U.S. Tax Review: Transfer Pricing, Pillar 2, and the Build Back Better Act

OECD Developments

Transfer Pricing Report

On January 20 the OECD published an updated version of its transfer pricing guidelines. The guidelines are now 658 pages and include all of the various revisions and additions that have been made by supplementation and modification. In particular, the 2022 OECD transfer pricing guidelines report consolidates into a single publication the changes to the 2017 edition resulting from the transaction profit-split method revisions (adopted June 4, 2018); the hard-to-value intangibles report (also adopted June 4, 2018); the report on financial transactions (adopted January 20, 2020); and other consistency changes needed to produce a consolidated report including an update to the foreword, the preface, and the glossary.

The foreword notes all the revisions that have been made to the original 1979 report. The preface states that the role of multinational enterprises has increased dramatically. At the policy level, jurisdictions need to reconcile their legitimate right to tax profits based on income and expenses that can reasonably be considered to arise within their territories with the need to avoid the taxation of the same item of income by more than one tax jurisdiction. The preface notes the importance of the arm’s-length standard. The OECD states that it has worked to build a consensus on international taxation principles, thereby avoiding unilateral responses to multilateral problems.

Pillar 2

On December 20, 2021, the OECD released the details of its pillar 2 proposal in a report called, “Tax Challenges Arising From the Digitalisation of the Economy, Global Anti-Base Erosion Model Rules (Pillar Two)” (the report).¹ The report provides that the implementation of these new rules is expected by 2023.

The report implements pillar 2 using the global anti-base-erosion (GLOBE) rules, which apply to large MNEs. These rules require income inclusion that applies a top-up tax to an MNE’s income that is taxed below an effective tax rate of 15 percent (the minimum rate), determined on a jurisdictional basis, and also deny deductions for payments that are taxed below the minimum tax rate.

The report states that, because the GLOBE rules apply a minimum rate on a jurisdictional basis, consideration will be given to the conditions under which the U.S. global intangible low-taxed income rules will coexist with the GLOBE rules to ensure a level playing field. However, the report does not address the interaction of these rules any further.

Chapter 1 defines the scope of the GLOBE rules. The rules apply to constituent entities that are members of an MNE group that has annual revenue of €750 million or more in the consolidated financial statements of the ultimate parent entity (UPE) in at least two of the four fiscal years immediately preceding the tested fiscal year. An MNE group means any group that includes at least one entity or permanent establishment in a different jurisdiction from the UPE.

A UPE is either an entity that is the head of a group of entities with overlapping controlling interests, or the main entity of a group, which is defined as an entity that is located in one jurisdiction and has one or more PEs located in other jurisdictions but is not part of a bigger group.

Because the GLOBE rules apply to constituent entities, this is a key concept. A constituent entity is any entity that is included in a group, and any PE of an entity that is included in a group and that includes the PE’s net income or loss in its financial statements. A group is a collection of entities that are related through ownership or control so that their assets, liabilities, income, expenses, and cash flows are included in the consolidated financial statements of the UPE, or excluded from the consolidated financial statements of the UPE solely on size or materiality grounds or because the entity is held for sale.

Consolidated financial statements are also a key concept in measuring revenue to determine whether the GLOBE rules apply. The term “consolidated financial statements” means:

Importantly, excluded entities are not subject to the GLOBE rules. An excluded entity is an entity that is a governmental entity; an international organization; a nonprofit organization; a pension fund; an investment fund that is a UPE; or a real estate investment vehicle that is a UPE. An excluded entity is also an entity:

• in which at least 95 percent of its value is owned (directly or through a chain of excluded entities) by one or more excluded entities listed above (other than a pension services entity, which is a type of pension fund) and in which that entity:

  • operates exclusively or almost exclusively to hold assets or invest funds for the benefit of the excluded entity or entities; or

  • carries out only activities that are ancillary to those carried out by the excluded entity or entities; or

• in which are least 85 percent of its value is owned (directly or through a chain of excluded entities) by one or more excluded entities listed above (other than a pension service entity) if substantially all of the entity’s income is excluded dividends or excluded equity gain or loss from the computation of GLOBE income or loss.

