Post by Tanenbaum on Apr 29, 2009 2:19:05 GMT 4
US Inbound: IRS issues proposed regulations addressing disregarded entities
On December 19 2008, the Internal Revenue Service (IRS) issued proposed regulations that address the application of the conduit financing arrangement rules of Treasury regulation ยง 1.881-3 to structures involving disregarded entities.
Under these regulations, the IRS can disregard the participation of one or more intermediate entities acting as conduit entities in financing arrangements that are designed to avoid taxes. This rule allows the IRS to disregard the participation of an intermediate entity and to re-characterise a multiple-party financing transaction as a transaction directly between the parties on either side of the conduit entity for purposes of imposing tax under section 871, 881, 1441 and 1442 of the code.
Under the check-the-box regulations, an eligible entity that isn't classified as a corporation and has a single owner may elect to be disregarded as an entity separate from its owner (a disregarded entity) for US federal income tax purposes.
Disregarded entities
Since the check-box-regulations were promulgated, some taxpayers have taken the position that there is uncertainty over the application of the conduit rules to structures that include a check-the-box disregarded entity. This perceived uncertainty resulted in some taxpayers arguing that the check-the-box election requires disregarding back-to-back financing arrangements so that the conduit regulations are inapplicable.
A back-to-back loan; in other words, a loan between an entity in a non-tax-treaty country and a US entity that is channelled through a subsidiary in a country that has a tax treaty with the United States could possibly allow the parties to profit from the treaty country subsidiary's tax treaty benefits. The anti-conduit regulations, however, disallow treaty benefits for treaty country conduit entities when those conduits are not considered the true beneficial owner of the income. Under the check-the box rules and section 894, however, disregarded entities may still be entitled to claim treaty benefits. Some practitioners were using that provision to effectuate back-to-back loan arrangements, possibly reducing, even to zero, the withholding tax required, while sidestepping the anti-conduit regulations.
The proposed regulations provides that, for purposes of the rules on conduit financing arrangements, the term person would include a business entity that was disregarded as an entity separate from its single member owner. Because a disregarded entity is a person, any transaction that it enters into will be taken into account for purposes of determining whether a conduit financing arrangement exists.
Therefore, the intermediate disregarded entity under the check-the-box regulations is regarded for purposes of possibly disregarding the entity under the conduit financing regulations and re-characterising the multiple-party financing transaction as a transaction directly between the parties on either side of the conduit entity.
Hybrid instruments
The Treasury department and the IRS are continuing to study conduit financing arrangements and may issue separate guidance on the treatment of hybrid instruments. Specifically, they are studying transactions in which a financing entity advances property to an intermediate entity in exchange for a hybrid instrument that is treated as debt under the laws of the foreign jurisdiction where the intermediate entity is a resident, but is treated as equity for US federal tax purposes. The issue under consideration is whether the conduit financing regulations should apply to such instruments.
Two possible options of treating these instruments are discussed in the proposed regulations. One option is to treat all transactions involving hybrid instruments as financing transactions subject to the anti-conduit rules. The other option expands the factors to consider in determining when stock in a corporation (or other similar interest in a partnership or trust) constitutes a financing arrangement. The IRS requests comments on both approaches.
Edward Tanenbaum (edward.tanenbaum@alston.com) New York
On December 19 2008, the Internal Revenue Service (IRS) issued proposed regulations that address the application of the conduit financing arrangement rules of Treasury regulation ยง 1.881-3 to structures involving disregarded entities.
Under these regulations, the IRS can disregard the participation of one or more intermediate entities acting as conduit entities in financing arrangements that are designed to avoid taxes. This rule allows the IRS to disregard the participation of an intermediate entity and to re-characterise a multiple-party financing transaction as a transaction directly between the parties on either side of the conduit entity for purposes of imposing tax under section 871, 881, 1441 and 1442 of the code.
Under the check-the-box regulations, an eligible entity that isn't classified as a corporation and has a single owner may elect to be disregarded as an entity separate from its owner (a disregarded entity) for US federal income tax purposes.
Disregarded entities
Since the check-box-regulations were promulgated, some taxpayers have taken the position that there is uncertainty over the application of the conduit rules to structures that include a check-the-box disregarded entity. This perceived uncertainty resulted in some taxpayers arguing that the check-the-box election requires disregarding back-to-back financing arrangements so that the conduit regulations are inapplicable.
A back-to-back loan; in other words, a loan between an entity in a non-tax-treaty country and a US entity that is channelled through a subsidiary in a country that has a tax treaty with the United States could possibly allow the parties to profit from the treaty country subsidiary's tax treaty benefits. The anti-conduit regulations, however, disallow treaty benefits for treaty country conduit entities when those conduits are not considered the true beneficial owner of the income. Under the check-the box rules and section 894, however, disregarded entities may still be entitled to claim treaty benefits. Some practitioners were using that provision to effectuate back-to-back loan arrangements, possibly reducing, even to zero, the withholding tax required, while sidestepping the anti-conduit regulations.
The proposed regulations provides that, for purposes of the rules on conduit financing arrangements, the term person would include a business entity that was disregarded as an entity separate from its single member owner. Because a disregarded entity is a person, any transaction that it enters into will be taken into account for purposes of determining whether a conduit financing arrangement exists.
Therefore, the intermediate disregarded entity under the check-the-box regulations is regarded for purposes of possibly disregarding the entity under the conduit financing regulations and re-characterising the multiple-party financing transaction as a transaction directly between the parties on either side of the conduit entity.
Hybrid instruments
The Treasury department and the IRS are continuing to study conduit financing arrangements and may issue separate guidance on the treatment of hybrid instruments. Specifically, they are studying transactions in which a financing entity advances property to an intermediate entity in exchange for a hybrid instrument that is treated as debt under the laws of the foreign jurisdiction where the intermediate entity is a resident, but is treated as equity for US federal tax purposes. The issue under consideration is whether the conduit financing regulations should apply to such instruments.
Two possible options of treating these instruments are discussed in the proposed regulations. One option is to treat all transactions involving hybrid instruments as financing transactions subject to the anti-conduit rules. The other option expands the factors to consider in determining when stock in a corporation (or other similar interest in a partnership or trust) constitutes a financing arrangement. The IRS requests comments on both approaches.
Edward Tanenbaum (edward.tanenbaum@alston.com) New York