Code Section 960
| Code Section | Effective Date | Name of Act | Name of Provision | 10yr Revenue Estimate ($millions) |
|---|---|---|---|---|
| 960 | 12/31/2010 | The Air Traffic Control Act | Limitation on the Amount of Foreign Taxes Deemed Paid with Respect to Section 956 Inclusions | 704 |
Limitation on the Amount of Foreign Taxes Deemed Paid with Respect to Section 956 Inclusions
Explanation of Provision
The provision imposes a limit on the amount of foreign taxes that a U.S. Shareholder is deemed to pay with respect to any section 956 inclusion.
For section 956 inclusions attributable to United States property acquired by a CFC after the effective date, the amount of foreign taxes deemed paid in each separate category is determined by comparing the foreign taxes deemed paid with respect to the U.S. Shareholder’s section 956 inclusion (determined without regard to the provision) (the ‘‘tentative credit’’) to its hypothetical amount of foreign taxes deemed paid as computed under the provision (the ‘‘hypothetical credit’’). The U.S. Shareholder’s hypothetical credit is the amount of foreign taxes it would have been deemed to have paid if cash in an amount equal to the section 956 inclusion had been distributed through the chain of ownership that begins with the foreign corporation that holds the investment in United States property and ends with the U.S. Shareholder. If the hypothetical credit is less than the tentative credit, then the amount of foreign taxes deemed paid with respect to the section 956 inclusion is limited to the hypothetical credit. However, the amount of the tentative credit is not increased if the hypothetical credit would have been greater than the tentative credit. This limitation applies whether the U.S. Shareholder chooses to claim a credit 1243 for foreign taxes paid or accrued, or to deduct such taxes.1244
In general, present-law foreign tax credit rules apply in determining the hypothetical credit. The only exception is that, to the extent an actual distribution would be subject to any income or withholding tax, such taxes are not taken into account in determining the hypothetical credit.1245 Thus, the generally applicable rules and definitions 1246 apply to each hypothetical distribution. For example, assume that, for the relevant tax year, and before taking into account the hypothetical distribution under the provision, a U.S. parent (‘‘USP’’) owns all of the vote and value of CFC1, a CFC organized in Country A with post-1986 undistributed earnings of 200u, and post-1986 foreign income taxes of $10.1247 CFC1 owns all of the vote and value of CFC2, a CFC organized in Country B with post-1986 undistributed earnings of 100u, and post-1986 foreign income taxes of $50. If CFC2 makes a loan to USP that results in a section 956 inclusion of 100u, the tentative credit is $50 (equal to 100u/100u × $50).
The hypothetical distribution of 100u from CFC2 to CFC1 would increase CFC1’s current E&P by 100u, from 200u to300u, and increase CFC1’s foreign income taxes from $10 to $60. The 100u hypothetical distribution results in a dividend of 100u that is non-subpart F income of CFC1 under the subpart F look-through rules.1248 Although Country B would impose a 10 percent withholding tax on an actual distribution of 100u to CFC1, for a total withholding tax of 10u, this amount is not taken into account in determining the hypothetical credit. Next, the 100u hypothetical distribution from CFC1 to USP would result in a dividend of 100u, on which USP would be deemed to have paid $20 in taxes.1249 Because the hypothetical credit of $20 is less than the tentative credit of $50, USP’s foreign taxes deemed paid with respect to its section 956 inclusion are limited to $20. USP’s section 78 gross-up with respect to the section 956 inclusion is also $20.1250
The provision is applied with regard to earnings and taxes in each separate category. In addition, treatment of any foreign taxes over the limit imposed under the provision (the ‘‘excess taxes’’) is the same as the treatment of any other foreign taxes paid or accrued, but not yet deemed paid for purposes of the foreign tax credit rules. Thus, if a foreign corporation’s excess taxes are in its general category post-1986 foreign income taxes pool, the foreign corporation’s excess taxes are still considered general category post- 1986 foreign income taxes.1251 Accordingly, such taxes are included in the computation of foreign taxes deemed paid with respect to a subsequent distribution from, or income inclusion with respect to, that foreign corporation, subject to applicable limitations including the limitation of the provision. In the example above, excess taxes that remain at CFC2 equal $30.1252
The provision applies to United States property acquired by a CFC after December 31, 2010. Thus, for example, any section 956 inclusions from a CFC loan that was made to its U.S. parent on or before December 31, 2010, would not be subject to the limitation imposed by the provision. However, the limitation imposed by the provision would apply if, after December 31, 2010, there is a significant modification of the debt instrument such that the original debt instrument is considered as exchanged for a modified instrument that differs materially from the original.1253
The provision requires the Secretary to issue regulations or guidance to carry out the purposes of the provision, including regulations that prevent the inappropriate use of the foreign corporation’s foreign income taxes not deemed paid by reason of the provision. It is anticipated that guidance will prohibit the inappropriate use of excess taxes, and will address attempted avoidance of the provision through a series of transactions.
