Practising Law Institute Tax Planning For Domestic & Foreign Partnerships, LLCs, Joint Ventures & Other Strategic Alliances 2016 International Joint Venture Issues Paul Oosterhuis Skadden, Arps, Slate, Meagher & Flom LLP Chris Trump Deloitte Tax LLP Jason T. Smyczek Senior Technical Reviewer, Branch 4, Associate Chief Counsel (International), IRS
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Practising Law Institute
Tax Planning For Domestic & Foreign
Partnerships, LLCs, Joint Ventures & Other
Strategic Alliances 2016
International Joint Venture Issues
Paul Oosterhuis
Skadden, Arps, Slate,
Meagher & Flom LLP
Chris Trump
Deloitte Tax LLP
Jason T. Smyczek
Senior Technical Reviewer, Branch 4,
Associate Chief Counsel (International), IRS
FORMATION AND NOTICE
2015-54
3
Partnership Contributions In General
Section 721(a) allows for the tax deferred transfer of built in gain (or loss) property by a partner
to a partnership, without analog to the control requirements imposed on transfers to corporations
when recognized would be included in the income of a non-U.S. person.
• Notice 2015-54, released on August 6, 2015, announced the intent to issue such
regulations and provided detailed rules with immediate effect.
− Notice 2015-54, although apparently targeting transfers of intellectual property, applies
regardless of the nature of the property transferred and irrespective of whether the income
from the property is subject to immediate U.S. taxation under subpart F or as effectively
connected income.
4
Pre-Notice Analysis
Facts
• USP, a U.S. corporation, wholly owns FS, a foreign
corporation. USP and FS contribute property to PRS, a
partnership.
• USP contributes Asset A, with a large amount of built-in
gain. FS contributes Asset B.
Pre-Notice Analysis
• The contribution of Asset A does not result in gain
recognition under section 721(a).
• PRS could use one of three methods (i.e., traditional
method, traditional method with curative allocations, or
remedial method), subject to certain anti-abuse rules, to
account for the built-in gain of Asset A in allocating items
of income, deduction, gain, or loss to its partners.
• Regardless of the form of consideration received (except
in the case of certain partnership interests), the transferor
is effectively selling a portion of Asset A.
• Following the contribution to the partnership, the
contributing partner recognizes income attributable to its
partnership interest.
• The timing of recognition of the built-in gain in the asset
depends on the section 704(c) method chosen.
Asset B
FS
PRS
USP
Asset A
Value – $100M
Basis – $0
5
Notice 2015-54 Notice 2015-54, issued on August 6, 2015, announces the intent to issue regulationsunder section 721(c) to ensure that, when a U.S. person transfers certain property to a partnership that has foreign partners related to the transferor, income or gain attributable to the property will be taken into account by the transferor either immediately or periodically (through the remedial section 704(c) method).
• The new regulations will have two main features:
− Significant new restrictions will apply if the U.S. partner and related foreign person
together own more than 50 percent of the interests in partnership capital, profits, deductions or losses, and the U.S. partner contributes built-in gain property to the partnership.
− Immediate gain recognition will be required under section 721(c) on the contributionunlessthepartnershipadoptsthe“GainDeferralMethod.”
Section 482 regulations will be issued to specify transfer pricing methods applicable tocontrolled transactions involving related-party partnerships. These specified methods, which may apply to partnership contributions, partnership distributions, and partnership allocations, will mirror the methods currently prescribed for cost-sharing arrangements andwillincludea‘periodictrigger’featuresimilartothecost-sharing periodic trigger.
6
Gain Deferral Method
The regulations will include an exception to the application of section 721(c)
• First. The Section 721(c) Partnership adopts the remedial allocation method
described in Treas. Reg. § 1.704-3(d) for Built-in Gain with respect to all
Section 721(c) Property contributed to the Section 721(c) Partnership
pursuant to the same plan by a U.S. Transferor and all other U.S. Transferors
that are Related Persons.
7
• Second. During any taxable year in which there is remaining Built-In Gain with respect to an item of Section 721(c) Property, the Section 721(c) Partnership allocates all items of section 704(b) income, gain, loss, and deduction with respect to that Section 721(c) Property in the same proportion;
• Third. Reporting requirements described in Section 4.06 of the Notice are satisfied.
