Firm Seeks to Avoid Pitfalls of Ownership Attribution Rules

July 2, 2019

CC:PA:LPD:PR (REG-125135-15)
Room 5203
Internal Revenue Service
1111 Constitution Avenue, NW
Washington, DC 20224

Re: Comments on Proposed Regulations Regarding Ownership Attribution for Purposes of Determining Whether a Person is Related to a Controlled Foreign Corporation (REG-125135-15)

Dear Sir or Madam:

Miller & Chevalier Chartered respectfully submits this letter in response to the Notice of Proposed Rulemaking under sections 954 and 958 of the Internal Revenue Code (the “Code”),¹ published in the Federal Register on May 20, 2019 (the “Proposed Regulations”).²

Among other things, the Proposed Regulations modify the application of the stock ownership attribution rules of section 958(b) for purposes of determining whether a person is related to a controlled foreign corporation (“CFC”) under section 954(d)(3). We applaud this provision of the Proposed Regulations because it avoids the “inappropriate results” that could otherwise ensue from a literal application of section 958(b), and in particular the cross-reference therein to section 318(a)(3), in determining whether a person is a related person to a CFC for purposes of section 954(d)(3).³ In general, the Proposed Regulations modify the application of the stock ownership attribution rules to ensure that a person is considered related to a CFC only when that person and the CFC are under common control. In this regard, the Proposed Regulations are consistent with the policies of the related person definition of section 954(d)(3), and the policies of the rules within subpart F and outside subpart F that contain cross-references to this related person definition.⁴

We understand that the Department of the Treasury (“Treasury”) and the Internal Revenue Service (“IRS”) are considering issuing guidance that would address the repeal of section 958(b)(4) in Public Law 115-97 (the “2017 Act”) and respectfully request that in doing so Treasury and IRS adopt an approach similar to that taken in the Proposed Regulations. In particular, we request that in issuing guidance relating to the repeal of section 958(b)(4), Treasury and IRS take into account the purpose and historical application of the CFC rules in a way that avoids the type of inappropriate results that could otherwise ensue from the literal application of section 958(b), including in particular the cross-reference therein to section 318(a)(3), to determine whether a foreign corporation is a CFC in certain situations.

As described in the preamble to the Proposed Regulations, section 958 provides rules for determining direct, indirect, and constructive ownership and states that such rules “shall apply” for purposes of section 954(d)(3) to the extent that the effect is to treat a person as a related person within the meaning of section 954(d)(3).⁵ Section 954(d)(3) provides that a person is a related person with respect to a CFC if the person is (i) an individual who controls the CFC, (ii) a corporation, partnership, trust, or estate that controls or is controlled by the CFC, or (iii) a corporation, partnership, trust, or estate that is controlled by the same person that controls the CFC. Section 954(d)(3) provides “control” means more than 50 percent ownership, and that in determining ownership of a corporation, partnership, trust, or estate, “rules similar to the rules of section 958 shall apply.” As noted in the preamble to the Proposed Regulations, the “rules similar to” language was introduced in 1986; pre-1986 law provided that the rules of section 958 “shall apply.”⁶ This change in language in the 1986 amendments accompanied the expansion of the definition of “related person” to include controlled partnerships (and other non-corporate entities). Because the section 958(b) attribution rules only address constructive ownership of corporate stock, the language of section 954(d)(3) was modified to allow for rules addressing the constructive ownership of partnership interests (and other ownership interests) in addition to corporate stock.⁷

The preamble to the Proposed Regulations expresses concern that, “in certain situations,” the literal application of the constructive ownership rules of section 318(a) and section 958(b) “could produce inappropriate results when defining related person for purposes of section 954(d)(3).”⁸ The preamble notes that a literal application of section 958(b) could cause an entity to be considered a “related person” to a CFC even though the entities “do not have a significant relationship to each other.”⁹ Consequently, Treasury and IRS have proposed that regulations under sections 954 and 958 will be revised to provide that the downward attribution rules of section 318(a)(3) do not apply for purposes of section 954(d)(3). Treasury and IRS have correctly acted under the authority of section 7805(a), which directs the Secretary to “prescribe all needful rules and regulations for the enforcement of this title, including all rules and regulations as may be necessary by reason of any alteration of law in relation to internal revenue.”

Several commenters have identified significant tax policy concerns arising from overbroad stock attribution following the repeal of section 958(b)(4), and have called on Treasury and the IRS to address those concerns pursuant to the authority of section 7805(a).¹⁰ The policy concerns that animated the Proposed Regulations are similar to those that are present in those cases, and we believe that Treasury and IRS are empowered take action to avoid “inappropriate results” under section 958(b) pursuant to the same regulatory authority that supports the Proposed Regulations. We understand that Treasury and IRS may view the regulatory authority under section 954(d)(3) as more expansive because the “similar to” language introduces ambiguity as to the interaction between section 954(d)(3) and section 958(b), but as described above the history and context of that language does not suggest any technical inconsistency, in particular as applied to the constructive ownership of stock. Rather, Treasury and IRS are appropriately drawing from the general authority of section 7805(a) to ensure that the subpart F rules operate in a coherent manner, consistent with the statutory scheme and the intent of Congress. The Proposed Regulations sensibly turn off the downward attribution rule of section 318(a)(3) both in cases that disadvantage taxpayers and in cases where taxpayers may benefit from an overbroad related party definition.¹¹ We suggest that Treasury and IRS reconsider the concern expressed in the preamble to Final Regulations under section 965, which declined to depart from a literal application of sections 318(a) and 958(b) in the case of section 965 in part because “it may benefit taxpayers” to apply stock attribution rules broadly for purposes of claiming deemed paid credits.¹² In our view, section 7805(a) provides ample regulatory authority to Treasury and IRS to issue regulations to avoid inappropriate results that are inconsistent with the statutory scheme equally in the cases of section 954(d)(3) and section 958(b).¹³

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We appreciate your consideration of our request and would be happy to answer any questions that you may have.

Respectfully submitted,

Rocco V. Femia

Marc J. Gerson

Miller & Chevalier
Washington, DC

cc:
David Kautter
Lafayette Harter III
Douglas Poms

Charles Rettig
Michael Desmond
Peter Blessing