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Oil and Gas Trade Group Seeks 4 Changes to Proposed Hybrid Regs

FEB. 25, 2019

Oil and Gas Trade Group Seeks 4 Changes to Proposed Hybrid Regs

DATED FEB. 25, 2019
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February 25, 2019

Internal Revenue Service
CC:PA:LPD:PR ([REG-104352-18)
Room 5203
Post Office Box 7604
Ben Franklin Station
Washington, DC 20044

To Whom It May Concern:

On behalf of the American Petroleum Institute (“API”) and its members I am submitting the attached comments pertaining to the Department of Treasury and Internal Revenue Service's proposed regulations regarding hybrid dividends and certain amounts paid or accrued in hybrid transactions or with hybrid entities.

Specifically API is requesting that consideration of final regulations include 1) amendment of the hybrid arrangement anti-avoidance rule such that taxpayers who transfer shares of CFCs in order to eliminate such hybrid arrangements are not included; 2) changes to the definition of a hybrid payment focusing on relationship between the distribution of the dividend and the foreign tax benefit; 3) changes to proposed regulation section 1.245A(e)-1(d)(4) to provide for the reduction of a shareholder's hybrid deduction account for amounts included under section 951(a); and 4) changes to allow hybrid deduction accounts to be correspondingly reduced by distributions of previously taxed earnings and profits but not be adjusted, up or down, by distributions of non-GILTI or non-subpart F earnings.

We welcome the opportunity to discuss these comments at your convenience. If you have questions, contact me at (202) 682-8455 or Ken Moy at (202) 682-8311 or moyk@api.org.

Sincerely,

Stephen Comstock
Director — Tax & Accounting Policy
American Petroleum Institute
Washington, DC


API Comments — Sections 245A(e) & 267A

Issue: The proposed regulations concerning hybrid arrangements contain an anti-avoidance rule which is overly broad and penalizes taxpayers who undertake reorganizations in order to eliminate hybrid structures.

Code Sections and Regulation Sections: Internal Revenue Code Sections 245A(e) and 267A; Proposed Treasury Regulation Section 1.245A(e)-1(e)

Requested Action: Amended the hybrid arrangement anti-avoidance rule such that taxpayers who transfer shares of CFCs in order to eliminate such hybrid arrangements are not included.

Discussion:

1. Summary of Proposal

If a taxpayer transfers shares of a CFC to another person or entity, the proposed anti-avoidance rule would seem to apply even if the principal purpose of the transfer is to eliminate such hybrid arrangements from the legal structure and not to secure continued deduction/no-inclusion outcomes. In order to address the tax policy to eliminate these arrangements, the regulations should clarify that the anti-avoidance rules do not apply in such situations.

2. Background

Section 245A(a) established a 100% dividends received deduction (“DRD”) for dividends from specified 10% owned foreign corporations. However, dividend income from hybrid arrangements is deemed ineligible for the DRD as it is the product of double non-taxation.1 A dividend is considered to be a hybrid dividend if two conditions are met: 1) but for section 245A(e), the section 245A(a) deduction would be allowed and 2) 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 law.2

Prior to the TCJA some US taxpayers contained arrangements within their legal structures which would have produced hybrid dividends under the definition in Proposed Treasury Regulation section 1.245A(e)-1(b) and (d). With the implementation of sections 245A and 267A US taxpayers are now incentivized to eliminate these types of arrangements from their legal structures. However, Proposed Treasury Regulation section 1.245A(e)-1(e) effectively penalizes taxpayers for undertaking the elimination of such structures.

The section 245A(e) anti-avoidance rule disregards the transfer of shares of a CFC's stock if the result is the elimination of the hybrid deduction account. Treasury and the IRS should distinguish taxpayer restructuring which attempts to convert hybrid arrangements to permissible structures eligible for the 245A DRD from restructurings which either shift the shares of the CFC to another person and the principal purpose is to shift the hybrid deduction account with respect to the share or cause the account to be eliminated, or to generally attempt to secure a deduction/no-inclusion outcome post-TCJA.

