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New Section 956 Foreign Tax Credit Blending Rule

Earlier this week, President Obama signed into law H.R. 1586.  This new law has several important changes to U.S. international tax rules.  Today’s blog post discusses the new Section 956 foreign tax credit blending rule.

The new law adds a new subsection (subsection (c)) to Code § 960.  Under this new rule, if there is a Section 956 inclusion where the U.S. shareholder will be allowed to claim deemed paid foreign tax credits (i.e., a “qualified group” exists), the amount of the deemed paid foreign tax credits can be limited.

Under the new rule, if the amount of the deemed paid foreign tax credits under the normal “hopscotch” rule would exceed the deemed paid foreign tax credits if cash (in an amount equal to the Section 956 inclusion) were distributed in a series of distributions through the chain of ownership, then the deemed paid foreign tax credits will be limited to the amount calculated under the hypothetical cash distribution.

For example, if a lower-tier foreign subsidiary (“CFC2”) had a high tax pool of earnings and a first-tier foreign subsidiary (“CFC1”) had a low tax pool of earnings, under the old rules the U.S. Parent could access the high tax pool of earnings and could bypass the low tax pool of earnings by making a 956 loan from CFC2 to the U.S. Parent.

956_inclusion_hopscotch

Under the new rule of Code § 960(c), U.S. Parent would only be able to claim foreign tax credits equal to the amount that would have been allowed if a cash distribution was made from CFC2 to CFC1, and then a cash distribution was made from CFC1 to U.S. Parent.  In other words, U.S. Parent cannot claim deemed paid foreign tax credits based solely on the earnings pool of CFC2, but instead must base the deemed paid foreign tax credits on CFC1’s earnings (after considering the hypothetical cash distribution from CFC2).

The good news is that the effective date of Code § 960(c) is for “acquisitions of United States property after December 31, 2010.”  Consequently, Congress has been kind enough to allow planning transactions for this year to extract as much lower-tier high taxed earnings as possible.

Interestingly, if a 956 loan is put in place on or before December 31, 2010, but generates 956 inclusions in years after 2010, it appears that the new blending rule may not apply.  This is because the new rule keys off of acquisitions of U.S. property after December 31, 2010.  If the loan (or other U.S. property) is in place prior to December 31, 2010, there would be no acquisition of U.S. property after December 31, 2010.

However, the new law authorizes the I.R.S. and the Treasury Department to issue regulations or other guidance to carry out the purposes of the new rule.  See new Code § 960(c)(2).

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