|Code Section||Effective Date||Name of Act||Name of Provision||10yr Revenue Estimate ($millions)|
|901(m)||*12/31/2010||The Air Traffic Control Act||Denial of Foreign Tax Credit with Respect to Foreign Income Not Subject to U.S. Taxation by Reason of Covered Asset Acquisitions||3,645|
* Notes on Effective Date
In general, the provision is effective for covered asset acquisitions after December 31, 2010. However, the provision does not apply to any covered asset acquisition with respect to which the transferor and transferee are not related if the acquisition is (1) made pursuant to a written agreement that was binding on January 1, 2011, and at all times thereafter, (2) described in a ruling request 1196 submitted to the IRS on or before July 29, 2010, or (3) described in a public announcement or filing with the SEC on or before January 1, 2011.
For this purpose, a person is treated as related to another person if the relationship between such persons is described in section 267 or 707(b).
Denial of Foreign Tax Credit with Respect to Foreign Income Not Subject to U.S. Taxation by Reason of Covered Asset Acquisitions
Explanation of Provision
The provision denies a foreign tax credit for the disqualified portion of any foreign income tax paid or accrued in connection with a covered asset acquisition.
A ‘‘covered asset acquisition’’ means: (1) a qualified stock purchase (as defined in section 338(d)(3)) to which section 338(a) applies; 1192 (2) any transaction that is treated as the acquisition of assets for U.S. tax purposes and as the acquisition of stock (or is disregarded) 1193 for purposes of the foreign income taxes of the relevant jurisdiction; 1194 (3) any acquisition of an interest in a partnership that has an election in effect under section 754; and (4) to the extent provided by the Secretary, any other similar transaction. It is anticipated that the Secretary will issue regulations identifying other similar transactions that result in an increase to the basis of assets for U.S. tax purposes without a corresponding increase for foreign tax purposes.
The disqualified portion of any foreign income taxes paid or accrued with respect to any covered asset acquisition, for any taxable year, is the ratio (expressed as a percentage) of (1) the aggregate basis differences allocable to such taxable year with respect to all relevant foreign assets, divided by (2) the income on which the foreign income tax is determined. For this purpose, the income on which the foreign income tax is determined is the income as determined under the law of the relevant jurisdiction. If the taxpayer fails to substantiate such income to the satisfaction of the Secretary, then such income is determined by dividing the amount of such foreign income tax by the highest marginal tax rate applicable to such income in the relevant jurisdiction.
For purposes of determining the aggregate basis difference allocable to a taxable year, the term ‘‘basis difference’’ means, with respect to any relevant foreign asset, the excess of (1) the adjusted basis of such asset immediately after the covered asset acquisition, over (2) the adjusted basis of such asset immediately before the covered asset acquisition. Thus, it is the tax basis for U.S. tax purposes that is relevant, and not the basis as determined under the law of the relevant foreign jurisdiction. Because CFCs are generally limited to straight-line cost recovery, it is anticipated that the basis difference applying U.S. tax principles generally is less than if the taxpayer were required to use the basis as determined under foreign law immediately before the covered asset acquisition. However, it is anticipated that the Secretary will issue regulations identifying those circumstances in which, for purposes of determining the adjusted basis of such assets immediately before the covered asset acquisition, it may be acceptable to utilize the basis of such asset under the law of the relevant jurisdiction or another reasonable method.
A built-in loss in a relevant foreign asset (i.e., in cases in which the fair market value of the asset is less than its adjusted basis immediately before the asset acquisition) is taken into account in determining the aggregate basis difference; however, a built-in loss cannot reduce the aggregate basis difference allocable to a taxable year below zero.
In the case of a qualified stock purchase to which section 338(a) applies, the covered asset acquisition is treated as occurring at the close of the acquisition date (as defined in section 338(h)(2)). In general, the amount of the basis difference allocable to a taxable year with respect to any relevant foreign asset is determined using the applicable cost recovery method under U.S. tax rules. If there is a disposition of any relevant foreign asset before its cost has been entirely recovered or of any relevant foreign asset that is not eligible for cost recovery (e.g., land), the basis difference allocated to the taxable year of the disposition is the excess of the basis difference with respect to such asset over the aggregate basis difference with respect to such asset that has been allocated under this provision to all prior taxable years. Thus, any remaining basis difference is captured in the year of the sale, and there is no remaining basis difference to be allocated to any subsequent tax years. However, it is intended that this provision generally apply in circumstances in which there is a disposition of a relevant foreign asset and the associated income or gain is taken into account for purposes of determining foreign income tax in the relevant jurisdiction.