3. Requested Action

The hybrid arrangement anti-avoidance rule under Proposed Treasury Regulation section 1.245A(e)-1(e) should be amended to clarify that the transfer of a shares of CFCs by a taxpayer in order to actually eliminate hybrid arrangements would not be covered by the anti-avoidance rule.


Issue: The rule that a dividend is a hybrid dividend to the extent the CFC paying the dividend received a deduction or foreign tax benefit under a respective foreign law that would not have been available under US law does not require a connection between the distribution and a foreign tax benefit. This is outside the scope of the statute.

Code Sections and Regulation Sections: Internal Revenue Code Section 245A(e)(4)(B); Proposed Treasury Regulation Section 1.245A(e)-1(d)

Requested Action: The definition of a hybrid payment should be dependent upon a relationship between the distribution of the dividend and the foreign tax benefit. The current language of the proposed regulations does not clearly require such a nexus.

Discussion:

1. Summary of Proposal

The proposed regulations currently do not require a nexus between the dividend paid by a CFC and the foreign tax benefit that causes the dividend to be characterized as a hybrid dividend. The proposed regulations should be amended such that a nexus is required between the dividend paid and the foreign tax benefit received.

2. Background

There are certain arrangements which may not affect the imposition of foreign taxes on earnings. The foreign tax benefit associated with these arrangements is not a product of the dividend paid but due to other reasons. For example, the United Kingdom imposes income tax on individual companies rather than on a consolidated basis. In order to share tax liability among related companies, the UK allows loss companies to surrender losses to members of the same affiliated group. Losses may be surrendered with or without actual payment, and any payments (actual or constructive) for loss surrenders are disregarded for UK tax purposes. For U.S. tax purposes, loss surrenders are treated as deemed distributions and contributions between UK subsidiaries and their common parent. Because proposed regulation section 1.245A(e)-1(d)(2) does not require a nexus between the deemed distribution and the foreign tax benefit received, these deemed distributions would be treated as hybrid dividends.

Proposed Treasury Regulation section 1.245A(e)-1(d)(2)(i)(B) creates an exception for deductions or other tax benefits which are the product of certain integration or imputation systems. A similar exception should be made for distributions which do not have a connection to the foreign tax benefit. This would place loss surrender regimes and similar tax systems that provide group relief on equal footing with other foreign tax consolidations.

3. Requested Action

An additional exception should be made to the definition of hybrid dividends when the foreign tax benefit is unrelated to the distribution of the dividend. These types of dividends should not be characterized as hybrid dividends.


Issue: The proposed hybrid dividend regulations provide no mechanism for reducing a shareholder's hybrid deduction account for amounts included under section 951(a) causing double taxation of inclusions of CFC investment in US property (“IUSP”).

Code Section and Regulation Section: Internal Revenue Code Sections 245A, 951(a); Proposed Treasury Regulation Sections 1.245A(e)-1 and 1.956-1(a)

Requested Action: Proposed Treasury Regulation section 1.245A(e)-1(d)(4) should provide for the reduction of a shareholder's hybrid deduction account for amounts included under section 951(a).

Discussion:

1. Background

Proposed Treasury Regulation section 1.245A(e)-1 provides no mechanism for reducing a shareholder's hybrid deduction account for amounts included in income under section 951(a). As a result, the proposed hybrid dividend regulations interact with Proposed Treasury Regulation section 1.956-1(a) to cause double taxation of section 951(a) inclusions from a CFC's IUSP to the extent of the shareholder's hybrid deduction account.

For example, suppose in Year 1, CFC, a first-tier CFC, has an IUSP that gives rise to a $100 inclusion. CFC also has sufficient accumulated earnings for a hypothetical distribution of $100 to be eligible for the section 245A deduction. If CFC's shareholder has no hybrid deduction account, Proposed Treasury Regulation section 1.956-1(a) reduces the $100 section 951(a) inclusion by the CFC earnings that would have been eligible for the section 245A deduction. The resulting IUSP inclusion is $0 ($100 inclusion, less $100 earnings eligible for the section 245A deduction).

