LMSB Tier I Issue Foreign Tax Credit Generator Directive - Revision 1
LMSB Control No: LMSB-04-0109-002
Impacted IRM 4.51.5
February 19, 2009
MEMORANDUM FOR INDUSTRY DIRECTORS
DIRECTOR, FIELD SPECIALISTS
DIRECTOR, PREFILING AND TECHNICAL GUIDANCE
DIRECTOR, INTERNATIONAL COMPLIANCE
STRATEGY AND POLICY
FROM: Walter L. Harris /s/ Walter L. Harris
Financial Services and Issue Owner
SUBJECT: Tier I Issue Foreign Tax Credit Generator Directive – Revision 1
This memorandum provides revised field direction on Tier I Issue Foreign Tax Credit Generators. The executive issue owner is Walter L. Harris, Industry Director, Financial Services.
Foreign tax credits (FTC) are intended to prevent the double taxation of foreign income. Our FTC regime permits a US taxpayer to claim a credit against its US income tax liability for foreign taxes imposed on foreign income. This regime is necessary to prevent double taxation of income because US taxpayers are subject to US tax on their worldwide income.
FTC Generators are highly structured transactions that exploit the FTC regime. Some of these transactions are designed to recover the foreign tax claimed as an FTC, so that, in substance, the transaction incurs no foreign tax cost. Other types of transactions are structured to eliminate the income that results in the FTC. Some transactions do both, and in either case, the FTC is inappropriate because the taxpayer claims an FTC where no double taxation of income occurs. In these situations, the FTC becomes an unintended monetary benefit generated by the transaction, which the parties to the transaction share. The parties adjust interest rates on loans or pay fees to share the US FTC benefit.
These transactions are particularly offensive because they are designed strictly to generate credits in any amounts desired by the parties. A strategic approach to address this issue is appropriate due to the significant compliance risk and the extensive commitment of resources needed to resolve these cases. Accordingly, the Service has designated this transaction a Tier I issue under its issue focus processes and has formed an Issue Management Team (IMT).
The IMT includes LMSB Field personnel, Technical Advisors, Counsel, and Appeals, all working together to ensure that factually similar cases are approached consistently.
The IRS and Treasury issued temporary and proposed regulations to address FTC generator transactions in July of 2008. TAM 200807015, issued on November 7, 2007 with respect to a US Lender Transaction, denied a taxpayer’s claim for FTCs on various grounds, including debt/equity, substance over form, regulatory, and lack of economic substance analyses of the transaction. The TAM was followed shortly thereafter by CCA 200826036, issued on February 29, 2008. The CCA concerned an “asset-parking” FTC Generator transaction, and disallowed the FTCs pursuant to the determination that the transaction lacked economic substance, and also in reliance on IRC 269.
Cases with this issue should be identified in the Issue Management System (IMS) with special UIL code, 901.13-00, Foreign Tax Credit (FTC) Generators. This code is being used in Compliance, Appeals and Counsel. The new Issue Attribute Tracking Code - IMS 3.0: F123 should also be used to identify the issue.
Planning and Examination Guidance:
A significant number of known cases were brought to our attention through JITSIC and our treaty exchange provisions. Not only are the transactions difficult to identify on a tax return, including Schedule M-3 or Forms 1118 (used to compute a corporation’s FTC), they are generally only detected during the course of an audit. Examiners may find a Form 8886, Reportable Transaction Disclosure Statement, attached to the US Tax return, describing the transaction and tax impact, which may be filed by the taxpayer on a protective basis. This form was included, in particular, with some of the asset parking transaction tax returns.
The majority of the known transactions involve taxpayers in the Financial Services Industry. This makes reporting of these transactions appear as a part of their general business operations and may be indistinguishable from other financing arrangements/transactions. They are thus more difficult to identify through regular audit inquiries or regulatory disclosure requirements.
Planning and Examination Risk Analysis:
The field should review and challenge arguments by taxpayers that claim FTCs generated through these highly structured transactions. The analysis is very fact specific and requires a careful examination of the transaction documentation.
Because of the significant impact that these transactions have on the Service’s ability to administer the FTC regime properly, as well as the resources required to work the issue, teams with this issue should contact one of the FTC Generator Technical Advisors as soon as they identify indicators of the issue. Teams should anticipate having regular communications with the IMT from the initial identification of the issue through development of the Notice of Proposed Adjustment (NOPA) challenging the FTCs that have been claimed.
While exam teams are totally responsible for preparation of the NOPAs on FTC Generator transactions identified in their exams, IMT concurrence with these NOPAs is required. To facilitate this process, exam teams are required to share NOPAs with the IMT (through Financial Services DFO-Manhattan) for purposes of obtaining the IMT’s approval. There is a clear expectation that certain key members of the IMT will work closely with the field team and local LMSB Counsel to enhance and facilitate the NOPA review and finalization process. The IMT’s approval must be received prior to the issuance of the NOPA to the taxpayer.
Appeals has published an Appeals Coordinated Issue Designation Memorandum that covers the two principal types of FTC Generator transactions (Attached).
Due to the difficulty in identifying these issues, the IMT has developed language to be inserted into an initial IDR (Attached) that is mandatory for all cases with at least $5 million of foreign taxes paid or accrued (or deemed paid) and reported on line 5, Part II, of Schedule B of Form 1118.
The IDR requests information related to foreign taxes that are attributable to an arrangement that satisfies the conditions described in Treas. Reg. §1.901-2T(e)(5)(iv)(B) (without regard to the effective date described in Treas. Reg. §1.901-2T(h)(2)) or to a substantially similar arrangement. While the Service cannot and will not challenge the FTCs generated in such arrangements on the basis of the regulations prior to their effective date, the criteria in the regulations are useful in identifying abusive arrangements. Such arrangements entered into prior to the effective date may be challenged on various grounds, including, but not limited to, the substance over form doctrine, the economic substance doctrine, debt-equity principles, Section 269, the partnership anti-abuse rules of Treas. Reg. § 1.701-2, and the substantial economic effect rules of Treas. Reg. § 1.704-1. Examiners may revise the mandatory IDR language to reflect information that they have already obtained.
The IMT has also developed language to use in a follow up IDR (Attached), which should be issued if the taxpayer’s response to the mandatory IDR indicates that the taxpayer has participated in any transaction that satisfies the conditions in the regulations. In most cases, full development of the issue will require the additional information described in the language to be inserted in the follow-up IDR, and failure to obtain such information will likely cause inadequate development of the issue.
Members of the IMT are available to assist agents and Counsel Attorneys in using and modifying the IDR. Examiners should contact Mark English: Foreign M&A, International Technical Advisor at (518) 427-5458 or Linda Azen, FTC Generator, International Technical Advisor at (717) 777-9609; Appeals Officers should contact William Duffy at (860) 290-4043; and Counsel Attorneys should contact Anna Kozoulina at (917) 421-4650 or Sashka Koleva at (917) 421-4651.
Penalties must be considered in accordance with general LMSB guidance. The IMT fully supports this position and will advise teams to include comprehensive coverage for this element. The IMT will assist teams in this aspect of issue development as well.
Questions regarding the development of the FTC Generator issue should be referred to the International Technical Advisors listed above.
This Directive is not an official pronouncement of law, and cannot be used, cited, or relied upon as such.
cc: Commissioner, LMSB
Deputy Commissioner, LMSB
Division Counsel, LMSB
Director, Performance, Quality and Analysis & Support