[Federal Register Volume 83, Number 248 (Friday, December 28, 2018)]
[Proposed Rules]
[Pages 67612-67651]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2018-27714]
[[Page 67611]]
Vol. 83
Friday,
No. 248
December 28, 2018
Part III
Department of the Treasury
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Internal Revenue Service
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26 CFR Parts 1 and 301
Rules Regarding Certain Hybrid Arrangements; Proposed Rule
Federal Register / Vol. 83 , No. 248 / Friday, December 28, 2018 /
Proposed Rules
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
[REG-104352-18]
RIN 1545-BO53
Rules Regarding Certain Hybrid Arrangements
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations implementing
sections 245A(e) and 267A of the Internal Revenue Code (``Code'')
regarding hybrid dividends and certain amounts paid or accrued in
hybrid transactions or with hybrid entities. Sections 245A(e) and 267A
were added to the Code by the Tax Cuts and Jobs Act, Public Law 115-97
(2017) (the ``Act''), which was enacted on December 22, 2017. This
document also contains proposed regulations under sections 1503(d) and
7701 to prevent the same deduction from being claimed under the tax
laws of both the United States and a foreign country. Further, this
document contains proposed regulations under sections 6038, 6038A, and
6038C to facilitate administration of certain rules in the proposed
regulations. The proposed regulations affect taxpayers that would
otherwise claim a deduction related to such amounts and certain
shareholders of foreign corporations that pay or receive hybrid
dividends.
DATES: Written or electronic comments and requests for a public hearing
must be received by February 26, 2019.
ADDRESSES: Send submissions to: Internal Revenue Service, CC:PA:LPD:PR
(REG-104352-18), Room 5203, Post Office 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 (indicate
REG-104352-18), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue NW, Washington, DC 20224, or sent electronically,
via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-
104352-18).
FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations,
contact Tracy Villecco at (202) 317-3800; concerning submissions of
comments or requests for a public hearing, Regina L. Johnson at (202)
317-6901 (not toll free numbers).
SUPPLEMENTARY INFORMATION:
Background
I. In General
This document contains proposed amendments to 26 CFR parts 1 and
301 under sections 245A(e), 267A, 1503(d), 6038, 6038A, 6038C, and 7701
(the ``proposed regulations''). Added to the Code by sections 14101(a)
and 14222(a) of the Act, section 245A(e) denies the dividends received
deduction under section 245A with respect to hybrid dividends, and
section 267A denies certain interest or royalty deductions involving
hybrid transactions or hybrid entities. The proposed regulations only
include rules under section 245A(e); rules addressing other aspects of
section 245A, including the general eligibility requirements for the
dividends received deduction under section 245A(a), will be addressed
in a separate notice of proposed rulemaking. Section 14101(f) of the
Act provides that section 245A, including section 245A(e), applies to
distributions made after December 31, 2017. Section 14222(c) of the Act
provides that section 267A applies to taxable years beginning after
December 31, 2017. Other provisions of the Code, such as sections
894(c) and 1503(d), also address certain hybrid arrangements.
II. Purpose of Anti-Hybrid Rules
A cross-border transaction may be treated differently for U.S. and
foreign tax purposes because of differences in the tax law of each
country. In general, the U.S. tax treatment of a transaction does not
take into account foreign tax law. However, in specific cases, foreign
tax law is taken into account--for example, in the context of
withholdable payments to hybrid entities for which treaty benefits are
claimed under section 894(c) and for dual consolidated losses subject
to section 1503(d)--in order to address policy concerns resulting from
the different treatment of the same transaction or arrangement under
U.S. and foreign tax law.
In response to international concerns regarding hybrid arrangements
used to achieve double non-taxation, Action 2 of the OECD's Base
Erosion and Profit Shifting (``BEPS'') project, and two final reports
thereunder, address hybrid and branch mismatch arrangements. See OECD/
G20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action
2: 2015 Final Report (October 2015) (the ``Hybrid Mismatch Report'');
OECD/G20, Neutralising the Effects of Branch Mismatch Arrangements,
Action 2: Inclusive Framework on BEPS (July 2017) (the ``Branch
Mismatch Report''). The Hybrid Mismatch Report sets forth
recommendations to neutralize the tax effects of hybrid arrangements
that exploit differences in the tax treatment of an entity or
instrument under the laws of two or more countries (such arrangements,
``hybrid mismatches''). The Branch Mismatch Report sets forth
recommendations to neutralize the tax effects of certain arrangements
involving branches that result in mismatches similar to hybrid
mismatches (such arrangements, ``branch mismatches''). Given the
similarity between hybrid mismatches and branch mismatches, the Branch
Mismatch Report recommends that a jurisdiction adopting rules to
address hybrid mismatches adopt, at the same time, rules to address
branch mismatches. See Branch Mismatch Report, at p. 11, Executive
Summary. Otherwise, taxpayers might ``shift[[hairsp]] from hybrid
mismatch to branch mismatch arrangements in order to secure the same
tax advantages.'' Id.
The Act's legislative history explains that section 267A is
intended to be ``consistent with many of the approaches to the same or
similar problems [regarding hybrid arrangements] taken in the Code, the
OECD base erosion and profit shifting project (``BEPS''), bilateral
income tax treaties, and provisions or rules of other countries.'' See
Senate Committee on Finance, Explanation of the Bill, at 384 (November
22, 2017). The types of hybrid arrangements of concern are arrangements
that ``exploit differences in the tax treatment of a transaction or
entity under the laws of two or more tax jurisdictions to achieve
double non-taxation, including long-term deferral.'' Id. Hybrid
arrangements targeted by these provisions are those that rely on a
hybrid element to produce such outcomes.
These concerns also arise in the context of section 245A as a
result of the enactment of a participation exemption system for taxing
foreign income. Under this system, section 245A(e) generally prevents
double non-taxation by disallowing the 100 percent dividends received
deduction for dividends received from a controlled foreign corporation
(``CFC''), or by mandating subpart F inclusions for dividends received
from a CFC by another CFC, if there is a corresponding deduction or
other tax benefit in the foreign country.
Explanation of Provisions
I. Section 245A(e)--Hybrid Dividends
A. Overview
The proposed regulations under section 245A(e) address certain
dividends involving hybrid arrangements. The proposed regulations
[[Page 67613]]
neutralize the double non-taxation effects of these dividends by either
denying the section 245A(a) dividends received deduction with respect
to the dividend or requiring an inclusion under section 951(a) with
respect to the dividend, depending on whether the dividend is received
by a domestic corporation or a CFC.
The proposed regulations provide that if a domestic corporation
that is a United States shareholder within the meaning of section
951(b) (``U.S. shareholder'') of a CFC receives a ``hybrid dividend''
from the CFC, then the U.S. shareholder is not allowed the section
245A(a) deduction for the hybrid dividend, and the rules of section
245A(d) (denial of foreign tax credits and deductions) apply. See
proposed Sec. 1.245A(e)-1(b). In general, a dividend is a hybrid
dividend if it satisfies two conditions: (i) But for section 245A(e),
the section 245A(a) deduction would be allowed, and (ii) the dividend
is one for which the CFC (or a related person) is or was allowed a
deduction or other tax benefit under a ``relevant foreign tax law''
(such a deduction or other tax benefit, a ``hybrid deduction''). See
proposed Sec. 1.245A(e)-1(b) and (d). The proposed regulations take
into account certain deductions or other tax benefits allowed to a
person related to a CFC (such as a shareholder) because, for example,
certain tax benefits allowed to a shareholder of a CFC are economically
equivalent to the CFC having been allowed a deduction.
B. Relevant Foreign Tax Law
The proposed regulations define a relevant foreign tax law as, with
respect to a CFC, any regime of any foreign country or possession of
the United States that imposes an income, war profits, or excess
profits tax with respect to income of the CFC, other than a foreign
anti-deferral regime under which an owner of the CFC is liable to tax.
See proposed Sec. 1.245A(e)-1(f). Thus, for example, a relevant
foreign tax law includes the tax law of a foreign country of which the
CFC is a tax resident, as well as the tax law applicable to a foreign
branch of the CFC.
C. Deduction or Other Tax Benefit
1. In General
Under the proposed regulations, only deductions or other tax
benefits that are ``allowed'' under the relevant foreign tax law may
constitute a hybrid deduction. See proposed Sec. 1.245A(e)-1(d). Thus,
for example, if the relevant foreign tax law contains hybrid mismatch
rules under which a CFC is denied a deduction for an amount of interest
paid with respect to a hybrid instrument to prevent a deduction/no-
inclusion (``D/NI'') outcome, then the payment of the interest does not
give rise to a hybrid deduction, because the deduction is not
``allowed.'' This prevents double-taxation that could arise if a hybrid
dividend were subject to both section 245A(e) and a hybrid mismatch
rule under a relevant foreign tax law.
For a deduction or other tax benefit to be a hybrid deduction, it
must relate to or result from an amount paid, accrued, or distributed
with respect to an instrument of the CFC that is treated as stock for
U.S. tax purposes. That is, there must be a connection between the
deduction or other tax benefit under the relevant foreign tax law and
the instrument that is stock for U.S. tax purposes. Thus, a hybrid
deduction includes an interest deduction under a relevant foreign tax
law with respect to a hybrid instrument (stock for U.S. tax purposes,
indebtedness for foreign tax purposes). It also includes dividends paid
deductions and other deductions allowed on equity under a relevant
foreign tax law, such as notional interest deductions (``NIDs''), which
raise similar concerns as traditional hybrid instruments. However, it
does not, for example, include an exemption provided to a CFC under its
tax law for certain types of income (such as income attributable to a
foreign branch), because there is not a connection between the tax
benefit and the instrument that is stock for U.S. tax purposes.
The proposed regulations provide that deductions or other tax
benefits allowed pursuant to certain integration or imputation systems
do not constitute hybrid deductions. See proposed Sec. 1.245A(e)-
1(d)(2)(i)(B). However, a system that has the effect of exempting
earnings that fund a distribution from foreign tax at both the CFC and
shareholder level gives rise to a hybrid deduction. See id.; see also
proposed Sec. 1.245A(e)-1(g)(2), Example 2.
2. Effect of Foreign Currency Gain or Loss
The payment of an amount by a CFC may, under a provision of foreign
tax law comparable to section 988, give rise to gain or loss to the CFC
that is attributable to foreign currency. The proposed regulations
provide that such foreign currency gain or loss recognized with respect
to such deduction or other tax benefit is taken into account for
purposes of determining hybrid deductions. See proposed Sec.
1.245A(e)-1(d)(6); see also section II.K.1 of this Explanation of
Provisions (requesting comments on foreign currency rules).
D. Tiered Hybrid Dividends
Proposed Sec. 1.245A(e)-1(c) sets forth rules related to hybrid
dividends of tiered corporations (``tiered hybrid dividends''), as
provided under section 245A(e)(2). A tiered hybrid dividend means an
amount received by a CFC from another CFC to the extent that the amount
would be a hybrid dividend under proposed Sec. 1.245A(e)-1(b) if the
receiving CFC were a domestic corporation. Accordingly, the amount must
be treated as a dividend under U.S. tax law to be treated as a tiered
hybrid dividend; the treatment of the amount under the tax law in which
the receiving CFC is a tax resident (or under any other foreign tax
law) is irrelevant for this purpose.
If a CFC receives a tiered hybrid dividend from another CFC, and a
domestic corporation is a U.S. shareholder of both CFCs, then (i) the
tiered hybrid dividend is treated as subpart F income of the receiving
CFC, (ii) the U.S. shareholder must include in gross income its pro
rata share of the subpart F income, and (iii) the rules of section
245A(d) apply to the amount included in the U.S. shareholder's gross
income. See proposed Sec. 1.245A(e)-1(c)(1). This treatment applies
notwithstanding any other provision of the Code. Thus, for example,
exceptions to subpart F income such as those provided under section
954(c)(3) (``same country'' exception for income received from related
persons) and section 954(c)(6) (look-through rule for related CFCs) do
not apply. As additional examples, the gross amount of subpart F income
cannot be reduced by deductions taken into account under section
954(b)(5) and Sec. 1.954-1(c), and is not subject to the current
earnings and profits limitation under section 952(c).
E. Interaction With Section 959
Distributions of previously taxed earnings and profits (``PTEP'')
attributable to amounts that have been taken into account by a U.S.
shareholder under section 951(a) are, in general, excluded from the
gross income of the U.S. shareholder when distributed under section
959(a), and under section 959(d) are not treated as a dividend (other
than to reduce earnings and profits). As a result, distributions from a
CFC to its U.S. shareholder out of PTEP are not eligible for the
dividends received deduction under section 245A(a), and section 245A(e)
does not apply. Similarly, distributions of PTEP from a CFC to an
upper-tier CFC are excluded from the gross income of the upper-tier CFC
under section 959(b), but
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only for the limited purpose of applying section 951(a). In addition,
such amounts continue to be treated as dividends because section 959(d)
does not apply to such amounts. Accordingly, distributions out of PTEP
could qualify as tiered hybrid dividends that would result in an income
inclusion to a U.S. shareholder. To prevent this result, the proposed
regulations provide that a tiered hybrid dividend does not include
amounts described in section 959(b). See proposed Sec. 1.245A(e)-
1(c)(2).
F. Interaction With Section 964(e)
Under section 964(e)(1), gain recognized by a CFC on the sale or
exchange of stock in another foreign corporation may be treated as a
dividend. In certain cases, section 964(e)(4): (i) Treats the dividend
as subpart F income of the selling CFC; (ii) requires a U.S.
shareholder of the CFC to include in its gross income its pro rata
share of the subpart F income; and (iii) allows the U.S. shareholder
the section 245A(a) deduction for its inclusion in gross income. As is
the case with the treatment of tiered hybrid dividends, the treatment
of dividends under section 964(e)(4) applies notwithstanding any other
provision of the Code.
The proposed regulations coordinate the tiered hybrid dividend
rules and the rules of section 964(e) by providing that, to the extent
a dividend arising under section 964(e)(1) is a tiered hybrid dividend,
the tiered hybrid dividend rules, rather than the rules of section
964(e)(4), apply. Thus, in such a case, a U.S. shareholder that
includes an amount in its gross income under the tiered hybrid dividend
rule is not allowed the section 245A(a) deduction, or foreign tax
credits or deductions, for the amount. See proposed Sec. 1.245A(e)-
1(c)(1) and (4).
G. Hybrid Deduction Accounts
1. In General
In some cases, the actual payment by a CFC of an amount that is
treated as a dividend for U.S. tax purposes will result in a
corresponding hybrid deduction. In many cases, however, the dividend
and the hybrid deduction may not arise pursuant to the same payment and
may be recognized in different taxable years. This may occur in the
case of a hybrid instrument for which under a relevant foreign tax law
the CFC is allowed deductions for accrued (but not yet paid) interest.
In such a case, to the extent that an actual payment has not yet been
made on the instrument, there generally would not be a dividend for
U.S. tax purposes for which the section 245A(a) deduction could be
disallowed under section 245A(e). Nevertheless, because the earnings
and profits of the CFC would not be reduced by the accrued interest
deduction, the earnings and profits may give rise to a dividend when
subsequently distributed to the U.S. shareholder. This same result
could occur in other cases, such as when a relevant foreign tax law
allows deductions on equity, such as NIDs.
The disallowance of the section 245A(a) deduction under section
245A(e) should not be limited to cases in which the dividend and the
hybrid deduction arise pursuant to the same payment (or in the same
taxable year for U.S. tax purposes and for purposes of the relevant
foreign tax law). Interpreting the provision in such a manner would
result in disparate treatment for hybrid arrangements that produce the
same D/NI outcome. Accordingly, the proposed regulations define a
hybrid dividend (or tiered hybrid dividend) based, in part, on the
extent of the balance of the ``hybrid deduction accounts'' of the
domestic corporation (or CFC) receiving the dividend. See proposed
Sec. 1.245A(e)-1(b) and (d). This ensures that dividends are subject
to section 245A(e) regardless of whether the same payment gives rise to
the dividend and the hybrid deduction.
A hybrid deduction account must be maintained with respect to each
share of stock of a CFC held by a person that, given its ownership of
the CFC and the share, could be subject to section 245A upon a dividend
paid by the CFC on the share. See proposed Sec. 1.245A(e)-1(d) and
(f). The account, which is maintained in the functional currency of the
CFC, reflects the amount of hybrid deductions of the CFC (allowed in
taxable years beginning after December 31, 2017) that have been
allocated to the share. A dividend paid by a CFC to a shareholder that
has a hybrid deduction account with respect to the CFC is generally
treated as a hybrid dividend or tiered hybrid dividend to the extent of
the shareholder's balance in all of its hybrid deduction accounts with
respect to the CFC, even if the dividend is paid on a share that has
not had any hybrid deductions allocated to it. Absent such an approach,
the purposes of section 245A(e) might be avoided by, for example,
structuring dividend payments such that they are generally made on
shares of stock to which a hybrid deduction has not been allocated
(rather than on shares of stock to which a hybrid deduction has been
allocated, such as a share that is a hybrid instrument).
Once an amount in a hybrid deduction account gives rise to a hybrid
dividend or a tiered hybrid dividend, the account is correspondingly
reduced. See proposed Sec. 1.245A(e)-1(d). The Treasury Department and
the IRS request comments on whether hybrid deductions attributable to
amounts included in income under section 951(a) or section 951A should
not increase the hybrid deduction account, or, alternatively, the
hybrid deduction account should be reduced by distributions of PTEP,
and on whether the effect of any deemed paid foreign tax credits
associated with such inclusions or distributions should be considered.
2. Transfers of Stock
Because hybrid deduction accounts are with respect to stock of a
CFC, the proposed regulations include rules that take into account
transfers of the stock. See proposed Sec. 1.245A(e)-1(d)(4)(ii)(A).
These rules, which are similar to the ``successor'' PTEP rules under
section 959 (see Sec. 1.959-1(d)), ensure that section 245A(e)
properly applies to dividends that give rise to a D/NI outcome in cases
where the shareholder that receives the dividend is not the same
shareholder that held the stock when the hybrid deduction was incurred.
These rules only apply when the stock is transferred among persons that
are required to keep hybrid deduction accounts. Thus, if the stock is
transferred to a person that is not required to keep a hybrid deduction
account--such as an individual or a foreign corporation that is not a
CFC--the account terminates (subject to the anti-avoidance rule,
discussed in section I.H of this Explanation of Provisions). Finally,
the proposed regulations include rules that take into account certain
non-recognition exchanges of the stock, such as exchanges in connection
with asset reorganizations, recapitalizations, and liquidations, as
well as transfers and exchanges that occur mid-way through a CFC's
taxable year. See proposed Sec. 1.245A(e)-1(d)(4)(ii)(B) and (d)(5).
The Treasury Department and the IRS request comments on these rules.
3. Dividends From Lower-Tier CFCs
The proposed regulations provide a special rule to address earnings
and profits of a lower-tier CFC that are included in a domestic
corporation's income as a dividend by virtue of section 1248(c)(2). In
these cases, the proposed regulations treat the domestic corporation as
having certain hybrid deduction accounts with respect to the lower-tier
CFC that are held and
[[Page 67615]]
maintained by other CFCs. See proposed Sec. 1.245A(e)-1(b)(3). This
ensures that, to the extent the earnings and profits of the lower-tier
CFC give rise to the dividend, hybrid deduction accounts with respect
to the lower-tier CFC are taken into account for purposes of the
determinations under section 245A(e), even though the accounts are held
indirectly by the domestic corporation. A similar rule applies with
respect to gains on stock sales treated as dividends under section
964(e)(1). See proposed Sec. 1.245A(e)-1(c)(3).
H. Anti-Avoidance Rule
The proposed regulations include an anti-avoidance rule. This rule
provides that appropriate adjustments are made, including adjustments
that would disregard a transaction or arrangement, if a transaction or
arrangement is engaged in with a principal purpose of avoiding the
purposes of proposed Sec. 1.245A(e)-1.
II. Section 267A--Related Party Amounts Involving Hybrid Transactions
and Hybrid Entities
A. Overview
As indicated in the Senate Finance Committee's Explanation of the
Bill, hybrid arrangements may exploit differences under U.S. and
foreign tax law between the tax characterization of an entity as
transparent or opaque or differences in the treatment of financial
instruments or other transactions. The proposed regulations under
section 267A address certain payments or accruals of interest or
royalties for U.S. tax purposes (the amount of such interest or
royalty, a ``specified payment'') that involve hybrid arrangements, or
similar arrangements involving branches, that produce D/NI (deduction/
no inclusion) outcomes or indirect D/NI outcomes. See also section
II.J.1 of this Explanation of Provisions (discussing certain amounts
that are treated as specified payments). The proposed regulations
neutralize the double non-taxation effects of the arrangements by
denying a deduction for the specified payment to the extent of the D/NI
outcome.
B. Scope
1. Disallowed Deductions
The proposed regulations generally disallow a deduction for a
specified payment if and only if the payment is (i) a ``disqualified
hybrid amount,'' meaning that it produces a D/NI outcome as a result of
a hybrid or branch arrangement; (ii) a ``disqualified imported mismatch
amount,'' meaning that it produces an indirect D/NI outcome as a result
of the effects of an offshore hybrid or branch arrangement being
imported into the U.S. tax system; or (iii) made pursuant to a
transaction a principal purpose of which is to avoid the purposes of
the regulations under section 267A and it produces a D/NI outcome. See
proposed Sec. 1.267A-1(b). Thus, the proposed regulations do not
address D/NI outcomes that are not the result of hybridity. See also
section II.E of this Explanation of Provisions (discussing the link
between hybridity and a D/NI outcome). In addition, the proposed
regulations do not address double-deduction outcomes. Section 267A is
intended to address D/NI outcomes; transactions that produce double-
deduction outcomes are addressed through other provisions (or
doctrines), such as the dual consolidated loss rules under section
1503(d). See also section IV.A.1 of this Explanation of Provisions
(discussing the dual consolidated loss rules).
2. Parties Subject to Section 267A
The application of section 267A by its terms is not limited to any
particular category of persons. The proposed regulations, however,
narrow the scope of section 267A so that it applies only to deductions
of ``specified parties.'' Deductions of persons other than specified
parties are not subject to disallowance under section 267A because the
deductions of such other persons generally do not have significant U.S.
tax consequences.
A specified party means any of (i) a tax resident of the United
States, (ii) a CFC for which there is one or more United States
shareholders that own (within the meaning of section 958(a)) at least
ten percent of the stock of the CFC, and (iii) a U.S. taxable branch
(which includes a U.S. permanent establishment of a tax treaty
resident). See proposed Sec. 1.267A-5(a). The term generally includes
a CFC because, for example, a specified payment made by a CFC to the
foreign parent of the CFC's U.S. shareholder, or a specified payment by
the CFC to an unrelated party pursuant to a structured arrangement, may
indirectly reduce income subject to U.S. tax. Specified payments made
by a CFC to other related CFCs or to U.S. shareholders of the CFC,
however, typically will not be subject to section 267A because of the
rules in proposed Sec. 1.267A-3(b) that exempt certain payments
included in income of a U.S. tax resident or taken into account under
the subpart F or global intangible low-tax income (``GILTI'') rules.
See also section II.F of this Explanation of Provisions (discussing the
relatedness or structured arrangement limitation); section II.H of this
Explanation of Provisions (discussing exceptions for amounts included
or includible in income). Similarly, the term includes a U.S. taxable
branch because a payment made by the home office may be allocable to
and thus reduce income subject to U.S. tax under sections 871(b) or
882. See also section II.K.2 of this Explanation of Provisions
(discussing amounts considered paid or accrued by a U.S. taxable branch
for section 267A purposes).
The term specified party does not include a partnership because a
partnership generally is not liable to tax and therefore is not the
person allowed a deduction. However, a partner of a partnership may be
a specified party. For example, in the case of a payment made by a
partnership a partner of which is a domestic corporation, the domestic
corporation is a specified party and its allocable share of the
deduction for the payment is subject to disallowance under section
267A.
C. Amount of a D/NI Outcome
1. In General
Proposed Sec. 1.267A-3(a) provides rules for determining the ``no-
inclusion'' aspect of a D/NI outcome--that is, the amount of a
specified payment that is or is not included in income under foreign
tax law. The proposed regulations provide that only ``tax residents''
or ``taxable branches'' are considered to include an amount in income.
Parties other than tax residents or taxable branches, for example, an
entity that is fiscally transparent for purposes of the relevant tax
laws, do not include an amount in income because such parties are not
liable to tax.
In general, a tax resident or taxable branch includes a specified
payment in income for this purpose to the extent that, under its tax
law, it includes the payment in its income or tax base at the full
marginal rate imposed on ordinary income, and the payment is not
reduced or offset by certain items (such as an exemption or credit)
particular to that type of payment. See proposed Sec. 1.267A-3(a)(1).
Whether a tax resident or taxable branch includes a specified
payment in income is determined without regard to any defensive or
secondary rule in hybrid mismatch rules (which generally requires the
payee to include certain amounts in income, if the payer is not denied
a deduction for the amount), if any, under the tax resident's or
taxable branch's tax law. Otherwise, in cases in which such tax law
contains a secondary response, the analysis of whether the specified
payment is
[[Page 67616]]
included in income could become circular: For example, whether the
United States denies a deduction under section 267A may depend on
whether the payee includes the specified payment in income, and whether
the payee includes it in income (under a secondary response) may depend
on whether the United States denies the deduction.
A specified payment may be considered included in income even
though offset by a generally applicable deduction or other tax
attribute, such as a deduction for depreciation or a net operating
loss. For this purpose, a deduction may be treated as being generally
applicable even if closely related to the specified payment (for
example, if the deduction and payment are in connection with a back-to-
back financing arrangement).
If a specified payment is taxed at a preferential rate, or if there
is a partial reduction or offset particular to the type of payment, a
portion of the payment is considered included in income. The portion
included in income is the amount that, taking into account the
preferential rate or reduction or offset, is subject to tax at the full
marginal rate applicable to ordinary income. See proposed Sec. 1.267A-
3(a)(1); see also proposed Sec. 1.267A-6(c), Example 2 and Example 7.
2. Timing Differences
Some specified payments may never be included in income. For
example, a specified payment treated as a dividend under a tax
resident's tax laws may be permanently excluded from its income under a
participation exemption. Permanent exclusions are always treated as
giving rise to a no-inclusion. See proposed Sec. 1.267A-3(a)(1).
Other specified payments, however, may be included in income but on
a deferred basis. Some of these timing differences result from
different methods of accounting between U.S. tax law and foreign tax
law. For example, and subject to certain limitations such as those
under sections 163(e)(3) and 267(a) (generally applicable to payments
involving related parties, but not to payments involving structured
arrangements), a specified payment may be deductible for U.S. tax
purposes when accrued and later included in a foreign tax resident's
income when actually paid. See also section II.K.3 of this Explanation
of Provisions (discussing the coordination of section 267A with rules
such as sections 163(e)(3) and 267(a)). Timing differences may also
occur in cases in which all or a portion of a specified payment that is
treated as interest for U.S. tax purposes is treated as a return of
principal for purposes of the foreign tax law.
In some cases, timing differences reverse after a short period of
time and therefore do not provide a meaningful deferral benefit. The
Treasury Department and the IRS have determined that routine, short-
term deferral does not give rise to the policy concerns that section
267A is intended to address. In addition, subjecting such short-term
deferral to section 267A could give rise to administrability issues for
both taxpayers and the IRS, because it may be challenging to determine
whether the taxable period in which a specified payment is included in
income matches the taxable period in which the payment is deductible.
Other timing differences, though, may provide a significant and
long-term deferral benefit. Moreover, taxpayers may structure
transactions that exploit these differences to achieve long-term
deferral benefits. Timing differences that result in long-term deferral
have an economic effect similar to a permanent exclusion and therefore
give rise to policy concerns that section 267A is intended to address.
See Senate Explanation, at 384 (expressing concern with hybrid
arrangements that ``achieve double non-taxation, including long-term
deferral.''). Accordingly, proposed Sec. 1.267A-3(a)(1) provides that
short-term deferral, meaning inclusion during a taxable year that ends
no more than 36 months after the end of the specified party's taxable
year, does not give rise to a D/NI outcome; inclusions outside of the
36-month timeframe, however, are treated as giving rise to a D/NI
outcome.
D. Hybrid and Branch Arrangements Giving Rise to Disqualified Hybrid
Amounts
1. Hybrid Transactions
Proposed Sec. 1.267A-2(a) addresses hybrid financial instruments
and similar arrangements (collectively, ``hybrid transactions'') that
result in a D/NI outcome. For example, in the case of an instrument
that is treated as indebtedness for purposes of the payer's tax law and
stock for purposes of the payee's tax law, a payment on the instrument
may constitute deductible interest expense of the payer and excludible
dividend income of the payee (for instance, under a participation
exemption).
In general, the proposed regulations provide that a specified
payment is made pursuant to a hybrid transaction if there is a mismatch
in the character of the instrument or arrangement such that the payment
is not treated as interest or a royalty, as applicable, under the tax
law of a ``specified recipient.'' Examples of such a specified payment
include a payment that is treated as interest for U.S. tax purposes
but, for purposes of a specified recipient's tax law, is treated as a
distribution on equity or a return of principal. When a specified
payment is made pursuant to a hybrid transaction, it generally is a
disqualified hybrid amount to the extent that the specified recipient
does not include the payment in income.
The proposed regulations broadly define specified recipient as (i)
any tax resident that under its tax law derives the specified payment,
and (ii) any taxable branch to which under its tax law the specified
payment is attributable. See proposed Sec. 1.267A-5(a)(19). In other
words, a specified recipient is any party that may be subject to tax on
the specified payment under its tax law. There may be more than one
specified recipient of a specified payment. For example, in the case of
a specified payment to an entity that is fiscally transparent for
purposes of the tax law of its tax resident owners, each of the owners
is a specified recipient of a share of the payment. In addition, if the
entity is a tax resident of the country in which it is established or
managed and controlled, then the entity is also a specified recipient.
Moreover, in the case of a specified payment attributable to a taxable
branch, both the taxable branch and the home office are specified
recipients.
The proposed regulations deem a specified payment as made pursuant
to a hybrid transaction if there is a long-term mismatch between when
the specified party is allowed a deduction for the payment under U.S.
tax law and when a specified recipient includes the payment in income
under its tax law. This rule applies, for example, when a specified
payment is made pursuant to an instrument viewed as indebtedness under
both U.S. and foreign tax law and, due to a mismatch in tax accounting
treatment between the U.S. and foreign tax law, results in long-term
deferral. In these cases, this rule treats the long-term deferral as
giving rise to a hybrid transaction; the rules in proposed Sec.
1.267A-3(a)(1) (discussed in section II.C.2 of this Explanation of
Provisions) treat the long-term deferral as creating a D/NI outcome.
Lastly, proposed Sec. 1.267A-2(a)(3) provides special rules to
address securities lending transactions, sale-repurchase transactions,
and similar transactions. In these cases, a specified payment (that is,
interest consistent with the substance of the transaction) might not be
regarded under a foreign
[[Page 67617]]
tax law. As a result, there might not be a specified recipient of the
specified payment under such foreign tax law, absent a special rule. To
address this scenario, the proposed regulations provide that the
determination of the identity of a specified recipient under the
foreign tax law is made with respect to an amount connected to the
specified payment and regarded under the foreign tax law--for example,
a dividend consistent with the form of the transaction. The Treasury
Department and the IRS request comments on whether similar rules should
be extended to other specific transactions.
2. Disregarded Payments
Proposed Sec. 1.267A-2(b) addresses disregarded payments.
Disregarded payments generally give rise to a D/NI outcome because they
are regarded under the payer's tax law and are therefore available to
offset income not taxable to the payee, but are disregarded under the
payee's tax law and therefore are not included in income.
In general, the proposed regulations define a disregarded payment
as a specified payment that, under a foreign tax law, is not regarded
because, for example, it is a disregarded transaction involving a
single taxpayer or between consolidated group members. For example, a
disregarded payment includes a specified payment made by a domestic
corporation to its foreign owner if, under the foreign tax law, the
domestic corporation is a disregarded entity and therefore the payment
is not regarded. It also includes a specified payment between related
foreign corporations that are members of the same foreign consolidated
group (or can otherwise share income or loss) if, under the foreign tax
law, payments between group members are not regarded, or give rise to a
deduction or similar offset to the payer member that is available to
offset the corresponding income of the recipient member.
