordance with Sections 6038 and 6038A.
4. Sections 1503(d) and 7701
The Proposed Regulations include rules under Sections 1503(d) and 7701 to prevent the use of certain structures involving domestic reverse hybrids to obtain a double-deduction outcome. The Proposed Regulations require, as a condition to a domestic entity electing to be treated as a corporation under §301.7701-3(c), that the domestic entity consent to be treated as a dual resident corporation for purposes of Section 1503(d) (such an entity, a domestic consenting corporation) for taxable years in which two requirements are satisfied. The requirements are intended to restrict the application of Section 1503(d) to cases in which it is likely that losses of the domestic consenting corporation could result in a double-deduction outcome.
The requirements are satisfied if (i) a “specified foreign tax resident” (generally, a body corporate that is a tax resident of a foreign country) under its tax law derives or incurs items of income, gain, deduction, or loss of the domestic consenting corporation, and (ii) the specified foreign tax resident is related to the domestic consenting corporation (as determined under Section 267(b) or 707(b)).
Further, if a domestic entity filed an election to be treated as a corporation before the date the Proposed Regulations are finalized, such that the entity was not required to consent to be treated as a dual resident corporation, then the entity is deemed to consent to being treated as a dual resident corporation as of its first taxable year beginning on or after the end of a 12-month transition period. This deemed consent can be avoided if the entity elects, effective before its first taxable year beginning on or after the end of the transition period, to be treated as a partnership or disregarded entity such that it ceases to be a corporation for U.S. tax purposes. For purposes of such an election, the 60 month limitation under §301.7701-3(c)(1)(iv) is waived.
The Proposed Regulations provide that the “mirror legislation rule” in §1.1503(d)-3(e) which generally prevents a domestic use election when a foreign jurisdiction has enacted legislation similar to Section 1503(d) that denies any opportunity for a foreign use of a dual consolidated loss, does not apply to dual consolidated losses of a domestic consenting corporation.
The Proposed Regulations modify the “compulsory transfer” triggering exception to dual consolidated loss recapture in §1.1503(d)-6(f)(5) which generally excludes certain transfers from triggering recapture of a dual consolidated loss if the transfer is a compulsory transfer involving a foreign government, such that the exception will also apply with respect to compulsory transfers involving the United States government.
5. Disregarded Payments Made to Domestic Corporations
Treasury also states in the preamble to the Proposed Regulations, that certain disregarded payments made to domestic corporations raise significant policy concerns that are similar to those relating to D/NI outcomes addressed by Sections 245A(e) and 267A, and the double-deduction outcomes addressed by Section 1503(d). Treasury further states in the preamble that it is studying these transactions and requests comments.
6. Applicability Dates
For the applicability dates of the provisions discussed above, see the Proposed Regulations.
The Proposed Regulations include highly technical rules that can significantly impact taxpayers with certain hybrid arrangements. BDO can assist clients with understanding the tax implications to these complex rules.