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The IRS and Treasury have issued new guidance on the treatment of United States property held by a controlled foreign corporation (CFC) in connection with certain transactions that involve partnerships. The regulations are issued under IRC Section 956, the Code section under which the amount a U.S. shareholder in a CFC must include in the shareholder’s gross income with respect to the CFC is determined.
Under IRC Section 956, in the case of any CFC, the amount determined under Section 956 with respect to any U.S. shareholder for any taxable year is the lesser of two amounts:
(1) such shareholder’s pro rata share of the average of the amounts of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of such taxable year, over the amount of earnings and profits described in Section 959(c)(1)(A) with respect to such shareholder, or
(2) such shareholder’s pro rata share of the CFC’s applicable earnings. [IRC § 956(a)].
The preamble to proposed regulations states: “The current regulations under Section 956 do not specifically address when the obligations of a foreign partnership will be treated as United States property.” [Preamble, 80 FR 53058]. The preamble further states that under the proposed regulations, an obligation of a foreign partnership is treated as an obligation of its partners for purposes of Section 956, with an exception for obligations of foreign partnerships in which neither the lending CFC nor any person related to the lending CFC is a partner. [Preamble, 80 FR 53058]. The preamble points to, specifically, the new rule in Treasury Regulation Section 1.956-4(c)(1):
Except as provided in paragraphs (c)(2) and (3) of this section [1.956-4], for purposes of section 956 , an obligation of a foreign partnership is treated as a separate obligation of each of the partners in the partnership to the extent of each partner's share of the obligation. A partner's share of the partnership's obligation is determined in accordance with the partner's interest in partnership profits. The partner's interest in partnership profits is determined by taking into account all facts and circumstances relating to the economic arrangement of the partners. An upper-tier partnership's share of an obligation of a lower-tier partnership is treated as an obligation of the upper-tier partnership for purposes of applying this paragraph (c)(1) to the partners of the upper-tier partnership. [Treas Reg § 1.956-4(c)(1)].
The exception in Treasury Regulation Section § 1.956-4(c)(2) is for obligations of partnerships in which neither the lending CFR nor any person related to the lending CFC is a partner. Pursuant to the exception, for purposes of Section 956, such obligations of foreign partnerships will be treated as obligations of the foreign partnerships, not as obligations of the partners. [Preamble, 80 FR 53058; Treas Reg § 1.956-4(c)(2)].
In addition, Treasury Regulation Section 1.956-4(c)(3) provides a special obligor rule in the case of certain partnership distributions. As explained in the preamble, under the special obligor rule, the amount of a foreign partnership obligation that is treated as U.S. property under the general rule will be increased when certain requirements are met. [Preamble, 80 FR 53058].
In addition to the new rules applicable to partnerships in Treasury Regulation Section 1.956-4, the proposed regulations include new rules with respect to certain trade or service receivables acquired from U.S. persons, in Treasury Regulation Section 1.956-3.