KPMG Seeks Revisions to Proposed Transition Tax Regs

October 9, 2018

CC:PA:LPD:PR (REG-104226-18)
Room 5203
Internal Revenue Service
P.O. Box 7604
Ben Franklin Station
Washington, DC 20044

Re: REG-104226-18 Relating to Proposed Regulations under Section 965

Dear Sir or Madam:

KPMG LLP (“KPMG”) appreciates the opportunity to comment on the proposed regulations issued under section 965 ¹ published in the Federal Register on August 9, 2018 (the “Proposed Regulations”)² on behalf of interested clients.

KPMG, the audit, tax and advisory firm, is the U.S. member firm of KPMG International Cooperative (“KPMG International”), which is a global network of professional firms providing audit, tax and advisory services. KPMG International operates in 152 countries and has 189,000 people working in member firms around the world. On a daily basis, KPMG assists numerous clients by providing financial accounting audit and attestation services, business advisory services, general U.S. federal, state, local and international tax advice, and domestic and cross-border transactional planning.

I. Introduction

This letter provides comments on the anti-avoidance rules in Prop. Reg. §§ 1.965-4(b) and (c)(2), under which certain transactions and entity classification elections are disregarded for purposes of determining the section 965 elements of a United States shareholder (a “USSH”). In particular, this letter addresses the application of such rules to transactions involving the transfer or deemed transfer by a USSH of specified foreign corporation (“SFC”) stock to an S corporation where the transaction does not result in a change in the net tax liability as defined in section 965(h)(6) of the Code and Prop. Reg. § 1.965-7(g)(10) (the “section 965 net tax liability”) of the transferring USSH or, where the transferring USSH is a domestic pass-through entity, the section 965 net tax liability of its ultimate domestic pass-through owners. The Proposed Regulations create significant confusion and unnecessary complexity without a corresponding policy benefit by disregarding transactions solely for section 965 purposes, but not for other purposes of the Code, when there is, in fact, no change to the transferring USSH's or domestic pass-through owner's section 965 net tax liability. In the particular case of transfers by USSHs to S corporations, the application of the Proposed Regulations also would improperly preclude the transferring USSHs or, if the transferring USSH is a domestic pass-through entity, its domestic pass-through owners, from being able to elect under section 965(i) to defer payment of their section 965 net tax liability incurred with respect to an S corporation.

Section 965(i) provides a congressionally intended benefit for taxpayers choosing to conduct their business through S corporations and to be bound by the limitations that subchapter S imposes. There is no indication from the statutory text, the legislative history, or otherwise that Congress intended to limit the availability of section 965(i) only to shareholders of S corporations that were in existence on November 2, 2017, or only with respect to SFC stock held by an S corporation on such date, nor is there any indication in the preamble to the Proposed Regulations (the “Preamble”) that the Treasury Department (“Treasury”) and the Internal Revenue Service (“IRS”) intended for the Proposed Regulations to preclude section 965(i) elections by shareholders of S corporations that acquired SFC stock after November 2, 2017. Accordingly, we request that the Proposed Regulations be revised as described below.

Part II of this letter provides background on Prop. Reg. §§ 1.965-4(b) (the “principal purpose rule”) and 1.965-4(c)(2) (the “CTB disregard rule,” and together with the principal purpose rule, the “anti-avoidance rules”). Part III discusses certain affected transactions involving transfers by USSHs to domestic pass-through entities, and particularly S corporations, as well as elections by existing domestic pass-through entities to be S corporations, and explains why it would be inappropriate for regulations to disregard such transactions when they do not otherwise impact a taxpayer's section 965 net tax liability, and to render section 965(i) elections unavailable in such cases. Part IV suggests possible approaches to modifying the Proposed Regulations to address the concerns raised in this comment letter.

II. Background: The Proposed Regulations

a. The Principal Purpose Rule

The principal purpose rule provides that a transaction is disregarded for purposes of determining the amounts of all section 965 elements of a USSH with respect to an SFC for its last taxable year beginning before January 1, 2018 (the “repat year”) if each of three conditions is met. First, the transaction must occur, in whole or in part, on or after November 2, 2017.