Alternatively, if CFC's shareholder has a hybrid deduction account of $100 with respect to CFC stock, the hypothetical distribution of CFC earnings would be treated as a hybrid dividend under section 245A(e) and would not be eligible for the section 245A deduction. In this case, there is no reduction of the section 951(a) inclusion amount under Proposed Treasury Regulation section 1.956-1(a), and the full $100 inclusion is subject to US tax in Year 1. Furthermore, because the distribution of CFC earnings is a hypothetical distribution and not an actual hybrid dividend, Proposed Treasury Regulation section 1.245A(e)-1 does not reduce the shareholder's hybrid deduction account. As a result, a subsequent distribution by CFC of $100 of non-previously taxed earnings and profits will be treated a hybrid dividend and denied a section 245A deduction. Alternatively, if CFC does not pay a hybrid dividend, but has another IUSP inclusion in the future, it will once again have to include the $100 in income as the hybrid deduction account is not reduced.

2. Requested Action

To prevent the double taxation of IUSP inclusions outlined above, Proposed Treasury Regulation section 1.245A(e)-1(d)(4) should provide for the reduction of a shareholder's hybrid deduction account for amounts included under section 951(a).


Issue: Hybrid deduction accounts must be maintained with respect to each share of stock of a CFC held by a person potentially subject to section 245A upon a dividend paid by the CFC on the share. These hybrid dividend accounts should be accordingly adjusted for distributions of previously taxed earnings and profits (“PTEP”).

Code Sections and Regulation Sections: Internal Revenue Code Sections 245A(a) and 245A(e); Proposed Treasury Regulation Sections 1.245A(e)-1(d)

Requested Action: Hybrid deduction accounts should be correspondingly reduced by distributions of PTEP but should not be adjusted, up or down, by distributions of non-GILTI or non-subpart F earnings.

Discussion:

1. Summary of Proposal

The TCJA implemented section 245A(e) to deny the dividend received deduction (“DRD”) for hybrid dividends produced by cross-border transactions for which there is different tax treatment for US and foreign tax purposes. Hybrid deduction accounts are required to track the amount of hybrid deductions of each CFC that have been allocated to each share of the CFC. In order to accurately reflect income previously taxed these hybrid deduction accounts should be decreased for distributions of PTEP.

2. Background

Treasury and the IRS specifically requested comments on whether hybrid deduction accounts should be correspondingly decreased for distributions of PTEP. The fundamental purpose of creating 245A(e) to prevent instances of double non-taxation. Although the US has moved to a quasi-territorial system of taxation regimes such as subpart F and the global intangible low taxed income (“GILTI”) immediately tax foreign CFC income whether it has been distributed to the US parent or not.

For example, assume the following set of facts. A CFC has $100 of PTEP due to GILTI or subpart F inclusions. Additionally, the CFC has $20 of E&P from non-GILTI or non-Subpart F earnings (e.g., foreign oil and gas extractive income “FOGEI”). The hybrid deduction account under Proposed Treasury Regulation Section 1.245A(e)-1(d) is $100, and $120 of cash is distributed to the US parent. Under the current proposed regulations $20 would be treated as a hybrid dividend.

However, if the proposed regulations were to be amended to reduce hybrid deduction accounts by distributions of PTEP, then the CFC's distribution of $120 to the US parent would be treated as a $100 distribution of PTEP, simultaneously reducing its hybrid deduction account to $0. The remaining $20 distribution would be a dividend entitled to the section 245A DRD.

It is reasonable for the hybrid deduction accounts to be reduced for distributions of PTEP in this case as there is no instance of double non-taxation. The $100 hybrid deduction account could be accounted for by the income amounts already subjected to domestic tax by GILTI or subpart F. Therefore, the hybrid deduction accounts should be correspondingly reduced. Were these hybrid deduction accounts not reduced at minimum $80 of the distribution deemed ineligible for the 245A DRD would be subject to double taxation.

3. Requested Action

Hybrid deduction accounts should be correspondingly reduced by distributions of PTEP but should not be adjusted, up or down, by distributions of non-GILTI or non-subpart F earnings.

FOOTNOTES

2Proposed Treasury Regulation § 1.245A(e)-1(b) and (d).

END FOOTNOTES

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