In general, a disregarded payment is a disqualified hybrid amount
only to the extent it exceeds dual inclusion income. For example, if a
domestic corporation that for foreign tax purposes is a disregarded
entity of its foreign owner makes a disregarded payment to its foreign
owner, the payment is a disqualified hybrid amount only to the extent
it exceeds the net of the items of gross income and deductible expense
taken into account in determining the domestic corporation's income for
U.S. tax purposes and the foreign owner's income for foreign tax
purposes. This prevents the excess of the disregarded payment over dual
inclusion income from offsetting non-dual inclusion income. Such an
offset could otherwise occur, for example, through the U.S.
consolidation regime, or a sale, merger, or similar transaction.
A disregarded payment could also be viewed as being made pursuant
to a hybrid transaction because the payment of interest or royalty
would not be viewed as interest or royalty under the foreign tax law
(since the payment is disregarded). The proposed regulations address
disregarded payments separately from hybrid transactions, however,
because disregarded payments are more likely to offset dual inclusion
income and therefore are treated as disqualified hybrid amounts only to
the extent they offset non-dual inclusion income.
3. Deemed Branch Payments
Proposed Sec. 1.267A-2(c) addresses deemed branch payments. These
payments result in a D/NI outcome when, under an income tax treaty, a
deductible payment is deemed to be made by a permanent establishment to
its home office and offsets income not taxable to the home office, but
the payment is not taken into account under the home office's tax law.
In general, the proposed regulations define a deemed branch payment
as interest or royalty considered paid by a U.S. permanent
establishment to its home office under an income tax treaty between the
United States and the home office country. See proposed Sec. 1.267A-
2(c)(2). Thus, for example, a deemed branch payment includes an amount
allowed as a deduction in computing the business profits of a U.S.
permanent establishment with respect to the use of intellectual
property developed by the home office. See, for example, the U.S.
Treasury Department Technical Explanation to the income tax convention
between the United States and Belgium, signed November 27, 2006
(``[T]he OECD Transfer Pricing Guidelines apply, by analogy, in
determining the profits attributable to a permanent establishment.'').
When a specified payment is a deemed branch payment, it is a
disqualified hybrid amount if the home office's tax law provides an
exclusion or exemption for income attributable to the branch. In these
cases, a deduction for the deemed branch payment would offset non-dual
inclusion income and therefore give rise to a D/NI outcome. If the home
office's tax law does not have an exclusion or exemption for income
attributable to the branch, then, because U.S. permanent establishments
cannot consolidate or otherwise share losses with U.S. taxpayers, there
would generally not be an opportunity for a deduction for the deemed
branch payment to offset non-dual inclusion income.
4. Reverse Hybrids
Proposed Sec. 1.267A-2(d) addresses payments to reverse hybrids.
In general, and as discussed below, a reverse hybrid is an entity that
is fiscally transparent for purposes of the tax law of the country in
which it is established but not for purposes of the tax law of its
owner. Thus, payments to a reverse hybrid may result in a D/NI outcome
because the reverse hybrid is not a tax resident of the country in
which it is established, and the owner does not derive the payment
under its tax law. Because this D/NI outcome may occur regardless of
whether the establishment country is a foreign country or the United
States, the proposed regulations provide that both foreign and domestic
entities may be reverse hybrids. A domestic entity that is a reverse
hybrid for this purpose therefore differs from a ``domestic reverse
hybrid entity'' under Sec. 1.894-1(d)(2)(i), which is defined as ``a
domestic entity that is treated as not fiscally transparent for U.S.
tax purposes and as fiscally transparent under the laws of an interest
holder's jurisdiction[.]''
For an entity to be a reverse hybrid under the proposed
regulations, two requirements must be satisfied. These requirements
generally implement the definition of hybrid entity in section
267A(d)(2), with certain modifications. First, the entity must be
fiscally transparent under the tax law of the country in which it is
established, whether or not it is a tax resident of another country.
For this purpose, the determination of whether an entity is fiscally
transparent with respect to an item of income is made using the
principles of Sec. 1.894-1(d)(3)(ii) (but without regard to whether
there is an income tax treaty in effect between the entity's
jurisdiction and the United States).
Second, the entity must not be fiscally transparent under the tax
law of an ``investor.'' An investor means a tax resident or taxable
branch that directly or indirectly owns an interest in the entity. For
this purpose, the determination of whether an investor's tax law treats
the entity as fiscally transparent with respect to an item of income is
made under the principles of Sec. 1.894-1(d)(3)(iii) (but without
regard to whether there is an income tax treaty in effect between the
investor's jurisdiction and the United States). If an investor views
the entity as not fiscally transparent, the investor generally will not
be currently taxed under its tax law
[[Page 67618]]
on payments to the entity. Thus, the non-fiscally-transparent status of
the entity is determined on an investor-by-investor basis, based on the
tax law of each investor. In addition, a tax resident or a taxable
branch may be an investor of a reverse hybrid even if the tax resident
or taxable branch indirectly owns the reverse hybrid through one or
more intermediary entities that, under the tax law of the tax resident
or taxable branch, are not fiscally transparent. In such a case,
however, the investor's no-inclusion would not be a result of the
payment being made to the reverse hybrid and therefore would not be a
disqualified hybrid amount. See also section II.E of this Explanation
of Provisions (explaining that the D/NI outcome must be a result of
hybridity); proposed Sec. 1.267A-6(c), Example 5 (analyzing whether a
D/NI outcome with respect to an upper-tier investor is a result of the
specified payment being made to the reverse hybrid).
When a specified payment is made to a reverse hybrid, it is
generally a disqualified hybrid amount to the extent that an investor
does not include the payment in income. For this purpose, whether an
investor includes the specified payment in income is determined without
regard to a subsequent distribution by the reverse hybrid. Although a
subsequent distribution may be included in the investor's income, the
distribution may not occur for an extended period and, when it does
occur, it may be difficult to determine whether the distribution is
funded from an amount comprising the specified payment.
In addition, if an investor takes a specified payment into account
under an anti-deferral regime, then the investor is considered to
include the payment in income to the extent provided under the general
rules of proposed Sec. 1.267A-3(a). See proposed Sec. 1.267A-6(c),
Example 5. Thus, for example, if the investor's inclusion under the
anti-deferral regime is subject to tax at a preferential rate, the
investor is considered to include only a portion of the specified
payment in income.
5. Branch Mismatch Payments
Proposed Sec. 1.267A-2(e) addresses branch mismatch payments.
These payments give rise to a D/NI outcome due to differences between
the home office's tax law and the branch's tax law regarding the
allocation of items of income or the treatment of the branch. This
could occur, for example, if the home office's tax law views a payment
as attributable to the branch and exempts the branch's income, but the
branch's tax law does not tax the payment.
Under the proposed regulations, a specified payment is a branch
mismatch payment when two requirements are satisfied. First, under a
home office's tax law, the specified payment is treated as attributable
to a branch of the home office. Second, under the tax law of the branch
country, either (i) the home office does not have a taxable presence in
the country, or (ii) the specified payment is treated as attributable
to the home office and not the branch. When a specified payment is a
branch mismatch payment, it is generally a disqualified hybrid amount
to the extent that the home office does not include the payment in
income.
E. Link Between Hybridity and D/NI Outcome
Under section 267A(a), a deduction for a payment is generally
disallowed if (i) the payment involves a hybrid arrangement, and (ii) a
D/NI outcome occurs. In certain cases, although both of these
conditions are satisfied, the D/NI outcome is not a result of the
hybridity. For example, in the hybrid transaction context, the D/NI
outcome may be a result of the specified recipient's tax law containing
a pure territorial system (and thus exempting from taxation all foreign
source income) or not having a corporate income tax, or a result of the
specified recipient's status as a tax-exempt entity under its tax law.
The proposed regulations provide that a D/NI outcome gives rise to
a disqualified hybrid amount only to the extent that the D/NI outcome
is a result of hybridity. See, for example, proposed Sec. 1.267A-
2(a)(1)(ii); see also Senate Explanation, at 384 (``[T]he Committee
believes that hybrid arrangements exploit differences in the tax
treatment of a transaction or entity under the laws of two or more
jurisdictions to achieve double non-taxation . . .'') (emphasis added).
To determine whether a D/NI outcome is a result of hybridity, the
proposed regulations generally apply a test based on facts that are
counter to the hybridity at issue. For example, in the hybrid
transaction context, a specified recipient's no-inclusion is a result
of the specified payment being made pursuant to the hybrid transaction
to the extent that the no-inclusion would not occur were the payment to
be treated as interest or a royalty for purposes of the specified
recipient's tax law.
This test also addresses cases in which, for example, a specified
payment is made to a fiscally transparent entity (such as a
partnership) and owners of the entity that are specified recipients of
the payment each derive only a portion of the payment under its tax
law. The test ensures that, with respect to each specified recipient,
only the no-inclusion that occurs for the portion of the specified
payment that it derives may give rise to a disqualified hybrid amount.
In addition, as a result of the relatedness or structured arrangement
limitation discussed in section II.F of this Explanation of Provisions,
the no-inclusion with respect to the specified recipient is taken into
account under the proposed regulations only if the specified recipient
is related to the specified party or is a party to a structured
arrangement pursuant to which the specified payment is made.
F. Relatedness or Structured Arrangement Limitation
In determining whether a specified payment is made pursuant to a
hybrid or branch mismatch arrangement, the proposed regulations
generally only consider the tax laws of tax residents or taxable
branches that are related to the specified party. See proposed Sec.
1.267A-2(f). For example, in general, only the tax law of a specified
recipient that is related to the specified party is taken into account
for purposes of determining whether the specified payment is made
pursuant to a hybrid transaction. Because a deemed branch payment by
its terms involves a related home office, the relatedness limitation in
proposed Sec. 1.267A-2(f) does not apply to proposed Sec. 1.267A-
2(c).
The proposed regulations provide that related status is determined
under the rules of section 954(d)(3) (involving ownership of more than
50 percent of interests) but without regard to downward attribution.
See proposed Sec. 1.267A-5(a)(14). In addition, to ensure that a tax
resident may be considered related to a specified party even though the
tax resident is a disregarded entity for U.S. tax purposes, the
proposed regulations provide that such a tax resident is treated as a
corporation for purposes of the relatedness test. A similar rule
applies with respect to a taxable branch.
However, the Treasury Department and the IRS are aware that some
hybrid arrangements involving unrelated parties are designed to give
rise to a D/NI outcome and therefore present the policy concerns
underlying section 267A. Furthermore, it is likely that in such cases
the specified party will have, or can reasonably obtain, the
information necessary to comply with section 267A. Accordingly, the
proposed regulations generally provide
[[Page 67619]]
that the tax law of an unrelated tax resident or taxable branch is
taken into account for purposes of section 267A if the tax resident or
taxable branch is a party to a structured arrangement. See proposed
Sec. 1.267A-2(f). The proposed regulations set forth a test for when a
transaction is a structured arrangement. See proposed Sec. 1.267A-
5(a)(20). In addition, the proposed regulations impute an entity's
participation in a structured arrangement to its investors. See id.
Thus, for example, in the case of a specified payment to a partnership
that is a party to a structured arrangement pursuant to which the
payment is made, a tax resident that is a partner of the partnership is
also a party to the structured arrangement, even though the tax
resident may not have actual knowledge of the structured arrangement.
G. Effect of Inclusion in Another Jurisdiction
The proposed regulations provide that a specified payment is a
disqualified hybrid amount if a D/NI outcome occurs as a result of
hybridity in any foreign jurisdiction, even if the payment is included
in income in another foreign jurisdiction. See proposed Sec. 1.267A-
6(c), Example 1. Absent such a rule, an inclusion of a specified
payment in income in a jurisdiction with a (generally applicable) low
rate might discharge the application of section 267A even though a D/NI
outcome occurs in another jurisdiction as a result of hybridity.
For example, assume FX, a tax resident of Country X, owns US1, a
domestic corporation, and FZ, a tax resident of Country Z that is
fiscally transparent for Country X tax purposes. Also, assume that
Country Z has a single, low-tax rate applicable to all income. Further,
assume that FX holds an instrument issued by US1, a $100x payment with
respect to which is treated as interest for U.S. tax purposes and an
excludible dividend for Country X tax purposes. In an attempt to avoid
US1's deduction for the $100x payment being denied under the hybrid
transaction rule, FX contributes the instrument to FZ, and, upon US1's
$100x payment, US1 asserts that, although a $100x no-inclusion occurs
with respect to FX as a result of the payment being made pursuant to
the hybrid transaction, the payment is not a disqualified hybrid amount
because FZ fully includes the payment in income (albeit at a low-tax
rate). The proposed regulations treat the payment as a disqualified
hybrid amount.
This rule only applies for inclusions under the laws of foreign
jurisdictions. See proposed Sec. 1.267A-3(b), and section II.H of this
Explanation of Provisions, for exceptions that apply when the payment
is included or includible in a U.S. tax resident's or U.S. taxable
branch's income.
The Treasury Department and IRS request comments on whether an
exception should apply if the specified payment is included in income
in any foreign jurisdiction, taking into account accommodation
transactions involving low-tax entities.
H. Exceptions for Certain Amounts Included or Includible in a U.S. Tax
Resident's or U.S. Taxable Branch's Income
Proposed Sec. 1.267A-3(b) provides rules that reduce disqualified
hybrid amounts to the extent the amounts are included or includible in
a U.S. tax resident's or U.S. taxable branch's income. In general,
these rules ensure that a specified payment is not a disqualified
hybrid amount to the extent included in the income of a tax resident of
the United States or a U.S. taxable branch, or taken into account by a
U.S. shareholder under the subpart F or GILTI rules.
Source-based withholding tax imposed by the United States (or any
other country) on disqualified hybrid amounts does not neutralize the
D/NI outcome and therefore does not reduce or otherwise affect
disqualified hybrid amounts. Withholding tax policies are unrelated to
the policies underlying hybrid arrangements--for example, withholding
tax can be imposed on non-hybrid payments--and, accordingly,
withholding tax is not a substitute for a specified payment being
included in income by a tax resident or taxable branch. See also
section II.L of this Explanation of Provisions (interaction with
withholding taxes and income tax treaties). Furthermore, other
jurisdictions applying the defensive or secondary rule to a payment
(which generally requires the payee to include the payment in income,
if the payer is not denied a deduction for the payment under the
primary rule) may not treat withholding taxes as satisfying the primary
rule and may therefore require the payee to include the payment in
income if a deduction for the payment is not disallowed (regardless of
whether withholding tax has been imposed).
Thus, the proposed regulations do not treat amounts subject to U.S.
withholding taxes as reducing disqualified hybrid amounts.
Nevertheless, the Treasury Department and the IRS request comments on
the interaction of the proposed regulations with withholding taxes and
whether, and the extent to which, there should be special rules under
section 267A when withholding taxes are imposed in connection with a
specified payment, taking into account how such a rule could be
coordinated with the hybrid mismatch rules of other jurisdictions.
I. Disqualified Imported Mismatch Amounts
Proposed Sec. 1.267A-4 sets forth a rule to address ``imported''
hybrid and branch arrangements. This rule is generally intended to
prevent the effects of an ``offshore'' hybrid arrangement (for example,
a hybrid arrangement between two foreign corporations completely
outside the U.S. taxing jurisdiction) from being shifted, or
``imported,'' into the U.S. taxing jurisdiction through the use of a
non-hybrid arrangement.
Accordingly, the proposed regulations disallow deductions for
specified payments that are ``disqualified imported mismatch amounts.''
In general, a disqualified imported mismatch amount is a specified
payment: (i) That is non-hybrid in nature, such as interest paid on an
instrument that is treated as indebtedness for both U.S. and foreign
tax purposes, and (ii) for which the income attributable to the payment
is directly or indirectly offset by a hybrid deduction of a foreign tax
resident or taxable branch. The rule addresses ``indirect'' offsets in
order to take into account, for example, structures involving
intermediaries where the foreign tax resident that receives the
specified payment is different from the foreign tax resident that
incurs the hybrid deduction. See proposed Sec. 1.267A-6(c), Example 8,
Example 9, and Example 10.
In general, a hybrid deduction for purposes of the imported
mismatch rule is an amount for which a foreign tax resident or taxable
branch is allowed an interest or royalty deduction under its tax law,
to the extent the deduction would be disallowed if such tax law were to
contain rules substantially similar to the section 267A proposed
regulations. For this purpose, it is not relevant whether the amount is
recognized as interest or a royalty under U.S. law, or whether the
amount would be allowed as a deduction under U.S. law. Thus, for
example, a deduction with respect to equity (such as a notional
interest deduction) constitutes a hybrid deduction even though such a
deduction would not be recognized (or allowed) under U.S. tax law. As
another example, a royalty deduction under foreign tax law may
constitute a hybrid deduction even though for U.S. tax purposes the
royalty is viewed as made
[[Page 67620]]
from a disregarded entity to its owner and therefore is not regarded.
The requirement that the deduction would be disallowed if the
foreign tax law were to contain rules substantially similar to those
under section 267A is intended to limit the application of the imported
mismatch rule to cases in which, had the foreign-to-foreign hybrid
arrangement instead involved a specified party, section 267A would have
applied to disallow the deduction. In other words, this requirement
prevents the imported mismatch rule from applying to arrangements
outside the general scope of section 267A, even if the arrangements are
hybrid in nature and result in a D/NI (or similar) outcome. For
example, in the case of a deductible payment of a foreign tax resident
to a tax resident of a foreign country that does not impose an income
tax, the deduction would generally not be a hybrid deduction--even
though it may be made pursuant to a hybrid instrument--because the D/NI
outcome would not be a result of hybridity. See section II.E of this
Explanation of Provisions (requiring a link between hybridity and the
D/NI outcome, for a specified payment to be a disqualified hybrid
amount).
Further, the proposed regulations include ``ordering'' and
``funding'' rules to determine the extent that a hybrid deduction
directly or indirectly offsets income attributable to a specified
payment. In addition, the proposed regulations provide that certain
payments made by non-specified parties the tax laws of which contain
hybrid mismatch rules are taken into account when applying the ordering
and funding rules. Together, these provisions are intended to
coordinate proposed Sec. 1.267A-4 with foreign imported mismatch
rules, in order to prevent the same hybrid deduction from resulting in
deductions for non-hybrid payments being disallowed under imported
mismatch rules in more than one jurisdiction.
J. Definitions of Interest and Royalty
1. Interest
There are no generally applicable regulations or statutory
provisions addressing when financial instruments are treated as debt
for U.S. tax purposes or when a payment is interest. As a general
matter, however, the factors that distinguish debt from equity are
described in Notice 94-47, 1994-1 C.B. 357, and interest is defined as
compensation for the use or forbearance of money. Deputy v. Dupont, 308
U.S. 488 (1940).
Using these principles, the proposed regulations define interest
broadly to include interest associated with conventional debt
instruments, other amounts treated as interest under the Code, as well
as transactions that are indebtedness in substance although not in
form. See proposed Sec. 1.267A-5(a)(12).
In addition, in order to address certain structured transactions,
the proposed regulations apply equally to ``structured payments.''
Proposed Sec. 1.267A-5(b)(5) defines structured payments to include a
number of items such as an expense or loss predominately incurred in
consideration of the time value of money in a transaction or series of
integrated or related transactions in which a taxpayer secures the use
of funds for a period of time. This approach is consistent with the
rules treating such payments similarly to interest under Sec. Sec.
1.861-9T and 1.954-2.
The definitions of interest and structured payments also provide
for adjustments to the amount of interest expense or structured
payments, as applicable, to reflect the impact of derivatives that
affect the economic yield or cost of funds of a transaction involving
interest or structured payments. The definitions of interest and
structured payments contained in the proposed regulations apply only
for purposes of section 267A. However, solely for purposes of certain
other provisions, similar definitions apply. For example, the
definition of interest and structured payments under the proposed
regulations is similar in scope to the definition of items treated
similarly to interest under Sec. 1.861-9T for purposes of allocating
and apportioning deductions under section 861 and similar to the items
treated as interest expense for purposes of section 163(j) in proposed
regulations under section 163(j).
The Treasury Department and the IRS considered three options with
respect to the definition of interest for purposes of section 267A. The
first option considered was to not provide a definition of interest,
and thus rely on general tax principles and case law to define interest
for purposes of section 267A. While adopting this option might reduce
complexity for some taxpayers, not providing an explicit definition of
interest would create its own uncertainty as neither taxpayers nor the
IRS might have a clear sense of what types of payments are treated as
interest expense subject to disallowance under section 267A. Such
uncertainty could increase burdens to the IRS and taxpayers by
increasing the number of disputes about whether particular payments are
interest for section 267A purposes. Moreover, this option could be
distortive as it would provide an incentive to taxpayers to engage in
transactions generating deductions economically similar to interest
while asserting that such deductions are not described by existing
principles defining interest expense. If successful, such strategies
could allow taxpayers to avoid the application of section 267A through
transactions that are similar to transactions involving interest.
The second option considered would have been to adopt a definition
of interest but limit the scope of the definition to cover only amounts
associated with conventional debt instruments and amounts that are
generally treated as interest for all purposes under the Code or
regulations prior to the passage of the Act. This would be equivalent
to only adopting the rule that is proposed in Sec. 1.267A-5(a)(12)(i)
without also addressing structured payments, which are described in
proposed Sec. 1.267A-5(b)(5). While this would clarify what would be
deemed interest for purposes of section 267A, the Treasury Department
and the IRS have determined that this approach would potentially
distort future financing transactions. Some taxpayers would choose to
use financial instruments and transactions that provide a similar
economic result of using a conventional debt instrument, but would
avoid the label of interest expense under such a definition,
potentially enabling these taxpayers to avoid the application of
section 267A. As a result, under this second approach, there would
still be an incentive for taxpayers to engage in the type of avoidance
transactions discussed in the first alternative.
The final option considered and the one ultimately adopted in the
proposed regulations is to provide a complete definition of interest
that addresses all transactions that are commonly understood to produce
interest expense, as well as structured payments that may have been
entered into to avoid the application of section 267A. The proposed
regulations also reduce taxpayer burden by adopting definitions of
interest that have already been developed and administered in
Sec. Sec. 1.861-9T and 1.954-2 and that have been proposed for
purposes of section 163(j). The definition of interest provided in the
proposed regulations applies only for purposes of section 267A and not
for other purposes of the Code, such as section 904(d)(3).
The Treasury Department and the IRS welcome comments on the
definition of
[[Page 67621]]
interest for purposes of section 267A contained in the proposed
regulations.
2. Royalty
Section 267A does not define the term royalty and there is no
universal definition of royalty under the Code. The Treasury Department
and the IRS considered providing no definition for royalties. However,
similar to the discussion in Section II.J.1 of this Explanation of
Provisions with respect to the definition of interest, not providing a
definition for royalties and relying instead on general tax principles
could create uncertainty as neither taxpayers nor the IRS might have a
clear sense of what types of payments are treated as royalties subject
to disallowance under section 267A. Such uncertainty could increase
burdens to the IRS and taxpayers with respect to disputes about whether
particular payments are royalties for section 267A purposes.
Instead, the Treasury Department and the IRS have determined that
providing a definition of royalties would increase certainty, and
therefore the proposed regulations define the term royalty for purposes
of section 267A to include amounts paid or accrued as consideration for
the use of, or the right to use, certain intellectual property and
certain information concerning industrial, commercial or scientific
experience. See proposed Sec. 1.267A-5(a)(16). The term does not
include amounts paid or accrued for after-sales services, for services
rendered by a seller to the purchaser under a warranty, for pure
technical assistance, or for an opinion given by an engineer, lawyer or
accountant. The definition of royalty provided in the proposed
regulations applies only for purposes of section 267A and not for other
purposes of the Code, such as section 904(d)(3).
The definition of royalty is generally based on the definition used
in tax treaties and, in particular, the definition incorporated into
Article 12 of the 2006 U.S. Model Income Tax Treaty. This definition is
also generally consistent with the language of section 861(a)(4). In
addition, similar to the approach in the technical explanation to
Article 12 of the 2006 U.S. Model Income Tax Treaty, the proposed
regulations provide certain circumstances where payments are not
treated as paid or accrued in consideration for the use of information
concerning industrial, commercial or scientific experience. By using
definitions that have already been developed and administered in other
contexts, the proposed regulations provide an approach that reduces
taxpayer burdens and uncertainty. The Treasury Department and the IRS
welcome comments on the definition of royalty for purposes of section
267A contained in the proposed regulations.
K. Miscellaneous Issues
1. Effect of Foreign Currency Gain or Loss
The proposed regulations provide that foreign currency gain or loss
recognized under section 988 is not separately taken into account under
section 267A. See proposed Sec. 1.267A-5(b)(2). Rather, foreign
currency gain or loss recognized with respect to a specified payment is
taken into account under section 267A only to the extent that the
specified payment is in respect of accrued interest or an accrued
royalty for which a deduction is disallowed under section 267A. Thus,
for example, a section 988 loss recognized with respect to a specified
payment of interest is not separately taken into account under section
267A (even though under the tax law of the tax resident to which the
specified payment is made the tax resident does not include in income
an amount corresponding to the section 988 loss, as the specified
payment is made in the tax resident's functional currency).
The Treasury Department and the IRS recognize that additional rules
addressing the effect of different foreign currencies may be necessary.
For example, a hybrid deduction for purposes of the imported mismatch
rule may be denominated in a different currency than a specified
payment, in which case a translation rule may be necessary to determine
the amount of the specified payment that is subject to the imported
mismatch rule. The Treasury Department and the IRS request comments on
foreign currency rules, including any rules regarding the translation
of amounts between currencies, for purposes of the proposed regulations
under sections 245A and 267A.
2. Payments by U.S. Taxable Branches
Certain expenses incurred by a nonresident alien or foreign
corporation are allowed as deductions under sections 873(a) and 882(c)
in determining that person's effectively connected income. To the
extent the deductions arise from transactions involving certain hybrid
or branch arrangements, the deductions should be disallowed under
section 267A, as discussed in section II.B of this Explanation of
Provisions. The proposed regulations do so by (i) treating a U.S.
taxable branch (which includes a permanent establishment of a foreign
person) as a specified party, and (ii) providing rules regarding
interest or royalties considered paid or accrued by a U.S. taxable
branch, solely for purposes of section 267A (and thus not for other
purposes, such as chapter 3 of the Code). See proposed Sec. 1.267A-
5(b)(3). The effect of this approach is that interest or royalties
considered paid or accrued by a U.S. taxable branch are specified
payments that are subject to the rules of proposed Sec. Sec. 1.267A-1
through 1.267A-4. See also proposed Sec. 1.267A-6(c), Example 4.
In general, a U.S. taxable branch is considered to pay or accrue
any interest or royalties allocated or apportioned to effectively
connected income of the U.S. taxable branch. See proposed Sec. 1.267A-
5(b)(3)(i). However, if a U.S. taxable branch constitutes a U.S.
permanent establishment of a treaty resident, then the U.S. permanent
establishment is considered to pay or accrue the interest or royalties
deductible in computing its business profits. Although interest paid by
a U.S. taxable branch may be subject to withholding tax as determined
under section 884(f)(1)(A) and Sec. 1.884-4, those rules are not
relevant for purposes of section 267A.
The proposed regulations also provide rules to identify the manner
in which a specified payment of a U.S. taxable branch is considered
made. See proposed Sec. 1.267A-5(b)(3)(ii). Absent such rules, it
might be difficult to determine whether the specified payment is made
pursuant to a hybrid or branch arrangement (for example, made pursuant
to a hybrid transaction or to a reverse hybrid). However, these rules
regarding the manner in which a specified payment is made do not apply
to interest or royalties deemed paid by a U.S. permanent establishment
in connection with inter-branch transactions that are permitted to be
taken into account under certain U.S. tax treaties--such payments, by
definition, constitute deemed branch payments (subject to disallowance
under proposed Sec. 1.267A-2(c)) and are therefore made pursuant to a
branch arrangement.
3. Coordination With Other Provisions
Proposed Sec. 1.267A-5(b)(1) coordinates the application of
section 267A with other provisions of the Code and regulations that
affect the deductibility of interest and royalties. This rule provides
that, in general, section 267A applies after the application of other
provisions of the Code and regulations. For example, a specified
payment is subject to section 267A for the taxable year for which a
deduction for the payment would
[[Page 67622]]
otherwise be allowed. Thus, if a deduction for an accrued amount is
deferred under section 267(a) (in certain cases, deferring a deduction
for an amount accrued to a related foreign person until paid), then the
deduction is tested for disallowance under section 267A for the taxable
year in which the amount is paid. Absent such a rule, an accrued amount
for which a deduction is deferred under section 267(a) could constitute
a disqualified hybrid amount even though the amount will be included in
the specified recipient's income when actually paid. This coordination
rule also provides that section 267A applies to interest or royalties
after taking into account provisions that could otherwise
recharacterize such amounts, such as Sec. 1.894-1(d)(2).
4. E&P Reduction
Proposed Sec. 1.267A-5(b)(4) provides that the disallowance of a
deduction under section 267A does not affect whether or when the amount
paid or accrued that gave rise to the deduction reduces earnings and
profits of a corporation. Thus, a corporation's earnings and profits
may be reduced as a result of a specified payment for which a deduction
is disallowed under section 267A. This is consistent with the approach
in the context of other disallowance rules. See Sec. 1.312-7(b)(1)
(``A loss . . . may be recognized though not allowed as a deduction (by
reason, for example, of the operation of sections 267 and 1211 . . .)
but the mere fact that it is not allowed does not prevent a decrease in
earnings and profits by the amount of such disallowed loss.''); Luckman
v. Comm'r, 418 F.2d 381, 383-84 (7th Cir. 1969) (``[T]rue expenses
incurred by the corporation reduce earnings and profits despite their
nondeductibility from current income for tax purposes.'').
5. De Minimis Exception
The proposed regulations provide a de minimis exception to make the
rules more administrable. See proposed Sec. 1.267A-1(c). As a result
of this exception, a specified party is excepted from the application
of section 267A for any taxable year for which the sum of its interest
and royalty deductions (plus interest and royalty deductions of any
related specified parties) is below $50,000. This rule applies based on
any interest or royalty deductions, regardless of whether the
deductions would be disallowed under section 267A. In addition, for
purposes of this rule, specified parties that are related are treated
as a single specified party.
The Treasury Department and the IRS welcome comments on the de
minimis exception and whether another threshold would be more
appropriate to implement the purposes of section 267A.
L. Interaction With Withholding Taxes and Income Tax Treaties
The determination of whether a deduction for a specified payment is
disallowed under section 267A is made without regard to whether the
payment is subject to withholding under section 1441 or 1442 or is
eligible for a reduced rate of tax under an income tax treaty. Since
the U.S. tax characterization of the payment prevails in determining
the treaty rate for interest or royalties, regardless of whether the
payment is made pursuant to a hybrid transaction, the proposed
regulations will generally result in the disallowance of a deduction
but treaty benefits may still be claimed, as long as the recipient is
the beneficial owner of the payment and otherwise eligible for treaty
benefits. On the other hand, if interest or royalties are paid to a
fiscally transparent entity that is a reverse hybrid, as defined in
proposed Sec. 1.267A-2(d), the payment generally will not be
deductible under the proposed regulations if the investor does not
derive the payment, and will not be eligible for treaty benefits if the
interest holder under Sec. 1.894-1(d) does not derive the payment. The
proposed regulations will only apply, however, if the investor is
related to the specified party, whereas the reduced rate under the
treaty may be denied without regard to whether the interest holder is
related to the payer of the interest or royalties.
Certain U.S. income tax treaties also address indirectly the branch
mismatch rules under proposed Sec. 1.267A-2(e). Special rules,
generally in the limitation on benefits articles of income tax
treaties, increase the tax treaty rate for interest and royalties to 15
percent (even if otherwise not taxable under the relevant treaty
article) if the amount paid to a permanent establishment of the treaty
resident is subject to minimal tax, and the foreign corporation that
derives and beneficially owns the payment is a resident of a treaty
country that excludes or otherwise exempts from gross income the
profits attributable to the permanent establishment to which the
payment was made.
