The IRS issued Notice 2014-44 on July 21, announcing that Treasury and the IRS intend to issue regulations addressing the application of Section 901(m) to disposition of assets following covered asset acquisitions (CAAs) and to CAAs consisting of the acquisition of an interest in a partnership that has an election in effect under Section 754.
Following a CAA, Section 901(m) limits foreign tax credits that are available to a taxpayer to the extent there is a basis difference in the acquired foreign entity's relevant foreign assets (assets that can be attributed to the foreign entity at the time of the CAA). However, Section 901(m)(3)(B)(ii) provides that, except as otherwise provided by the Treasury Department, the disposition of a relevant foreign asset (RFA) will generally cause any remaining basis difference that can be attributed to the RFA to be allocated to the year of the disposition (and thus not limit foreign tax credits in future years).
The IRS released Notice 2014-44 to address certain transactions that it believed were using the statutory disposition rule under Section 901(m)(3)(B)(ii) to avoid the purpose of Section 901(m). The notice provides an example where a wholly owned foreign subsidiary of a U.S. corporation purchases all of a foreign corporation's stock, makes an election under Section 338(g) to treat the acquisition of the target as an asset acquisition for U.S. tax purposes (a CAA), and shortly thereafter makes a check-the-box election under Treas. Reg. Sec. 301.7701-3 to treat the target as disregarded.
As a result of the entity classification election, the target is deemed, solely for U.S. tax purposes, to distribute all of its assets and liabilities to the foreign subsidiary in liquidation (a deemed liquidation) immediately before the closing of the day before the election is effective. Taxpayers have taken the position that the deemed liquidation constitutes a disposition of the RFAs for purposes of Section 901(m)(3)(B)(ii), and as a result, there should be no basis difference attributed to the RFAs following the disposition. The deemed liquidation is generally disregarded under local country law and is tax-free for U.S. purposes under Sections 332 and 337.
The notice provides that regulations will be issued to state that, for purposes of Section 901(m), a disposition means an event that results in gain or loss being recognized with respect to an RFA for purposes of U.S. income tax or a foreign income tax, or both. As such, transactions that are tax-free for U.S. tax purposes and disregarded under foreign law, such as the deemed liquidation described previously, will not affect the basis difference that can be attributed to RFAs. However, the notice provides that fully or partially taxable transactions will affect the basis difference that can be attributed to the RFAs. Further, the notice provides special basis adjustment rules in the case of acquisitions of an interest in a partnership that has an election in effect under Section 754.
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