To illustrate, assume USP, a domestic corporation, acquires 100 percent of the stock of FT, a foreign target organized in Country F with a ‘‘u’’ functional currency, in a qualified stock purchase for which a section 338(g) election is made. The tax rate in Country F is 25 percent. Assume further that the aggregate basis difference in connection with the qualified stock purchase is 200u, including: (1) 150u that is attributable to Asset A, with a 15-year recovery period for U.S. tax purposes (10u of annual amortization); and (2) 50u that is attributable to Asset B, with a 5-year recovery period (10u of annual depreciation). In each of years 1 and 2, FT’s taxable income is 100u for foreign tax purposes and FT pays foreign income tax of 25u (equal to $25 when translated at the average exchange rate for the year). As a result, the disqualified portion of foreign income tax in each of years 1 and 2 is $5 ((10u + 10u of allocable basis difference / 100u of foreign taxable income) × $25 foreign tax paid).
In year 3, FT’s taxable income is 140u, 40u of which is attributable to gain on the sale of Asset B. FT’s Country F tax is 35u (equal to $35 translated at the average exchange rate for the year). Accordingly, the disqualified portion of its foreign income taxes paid is $10 ((40u (including 10u of annual amortization on Asset A and 30u attributable to disposition of Asset B) of allocable basis difference / 140u of foreign taxable income) × $35 foreign tax paid).
An asset is a ‘‘relevant foreign asset’’ with respect to any covered asset acquisition, whether the entity acquired is domestic or foreign, only if any income, deduction, gain, or loss attributable to the asset (including goodwill, going concern value, and any other intangible asset) is taken into account in determining foreign income tax in the relevant jurisdiction. For this purpose, the term ‘‘foreign income tax’’ means any income, war profits, or excess profits tax paid or accrued to any foreign country or to any possession of the United States, including any tax paid in lieu of such a tax within the meaning of section 903. In cases in which there has been a covered asset acquisition that involves either (1) both U.S. assets and relevant foreign assets, or (2) assets in multiple relevant jurisdictions, it is anticipated that the Secretary may issue regulations clarifying the manner in which any relevant foreign asset (such as intangible assets that may relate to more than one jurisdiction) are to be allocated between those jurisdictions. It is also anticipated that the Secretary may issue regulations to clarify the extent to which income is considered attributable to a relevant foreign asset, as well as the treatment of an asset that ceases to be taken into account in determining the foreign income tax in the relevant jurisdiction by some mechanism other than a disposition.
To the extent that a foreign tax credit is disallowed, the disqualified portion is allowed as a deduction to the extent otherwise deductible.1195
The Secretary may issue regulations or other guidance as is necessary or appropriate to carry out the purposes of this provision, including to provide (1) an exemption for certain covered asset acquisitions, and (2) an exemption for relevant foreign assets with respect to which the basis difference is de minimis. For example, it is anticipated that the Secretary will exclude covered asset acquisitions that are not taxable for U.S. purposes, or in which the basis of the relevant foreign assets is also increased for purposes of the tax laws of the relevant jurisdiction.
1192- This includes transaction under section 338(g) and section 338(h)(10).
-Return to Explanation of Provision
1193- >For example, the deemed liquidation of a CFC as the result of the making of an entity classification election pursuant to Treas. Reg. sec. 301.7701–3 may result in a section 331 liquidation for U.S. tax purposes that is disregarded for foreign income tax purposes.
-Return to Explanation of Provision
1194- Section 336(e) provides that, to the extent provided by the Secretary, in cases in which (1) a corporation owns at least 80 percent of the vote and value of stock of another corporation (as defined in section 1504(a)(2)), and (2) such corporation sells, exchanges, or distributes all of stock of such corporation, an election may be made to treat this sale, exchange, or distribution as a disposition of all of the assets of the other corporation, and no gain or loss is recognized on the sale, exchange, or distribution of the stock. To date, the Secretary has not promulgated regulations under section 336(e) so no election may be made. Nonetheless, to the extent regulations are promulgated under section 336(e) in the future permitting such an election to be made, a transaction to which the section 336(e) election relates would be a covered asset acquisition.
-Return to Explanation of Provision
1195- Sec. 164(a)(3).
-Return to Explanation of Provision