III. Information Reporting Under Sections 6038, 6038A, and 6038C
Under section 6038(a)(1), U.S. persons that control foreign
business entities must file certain information returns with respect to
those entities, which includes information listed in section
6038(a)(1)(A) through (a)(1)(E), as well as information that ``the
Secretary determines to be appropriate to carry out the provisions of
this title.'' Section 6038A similarly requires 25-percent foreign-owned
domestic corporations (reporting corporations) to file certain
information returns with respect to those corporations, including
information related to transactions between the reporting corporation
and each foreign person which is a related party to the reporting
corporation. Section 6038C imposes the same reporting requirements on
certain foreign corporations engaged in a U.S. trade or business (also,
a reporting corporation).
The proposed regulations provide that a specified payment for which
a deduction is disallowed under section 267A, as well as hybrid
dividends and tiered hybrid dividends under section 245A, must be
reported on the appropriate information reporting form in accordance
with sections 6038 and 6038A. See proposed Sec. Sec. 1.6038-2(f)(13)
and (14), 1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii).
IV. Sections 1503(d) and 7701--Application to Domestic Reverse Hybrids
A. Overview
1. Dual Consolidated Loss Rules
Congress enacted section 1503(d) to prevent the ``double dipping''
of losses. See S. Rep. 313, 99th Cong., 2d Sess., at 419-20 (1986). The
Senate Report explains that ``losses that a corporation uses to offset
foreign tax on income that the United States does not subject to tax
should not also be used to reduce any other corporation's U.S. tax.''
Id. Section 1503(d) and the regulations thereunder generally provide
that, subject to certain exceptions, a dual consolidated loss of a
corporation cannot reduce the taxable income of a domestic affiliate (a
``domestic use''). See Sec. Sec. 1.1503(d)-2 and 1.1503-4(b). Section
1.1503(d)-1(b)(5) defines a dual consolidated loss as a net operating
loss of a dual resident corporation or the net loss attributable to a
separate unit (generally defined as either a foreign branch or an
interest in a hybrid entity). See Sec. 1.1503(d)-1(b)(4).
The general prohibition against the domestic use of a dual
consolidated loss does not apply if, pursuant to a ``domestic use
election,'' the taxpayer certifies that there has not been and will not
be a ``foreign use'' of the dual consolidated loss during a
certification period. See Sec. 1.1503(d)-6(d). If a foreign use or
other triggering event occurs during the certification period, the dual
consolidated loss is recaptured. A
[[Page 67623]]
foreign use occurs when any portion of the dual consolidated loss is
made available to offset the income of a foreign corporation or the
direct or indirect owner of a hybrid entity (generally non-dual
inclusion income). See Sec. 1.1503(d)-3(a)(1). Other triggering events
include certain transfers of the stock or assets of a dual resident
corporation, or the interests in or assets of a separate unit. See
Sec. 1.1503(d)-6(e).
The regulations include a ``mirror legislation'' rule that, in
general, prevents a domestic use election when a foreign jurisdiction
has enacted legislation similar to section 1503(d) that denies any
opportunity for a foreign use of the dual consolidated loss. See Sec.
1.1503(d)-3(e). As a result, the existence of mirror legislation may
prevent the dual consolidated loss from being put to a domestic use
(due to the domestic use limitation) or to a foreign use (due to the
foreign ``mirror legislation'') such that the loss becomes
``stranded.'' In such a case, the regulations contemplate that the
taxpayer may enter into an agreement with the United States and the
foreign country (for example, through the competent authorities)
pursuant to which the losses are used in only one country. See Sec.
1.1503(d)-6(b).
2. Entity Classification Rules
Sections 301.7701-1 through 301.7701-3 classify a business entity
with two or more members as either a corporation or a partnership, and
a business entity with a single owner as either a corporation or a
disregarded entity. Certain domestic business entities, such as limited
liability companies, are classified by default as partnerships (if they
have more than one member) or as disregarded entities (if they have
only one owner) but are eligible to elect for federal tax purposes to
be classified as corporations. See Sec. 301.7701-3(b)(1).
B. Domestic Reverse Hybrids
The Treasury Department and the IRS are aware that structures
involving domestic reverse hybrids have been used to obtain double-
deduction outcomes because they were not subject to limitation under
current section 1503(d) regulations. A domestic reverse hybrid
generally refers to a domestic business entity that elects under Sec.
301.7701-3(c) to be treated as a corporation for U.S. tax purposes, but
is treated as fiscally transparent under the tax law of its investors.
In these structures, a foreign parent corporation typically owns the
majority of the interests in the domestic reverse hybrid. Domestic
reverse hybrid structures can lead to double-deduction outcomes
because, for example, deductions incurred by the domestic reverse
hybrid can be used (i) under U.S. tax law to offset income that is not
subject to tax in the foreign parent's country, such as income of
domestic corporations with which the domestic reverse hybrid files a
U.S. consolidated return, and (ii) under the foreign parent's tax law
to offset income not subject to U.S. tax, such as income of the foreign
parent other than the income (if any) of the domestic reverse hybrid.
Taxpayers take the position that these structures are not subject to
the current section 1503(d) regulations because the domestic reverse
hybrid is neither a dual resident corporation (because it is not
subject to tax on a residence basis or on its worldwide income in the
foreign parent country) nor a separate unit of a domestic corporation.
A comment on regulations under section 1503(d) that were proposed
in 2005 asserted that this result is inconsistent with the policies
underlying section 1503(d), which was adopted, in part, to ensure that
domestic corporations were not put at a competitive disadvantage as
compared to foreign corporations through the use of certain inbound
acquisition structures. See TD 9315. The comment suggested that the
scope of the final regulations be broadened to treat such entities as
separate units, the losses of which are subject to the restrictions of
section 1503(d). Id.
In response to this comment, the preamble to the 2007 final dual
consolidated loss regulations stated that the Treasury Department and
the IRS acknowledged that this type of structure results in a double
dip similar to that which Congress intended to prevent through the
adoption of section 1503(d). The final regulations did not address
these structures, however, because the Treasury Department and the IRS
determined at that time that a domestic reverse hybrid was neither a
dual resident corporation nor a separate unit and, therefore, was not
subject to section 1503(d). See TD 9315. The preamble noted, however,
that the Treasury Department and the IRS would continue to study these
and similar structures.
The Treasury Department and the IRS have determined that these
structures are inconsistent with the principles of section 1503(d) and,
as a result, raise significant policy concerns. Accordingly, the
proposed regulations include rules under sections 1503(d) and 7701 to
prevent the use of these structures to obtain a double-deduction
outcome. The proposed regulations require, as a condition to a domestic
entity electing to be treated as a corporation under Sec. 301.7701-
3(c), that the domestic entity consent to be treated as a dual resident
corporation for purposes of section 1503(d) (such an entity, a
``domestic consenting corporation'') for taxable years in which two
requirements are satisfied. See proposed Sec. 301.7701-3(c)(3). The
requirements are intended to restrict the application of section
1503(d) to cases in which it is likely that losses of the domestic
consenting corporation could result in a double-deduction outcome.
The requirements are satisfied if (i) a ``specified foreign tax
resident'' (generally, a body corporate that is a tax resident of a
foreign country) under its tax law derives or incurs items of income,
gain, deduction, or loss of the domestic consenting corporation, and
(ii) the specified foreign tax resident is related to the domestic
consenting corporation (as determined under section 267(b) or 707(b)).
See proposed Sec. 1.1503(d)-1(c). For example, the requirements are
satisfied if a specified foreign tax resident directly owns all the
interests in the domestic consenting corporation and the domestic
consenting corporation is fiscally transparent under the specified
foreign tax resident's tax law. In addition, an item of the domestic
consenting corporation for a particular taxable year is considered
derived or incurred by the specified tax resident during that year even
if, under the specified foreign tax resident's tax law, the item is
recognized in, and derived or incurred by the specified foreign tax
resident in, a different taxable year.
Further, if a domestic entity filed an election to be treated as a
corporation before December 20, 2018 such that the entity was not
required to consent to be treated as a dual resident corporation, then
the entity is deemed to consent to being treated as a dual resident
corporation as of its first taxable year beginning on or after the end
of a 12-month transition period. This deemed consent can be avoided if
the entity elects, effective before its first taxable year beginning on
or after the end of the transition period, to be treated as a
partnership or disregarded entity such that it ceases to be a
corporation for U.S. tax purposes. For purposes of such an election,
the 60 month limitation under Sec. 301.7701-3(c)(1)(iv) is waived.
Finally, the proposed regulations provide that the mirror
legislation rule does not apply to dual consolidated losses of a
domestic consenting corporation. See proposed Sec. 1.1503(d)-3(e)(3).
This exception is intended to minimize cases in which dual
[[Page 67624]]
consolidated losses could be ``stranded'' when, for example, the
foreign parent jurisdiction has adopted rules similar to the
recommendations in Chapter 6 of the Hybrid Mismatch Report. The
exception does not apply to dual consolidated losses attributable to
separate units because, in such cases, the United States is the parent
jurisdiction and the dual consolidated loss rules should neutralize the
double-deduction outcome.
V. Triggering Event Exception for Compulsory Transfers
As noted in section IV.A.1 of this Explanation of Provisions,
certain triggering events require a dual consolidated loss that is
subject to a domestic use election to be recaptured and included in
income. The dual consolidated loss regulations also include various
exceptions to these triggering events, including an exception for
compulsory transfers involving foreign governments. See Sec.
1.1503(d)-6(f)(5).
A comment on the 2007 final dual consolidated loss regulations
stated that the policies underlying the triggering event exception for
compulsory transfers involving foreign governments apply equally to
compulsory transfers involving the United States government.
Accordingly, the comment requested guidance under Sec. 1.1503(d)-
3(c)(9) to provide that the exception is not limited to foreign
governments. The comment suggested, as an example, that the exception
should apply to a divestiture of a hybrid entity engaged in proprietary
trading pursuant to the ``Volcker Rule'' contained in the Dodd-Frank
Wall Street Reform and Consumer Protection Act, Public Law 111-203
(2010).
The Treasury Department and the IRS agree with this comment and,
accordingly, the proposed regulations modify the compulsory transfer
triggering event exception such that it will also apply with respect to
the United States government.
VI. Disregarded Payments Made to Domestic Corporations
As discussed in sections II.D.2 and 3 of this Explanation of
Provisions, the proposed regulations under section 267A address D/NI
outcomes resulting from actual and deemed payments of interest and
royalties that are regarded for U.S. tax purposes but disregarded for
foreign tax purposes. The proposed regulations under section 267A do
not, however, address similar structures involving payments to domestic
corporations that are regarded for foreign tax purposes but disregarded
for U.S. tax purposes.
For example, USP, a domestic corporation that is the parent of a
consolidated group, borrows from a bank to fund the acquisition of the
stock of FT, a foreign corporation that is tax resident of Country X.
USP contributes the loan proceeds to USS, a newly formed domestic
corporation that is a member of the USP consolidated group, in exchange
for all the stock of USS. USS then forms FDE, a disregarded entity that
is tax resident of Country X, USS lends the loan proceeds to FDE, and
FDE uses the proceeds to acquire the stock of FT. For U.S. tax
purposes, USP claims a deduction for interest paid on the bank loan,
and USS does not recognize interest income on interest payments made to
it from FDE because the payments are disregarded. For Country X tax
purposes, the interest paid from FDE to USS is regarded and gives rise
to a loss that can be surrendered (or otherwise used, such as through a
consolidation regime) to offset the operating income of FT.
Under the current section 1503(d) regulations, the loan from USS to
FDE does not result in a dual consolidated loss attributable to USS's
interest in FDE because interest paid on the loan is not regarded for
U.S. tax purposes; only items that are regarded for U.S. tax purposes
are taken into account for purposes of determining a dual consolidated
loss. See Sec. 1.1503(d)-5(c)(1)(ii). In addition, the regarded
interest expense of USP is not attributed to USS's interest in FDE
because only regarded items of USS, the domestic owner of FDE, are
taken into account for purposes of determining a dual consolidated
loss. Id. The result would generally be the same, however, even if USS,
rather than USP, were the borrower on the bank loan. See Sec.
1.1503(d)-7(c), Example 23.
The Treasury Department and the IRS have determined that these
transactions raise significant policy concerns that are similar to
those relating to the D/NI outcomes addressed by sections 245A(e) and
267A, and the double-deduction outcomes addressed by section 1503(d).
The Treasury Department and the IRS are studying these transactions and
request comments.
VII. Applicability Dates
Under section 7805(b)(2), and consistent with the applicability
date of section 245A, proposed Sec. 1.245A(e)-1 applies to
distributions made after December 31, 2017. Under section 7805(b)(2),
proposed Sec. Sec. 1.267A-1 through 1.267A-6 generally apply to
specified payments made in taxable years beginning after December 31,
2017. This applicability date is consistent with the applicability date
of section 267A. The Treasury Department and the IRS therefore expect
to finalize such provisions by June 22, 2019. See section 7805(b)(2).
However if such provisions are finalized after June 22, 2019, then the
Treasury Department and the IRS expect that such provisions will apply
only to taxable years ending on or after December 20, 2018. See section
7805(b)(1)(B).
As provided in proposed Sec. 1.267A-7(b), certain rules, such as
the disregarded payment and deemed branch payment rules as well as the
imported mismatch rule, apply to specified payments made in taxable
years beginning on or after December 20, 2018. See section
7805(b)(1)(B).
Proposed Sec. Sec. 1.6038-2, 1.6038-3, and 1.6038A-2, which
require certain reporting regarding deductions disallowed under section
267A, as well as hybrid dividends and tiered hybrid dividends under
section 245A, apply with respect to information for annual accounting
periods or tax years, as applicable, beginning on or after December 20,
2018. See section 7805(b)(1)(B).
Proposed Sec. Sec. 1.1503(d)-1 and -3, treating domestic
consenting corporations as dual resident corporations, apply to taxable
years ending on or after December 20, 2018. See section 7805(b)(1)(B).
Proposed Sec. 1.1503(d)-6, amending the compulsory transfer
triggering event exception, applies to transfers that occur on or after
December 20, 2018, but taxpayers may apply the rules to earlier
transfers. See section 7805(b)(1)(B).
Proposed Sec. 301.7701-3(a) and (c)(3) apply to a domestic
eligible entity that on or after December 20, 2018 files an election to
be classified as an association (regardless of whether the election is
effective before December 20, 2018). These provisions also apply to
certain domestic eligible entities the interests in which are
transferred or issued on or after December 20, 2018. See section
7805(b)(1)(B).
Special Analyses
I. Regulatory Planning and Review
Executive Orders 13771, 13563, and 12866 direct agencies to assess
costs and benefits of available regulatory alternatives and, if
regulation is necessary, to select regulatory approaches that maximize
net benefits, including potential economic, environmental, public
health and safety effects, distributive impacts, and equity. Executive
Order 13563 emphasizes the importance of quantifying both costs and
benefits, reducing costs,
[[Page 67625]]
harmonizing rules, and promoting flexibility. The preliminary E.O.
13771 designation for this proposed rulemaking is regulatory.
The proposed regulations have been designated by the Office of
Management and Budget's Office of Information and Regulatory Affairs
(OIRA) as subject to review under Executive Order 12866 pursuant to the
Memorandum of Agreement (April 11, 2018) between the Treasury
Department and the Office of Management and Budget regarding review of
tax regulations (``MOA''). OIRA has determined that the proposed
rulemaking is economically significant and subject to review under E.O.
12866 and section 1(c) of the Memorandum of Agreement. Accordingly, the
proposed regulations have been reviewed by the Office of Management and
Budget.
A. Background
Hybrid arrangements include both ``hybrid entities'' and ``hybrid
instruments.'' A hybrid entity is generally an entity which is treated
as a flow-through or disregarded entity for U.S. tax purposes but as a
corporation for foreign tax purposes or vice versa. Hybrid instruments
are financial instruments that share characteristics of both debt and
equity and are treated as debt for U.S. tax purposes and equity in the
foreign jurisdiction or vice versa.
Before the Act, U.S. subsidiaries of foreign-based multinational
enterprises could employ cross-border hybrid arrangements as legal tax-
avoidance techniques by exploiting differences in tax treatment across
jurisdictions. These arrangements allowed taxpayers to claim tax
deductions in the United States without a corresponding inclusion in
another jurisdiction.
The United States has a check-the-box regulatory provision, under
which some taxpayers can choose whether they are treated as
corporations, where they may face a separate entity level tax, or as
partnerships, where there is no such separate entity tax (but rather
only owner-level tax), under the U.S. tax code. This choice allows
taxpayers the ability to become hybrid entities that are viewed as
corporations in one jurisdiction, but not in another. For example, a
foreign parent could own a domestic subsidiary limited liability
partnership (LLP) that, under the check-the-box rules, elects to be
treated as a corporation under U.S. tax law. However, this subsidiary
could be viewed as a partnership under foreign tax law. The result is
that the domestic subsidiary could be entitled to a deduction for U.S.
tax purposes for making interest payments to the foreign parent, but
the foreign country would see a payment between a partnership and a
partner, and therefore would not tax the interest income. That is, the
corporate structure would enable the business entity to avoid paying
U.S. tax on the interest by allowing a deduction attributable to an
intra-group loan, despite the interest income never being included
under foreign tax law.
In addition, there are hybrid instruments, which share
characteristics of both debt and equity. Because of these shared
characteristics, countries may be inconsistent in their treatment of
such instruments. One example is perpetual debt, which many countries
treat as debt, but the United States treats as equity. If a foreign
affiliate of a U.S.-based multinational issued perpetual debt to a U.S.
holder, the interest payments would be tax deductible in a foreign
jurisdiction that treats the instrument as debt, while the payments are
treated as dividends in the United States and potentially eligible for
a dividends received deduction (DRD).
The Act adds section 245A(e) to the Code to address issues of
hybridity by introducing a hybrid dividends provision, which disallows
the DRD for any dividend received by a U.S. shareholder from a
controlled foreign corporation if the dividend is a hybrid dividend.
The statute defines a hybrid dividend as an amount received from a
controlled foreign corporation for which a deduction would be allowed
under section 245A(a) and for which the controlled foreign corporation
received a deduction or other tax benefit in a foreign country. Hybrid
dividends between controlled foreign corporations with a common U.S.
shareholder are treated as subpart F income.
The Act also adds section 267A of the Code to deny a deduction for
any disqualified related party amount paid or accrued as a result of a
hybrid transaction or by, or to, a hybrid entity. The statute defines a
disqualified related party amount as any interest or royalty paid or
accrued to a related party where there is no corresponding inclusion to
the related party in the other tax jurisdiction or the related party is
allowed a deduction with respect to such amount in the other tax
jurisdiction. The statute's definition of a hybrid transaction is any
transaction where there is a mismatch in tax treatment between the U.S.
and the other foreign jurisdiction. Similarly, a hybrid entity is any
entity which is treated as fiscally transparent for U.S. tax purposes
but not for purposes of the foreign tax jurisdiction, or vice versa.
B. Overview
The hybrids provisions in the Act and the proposed regulations are
anti-abuse measures. Taxpayers have been taking aggressive tax
positions to take advantage of tax treatment mismatches between
jurisdictions in order to achieve favorable tax outcomes at the
detriment of tax revenues (see OECD/G20 Hybrid Mismatch Report, October
2015 and OECD/G20 Branch Mismatch Report, July 2017). The statute and
the proposed regulations serve to conform the U.S. tax system to
recently agreed-upon international tax principles (see OECD/G20 Hybrids
Mismatch Report, October 2015 and OECD/G20 Branch Mismatch Report, July
2017), consistent with statutory intent, while protecting U.S.
interests and the U.S. tax base. International tax coordination is
particularly advantageous in the context of hybrids as it has the
potential to greatly curb opportunities for hybrid arrangements, while
avoiding double taxation. The anticipated effect of the statute and
proposed regulations is a reduction in tax revenue loss due to hybrid
arrangements, at the cost of an increase in compliance burden for a
limited number of sophisticated taxpayers, as explained below.
C. Need for the Proposed Regulations
Because the Act introduced new sections to the Code to address
hybrid entities and hybrid instruments, a large number of the relevant
terms and necessary calculations that taxpayers are currently required
to apply under the statute can benefit from greater specificity.
Taxpayers will lack clarity on which types of arrangements are subject
to the statute without the additional interpretive guidance and
clarifications contained in the proposed regulations. This lack of
clarity could lead to a shifting of corporate income overseas through
hybrid arrangements, further eroding U.S. tax revenues. Without
accompanying rules to cover branches, structured arrangements, imported
mismatches, and similar structures, the statute would be extremely easy
to avoid, a pathway that is contrary to Congressional intent. It could
also lead to otherwise similar taxpayers interpreting the statute
differently, distorting the equity of tax treatment for otherwise
similarly situated taxpayers. Finally, the lack of clarity could cause
some taxpayers unnecessary compliance burden if they misinterpret the
statute.
[[Page 67626]]
D. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the proposed regulations relative to a no-action baseline
reflecting anticipated tax-related behavior and other economic behavior
in the absence of the proposed regulations.
The baseline includes the Act, which effectively cut the top
statutory corporate income tax rate from 35 to 21 percent. This change
lowered the value of using hybrid arrangements for multinational
corporations, because the value of such arrangements is proportional to
the tax they allow the corporation to avoid. As such, some firms with
an incentive to set up hybrid arrangements prior to the Act would no
longer find it profitable to maintain these arrangements. The Act also
modified section 163(j), and regulations interpreting this provision
are expected to be finalized soon, which together further limit the
deductibility of interest payments. These statutory and regulatory
changes further curb the incentive to set up and maintain hybrid
arrangements for multinational corporations, since interest payments
are a primary vehicle through which hybrid arrangements generated
deductions prior to the Act. Further, prior to the Act, the Treasury
Department and the IRS issued a series of regulations that reduced or
eliminated the incentive for multinational corporations to invert, or
change their tax residence to avoid U.S. taxes (including setting up
some hybrid arrangements). As a result, under the baseline, the value
of hybrid arrangements reflects the existing regulatory framework and
the Act and its associated soon-to-be-finalized regulations, all of
which strongly affect the value of hybrid arrangements as a tax
avoidance technique.
2. Anticipated Costs and Benefits
i. Economic Effects
The Treasury Department has determined that the discretionary non-
revenue impacts of the proposed hybrid regulations will reduce U.S.
Gross Domestic Product (GDP) by less than $100 million per year
($2018).
To evaluate this effect, the Treasury Department considered the
share of interest deductions that would be disallowed by the proposed
regulations. Using Treasury Department models applied to confidential
2016 tax data, the Treasury Department calculated the average effective
tax rate for potentially affected taxpayers under a range of levels of
interest payment deductibility, including the level of deductibility
under the Act without the proposed regulations. The difference between
the estimated effective tax rate under the Act and without the
discretionary elements of the proposed regulations and the range of
estimated effective tax rates that include the proposed regulations
provides a range of estimates of the net increase in the effective tax
rate due to the discretion exercised in the proposed regulations. The
Treasury Department next applied an elasticity of taxable income to the
range of estimated increases in the effective tax rate to estimate the
reduction in taxable income for each of the affected taxpayers in the
sample. The Treasury Department then examined a range of estimates of
the relationship between the change in taxable income and the real
change in economic activity. Finally, the Treasury Department
extrapolated the results through 2027.
The Treasury Department concludes from this evaluation that the
discretionary aspects of the proposed rules will reduce GDP annually by
less than $100 million ($2018). The projected effects reflect the
proposed regulations alone and do not include non-revenue economic
effects stemming from the Act in the absence of the proposed
regulations. More specifically, the analysis did not estimate the
impacts of the statutory requirement that hybrid dividends shall be
treated as subpart F income of the receiving controlled foreign
corporations for purposes of section 951(a)(1)(A) for the taxable year
and shall not be permitted a foreign tax credit. See section 245A(e).
The Treasury Department solicits comments on the methodology used
to evaluate the non-revenue economic effects of the proposed
regulations and anticipates that further analysis will be provided at
the final rule stage.
ii. Anticipated Costs and Benefits of Specific Provisions
a. Section 245A(e)
Section 245A(e) applies in certain cases in which a CFC pays a
hybrid dividend, which is a dividend paid by the CFC for which the CFC
received a deduction or other tax benefit under foreign tax law (a
hybrid deduction). The proposed regulations provide rules for
identifying and tracking such hybrid deductions. These rules set forth
common standards for identifying hybrid deductions and therefore
clarify what is deemed a hybrid dividend by the statute and ensure
equitable tax treatment of otherwise similar taxpayers.
The proposed regulations also address timing differences to ensure
that there is parity between economically similar transactions. Absent
such rules, similar transactions may be treated differently due to
timing differences. For example, if a CFC paid out a dividend in a
given taxable year for which it received a deduction or other tax
benefit in a prior taxable year, the taxpayer might claim the dividend
is not a hybrid dividend, since the taxable year in which the dividend
is paid for U.S. tax purposes and the year in which the tax benefit is
received do not overlap. Absent rules, such as the proposed
regulations, the purpose of section 245A(e) might be avoided and
economically similar transactions might be treated differently.
Finally, these rules excuse certain taxpayers from having to track
hybrid deductions (namely taxpayers without a sufficient connection to
a section 245A(a) dividends received deduction). The utility of
requiring these taxpayers to track hybrid deductions would be
outweighed by the burdens of doing so. The proposed regulations reduce
the compliance burden on taxpayers that are not directly dealing with
hybrid dividends.
b. Section 267A
Section 267A disallows a deduction for interest or royalties paid
or accrued in certain transactions involving a hybrid arrangement.
Congress intended this provision to address cases in which the taxpayer
is provided a deduction under U.S. tax law, but the payee does not have
a corresponding income inclusion under foreign tax law, dubbed a
``deduction/no-inclusion outcome'' (D/NI outcome). See Senate
Explanation, at 384. This affects taxpayers that attempt to use hybrid
arrangements to strip income out of the United States taxing
jurisdiction.
The proposed regulations disallow a deduction under section 267A
only to the extent that the D/NI outcome is a result of a hybrid
arrangement. Note that under the statute but without the proposed
regulations, a deduction would be disallowed simply if a D/NI outcome
occurs and a hybrid arrangement exists (see section II.E of the
Explanation of Provisions). For example, a royalty payment made to a
hybrid entity in the U.K. qualifying for a low tax rate under the U.K.
patent box regime could be denied a deduction in the U.S. under the
statute. However, the low U.K. rate is a result of the lower tax rate
on patent box income and not a result of any hybrid arrangement. In
this example, there is no link between hybridity and the D/NI outcome,
since it is the U.K. patent box regime that
[[Page 67627]]
yields the D/NI outcome and the low U.K. patent box rate is available
to taxpayers regardless of whether they are organized as hybrid
entities or not. The proposed regulations limit the application of
section 267A to cases where the D/NI outcome occurs as a result of
hybrid arrangements and not due to a generally applicable feature of
the jurisdiction's tax system.
The proposed regulations also provide several exceptions to section
267A in order to refine the scope of the provision and minimize burdens
on taxpayers. First, the proposed regulations generally exclude from
section 267A payments that are included in a U.S. tax resident's or
U.S. taxable branch's income or are taken into account for purposes of
the subpart F or global intangible low-taxed income (GILTI) provisions.
While the exception for income taken into account for purposes of
subpart F is in the statute, the proposed regulations expand the
exception to cover GILTI. This avoids potential double taxation on that
income. In addition, as a refinement compared with the statute, the
extent to which a payment is taken into account under subpart F is
determined without regard to allocable deductions or qualified
deficits. The proposed regulations also provide a de minimis rule that
excepts small taxpayers from section 267A, minimizing the burden on
small taxpayers.
Finally, the proposed regulations address a comprehensive set of
transactions that give rise to D/NI outcomes. The statute, as written,
does not apply to certain hybrid arrangements, including branch
arrangements and certain reverse hybrids, as described above (see
section II.D of the Explanation of Provisions). The exclusion of these
arrangements could have large economic and fiscal consequences due to
taxpayers shifting tax planning towards these arrangements to avoid the
new anti-abuse statute. The proposed regulations close off this
potential avenue for additional tax avoidance by applying the rules of
section 267A to branch mismatches, reverse hybrids, certain
transactions with unrelated parties that are structured to achieve D/NI
outcomes, certain structured transactions involving amounts similar to
interest, and imported mismatches.
3. Alternatives Considered
i. Addressing conduit arrangements/imported mismatches
Section 267A(e)(1) provides regulatory authority to apply the rules
of section 267A to conduit arrangements and thus to disallow a
deduction in cases in which income attributable to a payment is
directly or indirectly offset by an offshore hybrid deduction. The
Treasury Department and the IRS considered four options with regards to
conduit arrangement rules.
The first option was to not implement any conduit rules, and thus
rely on existing and established judicial doctrines (such as conduit
principles and substance-over-form principles) to police these
transactions. A second option considered was to address conduit
arrangement concerns through a broad anti-abuse rule. On the one hand,
both of these approaches might reduce complexity by eliminating the
need for detailed regulatory rules addressing conduit arrangements. On
the other hand, such approaches could create uncertainty (as neither
taxpayers nor the IRS might have a clear sense of what types of
transactions might be challenged under the judicial doctrines or anti-
abuse rule) and could increase burdens to the IRS (as challenging under
judicial doctrines or anti-abuse rules are generally difficult and
resource intensive). Significantly, such approaches could result in
double non-taxation (if judicial doctrines or anti-abuse rules were to
not be successfully asserted) or double-taxation (if judicial doctrines
or anti-abuse rules were to not take into account the application of
foreign tax law, such as a foreign imported mismatch rule).
A third option considered was to implement rules modeled off
existing U.S. anti-conduit rules under Sec. 1.881-3. On the positive
side, such an approach would rely on an established and existing
framework that taxpayers are already familiar with and thus there would
be a lesser need to create and apply a new framework or set of rules.
On the negative side, existing anti-conduit rules are limited in
certain respects as they apply only to certain financing arrangements,
which exclude certain stock, and they address only withholding tax
policies, which pose separate concerns from section 267A policies (D/NI
policies). Furthermore, taxpayers have implemented structures that
attempt to avoid the application of the existing anti-conduit rules.
Detrimental to tax equity, such an approach could also lead to double-
taxation, as the existing anti-conduit rules do not take into account
the application of foreign tax law, such as a foreign imported mismatch
rule.
The final option considered was to implement rules that are
generally consistent with the BEPS imported mismatch rule. The first
advantage of such an approach is that it provides certainty about when
a deduction will or will not be disallowed under the rule. The second
advantage of this approach is that it neutralizes the risk of double
non-taxation, while also neutralizing the risk of double taxation. This
is because this option is modeled off the BEPS approach, which is being
implemented by other countries, and also contains explicit rules to
coordinate with foreign tax law. Coordinating with the global tax
community reduces opportunities for economic distortions. Although such
an approach involves greater complexity than the alternatives, the
Treasury Department and IRS expect the benefits of this approach's
comprehensiveness, administrability, and conduciveness to taxpayer
certainty, to be substantially greater than the complexity burden in
comparison with the available alternative approaches. Thus, this is the
approach adopted in the proposed regulations.
ii. De Minimis Rules
The proposed regulations provide a de minimis exception that
exempts taxpayers from the application of section 267A for any taxable
year for which the sum of the taxpayer's interest and royalty
deductions (plus interest and royalty deductions of any related
specified parties) is below $50,000. The exception's $50,000 threshold
looks to a taxpayer's amount of interest or royalty deductions without
regard to whether the deductions involve hybrid arrangements and
therefore, absent the de minimis exception, would be disallowed under
section 267A.
The Treasury Department and the IRS considered not providing a de
minimis exception because hybrid arrangements are highly likely to be
tax-motivated structures undertaken only by mostly sophisticated
investors. However, it is possible that, in limited cases, small
taxpayers could be subject to these rules, for example, as a result of
timing differences or a lack of familiarity with foreign law.
