Internal Revenue Bulletin: 2009-4
January 26, 2009
Table of Contents
This document contains proposed regulations relating to conduit financing arrangements issued under the authority granted by section 7701(l) of the Internal Revenue Code (Code). The proposed regulations apply to multiple-party financing arrangements that are effected through disregarded entities, and are necessary in order to determine which of those arrangements should be recharacterized under section 7701(l) and Treas. Reg. §1.881-3.
Written or electronic comments and requests for a public hearing must be received by March 23, 2009.
Send submissions to: CC:PA:LPD:PR (REG-113462-08), Internal Revenue Service, room 5205, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-113462-08), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, N.W., Washington, DC 20224, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov IRS REG-113462-08).
Concerning the proposed regulations, Quyen Huynh at (202) 622-3880 or John H. Seibert at (202) 622-3860; concerning submissions of comments, Oluwafunmilayo Taylor, at (202) 622-7180 (not toll-free numbers).
Section 7701(l) of the Code authorizes the Secretary to prescribe regulations recharacterizing any multiple-party financing transaction as a transaction directly among any two or more of such parties where the Secretary determines that such recharacterization is appropriate to prevent the avoidance of any tax imposed by the Code. In Treasury decision 8611, 1995-2 C.B. 286 [60 FR 40997], published August 10, 1995, the Treasury Department and the Internal Revenue Service (IRS) issued implementing regulations under Treas. Reg. §1.881-3 relating to conduit financing arrangements pursuant to the authority granted by section 7701(l).
In general, §1.881-3 allows the IRS to disregard the participation of one or more intermediate entities in a financing arrangement where such entities are acting as conduit entities, and to recharacterize the financing arrangement as a transaction directly between the remaining parties to the financing arrangement for purposes of imposing tax under sections 871, 881, 1441 and 1442 of the Code. Section 1.881-3(a)(2)(i)(A) of the regulations defines a financing arrangement to mean a series of financing transactions by which one person (the financing entity) advances money or other property, or grants rights to use property, and another person (the financed entity) receives money or other property, or rights to use property, if the advance and receipt are effected through one or more other persons (intermediate entities). Except in cases to which §1.881-3(a)(2)(i)(B) (special rule for related parties) applies, the regulations apply only if financing transactions as defined in §1.881-3(a)(2)(ii) link the financing entity, each of the intermediate entities, and the financed entity.
Since the publication of §1.881-3 on August 10, 1995, the Treasury Department and IRS issued the so-called “check-the-box” regulations, under §§301.7701-1 through 301.7701-3, effective January 1, 1997 (T.D. 8697, 1997-1 C.B. 215 [61 FR 66854]). Section 301.7701-3 provides, in part, that an entity that is not classified as a corporation and that has a single owner may elect to be disregarded as an entity separate from its owner (a disregarded entity).
The Treasury Department and IRS are aware that issues have arisen regarding the proper treatment of disregarded entities under §1.881-3. These proposed regulations clarify that a disregarded entity is a person for purposes of §1.881-3. Thus, transactions that a disregarded entity enters into will be taken into account for purposes of determining whether a financing arrangement exists.
The Treasury Department and IRS are continuing to study conduit financing arrangements and may issue separate guidance to address the treatment under §1.881-3 of certain hybrid instruments. Specifically, the Treasury Department and IRS are studying transactions where a financing entity advances cash or other property to an intermediate entity in exchange for a hybrid instrument that is treated as debt under the laws of the foreign jurisdiction where the intermediate entity is resident and is not treated as debt for U.S. federal tax purposes. The issue under consideration is whether such instruments should constitute a financing transaction under §1.881-3(a)(2)(ii)(A) and part of a financing arrangement within the meaning of §1.881-3(a)(2)(i)(A). No inference should be drawn from the approaches described in this preamble regarding the treatment of such instruments under current law, including judicial doctrines with respect to conduit financing transactions.
One possible approach is to treat all transactions involving such hybrid instruments between a financing entity and an intermediate entity as financing transactions under §1.881-3(a)(2)(ii)(A). Comments are requested on this approach, including whether and to what extent a connection or relationship between the issuer and recipient of the hybrid instrument (for example, an equity ownership percentage) should be required in order to treat such instruments as financing transactions.