Second, the transaction must be undertaken with a principal purpose of changing the amount of a section 965 element of a USSH. Generally, this requires a facts and circumstances inquiry. However, certain transactions are presumed to be undertaken with a principal purpose of changing the amount of a section 965 element of a USSH for purposes of the principal purpose rule. One such transaction is a “pro rata share reduction” transaction. A pro rata share reduction transaction is defined as:

a transfer of the stock of a specified foreign corporation by either a United States shareholder of the specified foreign corporation or a person related to a United States shareholder of the specified foreign corporation (including by the specified foreign corporation itself) to a person related to the United States shareholder if the transfer would, without regard to paragraph (b)(1) of this section, reduce the United States shareholder's pro rata share of the section 965(a) earnings amount of the specified foreign corporation, reduce the United States shareholder's pro rata share of the cash position of the specified foreign corporation, or both.³

Significantly, a USSH's pro rata share of the section 965(a) earnings amount and of the cash position of an SFC is determined based upon such USSH's ownership of the stock within the meaning of section 958(a) (“section 958(a) ownership,” and a person having such section 958(a) ownership, being the “section 958(a) USSH”) of the SFC on the last day of the SFC's repat year in which it is an SFC.⁴ Thus, a transaction will be a pro rata share reduction transaction — and therefore presumed to have been undertaken with a principal purpose of changing the amount of a section 965 element of a USSH — if a USSH transfers stock of an SFC and such transfer results in a reduction of the USSH's section 958(a) ownership of the SFC measured as of the last day of the SFC's repat year in which it is an SFC.

The final element of the principal purpose rule requires a change in at least one of the USSH's section 965 elements. A transaction changes a section 965 element if such transaction does any one of three things: (i) reduces a section 965(a) inclusion amount of the USSH with respect to any SFC, (ii) reduces the aggregate foreign cash position of the USSH (the “AFCP”) (but only if such amount is less than the USSH's aggregate section 965(a) inclusion amount), or (iii) increases the amount of foreign income taxes of any SFC deemed paid by the USSH under section 960 as a result of an inclusion under section 951(a) by reason of section 965 (“deemed paid taxes”).⁵ A USSH's section 965(a) inclusion amount is the amount included by a USSH pursuant to section 965 because the USSH owns stock of an SFC within the meaning of section 958(a) on the last day of the SFC's repat year in which it is an SFC.⁶ A USSH's AFCP is generally the greater of the aggregate of the USSH's pro rata share of the cash position of each SFC as of the last day of the SFC's repat year and one half the sum of such amount as of the last day of the SFC's two taxable years preceding the SFC's repat year.⁷ A transaction that changes a USSH's section 958(a) ownership of an SFC prior to the end of the SFC's repat year could change the USSH's section 965(a) inclusion amount, AFCP, and deemed paid taxes.

Prop. Reg. § 1.965-4(b)(2) provides that if a transaction is presumed to have been undertaken with a principal purpose of changing the amount of a section 965 element of the USSH, the USSH may seek to rebut such presumption by attaching a statement to its tax return for its taxable year in which or with which the relevant taxable year of the relevant SFC ends disclosing that it has rebutted the presumption. ⁸ The Proposed Regulations allow the presumption to be rebutted only if the facts and circumstances clearly establish that the transaction was not undertaken with a principal purpose of changing the amount of a section 965 element of a USSH.

b. The CTB Disregard Rule

The CTB disregard rule provides that an election to change the classification of an entity under Reg. § 301.7701-3 that is filed on or after November 2, 2017, is disregarded for purposes of determining all section 965 elements of a USSH if, without regard to the CTB disregard rule, the election would change the amount of any section 965 element of the USSH. As with the principal purpose rule, there is a change in a section 965 element of a USSH if there is a reduction in the USSH's section 965(a) inclusion amount, a reduction in the USSH's AFCP, or an increase in the USSH's deemed paid taxes. However, unlike the principal purpose rule, the application of the CTB disregard rule is automatic; it does not depend on whether the election was made with a principal purpose of changing the amount of a section 965 element of the USSH.