• Fourth. U.S. Transferor recognizes Built-in Gain with respect to any item of Section 721(c) Property upon an Acceleration Event described in Section 4.05 of the Notice; and
• Fifth. The Gain Deferral Method is adopted for all Section 721(c) Property subsequently contributed by the U.S. Transferor and related U.S. Transferors until the earlier of:
− the date when no Built-in Gain remains with respect to any Section 721(c) Property to which the Gain Deferral Method first applied; or
− 60 months after the initial contribution of Section 721(c) Property to which the Gain Deferral Method first applied.
Gain Deferral Method
8
Effective Dates
The regulations described in the Notice with respect to the application of section
721(c) will apply to transfers occurring on or after August 6, 2015, and to transfers
occurring before August 6, 2015, resulting from entity classification elections made
under Treas. Reg. § 301.7701-3 that are filed on or after August 6, 2015, and that
are effective on or before August 6, 2015.
The section 482 and section 6662 regulations described in the Notice will apply to
transactions occurring on or after the date regulations are published.
8
9
Notice 2015-54: Example 1
USP, a domestic corporation, wholly owns
FS, a foreign corporation
USP and FS form a new partnership, PRS
FS contributes cash of $1.5M
:USP contributes
• a patent with FMV = $1.2M,
basis = $0
• a security with FMV = $100k, basis =
$20K
• a machine with FMV = $200K,
basis = $600K
$1.5M
cash
FS (Foreign)
USP (U.S.)
PRS
$1.5M:
1. Patent
2. Security
3. Machine
10
Notice 2015-54: Example 1 (cont’d)
Analysis
The Patent is Section 721(c) Property because
it has Built-in Gain (FMV = $1.2M; AB = $0).
The security has Built-in Gain, but is Excluded
Property.
The machine has built-in loss; therefore, it is
not Section 721(c) Property.
.FS is a Related Foreign Person to USP
USP and FS collectively own more than 50% of
the interests in the capital, profits, deductions
or losses of PRS; therefore, PRS is a Section
721(c) Partnership.
USP’stoapplynotdoes(a)721Section
contribution of the patent to PRS unless the
Gain Deferral Method is applied.
$1.5M:
1. Patent
2. Security
3. Machine
FS (Foreign)
USP (U.S.)
PRS
$1.5M Cash
11
Notice 2015-54: Example 2
USP, a domestic corporation, wholly owns
FS, a foreign corporation.
USP and FS own all of the interests in
PRS, which was formed prior to the
effective date of Notice 2015-54.
USP’smanagementconcludesthatUSP
should not hold the PRS interest directly
and causes USP to contribute the PRS
interest to U.S. Sub in exchange for U.S.
Sub Stock.
U.S. Sub (U.S.)
USP (U.S.)
FS (Foreign)
USP (U.S.)
U.S. Sub (U.S.)
FS (Foreign)
PRS (U.S.)
PRS (U.S)
.
Stock
PRS
Interest
40%
60%
40% 60%
12
Notice 2015-54: Example 2 (Cont’d)
PRS terminates for tax purposes under
section 708(b)(1)(B).
Deemed Transactions:
PRS contributes its assets to new
PRS in exchange for New PRS
interestsandNewPRS’assumption
ofPRS’liabilities.
New PRS liquidates, distributing New
PRS interests to FS and to U.S. Sub.
Notice 2015-54 Applies?
New PRS Interest
USP
(U.S.)
FS
(Foreign)
PRS
(U.S.)
U.S. Sub
(U.S.)
Assets
New
PRS
New PRS
Interest
Deemed
Transactions
New PRS Interests
13
Observations / Open Questions
Third Party JVs - Although the Notice appears to be targeted at
partnerships between related taxpayers, the rules are broad enough to
affect some third-party joint ventures.
Deemed Partnerships - It is not always clear whether the economic
relationship between taxpayers constitutes a partnership for U.S. federal
for the IRS to treat CFC as holding U.S. property.
USP
(U.S.)
USS CFC
FP
(For)
32
Application of Sec. 956 to Partnerships
Temporary and Proposed Regulations
On September 2, 2015, Treasury released temporary and proposed regulations
addressing application of section 956 to partnership transactions.
The temporary regulations address application of the anti-abuse rule to partnership
entities and partnership distributions funded by CFCs.
• The temporary regulations are effective with respect to taxable years of CFCs
ending on or after September 2, 2015.
• The temporary regulations expire in three years if not finalized under the sunset
provisions.
.The proposed regulations address, in part, whether the obligations of a non-U.S
partnership will be treated as U.S. property for purposes of section 956.
• The proposed regulations are proposed to be effective with respect to taxable
years of CFCs ending on or after the date final regulations are published, and
taxable years of U.S. shareholders in which or with respect to which such taxable
years end.