1243- Sec. 901.
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1244- Sec. 164(a)(3).
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1245- Similarly, if this hypothetical distribution would be subject to a withholding tax upon distribution to USP, if it had been actually made, any such tax would not be taken into account in determining the hypothetical credit. However, this conclusion results because such taxes are described in section 901(b), thus they are outside the scope of the provision.
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1246- See, e.g., secs. 902(b), (c), and 904(d)(3)(B), (D).
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1247- For purposes of this example, assume that each CFC has: (1) a ‘‘u’’ functional currency; (2) E&P comprising solely post-1986 undistributed earnings or deficits in post-1986 undistributed earnings, such that there are no pre-1987 accumulated profits; (3) only post-1986 foreign income taxes; (4) no previously-taxed income; (5) only E&P and foreign income taxes in the section 904(d) general category; and (6) no other attributes than those listed. Except as provided in the example, there are no other distributions or inclusions during the taxable year. In addition, Country B imposes a 10-percent withholding tax on dividend payments to foreign shareholders.
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1248- Sec. 954(c)(6). This assumes that the subpart F look-through rules of section 954(c)(6) are extended, and are therefore applicable to the hypothetical distribution. In the event the lookthrough rule of section 954(c)(6) expires, the 100u hypothetical distribution would result in a dividend of 100u that would be currently included in USP’s income as a subpart F item at the level of CFC1.
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1249- The hypothetical amount of foreign taxes deemed paid equals (100u/300u) × $60. The post- 1986 undistributed earnings that is the denominator of the section 902(a) fraction for purposes of the provision equals CFC1’s post-1986 undistributed earnings of 200u (determined without regard to the provision) plus the amount of the hypothetical dividend from CFC2, 100u.
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1250- If, in the same taxable year, CFC1 were also to make an actual distribution of all its accumulated E&P of 200u, the 100u hypothetical distribution from CFC1 to USP would have no impact on the calculation of USP’s actual deemed paid credit from CFC1’s actual dividend. The deemed-paid credit on the 200u dividend would be $10, which equals (200u/200u × $10). In addition, the calculation of the hypothetical credit with respect to the hypothetical distribution of 100u from CFC2 would be the same (100u/300u × $60 = $20) whether or not CFC1 paid an actual
dividend.
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1251- Sec. 902(c)(2).
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1252- The excess taxes equal the deemed paid foreign tax credit (determined without regard to the provision) of $50 minus the hypothetical credit of $20. Alternatively, if CFC2’s E&P also included 125u in previously taxed income (which is taken into account in determining that the section 956 inclusion is 100u), then the excess taxes remaining at CFC2 would be $50, because the applicable ordering rules would prioritize the hypothetical distribution as coming first from the 125u in previously taxed income over the 100u in untaxed earnings. See sec. 959(c).
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1253- See Treas. Reg. sec. 1.1001–3.
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