United States: New Chief Counsel Memorandum Revisits Definition Of "Obligation" Under IRC Section 956

ILM 201436047

In a recent memorandum, ILM 201436047 (Sept. 8, 2014), the IRS chief counsel seemingly exceeded the scope of its own regulations in advising that the amount of a CFC's section 956 investment included accrued but unpaid interest of its U.S. parent on debt guaranteed by the CFC. This ILM has important implications for the application of 956 since it demonstrates that the IRS will advocate an expansive definition of investments in U.S. property.

Background of ILM

In the ILM, the US Parent company was the borrower on a third party loan that required it to pay stated interest annually. The Parent's CFC provided a guarantee or other credit support to the lender, so that CFC, under § 956(d), was treated as having made an investment in U.S. property to the extent of the Parent's guaranteed indebtedness.

It is unclear from the ILM whether the CFC was deliberately or inadvertently included in the guarantee parties under the third-party loan agreement. Typically, CFCs are excluded from the parties who provide a guarantee to avoid Section 956 exposure. Section 956 can be a major pitfall for 1a U.S. borrower, as improperly structured credit support by its CFCs can easily lead to a full inclusion of the CFCs' earnings and a major tax liability to the United States parent corporation.

In the ILM, the Parent was required to make regular payments of stated interest on its third-party debt that was guaranteed by the CFC. Presumably due to the Parent's financial difficulties, the Parent had not made the payments of stated interest as required, so that there existed an unpaid interest balance on the indebtedness.

Analysis of the ILM

In the ILM, the specific issue addressed by the IRS was whether the guarantor CFC's amount of section 956 investment included not only principal on the guaranteed debt, but also accrued, but unpaid interest. In this situation, the regulations state that the amount of the section 956 investment "shall be the unpaid principal amount on the applicable determination date of the obligation with respect to which the controlled foreign corporation is a pledgor or guarantor."1 (Emphasis provided). Thus, the taxpayer apparently argued that only principal, and not unpaid interest, was captured by § 956. The IRS, on the other hand, disagreed and advised that the full unpaid balance of the obligation should be included in CFC's § 956 investment.

In reaching this conclusion, the ILM sidestepped the regulations on guarantees and focused instead on the general definition of US property in the statute and regulations. The regulations, in relevant part, define an "obligation" to "include[]any bond, note, debenture, certificate, bill receivable, account receivable, note receivable, open account, or other indebtedness..."2 The amount of the CFC's section 956 investment in the case of a direct loan is the CFC's adjusted tax basis in the Parent's obligation.3 Under that definition, the Parent's obligation to pay accrued interest would, in the IRS's view, constitute an "account receivable" or "other indebtedness" owing by the U.S. parent to the CFC. Further, as long as the CFC had sufficient prospects of recovery to be required to accrue the interest as income under the principles of the accrual method of accounting,4 its adjusted tax basis in the Parent's debt obligation would include unpaid interest. The IRS then extrapolated this application of the direct investment rules to the guarantee case to hold that the CFC would have an investment in U.S. property indirectly through a guarantee to the extent that the accrued interest would have been included in the CFC's § 956 investment if made directly.

The IRS also put forth a policy rationale, stating that the purpose of section 956 is to tax earnings of a CFC that are available for use by a related United States person similarly to the way that earnings distributed to a United States shareholder of the CFC would be taxed. The ILM states that both principal and accrued interest fit within this category.

Commentary on the ILM and Implications for Other Areas

The ILM's reasoning, if correct, makes the guarantee rule (Treas. Reg. § 1.956-1(e)(2)) superfluous. There is simply no need for a rule stating that the principal amount of a U.S. parent's debt guaranteed by a CFC is section 956 property if regulations covering the definition of an obligation include guarantees of accrued interest. Since differences in regulatory language are presumed not to be superfluous, it would seem that the ILM can only mean one of two things: either Treasury erred by making the guarantee rule under-inclusive or, more likely, Treasury had a good reason for not including unpaid interest in the guarantee rule. Indeed, at the time a CFC guarantees its U.S parent's debt, its earnings are being used to induce a loan, and not to induce the nonpayment of interest. Further, if the U.S. parent is in such poor financial shape at the time the loan is made, then there are alternatives available to the IRS (see, e.g., Plantation Patterns) to characterize the obligation to pay both principal and unpaid interest as a direct indebtedness of the CFC.

The ILM does not attempt to square its interpretation of the guarantee rule with the plain language of the regulation's reference to "unpaid principal amount." The guarantee rule is written differently from the direct investment rule, and by treating interest as principal, the ILM ignores this difference in language. The principal balance of the third-party debt measures the amount of cash provided by the lender to the U.S. person benefitted by the guarantee that is treated as a § 956 investment. The ILM extends this analysis one step further to treat the unpaid interest on the third-party debt guaranteed by the CFC as constituting a direct benefit from the CFC to the Parent.

The ILM's analysis includes in the principal amount the stated interest that the unrelated party would be required to accrue in its income under the accrual method. If the Parent lacks liquidity or ability to pay interest, as seems likely on the facts of the ILM, one question is whether the lender would be entitled to apply the doubtful collectability exception5 to stop the accrual of interest. The ILM's analysis is premised on the conclusion that the interest did accrue for tax purposes to be added to the principal amount. The IRS appears to leave open the Parent to argue that the lender, in a doubtful collectability analysis, would not be required to accrue the interest on the debt.

The ILM's facts also are limited to the accrual of stated interest on the debt. It does not, by its terms, address original issue discount. For example, assume that, rather than borrowing $10 million at 5% interest, the Parent issued a $12 million zero coupon bond for a $10 million issue price. In this case, could the IRS assert that the "unpaid principal balance" in year 1 was $12 million face amount, or only the $10 million original issue price of the debt?


The ILM raises and resolves, in an anti-taxpayer manner, a difference between the rules for direct investments in U.S. property and indirect investments through a pledge or guarantee. It raises the prospects of the IRS broadly construing section 956 and the regulations thereunder in other instances where it believes a section 956 inclusion is warranted.

In the case of a third party loan to a U.S. parent, the borrowing company's best practice is to carefully analyze its credit agreements and push hard to avoid including CFCs within the net of guarantors of the agreement. Had the agreement been more carefully structured, or the taxpayer been more adamant to exclude the CFCs from the guarantee, the tax exposure addressed by the ILM would never have arisen.


1 Treas. Reg. § 1.956-1(e)(2).

2 Temp. Treas. Reg. § 1.956-2T(d)(2)(i).

3 See Treas. Reg. § 1.956-1(e)(1).

4 In this regard, the ILM cites and applies Rev. Rul. 80-361 and Rev. Rul. 2007-32.

5 See generally Garlock, Federal Income Taxation of Debt Instruments, ¶1602.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Events from this Firm
16 Nov 2018, Other, California, United States

Join leading dealmakers for a complimentary ​live video webcast panel on cross border M&A.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions