Firm Seeks Guidance Clarifying Transition Tax Rules

March 16, 2018

Ms. Brenda Zent, Esq.
Special Advisor on International Taxation
Office of Tax Policy
U.S. Department of the Treasury
1500 Pennsylvania Avenue N.W.
Washington, D.C. 20220

Dear Ms. Zent:

The purpose of this letter is to request the issuance of guidance on the appropriate application of Section 951(a) and Section 965 of the Internal Revenue Code, as amended (the “Code”)(sometimes referred to herein as the “Transition Tax Rules”), following the enactment of Public Law 115-97 (commonly known as the Tax Cuts and Jobs Act of 2017). In general. Section 965 of the Code requires United States shareholders, as defined under Section 951(b) of the Code, to pay a transition tax on the untaxed foreign earnings of certain “specified foreign corporations” as if those earnings had been repatriated to the United States. Generally, Section 965(e)(1) of the Code provides that a specified foreign corporation means either a controlled foreign corporation, as defined under Section 957 of the Code (“CFC”), or a foreign corporation (other than a passive foreign investment company, as defined under Section 1297 of the Code, that is not also a CFC) that has a United States shareholder that is a domestic corporation. The Transaction Tax Rules apply with respect to the last taxable year of certain specified foreign corporations beginning before January 1,2018, and the amount included in income under Section 965 of the Code is includible in the United States shareholder's year in which or with which such a specified foreign corporation's year ends. Taxpayers may have to pay tax resulting from Section 965 of the Code when filing their 2017 tax returns.

Requested Guidance

Guidance is necessary to clarify that, when determining whether a foreign corporation is a “specified foreign corporation” under Section 965(e)(1)(B) (a “Clause B SFC”), Section 958(b) will not be applied to treat a domestic corporation as a United States shareholder with respect to a foreign corporation if such domestic corporation does not own, directly or indirectly under Section 958(a), any stock in such foreign corporation (the “Proposed Guidance”).

Unintended and Inappropriate Consequences:

Without the Proposed Guidance, many foreign corporations that are not CFCs will be treated as Clause B SFCs even though no domestic corporation owns a direct or indirect interest in the foreign corporation. Such result leads to inconsistent, unintended and inappropriate consequences:

• In many cases, a US person that is not a domestic corporation but is a shareholder of a foreign corporation may not know whether there is a domestic corporation that is a constructive United States shareholder of such foreign corporation after applying the constructive ownership rules of Section 958(b).

  For example, suppose a US person (A) that is an individual owns 10% of a foreign corporation (FC), and the other 90% of FC is owned by a group of unrelated foreign individuals. One of those foreign individuals (B) owns 10% of FC and separately owns 100% of the stock of a domestic corporation (C) to hold her US residence, which residence is completely unrelated to her ownership of FC and completely unknown to A. Under Section 958(b) as applied to this scenario, C will be a constructive domestic corporation shareholder of FC, FC will be a specified foreign corporation with respect to A, and A could have a subpart F inclusion under Section 965 solely because of how B structured her unrelated US investment. FC otherwise would not be treated as having a 10% domestic corporation shareholder.

• In other cases, the application of Section 958(b) would lead to similarly unintended and inappropriate results.

  For example, suppose that US individual (A) owns 20% of the stock in a foreign corporation (FC), and the remainder of the stock in FC is owned by unrelated foreign persons. A also owns a farm in the United States (entirely unrelated to the investment in FC). A formed a wholly-owned domestic corporation (C) to purchase the farm. Applying Section 958(b) to this example, C will be a constructive domestic corporation shareholder of FC, FC will be a specified foreign corporation with respect to A, and A could have a subpart F inclusion under Section 965. If, on the other hand, A had formed an LLC to own the farm, there would be no such inclusion if FC otherwise is not treated as having a 10 percent domestic corporation shareholder.

Administration Problems under Section 965

In addition, without the Proposed Guidance, it will be difficult for the Internal Revenue Service to administer Section 965 in a situation where a US person owns stock in a foreign corporation but such foreign corporation does not have any direct or indirect domestic corporation shareholders. In such cases, the IRS will need ownership information from all shareholders (including foreign shareholders) of the foreign corporation to determine if there is a constructive United States shareholder somewhere in the ownership chain in order to assess whether there is an inclusion event under Section 965.

Authority to Issue Proposed Guidance

The authority to issue the Proposed Guidance is clear in this case. Section 965(o) grants authority for the Treasury Secretary to prescribe regulations or other guidance as may be “necessary or appropriate to carry out” the Section 965 provisions. (That legislative grant of authority is not limited to preventing the avoidance of the provisions.) Clarifying the application of Section 958(b) to the term “United States shareholder” as used in Section 965(e)(1)(B) is necessary and appropriate for the reasons noted above. We note that the Commissioner has already issued needed guidance under Section 965 in the form of two Notices.

Furthermore, the structure of the statute and the legislative history suggest strongly that, for purposes of the definition of a “specified foreign corporation” under Section 965(e)(1)(B), a foreign corporation must have at least one 10 percent domestic corporation shareholder that actually owns stock in such foreign corporation and is required to have an inclusion under Section 965. We can provide a more detailed discussion of that statutory structure and legislative history if you would like one. If a taxpayer were to challenge the validity of the Proposed Guidance, there is a long tradition of judicial review of agency regulations that firmly establishes that it is necessary and proper for an agency to provide guidance regarding statutes whose terms in isolation appear clear, but, when viewed in context of the full statutory framework, lead to unintended, inconsistent or absurd results. We would be pleased to provide a more detailed analysis of that judicial review on request.

Thank you in advance for your consideration of this urgent request. We appreciate the opportunity to submit this request and would welcome the opportunity to meet with the Treasury Department and the IRS to discuss in greater detail or to answer questions that you may have.

* * * * * *

Respectfully submitted,

Jeff McMillen
Akin Gump Strauss Hauer Feld LLP

cc:
Lafayette "Chip" G. Harter III, Esq.
Douglas Poms, Esq.
Gary Scanlon, Esq.
Jason Yen, Esq.
Lindsay Kitzinger, Esq.
Leni C. Perkins, Esq.