33
Application of Sec. 956 to Partnership Transactions
Temporary Regulations
The temporary regulations address Treasury and IRS concerns that taxpayers maybe using partnerships to structure transactions that are similar to transactions addressed by Treas. Reg. § 1.956-1T(b)(4)
• Treas. Reg. § 1.956-1T(b)(4) is currently applicable to transactions that involve foreign corporations that are controlled by a CFC and requires the IRS to exercise its discretion
• Treasury and IRS were concerned with the following transactions:
− CFC funded loans
◦ CFC contributes cash to partnership
◦ Partnership loans cash to U.S. shareholder of the CFC
◦ Taxpayer position: CFC is treated as holding an interest in the obligation only to the extentoftheCFC’sinterestinthepartnership
− CFC funded distributions
◦ CFC lends (or guarantees loan) to foreign partnership
◦ Foreign partnership distributes proceeds to U.S. partner who is related to CFC
◦ Taxpayer position: Section 956 does not apply
34
Application of Sec. 956 to Partnership Transactions
Temporary Regulations
Treas. Reg. § 1.956-1T(b)(4) expanded to include transactions involvingpartnerships that are controlled by the CFC
• U.S. property held indirectly by a CFC includes –
− “Propertyacquiredbyapartnershipthatiscontrolledbythecontrolledforeigncorporation if the property would be United States property if held directly by the controlled foreign corporation, and a principal purpose of creating, organizing, or funding by any means (including through capital contributions or debt) the partnership is to avoid the application of section 956 with respect to thecontrolledforeigncorporation.”
− Control –
◦ CFC controls the foreign partnership if the CFC and the partnership are related within the meaning of 707(b)
◦ For purposes of determining whether two corporations are members of the same “controlledgroup”,section267(c)principlesapply
Rule is self-executing (both with respect to transactions involving corporations andtransactions involving partnerships)
35
FS1 has substantial e&p
FS1 contributes $600 to FP inexchange for a 60% interest
USP contributes Non-US real propertyvalued at $400 in exchange for a 40% interest
FP lends $100 to USP
• FS1 is treated as holding U.S. property of $60 pursuant to Treas. Reg. 1.956-2(a)(3).
If a principal purpose of organizing FPis to avoid section 956 with respect to FS1, FS1 is treated as holding U.S. property of $100
• $60 under Treas. Reg. § 1.956-2(a)(3)
• $40 under Temp. Treas. Reg. § 1.956-2(b)(4)(i)(C) and (b)(4)(iii)
USP
(U.S.)
FS1
FP
(For)
40%
Non-US RP
$400 value
60%
$100 Loan
Application of Sec. 956 to Partnership Transactions
Temporary Regulations
36
General Rule
An obligation of a foreign partnership held (or treated as held) by a CFC is
treated as a separate obligation of a partner in the partnership if –
• The foreign partnership distributes an amount of money or property to the
partner
• The foreign partnership would not have made the distribution but for a funding
of the partnership through the obligation
• The partner is related to the CFC within the meaning of section 954(d)(3)
Amount of obligation
The lesser of (a) the amount of the partnership distribution that would not
have been made but for such funding or (b) the amount of the obligation of
the foreign partnership that is held (or treated as held) by the CFC
Application of Sec. 956 to Partnership Transactions
Temporary Regulations – Partnership Distributions
37
USP wholly owns FS, a CFC
USP owns a 70% interest in FP
UTP, a domestic corporation, owns theremaining 30% interest in FP
FP borrows $100 from FS anddistributes $80 to USP
FP would not have made thedistribution to USP but for the funding by FS
A portion of the obligation that FS holdsis treated as an obligation of USP
The amount treated as an obligation ofUSP is the lesser of $80 (the amount of the distribution) or $100 (the amount of the obligation that is held by the CFC)
UTP (U.S.) FS
FP
(For)
30%
70%
$100 Loan
USP
(U.S.)