A filing constituent entity may elect not to treat an entity as an excluded entity. This is a five-year election.

Chapter 2 determines the constituent entities in the group that are liable for any top-up tax and the portion of any top-up tax charged to any such entity. The amount of top-up tax charged to a parent entity or to the constituent entities located in an undertaxed payments rule (UTPR) jurisdiction is determined by attributing the top-up tax of each low-taxed constituent entity determined under the rules in Chapter 5 to the parent entity under the income inclusion rule (IIR) in which that top-up tax is multiplied by the parent entity’s inclusion ratio for the low-taxed constituent entity for the fiscal year, and then allocating the residual top-up tax, if any, to UTPR jurisdictions.

The IIR is the set of rules provided in Chapter 2. Either the UPE of the MNE group must be required to apply a set of rules equivalent to those in Chapter 2 that are included in the domestic law of its jurisdiction and implemented and administered in a way that is consistent with the GLOBE rules without any benefits in the jurisdiction, or an intermediate parent entity of an MNE group must apply these rules in its jurisdiction (called a UTPR jurisdiction).

A parent entity’s inclusion ratio for a low-taxed constituent entity for a fiscal year is the ratio of the GLOBE income of the low-taxed constituent entity for the fiscal year, reduced by the amount of such income attributable to ownership interests held by other owners, to the GLOBE income of the low-taxed constituent entity for the fiscal year. The GLOBE income or loss of each constituent entity is its financial accounting net income or loss, with certain adjustments.

As part of the implementation of the additional tax, constituent entities of an MNE group located in an implementing jurisdiction are denied a deduction (or required to make an equivalent adjustment under domestic law) in an amount resulting in those constituent entities having an additional cash tax expense equal to the UTPR top-up tax amount for the fiscal year allocated to that jurisdiction. If this adjustment is insufficient to produce an additional cash tax expense for this tax year equal to the UTPR top-up tax amount allocated to this implementing jurisdiction for the fiscal year, the difference is carried forward to the extent necessary to the succeeding fiscal years, subject to certain adjustments, for each tax year.

The total UTPR top-up tax amount for a fiscal year is equal to the sum of the top-up tax calculated for each low-taxed constituent entity of an MNE group for that fiscal year, subject to certain adjustments. The UTPR top-up tax amount allocated to the implementing jurisdiction is determined by multiplying the total UTPR top-up tax amount by the jurisdiction’s UTPR percentage. The UTPR percentage is determined each fiscal year for each MNE group as follows:

The top-up tax is otherwise detailed in Chapter 5.

Chapters 3 and 4 set out the components of the effective tax rate calculation under the GLOBE rules. Chapter 3 determines the income (or loss) for the period for each constituent entity in the MNE group, and Chapter 4 then identifies the taxes attributable to that income.

The amount of a constituent entity’s covered taxes is determined by taking the current taxes determined for the constituent entity for the fiscal year, adjusted to reflect certain timing differences, by allocating covered taxes from one constituent entity to another in some cases, and by taking into account the effect of certain post-filing tax adjustments.

The term “covered taxes” means taxes recorded in the financial accounts of a constituent entity with respect to its income or profits or its share of the income or profits of a constituent entity in which it has an ownership interest; taxes on distributed profits, deemed profit distributions, and nonbusiness expenses imposed under an eligible distribution tax system; taxes imposed in lieu of a generally applicable corporate income tax; and taxes levied by reference to retained earnings and corporate equity, including a tax on multiple components based on income and equity.

Chapter 5 aggregates the income and taxes of all constituent entities located in the same jurisdiction to determine the effective tax rate for that jurisdiction. If the effective tax rate is below the minimum rate of 15 percent, the difference results in a top-up tax percentage that is applied to the jurisdictional income to determine the total amount of top-up tax. The top-up tax is pro-rated among the constituent entities located in that jurisdiction and then charged to the constituent entities liable for any top-up tax in accordance with Chapter 2.

