Proposed Regs Focus on Hybrid Arrangements, Deduction Allocation

Proposed Regs Focus on Hybrid Arrangements, Deduction Allocation

Internal Revenue Service

The IRS has published proposed regulations (REG-106013-19) on hybrid arrangements and the allocation of deductions attributable to some disqualified payments under section 951A on global intangible low-taxed income. The IRS issued companion final regs (<a href="/lr/resolve//2cczg">T.D. 9896</a>) under section 245A(e) on hybrid dividends and some amounts paid or accrued under hybrid arrangements. Comments and public hearing requests on the proposed regs are due by June 8. The preamble to the proposed regs explains that a failure to reduce hybrid deduction accounts by some earnings of a controlled foreign corporation that are indirectly included in the income of a U.S. shareholder may result in double taxation for some taxpayers. An example is an account that has subpart F or GILTI income inclusions. Failure to address some equity interests under the conduit financing regulations may allow some multinational corporations to avoid U.S. tax by shifting additional income toward conduit financing arrangements that use financial instruments treated as equity for U.S. tax purposes but as debt in a foreign jurisdiction. Treasury and the IRS are aware that some transactions that accelerate income but do not give rise to a disposition of property fall outside the scope of the GILTI final regs. To treat similar transactions similarly, these types of transactions need to be addressed by regulation, the preamble states. The proposed regs focus on three issues: adjustments to hybrid deduction accounts to take into account earnings and profits of a CFC that are included in income by a U.S. shareholder; conduit financing arrangements that use some equity interests that allow the issuer a deduction or other tax benefit under foreign tax law; and the treatment of some payments between related CFCs during a disqualified period under section 951A and the GILTI final regs. First, T.D. 9896 (the section 245A(e) final regs) stipulates that hybrid deduction accounts should generally be reduced to the extent that earnings and profits of the CFC that have not been subject to foreign tax as a result of some hybrid arrangements are included in income in the United States by some provision other than section 245A(e). The proposed regs provide new rules for reducing hybrid deduction accounts because of income inclusions attributable to subpart F, GILTI, and sections 951(a)(1)(B) and 956. An inclusion because of subpart F or GILTI reduces a hybrid deduction account only to the extent that the inclusion is not offset by a deduction or credit, such as a foreign tax credit, that likely will be afforded to the inclusion. Because deductions and credits are typically not available to offset income inclusions under section 951(a)(1)(B) and 956, these inclusions reduce a hybrid deduction account dollar-for-dollar. Second, the proposed regs address conduit financing arrangements under reg. section 1.881-3 by expanding the types of transactions classified as financing transactions. If the issuer of a financial instrument is allowed a deduction or tax benefit for an amount paid, accrued, or distributed regarding a stock or similar interest under the tax law of the foreign jurisdiction when the issuer is a resident, then it may now be characterized as a financing transaction even though the instrument is equity for U.S. tax purposes. Accordingly, the conduit financing regs would apply to multiple-party financing arrangements using these types of instruments, which include some types of hybrid instruments. This change aligns the conduit regulations with the policy of section 267A by discouraging the exploitation of differences in treatment of financial instruments across jurisdictions. While section 267A and the final regs apply only if the deduction/no inclusion outcome results from the use of a hybrid entity or instrument, the conduit financing regs apply regardless of causation and instead look to whether there is a tax avoidance plan. Thus, the new rule addresses economically similar transactions that section 267A and the section 267A final regs do not cover. Lastly, the proposed regs address the treatment of some payments between related CFCs during a disqualified period under section 951A and the GILTI final regs. Specifically, this section of the proposed regs focuses on payments made after December 31, 2017, but before the date of the start of the first fiscal year for the transferor CFC for which 951A applies (the disqualified period) in which payments, such as prepayments of royalties, create income during the disqualified period and a corresponding deduction or loss claimed in tax years after the disqualified period. Absent the proposed regs, those deductions or losses could have been used to reduce tested income or increase tested losses, among other benefits. However, under the proposed regs these deductions will no longer provide such a tax benefit and will instead be allocated to residual CFC income, similar to deductions or losses from some property transfers in the disqualified period under the GILTI final regs.

The IRS has published proposed regulations (REG-106013-19) on hybrid arrangements and the allocation of deductions attributable to some disqualified payments under section 951A on global intangible low-taxed income.