$80
Distribution
Application of Sec. 956 to Partnership Transactions
Temporary Regulations
38
Treasury and IRS determined that failing to treat an obligation of a foreign
partnership as an obligation of its partners could allow deferral of U.S. taxation of
CFC earnings and profits in a manner inconsistent with the purposes of section
956
:Areas of concern
• Potential ability of U.S. shareholder to access deferred CFC earnings loaned to
a foreign partnership in which the U.S. shareholder is a partner without those
earnings becoming subject to U.S. tax by causing the partnership to make a
distribution
Proposed regulations treat an obligation of a foreign partnership as an obligation
of its partners, subject to an exception for obligations of foreign partnerships in
which neither the lending CFC nor any person related to the lending CFC is a
partner
Application of Sec. 956 to Partnership Transactions
Proposed Regulations § 1.956-4
39
Application of Sec. 956 to Partnership Transactions
Proposed Regulations § 1.956-4(b)
A partner in a partnership is treated as holding its attributable share of any
property held by the partnership (including partnership obligations)
its(i)ofgreatertheisobligationtheofshareUSP’sshare of the obligation ($70), or (ii) the lesser of (a) the distribution ($80), or (b) the amount of the obligation ($100).
• Thus, on the date of the loan, FS is treated as holding US property of $80
FS
FP (For)
30% Profits
USP (U.S.)
$80 Distribution
UTP X (U.S.)
70% Profits $100 Loan
48
Application of Sec. 956 to Partnership Transactions
Proposed Regulations
Pledges and Guarantees
• Current Rule
− An obligation of a U.S. person with respect to which a CFC is a pledgor or guarantor is
considered for purposes of section 956 to be U.S. property held by the CFC
• Proposed Regulations
− Any obligation of a U.S. person with respect to which a CFC or a partnership is a pledgor
or guarantor (directly or indirectly) is considered for purposes of section 956 to be U.S.
property held by the CFC, or the partnership, as the case may be.
◦ CFC that is a partner in the pledgor partnership is not itself treated as a pledgor solely as a
result of its ownership of an interest in the partnership
◦ How does one treat the pledge of a partnership interest by a U.S. person that has a related CFC partner?
− Existing Pledges and Guarantees
◦ The proposed regulations are proposed to be effective with respect to pledges and guarantees
entered into on or after the date published in the federal register
◦ A pledgor or guarantor is treated as entering into a pledge or guarantee when there is a
significant modification of an obligation with respect to which it is a pledgor or guarantor on or
after the date the regulations are published in the federal register
49
Application of Sec. 956 to Partnerships
Proposed Regulations – Pledges and Guarantees
USP owns 90% of FP, a foreignpartnership, and 70% of FS, a foreign corporation that is a CFC
profitsFP’sininterest90%ahasUSP
Z, an unrelated third party loans $100to FP
FS pledges its assets as security for theloan
Under Prop. Treas. Reg. § 1.956-4(c)isZUTPtoobligation$100FP’sof$90treated as an obligation of USP for purposes of section 956
-Under Prop. Treas. Reg. § 1.9562(c)(1), FS is considered to hold an obligation of USP in the amount of $90 and is treated as holding US property in the amount of $90
UTP X (Non-
U.S.)
FS
FP
(For)
10%
$100 Loan
USP (U.S.)
Pledge Assets
as Security
for Loan
30% 70%
UTP Y (Non-
U.S.) 90%
UTP Z
DISPOSITION
51
Exit Strategies
Sale of partnership assets or interests source/character
Buy out other partner. Note Rev. Rul. 91-32 and the
Administration’s 2016 Budget proposal to codify the ruling
Partnership redeems out a partner – consider section 736,
source, and character
Liquidate partnership – sections 731, 704(c), 751(b), etc.
Incorporate partnership - Note section 367 issues
Partnership division
Section 1248 and Partnerships: Sale of Interest in
Partnership Holding CFC Stock Section 751(c) treats stock of a CFC held
through a partnership as a zero-basis unrealized
receivable in an amount equal to the potential
section 1248 dividend amount
CFC FMV 600
Partnership Basis in CFC 100
Gain on Sale 500
Potential Section 1248 Dividend Amt. 300
A domestic partner of the partnership recognizes
ordinary income to the extent of its share of any
gain that would have been treated as a dividend
under section 1248 had the partnership sold the
CFC stock directly
FMV Partnership Interest 360
Basis in Partnership Interest 60
Gain on Sale 300
Section 751(c) Ordinary Income
(Allocable Share of Potential Section
1248 Amount) 180
Section 741 Capital Gain 120
IRS position appears to be no FTCs and no QDI; see §1248(g)(2).
FMV: 600
Basis: 100
E&P: 300
FMV:
360
CFC
Sale of FJV
Partnership
Interest
40% 60%
FJV
(Foreign)
Foreign Co US Co
Section 1248: Sale of Partnership Interest and
Section 338 Election
Purchase of 100% of partnership interests is treated as a purchase of PS assets
under Rev. Rul. 99-6, enabling Buyer to make a §338 election for CFC, wiping
out E&P
If §751(c) and IRS view of §1248(g)(2) applies here, who takes E&P and
associated FTCs into account?