The top-up tax of each low-taxed constituent entity is determined by:

• aggregating each constituent entity’s GLOBE income or loss (determined under Chapter 3) and adjusted covered taxes (determined under Chapter 4) with those of other constituent entities located in the same jurisdiction to determine an effective tax rate for the jurisdiction;

• identifying which jurisdiction is a low-tax jurisdiction (that is, has an effective tax rate that is below the minimum rate of 15 percent);

• computing a jurisdictional top-up tax percentage for each low-tax jurisdiction;

• applying the substance-based income exclusion to the net GLOBE income in the low-tax jurisdiction to determine the excess profits in that jurisdiction;

• multiplying the top-up tax percentage by such excess profit and reducing the result by the amount of any qualified domestic minimum top-up tax to determine the top-up tax for each low-tax jurisdiction; and

• allocating such top-up taxes to the constituent entities in the low-tax jurisdiction in proportion to their GLOBE income.

The resulting top-up tax of each low-taxed constituent entity is then charged to a parent entity or to constituent entities located in a UTPR jurisdiction under Chapter 2.

The effective tax rate of the MNE group for a jurisdiction is equal to the sum of the adjusted covered taxes of each constituent entity located in the jurisdiction divided by the net GLOBE income of the jurisdiction for the fiscal year. The net GLOBE income of a jurisdiction for a fiscal year is the positive amount, if any, computed in accordance with the following formula:

The top-up tax percentage for a jurisdiction for a fiscal year is the positive percentage point difference, if any, computed in accordance with the following formula:

Chapter 5 also includes an elective substance-based income exclusion that may reduce the amount of profits subject to any top-up tax. It also includes de minimis exclusion rules for constituent entities that are in the same jurisdiction and have aggregate revenue and income below specified thresholds.

Chapter 6 contains the rules for acquisitions, disposals, and joint ventures, including rules on the consolidation of revenue and the application of the various GLOBE rules in a restructuring.

If there is a merger of two or more groups, then the consolidated revenue threshold for any fiscal year prior to the merger is deemed to be met if the sum of the groups’ revenues is equal to or greater than €750 million.

If an MNE group within the scope of the GLOBE rules demerges, the consolidated revenue threshold is deemed to be met by a demerged group for the first tested fiscal year ending after the demerger, if the demerged group has annual revenues of €750 million or more in that year; or for the second to fourth tested fiscal years ending after the demerger, if the demerged group has annual revenues of €750 million or more in at least two of the fiscal years following the year of the demerger.

In terms of joint ventures, the GLOBE rules and calculations apply for purposes of computing any top-up tax as if they were constituent entities of a separate MNE group and as if the joint venture was the UPE of that group. For a parent entity that holds ownership interests in the joint venture or a joint venture subsidiary the IIR applies to the allocable share of the top-up tax. The joint venture group top-up tax is reduced by each parent entity’s allocable share of the top-up tax brought into charge under a qualified IIR, and any remaining amount is added to the total UTPR top-up tax amount.

For multiparented MNE groups, the entities and constituent entities of each group are treated as members of a single MNE group for purposes of the GLOBE rules, and there are specific provisions on how the various rules apply in that situation.

Chapter 7 deals with the application of the GLOBE rules to certain tax neutrality and other distribution regimes. These provisions provide the rules for when the UPE is a flow-through entity or is entitled to deduct dividend payments, or cases in which taxes apply to earnings when they are distributed or deemed to be distributed. There is a five-year election to treat specified investment entities as tax transparent if the owner is subject to tax on a mark-to-market basis at a rate that equals or exceeds the minimum rate. There is also a five-year election to apply a taxable distribution method to investment entities in which the owner can reasonably be expected to be subject to tax on distributions at a rate that equals or exceeds the minimum rate.

Chapter 8 addresses administrative issues, including the obligation to file standardized information returns with the various GLOBE tax calculations. The GLOBE information return should be filed no later than 15 months after the last day of the relevant fiscal year.