Furthermore, section 267A is intended to stop base erosion and tax
avoidance, and in the case of small taxpayers, it is expected that the
revenue gains from applying these rules would be minimal since few
small taxpayers are expected to engage in hybrid arrangements.
The Treasury Department and IRS also considered a de minimis
exception based on a dollar threshold with respect to the amount of
interest or royalties involving hybrid arrangements. However, such an
approach would require a taxpayer to first apply the rules of section
267A to identify its interest or royalty deductions involving hybrid
arrangements in order to
[[Page 67628]]
determine whether the de minimis threshold is satisfied and thus
whether it is subject to section 267A for the taxable year. This would
therefore not significantly reduce burdens on taxpayers with respect to
applying the rules of section 267A.
Therefore, the proposed regulations adopt a rule that looks to the
overall amount of interest and royalty payments, whether or not such
payments involve hybrid arrangements. This has the effect of exempting,
in an efficient manner, small taxpayers that are unlikely to engage in
hybrid arrangements, and therefore such taxpayers do not need to
consider the application of these rules.
iii. Deemed Branch Payments and Branch Mismatch Payments
The proposed regulations expand the application of section 267A to
certain transactions involving branches. This was necessary in order to
ensure that taxpayers could not avoid section 267A by engaging in
transactions that were economically similar to the hybrid arrangements
that are covered by the statute. For example, assume that a related
party payment is made to a foreign entity in Country X that is owned by
a parent company in Country Y. Further assume that there is a mismatch
between how Country X views the entity (fiscally transparent) versus
how Country Y views it (not fiscally transparent). In general, section
267A's hybrid entity rules prevent a D/NI outcome in this case.
However, assume instead that the parent company forms a branch in
Country X instead of a foreign entity, and Country Y (the parent
company's jurisdiction) exempts all branch income under its territorial
system. On the other hand, due to a mismatch in laws governing whether
a branch exists, Country X does not view the branch as existing and
therefore does not tax payments made to the branch. Absent regulations,
taxpayers could easily avoid section 267A through use of branch
structures, which are economically similar to the foreign entity
structure in the first example.
In the absence of the proposed regulations, taxpayers may have
found it valuable to engage in transactions that are economically
similar to hybrid arrangements but that avoided the application of
267A. Such transactions would have resulted in a loss in U.S. tax
revenue without any accompanying efficiency gain. Furthermore, to the
extent that these transactions were structured specifically to avoid
the application of section 267A and were not available to all
taxpayers, they would generally have led to an efficiency loss in
addition to the loss in U.S. tax revenue.
iv. Exceptions for Income Included in U.S. Tax and GILTI Inclusions
Section 267A(b)(1) provides that deductions for interest and
royalties that are paid to a CFC and included under section 951(a) in
income (as subpart F income) by a United States shareholder of such CFC
are not subject to disallowance under section 267A. The statute does
not state whether section 267A applies to a payment that is included
directly in the U.S. tax base (for example, because the payment is made
directly to a U.S. taxpayer or a U.S. taxable branch), or a payment
made to a CFC that is taken into account under GILTI (as opposed to
being included as subpart F income) by such CFC's United States
shareholders. However, the grant of regulatory authority in section
267A(e) includes a specific mention of exceptions in ``cases which the
Secretary determines do not present a risk of eroding the Federal tax
base.'' See section 267A(e)(7)(B).
The Treasury Department and the IRS considered providing no
additional exception for payments included in the U.S. tax base (either
directly or under GILTI), therefore the only exception available would
be the exception provided in the statute for payments included in the
U.S tax base by subpart F inclusions. This approach was rejected in the
case of a payment to a U.S. taxpayer since it would result in double
taxation by the United States, as the United States would both deny a
deduction for a payment as well as fully include such payment in income
for U.S. tax purposes. Similarly, in the case of hybrid payments made
by one CFC to another CFC with the same United States shareholders, a
payment would be included in tested income of the recipient CFC and
therefore taken into account under GILTI. If section 267A were to apply
to also disallow the deduction by the payor CFC, this could also lead
to the same amount being subject to section 951A twice because the
payor CFC's tested income would increase as a result of the denial of
deduction, and the payee would have additional tested income for the
same payment.
Payments that are included directly in the U.S. tax base or that
are included in GILTI do not give rise to a D/NI outcome and,
therefore, it is consistent with the policy of section 267A and the
grant of authority in section 267A(e) to exempt them from disallowance
under section 267A. Therefore, the proposed regulations provide that
such payments are not subject to disallowance under section 267A.
v. Link Between Hybridity and D/NI
As discussed in section II.E of the Explanation of Provisions and
section I.D.2.ii of this Special Analyses, the proposed regulations
limit disallowance to cases in which the no-inclusion portion of the D/
NI outcome is a result of hybridity as opposed to a different feature
of foreign tax law, such as a general preference for royalty income.
Under the language of the statute, no link between hybridity and
the no-inclusion outcome appears to be required. The Treasury
Department and the IRS considered following this approach, which would
have resulted in a deduction being disallowed even though if the
transaction had been a non-hybrid transaction, the same no-inclusion
outcome would have resulted. However, the Treasury Department and the
IRS rejected this option because it would lead to inconsistent and
arbitrary results. In particular, such an approach would incentivize
taxpayers to restructure to eliminate hybridity in order to avoid the
application of section 267A in cases where hybridity does not cause a
D/NI outcome. Such restructuring would eliminate the hybridity without
actually eliminating the D/NI outcome since the hybridity did not cause
the D/NI outcome. Interpreting section 267A in a manner that
incentivizes taxpayers to engage in restructurings of this type would
generally impose costs on taxpayers to retain deductions where
hybridity is irrelevant to a D/NI outcome, without furthering the
statutory purpose of section 267A to neutralize hybrid arrangements.
Furthermore, the policy of section 267A is not to address all
situations that give rise to no-inclusion outcomes, but to only address
a subset of such situations where they arise due to hybrid
arrangements. When base erosion or double non-taxation arises due to
other features of the international tax system (such as the existence
of low-tax jurisdictions or preferential regimes for certain types of
income), there are other types of rules that are better suited to
address these concerns (for example, through statutory impositions of
withholding taxes, revisions to tax treaties, or new statutory
provisions such as the base erosion and anti-abuse tax under section
59A). Moreover, the legislative history to section 267A makes clear
that the policy of the provision is to eliminate the tax-motivated
hybrid structures that lead to D/NI outcomes, and was not a general
provision for eliminating all cases of D/
[[Page 67629]]
NI outcomes. See Senate Explanation, at 384 (``[T]he Committee believes
that hybrid arrangements exploit differences in the tax treatment of a
transaction or entity under the laws of two or more jurisdictions to
achieve double non-taxation . . .'') (emphasis added). In addition, to
the extent that regulations limit disallowance to those cases in which
the no-inclusion portion of the D/NI outcome is a result of hybridity,
the scope of section 267A is limited and the burden on taxpayers is
reduced without impacting the core policy underlying section 267A.
Therefore, the proposed regulations provide that a deduction is
disallowed under section 267A only to the extent that the no-inclusion
portion of the D/NI outcome is a result of hybridity.
vi. Timing Differences Under Section 245A
In some cases, there may be a timing difference between when a CFC
pays an amount constituting a dividend for U.S. tax purposes and when
the CFC receives a deduction for the amount in a foreign jurisdiction.
Timing differences may raise issues about whether a deduction is a
hybrid deduction and thus whether a dividend is considered a hybrid
dividend. The Treasury Department and the IRS considered three options
with respect to this timing issue.
The first option considered was to not address timing differences,
and thus not treat such transactions as giving rise to hybrid
dividends. Not addressing the timing differences would raise policy
concerns, since failure to treat the deduction as giving rise to a
hybrid dividend would result in the section 245A(a) DRD applying to the
dividend, allowing the amount to permanently escape both foreign tax
(through the deduction) and U.S. tax (through the DRD).
The second option considered was to not address the timing
difference directly under section 245A(e), but instead address it under
another Code section or regime. For example, one method that would be
consistent with the BEPS Report would be to mandate an income inclusion
to the U.S. parent corporation at the time the deduction is permitted
under foreign law. This would rely on a novel approach that deems an
inclusion at a particular point in time despite the fact that the
income has otherwise not been recognized for U.S. tax purposes.
The final option was to address the timing difference by providing
rules requiring the establishment of hybrid deduction accounts. These
hybrid deduction accounts will be maintained across years so that
deductions that accrue in one year will be matched up with income
arising in a different year, thus addressing the timing differences
issue. This approach appropriately addresses the timing differences
under section 245A of the Code. The Treasury Department and IRS expect
the benefits of this option's comprehensiveness and clarity to be
substantially greater than the tax administration and compliance costs
it imposes, relative to the alternative options. This is the approach
adopted by the proposed regulations.
vii. Timing Differences Under Section 267A
A similar timing issue arises under section 267A. Here, there is a
timing difference between when the deduction is otherwise permitted
under U.S. tax law and when the payment is included in the payee's
income under foreign tax law. The legislative history to section 267A
indicates that in certain cases such timing differences can lead to
``long term deferral'' and that such long-term deferral should be
treated as giving rise to a D/NI outcome. In the context of section
267A, the Treasury Department and the IRS considered three options with
respect to this timing issue.
The first option considered was to not address timing differences,
because they will eventually reverse over time. Although such an
approach would result in a relatively simple rule, it would raise
significant policy concerns because, as indicated in the legislative
history, long-term deferral can be equivalent to a permanent exclusion.
The second option considered was to address all timing differences,
because even a timing difference that reverses within a short period of
time provides a tax benefit during the short term. Although such an
approach might be conceptually pure, it would raise significant
practical and administrative difficulties. It could also lead to some
double-tax, absent complicated rules to calibrate the disallowed amount
to the amount of tax benefit arising from the timing mismatch.
The final option considered was to address only certain timing
differences--namely, long-term timing differences, such as timing
differences that do not reverse within a 3 taxable year period. The
Treasury Department and IRS expect that the net benefits of this
option's comprehensiveness, clarity, and tax administrability and
compliance burden are substantially higher than those of the available
alternatives. Thus, this option is adopted in the proposed regulations.
4. Anticipated Impacts on Administrative and Compliance Costs
The Treasury Department and the IRS estimate that there are
approximately 10,000 taxpayers in the current population of taxpayers
affected by the proposed regulations or about 0.5% of all corporate
filers. This is the best estimate of the number of sophisticated
taxpayers with capabilities to structure a hybrid arrangement. However,
the Treasury Department and the IRS anticipate that fewer taxpayers
would engage in hybrid arrangements going forward as the statute and
the proposed regulations would make such arrangements less beneficial
to taxpayers. As such, the taxpayer counts provided in section II of
this Special Analyses are an upper bound of the number of affected
taxpayers by the proposed regulations.
It is important to note that the population of taxpayers affected
by section 267A and the proposed regulations under section 267A will
seldom include U.S.-based companies as these companies are taxed under
the new GILTI regime as well as subpart F. Instead, section 267A and
the proposed regulations apply predominantly to foreign-headquartered
companies that employ hybrid arrangements to strip income out of the
U.S., undermining the collection of U.S. tax revenue. In addition,
although section 245A(e) applies primarily to U.S.-based companies, the
amounts of dividends affected are limited because a large portion of
distributions will be treated as previously taxed earnings and profits
due to the operation of both the GILTI regime and the transition tax
under section 965, and such distributions are not subject to section
245A(e).
II. Paperwork Reduction Act
The collections of information in the proposed regulations are in
proposed Sec. Sec. 1.6038-2(f)(13) and (14), 1.6038-3(g)(3), and
1.6038A-2(b)(5)(iii).
The collection of information in proposed Sec. 1.6038-2(f)(13) and
(14) is mandatory for every U.S. person that controls a foreign
corporation that has a deduction disallowed under section 267A, or that
pays or receives a hybrid dividend or tiered hybrid dividend under
section 245A, respectively, during an annual accounting period and
files Form 5471 for that period (OMB control number 1545-0123,
formerly, OMB control number 1545-0704). The collection of information
in proposed Sec. 1.6038-2(f)(13) is satisfied by providing information
about the disallowance of the deduction for any interest or royalty
under section 267A
[[Page 67630]]
for the corporation's accounting period as Form 5471 and its
instructions may prescribe, and the collection of information in
proposed Sec. 1.6038-2(f)(14) is satisfied by providing information
about hybrid dividends or tiered hybrid dividends under section 245A(e)
for the corporation's accounting period as Form 5471 and its
instructions may prescribe. For purposes of the PRA, the reporting
burden associated with proposed Sec. 1.6038-2(f)(13) and (14) will be
reflected in the IRS Form 14029, Paperwork Reduction Act Submission,
associated with Form 5471. As provided below, the estimated number of
respondents for the reporting burden associated with proposed Sec.
1.6038-2(f)(13) and (14) is 1,000 and 2,000, respectively.
The collection of information in proposed Sec. 1.6038-3(g)(3) is
mandatory for every U.S. person that controls a foreign partnership
that paid or accrued any interest or royalty for which a deduction is
disallowed under section 267A during the partnership tax year and files
Form 8865 for that period (OMB control number 1545-1668). The
collection of information in proposed Sec. 1.6038-3(g)(3) is satisfied
by providing information about the disallowance of the deduction for
any interest or royalty under section 267A for the partnership's tax
year as Form 8865 and its instructions may prescribe. For purposes of
the PRA, the reporting burden associated with proposed Sec. 1.6038-
3(g)(3) will be reflected in the IRS Form 14029, Paperwork Reduction
Act submission, associated with Form 8865. As provided below, the
estimated number of respondents for the reporting burden associated
with proposed Sec. 1.6038-3(g)(3) is less than 1,000.
The collection of information in proposed Sec. 1.6038A-
2(b)(5)(iii) is mandatory for every reporting corporation that has a
deduction disallowed under section 267A and files Form 5472 (OMB
control number 1545-0123, formerly, OMB control number 1545-0805) for
the tax year. The collection of information in proposed Sec. 1.6038A-
2(b)(5)(iii) is satisfied by providing information about the
disallowance of the reporting corporation's deduction for any interest
or royalty under section 267A for the tax year as Form 5472 and its
instructions may prescribe. For purposes of the PRA, the reporting
burden associated with proposed Sec. 1.6038A-2(b)(5)(iii) will be
reflected in the IRS Form 14029, Paperwork Reduction Act submission,
associated with Form 5472. As provided below, the estimated number of
respondents for the reporting burden associated with proposed Sec.
1.6038A-2(b)(5)(iii) is 7,000.
The revised tax forms are as follows:
----------------------------------------------------------------------------------------------------------------
Number of
respondents
New Revision of (estimated,
existing form rounded to
nearest 1,000)
----------------------------------------------------------------------------------------------------------------
Schedule G (Form 5471)................................... .............. [check] 1,000
Schedule I (Form 5471)................................... .............. [check] 2,000
Form 5472................................................ .............. [check] 7,000
Form 8865................................................ .............. [check] <1,000
----------------------------------------------------------------------------------------------------------------
The current status of the Paperwork Reduction Act submissions
related to the tax forms that will be revised as a result of the
information collections in the proposed regulations is provided in the
accompanying table. As described above, the reporting burdens
associated with the information collections in proposed Sec. Sec.
1.6038-2(f)(13) and (14) and 1.6038A-2(b)(5)(iii) are included in the
aggregated burden estimates for OMB control number 1545-0123, which
represents a total estimated burden time for all forms and schedules
for corporations of 3.157 billion hours and total estimated monetized
costs of $58.148 billion ($2017). The overall burden estimates provided
in 1545-0123 are aggregate amounts that relate to the entire package of
forms associated with the OMB control number and will in the future
include but not isolate the estimated burden of the tax forms that will
be revised as a result of the information collections in the proposed
regulations. These numbers are therefore unrelated to the future
calculations needed to assess the burden imposed by the proposed
regulations. They are further identical to numbers provided for the
proposed regulations relating to foreign tax credits (83 FR 63200). The
Treasury Department and IRS urge readers to recognize that these
numbers are duplicates and to guard against overcounting the burden
that international tax provisions imposed prior to the Act. No burden
estimates specific to the proposed regulations are currently available.
The Treasury Department has not identified any burden estimates,
including those for new information collections, related to the
requirements under the proposed regulations. Those estimates would
capture both changes made by the Act and those that arise out of
discretionary authority exercised in the proposed regulations. The
Treasury Department and the IRS request comments on all aspects of
information collection burdens related to the proposed regulations. In
addition, when available, drafts of IRS forms are posted for comment at
https://apps.irs.gov/app/picklist/list/draftTaxForms.htm.
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No. Status
----------------------------------------------------------------------------------------------------------------
Form 5471............................ All other Filers 1545-0121.............. Approved by OMB through
(mainly trusts and 10/30/2020.
estates) (Legacy
system).
--------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201704-1545-023 023.
--------------------------------------------------------------------------
Business (NEW Model)... 1545-0123.............. Published in the
Federal Register
Notice (FRN) on 10/8/
18. Public Comment
period closed on 12/10/
18.
--------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
--------------------------------------------------------------------------
[[Page 67631]]
Individual (NEW Model). 1545-0074.............. Limited Scope
submission (1040 only)
on 10/11/18 at OIRA
for review. Full ICR
submission (all forms)
scheduled in 3/2019.
60 Day FRN not
published yet for full
collection.
--------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
--------------------------------------------------------------------------
Form 5472............................ Business (NEW Model)... 1545-0123.............. Published in the FRN on
10/8/18. Public
Comment period closed
on 12/10/18.
--------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
--------------------------------------------------------------------------
Individual (NEW Model). 1545-0074.............. Limited Scope
submission (1040 only)
on 10/11/18 at OIRA
for review. Full ICR
submission for all
forms in 3/2019. 60
Day FRN not published
yet for full
collection.
--------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
Form 8865............................ All other Filers 1545-1668.............. Published in the FRN on
(mainly trusts and 10/1/18. Public
estates) (Legacy Comment period closed
system). on 11/30/18. ICR in
process by Treasury as
of 10/17/18.
--------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/01/2018-21288/proposed-collection-comment-request-for-regulation-project.
--------------------------------------------------------------------------
Business (NEW Model)... 1545-0123.............. Published in the FRN on
10/8/18. Public
Comment period closed
on 12/10/18.
--------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
--------------------------------------------------------------------------
Individual (NEW Model). 1545-0074.............. Limited Scope
submission (1040 only)
on 10/11/18 at OIRA
for review. Full ICR
submission for all
forms in 3/2019. 60
Day FRN not published
yet for full
collection.
--------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
III. Regulatory Flexibility Act
It is hereby certified that this notice of proposed rulemaking will
not have a significant economic impact on a substantial number of small
entities within the meaning of section 601(6) of the Regulatory
Flexibility Act (5 U.S.C. chapter 6).
The small entities that are subject to proposed Sec. Sec. 1.6038-
2(f)(13), 1.6038-3(g)(3), and 1.6038A-2(b)(5)(iii) are small entities
that are controlling U.S. shareholders of a CFC that is disallowed a
deduction under section 267A, small entities that are controlling
fifty-percent partners of a foreign partnership that makes a payment
for which a deduction is disallowed under section 267A, and small
entities that are 25 percent foreign-owned domestic corporations and
disallowed a deduction under section 267A, respectively. In addition,
the small entities that are subject to proposed Sec. 1.6038-2(f)(14)
are controlling U.S. shareholders of a CFC that pays or received a
hybrid dividend or a tiered hybrid dividend.
A controlling U.S. shareholder of a CFC is a U.S. person that owns
more than 50 percent of the CFC's stock. A controlling fifty-percent
partner is a U.S. person that owns more than a fifty-percent interest
in the foreign partnership. A 25 percent foreign-owned domestic
corporation is a domestic corporation at least 25 percent of the stock
of which is owned by a foreign person.
The Treasury Department and the IRS do not have data readily
available to assess the number of small entities potentially affected
by proposed Sec. Sec. 1.6038-2(f)(13) or (14), 1.6038-3(g)(3), or
1.6038A-2(b)(5)(iii). However, entities potentially affected by these
sections are generally not small businesses, because the resources and
investment necessary for an entity to be a controlling U.S.
shareholder, a controlling fifty-percent partner, or a 25 percent
foreign-owned domestic corporation are generally significant. Moreover,
the de minimis exception under section 267A excepts many small entities
from the application of section 267A for any taxable year for which the
sum of its interest and royalty deductions (plus interest and royalty
deductions of certain related persons) is below $50,000. Therefore, the
Treasury Department and the IRS do not believe that a substantial
number of domestic small business entities will be subject to proposed
Sec. Sec. 1.6038-2(f)(13) or (14), 1.6038-3(g)(3), or 1.6038A-
2(b)(5)(iii). Accordingly, the Treasury Department and the IRS do not
believe that proposed Sec. Sec. 1.6038-2(f)(13) or (14), 1.6038-
3(g)(3), or 1.6038A-2(b)(5)(iii) will have a significant economic
impact on a substantial number of small entities. Therefore, a
Regulatory Flexibility Analysis under the Regulatory Flexibility Act is
not required.
The Treasury Department and the IRS do not believe that the
proposed regulations have a significant economic impact on domestic
small business entities. Based on published information from 2012 from
form 5472, interest and royalty amounts paid to related foreign
entities by foreign-owned
[[Page 67632]]
U.S. corporations over total receipts is 1.6 percent (https://www.irs.gov/statistics/soi-tax-stats-transactions-of-foreign-owned-domestic-corporations#_2, Classified by Industry 2012). This is
substantially less than the 3 to 5 percent threshold for significant
economic impact. The calculated percentage is likely to be an upper
bound of the related party payments affected by the proposed hybrid
regulations. In particular, this is the ratio of the potential income
affected and not the tax revenues, which would be less than half this
amount. While 1.6 percent is only for foreign-owned domestic
corporations with total receipts of $500 million or more, these are
entities that are more likely to have related party payments and so the
percentage would be higher. Moreover, hybrid arrangements are only a
subset of these related party payments; therefore this percentage is
higher than what it would be if only considering hybrid arrangements.
Notwithstanding this certification, Treasury and IRS invite
comments about the impact this proposal may have on small entities.
Pursuant to section 7805(f) of the 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.
Comments and Requests for a Public Hearing
Before the proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
The Treasury Department and the IRS request comments on all aspects of
the proposed rules. All comments will be available at
www.regulations.gov or upon request. 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.
Drafting Information
The principal authors of the proposed regulations are Shane M.
McCarrick and Tracy M. Villecco of the Office of Associate Chief
Counsel (International). However, other personnel from the Treasury
Department and the IRS participated in the development of the proposed
regulations.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income
taxes, Penalties, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 301 are proposed to be amended as
follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by adding
sectional authorities for Sec. Sec. 1.245A(e)-1 and 1.267A-1 through
1.267A-7 in numerical order and revising the entry for Sec. 1.6038A-2
to read in part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.245A(e)-1 also issued under 26 U.S.C. 245A(g).
* * * * *
Sections 1.267A-1 through 1.267A-7 also issued under 26 U.S.C.
267A(e).
* * * * *
Section 1.6038A-2 also issued under 26 U.S.C. 6038A and 6038C.
* * * * *
0
Par. 2. Section 1.245A(e)-1 is added to read as follows:
Sec. 1.245A(e)-1 Special rules for hybrid dividends.
(a) Overview. This section provides rules for hybrid dividends.
Paragraph (b) of this section disallows the deduction under section
245A(a) for a hybrid dividend received by a United States shareholder
from a CFC. Paragraph (c) of this section provides a rule for hybrid
dividends of tiered corporations. Paragraph (d) of this section sets
forth rules regarding a hybrid deduction account. Paragraph (e) of this
section provides an anti-avoidance rule. Paragraph (f) of this section
provides definitions. Paragraph (g) of this section illustrates the
application of the rules of this section through examples. Paragraph
(h) of this section provides the applicability date.
(b) Hybrid dividends received by United States shareholders--(1) In
general. If a United States shareholder receives a hybrid dividend,
then--
(i) The United States shareholder is not allowed a deduction under
section 245A(a) for the hybrid dividend; and
(ii) The rules of section 245A(d) (disallowance of foreign tax
credits and deductions) apply to the hybrid dividend.
(2) Definition of hybrid dividend. The term hybrid dividend means
an amount received by a United States shareholder from a CFC for which
but for section 245A(e) and this section the United States shareholder
would be allowed a deduction under section 245A(a), to the extent of
the sum of the United States shareholder's hybrid deduction accounts
(as described in paragraph (d) of this section) with respect to each
share of stock of the CFC, determined at the close of the CFC's taxable
year (or in accordance with paragraph (d)(5) of this section, as
applicable). No other amount received by a United States shareholder
from a CFC is a hybrid dividend for purposes of section 245A.
(3) Special rule for certain dividends attributable to earnings of
lower-tier foreign corporations. This paragraph (b)(3) applies if a
domestic corporation sells or exchanges stock of a foreign corporation
and, pursuant to section 1248, the gain recognized on the sale or
exchange is included in gross income as a dividend. In such a case, for
purposes of this section--
(i) To the extent that earnings and profits of a lower-tier CFC
gave rise to the dividend under section 1248(c)(2), those earnings and
profits are treated as distributed as a dividend by the lower-tier CFC
directly to the domestic corporation under the principles of Sec.
1.1248-1(d); and
(ii) To the extent the domestic corporation indirectly owns (within
the meaning of section 958(a)(2)) shares of stock of the lower-tier
CFC, the hybrid deduction accounts with respect to those shares are
treated as hybrid deduction accounts of the domestic corporation. Thus,
for example, if a domestic corporation sells or exchanges all the stock
of an upper-tier CFC and under this paragraph (b)(3) there is
considered to be a dividend paid directly by the lower-tier CFC to the
domestic corporation, then the dividend is generally a hybrid dividend
to the extent of the sum of the upper-tier CFC's hybrid deduction
accounts with respect to stock of the lower-tier CFC.
(4) Ordering rule. Amounts received by a United States shareholder
from a CFC are subject to the rules of section 245A(e) and this section
based on the order in which they are received. Thus, for example, if on
different days during a CFC's taxable year a United States shareholder
receives dividends from the CFC, then the rules of section 245A(e) and
this section apply first to the dividend received on the earliest date
(based on the sum of the United States shareholder's hybrid deduction
accounts with respect to each share of stock of the CFC), and then to
the
[[Page 67633]]
dividend received on the next earliest date (based on the remaining
sum).
(c) Hybrid dividends of tiered corporations--(1) In general. If a
CFC (the receiving CFC) receives a tiered hybrid dividend from another
CFC, and a domestic corporation is a United States shareholder with
respect to both CFCs, then, notwithstanding any other provision of the
Code--
(i) The tiered hybrid dividend is treated for purposes of section
951(a)(1)(A) as subpart F income of the receiving CFC for the taxable
year of the CFC in which the tiered hybrid dividend is received;
(ii) The United States shareholder must include in gross income an
amount equal to its pro rata share (determined in the same manner as
under section 951(a)(2)) of the subpart F income described in paragraph
(c)(1)(i) of this section; and
(iii) The rules of section 245A(d) (disallowance of foreign tax
credit, including for taxes that would have been deemed paid under
section 960(a) or (b), and deductions) apply to the amount included
under paragraph (c)(1)(ii) of this section in the United States
shareholder's gross income.
(2) Definition of tiered hybrid dividend. The term tiered hybrid
dividend means an amount received by a receiving CFC from another CFC
to the extent that the amount would be a hybrid dividend under
paragraph (b)(2) of this section if, for purposes of section 245A and
the regulations under section 245A as contained in 26 CFR part 1
(except for section 245A(e)(2) and this paragraph (c)), the receiving
CFC were a domestic corporation. A tiered hybrid dividend does not
include an amount described in section 959(b). No other amount received
by a receiving CFC from another CFC is a tiered hybrid dividend for
purposes of section 245A.
(3) Special rule for certain dividends attributable to earnings of
lower-tier foreign corporations. This paragraph (c)(3) applies if a CFC
sells or exchanges stock of a foreign corporation and pursuant to
section 964(e)(1) the gain recognized on the sale or exchange is
included in gross income as a dividend. In such a case, rules similar
to the rules of paragraph (b)(3) of this section apply.
(4) Interaction with rules under section 964(e). To the extent a
dividend described in section 964(e)(1) (gain on certain stock sales by
CFCs treated as dividends) is a tiered hybrid dividend, the rules of
section 964(e)(4) do not apply and, therefore, the United States
shareholder is not allowed a deduction under section 245A(a) for the
amount included in gross income under paragraph (c)(1)(ii) of this
section.
(d) Hybrid deduction accounts--(1) In general. A specified owner of
a share of CFC stock must maintain a hybrid deduction account with
respect to the share. The hybrid deduction account with respect to the
share must reflect the amount of hybrid deductions of the CFC allocated
to the share (as determined under paragraphs (d)(2) and (3) of this
section), and must be maintained in accordance with the rules of
paragraphs (d)(4) through (6) of this section.
(2) Hybrid deductions--(i) In general. The term hybrid deduction of
a CFC means a deduction or other tax benefit (such as an exemption,
exclusion, or credit, to the extent equivalent to a deduction) for
which the requirements of paragraphs (d)(2)(i)(A) and (B) of this
section are both satisfied.
(A) The deduction or other tax benefit is allowed to the CFC (or a
person related to the CFC) under a relevant foreign tax law.
(B) The deduction or other tax benefit relates to or results from
an amount paid, accrued, or distributed with respect to an instrument
issued by the CFC and treated as stock for U.S. tax purposes. Examples
of such a deduction or other tax benefit include an interest deduction,
a dividends paid deduction, and a deduction with respect to equity
(such as a notional interest deduction). See paragraph (g)(1) of this
section. However, a deduction or other tax benefit relating to or
resulting from a distribution by the CFC with respect to an instrument
treated as stock for purposes of the relevant foreign tax law is
considered a hybrid deduction only to the extent it has the effect of
causing the earnings that funded the distribution to not be included in
income (determined under the principles of Sec. 1.267A-3(a)) or
otherwise subject to tax under the CFC's tax law. Thus, for example, a
refund to a shareholder of a CFC (including through a credit), upon a
distribution by the CFC to the shareholder, of taxes paid by the CFC on
the earnings that funded the distribution results in a hybrid deduction
of the CFC, but only to the extent that the shareholder, if a tax
resident of the CFC's country, does not include the distribution in
income under the CFC's tax law or, if not a tax resident of the CFC's
country, is not subject to withholding tax (as defined in section
901(k)(1)(B)) on the distribution under the CFC's tax law. See
paragraph (g)(2) of this section.
(ii) Application limited to items allowed in taxable years
beginning after December 31, 2017. A deduction or other tax benefit
allowed to a CFC (or a person related to the CFC) under a relevant
foreign tax law is taken into account for purposes of this section only
if it was allowed with respect to a taxable year under the relevant
foreign tax law beginning after December 31, 2017.
(3) Allocating hybrid deductions to shares. A hybrid deduction is
allocated to a share of stock of a CFC to the extent that the hybrid
deduction (or amount equivalent to a deduction) relates to an amount
paid, accrued, or distributed by the CFC with respect to the share.
However, in the case of a hybrid deduction that is a deduction with
respect to equity (such as a notional interest deduction), the
deduction is allocated to a share of stock of a CFC based on the
product of--
(i) The amount of the deduction allowed for all of the equity of
the CFC; and
(ii) A fraction, the numerator of which is the value of the share
and the denominator of which is the value of all of the stock of the
CFC.
(4) Maintenance of hybrid deduction accounts--(i) In general. A
specified owner's hybrid deduction account with respect to a share of
stock of a CFC is, as of the close of the taxable year of the CFC,
adjusted pursuant to the following rules.
(A) First, the account is increased by the amount of hybrid
deductions of the CFC allocable to the share for the taxable year.
(B) Second, the account is decreased by the amount of hybrid
deductions in the account that gave rise to a hybrid dividend or tiered
hybrid dividend during the taxable year. If a specified owner has more
than one hybrid deduction account with respect to its stock of the CFC,
then a pro rata amount in each hybrid deduction account is considered
to have given rise to the hybrid dividend or tiered hybrid dividend,
based on the amounts in the accounts before applying this paragraph
(d)(4)(i)(B).