c. Legislative History

The authority to promulgate the principal purpose rule and the CTB disregard rule derives from sections 965(c)(3)(F) and (o). Section 965(c)(3)(F) allows the Secretary to disregard transactions for purposes of determining a USSH's AFCP if the Secretary determines that a principal purpose of the transaction was to reduce the USSH's AFCP. The House Report accompanying H.R. 1 and the Joint Committee on Taxation Report both state that the purpose of section 965(c)(3)(F) is to provide the Secretary with the ability to disregard transactions that the Secretary determines had the principal purpose of reducing the AFCP.⁹ A USSH's AFCP is only relevant for purposes of determining the amount of the section 965(c) deduction.¹⁰ Thus, Congress appears to have added section 965(c)(3)(F) to prevent a USSH from increasing its section 965(c) deduction and thereby reducing the USSH's section 965 net tax liability.

Section 965(o) is broader than section 965(c)(3)(F). It instructs the Secretary to “prescribe such regulations or other guidance as may be necessary or appropriate to carry out the provisions of this section, including . . . regulations or other guidance to prevent the avoidance of the purposes of this section, including through a reduction in earnings and profits, through changes in entity classification or accounting methods, or otherwise.” In describing this rule, the Conference Report¹¹ states:

The conferees are also aware that certain taxpayers may have engaged in tax strategies designed to reduce the amount of post-1986 earnings and profits in order to decrease the amount of the inclusion required under this provision. Such tax strategies may include a change in entity classification, accounting method, and taxable year, or intragroup transactions such as distributions or liquidations. The conferees expect the Secretary to prescribe rules to adjust the amount of post-1986 earnings and profits in such cases in order to prevent the avoidance of the purposes of this section.¹²

The Conference Report also includes excerpts from the JCT Report, which provides that section 965(o) “specifies that the Secretary shall prescribe rules or guidance in order to deter tax avoidance through the use of entity classification elections and accounting method changes, among other possible strategies.”¹³

d. Preamble to the Proposed Regulations

The Preamble provides additional context regarding the intended application of the principal purpose and CTB disregard rules. Broadly, their purpose is “consistent with section 3.04 of Notice 2018-26, to prevent the avoidance of section 965.” The Preamble states that “[t]he application of the anti-avoidance rule is based on whether there is a 'change in the amount of a 965 element' rather than a change in the section 965 tax liability, as described in [Notice 2018-26].” No explanation is provided for this change.

The Preamble also addresses various comments with respect to the rules announced in Notice 2018-26¹⁴ in a manner that helps delineate what constitutes an avoidance of section 965. First, the Preamble reiterates that a transaction or strategy to reduce a USSH's inclusion under section 965 should be disregarded. In response to a comment requesting that the anti-avoidance rule not apply to the extent that a reduction in a taxpayer's section 965 net tax liability is offset by a tax increase pursuant to a different Code provision, the Preamble states that “the Conference Report reflects an intent for the Treasury Department and the IRS to address all strategies for avoiding a section 965(a) inclusion, without regard to the effect on overall tax liability.”¹⁵ Notably, the Preamble focuses on a reduction of a section 965(a) inclusion. That term is defined in Prop. Reg. § 1.965-1(f)(37) as an amount included in income by a USSH by reason of section 965 because of such USSH's section 958(a) ownership of an SFC or as a result of its ownership of a domestic pass-through entity that is a section 958(a) USSH of an SFC.¹⁶ The anti-avoidance rules, however, focus on the USSH's “section 965(a) inclusion amount,” a separately defined term¹⁷ that is narrower than Treasury and the IRS's own description in the Preamble of the amount that Congress intended to be preserved with respect to particular USSHs.