Chapter 9 sets out specific transition rules, including determining the effective tax rate for a jurisdiction in a transition year and an exclusion from UTPR in the initial phase of international activity. In a transitional year, the 15-months filing date is extended to 18 months for the first GLOBE information return.

Chapter 10 sets out the defined terms.

Peer Review Reports

The OECD/G-20 inclusive framework on base erosion and profit shifting released the 2020 peer review assessment of 131 jurisdictions on the exchange of information on tax rulings under BEPS action 5. It states that the BEPS action 5 minimum standard on tax rulings has increased its reach and that 95 jurisdictions are now in full compliance with action 5, including the United States. Also, 36 jurisdictions have received one or more recommendations to improve their legal or operational frameworks to identify and exchange tax rulings. This is the first review under the renewed peer review process, and it identified 22,000 tax rulings issued by the included 131 jurisdictions that are in scope of the transparency framework, including rulings since 2010, with 1,700 issued in 2020. The report also provided that 41,000 exchanges between jurisdictions have taken place, with 5,000 in 2020.

All members of the OECD/G-20 inclusive framework on BEPS have committed to implement action 5, including compulsory spontaneous exchange of information on certain tax rulings. In particular, five categories of taxpayer-specific rulings are included:

• rulings related to certain preferential regimes;

• unilateral advance pricing arrangements or other cross-border unilateral rulings regarding transfer pricing;

• rulings providing for a downward adjustment of taxable profits;

• PE rulings; and

• related-party conduit rulings.

TEI Comments on the BBBA

The Tax Executives Institute submitted comments and recommendations on select corporate and international tax reform proposals included in the Build Back Better Act (BBBA, H.R. 5376). The BBBA provisions remain important as President Biden suggested that some of those provisions could be enacted on a piecemeal basis.

TEI states that its members were taken aback by the post-House Ways and Means Committee addition of a proposed book-based alternative minimum tax (AMT) on corporations. The BBBA would generally impose a new 15 percent minimum tax on the adjusted financial statement income of corporations with such income in excess of $1 billion.

TEI stated its introduction would be neither simple nor administrable and would pose a competitive disadvantage to U.S.-headquartered businesses while increasing the incidence of unrelieved double taxation. TEI questioned the underlying policy rationale. Apart from tax policy considerations, TEI is deeply concerned about the substantial administrative costs and compliance burdens.

The new corporate AMT would be based on “adjusted financial statement income,” as set forth on the applicable financial statement — generally, a corporation’s Form 10-K filed, an audited financial statement, or other similar financial statement — with certain adjustments. The legislative text enumerates no fewer than 10 “general adjustments” and authorizes additional adjustments by regulation. TEI states that using adjusted financial statement income would be the antithesis of sound tax policy and administration. Using adjusted financial statement income as the base for a new corporate AMT would effectively nullify the intended tax benefits from bonus depreciation because depreciation is not accelerated for financial statement purposes.

TEI is concerned that numerous, extremely complex adjustments would be required to conform the consolidated book group to the consolidated return group for purposes of determining the taxpayer’s adjusted financial statement income. TEI is also concerned that the proposed rule may not apply as intended in cases in which a long-term, strategic investment — such as a less-than-20-percent investment in another corporation’s capital stock — is accounted for under the fair value method of accounting for financial reporting purposes. TEI sees no policy justification for the disparate treatment of taxpayers that apply the equity method of accounting versus the fair value method of accounting for financial reporting purposes. TEI also questions the policy rationale for limiting the carryover of financial statement net operating losses to only those appearing on the corporation’s applicable financial statements for tax years ending after December 31, 2019.

If Congress ultimately adopts a new corporate AMT, TEI recommends that it more closely resemble the pre-2018 corporate AMT regime, which was based on alternative minimum taxable income. TEI also implores the congressional taxwriters to revisit the proposed treatment of foreign tax credits under the AMT.