(ii) Acquisition of account--(A) In general. The following rules
apply when a person (the acquirer) acquires a share of stock of a CFC
from another person (the transferor).
(1) In the case of an acquirer that is a specified owner of the
share immediately after the acquisition, the transferor's hybrid
deduction account, if any, with respect to the share becomes the hybrid
deduction account of the acquirer.
(2) In the case of an acquirer that is not a specified owner of the
share immediately after the acquisition, the transferor's hybrid
deduction account, if any, is eliminated and accordingly is not
thereafter taken into account by any person.
[[Page 67634]]
(B) Additional rules. The following rules apply in addition to the
rules of paragraph (d)(4)(ii)(A) of this section.
(1) Certain section 354 or 356 exchanges. The following rules apply
when a shareholder of a CFC (the CFC, the target CFC; the shareholder,
the exchanging shareholder) exchanges stock of the target CFC for stock
of another CFC (the acquiring CFC) pursuant to an exchange described in
section 354 or 356 that occurs in connection with a transaction
described in section 381(a)(2) in which the target CFC is the
transferor corporation.
(i) In the case of an exchanging shareholder that is a specified
owner of one or more shares of stock of the acquiring CFC immediately
after the exchange, the exchanging shareholder's hybrid deduction
accounts with respect to the shares of stock of the target CFC that it
exchanges are attributed to the shares of stock of the acquiring CFC
that it receives in the exchange.
(ii) In the case of an exchanging shareholder that is not a
specified owner of one or more shares of stock of the acquiring CFC
immediately after the exchange, the exchanging shareholder's hybrid
deduction accounts with respect to its shares of stock of the target
CFC are eliminated and accordingly are not thereafter taken into
account by any person.
(2) Section 332 liquidations. If a CFC is a distributor corporation
in a transaction described in section 381(a)(1) (the distributing CFC)
in which a controlled foreign corporation is the acquiring corporation
(the distributee CFC), then each hybrid account with respect to a share
of stock of the distributee CFC is increased pro rata by the sum of the
hybrid accounts with respect to shares of stock of the distributing
CFC.
(3) Recapitalizations. If a shareholder of a CFC exchanges stock of
the CFC pursuant to a reorganization described in section 368(a)(1)(E)
or a transaction to which section 1036 applies, then the shareholder's
hybrid deduction accounts with respect to the stock of the CFC that it
exchanges are attributed to the shares of stock of the CFC that it
receives in the exchange.
(5) Determinations and adjustments made on transfer date in certain
cases. This paragraph (d)(5) applies if on a date other than the date
that is the last day of the CFC's taxable year a United States
shareholder of the CFC or an upper-tier CFC with respect to the CFC
directly or indirectly transfers a share of stock of the CFC, and,
during the taxable year, but on or before the transfer date, the United
States shareholder or upper-tier CFC receives an amount from the CFC
that is subject to the rules of section 245A(e) and this section. In
such a case, as to the United States shareholder or upper-tier CFC and
the United States shareholder's or upper-tier CFC's hybrid deduction
accounts with respect to each share of stock of the CFC (regardless of
whether such share is transferred), the determinations and adjustments
under this section that would otherwise be made at the close of the
CFC's taxable year are made at the close of the date of the transfer.
Thus, for example, if a United States shareholder of a CFC exchanges
stock of the CFC in an exchange described in Sec. 1.367(b)-4(b)(1)(i)
and is required to include in income as a deemed dividend the section
1248 amount attributable to the stock exchanged, the sum of the United
States shareholder's hybrid deduction accounts with respect to each
share of stock of the CFC is determined, and the accounts are adjusted,
as of the close of the date of the exchange. For this purpose, the
principles of Sec. 1.1502-76(b)(2)(ii) apply to determine amounts in
hybrid deduction accounts at the close of the date of the transfer.
(6) Effects of CFC functional currency--(i) Maintenance of the
hybrid deduction account. A hybrid deduction account with respect to a
share of CFC stock must be maintained in the functional currency
(within the meaning of section 985) of the CFC. Thus, for example, the
amount of a hybrid deduction and the adjustments described in
paragraphs (d)(4)(i)(A) and (B) of this section are determined based on
the functional currency of the CFC. In addition, for purposes of this
section, the amount of a deduction or other tax benefit allowed to a
CFC (or a person related to the CFC) is determined taking into account
foreign currency gain or loss recognized with respect to such deduction
or other tax benefit under a provision of foreign tax law comparable to
section 988 (treatment of certain foreign currency transactions).
(ii) Determination of amount of hybrid dividend. This paragraph
(d)(6)(ii) applies if a CFC's functional currency is other than the
functional currency of a United States shareholder or upper-tier CFC
that receives an amount from the CFC that is subject to the rules of
section 245A(e) and this section. In such a case, the sum of the United
States shareholder's or upper-tier CFC's hybrid deduction accounts with
respect to each share of stock of the CFC is, for purposes of
determining the extent that a dividend is a hybrid dividend or tiered
hybrid dividend, translated into the functional currency of the United
States shareholder or upper-tier CFC based on the spot rate (within the
meaning of Sec. 1.988-1(d)) as of the date of the dividend.
(e) Anti-avoidance rule. Appropriate adjustments are made pursuant
to this section, including adjustments that would disregard the
transaction or arrangement, if a transaction or arrangement is
undertaken with a principal purpose of avoiding the purposes of this
section. For example, if a specified owner of a share of CFC stock
transfers the share to another person, and a principal purpose of the
transfer is to shift the hybrid deduction account with respect to the
share to the other person or to cause the hybrid deduction account to
be eliminated, then for purposes of this section the shifting or
elimination of the hybrid deduction account is disregarded as to the
transferor. As another example, if a transaction or arrangement is
undertaken to affirmatively fail to satisfy the holding period
requirement under section 246(c)(5) with a principal purpose of
avoiding the tiered hybrid dividend rules described in paragraph (c) of
this section, the transaction or arrangement is disregarded for
purposes of this section.
(f) Definitions. The following definitions apply for purposes of
this section.
(1) The term controlled foreign corporation (or CFC) has the
meaning provided in section 957.
(2) The term person has the meaning provided in section 7701(a)(1).
(3) The term related has the meaning provided in this paragraph
(f)(3). A person is related to a CFC if the person is a related person
within the meaning of section 954(d)(3).
(4) The term relevant foreign tax law means, with respect to a CFC,
any regime of any foreign country or possession of the United States
that imposes an income, war profits, or excess profits tax with respect
to income of the CFC, other than a foreign anti-deferral regime under
which a person that owns an interest in the CFC is liable to tax. Thus,
the term includes any regime of a foreign country or possession of the
United States that imposes income, war profits, or excess profits tax
under which--
(i) The CFC is liable to tax as a resident;
(ii) The CFC has a branch that gives rise to a taxable presence in
the foreign country or possession of the United States; or
(iii) A person related to the CFC is liable to tax as a resident,
provided that under such person's tax law the person is allowed a
deduction for amounts paid or accrued by the CFC (because, for
[[Page 67635]]
example, the CFC is fiscally transparent under the person's tax law).
(5) The term specified owner means, with respect to a share of
stock of a CFC, a person for which the requirements of paragraphs
(f)(5)(i) and (ii) of this section are satisfied.
(i) The person is a domestic corporation that is a United States
shareholder of the CFC, or is an upper-tier CFC that would be a United
States shareholder of the CFC were the upper-tier CFC a domestic
corporation.
(ii) The person owns the share directly or indirectly through a
partnership, trust, or estate. Thus, for example, if a domestic
corporation directly owns all the shares of stock of an upper-tier CFC
and the upper-tier CFC directly owns all the shares of stock of another
CFC, the domestic corporation is the specified owner with respect to
each share of stock of the upper-tier CFC and the upper-tier CFC is the
specified owner with respect to each share of stock of the other CFC.
(6) The term United States shareholder has the meaning provided in
section 951(b).
(g) Examples. This paragraph (g) provides examples that illustrate
the application of this section. For purposes of the examples in this
paragraph (g), unless otherwise indicated, the following facts are
presumed. US1 is a domestic corporation. FX and FZ are CFCs formed at
the beginning of year 1. FX is a tax resident of Country X and FZ is a
tax resident of Country Z. US1 is a United States shareholder with
respect to FX and FZ. No distributed amounts are attributable to
amounts which are, or have been, included in the gross income of a
United States shareholder under section 951(a). All instruments are
treated as stock for U.S. tax purposes.
(1) Example 1. Hybrid dividend resulting from hybrid
instrument--(i) Facts. US1 holds both shares of stock of FX, which
have an equal value. One share is treated as indebtedness for
Country X tax purposes (``Share A''), and the other is treated as
equity for Country X tax purposes (``Share B''). During year 1,
under Country X tax law, FX accrues $80x of interest to US1 with
respect to Share A and is allowed a deduction for the amount (the
``Hybrid Instrument Deduction''). During year 2, FX distributes $30x
to US1 with respect to each of Share A and Share B. For U.S. tax
purposes, each of the $30x distributions is treated as a dividend
for which, but for section 245A(e) and this section, US1 would be
allowed a deduction under section 245A(a). For Country X tax
purposes, the $30x distribution with respect to Share A represents a
payment of interest for which a deduction was already allowed (and
thus FX is not allowed an additional deduction for the amount), and
the $30x distribution with respect to Share B is treated as a
dividend (for which no deduction is allowed).
(ii) Analysis. The entire $30x of each dividend received by US1
from FX during year 2 is a hybrid dividend, because the sum of US1's
hybrid deduction accounts with respect to each of its shares of FX
stock at the end of year 2 ($80x) is at least equal to the amount of
the dividends ($60x). See paragraph (b)(2) of this section. This is
the case for the $30x dividend with respect to Share B even though
there are no hybrid deductions allocated to Share B. See id. As a
result, US1 is not allowed a deduction under section 245A(a) for the
entire $60x of hybrid dividends and the rules of section 245A(d)
(disallowance of foreign tax credits and deductions) apply. See
paragraph (b)(1) of this section. Paragraphs (g)(1)(ii)(A) through
(D) of this section describe the determinations under this section.
(A) At the end of year 1, US1's hybrid deduction accounts with
respect to Share A and Share B are $80x and $0, respectively,
calculated as follows.
(1) The $80x Hybrid Instrument Deduction allowed to FX under
Country X tax law (a relevant foreign tax law) is a hybrid deduction
of FX, because the deduction is allowed to FX and relates to or
results from an amount accrued with respect to an instrument issued
by FX and treated as stock for U.S. tax purposes. See paragraph
(d)(2)(i) of this section. Thus, FX's hybrid deductions for year 1
are $80x.
(2) The entire $80x Hybrid Instrument Deduction is allocated to
Share A, because the deduction was accrued with respect to Share A.
See paragraph (d)(3) of this section. As there are no additional
hybrid deductions of FX for year 1, there are no additional hybrid
deductions to allocate to either Share A or Share B. Thus, there are
no hybrid deductions allocated to Share B.
(3) At the end of year 1, US1's hybrid deduction account with
respect to Share A is increased by $80x (the amount of hybrid
deductions allocated to Share A). See paragraph (d)(4)(i)(A) of this
section. Because FX did not pay any dividends with respect to either
Share A or Share B during year 1 (and therefore did not pay any
hybrid dividends or tiered hybrid dividends), no further adjustments
are made. See paragraph (d)(4)(i)(B) of this section. Therefore, at
the end of year 1, US1's hybrid deduction accounts with respect to
Share A and Share B are $80x and $0, respectively.
(B) At the end of year 2, and before the adjustments described
in paragraph (d)(4)(i)(B) of this section, US1's hybrid deduction
accounts with respect to Share A and Share B remain $80x and $0,
respectively. This is because there are no hybrid deductions of FX
for year 2. See paragraph (d)(4)(i)(A) of this section.
(C) Because at the end of year 2 (and before the adjustments
described in paragraph (d)(4)(i)(B) of this section) the sum of
US1's hybrid deduction accounts with respect to Share A and Share B
($80x, calculated as $80x plus $0) is at least equal to the
aggregate $60x of year 2 dividends, the entire $60x dividend is a
hybrid dividend. See paragraph (b)(2) of this section.
(D) At the end of year 2, US1's hybrid deduction account with
respect to Share A is decreased by $60x, the amount of the hybrid
deductions in the account that gave rise to a hybrid dividend or
tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(B) of
this section. Because there are no hybrid deductions in the hybrid
deduction account with respect to Share B, no adjustments with
respect to that account are made under paragraph (d)(4)(i)(B) of
this section. Therefore, at the end of year 2 and taking into
account the adjustments under paragraph (d)(4)(i)(B) of this
section, US1's hybrid deduction account with respect to Share A is
$20x ($80x less $60x) and with respect to Share B is $0.
(iii) Alternative facts--notional interest deductions. The facts
are the same as in paragraph (g)(1)(i) of this section, except that
for each of year 1 and year 2 FX is allowed $10x of notional
interest deductions with respect to its equity, Share B, under
Country X tax law (the ``NIDs''). In addition, during year 2, FX
distributes $47.5x (rather than $30x) to US1 with respect to each of
Share A and Share B. For U.S. tax purposes, each of the $47.5x
distributions is treated as a dividend for which, but for section
245A(e) and this section, US1 would be allowed a deduction under
section 245A(a). For Country X tax purposes, the $47.5x distribution
with respect to Share A represents a payment of interest for which a
deduction was already allowed (and thus FX is not allowed an
additional deduction for the amount), and the $47.5x distribution
with respect to Share B is treated as a dividend (for which no
deduction is allowed). The entire $47.5x of each dividend received
by US1 from FX during year 2 is a hybrid dividend, because the sum
of US1's hybrid deduction accounts with respect to each of its
shares of FX stock at the end of year 2 ($80x plus $20x, or $100x)
is at least equal to the amount of the dividends ($95x). See
paragraph (b)(2) of this section. As a result, US1 is not allowed a
deduction under section 245A(a) for the $95x hybrid dividend and the
rules of section 245A(d) (disallowance of foreign tax credits and
deductions) apply. See paragraph (b)(1) of this section. Paragraphs
(g)(1)(iii)(A) through (D) of this section describe the
determinations under this section.
(A) The $10x of NIDs allowed to FX under Country X tax law in
year 1 are hybrid deductions of FX for year 1. See paragraph
(d)(2)(i) of this section. The $10x of NIDs is allocated equally to
each of Share A and Share B, because the hybrid deduction is with
respect to equity and the shares have an equal value. See paragraph
(d)(3) of this section. Thus, $5x of the NIDs is allocated to each
of Share A and Share B for year 1. For the reasons described in
paragraph (g)(1)(ii)(A) of this section, the entire $80x Hybrid
Instrument Deduction is allocated to Share A. Therefore, at the end
of year 1, US1's hybrid deduction accounts with respect to Share A
and Share B are $85x and $5x, respectively.
(B) Similarly, the $10x of NIDs allowed to FX under Country X
tax law in year 2 are hybrid deductions of FX for year 2, and $5x of
the NIDs is allocated to each of Share A and Share B for year 2. See
paragraphs (d)(2)(i) and (d)(3) of this section. Thus, at the
[[Page 67636]]
end of year 2 (and before the adjustments described in paragraph
(d)(4)(i)(B) of this section), US1's hybrid deduction account with
respect to Share A is $90x ($85x plus $5x) and with respect to Share
B is $10x ($5x plus $5x). See paragraph (d)(4)(i) of this section.
(C) Because at the end of year 2 (and before the adjustments
described in paragraph (d)(4)(i)(B) of this section) the sum of
US1's hybrid deduction accounts with respect to Share A and Share B
($100x, calculated as $90x plus $10x) is at least equal to the
aggregate $95x of year 2 dividends, the entire $95x of dividends are
hybrid dividends. See paragraph (b)(2) of this section.
(D) At the end of year 2, US1's hybrid deduction accounts with
respect to Share A and Share B are decreased by the amount of hybrid
deductions in the accounts that gave rise to a hybrid dividend or
tiered hybrid dividend during year 2. See paragraph (d)(4)(i)(B) of
this section. A total of $95x of hybrid deductions in the accounts
gave rise to a hybrid dividend during year 2. For the hybrid
deduction account with respect to Share A, $85.5x in the account is
considered to have given rise to a hybrid deduction (calculated as
$95x multiplied by $90x/$100x). See id. For the hybrid deduction
account with respect to Share B, $9.5x in the account is considered
to have given rise to a hybrid deduction (calculated as $95x
multiplied by $10x/$100x). See id. Thus, following these
adjustments, at the end of year 2, US1's hybrid deduction account
with respect to Share A is $4.5x ($90x less $85.5x) and with respect
to Share B is $0.5x ($10x less $9.5x).
(iv) Alternative facts--deduction in branch country--(A) Facts.
The facts are the same as in paragraph (g)(1)(i) of this section,
except that for Country X tax purposes Share A is treated as equity
(and thus the Hybrid Instrument Deduction does not exist and under
Country X tax law FX is not allowed a deduction for the $30x
distributed in year 2 with respect to Share A). However, FX has a
branch in Country Z that gives rise to a taxable presence under
Country Z tax law, and for Country Z tax purposes Share A is treated
as indebtedness and Share B is treated as equity. Also, during year
1, for Country Z tax purposes, FX accrues $80x of interest to US1
with respect to Share A and is allowed an $80x interest deduction
with respect to its Country Z branch income. Moreover, for Country Z
tax purposes, the $30x distribution with respect to Share A in year
2 represents a payment of interest for which a deduction was already
allowed (and thus FX is not allowed an additional deduction for the
amount), and the $30x distribution with respect to Share B in year 2
is treated as a dividend (for which no deduction is allowed).
(B) Analysis. The $80x interest deduction allowed to FX under
Country Z tax law (a relevant foreign tax law) with respect to its
Country Z branch income is a hybrid deduction of FX for year 1. See
paragraphs (d)(2)(i) and (f)(4) of this section. For reasons similar
to those discussed in paragraph (g)(1)(ii) of this section, at the
end of year 2 (and before the adjustments described in paragraph
(d)(4)(i)(B) of this section), US1's hybrid deduction accounts with
respect to Share A and Share B are $80x and $0, respectively, and
the sum of the accounts is $80x. Accordingly, the entire $60x of the
year 2 dividend is a hybrid dividend. See paragraph (b)(2) of this
section. Further, for the reasons described in paragraph
(g)(1)(ii)(D) of this section, at the end of year 2 and taking into
account the adjustments under paragraph (d)(4)(i)(B) of this
section, US1's hybrid deduction account with respect to Share A is
$20x ($80x less $60x) and with respect to Share B is $0.
(2) Example 2. Tiered hybrid dividend rule; tax benefit
equivalent to a deduction--(i) Facts. US1 holds all the stock of FX,
and FX holds all 100 shares of stock of FZ (the ``FZ shares''),
which have an equal value. The FZ shares are treated as equity for
Country Z tax purposes. During year 2, FZ distributes $10x to FX
with respect to each of the FZ shares, for a total of $1,000x. The
$1,000x is treated as a dividend for U.S. and Country Z tax
purposes, and is not deductible for Country Z tax purposes. If FX
were a domestic corporation, then, but for section 245A(e) and this
section, FX would be allowed a deduction under section 245A(a) for
the $1,000x. Under Country Z tax law, 75% of the corporate income
tax paid by a Country Z corporation with respect to a dividend
distribution is refunded to the corporation's shareholders
(regardless of where such shareholders are tax residents) upon a
dividend distribution by the corporation. The corporate tax rate in
Country Z is 20%. With respect to FZ's distributions, FX is allowed
a refundable tax credit of $187.5x. The $187.5x refundable tax
credit is calculated as $1,250x (the amount of pre-tax earnings that
funded the distribution, determined as $1,000x (the amount of the
distribution) divided by 0.8 (the percentage of pre-tax earnings
that a Country Z corporation retains after paying Country Z
corporate tax)) multiplied by 0.2 (the Country Z corporate tax rate)
multiplied by 0.75 (the percentage of the Country Z tax credit).
Under Country Z tax law, FX is not subject to Country Z withholding
tax (or any other tax) with respect to the $1,000x dividend
distribution.
(ii) Analysis. $937.5x of the $1,000x of dividends received by
FX from FZ during year 2 is a tiered hybrid dividend, because the
sum of FX's hybrid deduction accounts with respect to each of its
shares of FZ stock at the end of year 2 is $937.5x. See paragraphs
(b)(2) and (c)(2) of this section. As a result, the $937.5x tiered
hybrid dividend is treated for purposes of section 951(a)(1)(A) as
subpart F income of FX and US1 must include in gross income its pro
rata share of such subpart F income, which is $937.5x. See paragraph
(c)(1) of this section. In addition, the rules of section 245A(d)
(disallowance of foreign tax credits and deductions) apply with
respect to US1's inclusion. Id. Paragraphs (g)(2)(ii)(A) through (C)
of this section describe the determinations under this section. The
characterization of the FZ stock for Country X tax purposes (or for
purposes of any other foreign tax law) does not affect this
analysis.
(A) The $187.5x refundable tax credit allowed to FX under
Country Z tax law (a relevant foreign tax law) is equivalent to a
$937.5x deduction, calculated as $187.5x (the amount of the credit)
divided by 0.2 (the Country Z corporate tax rate). The $937.5x is a
hybrid deduction of FZ because it is allowed to FX (a person related
to FZ), it relates to or results from amounts distributed with
respect to instruments issued by FZ and treated as stock for U.S.
tax purposes, and it has the effect of causing the earnings that
funded the distributions to not be included in income under Country
Z tax law. See paragraph (d)(2)(i) of this section. $9.375x of the
hybrid deduction is allocated to each of the FZ shares, calculated
as $937.5x (the amount of the hybrid deduction) multiplied by 1/100
(the value of each FZ share relative to the value of all the FZ
shares). See paragraph (d)(3) of this section. The result would be
the same if FX were instead a tax resident of Country Z (and not
Country X) and under Country Z tax law FX were to not include the
$1,000x in income (because, for example, Country Z tax law provides
Country Z resident corporations a 100% exclusion or dividends
received deduction with respect to dividends received from a
resident corporation). See paragraph (d)(2)(i) of this section.
(B) Thus, at the end of year 2, and before the adjustments
described in paragraph (d)(4)(i)(B) of this section, the sum of FX's
hybrid deduction accounts with respect to each of its shares of FZ
stock is $937.5x, calculated as $9.375x (the amount in each account)
multiplied by 100 (the number of accounts). See paragraph (d)(4)(i)
of this section. Accordingly, $937.5x of the $1,000x dividend
received by FX from FZ during year 2 is a tiered hybrid dividend.
See paragraphs (b)(2) and (c)(2) of this section.
(C) Lastly, at the end of year 2, each of FX's hybrid deduction
accounts with respect to its shares of FZ is decreased by the
$9.375x in the account that gave rise to a hybrid dividend or tiered
hybrid dividend during year 2. See paragraph (d)(4)(i)(B) of this
section. Thus, following these adjustments, at the end of year 2,
each of FX's hybrid deduction accounts with respect to its shares of
FZ stock is $0, calculated as $9.375x (the amount in the account
before the adjustments described in paragraph (d)(4)(i)(B) of this
section) less $9.375x (the adjustment described in paragraph
(d)(4)(i)(B) of this section with respect to the account).
(iii) Alternative facts--imputation system that taxes
shareholders. The facts are the same as in paragraph (g)(2)(i) of
this section, except that under Country Z tax law the $1,000
dividend to FX is subject to a 30% gross basis withholding tax, or
$300x, and the $187.5x refundable tax credit is applied against and
reduces the withholding tax to $112.5x. The $187.5x refundable tax
credit provided to FX is not a hybrid deduction because FX was
subject to Country Z withholding tax of $300x on the $1,000x
dividend (such withholding tax being greater than the $187.5x
credit). See paragraph (d)(2)(i) of this section.
(h) Applicability date. This section applies to distributions made
after December 31, 2017.
0
Par. 3. Sections 1.267A-1 through 1.267A-7 are added to read as
follows:
[[Page 67637]]
Sec. 1.267A-1 Disallowance of certain interest and royalty
deductions.
(a) Scope. This section and Sec. Sec. 1.267A-2 through 1.267A-5
provide rules regarding when a deduction for any interest or royalty
paid or accrued is disallowed under section 267A. Section 1.267A-2
describes hybrid and branch arrangements. Section 1.267A-3 provides
rules for determining income inclusions and provides that certain
amounts are not amounts for which a deduction is disallowed. Section
1.267A-4 provides an imported mismatch rule. Section 1.267A-5 sets
forth definitions and special rules that apply for purposes of section
267A. Section 1.267A-6 illustrates the application of section 267A
through examples. Section 1.267A-7 provides applicability dates.
(b) Disallowance of deduction. This paragraph (b) sets forth the
exclusive circumstances in which a deduction is disallowed under
section 267A. Except as provided in paragraph (c) of this section, a
specified party's deduction for any interest or royalty paid or accrued
(the amount paid or accrued with respect to the specified party, a
specified payment) is disallowed under section 267A to the extent that
the specified payment is described in this paragraph (b). See also
Sec. 1.267A-5(b)(5) (treating structured payments as specified
payments). A specified payment is described in this paragraph (b) to
the extent that it is--
(1) A disqualified hybrid amount, as described in Sec. 1.267A-2
(hybrid and branch arrangements);
(2) A disqualified imported mismatch amount, as described in Sec.
1.267A-4 (payments offset by a hybrid deduction); or
(3) A specified payment for which the requirements of the anti-
avoidance rule of Sec. 1.267A-5(b)(6) are satisfied.
(c) De minimis exception. Paragraph (b) of this section does not
apply to a specified party for a taxable year in which the sum of the
specified party's interest and royalty deductions (determined without
regard to this section) is less than $50,000. For purposes of this
paragraph (c), specified parties that are related (within the meaning
of Sec. 1.267A-5(a)(14)) are treated as a single specified party.
Sec. 1.267A-2 Hybrid and branch arrangements.
(a) Payments pursuant to hybrid transactions--(1) In general. If a
specified payment is made pursuant to a hybrid transaction, then,
subject to Sec. 1.267A-3(b) (amounts included or includible in
income), the payment is a disqualified hybrid amount to the extent
that--
(i) A specified recipient of the payment does not include the
payment in income, as determined under Sec. 1.267A-3(a) (to such
extent, a no-inclusion); and
(ii) The specified recipient's no-inclusion is a result of the
payment being made pursuant to the hybrid transaction. For this
purpose, the specified recipient's no-inclusion is a result of the
specified payment being made pursuant to the hybrid transaction to the
extent that the no-inclusion would not occur were the specified
recipient's tax law to treat the payment as interest or a royalty, as
applicable. See Sec. 1.267A-6(c)(1) and (2).
(2) Definition of hybrid transaction. The term hybrid transaction
means any transaction, series of transactions, agreement, or instrument
one or more payments with respect to which are treated as interest or
royalties for U.S. tax purposes but are not so treated for purposes of
the tax law of a specified recipient of the payment. Examples of a
hybrid transaction include an instrument a payment with respect to
which is treated as interest for U.S. tax purposes but, for purposes of
a specified recipient's tax law, is treated as a distribution with
respect to equity or a return of principal. In addition, a specified
payment is deemed to be made pursuant to a hybrid transaction if the
taxable year in which a specified recipient recognizes the payment
under its tax law ends more than 36 months after the end of the taxable
year in which the specified party would be allowed a deduction for the
payment under U.S. tax law. See also Sec. 1.267A-6(c)(8). Further, a
specified payment is not considered made pursuant to a hybrid
transaction if the payment is a disregarded payment, as described in
paragraph (b)(2) of this section.
(3) Payments pursuant to securities lending transactions, sale-
repurchase transactions, or similar transactions. This paragraph (a)(3)
applies if a specified payment is made pursuant to a repo transaction
and is not regarded under a foreign tax law but another amount
connected to the payment (the connected amount) is regarded under such
foreign tax law. For this purpose, a repo transaction means a
transaction one or more payments with respect to which are treated as
interest (as defined in Sec. 1.267A-5(a)(12)) or a structured payment
(as defined in Sec. 1.267A-5(b)(5)(ii)) for U.S. tax purposes and that
is a securities lending transaction or sale-repurchase transaction
(including as described in Sec. 1.861-2(a)(7)), or other similar
transaction or series of related transactions in which legal title to
property is transferred and the property (or similar property, such as
securities of the same class and issue) is reacquired or expected to be
reacquired. For example, this paragraph (a)(3) applies if a specified
payment arising from characterizing a repo transaction of stock in
accordance with its substance (that is, characterizing the specified
payment as interest) is not regarded as such under a foreign tax law
but an amount consistent with the form of the transaction (such as a
dividend) is regarded under such foreign tax law. When this paragraph
(a)(3) applies, the determination of the identity of a specified
recipient of the specified payment under the foreign tax law is made
with respect to the connected amount. In addition, if the specified
recipient includes the connected amount in income (as determined under
Sec. 1.267A-3(a), by treating the connected amount as the specified
payment), then the amount of the specified recipient's no-inclusion
with respect to the specified payment is correspondingly reduced. See
Sec. 1.267A-6(c)(2). Further, the principles of this paragraph (a)(3)
apply to cases similar to repo transactions in which a foreign tax law
does not characterize the transaction in accordance with its substance.
(b) Disregarded payments--(1) In general. Subject to Sec. 1.267A-
3(b) (amounts included or includible in income), the excess (if any) of
the sum of a specified party's disregarded payments for a taxable year
over its dual inclusion income for the taxable year is a disqualified
hybrid amount. See Sec. 1.267A-6(c)(3) and (4).
(2) Definition of disregarded payment. The term disregarded payment
means a specified payment to the extent that, under the tax law of a
tax resident or taxable branch to which the payment is made, the
payment is not regarded (for example, because under such tax law it is
a disregarded transaction involving a single taxpayer or between group
members) and, were the payment to be regarded (and treated as interest
or a royalty, as applicable) under such tax law, the tax resident or
taxable branch would include the payment in income, as determined under
Sec. 1.267A-3(a). In addition, a disregarded payment includes a
specified payment that, under the tax law of a tax resident or taxable
branch to which the payment is made, is a payment that gives rise to a
deduction or similar offset allowed to the tax resident or taxable
branch (or group of entities that include the tax resident or taxable
branch) under a foreign consolidation, fiscal unity, group relief, loss
sharing, or any similar
[[Page 67638]]
regime. Moreover, a disregarded payment does not include a deemed
branch payment, or a specified payment pursuant to a repo transaction
or similar transaction described in paragraph (a)(3) of this section.
(3) Definition of dual inclusion income. With respect to a
specified party, the term dual inclusion income means the excess, if
any, of--
(i) The sum of the specified party's items of income or gain for
U.S. tax purposes, to the extent the items of income or gain are
included in the income of the tax resident or taxable branch to which
the disregarded payments are made, as determined under Sec. 1.267A-
3(a) (by treating the items of income or gain as the specified
payment); over
(ii) The sum of the specified party's items of deduction or loss
for U.S. tax purposes (other than deductions for disregarded payments),
to the extent the items of deduction or loss are allowable (or have
been or will be allowable during a taxable year that ends no more than
36 months after the end of the specified party's taxable year) under
the tax law of the tax resident or taxable branch to which the
disregarded payments are made.
(4) Payments made indirectly to a tax resident or taxable branch. A
specified payment made to an entity an interest of which is directly or
indirectly (determined under the rules of section 958(a) without regard
to whether an intermediate entity is foreign or domestic) owned by a
tax resident or taxable branch is considered made to the tax resident
or taxable branch to the extent that, under the tax law of the tax
resident or taxable branch, the entity to which the payment is made is
fiscally transparent (and all intermediate entities, if any, are also
fiscally transparent).
(c) Deemed branch payments--(1) In general. If a specified payment
is a deemed branch payment, then the payment is a disqualified hybrid
amount if the tax law of the home office provides an exclusion or
exemption for income attributable to the branch. See Sec. 1.267A-
6(c)(4).
