The Treasury and IRS have adopted as final the 2016 proposed regulations on covered assets acquisitions (CAAs) under Code Sec. 901(m) and Code Sec. 704. Proposed regulations issued under Code Sec. 901(m) are adopted with revisions, and the Code Sec. 704 proposed regulations are adopted without revisions. The Code Sec. 901(m) rules were also issued as temporary regulations. The CAA rules impact taxpayers claiming either direct or deemed-paid foreign tax credits.
Covered Asset Acquisitions
The CAA rules are designed to address transactions that result in a basis difference for U.S. and foreign income tax purposes. In a CAA, the disqualified portion of any foreign income tax determined with respect to income or gain attributable to relevant foreign assets (RFAs) is not taken into account in determining direct or indirect foreign tax credits. Foreign taxes that are disqualified for foreign tax credit purposes remain eligible to be deducted.
Under Code Sec. 901(m), a CAA includes the following categories of transactions:
- a qualified stock purchase (defined in Code Sec. 338(d)(3) to which Code Sec. 338(a) applies (Code Sec. 338 CAA);
- a transaction treated as the acquisition of assets for U.S. income tax purposes and as an acquisition of stock for foreign income tax purposes;
- any acquisition of an interest in a partnership that has an election in effect under Code Sec. 754 ( Code Sec. 743(b) CAA); and
- any similar transaction determined by the Secretary of the Treasury.
An RFA is any asset, if income, deduction, gain or loss, attributable to the asset is taken into account in determining the foreign income tax.
The disqualified portion of the foreign income tax for the tax year is the ratio of:
- the aggregate base differences (i.e., excess of U.S. basis of RFA after CAA over U.S. basis before CAA) allocable to the tax year with respect to all RFAS, and
- the income on which the foreign income tax is determined.
Exemptions, Other Changes
The proposed regulations added the following three CAA transaction categories which are retained in the final regulations:
- transactions treated as an acquisition of assets for U.S. tax purposes, and as an interest in a fiscally transparent entity for purposes of foreign income tax purposes;
- transactions treated as a partnership distribution of one or more assets, the U.S. basis of which is determined under Code Sec. 732(b), Code Sec. 732(d), or which causes the U.S. basis of the partnership’s remaining assets to be adjusted under Code Sec. 734(b), provided the transaction results in an increase in the U.S. basis of one or more of the assets distributed by the partnership or retained by the partnership without a corresponding increase in the foreign basis of such assets; and
- transactions treated as an acquisition of assets for purposes of both U.S. income tax and a foreign income tax, provided the transaction results in an increase in the U.S. basis without a corresponding increase in the foreign basis of one or more assets.
The final regulations provide an exemption for CAAs if a domestic Code Sec. 901 payor or members of its consolidated group recognized the gains or losses or took into account its distributive share of the gains and losses recognized by a partnership for U.S. tax purposes as part of the original CAA. The term “aggregate base difference” is modified to take into account adjustments based on gain or loss recognized with respect to an RFA as a result of a CAA.
Under the foreign basis election in the proposed regulations, a taxpayer can elect to determine base difference as the U.S. basis in the RFA immediately after the CAA less the foreign basis in the RFA immediately after the CAA. Taxpayers may apply the election retroactively to CAAs that occurred on or after January 1, 2011, provided the remaining rules in the proposed regulations were applied retroactively. The final regulations modify the consistency requirement so that it applies only for tax years that remain open. Under a new requirement, deficiencies must be taken into account that would have resulted from the consistent application of the final regulations for a closed tax year.
The final regulations also extend the scope of the de minimis rule, under which a basis difference is not taken into account if:
- the sum of the basis differences for all RFAs is less than the greater of $10 million or 10 percent of the total U.S. basis or all RFAs after the CAA; or
- the RFA is part of a class of RFAs for which the sum of the basis differences of all RFAs in the class is less than the greater of $2 million or 10 percent of the total U.S. basis of all RFAs in the class immediately after the CAA.
An additional exclusion is added for an individual RFA with a base difference of less than $20,000.
The final regulations add a priority rule to address transactions to which both Code Sec. 901(m) and Code Sec. 909 apply. Under the rule, Code Sec. 901(m) calculations are taken into account before applying Code Sec. 909.
Tax Cut and Jobs Act changes, including the repeal of Code Sec. 902, are also reflected.
The final regulations apply to CAAs occurring on or after the date the final regulations are published in the Federal Register. A taxpayer may choose to apply the regulations before they would otherwise apply, provided consistency requirements are met, for tax years open for assessment. Returns for tax years ending before the date the final regulations are published must be filed no later than one year after the publication date. For tax years not open for assessment, appropriate adjustments must be made to account for deficiencies that would have resulted from a consistent application of the rules.