TEI stated that the BBBA’s proposed reduction in the deduction percentages for foreign-derived intangible income and GILTI was a source of significant concern, given the prospect of creating a competitive disadvantage for U.S.-headquartered businesses relative to their non-U.S.-headquartered competitors. The congruity in effective tax rates on FDII and GILTI was intentional and reflects Congress’s goal of removing the tax incentive to locate intangible income abroad while encouraging U.S. taxpayers to locate intangible income, and potentially valuable economic activity, in the United States. TEI views this parity among effective tax rates as an essential tenet of the current U.S. international tax system — one worthy of preserving through 2025 and beyond.

The BBBA would reduce the section 250 deduction percentages for FDII from 37.5 percent to 24.8 percent and for GILTI from 50 percent to 28.5 percent. Combined with the BBBA’s proposal to reduce the GILTI FTC haircut in section 960(d)(1), this proposal would yield an effective tax rate on FDII of approximately 15.792 percent and an effective tax rate on GILTI of approximately 15.805 percent. TEI commends the House of Representatives for advancing a proposal that would generally maintain the complimentary nature of these two regimes.

However, in light of pillar 2, TEI recommends that Congress ensure U.S. economic competitiveness through the retention of complementary effective tax rates on GILTI and FDII that do not exceed 15 percent.

In terms of the country-by-country changes, TEI strongly recommends a delay in the effective date by one additional year — applying to tax years of foreign corporations beginning after December 31, 2023. This would allow for more rational implementation and administration. A delayed effective date would also mitigate the competitive disadvantage of subjecting U.S.-based companies to a global minimum tax regime before their foreign counterparts become subject to one.

In terms of the qualified business asset investment reduction, TEI recommends that Congress revise the provision to maintain the 10 percent deemed rate of return under existing law or, at a minimum, harmonize it with the
OECD/G-20 agreement’s formulaic substance carveout. Enacting tax policy in the United States that is more burdensome than the policy reflected in the OECD/G-20 agreement would needlessly risk U.S. economic competitiveness.

TEI is also concerned that, if enacted in its current form, the provision’s special separate limitation loss rule would expose taxpayers to potential instances of unmitigated international double taxation of income in the GILTI FTC basket. This exposure would result from the fact that excess separate limitation loss in a non-GILTI basket could still offset separate limitation income in the GILTI basket for a different country, potentially preventing the taxpayer’s use of associated FTCs. In other words, while the proposed CbC application of section 904 aims to end the blending of jurisdictional foreign tax crediting, such blending would nonetheless continue under the provision’s special separate limitation loss rule.

TEI recommends that Congress amend section 951A to expressly allow taxpayers an annual election to exclude income of a controlled foreign corporation taxable unit from treatment as tested income under section 951A if such income is subject to an effective foreign tax rate of at least 15 percent, applying U.S. tax principles. This high-tax exclusion could be modeled on existing Treasury regulations, provided that taxpayers are permitted to make the election annually and on a per-country basis. Such an election would help avoid inequitable results in cases in which, because of timing differences between U.S. and foreign law, the effective tax rate of a particular country may vary significantly from year to year, and applying the high-tax exclusion could itself expose the taxpayer to double taxation. This approach would more closely align with pillar 2 while still preventing taxpayers from using excess FTCs from foreign taxes paid to high-tax countries to reduce their U.S. tax liability on income earned in low-tax countries.

The BBBA would temporarily limit the carryforward of excess foreign taxes in the GILTI basket to five succeeding tax years for any such taxes paid or accrued in tax years beginning before January 1, 2031. TEI recommends that Congress amend this provision to eliminate the temporary limitation on the carryforward of excess foreign taxes in the GILTI basket to only five succeeding tax years.

In terms of the limitations on deductions for interest expense, under the OECD’s recommended approach, taxpayers can deduct interest expense based on whichever of the two limitations allows for a greater interest expense deduction. TEI recommends that Congress preserve U.S. economic competitiveness by aligning with the OECD’s recommended approach, whereby the amount of interest that would be deductible in any tax year would be determined by the more permissive of the two limitations.