(2) Definition of deemed branch payment. The term deemed branch
payment means, with respect to a U.S. taxable branch that is a U.S.
permanent establishment of a treaty resident eligible for benefits
under an income tax treaty between the United States and the treaty
country, any amount of interest or royalties allowable as a deduction
in computing the business profits of the U.S. permanent establishment,
to the extent the amount is deemed paid to the home office (or other
branch of the home office) and is not regarded (or otherwise taken into
account) under the home office's tax law (or the other branch's tax
law). A deemed branch payment may be otherwise taken into account for
this purpose if, for example, under the home office's tax law a
corresponding amount of interest or royalties is allocated and
attributable to the U.S. permanent establishment and is therefore not
deductible.
(d) Payments to reverse hybrids--(1) In general. If a specified
payment is made to a reverse hybrid, then, subject to Sec. 1.267A-3(b)
(amounts included or includible in income), the payment is a
disqualified hybrid amount to the extent that--
(i) An investor of the reverse hybrid does not include the payment
in income, as determined under Sec. 1.267A-3(a) (to such extent, a no-
inclusion); and
(ii) The investor's no-inclusion is a result of the payment being
made to the reverse hybrid. For this purpose, the investor's no-
inclusion is a result of the specified payment being made to the
reverse hybrid to the extent that the no-inclusion would not occur were
the investor's tax law to treat the reverse hybrid as fiscally
transparent (and treat the payment as interest or a royalty, as
applicable). See Sec. 1.267A-6(c)(5).
(2) Definition of reverse hybrid. The term reverse hybrid means an
entity (regardless of whether domestic or foreign) that is fiscally
transparent under the tax law of the country in which it is created,
organized, or otherwise established but not fiscally transparent under
the tax law of an investor of the entity.
(3) Payments made indirectly to a reverse hybrid. A specified
payment made to an entity an interest of which is directly or
indirectly (determined under the rules of section 958(a) without regard
to whether an intermediate entity is foreign or domestic) owned by a
reverse hybrid is considered made to the reverse hybrid to the extent
that, under the tax law of an investor of the reverse hybrid, the
entity to which the payment is made is fiscally transparent (and all
intermediate entities, if any, are also fiscally transparent).
(e) Branch mismatch payments--(1) In general. If a specified
payment is a branch mismatch payment, then, subject to Sec. 1.267A-
3(b) (amounts included or includible in income), the payment is a
disqualified hybrid amount to the extent that--
(i) A home office, the tax law of which treats the payment as
income attributable to a branch of the home office, does not include
the payment in income, as determined under Sec. 1.267A-3(a) (to such
extent, a no-inclusion); and
(ii) The home office's no-inclusion is a result of the payment
being a branch mismatch payment. For this purpose, the home office's
no-inclusion is a result of the specified payment being a branch
mismatch payment to the extent that the no-inclusion would not occur
were the home office's tax law to treat the payment as income that is
not attributable a branch of the home office (and treat the payment as
interest or a royalty, as applicable). See Sec. 1.267A-6(c)(6).
(2) Definition of branch mismatch payment. The term branch mismatch
payment means a specified payment for which the following requirements
are satisfied:
(i) Under a home office's tax law, the payment is treated as income
attributable to a branch of the home office; and
(ii) Either--
(A) The branch is not a taxable branch; or
(B) Under the branch's tax law, the payment is not treated as
income attributable to the branch.
(f) Relatedness or structured arrangement limitation. A specified
recipient, a tax resident or taxable branch to which a specified
payment is made, an investor, or a home office is taken into account
for purposes of paragraphs (a), (b), (d), and (e) of this section,
respectively, only if the specified recipient, the tax resident or
taxable branch, the investor, or the home office, as applicable, is
related (as defined in Sec. 1.267A-5(a)(14)) to the specified party or
is a party to a structured arrangement (as defined in Sec. 1.267A-
5(a)(20)) pursuant to which the specified payment is made.
Sec. 1.267A-3 Income inclusions and amounts not treated as
disqualified hybrid amounts.
(a) Income inclusions--(1) General rule. For purposes of section
267A, a tax resident or taxable branch includes in income a specified
payment to the extent that, under the tax law of the tax resident or
taxable branch--
(i) It includes (or it will include during a taxable year that ends
no more than 36 months after the end of the specified party's taxable
year) the payment in its income or tax base at the full marginal rate
imposed on ordinary income; and
(ii) The payment is not reduced or offset by an exemption,
exclusion, deduction, credit (other than for withholding tax imposed on
the payment), or other similar relief particular to such type of
payment.
[[Page 67639]]
Examples of such reductions or offsets include a participation
exemption, a dividends received deduction, a deduction or exclusion
with respect to a particular category of income (such as income
attributable to a branch, or royalties under a patent box regime), and
a credit for underlying taxes paid by a corporation from which a
dividend is received. A specified payment is not considered reduced or
offset by a deduction or other similar relief particular to the type of
payment if it is offset by a generally applicable deduction or other
tax attribute, such as a deduction for depreciation or a net operating
loss. For this purpose, a deduction may be treated as being generally
applicable even if it is arises from a transaction related to the
specified payment (for example, if the deduction and payment are in
connection with a back-to-back financing arrangement).
(2) Coordination with foreign hybrid mismatch rules. Whether a tax
resident or taxable branch includes in income a specified payment is
determined without regard to any defensive or secondary rule contained
in hybrid mismatch rules, if any, under the tax law of the tax resident
or taxable branch. For this purpose, a defensive or secondary rule
means a provision of hybrid mismatch rules that requires a tax resident
or taxable branch to include an amount in income if a deduction for the
amount is not disallowed under applicable tax law.
(3) Inclusions with respect to reverse hybrids. With respect to a
tax resident or taxable branch that is an investor of a reverse hybrid,
whether the investor includes in income a specified payment made to the
reverse hybrid is determined without regard to a distribution from the
reverse hybrid (or right to a distribution from the reverse hybrid
triggered by the payment).
(4) De minimis inclusions and deemed full inclusions. A
preferential rate, exemption, exclusion, deduction, credit, or similar
relief particular to a type of payment that reduces or offsets 90
percent or more of the payment is considered to reduce or offset 100
percent of the payment. In addition, a preferential rate, exemption,
exclusion, deduction, credit, or similar relief particular to a type of
payment that reduces or offsets 10 percent or less of the payment is
considered to reduce or offset none of the payment.
(b) Certain amounts not treated as disqualified hybrid amounts to
extent included or includible in income--(1) In general. A specified
payment, to the extent that but for this paragraph (b) it would be a
disqualified hybrid amount (such amount, a tentative disqualified
hybrid amount), is reduced under the rules of paragraphs (b)(2) through
(4) of this section, as applicable. The tentative disqualified hybrid
amount, as reduced under such rules, is the disqualified hybrid amount.
See Sec. 1.267A-6(c)(3) and (7).
(2) Included in income of United States tax resident or U.S.
taxable branch. A tentative disqualified hybrid amount is reduced to
the extent that a specified recipient that is a tax resident of the
United States or a U.S. taxable branch takes the tentative disqualified
hybrid amount into account in its gross income.
(3) Includible in income under section 951(a)(1). A tentative
disqualified hybrid amount is reduced to the extent that the tentative
disqualified hybrid amount is received by a CFC and includible under
section 951(a)(1) (determined without regard to properly allocable
deductions of the CFC and qualified deficits under section
952(c)(1)(B)) in the gross income of a United States shareholder of the
CFC. However, the tentative disqualified hybrid amount is reduced only
if the United States shareholder is a tax resident of the United States
or, if the United States shareholder is not a tax resident of the
United States, then only to the extent that a tax resident of the
United States would take into account the amount includible under
section 951(a)(1) in the gross income of the United States shareholder.
(4) Includible in income under section 951A(a). A tentative
disqualified hybrid amount is reduced to the extent that the tentative
disqualified hybrid amount increases a United States shareholder's pro
rata share of tested income (within the meaning of section
951A(c)(2)(A)) with respect to a CFC, reduces the shareholder's pro
rata share of tested loss (within the meaning of section 951A(c)(2)(B))
of the CFC, or both. However, the tentative disqualified hybrid amount
is reduced only if the United States shareholder is a tax resident of
the United States or, if the United States shareholder is not a tax
resident of the United States, then only to the extent that a tax
resident of the United States would take into account the amount that
increases the United States shareholder's pro rata share of tested
income with respect to the CFC, reduces the shareholder's pro rata
share of tested loss of the CFC, or both.
Sec. 1.267A-4 Disqualified imported mismatch amounts.
(a) Disqualified imported mismatch amounts. A specified payment (to
the extent not a disqualified hybrid amount, as described in Sec.
1.267A-2) is a disqualified imported mismatch amount to the extent
that, under the set-off rules of paragraph (c) of this section, the
income attributable to the payment is directly or indirectly offset by
a hybrid deduction incurred by a tax resident or taxable branch that is
related to the specified party (or that is a party to a structured
arrangement pursuant to which the payment is made). For purposes of
this section, any specified payment (to the extent not a disqualified
hybrid amount) is referred to as an imported mismatch payment; the
specified party is referred to as an imported mismatch payer; and a tax
resident or taxable branch that includes the imported mismatch payment
in income (or a tax resident or taxable branch the tax law of which
otherwise prevents the imported mismatch payment from being a
disqualified hybrid amount, for example, because under such tax law the
tax resident's no-inclusion is not a result of hybridity) is referred
to as the imported mismatch payee. See Sec. 1.267A-6(c)(8), (9), and
(10).
(b) Hybrid deduction. A hybrid deduction means, with respect to a
tax resident or taxable branch that is not a specified party, a
deduction allowed to the tax resident or taxable branch under its tax
law for an amount paid or accrued that is interest (including an amount
that would be a structured payment under the principles of Sec.
1.267A-5(b)(5)(ii)) or royalty under such tax law (regardless of
whether or how such amounts would be recognized under U.S. law), to the
extent that a deduction for the amount would be disallowed if such tax
law contained rules substantially similar to those under Sec. Sec.
1.267A-1 through 1.267A-3 and 1.267A-5. In addition, with respect to a
tax resident that is not a specified party, a hybrid deduction includes
a deduction allowed to the tax resident with respect to equity, such as
a notional interest deduction. Further, a hybrid deduction for a
particular accounting period includes a loss carryover from another
accounting period, to the extent that a hybrid deduction incurred in an
accounting period beginning on or after December 20, 2018 comprises the
loss carryover.
(c) Set-off rules--(1) In general. In the order described in
paragraph (c)(2) of this section, a hybrid deduction directly or
indirectly offsets the income attributable to an imported mismatch
payment to the extent that, under paragraph (c)(3) of this section, the
payment directly or indirectly funds the hybrid deduction.
[[Page 67640]]
(2) Ordering rules. The following ordering rules apply for purposes
of determining the extent that a hybrid deduction directly or
indirectly offsets income attributable to imported mismatch payments.
(i) First, the hybrid deduction offsets income attributable to a
factually-related imported mismatch payment that directly or indirectly
funds the hybrid deduction. For this purpose, a factually-related
imported mismatch payment means an imported mismatch payment that is
made pursuant to a transaction, agreement, or instrument entered into
pursuant to the same plan or series of related transactions that
includes the transaction, agreement, or instrument pursuant to which
the hybrid deduction is incurred.
(ii) Second, to the extent remaining, the hybrid deduction offsets
income attributable to an imported mismatch payment (other than a
factually-related imported mismatch payment) that directly funds the
hybrid deduction.
(iii) Third, to the extent remaining, the hybrid deduction offsets
income attributable to an imported mismatch payment (other than a
factually-related imported mismatch payment) that indirectly funds the
hybrid deduction.
(3) Funding rules. The following funding rules apply for purposes
of determining the extent that an imported mismatch payment directly or
indirectly funds a hybrid deduction.
(i) The imported mismatch payment directly funds a hybrid deduction
to the extent that the imported mismatch payee incurs the deduction.
(ii) The imported mismatch payment indirectly funds a hybrid
deduction to the extent that the imported mismatch payee is allocated
the deduction.
(iii) The imported mismatch payee is allocated a hybrid deduction
to the extent that the imported mismatch payee directly or indirectly
makes a funded taxable payment to the tax resident or taxable branch
that incurs the hybrid deduction.
(iv) An imported mismatch payee indirectly makes a funded taxable
payment to the tax resident or taxable branch that incurs a hybrid
deduction to the extent that a chain of funded taxable payments exists
connecting the imported mismatch payee, each intermediary tax resident
or taxable branch, and the tax resident or taxable branch that incurs
the hybrid deduction.
(v) The term funded taxable payment means, with respect to a tax
resident or taxable branch that is not a specified party, a deductible
amount paid or accrued by the tax resident or taxable branch under its
tax law, other than an amount that gives rise to a hybrid deduction.
However, a funded taxable payment does not include an amount deemed to
be an imported mismatch payment pursuant to paragraph (f) of this
section.
(vi) If, with respect to a tax resident or taxable branch that is
not a specified party, a deduction or loss that is not incurred by the
tax resident or taxable branch is directly or indirectly made available
to offset income of the tax resident or taxable branch under its tax
law, then, for purposes of this paragraph (c), the tax resident or
taxable branch to which the deduction or loss is made available and the
tax resident or branch that incurs the deduction or loss are treated as
a single tax resident or taxable branch. For example, if a deduction or
loss of one tax resident is made available to offset income of another
tax resident under a tax consolidation, fiscal unity, group relief,
loss sharing, or any similar regime, then the tax residents are treated
as a single tax resident for purposes of paragraph (c) of this section.
(d) Calculations based on aggregate amounts during accounting
period. For purposes of this section, amounts are determined on an
accounting period basis. Thus, for example, the amount of imported
mismatch payments made by an imported mismatch payer to a particular
imported mismatch payee is equal to the aggregate amount of all such
payments made by the payer during the accounting period.
(e) Pro rata adjustments. Amounts are allocated on a pro rata basis
if there would otherwise be more than one permissible manner in which
to allocate the amounts. Thus, for example, if multiple imported
mismatch payers make an imported mismatch payment to a particular
imported mismatch payee, the amount of such payments exceeds the hybrid
deduction incurred by the payee, and the payments are not factually-
related imported mismatch payments, then a pro rata portion of each
payer's payment is considered to directly fund the hybrid deduction.
See Sec. 1.267A-6(c)(9).
(f) Certain amounts deemed to be imported mismatch payments for
certain purposes. For purposes of determining the extent that income
attributable to an imported mismatch payment is directly or indirectly
offset by a hybrid deduction, an amount paid or accrued by a tax
resident or taxable branch that is not a specified party is deemed to
be an imported mismatch payment (and such tax resident or taxable
branch and a specified recipient of the amount, determined under Sec.
1.267A-5(a)(19), by treating the amount as the specified payment, are
deemed to be an imported mismatch payer and an imported mismatch payee,
respectively) to the extent that--
(1) The tax law of such tax resident or taxable branch contains
hybrid mismatch rules; and
(2) Under a provision of the hybrid mismatch rules substantially
similar to this section, the tax resident or taxable branch is denied a
deduction for all or a portion of the amount. See Sec. 1.267A-
6(c)(10).
Sec. 1.267A-5 Definitions and special rules.
(a) Definitions. For purposes of Sec. Sec. 1.267A-1 through
1.267A-7 the following definitions apply.
(1) The term accounting period means a taxable year, or a period of
similar length over which, under a provision of hybrid mismatch rules
substantially similar to Sec. 1.267A-4, computations similar to those
under that section are made under a foreign tax law.
(2) The term branch means a taxable presence of a tax resident in a
country other than its country of residence under either the tax
resident's tax law or such other country's tax law.
(3) The term branch mismatch payment has the meaning provided in
Sec. 1.267A-2(e)(2).
(4) The term controlled foreign corporation (or CFC) has the
meaning provided in section 957.
(5) The term deemed branch payment has the meaning provided in
Sec. 1.267A-2(c)(2).
(6) The term disregarded payment has the meaning provided in Sec.
1.267A-2(b)(2).
(7) The term entity means any person (as described in section
7701(a)(1), including an entity that under Sec. Sec. 301.7701-1
through 301.7701-3 of this chapter is disregarded as an entity separate
from its owner) other than an individual.
(8) The term fiscally transparent means, with respect to an entity,
fiscally transparent with respect to an item of income as determined
under the principles of Sec. 1.894-1(d)(3)(ii) and (iii), without
regard to whether a tax resident (either the entity or interest holder
in the entity) that derives the item of income is a resident of a
country that has an income tax treaty with the United States.
(9) The term home office means a tax resident that has a branch.
(10) The term hybrid mismatch rules means rules, regulations, or
other tax guidance substantially similar to section 267A, and includes
rules the purpose of which is to neutralize the deduction/no-inclusion
outcome of hybrid and branch mismatch arrangements. Examples of such
rules would include rules based
[[Page 67641]]
on, or substantially similar to, the recommendations contained in OECD/
G-20, Neutralising the Effects of Hybrid Mismatch Arrangements, Action
2: 2015 Final Report (October 2015), and OECD/G-20, Neutralising the
Effects of Branch Mismatch Arrangements, Action 2: Inclusive Framework
on BEPS (July 2017).
(11) The term hybrid transaction has the meaning provided in Sec.
1.267A-2(a)(2).
(12) The term interest means any amount described in paragraph
(a)(12)(i) or (ii) of this section (as adjusted by amounts described in
paragraph (a)(12)(iii) of this section) that is paid or accrued, or
treated as paid or accrued, for the taxable year or that is otherwise
designated as interest expense in paragraph (a)(12)(i) or (ii) of this
section (as adjusted by amounts described in paragraph (a)(12)(iii) of
this section).
(i) In general. Interest is an amount paid, received, or accrued as
compensation for the use or forbearance of money under the terms of an
instrument or contractual arrangement, including a series of
transactions, that is treated as a debt instrument for purposes of
section 1275(a) and Sec. 1.1275-1(d), and not treated as stock under
Sec. 1.385-3, or an amount that is treated as interest under other
provisions of the Internal Revenue Code (Code) or the regulations under
26 CFR part 1. Thus, for example, interest includes--
(A) Original issue discount (OID);
(B) Qualified stated interest, as adjusted by the issuer for any
bond issuance premium;
(C) OID on a synthetic debt instrument arising from an integrated
transaction under Sec. 1.1275-6;
(D) Repurchase premium to the extent deductible by the issuer under
Sec. 1.163-7(c);
(E) Deferred payments treated as interest under section 483;
(F) Amounts treated as interest under a section 467 rental
agreement;
(G) Forgone interest under section 7872;
(H) De minimis OID taken into account by the issuer;
(I) Amounts paid or received in connection with a sale-repurchase
agreement treated as indebtedness under Federal tax principles; in the
case of a sale-repurchase agreement relating to tax-exempt bonds,
however, the amount is not tax-exempt interest;
(J) Redeemable ground rent treated as interest under section
163(c); and
(K) Amounts treated as interest under section 636.
(ii) Swaps with significant nonperiodic payments--(A) Non-cleared
swaps. A swap that is not a cleared swap and that has significant
nonperiodic payments is treated as two separate transactions consisting
of an on-market, level payment swap and a loan. The loan must be
accounted for by the parties to the contract independently of the swap.
The time value component associated with the loan, determined in
accordance with Sec. 1.446-3(f)(2)(iii)(A), is recognized as interest
expense to the payor.
(B) [Reserved]
(C) Definition of cleared swap. The term cleared swap means a swap
that is cleared by a derivatives clearing organization, as such term is
defined in section 1a of the Commodity Exchange Act (7 U.S.C. 1a), or
by a clearing agency, as such term is defined in section 3 of the
Securities Exchange Act of 1934 (15 U.S.C. 78c), that is registered as
a derivatives clearing organization under the Commodity Exchange Act or
as a clearing agency under the Securities Exchange Act of 1934,
respectively, if the derivatives clearing organization or clearing
agency requires the parties to the swap to post and collect margin or
collateral.
(iii) Amounts affecting the effective cost of borrowing that adjust
the amount of interest expense. Income, deduction, gain, or loss from a
derivative, as defined in section 59A(h)(4)(A), that alters a person's
effective cost of borrowing with respect to a liability of the person
is treated as an adjustment to interest expense of the person. For
example, a person that is obligated to pay interest at a floating rate
on a note and enters into an interest rate swap that entitles the
person to receive an amount that is equal to or that closely
approximates the interest rate on the note in exchange for a fixed
amount is, in effect, paying interest expense at a fixed rate by
entering into the interest rate swap. Income, deduction, gain, or loss
from the swap is treated as an adjustment to interest expense.
Similarly, any gain or loss resulting from a termination or other
disposition of the swap is an adjustment to interest expense, with the
timing of gain or loss subject to the rules of Sec. 1.446-4.
(13) The term investor means, with respect to an entity, any tax
resident or taxable branch that directly or indirectly (determined
under the rules of section 958(a) without regard to whether an
intermediate entity is foreign or domestic) owns an interest in the
entity.
(14) The term related has the meaning provided in this paragraph
(a)(14). A tax resident or taxable branch is related to a specified
party if the tax resident or taxable branch is a related person within
the meaning of section 954(d)(3), determined by treating the specified
party as the ``controlled foreign corporation'' referred to in that
section and the tax resident or taxable branch as the ``person''
referred to in that section. In addition, for these purposes, a tax
resident that under Sec. Sec. 301.7701-1 through 301.7701-3 of this
chapter is disregarded as an entity separate from its owner for U.S.
tax purposes, as well as a taxable branch, is treated as a corporation.
Further, for these purposes neither section 318(a)(3), nor Sec. 1.958-
2(d) or the principles thereof, applies to attribute stock or other
interests to a tax resident, taxable branch, or specified party.
(15) The term reverse hybrid has the meaning provided in Sec.
1.267A-2(d)(2).
(16) The term royalty includes amounts paid or accrued as
consideration for the use of, or the right to use--
(i) Any copyright, including any copyright of any literary,
artistic, scientific or other work (including cinematographic films and
software);
(ii) Any patent, trademark, design or model, plan, secret formula
or process, or other similar property (including goodwill); or
(iii) Any information concerning industrial, commercial or
scientific experience, but does not include--
(A) Amounts paid or accrued for after-sales services;
(B) Amounts paid or accrued for services rendered by a seller to
the purchaser under a warranty;
(C) Amounts paid or accrued for pure technical assistance; or
(D) Amounts paid or accrued for an opinion given by an engineer,
lawyer or accountant.
(17) The term specified party means a tax resident of the United
States, a CFC (other than a CFC with respect to which there is not a
United States shareholder that owns (within the meaning of section
958(a)) at least ten percent (by vote or value) of the stock of the
CFC), and a U.S. taxable branch. Thus, an entity that is fiscally
transparent for U.S. tax purposes is not a specified party, though an
owner of the entity may be a specified party. For example, in the case
of a payment by a partnership, a domestic corporation or a CFC that is
a partner of the partnership is a specified party whose deduction for
its allocable share of the payment is subject to disallowance under
section 267A.
(18) The term specified payment has the meaning provided in Sec.
1.267A-1(b).
(19) The term specified recipient means, with respect to a
specified payment, any tax resident that derives the payment under its
tax law or any taxable branch to which the payment is
[[Page 67642]]
attributable under its tax law. The principles of Sec. 1.894-1(d)(1)
apply for purposes of determining whether a tax resident derives a
specified payment under its tax law, without regard to whether the tax
resident is a resident of a country that has an income tax treaty with
the United States. There may be more than one specified recipient with
respect to a specified payment.
(20) The term structured arrangement means an arrangement with
respect to which one or more specified payments would be a disqualified
hybrid amount (or a disqualified imported mismatch amount) if the
specified payment were analyzed without regard to the relatedness
limitation in Sec. 1.267A-2(f) (or without regard to the language
``that is related to the specified party'' in Sec. 1.267A-4(a))
(either such outcome, a hybrid mismatch), provided that either
paragraph (a)(20)(i) or (ii) of this section is satisfied. A party to a
structured arrangement means a tax resident or taxable branch that
participates in the structured arrangement. For this purpose, an
entity's participation in a structured arrangement is imputed to its
investors.
(i) The hybrid mismatch is priced into the terms of the
arrangement.
(ii) Based on all the facts and circumstances, the hybrid mismatch
is a principal purpose of the arrangement. Facts and circumstances that
indicate the hybrid mismatch is a principal purpose of the arrangement
include--
(A) Marketing the arrangement as tax-advantaged where some or all
of the tax advantage derives from the hybrid mismatch;
(B) Primarily marketing the arrangement to tax residents of a
country the tax law of which enables the hybrid mismatch;
(C) Features that alter the terms of the arrangement, including the
return, in the event the hybrid mismatch is no longer available; or
(D) A below-market return absent the tax effects or benefits
resulting from the hybrid mismatch.
(21) The term tax law of a country includes statutes, regulations,
administrative or judicial rulings, and treaties of the country. When
used with respect to a tax resident or branch, tax law refers to--
(i) In the case of a tax resident, the tax law of the country or
countries where the tax resident is resident; and
(ii) In the case of a branch, the tax law of the country where the
branch is located.
(22) The term taxable branch means a branch that has a taxable
presence under its tax law.
(23) The term tax resident means either of the following:
(i) A body corporate or other entity or body of persons liable to
tax under the tax law of a country as a resident. For this purpose, a
body corporate or other entity or body of persons may be considered
liable to tax under the tax law of a country as a resident even though
such tax law does not impose a corporate income tax. A body corporate
or other entity or body of persons may be a tax resident of more than
one country.
(ii) An individual liable to tax under the tax law of a country as
a resident. An individual may be a tax resident of more than one
country.
(24) The term United States shareholder has the meaning provided in
section 951(b).
(25) The term U.S. taxable branch means a trade or business carried
on in the United States by a tax resident of another country, except
that if an income tax treaty applies, the term means a permanent
establishment of a tax treaty resident eligible for benefits under an
income tax treaty between the United States and the treaty country.
Thus, for example, a U.S. taxable branch includes a U.S. trade or
business of a foreign corporation taxable under section 882(a) or a
U.S. permanent establishment of a tax treaty resident.
(b) Special rules. For purposes of Sec. Sec. 1.267A-1 through
1.267A-7, the following special rules apply.
(1) Coordination with other provisions. Except as otherwise
provided in the Code or in regulations under 26 CFR part 1, section
267A applies to a specified payment after the application of any other
applicable provisions of the Code and regulations under 26 CFR part 1.
Thus, the determination of whether a deduction for a specified payment
is disallowed under section 267A is made with respect to the taxable
year for which a deduction for the payment would otherwise be allowed
for U.S. tax purposes. See, for example, sections 163(e)(3) and
267(a)(3) for rules that may defer the taxable year for which a
deduction is allowed. See also Sec. 1.882-5(a)(5) (providing that
provisions that disallow interest expense apply after the application
of Sec. 1.882-5). In addition, provisions that characterize amounts
paid or accrued as something other than interest or royalty, such as
Sec. 1.894-1(d)(2), govern the treatment of such amounts and therefore
such amounts would not be treated as specified payments.
(2) Foreign currency gain or loss. Except as set forth in this
paragraph (b)(2), section 988 gain or loss is not taken into account
under section 267A. Foreign currency gain or loss recognized with
respect to a specified payment is taken into account under section 267A
to the extent that a deduction for the specified payment is disallowed
under section 267A, provided that the foreign currency gain or loss is
described in Sec. 1.988-2(b)(4) (relating to exchange gain or loss
recognized by the issuer of a debt instrument with respect to accrued
interest) or Sec. 1.988-2(c) (relating to items of expense or gross
income or receipts which are to be paid after the date accrued). If a
deduction for a specified payment is disallowed under section 267A,
then a proportionate amount of foreign currency loss under section 988
with respect to the specified payment is also disallowed, and a
proportionate amount of foreign currency gain under section 988 with
respect to the specified payment reduces the amount of the
disallowance. For this purpose, the proportionate amount is the amount
of the foreign currency gain or loss under section 988 with respect to
the specified payment multiplied by the amount of the specified payment
for which a deduction is disallowed under section 267A.
(3) U.S. taxable branch payments--(i) Amounts considered paid or
accrued by a U.S. taxable branch. For purposes of section 267A, a U.S.
taxable branch is considered to pay or accrue an amount of interest or
royalty equal to--
(A) The amount of interest or royalty allocable to effectively
connected income of the U.S. taxable branch under section 873(a) or
882(c)(1), as applicable; or
(B) In the case of a U.S. taxable branch that is a U.S. permanent
establishment of a treaty resident eligible for benefits under an
income tax treaty between the United States and the treaty country, the
amount of interest or royalty deductible in computing the business
profits attributable to the U.S. permanent establishment, if such
amounts differ from the amounts allocable under paragraph (b)(3)(i)(A)
of this section.
(ii) Treatment of U.S. taxable branch payments--(A) Interest.
Interest considered paid or accrued by a U.S. taxable branch of a
foreign corporation under paragraph (b)(3)(i) of this section is
treated as a payment directly to the person to which the interest is
payable, to the extent it is paid or accrued with respect to a
liability described in Sec. 1.882-5(a)(1)(ii)(A) (resulting in
directly allocable interest) or with respect to a U.S. booked
liability, as defined in Sec. 1.882-5(d)(2). If the amount of interest
allocable to the U.S. taxable branch exceeds the interest paid or
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accrued on its U.S. booked liabilities, the excess amount is treated as
paid or accrued by the U.S. taxable branch on a pro-rata basis to the
same persons and pursuant to the same terms that the home office paid
or accrued interest for purposes of the calculations described in
paragraph (b)(3)(i) of this section, excluding any interest treated as
already paid directly by the branch.
(B) Royalties. Royalties considered paid or accrued by a U.S.
taxable branch under paragraph (b)(3)(i) of this section are treated
solely for purposes of section 267A as paid or accrued on a pro-rata
basis by the U.S. taxable branch to the same persons and pursuant to
the same terms that the home office paid or accrued such royalties.
(C) Permanent establishments and interbranch payments. If a U.S.
taxable branch is a permanent establishment in the United States, rules
analogous to the rules in paragraphs (b)(3)(ii)(A) and (B) of this
section apply with respect to interest and royalties allowed in
computing the business profits of a treaty resident eligible for treaty
benefits. This paragraph (b)(3)(ii)(C) does not apply to interbranch
interest or royalty payments allowed as deduction under certain U.S.
income tax treaties (as described in Sec. 1.267A-2(c)(2)).
(4) Effect on earnings and profits. The disallowance of a deduction
under section 267A does not affect whether or when the amount paid or
accrued that gave rise to the deduction reduces earnings and profits of
a corporation.
(5) Application to structured payments--(i) In general. For
purposes of section 267A and the regulations under section 267A as
contained in 26 CFR part 1, a structured payment (as defined in
paragraph (b)(5)(ii) of this section) is treated as a specified
payment.
(ii) Structured payment. A structured payment means any amount
described in paragraphs (b)(5)(ii)(A) or (B) of this section (as
adjusted by amounts described in paragraph (b)(5)(ii)(C) of this
section).
(A) Certain payments related to the time value of money (structured
interest amounts)--(1) Substitute interest payments. A substitute
interest payment described in Sec. 1.861-2(a)(7).
(2) Certain amounts labeled as fees--(i) Commitment fees. Any fees
in respect of a lender commitment to provide financing if any portion
of such financing is actually provided.
(ii) [Reserved]
(3) Debt issuance costs. Any debt issuance costs subject to Sec.
1.446-5.
(4) Guaranteed payments. Any guaranteed payments for the use of
capital under section 707(c).
(B) Amounts predominately associated with the time value of money.
Any expense or loss, to the extent deductible, incurred by a person in
a transaction or series of integrated or related transactions in which
the person secures the use of funds for a period of time, if such
expense or loss is predominately incurred in consideration of the time
value of money.
(C) Adjustment for amounts affecting the effective cost of funds.
Income, deduction, gain, or loss from a derivative, as defined in
section 59A(h)(4)(A), that alters a person's effective cost of funds
with respect to a structured payment described in paragraph
(b)(5)(ii)(A) or (B) of this section is treated as an adjustment to the
structured payment of the person.
(6) Anti-avoidance rule. A specified party's deduction for a
specified payment is disallowed to the extent that both of the
following requirements are satisfied:
(i) The payment (or income attributable to the payment) is not
included in the income of a tax resident or taxable branch, as
determined under Sec. 1.267A-3(a) (but without regard to the de
minimis and full inclusion rules in Sec. 1.267A-3(a)(3)).