The IRS has published proposed regulations (REG-106013-19) on hybrid arrangements and the allocation of deductions attributable to some disqualified payments under section 951A on global intangible low-taxed income. The IRS issued companion final regs (T.D. 9896) under section 245A(e) on hybrid dividends and some amounts paid or accrued under hybrid arrangements. Comments and public hearing requests on the proposed regs are due by June 8. The preamble to the proposed regs explains that a failure to reduce hybrid deduction accounts by some earnings of a controlled foreign corporation that are indirectly included in the income of a U.S. shareholder may result in double taxation for some taxpayers. An example is an account that has subpart F or GILTI income inclusions. Failure to address some equity interests under the conduit financing regulations may allow some multinational corporations to avoid U.S. tax by shifting additional income toward conduit financing arrangements that use financial instruments treated as equity for U.S. tax purposes but as debt in a foreign jurisdiction. Treasury and the IRS are aware that some transactions that accelerate income but do not give rise to a disposition of property fall outside the scope of the GILTI final regs. To treat similar transactions similarly, these types of transactions need to be addressed by regulation, the preamble states. The proposed regs focus on three issues: adjustments to hybrid deduction accounts to take into account earnings and profits of a CFC that are included in income by a U.S. shareholder; conduit financing arrangements that use some equity interests that allow the issuer a deduction or other tax benefit under foreign tax law; and the treatment of some payments between related CFCs during a disqualified period under section 951A and the GILTI final regs. First, T.D. 9896 (the section 245A(e) final regs) stipulates that hybrid deduction accounts should generally be reduced to the extent that earnings and profits of the CFC that have not been subject to foreign tax as a result of some hybrid arrangements are included in income in the United States by some provision other than section 245A(e). The proposed regs provide new rules for reducing hybrid deduction accounts because of income inclusions attributable to subpart F, GILTI, and sections 951(a)(1)(B) and 956. An inclusion because of subpart F or GILTI reduces a hybrid deduction account only to the extent that the inclusion is not offset by a deduction or credit, such as a foreign tax credit, that likely will be afforded to the inclusion. Because deductions and credits are typically not available to offset income inclusions under section 951(a)(1)(B) and 956, these inclusions reduce a hybrid deduction account dollar-for-dollar. Second, the proposed regs address conduit financing arrangements under reg. section 1.881-3 by expanding the types of transactions classified as financing transactions. If the issuer of a financial instrument is allowed a deduction or tax benefit for an amount paid, accrued, or distributed regarding a stock or similar interest under the tax law of the foreign jurisdiction when the issuer is a resident, then it may now be characterized as a financing transaction even though the instrument is equity for U.S. tax purposes. Accordingly, the conduit financing regs would apply to multiple-party financing arrangements using these types of instruments, which include some types of hybrid instruments. This change aligns the conduit regulations with the policy of section 267A by discouraging the exploitation of differences in treatment of financial instruments across jurisdictions. While section 267A and the final regs apply only if the deduction/no inclusion outcome results from the use of a hybrid entity or instrument, the conduit financing regs apply regardless of causation and instead look to whether there is a tax avoidance plan. Thus, the new rule addresses economically similar transactions that section 267A and the section 267A final regs do not cover. Lastly, the proposed regs address the treatment of some payments between related CFCs during a disqualified period under section 951A and the GILTI final regs. Specifically, this section of the proposed regs focuses on payments made after December 31, 2017, but before the date of the start of the first fiscal year for the transferor CFC for which 951A applies (the disqualified period) in which payments, such as prepayments of royalties, create income during the disqualified period and a corresponding deduction or loss claimed in tax years after the disqualified period. Absent the proposed regs, those deductions or losses could have been used to reduce tested income or increase tested losses, among other benefits. However, under the proposed regs these deductions will no longer provide such a tax benefit and will instead be allocated to residual CFC income, similar to deductions or losses from some property transfers in the disqualified period under the GILTI final regs.

Sec. 951A Global intangible low-taxed income included in gross income of United States shareholders

Sec. 245A Deduction for foreign source-portion of dividends received by domestic corporations from specified 10-percent owned foreign corporations.

Sec. 956 Investment of earnings in United States property

Sec. 881 Tax on income of foreign corporations not connected with United States business

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Proposed Regs Focus on Hybrid Arrangements, Deduction Allocation