By proposing to incorporate an effective foreign tax rate test into the base erosion and antiabuse tax, the BBBA seeks to better align the BEAT regime with the pillar 2 UTPR, which would deny deductions or require an equivalent adjustment to the extent that low-taxed income of a constituent entity is not subject to tax under a qualifying income inclusion rule (for example, one with a minimum tax rate of 15 percent). The proposal could mitigate the overinclusiveness of the existing regime, which generally fails to distinguish between base-eroding payments made to low-taxed affiliates and those made elsewhere. However, TEI is deeply concerned about the provision’s lack of clear legislative rules for establishing the effective rate of foreign income tax. TEI recommends that Congress either adopt or specifically authorize Treasury to issue regulations adopting an approach that conforms to the effective tax rate test used by the UTPR in pillar 2.

Practice Units

BEAT

The IRS released a practice unit titled “IRC 59A Base Erosion Anti-Abuse Tax Overview” (INT-C-245). The practice unit provides an overview of the BEAT regulatory history, an overview of how BEAT operates, and summary comparison of BEAT to the AMT. It further defines the terms and acronyms used in determining the BEAT and explains various BEAT concepts, including how to determine an aggregate group. This practice unit has a fair amount of detail and is not simply a high-level overview of the BEAT. The practice unit references the regulations and describes the many rules that are relevant in calculating the BEAT.

In the overview, the IRS provides that the BEAT gross receipts threshold generally includes total sales (net of returns and allowances) and all amounts received for services, interest, dividends, rents, royalties, and annuities, regardless of whether these amounts are derived in the ordinary course of the taxpayer’s trade or business. It details that the gross receipts are not reduced by cost of goods sold or by the cost of property sold if that property is excluded from the capital asset definition under section 1221 — for example, stock sold to customers as part of the taxpayer’s trade or business and patents created by the taxpayer. For sales of capital assets as defined in section 1221 or sales of property described in section 1221(2) (relating to property used in a trade or business), gross receipts must be reduced by the taxpayer’s adjusted basis in the property.

The BEAT practice unit describes the operating rules to determine a base erosion payment, including payments that are excluded, and describes the antiabuse rules in detail. It also summarizes the various effective dates in each set of BEAT regulations that have been released.

After explaining the BEAT requirements in detail, the practice unit includes a few examples with detailed calculations. Lastly, it includes a list of all tax forms in which BEAT items must be reported.

Flow-Through FTC

The IRS updated a prior practice unit on the effects of flow-through entities on the FTC
(INT-C-057). The update reflects the finalization of reg. section 1.861-9. The practice unit cites reg. section 1.861-9 and states that under the rules for sourcing partnership interest deduction to individuals who are general partners or partners whose interest in the partnership is 10 percent or more, they must classify their distributive share of partnership interest expense as interest in the following categories:

• interest incurred in the active conduct of a trade or business;

• passive activity interest; or

• investment interest.

Then they must apportion their interest expense under the following rules:

• individuals who incur business interest apportion that interest expense using an asset method by reference to the individual’s business assets;

• individuals who incur investment interest apportion that interest expense on the basis of the individual’s investment assets; or

• individuals who incur passive activity interest apportion that interest expense on the basis of the individual’s passive activity assets.

The individual’s assets for the purpose of these allocations include its proportionate share of the partnership’s assets. Limited partners whose interest in the partnership is 10 percent or less generally allocate interest expense proportionately based on the partner’s distributive share of foreign-source gross income in each limitation category.

International No-Rule List

The IRS updated its no-rule lists for 2022, providing a list of areas and code sections for which it will not issue letter rulings or determination letters. Rev. Proc. 2022-7, 2022-1 IRB 297, provides the no-rule list for international tax issues. This list is almost identical to the 2021 international tax no-rule list (Rev. Proc. 2021-7, 2021-1 IRB 290). The only change is in the revenue procedure’s section 4.01(5) related to portfolio interest exemption.

