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Practitioners Await Relief on Downward Attribution

Posted on Aug. 22, 2019

Practitioners are hopeful that guidance related to a change in the downward attribution rule will come soon and provide welcome relief.  

As part of the provision on the transition tax, the Tax Cuts and Jobs Act repealed section 958(b)(4), which had provided rules for determining the constructive stock ownership of a foreign corporation for subpart F purposes. Section 958(b)(4) specified that the downward attribution rule of section 318(a)(3) was not to be applied so that a U.S. person would be regarded as owning stock owned by a non-U.S. person.

The effect of the change has frustrated practitioners, given its potential to create many new controlled foreign corporations and the related burden that comes with information reporting and withholding. The IRS said in November 2018 that it was working on proposed regs to “tailor the application” of the rules. The IRS’s February 26 Tax Reform Enterprise Integrated Program Plan also outlined a goal of releasing proposed regs on the issue.

However, based on “chatter in D.C.,” Martin Milner of EY believes the coming administrative relief will take the form of a notice. That notice would clarify a taxpayer’s obligations in making a CFC determination that  might be affected by other minority U.S. shareholders, Milner said. He said he also expects the guidance to clarify a taxpayer’s duties regarding reporting under Form 5471, "Information Return of U.S. Persons With Respect to Certain Foreign Corporations."

“It’s really hard when you are a minority shareholder to get all of the information required for [Form] 5471. So hopefully we will see a notice in the next month or so that will decrease that,” Milner said on a firm webcast August 21. “In the interim, teams have to continue to issue and prepare all their returns because we are up against an October 15 deadline. [The relief] is not something you can sit around and wait on.”

Milner added that he hopes a legislative technical correction will eventually add section 958(b)(4) back into the code, which would affect most private equity structures.

Dan Farrell of EY said that funds have continued to move away from onshore partnerships in favor of non-U.S. structures, in part because of reporting requirements. However, he acknowledged that if the IRS were to provide sufficient section 958(b)(4) relief, it could change that decision-making process for firms.

Belt and Suspenders

Regarding recently released proposed regs (REG-105474-18) resolving ambiguities in the passive foreign investment company regime, Farrell said he has been addressing uncertainty in several transactions as to whether qualified electing fund (QEF) elections for PFICs would be made at the U.S. fund level or U.S. investor level.

A QEF shareholder must annually include as ordinary income its pro rata share of the QEF ordinary earnings and as long-term capital gain its pro rata share of the net capital gain.

Farrell said that based on the regs, it is reasonable to conclude that the election is made by the first domestic partnership, although that doesn’t necessarily align with instinct.

“Intuitively, you would think it would be the . . . indirect partner that should be making the ongoing elections going forward. We have seen a number of advisers suggesting maybe, for belt and suspenders purposes, having the election made [at that level] as well, or at least making a disclosure at the indirect partner level,” Farrell said.

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