The Preamble also makes clear that anti-avoidance rules are intended to apply broadly to prevent any reduction of a USSH's tax due to the application of section 965 through tax avoidance strategies. In response to a comment requesting a de minimis exception, the Preamble provides that “[t]he Treasury Department and the IRS have determined that any reduction in tax imposed by reason of section 965 through tax avoidance strategies occurring after November 2, 2017, is inconsistent with congressional intent and should not be respected.” Furthermore, the Preamble states in response to a comment about accounting method changes that “[t]he choice of a November 2, 2017, measurement date reflects an intent to impose a transition tax on a snapshot of earnings as of a date that coincides with the introduction of the Act in Congress, and reflects a general policy of disregarding taxpayer actions occurring after November 2, 2017, that reduce the taxpayer's liability imposed by reason of section 965, even if such future actions are otherwise respected under the Code” and that “[a] rule disregarding [changes in accounting methods] is also consistent with the Conference Report, which reflects a clear intent for the Treasury Department and the IRS to exercise their authority under section 965(o) to disregard accounting method changes that reduce a taxpayer's tax lability under section 965.” All of these statements suggest that Treasury and the IRS were not focused on any particular form of transaction or strategy and that, instead, Treasury and the IRS intended that, whatever the form, a transaction occurring or strategy implemented after November 2, 2017, should be disregarded if its effect is a reduction of the tax imposed on a taxpayer by reason of section 965. However, the Preamble also suggests that Treasury and the IRS did not contemplate that a transaction that does not reduce such tax should be disregarded.

As described above, the principal purpose rule generally allows a USSH to rebut the presumption that a transaction was undertaken with a principal purpose of changing the amount of a section 965 element. Neither the Proposed Regulations nor the Preamble describes when the facts and circumstances would clearly establish that a transaction was not undertaken with a principal purpose of changing a section 965 element of a USSH. The Preamble does, however, provide that “[d]epending on the facts and circumstances, transactions that do not reduce overall tax liability may not meet the principal purpose test described in proposed § 1.965-4(b)(1).”

III. Transactions at Issue and Analysis

Certain USSHs (“transferring USSHs”) that owned stock of one or more SFCs within the meaning of section 958(a) before November 2, 2017, transferred all or a portion of such stock to an S corporation such that the S corporation owned the stock of the transferred SFCs on the last day of their repat year (“SFC stock transfer cases”). In addition, certain existing domestic partnerships that owned SFC stock within the meaning of section 958(a) before November 2, 2017, elected to be treated as S corporations for U.S. federal income tax purposes¹⁸ on or after November 2, 2017, and prior to the last day of the SFCs' repat year (“S election cases”). Notably, there may have been no change as a result of these transactions to the section 965(a) inclusion or the resulting section 965 net tax liability of the transferring USSHs in the SFC stock transfer cases or, in the S election cases, of the domestic pass-through owners (some of which may have been USSHs). Instead, the section 965(a) inclusion was simply received indirectly through the S corporation rather than via section 958(a) ownership in the stock transfer cases or through the pre-existing domestic partnership in the S election cases. These transactions did, however, enable the transferring USSHs or domestic pass-through owners to make a section 965(i) election with respect to their section 965 net tax liability attributable to the stock of the SFCs held by the S corporation at the end of the repat year.

Under a literal reading of the anti-avoidance rules in the Proposed Regulations, and specifically because those rules focus narrowly on whether a transaction changes any of the section 965 elements of a section 958(a) USSH rather than on whether there is a reduction in the section 965 net tax liability of a USSH or domestic pass-through owner who is actually subject to tax on the section 965(a) inclusion, these transactions would be disregarded for section 965 purposes. In SFC stock transfer cases, the transfer resulted in the transferring USSH's section 958(a) ownership of the transferred SFCs being reduced between November 2, 2017, and the end of the SFCs' repat year. This reduction in section 958(a) ownership in turn caused a change in the transferring USSH's section 965 elements because the reduction in such USSH's section 958(a) ownership resulted in a reduction in such USSH's pro rata share (defined by reference to section 958(a) ownership) of the section 965(a) inclusion amount¹⁹ with respect to the transferred SFCs and, in certain cases, a reduction in the transferring USSH's AFCP (via a reduction in the USSH's pro rata share of the cash position of the transferred SFCs as of the last day of their repat year). In S election cases, as a result of the S corporation election, the partnership's section 958(a) ownership of the SFCs would be reduced between November 2, 2017, and the end of the SFCs' repat year, which similarly reduces the partnership's share of the section 965(a) inclusion amount and potentially also its AFCP.