Buyer
“New”CFC
DE
deemed
asset sale
sell 100% of
partnership interests
CFC
40% 60%
E&P: 300
FJV
(Foreign)
Foreign Co US Co
Section 1248 and Partnerships: Sale of
Interest in Partnership Holding CFC Stock
Subpart F: Section 954(c)(4) treats as a
sale by CFC1 of its proportionate share of
assets of Foreign Partnership (i.e., CFC2
stock)
But:
Treated as a sale of CFC2 stock by
CFC1 for purposes of section 964(e)?
No;954(c)(4)says“onlyforpurposes
of this section”
Deemed dividend to CFC1? No
Availability of FTCs? No
See section 1248(g)(2) CFC2
Disposition
40% 60%
FJV
(Foreign)
Foreign Co US Co
CFC1
Section 1248 and Partnerships: Sale of
CFC by Domestic Partnership
Disposition treated as a sale of CFC
stock by a U.S. person to which
section 1248 applies
Each partner allocated its
respective share of section 1248
dividend income and capital gain
Credits allowable to domestic
partners under Rev. Rul. 71-141
and section 902(c)(7)
QDI
CFC FMV 600
Partnership Basis in CFC 100
Gain on Sale 500
Section 1248: 300
Capital Gain: 200
CFC
Disposition
40% 60%
E&P: 300
JV
(U.S)
Foreign Co US Co
Section 1248 and Partnerships: Sale of
CFC by Foreign Partnership
Partners of Foreign Partnership
treated as selling or exchanging their
proportionate share of the stock of
CFC. Treas. Reg. §1.1248-1(a)(4)
CFC 600
Partnership Basis in CFC
100
Gain on Sale 500
Gain Allocable to
Domestic Partners (60% x 500) 300
E&P Allocable to
Domestic Partners (60% x 300) 180
Section 1248 180
Capital Gain 120
See Treas. Reg. § 1.1248-1(a)(5), Ex. 4.
Results are not different from
previous slide, but mechanics are
CFC
Disposition
40% 60%
E&P: 300
FJV
(Foreign)
Foreign Co US Co
PARTNERSHIPS AND SECTION
7874
Section 7874:
Acquisition of U.S. P/S by Foreign Corporation
.Section 7874 applies to a foreign corporation acquiring a trade or business of a U.S
partnership if:
• after the transaction partners in U.S. partnership own 60%
(or 80%) or more of a foreign corporation by reason of their ownership of interests in
the U.S. partnership,
• the foreign corporation directly or indirectly acquires substantially all the properties
constituting a trade or business of the U.S. partnership, and
• The foreign corporation and its subsidiaries do not have substantial business
activities in the country in which the foreign corporation is incorporated
o Temp Regulations (June 2012) adopt 3-part 25% test – assets, employees,
gross income
59
Anti-Inversion Legislation: Partnerships
Does section 7874 apply to wholly foreign operations of USP?
Dissolution of USP /conversion to FP subject to anti-avoidance rule?
EU-5
DE
EU-4
DE
EU-3
DE
EU-2
DE EU-1
DE
USP
US Non-Corporates
Anti-Inversion Acquisition o
Injected cash from IPO of Bermuda
Co disregarded in testing ownership
fraction received for U.S.
partnership under section
7874(c)(2)(B)
Treas. Reg. § 1.7874-4T (Jan. 2014)
expanded rule to certain private
transactions (see Notice 2009-78)
On April 4, 2016, Treas. Reg. §
1.7874-4T was amended to reflect
Notice 2014-52, Notice 2015-79 and
the new 2016 temporary regulations
Public
Shareholders
Foreign Parent
(Bermuda)
U.S.
Service
Partners/SHs
Limitations on Go-Private Transactions
As in the Notices, Treas. Reg. § 1.7874-4T excludes from the denominator of the
ownership fraction, stock issued by the foreign acquirer in exchange for
nonqualified property
Theterm“nonqualifiedproperty”isdefinedas
Cash and cash equivalents,
Marketable securities,
Disqualified obligations (not previously included in Notice 2009-78), or
Any other property acquired in a transaction with a principal purpose of avoiding the
purposes of section 7874, regardless of whether the transaction involves an indirect
transfer of nonqualified property
However, subject to an anti-abuse rule, a marketable interest in a corporation or