Hedges Letter Ruling

In LTR 202152012, the IRS issued a ruling on the integration of a hedge related to the foreign currency exposure on an acquisition.

The publicly traded Parent of a consolidated group of companies formed a Subsidiary to acquire a Target company. The Subsidiary has potential currency exposure because the cash consideration must be paid in Currency A, and Subsidiary has the U.S. dollar as its functional currency. Thus, Subsidiary will purchase Currency A and Currency A derivatives to hedge its Currency A exposure relative to the U.S. dollar up to the maximum cash amount needed in the acquisition.

The maximum cash amount will only be reduced when the amount of cash consideration required to be paid to the Target shareholders decreases. The maximum cash amount will only be increased if the cash consideration offered for Target shares under the acquisition is increased and then only by the amount of that increase. The maximum cash amount will never be adjusted based on projections of the maximum cash amount, including projections regarding the number of Target shares that will elect stock consideration or the number of employee shares.

Until all the conditions for the acquisition are satisfied, Subsidiary will not know when the acquisition will accrue or close. Whether the conditions for the acquisition will be satisfied and the aggregate amount of cash consideration will not be known until very close to the time of the acquisition. For example, the acquisition is dependent on regulatory approvals. Also, the acquisition could be dependent on court approval, and the timing might be determined by Target shareholder acceptances in certain circumstances.

The taxpayer represented that each hedge will satisfy the requirements of reg. section 1.988-5(b) (treating the offer announcement as the date on which the executory contract is entered and the anticipated Target share acquisition as the executory contract), including:

(i) each Hedge is either (A) a Currency A deposit placed in a hedging account as defined in Treas. Reg. section 1.988-5(b)(2)(iii)(D) (any such Hedge, a “Deposit”) or (B) a forward, future, or option described in Treas. Reg. section 1.988-1(a)(1)(ii) and (2)(iii) and Treas. Reg. section 1.988-5(b)(2)(iii)(A), in either case that is a “section 988 transaction” within the meaning of section 988(c)(1),

(ii) each Hedge has or will be timely identified in accordance with Treas. Reg. section 1.988-5(b)(3) as a hedge for integration with the anticipated Target share acquisition pursuant to the Treas. Reg. section 1.988-5(e) private letter ruling, if received,

(iii) each Hedge was or is entered into on or after the offer announcement (and after Date A) and before the accrual date as defined in Treas. Reg. section 1.988-5(b)(2)(iv) (the “Accrual Date”) in accordance with Treas. Reg. section 1.988-5(b)(2)(i)(B), treating each transaction separately and not combining any Hedge with a subsequent transaction, even if the item is or was acquired or entered into to replace or otherwise succeed a Hedge,

(iv) the anticipated Target share acquisition is hedged in whole or in part with Hedges through the period beginning with the date the first Hedge was identified in accordance with Treas. Reg. section 1.988-5(b)(3) and ending on or after the Accrual Date,

(v) none of the parties to any Hedge are related within the meaning of section 267(b) or 707(c)(1), and

(vi) each Hedge will only hedge Subsidiary’s Currency A exposure to the anticipated Target acquisition.

Subsidiary will not hedge more than the maximum cash amount. Subsidiary has not and will never reduce and then increase afterward the Currency A amount of the hedges, even if the maximum cash amount increases subsequently. On any day the maximum cash amount is subject to a reduction, Subsidiary will reduce (or treat as sold for its fair market value at that time) the portion of the hedges in excess of the maximum cash amount that day and clearly identify what portion of the hedges has been reduced (or treated as sold).

The accrual date for the Target acquisition under Method 1 (the court approval method) is the date the applicable court approves the acquisition. The accrual dates for the Target acquisition under Method 2 (closing and acceptance condition method) are the dates the offer becomes unconditional (in other words, the date all the closing and acceptance conditions are satisfied), any subsequent dates on which a Target shareholder accepts the offer during the offer period, and if there is a squeeze-out, the squeeze-out date.