The anti-avoidance rules should not apply to actual or deemed transfers that merely cause a transferring USSH to change from directly owning SFC stock to indirectly owning such stock through a domestic pass-through entity, or that merely cause domestic pass-through owners to receive their section 965(a) inclusion through a different pass-through entity, to the extent that the transfers do not reduce the relevant taxpayer's section 965 net tax liability. An overbroad application of the anti-avoidance rules to such transactions will create unnecessary confusion and complexity as taxpayers and the IRS sort through what it means to disregard a transaction for some purposes but not others. Moreover, when the transferee or deemed transferee is an S corporation, application of the anti-avoidance rules will improperly prevent the S corporation's shareholders from making a section 965(i) election, a benefit that Congress intended to be available to taxpayers that do business in S corporation form without any express or implied limitation on when the S corporation became the owner of SFC stock.

As a general matter, the anti-avoidance rules should not apply when there has been a change in a USSH's pro rata share (defined narrowly by reference to section 958(a) ownership) of the elements used to construct a USSH's section 965 net tax liability if there was, in fact, no change in such liability. This is consistent with the purposes of sections 965(c)(3)(F) and (o) as described by the Preamble. The Preamble's discussion of the anti-avoidance rules — which include the principal purpose rule and the CTB disregard rule — makes clear that Treasury and the IRS view sections 965(c)(3)(F) and (o) as intended to prevent a reduction of a taxpayer's section 965 net tax liability through the use of transactions or other strategies that occur on or after November 2, 2017. Nothing in either the legislative history to section 965 or the Preamble, however, suggests that Congress was particularly concerned about reductions in a USSH's section 958(a) ownership of an SFC in and of themselves, rather than as a means to reduce a USSH's section 965 net tax liability. Disregarding transactions or strategies that do not reduce a USSH's section 965 net tax liability, even if they affect section 958(a) ownership, would therefore not appear to be the intent of Congress.

Moreover, the anti-avoidance rules introduce significant complexity and confusion by disregarding transactions and elections solely for purposes of section 965 but not other provisions of the Code, complexity and confusion that is unwarranted when the transaction or election at issue has no impact on the section 965 net tax liability of the transferring USSH or the relevant domestic pass-through owners. Consider, for example, if the CTB election rule is applied to S corporation election cases. The S corporation election would be disregarded for section 965 purposes. This could result in the partnership, which ceases to exist as of the effective date of the election for all other tax purposes, being deemed for section 965 purposes to continue through the end of the SFCs' repat years. Deeming the partnership to continue to exist may cause significant confusion with respect to the treatment of the deemed continuing partnership, the tax attributes of the partners in their deemed partnership interests, and the tax attributes of the owners' interests in the S corporation generally and with respect to the effects of the section 965(a) inclusion specifically.²⁰

With respect to the effect of the anti-avoidance rules on the availability of the section 965(i) election, section 965(i) provides that a shareholder of an S corporation may elect to defer payment of the portion of the shareholder's section 965 net tax liability that results from the shareholder's ownership of stock in an S corporation that is a USSH of an SFC that has deferred foreign income. The payment of the section 965 net tax liability with respect to such S corporation is deferred until the taxable year in which there is a triggering event as defined in section 965(i)(2). Under section 965(i)(5), the S corporation itself becomes jointly and severally liable for any section 965 net tax liability deferred under section 965(i). Rules regarding the section 965(i) election are included in Prop. Reg. § 1.965-7(c).