(ii) A principal purpose of the plan or arrangement is to avoid the
purposes of the regulations under section 267A.
Sec. 1.267A-6 Examples.
(a) Scope. This section provides examples that illustrate the
application of Sec. Sec. 1.267A-1 through 1.267A-5.
(b) Presumed facts. For purposes of the examples in this section,
unless otherwise indicated, the following facts are presumed:
(1) US1, US2, and US3 are domestic corporations that are tax
residents solely of the United States.
(2) FW, FX, and FZ are bodies corporate established in, and tax
residents of, Country W, Country X, and Country Z, respectively. They
are not fiscally transparent under the tax law of any country.
(3) Under the tax law of each country, interest and royalty
payments are deductible.
(4) The tax law of each country provides a 100 percent
participation exemption for dividends received from non-resident
corporations.
(5) The tax law of each country, other than the United States,
provides an exemption for income attributable to a branch.
(6) Except as provided in paragraphs (b)(4) and (5) of this
section, all amounts derived (determined under the principles of Sec.
1.894-1(d)(1)) by a tax resident, or attributable to a taxable branch,
are included in income, as determined under Sec. 1.267A-3(a).
(7) Only the tax law of the United States contains hybrid mismatch
rules.
(c) Examples--(1) Example 1. Payment pursuant to a hybrid
financial instrument--(i) Facts. FX holds all the interests of US1.
FX holds an instrument issued by US1 that is treated as equity for
Country X tax purposes and indebtedness for U.S. tax purposes (the
FX-US1 instrument). On date 1, US1 pays $50x to FX pursuant to the
instrument. The amount is treated as an excludible dividend for
Country X tax purposes (by reason of the Country X participation
exemption) and as interest for U.S. tax purposes.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $50x specified payment is subject to disallowance under section
267A. As described in paragraphs (c)(1)(ii)(A) through (C) of this
section, the entire $50x payment is a disqualified hybrid amount
under the hybrid transaction rule of Sec. 1.267A-2(a) and, as a
result, a deduction for the payment is disallowed under Sec.
1.267A-1(b)(1).
(A) US1's payment is made pursuant to a hybrid transaction
because a payment with respect to the FX-US1 instrument is treated
as interest for U.S. tax purposes but not for purposes of Country X
tax law (the tax law of FX, a specified recipient that is related to
US1). See Sec. 1.267A-2(a)(2) and (f). Therefore, Sec. 1.267A-2(a)
applies to the payment.
(B) For US1's payment to be a disqualified hybrid amount under
Sec. 1.267A-2(a), a no-inclusion must occur with respect to FX. See
Sec. 1.267A-2(a)(1)(i). As a consequence of the Country X
participation exemption, FX includes $0 of the payment in income and
therefore a $50x no-inclusion occurs with respect to FX. See Sec.
1.267A-3(a)(1). The result is the same regardless of whether, under
the Country X participation exemption, the $50x payment is simply
excluded from FX's taxable income or, instead, is reduced or offset
by other means, such as a $50x dividends received deduction. See id.
(C) Pursuant to Sec. 1.267A-2(a)(1)(ii), FX's $50x no-inclusion
gives rise to a disqualified hybrid amount to the extent that it is
a result of US1's payment being made pursuant to the hybrid
transaction. FX's $50x no-inclusion is a result of the payment being
made pursuant to the hybrid transaction because, were the payment to
be treated as interest for Country X tax purposes, FX would include
$50x in income and, consequently, the no-inclusion would not occur.
(iii) Alternative facts--multiple specified recipients. The
facts are the same as in paragraph (c)(1)(i) of this section, except
that FX holds all the interests of FZ, which is fiscally transparent
for Country X tax purposes, and FZ holds all of the interests of
US1. Moreover, the FX-US1 instrument is held by FZ (rather than by
FX) and US1 makes its $50x payment to FZ (rather than to FX); the
payment is derived by FZ under its tax law and by FX under its tax
law and, accordingly, both FZ and FX are specified recipients of the
payment. Further, the
[[Page 67644]]
payment is treated as interest for Country Z tax purposes and FZ
includes it in income. For the reasons described in paragraph
(c)(1)(ii) of this section, FX's no-inclusion causes the payment to
be a disqualified hybrid amount. FZ's inclusion in income
(regardless of whether Country Z has a low or high tax rate) does
not affect the result, because the hybrid transaction rule of Sec.
1.267A-2(a) applies if any no-inclusion occurs with respect to a
specified recipient of the payment as a result of the payment being
made pursuant to the hybrid transaction.
(iv) Alternative facts--preferential rate. The facts are the
same as in paragraph (c)(1)(i) of this section, except that for
Country X tax purposes US1's payment is treated as a dividend
subject to a 4% tax rate, whereas the marginal rate imposed on
ordinary income is 20%. FX includes $10x of the payment in income,
calculated as $50x multiplied by 0.2 (.04, the rate at which the
particular type of payment (a dividend for Country X tax purposes)
is subject to tax in Country X, divided by 0.2, the marginal tax
rate imposed on ordinary income). See Sec. 1.267A-3(a)(1). Thus, a
$40x no-inclusion occurs with respect to FX ($50x less $10x). The
$40x no-inclusion is a result of the payment being made pursuant to
the hybrid transaction because, were the payment to be treated as
interest for Country X tax purposes, FX would include the entire
$50x in income at the full marginal rate imposed on ordinary income
(20%) and, consequently, the no-inclusion would not occur.
Accordingly, $40x of US1's payment is a disqualified hybrid amount.
(v) Alternative facts--no-inclusion not the result of hybridity.
The facts are the same as in paragraph (c)(1)(i) of this section,
except that Country X has a pure territorial regime (that is,
Country X only taxes income with a domestic source). Although US1's
payment is pursuant to a hybrid transaction and a $50x no-inclusion
occurs with respect to FX, FX's no-inclusion is not a result of the
payment being made pursuant to the hybrid transaction. This is
because if Country X tax law were to treat the payment as interest,
FX would include $0 in income and, consequently, the $50x no-
inclusion would still occur. Accordingly, US1's payment is not a
disqualified hybrid amount. See Sec. 1.267A-2(a)(1)(ii). The result
would be the same if Country X instead did not impose a corporate
income tax.
(2) Example 2. Payment pursuant to a repo transaction--(i)
Facts. FX holds all the interests of US1, and US1 holds all the
interests of US2. On date 1, US1 and FX enter into a sale and
repurchase transaction. Pursuant to the transaction, US1 transfers
shares of preferred stock of US2 to FX in return for $1,000x paid
from FX to US1, subject to a binding commitment of US1 to reacquire
those shares on date 3 for an agreed price, which represents a
repayment of the $1,000x plus a financing or time value of money
return reduced by the amount of any distributions paid with respect
to the preferred stock between dates 1 and 3 that are retained by
FX. On date 2, US2 pays a $100x dividend on its preferred stock to
FX. For Country X tax purposes, FX is treated as owning the US2
preferred stock and therefore is the beneficial owner of the
dividend. For U.S. tax purposes, the transaction is treated as a
loan from FX to US1 that is secured by the US2 preferred stock.
Thus, for U.S. tax purposes, US1 is treated as owning the US2
preferred stock and is the beneficial owner of the dividend. In
addition, for U.S. tax purposes, US1 is treated as paying $100x of
interest to FX (an amount corresponding to the $100x dividend paid
by US2 to FX). Further, the marginal tax rate imposed on ordinary
income under Country X tax law is 25%. Moreover, instead of a
participation exemption, Country X tax law provides its tax
residents a credit for underlying foreign taxes paid by a non-
resident corporation from which a dividend is received; with respect
to the $100x dividend received by FX from US2, the credit is $10x.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $100x specified payment is subject to disallowance under section
267A. As described in paragraphs (c)(2)(ii)(A) through (D) of this
section, $40x of the payment is a disqualified hybrid amount under
the hybrid transaction rule of Sec. 1.267A-2(a) and, as a result,
$40x of the deduction is disallowed under Sec. 1.267A-1(b)(1).
(A) Although US1's $100x interest payment is not regarded under
Country X tax law, a connected amount (US2's dividend payment) is
regarded and derived by FX under such tax law. Thus, FX is
considered a specified recipient with respect to US1's interest
payment. See Sec. 1.267A-2(a)(3).
(B) US1's payment is made pursuant to a hybrid transaction
because a payment with respect to the sale and repurchase
transaction is treated as interest for U.S. tax purposes but not for
purposes of Country X tax law (the tax law of FX, a specified
recipient that is related to US1), which does not regard the
payment. See Sec. 1.267A-2(a)(2) and (f). Therefore, Sec. 1.267A-
2(a) applies to the payment.
(C) For US1's payment to be a disqualified hybrid amount under
Sec. 1.267A-2(a), a no-inclusion must occur with respect to FX. See
Sec. 1.267A-2(a)(1)(i). As a consequence of Country X tax law not
regarding US1's payment, FX includes $0 of the payment in income and
therefore a $100x no-inclusion occurs with respect to FX. See Sec.
1.267A-3(a). However, FX includes $60x of a connected amount (US2's
dividend payment) in income, calculated as $100x (the amount of the
dividend) less $40x (the portion of the connected amount that is not
included in Country X due to the foreign tax credit, determined by
dividing the amount of the credit, $10x, by 0.25, the tax rate in
Country X). See id. Pursuant to Sec. 1.267A-2(a)(3), FX's inclusion
in income with respect to the connected amount correspondingly
reduces the amount of its no-inclusion with respect to US1's
payment. Therefore, for purposes of Sec. 1.267A-2(a), FX's no-
inclusion with respect to US1's payment is considered to be $40x
($100x less $60x). See Sec. 1.267A-2(a)(3).
(D) Pursuant to Sec. 1.267A-2(a)(1)(ii), FX's $40x no-inclusion
gives rise to a disqualified hybrid amount to the extent that FX's
no-inclusion is a result of US1's payment being made pursuant to the
hybrid transaction. FX's $40x no-inclusion is a result of US1's
payment being made pursuant to the hybrid transaction because, were
the sale and repurchase transaction to be treated as a loan from FX
to US1 for Country X tax purposes, FX would include US1's $100x
interest payment in income (because it would not be entitled to a
foreign tax credit) and, consequently, the no-inclusion would not
occur.
(iii) Alternative facts--structured arrangement. The facts are
the same as in paragraph (c)(2)(i) of this section, except that FX
is a bank that is unrelated to US1. In addition, the sale and
repurchase transaction is a structured arrangement and FX is a party
to the structured arrangement. The result is the same as in
paragraph (c)(2)(ii) of this section. That is, even though FX is not
related to US1, it is taken into account with respect to the
determinations under Sec. 1.267A-2(a) because it is a party to a
structured arrangement pursuant to which the payment is made. See
Sec. 1.267A-2(f).
(3) Example 3. Disregarded payment--(i) Facts. FX holds all the
interests of US1. For Country X tax purposes, US1 is a disregarded
entity of FX. During taxable year 1, US1 pays $100x to FX pursuant
to a debt instrument. The amount is treated as interest for U.S. tax
purposes but is disregarded for Country X tax purposes as a
transaction involving a single taxpayer. During taxable year 1,
US1's only other items of income, gain, deduction, or loss are $125x
of gross income and a $60x item of deductible expense. The $125x
item of gross income is included in FX's income, and the $60x item
of deductible expense is allowable for Country X tax purposes.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $100x specified payment is subject to disallowance under section
267A. As described in paragraphs (c)(3)(ii)(A) and (B) of this
section, $35x of the payment is a disqualified hybrid amount under
the disregarded payment rule of Sec. 1.267A-2(b) and, as a result,
$35x of the deduction is disallowed under Sec. 1.267A-1(b)(1).
(A) US1's $100x payment is not regarded under the tax law of
Country X (the tax law of FX, a related tax resident to which the
payment is made) because under such tax law the payment is a
disregarded transaction involving a single taxpayer. See Sec.
1.267A-2(b)(2) and (f). In addition, were the tax law of Country X
to regard the payment (and treat it as interest), FX would include
it in income. Therefore, the payment is a disregarded payment to
which Sec. 1.267A-2(b) applies. See Sec. 1.267A-2(b)(2).
(B) Under Sec. 1.267A-2(b)(1), the excess (if any) of US1's
disregarded payments for taxable year 1 ($100x) over its dual
inclusion income for the taxable year is a disqualified hybrid
amount. US1's dual inclusion income for taxable year 1 is $65x,
calculated as $125x (the amount of US1's gross income that is
included in FX's income) less $60x (the amount of US1's deductible
expenses, other than deductions for disregarded payments, that are
allowable for Country X tax purposes). See Sec. 1.267A-2(b)(3).
Therefore, $35x is a disqualified hybrid amount ($100x less $65x).
See Sec. 1.267A-2(b)(1).
(iii) Alternative facts--non-dual inclusion income arising from
hybrid transaction. The
[[Page 67645]]
facts are the same as in paragraph (c)(3)(i) of this section, except
that US1 holds all the interests of FZ (a CFC) and US1's only item
of income, gain, deduction, or loss during taxable year 1 (other
than the $100x payment to FX) is $80x paid to US1 by FZ pursuant to
an instrument treated as indebtedness for U.S. tax purposes and
equity for Country X tax purposes (the US1-FZ instrument). In
addition, the $80x is treated as interest for U.S. tax purposes and
an excludible dividend for Country X tax purposes (by reason of the
Country X participation exemption). Paragraphs (c)(3)(iii)(A) and
(B) of this section describe the extent to which the specified
payments by FZ and US1, each of which is a specified party, are
disqualified hybrid amounts.
(A) The hybrid transaction rule of Sec. 1.267A-2(a) applies to
FZ's payment because such payment is made pursuant to a hybrid
transaction, as a payment with respect to the US1-FZ instrument is
treated as interest for U.S. tax purposes but not for purposes of
Country X's tax law (the tax law of FX, a specified recipient that
is related to FZ). As a consequence of the Country X participation
exemption, an $80x no-inclusion occurs with respect to FX, and such
no-inclusion is a result of the payment being made pursuant to the
hybrid transaction. Thus, but for Sec. 1.267A-3(b), the entire $80x
of FZ's payment would be a disqualified hybrid amount. However,
because US1 (a tax resident of the United States that is also a
specified recipient of the payment) takes the entire $80x payment
into account in its gross income, no portion of the payment is a
disqualified hybrid amount. See Sec. 1.267A-3(b)(2).
(B) The disregarded payment rule of Sec. 1.267A-2(b) applies to
US1's $100x payment to FX, for the reasons described in paragraph
(c)(3)(ii)(A) of this section. In addition, US1's dual inclusion
income for taxable year 1 is $0 because, as a result of the Country
X participation exemption, no portion of FZ's $80x payment to US1
(which is derived by FX under its tax law) is included in FX's
income. See Sec. Sec. 1.267A-2(b)(3) and 1.267A-3(a). Therefore,
the entire $100x payment from US1 to FX is a disqualified hybrid
amount, calculated as $100x (the amount of the payment) less $0 (the
amount of dual inclusion income). See Sec. 1.267A-2(b)(1).
(4) Example 4. Payment allocable to a U.S. taxable branch--(i)
Facts. FX1 and FX2 are foreign corporations that are bodies
corporate established in and tax residents of Country X. FX1 holds
all the interests of FX2, and FX1 and FX2 file a consolidated return
under Country X tax law. FX2 has a U.S. taxable branch (``USB'').
During taxable year 1, FX2 pays $50x to FX1 pursuant to an
instrument (the ``FX1-FX2 instrument''). The amount paid pursuant to
the instrument is treated as interest for U.S. tax purposes but, as
a consequence of the Country X consolidation regime, is treated as a
disregarded transaction between group members for Country X tax
purposes. Also during taxable year 1, FX2 pays $100x of interest to
an unrelated bank that is not a party to a structured arrangement
(the instrument pursuant to which the payment is made, the ``bank-
FX2 instrument''). FX2's only other item of income, gain, deduction,
or loss for taxable year 1 is $200x of gross income. Under Country X
tax law, the $200x of gross income is attributable to USB, but is
not included in FX's income because Country X tax law exempts income
attributable to a branch. Under U.S. tax law, the $200x of gross
income is effectively connected income of USB. Further, under
section 882, $75x of interest is, for taxable year 1, allocable to
USB's effectively connected income. USB has neither liabilities that
are directly allocable to it, as described in Sec. 1.882-
5(a)(1)(ii)(A), nor booked liabilities, as defined in Sec. 1.882-
5(d)(2).
(ii) Analysis. USB is a specified party and thus any interest or
royalty allowable as a deduction in determining its effectively
connected income is subject to disallowance under section 267A.
Pursuant to Sec. 1.267A-5(b)(3)(i)(A), USB is treated as paying
$75x of interest, and such interest is thus a specified payment. Of
that $75x, $25x is treated as paid to FX1, calculated as $75x (the
interest allocable to USB under section 882) multiplied by \1/3\
($50x, FX2's payment to FX1, divided by $150x, the total interest
paid by FX2). See Sec. 1.267A-5(b)(3)(ii)(A). As described in
paragraphs (c)(4)(ii)(A) and (B) of this section, the $25x of the
specified payment treated as paid by USB to FX1 is a disqualified
hybrid amount under the disregarded payment rule of Sec. 1.267A-
2(b) and, as a result, a deduction for that amount is disallowed
under Sec. 1.267A-1(b)(1).
(A) USB's $25x payment to FX1 is not regarded under the tax law
of Country X (the tax law of FX1, a related tax resident to which
the payment is made) because under such tax law the payment is a
disregarded transaction between group members. See Sec. 1.267A-
2(b)(2) and (f). In addition, were the tax law of Country X to
regard the payment (and treat it as interest), FX1 would include it
in income. Therefore, the payment is a disregarded payment to which
Sec. 1.267A-2(b) applies. See Sec. 1.267A-2(b)(2).
(B) Under Sec. 1.267A-2(b)(1), the excess (if any) of USB's
disregarded payments for taxable year 1 ($25x) over its dual
inclusion income for the taxable year is a disqualified hybrid
amount. USB's dual inclusion income for taxable year 1 is $0. This
is because, as a result of the Country X exemption for income
attributable to a branch, no portion of USB's $200x item of gross
income is included in FX2's income. See Sec. 1.267A-2(b)(3).
Therefore, the entire $25x of the specified payment treated as paid
by USB to FX1 is a disqualified hybrid amount, calculated as $25x
(the amount of the payment) less $0 (the amount of dual inclusion
income). See Sec. 1.267A-2(b)(1).
(iii) Alternative facts--deemed branch payment. The facts are
the same as in paragraph (c)(4)(i) of this section, except that FX2
does not pay any amounts during taxable year 1 (thus, it does not
pay the $50x to FX1 or the $100x to the bank). However, under an
income tax treaty between the United States and Country X, USB is a
U.S. permanent establishment and, for taxable year 1, $25x of
royalties is allowable as a deduction in computing the business
profits of USB and is deemed paid to FX2. Under Country X tax law,
the $25x is not regarded. Accordingly, the $25x is a specified
payment that is a deemed branch payment. See Sec. Sec. 1.267A-
2(c)(2) and 1.267A-5(b)(3)(i)(B). The entire $25x is a disqualified
hybrid amount for which a deduction is disallowed because the tax
law of Country X provides an exclusion or exemption for income
attributable to a branch. See Sec. 1.267A-2(c)(1).
(5) Example 5. Payment to a reverse hybrid--(i) Facts. FX holds
all the interests of US1 and FY, and FY holds all the interests of
FV. FY is an entity established in Country Y, and FV is an entity
established in Country V. FY is fiscally transparent for Country Y
tax purposes but is not fiscally transparent for Country X tax
purposes. FV is fiscally transparent for Country X tax purposes. On
date 1, US1 pays $100x to FY. The amount is treated as interest for
U.S. tax purposes and Country X tax purposes.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $100x specified payment is subject to disallowance under section
267A. As described in paragraphs (c)(5)(ii)(A) through (C) of this
section, the entire $100x payment is a disqualified hybrid amount
under the reverse hybrid rule of Sec. 1.267A-2(d) and, as a result,
a deduction for the payment is disallowed under Sec. 1.267A-
1(b)(1).
(A) US1's payment is made to a reverse hybrid because FY is
fiscally transparent under the tax law of Country Y (the tax law of
the country in which it is established) but is not fiscally
transparent under the tax law of Country X (the tax law of FX, an
investor that is related to US1). See Sec. 1.267A-2(d)(2) and (f).
Therefore, Sec. 1.267A-2(d) applies to the payment. The result
would be the same if the payment were instead made to FV. See Sec.
1.267A-2(d)(3).
(B) For US1's payment to be a disqualified hybrid amount under
Sec. 1.267A-2(d), a no-inclusion must occur with respect to FX. See
Sec. 1.267A-2(d)(1)(i). Because FX does not derive the $100x
payment under Country X tax law (as FY is not fiscally transparent
under such tax law), FX includes $0 of the payment in income and
therefore a $100x no-inclusion occurs with respect to FX. See Sec.
1.267A-3(a).
(C) Pursuant to Sec. 1.267A-2(d)(1)(ii), FX's $100x no-
inclusion gives rise to a disqualified hybrid amount to the extent
that it is a result of US1's payment being made to the reverse
hybrid. FX's $100x no-inclusion is a result of the payment being
made to the reverse hybrid because, were FY to be treated as
fiscally transparent for Country X tax purposes, FX would include
$100x in income and, consequently, the no-inclusion would not occur.
The result would be the same if Country X tax law instead viewed
US1's payment as a dividend, rather than interest. See Sec. 1.267A-
2(d)(1)(ii).
(iii) Alternative facts--inclusion under anti-deferral regime.
The facts are the same as in paragraph (c)(5)(i) of this section,
except that, under a Country X anti-deferral regime, FX includes in
its income $100x attributable to the $100x payment received by FY.
If under the rules of Sec. 1.267A-3(a) FX includes the entire
attributed amount in income (that is, if FX includes the amount in
its income at the full marginal rate imposed on ordinary
[[Page 67646]]
income and the amount is not reduced or offset by certain relief
particular to the amount), then a no-inclusion does not occur with
respect to FX. As a result, in such a case, no portion of US1's
payment would be a disqualified hybrid amount under Sec. 1.267A-
2(d).
(iv) Alternative facts--multiple investors. The facts are the
same as in paragraph (c)(5)(i) of this section, except that FX holds
all the interests of FZ, which is fiscally transparent for Country X
tax purposes; FZ holds all the interests of FY, which is fiscally
transparent for Country Z tax purposes; and FZ includes the $100x
payment in income. Thus, each of FZ and FX is an investor of FY, as
each directly or indirectly holds an interest of FY. See Sec.
1.267A-5(a)(13). A no-inclusion does not occur with respect to FZ,
but a $100x no-inclusion occurs with respect to FX. FX's no-
inclusion is a result of the payment being made to the reverse
hybrid because, were FY to be treated as fiscally transparent for
Country X tax purposes, then FX would include $100x in income (as FZ
is fiscally transparent for Country X tax purposes). Accordingly,
FX's no-inclusion is a result of US1's payment being made to the
reverse hybrid and, consequently, the entire $100x payment is a
disqualified hybrid amount.
(v) Alternative facts--portion of no-inclusion not the result of
hybridity. The facts are the same as in paragraph (c)(5)(i) of this
section, except that the $100x is viewed as a royalty for U.S. tax
purposes and Country X tax purposes, and Country X tax law contains
a patent box regime that provides an 80% deduction with respect to
certain royalty income. If the payment would qualify for the Country
X patent box deduction were FY to be treated as fiscally transparent
for Country X tax purposes, then only $20x of FX's $100x no-
inclusion would be the result of the payment being paid to a reverse
hybrid, calculated as $100x (the no-inclusion with respect to FX
that actually occurs) less $80x (the no-inclusion with respect to FX
that would occur if FY were to be treated as fiscally transparent
for Country X tax purposes). See Sec. 1.267A-3(a). Accordingly, in
such a case, only $20x of US1's payment would be a disqualified
hybrid amount.
(6) Example 6. Branch mismatch payment--(i) Facts. FX holds all
the interests of US1 and FZ. FZ owns BB, a Country B branch that
gives rise to a taxable presence in Country B under Country Z tax
law but not under Country B tax law. On date 1, US1 pays $50x to FZ.
The amount is treated as a royalty for U.S. tax purposes and Country
Z tax purposes. Under Country Z tax law, the amount is treated as
income attributable to BB and, as a consequence of County Z tax law
exempting income attributable to a branch, is excluded from FZ's
income.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $50x specified payment is subject to disallowance under section
267A. As described in paragraphs (c)(6)(ii)(A) through (C) of this
section, the entire $50x payment is a disqualified hybrid amount
under the branch mismatch rule of Sec. 1.267A-2(e) and, as a
result, a deduction for the payment is disallowed under Sec.
1.267A-1(b)(1).
(A) US1's payment is a branch mismatch payment because under
Country Z tax law (the tax law of FZ, a home office that is related
to US1) the payment is treated as income attributable to BB, and BB
is not a taxable branch (that is, under Country B tax law, BB does
not give rise to a taxable presence). See Sec. 1.267A-2(e)(2) and
(f). Therefore, Sec. 1.267A-2(e) applies to the payment. The result
would be the same if instead BB were a taxable branch and, under
Country B tax law, US1's payment were treated as income attributable
to FZ and not BB. See Sec. 1.267A-2(e)(2).
(B) For US1's payment to be a disqualified hybrid amount under
Sec. 1.267A-2(e), a no-inclusion must occur with respect to FZ. See
Sec. 1.267A-2(e)(1)(i). As a consequence of the Country Z branch
exemption, FZ includes $0 of the payment in income and therefore a
$50x no-inclusion occurs with respect to FZ. See Sec. 1.267A-3(a).
(C) Pursuant to Sec. 1.267A-2(e)(1)(ii), FZ's $50x no-inclusion
gives rise to a disqualified hybrid amount to the extent that it is
a result of US1's payment being a branch mismatch payment. FZ's $50x
no-inclusion is a result of the payment being a branch mismatch
payment because, were the payment to not be treated as income
attributable to BB for Country Z tax purposes, FZ would include $50x
in income and, consequently, the no-inclusion would not occur.
(7) Example 7. Reduction of disqualified hybrid amount for
certain amounts includible in income--(i) Facts. US1 and FW hold 60%
and 40%, respectively, of the interests of FX, and FX holds all the
interests of FZ. Each of FX and FZ is a CFC. FX holds an instrument
issued by FZ that it is treated as equity for Country X tax purposes
and as indebtedness for U.S. tax purposes (the FX-FZ instrument). On
date 1, FZ pays $100x to FX pursuant to the FX-FZ instrument. The
amount is treated as a dividend for Country X tax purposes and as
interest for U.S. tax purposes. In addition, pursuant to section
954(c)(6), the amount is not foreign personal holding company income
of FX. Further, under section 951A, the payment is included in FX's
tested income. Lastly, Country X tax law provides an 80%
participation exemption for dividends received from nonresident
corporations and, as a result of such participation exemption, FX
includes $20x of FZ's payment in income.
(ii) Analysis. FZ, a CFC, is a specified party and thus a
deduction for its $100x specified payment is subject to disallowance
under section 267A. But for Sec. 1.267A-3(b), $80x of FZ's payment
would be a disqualified hybrid amount (such amount, a ``tentative
disqualified hybrid amount''). See Sec. Sec. 1.267A-2(a) and
1.267A-3(b)(1). Pursuant to Sec. 1.267A-3(b), the tentative
disqualified hybrid amount is reduced by $48x. See Sec. 1.267A-
3(b)(4). The $48x is the tentative disqualified hybrid amount to the
extent that it increases US1's pro rata share of tested income with
respect to FX under section 951A (calculated as $80x multiplied by
60%). See id. Accordingly, $32x of FZ's payment ($80x less $48x) is
a disqualified hybrid amount under Sec. 1.267A-2(a) and, as a
result, $32x of the deduction is disallowed under Sec. 1.267A-
1(b)(1).
(iii) Alternative facts--United States shareholder not a tax
resident of the United States. The facts are the same as in
paragraph (c)(7)(i) of this section, except that US1 is a domestic
partnership, 90% of the interests of which are held by US2 and the
remaining 10% of which are held by a foreign individual that is a
nonresident alien (as defined in section 7701(b)(1)(B)). As is the
case in paragraph (c)(7)(ii) of this section, $48x of the $80x
tentative disqualified hybrid amount increases US1's pro rata share
of the tested income of FX. However, US1 is not a tax resident of
the United States. Thus, the $48x reduces the tentative disqualified
hybrid amount only to the extent that the $48x would be taken into
account by a tax resident of the United States. See Sec. 1.267A-
3(b)(4). US2 (a tax resident of the United States) would take into
account $43.2x of such amount (calculated as $48x multiplied by
90%). Thus, $36.8x of FZ's payment ($80x less $43.2x) is a
disqualified hybrid amount under Sec. 1.267A-2(a). See id.
(8) Example 8. Imported mismatch rule--direct offset--(i) Facts.
FX holds all the interests of FW, and FW holds all the interests of
US1. FX holds an instrument issued by FW that is treated as equity
for Country X tax purposes and indebtedness for Country W tax
purposes (the FX-FW instrument). FW holds an instrument issued by
US1 that is treated as indebtedness for Country W and U.S. tax
purposes (the FW-US1 instrument). In accounting period 1, FW pays
$100x to FX pursuant to the FX-FW instrument. The amount is treated
as an excludible dividend for Country X tax purposes (by reason of
the Country X participation exemption) and as interest for Country W
tax purposes. Also in accounting period 1, US1 pays $100x to FW
pursuant to the FW-US1 instrument. The amount is treated as interest
for Country W and U.S. tax purposes and is included in FW's income.
The FX-FW instrument was not entered into pursuant to the same plan
or series of related transactions pursuant to which the FW-US1
instrument was entered into.
(ii) Analysis. US1 is a specified party and thus a deduction for
its $100x specified payment is subject to disallowance under section
267A. The $100x payment is not a disqualified hybrid amount. In
addition, FW's $100x deduction is a hybrid deduction because it is a
deduction allowed to FW that results from an amount paid that is
interest under Country W tax law, and were Country X law to have
rules substantially similar to those under Sec. Sec. 1.267A-1
through 1.267A-3 and 1.267A-5, a deduction for the payment would be
disallowed (because under such rules the payment would be pursuant
to a hybrid transaction and FX's no-inclusion would be a result of
the hybrid transaction). See Sec. Sec. 1.267A-2(a) and 1.267A-4(b).
Under Sec. 1.267A-4(a), US1's payment is an imported mismatch
payment, US1 is an imported mismatch payer, and FW (the tax resident
that includes the imported mismatch payment in income) is an
imported mismatch payee. The imported mismatch payment is a
disqualified imported mismatch amount to the extent that the income
attributable to the payment is directly or indirectly offset by the
hybrid deduction incurred by FX (a tax
[[Page 67647]]
resident that is related to US1). See Sec. 1.267A-4(a). Under Sec.
1.267A-4(c)(1), the $100x hybrid deduction directly or indirectly
offsets the income attributable to US1's imported mismatch payment
to the extent that the payment directly or indirectly funds the
hybrid deduction. The entire $100x of US1's payment directly funds
the hybrid deduction because FW (the imported mismatch payee) incurs
at least that amount of the hybrid deduction. See Sec. 1.267A-
4(c)(3)(i). Accordingly, the entire $100x payment is a disqualified
imported mismatch amount under Sec. 1.267A-4(a) and, as a result, a
deduction for the payment is disallowed under Sec. 1.267A-1(b)(2).
(iii) Alternative facts--long-term deferral. The facts are the
same as in paragraph (c)(8)(i) of this section, except that the FX-
FW instrument is treated as indebtedness for Country X and Country W
tax purposes, and FW does not pay any amounts pursuant to the
instrument during accounting period 1. In addition, under Country W
tax law, FW is allowed to deduct interest under the FX-FW instrument
as it accrues, whereas under Country X tax law FX does not recognize
income under the FX-FW instrument until interest is paid. Further,
FW accrues $100x of interest during accounting period 1, and FW will
not pay such amount to FX for more than 36 months after the end of
the accounting period. The results are the same as in paragraph
(c)(8)(ii) of this section. That is, FW's $100x deduction is a
hybrid deduction, see Sec. Sec. 1.267A-2(a), 1.267A-3(a), and
1.267A-4(b), and the income attributable to US1's $100x imported
mismatch payment is offset by the hybrid deduction for the reasons
described in paragraph (c)(8)(ii) of this section. As a result, a
deduction for the payment is disallowed under Sec. 1.267A-1(b)(2).
