Final regulations: Foreign tax credit “splitter” rules

Final regulations: Foreign tax credit “splitter” rules

The Treasury Department and IRS today released for publication in the Federal Register final regulations (T.D. 9710) on the application of the section 909 foreign tax credit “splitter” rules to post-2010 tax years.

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These final regulations [PDF 274 KB] adopt rules that were issued in proposed and temporary form in February 2012 with certain modifications made in response to written comments, and remove the corresponding temporary regulations.

Proposed regulations under section 704 concerning partnership inter-branch splitter arrangements are finalized and adopted without amendment, and the corresponding temporary regulations are removed.


The 2012 temporary and proposed regulations provided definitions of terms used in section 909, and an exclusive list of arrangements that are to be treated as giving rise to foreign tax credit splitting events for foreign taxes paid or accrued in tax years beginning on or after January 1, 2012.

The preamble to the temporary and proposed regulations left open the possibility that additional transactions may be added (prospectively). For example, the preamble indicated that Treasury and the IRS were considering whether section 909 would apply to transactions that are taxable under foreign law but do not result in income recognition for U.S. tax purposes (so-called “base differences”).

The temporary and proposed regulations provided only limited guidance on the mechanical rules for computing split taxes and related income, and actions required to “unite” related income with split taxes and thus “unsuspend” the taxes.

The preamble to today’s final regulations states that the IRS and Treasury received written comments in response to the 2012 proposed regulations and that the proposed regulations are adopted with amendments.

Final regulations—overview

According to the preamble, today’s final regulations make “clarifying changes” to certain definitions of splitter arrangements and to the interim mechanics rules for tracking split taxes and related income. These final regulations do not, however, address mechanical issues relating to the calculation of related income and split taxes and how taxes are “unsuspended.” The preamble states that these issues are “still under consideration and will be addressed in future guidance,” but provides no timetable for issuing that guidance.

The final regulations do not add any new categories of foreign tax credit splitter arrangements, and do not address the issue raised in the preamble to the temporary and proposed regulations as to whether section 909 would apply to base difference transactions.

Final regulations—changes

The following descriptions provide summaries of changes included in today’s final regulations.

Changes with respect to reverse hybrid splitter arrangements

The final regulations add two examples clarifying how to determine the related income with respect to a reverse hybrid splitter arrangement over multiple years. (Reg. section 1.909-2(b)(1)(v)).

Changes with respect to loss sharing splitter arrangements

The final regulations clarify that the definition of a “usable shared loss” of a “U.S. combined income group” includes a loss that could be used to offset income of a U.S. combined income group in the current year or a previous foreign tax year. The IRS and Treasury concluded that it is not appropriate to require taxpayers to look forward and determine whether a U.S. combined income group potentially may be able to use the loss in a future year, but it is appropriate to look back. Thus, if a loss could be carried back to a prior year and used within the U.S. combined income group, that loss cannot be shared with another group without creating a splitter arrangement. The IRS and Treasury Department noted that this may require taxpayers to retroactively treat taxes paid in prior years as split taxes if they surrender a current year loss out of the group rather than carrying it back.

KPMG observation

Consider the following example. UK Co earns 100 of taxable income in year 1 and pays 25 of UK tax. In year 2, UK Co loses (100). If UK Co surrenders the year 2 loss to an affiliate rather than carrying it back to obtain a refund of year 1 taxes paid, the 25 of year 1 taxes retroactively become suspended taxes. In contrast, if the loss was in year 1, it could be surrendered without creating a splitter, even if UK Co knows that it will have taxable income in year 2 to which it could carry the loss.

Changes with respect to hybrid instrument splitter arrangements

The final regulations clarify that if an accrual under foreign law gives rise to a deduction with respect to a U.S. equity hybrid instrument, and the accrual results in foreign income tax to the holder without giving rise to U.S. taxable income, then a splitter arrangement exists regardless of whether an actual payment of the accrued amount is made. Any actual payments may be treated as distributions of related income.

KPMG observation

This means that a splitter arrangement will exist in every situation in which an instrument gives rise to a deduction and a taxable inclusion on an accrual basis under foreign law but is treated as equity for U.S. tax purposes, even if annual payments of the accrued amounts are actually made and includible in income as dividends for U.S. tax purposes. If there is a payment of such an accrued amount in the same year, however, the amount of tax that remains suspended as of the start of the following year would be reduced.

Changes with respect to section 381 transactions

The IRS and Treasury declined to adopt a proposal that split taxes carry over to a U.S. corporation in an inbound section 381 transaction. Reg. section 1.909-6(e)(3) provides that when split taxes carry over to another foreign corporation in a section 381 transaction, they retain their character as split taxes. A commenter requested that this rule be extended to apply to an inbound section 381 transaction, allowing a U.S. person to succeed to split taxes and treat them as section 901 suspended taxes. Among the reasons given for not adopting this rule, the IRS and Treasury noted that if the suspended taxes were included in the foreign corporation’s post-1986 foreign income tax pool and the foreign corporation had a post-1986 undistributed earnings deficit, the taxes would not be deemed paid or otherwise carry over to the U.S. shareholder. Allowing suspended taxes to carry over thus could, in some cases, create preferential treatment for suspended taxes.

The IRS and Treasury also declined to adopt a rule providing a mechanism for taking split taxes into account if a covered person with respect to the related income ceases to be a covered person before the split taxes are unsuspended. The preamble concludes that section 909 contemplates situations in which taxes may be permanently suspended, and the IRS and Treasury declined to provide a rule covering situations in which the related parties take no action to unite related income with suspended taxes before a disposition or liquidation of the covered person.

The final regulations also clarify that when there is a section 381 transaction that combines the covered person and the payor section 902 corporation, the associated split taxes are only unsuspended to the extent the payor section 902 corporation takes into account related income either as a distribution or inclusion arising from the section 381 transaction or as an upward adjustment in the earnings and profits of the covered person under section 381 transaction. For example, if a covered person with €100 (euros) of related income but only €80 of earnings and profits merges into the payor section 902 corporation, only 80% of the split taxes would be unsuspended.

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