Neither section 965(i) nor Prop. Reg. § 1.965-7(c) provide any limitation on the availability of the section 965(i) election based on when SFC stock was acquired by an S corporation if a shareholder of the S corporation otherwise meets the statutory requirements for making the election (including the requirement that the S corporation owned the SFC stock on the last day of its repat year). In particular, neither provision provides that the election is unavailable for any section 965 net tax liability that is attributable to SFC stock that was transferred to an S corporation on or after November 2, 2017. The Conference Report is also silent with respect to this issue. Congress easily could have limited the availability of the section 965(i) election by requiring a minimum holding period for the S corporation's ownership of the SFC stock or by requiring the S corporation to have owned the SFC stock as of November 2, 2017. We find it notable that a statute that otherwise goes to great lengths to try to fix a USSH's section 965 net tax liability by reference to the state of affairs existing at the time of introduction of H.R. 1 on November 2, 2017, contains no hint of any intent to limit the availability of section 965(i) for shareholders of S corporations that acquired SFC stock after that date.²¹ Consistent with that, neither the Proposed Regulations nor the Preamble contain any reference whatsoever to limiting the availability of the section 965(i) election. That is, it appears that the impact of the anti-avoidance rules on the ability of a shareholder of an S corporation to make the section 965(i) election for its section 965 net tax liability with respect to the S corporation was an unintended byproduct of the drafting approach taken in the anti-avoidance rules.

The section 965(i) election is fairly viewed as a benefit that Congress intended to make available to all taxpayers doing business in S corporation form, and it would not be appropriate to favor historic S corporation shareholders over new S corporation shareholders in administering section 965.²² Operating in S corporation form means accepting the substantial limitations imposed on S corporations by subchapter S and the adverse consequences of operating as a corporation under certain other provisions of the Code. In particular, subchapter S limits the number and type of shareholders an S corporation can have, and restricts S corporations to having only a single class of stock.²³ In addition, in stark contrast to partnerships, assets held by an S corporation may not be withdrawn from corporate solution without triggering corporate level gain recognition under section 311(b) of the Code.²⁴ These restrictions apply equally to both S corporations existing prior to November 2, 2017, and those organized thereafter, as well as to all property of an S corporation regardless of when acquired. To the extent that these distinctive features of S corporations serve as a reason for providing and restricting the section 965(i) election to S corporation shareholders, there should be no basis for denying the election to shareholders of S corporations who acquired their shares in SFC stock transfer cases or S election cases. Indeed, if the section 965(i) election is denied to taxpayers who acquired their S corporation shares in SFC stock transfer cases or S election cases with the understanding — entirely reasonable based on the statute and the legislative history — that they would be eligible for the section 965(i) election, such taxpayers will have undertaken the burdens of operating in the S corporation form going forward, but without one of its important benefits. Such taxpayers would not be able to unwind their S corporations without recognizing any unrealized appreciation in their SFC stock.

IV. Change Requested

We respectfully request that the principal purpose rule and CTB disregard rule be revised to exclude from their application transactions such as the SFC stock transfer cases and the S election cases where the transferring USSH's or the relevant domestic pass-through owners' section 965 net tax liability remains unchanged as a result of the transaction. This change could be accomplished in several ways.

The most direct approach would be to amend the Proposed Regulations to provide that, at least with respect to a taxpayer that is a domestic pass-through owner following a transaction or entity classification election, the anti-avoidance rules apply only if the taxpayer's section 965 net tax liability, as currently defined in Prop. Reg. § 1.965-7(g)(10), was reduced as a result of the transaction or entity classification election. Alternatively, if it is determined that it is necessary to retain the regulations' current focus on section 965 elements, this approach could be implemented by redefining the first two section 965 elements as follows: (i) replacing the reference in Prop. Reg. § 1.965-4(d)(1) to section 965(a) inclusion amount as such term is currently defined in Prop. Reg. § 1.965-1(f)(38) with the 965(a) inclusion as currently defined in Prop. Reg. § 1.965-1(f)(37),²⁵ and (ii) replacing the reference to AFCP in Prop. Reg. § 1.965-4(d)(2) to instead refer to the section 965(c) deduction as currently defined in Prop. Reg. § 1.965-1(f)(41).²⁶