(iv) Alternative facts--notional interest deduction. The facts
are the same as in paragraph (c)(8)(i) of this section, except that
the FX-FW instrument does not exist and thus FW does not pay any
amounts to FX during accounting period 1. However, during accounting
period 1, FW is allowed a $100x notional interest deduction with
respect to its equity under Country W tax law. Pursuant to Sec.
1.267A-4(b), FW's notional interest deduction is a hybrid deduction.
The results are the same as in paragraph (c)(8)(ii) of this section.
That is, the income attributable to US1's $100x imported mismatch
payment is offset by FW's hybrid deduction for the reasons described
in paragraph (c)(8)(ii) of this section. As a result, a deduction
for the payment is disallowed under Sec. 1.267A-1(b)(2).
(v) Alternative facts--foreign hybrid mismatch rules prevent
hybrid deduction. The facts are the same as in paragraph (c)(8)(i)
of this section, except that the tax law of Country W contains
hybrid mismatch rules and under such rules FW is not allowed a
deduction for the $100x that it pays to FX on the FX-FW instrument.
The $100x paid by FW therefore does not give rise to a hybrid
deduction. See Sec. 1.267A-4(b). Accordingly, because the income
attributable to US1's payment is not directly or indirectly offset
by a hybrid deduction, the payment is not a disqualified imported
mismatch amount. Therefore, a deduction for the payment is not
disallowed under Sec. 1.267A-2(b)(2).
(9) Example 9. Imported mismatch rule--indirect offsets and pro
rata allocations--(i) Facts. FX holds all the interests of FZ, and
FZ holds all the interests of US1 and US2. FX has a Country B branch
that, for Country X and Country B tax purposes, gives rise to a
taxable presence in Country B and is therefore a taxable branch
(``BB''). Under the Country B-Country X income tax treaty, BB is a
permanent establishment entitled to deduct expenses properly
attributable to BB for purposes of computing its business profits
under the treaty. BB is deemed to pay a royalty to FX for the right
to use intangibles developed by FX equal to cost plus y%. The deemed
royalty is a deductible expense properly attributable to BB under
the Country B-Country X income tax treaty. For Country X tax
purposes, any transactions between BB and X are disregarded. The
deemed royalty amount is equal to $80x during accounting period 1.
In addition, an instrument issued by FZ to FX is properly reflected
as an asset on the books and records of BB (the FX-FZ instrument).
The FX-FZ instrument is treated as indebtedness for Country X,
Country Z, and Country B tax purposes. In accounting period 1, FZ
pays $80x pursuant to the FX-FZ instrument; the amount is treated as
interest for Country X, Country Z, and Country B tax purposes, and
is treated as income attributable to BB for Country X and Country B
tax purposes (but, for Country X tax purposes, is excluded from FX's
income as a consequence of the Country X exemption for income
attributable to a branch). Further, in accounting period 1, US1 and
US2 pay $60x and $40x, respectively, to FZ pursuant to instruments
that are treated as indebtedness for Country Z and U.S. tax
purposes; the amounts are treated as interest for Country Z and U.S.
tax purposes and are included in FZ's income for Country Z tax
purposes. Lastly, neither the instrument pursuant to which US1 pays
the $60x nor the instrument pursuant to which US2 pays the $40x was
entered into pursuant to a plan or series of related transactions
that includes the transaction or agreement giving rise to BB's
deduction for the deemed royalty.
(ii) Analysis. US1 and US2 are specified parties and thus
deductions for their specified payments are subject to disallowance
under section 267A. Neither of the payments is a disqualified hybrid
amount. In addition, BB's $80x deduction for the deemed royalty is a
hybrid deduction because it is a deduction allowed to BB that
results from an amount paid that is treated as a royalty under
Country B tax law (regardless of whether a royalty deduction would
be allowed under U.S. law), and were Country B tax law to have rules
substantially similar to those under Sec. Sec. 1.267A-1 through
1.267A-3 and 1.267A-5, a deduction for the payment would be
disallowed because under such rules the payment would be a deemed
branch payment and Country X has an exclusion for income
attributable to a branch. See Sec. Sec. 1.267A-2(c) and 1.267A-
4(b). Under Sec. 1.267A-4(a), each of US1's and US2's payments is
an imported mismatch payment, US1 and US2 are imported mismatch
payers, and FZ (the tax resident that includes the imported mismatch
payments in income) is an imported mismatch payee. The imported
mismatch payments are disqualified imported mismatch amounts to the
extent that the income attributable to the payments is directly or
indirectly offset by the hybrid deduction incurred by BB (a taxable
branch that is related to US1 and US2). See Sec. 1.267A-4(a). Under
Sec. 1.267A-4(c)(1), the $80x hybrid deduction directly or
indirectly offsets the income attributable to the imported mismatch
payments to the extent that the payments directly or indirectly fund
the hybrid deduction. Paragraphs (c)(9)(ii)(A) and (B) of this
section describe the extent to which the imported mismatch payments
directly or indirectly fund the hybrid deduction.
(A) Neither US1's nor US2's payment directly funds the hybrid
deduction because FZ (the imported mismatch payee) did not incur the
hybrid deduction. See Sec. 1.267A-4(c)(3)(i). To determine the
extent to which the payments indirectly fund the hybrid deduction,
the amount of the hybrid deduction that is allocated to FZ must be
determined. See Sec. 1.267A-4(c)(3)(ii). FZ is allocated the hybrid
deduction to the extent that it directly or indirectly makes a
funded taxable payment to BB (the taxable branch that incurs the
hybrid deduction). See Sec. 1.267A-4(c)(3)(iii). The $80x that FZ
pays pursuant to the FX-FZ instrument is a funded taxable payment of
FZ to BB. See Sec. 1.267A-4(c)(3)(v). Therefore, because FZ makes a
funded taxable payment to BB that is at least equal to the amount of
the hybrid deduction, FZ is allocated the entire amount of the
hybrid deduction. See Sec. 1.267A-4(c)(3)(iii).
(B) But for US2's imported mismatch payment, the entire $60x of
US1's imported mismatch payment would indirectly fund the hybrid
deduction because FZ is allocated at least that amount of the hybrid
deduction. See Sec. 1.267A-4(c)(3)(ii). Similarly, but for US1's
imported mismatch payment, the entire $40x of US2's imported
mismatch payment would indirectly fund the hybrid deduction because
FZ is allocated at least that amount of the hybrid deduction. See
id. However, because the sum of US1's and US2's imported mismatch
payments to FZ ($100x) exceeds the hybrid deduction allocated to FZ
($80x), pro rata adjustments must be made. See Sec. 1.267A-4(e).
Thus, $48x of US1's imported mismatch payment is considered to
indirectly fund the hybrid deduction, calculated as $80x (the amount
of the hybrid deduction) multiplied by 60% ($60x, the amount of
US1's imported mismatch payment to FZ, divided by $100x, the sum of
the imported mismatch payments that US1 and US2 make to FZ).
Similarly, $32x of US2's imported mismatch payment is considered to
indirectly fund the hybrid deduction, calculated as $80x (the amount
of the hybrid deduction) multiplied by 40% ($40x, the amount of
US2's imported mismatch payment to FZ, divided by $100x, the sum of
the imported mismatch payments that US1 and US2 make to FZ).
Accordingly, $48x of US1's imported mismatch payment, and $32x of
US2's imported mismatch payment, is a disqualified imported mismatch
amount under Sec. 1.267A-4(a) and,
[[Page 67648]]
as a result, a deduction for such amounts is disallowed under Sec.
1.267A-1(b)(2).
(iii) Alternative facts--loss made available through foreign
group relief regime. The facts are the same as in paragraph
(c)(9)(i) of this section, except that FZ holds all the interests in
FZ2, a body corporate that is a tax resident of Country Z, FZ2
(rather than FZ) holds all the interests of US1 and US2, and US1 and
US2 make their respective $60x and $40x payments to FZ2 (rather than
to FZ). Further, in accounting period 1, a $10x loss of FZ is made
available to offset income of FZ2 through a Country Z foreign group
relief regime. Pursuant to Sec. 1.267A-4(c)(3)(vi), FZ and FZ2 are
treated as a single tax resident for purposes of Sec. 1.267A-4(c)
because a loss that is not incurred by FZ2 (FZ's $10x loss) is made
available to offset income of FZ2 under the Country Z group relief
regime. Accordingly, the results are the same as in paragraph
(c)(9)(ii) of this section. That is, by treating FZ and FZ2 as a
single tax resident for purposes of Sec. 1.267A-4(c), BB's hybrid
deduction offsets the income attributable to US1's and US2's
imported mismatch payments to the same extent as described in
paragraph (c)(9)(ii) of this section.
(10) Example 10. Imported mismatch rule--ordering rules and rule
deeming certain payments to be imported mismatch payments--(i)
Facts. FX holds all the interests of FW, and FW holds all the
interests of US1, US2, and FZ. FZ holds all the interests of US3. FX
advances money to FW pursuant to an instrument that is treated as
equity for Country X tax purposes and indebtedness for Country W tax
purposes (the FX-FW instrument). In a transaction that is pursuant
to the same plan pursuant to which the FX-FW instrument is entered
into, FW advances money to US1 pursuant to an instrument that is
treated as indebtedness for Country W and U.S. tax purposes (the FW-
US1 instrument). In accounting period 1, FW pays $125x to FX
pursuant to the FX-FW instrument; the amount is treated as an
excludible dividend for Country X tax purposes (by reason of the
Country X participation exemption regime) and as deductible interest
for Country W tax purposes. Also in accounting period 1, US1 pays
$50x to FW pursuant to the FW-US1 instrument; US2 pays $50x to FW
pursuant to an instrument treated as indebtedness for Country W and
U.S. tax purposes (the FW-US2 instrument); US3 pays $50x to FZ
pursuant to an instrument treated as indebtedness for Country Z and
U.S. tax purposes (the FZ-US3 instrument); and FZ pays $50x to FW
pursuant to an instrument treated as indebtedness for Country W and
Country Z tax purposes (FW-FZ instrument). The amounts paid by US1,
US2, US3, and FZ are treated as interest for purposes of the
relevant tax laws and are included in the respective specified
recipient's income. Lastly, neither the FW-US2 instrument, the FW-FZ
instrument, nor the FZ-US3 instrument was entered into pursuant to a
plan or series of related transactions that includes the transaction
pursuant to which the FX-FW instrument was entered into.
(ii) Analysis. US1, US2, and US3 are specified parties (but FZ
is not a specified party, see Sec. 1.267A-5(a)(17)) and thus
deductions for US1's, US2's, and US3's specified payments are
subject to disallowance under section 267A. None of the specified
payments is a disqualified hybrid amount. Under Sec. 1.267A-4(a),
each of the payments is thus an imported mismatch payment, US1, US2,
and US3 are imported mismatch payers, and FW and FZ (the tax
residents that include the imported mismatch payments in income) are
imported mismatch payees. The imported mismatch payments are
disqualified imported mismatch amounts to the extent that the income
attributable to the payments is directly or indirectly offset by
FW's $125x hybrid deduction. See Sec. 1.267A-4(a) and (b). Under
Sec. 1.267A-4(c)(1), the $125x hybrid deduction directly or
indirectly offsets the income attributable to the imported mismatch
payments to the extent that the payments directly or indirectly fund
the hybrid deduction. Paragraphs (c)(10)(ii)(A) through (C) of this
section describe the extent to which the imported mismatch payments
directly or indirectly fund the hybrid deduction and are therefore
disqualified hybrid amounts for which a deduction is disallowed
under Sec. 1.267A-1(b)(2).
(A) First, the $125x hybrid deduction offsets the income
attributable to US1's imported mismatch payment, a factually-related
imported mismatch payment that directly funds the hybrid deduction.
See Sec. 1.267A-4(c)(2)(i). The entire $50x of US1's payment
directly funds the hybrid deduction because FW (the imported
mismatch payee) incurs at least that amount of the hybrid deduction.
See Sec. 1.267A-4(c)(3)(i). Accordingly, the entire $50x of the
payment is a disqualified imported mismatch amount under Sec.
1.267A-4(a).
(B) Second, the remaining $75x hybrid deduction offsets the
income attributable to US2's imported mismatch payment, a factually-
unrelated imported mismatch payment that directly funds the
remaining hybrid deduction. Sec. 1.267A-4(c)(2)(ii). The entire
$50x of US2's payment directly funds the remaining hybrid deduction
because FW (the imported mismatch payee) incurs at least that amount
of the remaining hybrid deduction. See Sec. 1.267A-4(c)(3)(i).
Accordingly, the entire $50x of the payment is a disqualified
imported mismatch amount under Sec. 1.267A-4(a).
(C) Third, the $25x remaining hybrid deduction offsets the
income attributable to US3's imported mismatch payment, a factually-
unrelated imported mismatch payment that indirectly funds the
remaining hybrid deduction. See Sec. 1.267A-4(c)(2)(iii). The
imported mismatch payment indirectly funds the remaining hybrid
deduction to the extent that FZ (the imported mismatch payee) is
allocated the remaining hybrid deduction. Sec. 1.267A-4(c)(3)(ii).
FZ is allocated the remaining hybrid deduction to the extent that it
directly or indirectly makes a funded taxable payment to FW (the tax
resident that incurs the hybrid deduction). Sec. 1.267A-
4(c)(3)(iii). The $50x that FZ pays to FW pursuant to the FW-FZ
instrument is a funded taxable payment of FZ to FW. Sec. 1.267A-
4(c)(3)(v). Therefore, because FZ makes a funded taxable payment to
FW that is at least equal to the amount of the remaining hybrid
deduction, FZ is allocated the remaining hybrid deduction. Sec.
1.267A-4(c)(3)(iii). Accordingly, $25x of US3's payment indirectly
funds the $25x remaining hybrid deduction and, consequently, $25x of
US3's payment is a disqualified imported mismatch amount under Sec.
1.267A-4(a).
(iii) Alternative facts--amount deemed to be an imported
mismatch payment. The facts are the same as in paragraph (c)(10)(i)
of this section, except that US1 is not a domestic corporation but
instead is a body corporate that is only a tax resident of Country E
(hereinafter, ``FE'') (thus, for purposes of this paragraph
(c)(10)(iii), the FW-US1 instrument is instead issued by FE and is
the ``FW-FE instrument''). In addition, the tax law of Country E
contains hybrid mismatch rules and, under a provision of such rules
substantially similar to Sec. 1.267A-4, FE is denied a deduction
for the $50x it pays to FW under the FW-FE instrument. Pursuant to
Sec. 1.267A-4(f), the $50x that FE pays to FW pursuant to the FW-FE
instrument is deemed to be an imported mismatch payment for purposes
of determining the extent to which the income attributable to US2's
and US3's imported mismatch payments is offset by FW's hybrid
deduction. The results are the same as in paragraphs (c)(10)(ii)(B)
and (C) of this section. That is, by treating the $50x that FE pays
to FW as an imported mismatch payment, FW's hybrid deduction offsets
the income attributable to US2's and US3's imported mismatch
payments to the same extent as described in paragraphs
(c)(10)(ii)(B) and (C) of this section.
(iv) Alternative facts--amount deemed to be an imported mismatch
payment not treated as a funded taxable payment. The facts are the
same as in paragraph (c)(10)(i) of this section, except that FZ
holds its interests of US3 indirectly through FE, a body corporate
that is only a tax resident of Country E (hereinafter, ``FE''), and
US3 makes its $50x payment to FE (rather than to FZ); US3's $50x
payment is treated as interest for Country E tax purposes and FE
includes the payment in income. In addition, during accounting
period 1, FE pays $50x of interest to FZ pursuant to an instrument
and such amount is included in FZ's income. Further, the tax law of
Country E contains hybrid mismatch rules and, under a provision of
such rules substantially similar to Sec. 1.267A-4, FE is denied a
deduction for $25x of the $50x it pays to FZ, because under such
provision $25x of the income attributable to FE's payment is
considered offset against $25x of FW's hybrid deduction. With
respect to US1 and US2, the results are the same as described in
paragraphs (c)(10)(ii)(A) and (B) of this section. However, no
portion of US3's payment is a disqualified imported mismatch amount.
This is because the $50x that FE pays to FZ is not considered to be
a funded taxable payment, because under a provision of Country E's
hybrid mismatch rules that is substantially similar to Sec. 1.267A-
4, FE is denied a deduction for a portion of the $50x. See Sec.
1.267A-4(c)(3)(v) and (f). Therefore, there is no chain of funded
taxable payments connecting US3 (the imported mismatch payer) and FW
(the tax resident that incurs the hybrid deduction); as a result,
US3's payment does not indirectly
[[Page 67649]]
fund the hybrid deduction. See Sec. 1.267A-4(c)(3)(ii) through
(iv).
Sec. 1.267A-7 Applicability dates.
(a) General rule. Except as provided in paragraph (b) of this
section, Sec. Sec. 1.267A-1 through 1.267A-6 apply to taxable years
beginning after December 31, 2017.
(b) Special rules. Sections 1.267A-2(b), (c), (e), 1.267A-4, and
1.267A-5(b)(5) apply to taxable years beginning on or after December
20, 2018. In addition, Sec. 1.267A-5(a)(20) (defining structured
arrangement), as well as the portions of Sec. Sec. 1.267A-1 through
1.267A-3 that relate to structured arrangements and that are not
otherwise described in this paragraph (b), apply to taxable years
beginning on or after December 20, 2018.
0
Par. 4. Section 1.1503(d)-1 is amended by:
0
1. In paragraph (b)(2)(i), removing the word ``and''.
0
2. In paragraph (b)(2)(ii), removing the second period and adding in
its place ``; and''.
0
3. Adding paragraph (b)(2)(iii).
0
4. Redesignating paragraph (c) as paragraph (d).
0
5. Adding new paragraph (c).
0
6. In the first sentence of newly-redesignated paragraph (d)(2)(ii),
removing the language ``(c)(2)(i)'' and adding the language
``(d)(2)(i)'' in its place.
The additions read as follows:
Sec. 1.1503(d)-1 Definitions and special rules for filings under
section 1503(d).
* * * * *
(b) * * *
(2) * * *
(iii) A domestic consenting corporation (as defined in Sec.
301.7701-3(c)(3)(i) of this chapter), as provided in paragraph (c)(1)
of this section. See Sec. 1.1503(d)-7(c)(41).
* * * * *
(c) Treatment of domestic consenting corporation as a dual resident
corporation--(1) Rule. A domestic consenting corporation is treated as
a dual resident corporation under paragraph (b)(2)(iii) of this section
for a taxable year if, on any day during the taxable year, the
following requirements are satisfied:
(i) Under the tax law of a foreign country where a specified
foreign tax resident is tax resident, the specified foreign tax
resident derives or incurs (or would derive or incur) items of income,
gain, deduction, or loss of the domestic consenting corporation
(because, for example, the domestic consenting corporation is fiscally
transparent under such tax law).
(ii) The specified foreign tax resident bears a relationship to the
domestic consenting corporation that is described in section 267(b) or
707(b). See Sec. 1.1503(d)-7(c)(41).
(2) Definitions. The following definitions apply for purposes of
this paragraph (c).
(i) The term fiscally transparent means, with respect to a domestic
consenting corporation or an intermediate entity, fiscally transparent
as determined under the principles of Sec. 1.894-1(d)(3)(ii) and
(iii), without regard to whether a specified foreign tax resident is a
resident of a country that has an income tax treaty with the United
States.
(ii) The term specified foreign tax resident means a body corporate
or other entity or body of persons liable to tax under the tax law of a
foreign country as a resident.
* * * * *
0
Par. 5. Section 1.1503(d)-3 is amended by adding the language ``or
(e)(3)'' after the language ``paragraph (e)(2)'' in paragraph (e)(1),
and adding paragraph (e)(3) to read as follows:
Sec. 1.1503(d)-3 Foreign use.
* * * * *
(e) * * *
(3) Exception for domestic consenting corporations. Paragraph
(e)(1) of this section will not apply so as to deem a foreign use of a
dual consolidated loss incurred by a domestic consenting corporation
that is a dual resident corporation under Sec. 1.1503(d)-1(b)(2)(iii).
Sec. 1.1503(d)-6 [Amended]
0
Par. 6. Section 1.1503(d)-6 is amended by:
0
1. Removing the language ``a foreign government'' and ``a foreign
country'' in paragraph (f)(5)(i), and adding the language ``a
government of a country'' and ``the country'' in their places,
respectively.
0
2. Removing the language ``a foreign government'' in paragraph
(f)(5)(ii), and adding the language ``a government of a country'' in
its place.
0
3. Removing the language ``the foreign government'' in paragraph
(f)(5)(iii), and adding the language ``a government of a country'' in
its place.
0
Par. 7. Section 1.1503(d)-7 is amended by redesignating Examples 1
through 40 as paragraphs (c)(1) through (40), respectively, and adding
paragraph (c)(41) to read as follows:
Sec. 1.1503(d)-7 Examples.
* * * * *
(c) * * *
(41) Example 41. Domestic consenting corporation--treated as
dual resident corporation--(i) Facts. FSZ1, a Country Z entity that
is subject to Country Z tax on its worldwide income or on a
residence basis and is classified as a foreign corporation for U.S.
tax purposes, owns all the interests in DCC, a domestic eligible
entity that has filed an election to be classified as an
association. Under Country Z tax law, DCC is fiscally transparent.
For taxable year 1, DCC's only item of income, gain, deduction, or
loss is a $100x deduction and such deduction comprises a $100x net
operating loss of DCC. For Country Z tax purposes, FSZ1's only item
of income, gain, deduction, or loss, other than the $100x loss
attributable to DCC, is $60x of operating income.
(ii) Result. DCC is a domestic consenting corporation because by
electing to be classified as an association, it consents to be
treated as a dual resident corporation for purposes of section
1503(d). See Sec. 301.7701-3(c)(3) of this chapter. For taxable
year 1, DCC is treated as a dual resident corporation under Sec.
1.1503(d)-1(b)(2)(iii) because FSZ1 (a specified foreign tax
resident that bears a relationship to DCC that is described in
section 267(b) or 707(b)) derives or incurs items of income, gain,
deduction, or loss of DCC. See Sec. 1.1503(d)-1(c). FSZ1 derives or
incurs items of income, gain, deduction, or loss of DCC because,
under Country Z tax law, DCC is fiscally transparent. Thus, DCC has
a $100x dual consolidated loss for taxable year 1. See Sec.
1.1503(d)-1(b)(5). Because the loss is available to, and in fact
does, offset income of FSZ1 under Country Z tax law, there is a
foreign use of the dual consolidated loss in year 1. Accordingly,
the dual consolidated loss is subject to the domestic use limitation
rule of Sec. 1.1503(d)-4(b). The result would be the same if FSZ1
were to indirectly own its DCC stock through an intermediate entity
that is fiscally transparent under Country Z tax law, or if an
individual were to wholly own FSZ1 and FSZ1 were a disregarded
entity. In addition, the result would be the same if FSZ1 had no
items of income, gain, deduction, or loss, other than the $100x loss
attributable to DCC.
(iii) Alternative facts--DCC not treated as a dual resident
corporation. The facts are the same as in paragraph (c)(41)(i) of
this section, except that DCC is not fiscally transparent under
Country Z tax law and thus under Country Z tax law FSZ1 does not
derive or incur items of income, gain, deduction, or loss of DCC.
Accordingly, DCC is not treated as a dual resident corporation under
Sec. 1.1503(d)-1(b)(2)(iii) for year 1 and, consequently, its $100x
net operating loss in that year is not a dual consolidated loss.
(iv) Alternative facts--mirror legislation. The facts are the
same as in paragraph (c)(41)(i) of this section, except that, under
provisions of Country Z tax law that constitute mirror legislation
under Sec. 1.1503(d)-3(e)(1) and that are substantially similar to
the recommendations in Chapter 6 of OECD/G-20, Neutralising the
Effects of Hybrid Mismatch Arrangements, Action 2: 2015 Final Report
(October 2015), Country Z tax law prohibits the $100x loss
attributable to DCC from offsetting FSZ1's income that is not also
subject to U.S. tax. As is the case in
[[Page 67650]]
paragraph (c)(41)(ii) of this section, DCC is treated as a dual
resident corporation under Sec. 1.1503(d)-1(b)(2)(iii) for year 1
and its $100x net operating loss is a dual consolidated loss.
Pursuant to Sec. 1.1503(d)-3(e)(3), however, the dual consolidated
loss is not deemed to be put to a foreign use by virtue of the
Country Z mirror legislation. Therefore, DCC is eligible to make a
domestic use election for the dual consolidated loss.
0
Par. 8. Section 1.1503(d)-8 is amended by removing the language ``Sec.
1.1503(d)-1(c)'' and adding in its place the language ``Sec.
1.1503(d)-1(d)'' wherever it appears in paragraphs (b)(3)(i) and (iii),
and adding paragraphs (b)(6) and (7) to read as follows:
Sec. 1.1503(d)-8 Effective dates.
* * * * *
(b) * * *
(6) Rules regarding domestic consenting corporations. Section
1.1503(d)-1(b)(2)(iii), (c), and (d), as well Sec. 1.1503(d)-3(e)(1)
and (e)(3), apply to determinations under Sec. Sec. 1.1503(d)-1
through 1.1503(d)-7 relating to taxable years ending on or after
December 20, 2018. For taxable years ending before December 20, 2018,
see Sec. Sec. 1.1503(d)-1(c) (previous version of Sec. 1.1503(d)-
1(d)) and 1.1503(d)-3(e)(1) (previous version of Sec. 1.1503(d)-
3(e)(1)) as contained in 26 CFR part 1 revised as of April 1, 2018.
(7) Compulsory transfer triggering event exception. Sections
1.1503(d)-6(f)(5)(i) through (iii) apply to transfers that occur on or
after December 20, 2018. For transfers occurring before December 20,
2018, see Sec. 1.1503(d)-6(f)(5)(i) through (iii) as contained in 26
CFR part 1 revised as of April 1, 2018. However, taxpayers may
consistently apply Sec. 1.1503(d)-6(f)(5)(i) through (iii) to
transfers occurring before December 20, 2018.
0
Par. 9. Section 1.6038-2 is amended by adding paragraphs (f)(13) and
(14) and adding a sentence at the end of paragraph (m) to read as
follows:
Sec. 1.6038-2 Information returns required of United States persons
with respect to annual accounting periods of certain foreign
corporations beginning after December 31, 1962.
* * * * *
(f) * * *
(13) Amounts involving hybrid transactions or hybrid entities under
section 267A. If for the annual accounting period, the corporation pays
or accrues interest or royalties for which a deduction is disallowed
under section 267A and the regulations under section 267A as contained
in 26 CFR part 1, then Form 5471 (or successor form) must contain such
information about the disallowance in the form and manner and to the
extent prescribed by the form, instruction, publication, or other
guidance published in the Internal Revenue Bulletin.
(14) Hybrid dividends under section 245A. If for the annual
accounting period, the corporation pays or receives a hybrid dividend
or a tiered hybrid dividend under section 245A and the regulations
under section 245A as contained in 26 CFR part 1, then Form 5471 (or
successor form) must contain such information about the hybrid dividend
or tiered hybrid dividend in the form and manner and to the extent
prescribed by the form, instruction, publication, or other guidance
published in the Internal Revenue Bulletin.
* * * * *
(m) Applicability dates. * * * Paragraphs (f)(13) and (14) of this
section apply with respect to information for annual accounting periods
beginning on or after December 20, 2018.
0
Par. 10. Section 1.6038-3 is amended by:
0
1. Adding paragraph (g)(3).
0
2. Redesignating the final paragraph (1) of the section as paragraph
(l), revising the paragraph heading for newly-designated paragraph (l),
and adding a sentence to the end of newly-designated paragraph (l).
The additions and revision read as follows:
Sec. 1.6038-3 Information returns required of certain United States
persons with respect to controlled foreign partnerships (CFPs).
* * * * *
(g) * * *
(3) Amounts involving hybrid transactions or hybrid entities under
section 267A. In addition to the information required pursuant to
paragraphs (g)(1) and (2) of this section, if, during the partnership's
taxable year for which the Form 8865 is being filed, the partnership
paid or accrued interest or royalties for which a deduction is
disallowed under section 267A and the regulations under section 267A as
contained in 26 CFR part 1, the controlling fifty-percent partners must
provide information about the disallowance in the form and manner and
to the extent prescribed by Form 8865 (or successor form), instruction,
publication, or other guidance published in the Internal Revenue
Bulletin.
* * * * *
(l) Applicability dates. * * * Paragraph (g)(3) of this section
applies for taxable years of a foreign partnership beginning on or
after December 20, 2018.
0
Par. 11. Section 1.6038A-2 is amended by adding paragraph (b)(5)(iii)
and adding a sentence at the end of paragraph (g) to read as follows:
Sec. 1.6038A-2 Requirement of return.
* * * * *
(b) * * *
(5) * * *
(iii) If, for the taxable year, a reporting corporation pays or
accrues interest or royalties for which a deduction is disallowed under
section 267A and the regulations under section 267A as contained in 26
CFR part 1, then the reporting corporation must provide such
information about the disallowance in the form and manner and to the
extent prescribed by Form 5472 (or successor form), instruction,
publication, or other guidance published in the Internal Revenue
Bulletin.
* * * * *
(g) * * * Paragraph (b)(5)(iii) of this section applies with
respect to information for annual accounting periods beginning on or
after December 20, 2018.
PART 301--PROCEDURE AND ADMINISTRATION
0
Paragraph 12. The authority citation for part 301 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 13. Section 301.7701-3 is amended by revising the sixth sentence
of paragraph (a) and adding paragraph (c)(3) to read as follows:
Sec. 301.7701-3 Classification of certain business entities.
(a) In general. * * * Paragraph (c) of this section provides rules
for making express elections, including a rule under which a domestic
eligible entity that elects to be classified as an association consents
to be subject to the dual consolidated loss rules of section 1503(d).
* * * * *
(c) * * *
(3) Consent to be subject to section 1503(d)--(i) Rule. A domestic
eligible entity that elects to be classified as an association consents
to be treated as a dual resident corporation for purposes of section
1503(d) (such an entity, a domestic consenting corporation), for any
taxable year for which it is classified as an association and the
condition set forth in Sec. 1.1503(d)-1(c)(1) of this chapter is
satisfied.
(ii) Transition rule--deemed consent. If, as a result of the
applicability date relating to paragraph (c)(3)(i) of this section, a
domestic eligible entity that is classified as an association has not
[[Page 67651]]
consented to be treated as a domestic consenting corporation pursuant
to paragraph (c)(3)(i) of this section, then the domestic eligible
entity is deemed to consent to be so treated as of its first taxable
year beginning on or after December 20, 2019. The first sentence of
this paragraph (c)(3)(ii) does not apply if the domestic eligible
entity elects, on or after December 20, 2018 and effective before its
first taxable year beginning on or after December 20, 2019, to be
classified as a partnership or disregarded entity such that it ceases
to be a domestic eligible entity that is classified as an association.
For purposes of the election described in the second sentence of this
paragraph (c)(3)(ii), the sixty month limitation under paragraph
(c)(1)(iv) of this section is waived.
(iii) Applicability date. The sixth sentence of paragraph (a) of
this section and paragraph (c)(3)(i) of this section apply to a
domestic eligible entity that on or after December 20, 2018 files an
election to be classified as an association (regardless of whether the
election is effective before December 20, 2018). Paragraph (c)(3)(ii)
of this section applies as of December 20, 2018.
* * * * *
Kirsten Wielobob,
Deputy Commissioner for Services and Enforcement.
[FR Doc. 2018-27714 Filed 12-20-18; 4:15 pm]
BILLING CODE 4830-01-P