Another possible approach is to add additional factors to consider in determining when stock in a corporation (or other similar interest in a partnership or trust) may constitute a financing transaction under §1.881-3(a)(2)(ii)(B). The additional factors would focus on whether, based on the facts and circumstances surrounding the stock (or other similar interest in a partnership or trust), the financing entity had sufficient legal rights to, or other practical assurances regarding, the payment received by the intermediate entity to treat the stock as a financing transaction. Some possible factors to indicate the presence of a financing transaction might include:
(1) Intent of the parties to pay all or substantially all payments received by the intermediate entity to the financing entity;
(2) History of payment of amounts received by the intermediate entity to the financing entity; and
(3) Precedence of the obligees over other creditors regarding the payment of interest and principal, currently or in bankruptcy.
Comments are requested concerning other possible approaches and any additional factors that the Treasury Department and IRS should consider in expanding the conduit financing regulations under §1.881-3.
Section 1.881-3(a)(2)(i)(C) of the proposed regulations provides that for purposes of this section, the term person includes a business entity that is disregarded as an entity separate from its single member owner under §§301.7701-1 through 301.7701-3. Because a disregarded entity is a person, any transaction that it enters into will be taken into account for purposes of determining whether a conduit financing arrangement exists.
These proposed regulations also modify the parenthetical in §1.881-3(a)(2)(ii)(A)(2) and §1.881-3(a)(2)(ii)(B)(1). The proposed regulations also correct a typographical error in §1.881-3(a)(3)(ii)(B) of the final regulations and update titles and cross-references in the final regulations.
It has been determined that this notice of proposed rulemaking is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that this regulation will not have a significant economic impact on a substantial number of small entities. Accordingly, a regulatory flexibility analysis is not required. Pursuant to section 7805(f) of the Internal Revenue Code, this notice of proposed rulemaking has been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.
Before these proposed regulations are adopted as final regulations, consideration will be given to any written (a signed original and eight (8) copies) or electronic comments that are submitted timely to the IRS. All comments will be available for public inspection and copying. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, notice of the date, time, and place for the public hearing will be published in the Federal Register.
Accordingly, 26 CFR part 1 is proposed to be amended as follows:
Paragraph 1. The authority citation for part 1 continues to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.881-3 is amended by:
1. Removing the language “district director” throughout this section and adding “director of field operations” in its place.
2. Removing the language “§1.1441-3(j)” throughout this section and adding “§1.1441-3(g)” in its place.
3. Removing the language “§1.1441-7(d)” throughout this section and adding “§1.1441-7(f)” in its place.
4. In the last sentence of paragraph (a)(3)(ii)(B), removing the second “financed” and adding “financing” in its place.
5. Removing the parenthetical language “(or a similar interest in a partnership or trust)” in paragraphs (a)(2)(ii)(A)(2) and (a)(2)(ii)(B)(1) and adding “(or a similar interest in a partnership, trust, or other person)” in its place.
6. Adding a new paragraph (a)(2)(i)(C).
7. In paragraph (e), redesignating Examples 3, 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, and 25 as Examples 4, 5, 6, 7, 8, 9, 10, 11, 12, 13, 14, 15, 16, 17, 18, 19, 20, 21, 22, 23, 24, 25, and 26, respectively.
8. Adding a new Example 3 in paragraph (e).
9. Adding a new sentence at the end of paragraph (f).
The additions read as follows:
* * * * *
(a) * * *
(2) * * *
(i) * * *
(C) Treatment of disregarded entities. For purposes of this section, the term person includes a business entity that is disregarded as an entity separate from its single member owner under §§301.7701-1 through 301.7701-3.
* * * * *
(e) Examples. * * *
Example 3. Participation of a disregarded intermediate entity. (i) The facts are the same as in Example 2, except that, in addition, FS is an entity that is disregarded as an entity separate from its owner, FP, under §301.7701-3. Under paragraph (a)(2)(i)(C) of this section, FS is a person and therefore may itself be an intermediate entity that is linked by financing transactions to other persons in a financing arrangement. The DS note held by FS and the FS note held by FP are financing transactions within the meaning of paragraph (a)(2)(ii) of this section, and together constitute a financing arrangement within the meaning of paragraph (a)(2)(i) of this section.
* * * * *
(f) Effective/applicability date. * * * Paragraph (a)(2)(i)(C) of this section is effective for payments made on or after the date of publication of the Treasury decision adopting these regulations as final regulations in the Federal Register.
Linda E. Stiff,
Deputy Commissioner for
Services and Enforcement.
(Filed by the Office of the Federal Register on December 19, 2008, 8:45 a.m., and published in the issue of the Federal Register for December 22, 2008, 73 F.R. 78252)
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