The taxpayer represented that Subsidiary will include any interest income from deposits in income as provided in section 61. Subsidiary will not treat any item as a hedge that does not meet the definition of a hedge, including the requirements listed above. Hedges will be used only to pay cash consideration. If all or a portion of the hedges are determined to be unneeded as a result of a reduction, the unneeded hedge will be sold or terminated, or treated as sold for its FMV at that time, on the day of the reduction. Subsidiary has not and will not make an election under section 988(a)(1)(B) regarding any hedge.

Parent has determined that the acquisition and the hedges are not eligible for hedge accounting treatment. Subsidiary will only adjust the amount of the hedges as provided above and will not engage in speculative trading of any foreign currency.

Section 988(d)(1) provides that, to the extent provided in regulations, if any section 988 transaction is part of a section 988 hedging transaction, all transactions which are part of such section 988 hedging transaction shall be integrated and treated as a single transaction or otherwise treated consistently.

Reg. section 1.988-5(e) provides that in his sole discretion, the IRS commissioner may issue an advance ruling addressing the income tax consequences of a taxpayer’s system of hedging either its net nonfunctional currency exposure or anticipated nonfunctional currency exposure.

The anticipated Target acquisition is not an executory contract as defined in reg. section 1.988-5(b)(2)(ii), and therefore there is no executory contract at the time the hedging transactions are entered into, which would qualify for integrated hedging treatment under reg. section 1.988-5(b). Absent an advance ruling to the contrary under reg. section 1.988-5(e), Subsidiary is required to treat the hedges as separate section 988 transactions that are not integrated with the anticipated Target share acquisition. Without an advance ruling, foreign currency gains or losses on hedges would be realized and recognized under appropriate timing principles.

The ruling determined that Subsidiary should be allowed to generally apply the principles of reg. section 1.988-5(b) (with certain modifications) to integrate its hedges of underlying foreign currency exposure for its anticipated Target share acquisition.

The ruling only applies the principles of reg. section 1.988-5(b) (treating the anticipated Target share acquisition as an executory contract under reg. section 1.988-5(b)(2)(ii) and the hedges as hedges under reg. section 1.988-5(b)(2)(iii)) if the acquisition is completed or terminated within one year, subject to the following modifications:

a. For any Unneeded Hedge amount, Subsidiary will dispose of (or treat as sold for fair market value) the Hedges in an amount equal to the Unneeded Hedge amount on the day it is determined that there is an Unneeded Hedge, which will be the same day as the relevant reduction, in the order in which the Hedges were acquired (in other words, under a first in, first out method). For this purpose, each transaction is treated separately and no subsequent transaction is combined with a prior Hedge, even if the item is or was acquired or entered into to replace or otherwise succeed a Hedge. If more than one Hedge was acquired on a single day, the Hedges for that day will be disposed of on a pro rata basis (based on the number of Currency A hedged by each transaction). Any amount disposed of (or treated as sold) will no longer be a Hedge and Subsidiary will revise the identification for any amount it treated as sold at that time. The foreign currency gain or loss from any Unneeded Hedge amount will be treated the same as the other Hedges. Any foreign currency gain or loss from a section 988 transaction that is retained after it is no longer a Hedge will not be covered by the ruling and instead will be subject to the general rules under section 988.

b. Subsidiary will allocate a pro rata portion of the net foreign currency gain or loss from the Hedges to the basis of each Target share acquired.

c. If the amount of the Hedges is less than the total Cash Consideration required to be paid, Subsidiary will apply the rule in Treas. Reg. section 1.988-5(b)(4)(ii) to the portion of the Target shares for which the Hedges were not sufficient to pay for the Cash Consideration, except paragraph (1)b will still apply to those shares.

If the acquisition is not completed within one year, Subsidiary will treat the hedges as sold for FMV on the day that is one year after and the resulting gain or loss is recognized on such date as section 988 gain or loss.

The basis for Currency A in the deposit account will not be averaged but instead will be determined under the first-in, first-out method.