An alternative approach that would retain the general framework of the anti-avoidance rules would be to provide relief from the overbroad application of the anti-avoidance rules by way of an exception. For example, the regulations could provide that, regardless of the effect of a transaction or entity classification election on a USSH's section 965 elements (as currently narrowly defined in Prop. Reg. 1.965-4(d)), the anti-avoidance rules would not apply if in fact the relevant taxpayer's section 965 net tax liability, as currently defined in Prop. Reg. § 1.965-7(g)(10), was not reduced as a result of the transaction or entity classification election. Such an exception could also be achieved by allowing a taxpayer that is a domestic pass-through owner to rebut the application of the principal purpose rule and the CTB disregard rule by establishing that (i) the domestic pass-through owner's section 965(a) inclusion as currently defined in Prop. Reg. § 1.965-1(f)(37) was not reduced; (ii) the domestic pass-through owner's section 965(c) deduction as currently defined in Prop. Reg. § 1.965-1(f)(41) was not increased; and (iii) the amount of the domestic pass-through owner's deemed paid taxes did not increase.

There may, however, be SFC stock transfer cases or S election cases in which a transferring USSH's or domestic pass-through owner's section 965(c) deduction, as defined in Prop. Reg. § 1.965-1(f)(41), is increased — and the section 965 net tax liability is accordingly reduced — as a result of the transfer or election because a pro rata share of the cash position of an SFC as of the first cash measurement date, as defined in Prop. Reg. § 1.965-1(f)(25), and the second cash measurement date, as defined in Prop. Reg. § 1.965-1(f)(31), may not be taken into account by the S corporation (i.e., because the S corporation did not exist and/or own the SFC stock on such dates). Although we are not aware of any taxpayer in an SFC stock transfer case or CTB disregard case undertaking the transaction or making an election with a view to reducing its AFCP, Treasury and the IRS may be concerned about allowing such transactions and elections to increase the relevant transferring USSH's or domestic pass-through owners' section 965(c) deduction. Rather than disregarding the transaction or election in such cases, with the attendant consequences for the section 965(i) election, we think this concern could be addressed by requiring the S corporation to calculate its AFCP and resulting section 965(c) deduction amount, as defined in Prop. Reg. § 1.965-1(f)(42), by taking into account its pro rata share of the cash position of any SFC stock that it received (or was deemed to receive) as a result of the SFC stock transfer or the S corporation election to the same extent that such pro rata share would have been taken into account by the transferring USSHs or domestic pass-through entity if the transaction or election had not occurred. This adjustment to the S corporation's section 965(c) deduction would then be taken into account in determining whether the above tests are satisfied.

Finally, at a minimum, the regulations could be revised to provide that the anti-avoidance rules apply solely for purposes of determining a taxpayer's section 965 net tax liability, including the various elements that go into the determination thereof, and not for purposes of determining whether such amounts are received by such taxpayer with respect to S corporation stock or whether a taxpayer is eligible to make a section 965(i) election with respect to the section 965 net tax liability as so determined.

We welcome the opportunity to discuss our comments further with any interested personnel at the Treasury Department and the IRS. Please feel free to contact Erik Corwin (202-533-3655, ecorwin@kpmg.com) or Danielle Rolfes (703-861-3002, drolfes@kpmg.com).

Very truly yours,

KPMG LLP

cc:
Lafayette “Chip” G. Harter III
Deputy Assistant Secretary (International Tax Affairs)
Department of the Treasury

Douglas L. Poms
International Tax Counsel
Department of the Treasury

Brenda L. Zent
Special Advisor on International Taxation
Department of the Treasury

Marjorie A. Rollinson
Associate Chief Counsel (International)
Internal Revenue Service

Daniel M. McCall
Deputy Associate Chief Counsel (International)
Internal Revenue Service

Raymond J. Stahl
Special Counsel, Associate Chief Counsel (International)
Internal Revenue Service

Jeffery G. Mitchell
Branch Chief, Office of Associate Chief Counsel (International), Branch 2
Internal Revenue Service

Leni C. Perkins
Attorney, Office of Associate Chief Counsel (International), Branch 2
Internal Revenue Service