International Tax Alert
On January 9, 2007, the IRS announced in Notice 2007-13 its intention to eliminate the Subpart F “substantial assistance” rules for foreign-to-foreign service arrangements and to limit their application to certain instances in which a U.S. person provides substantial assistance to a related foreign company. Treas. Reg. §§ 1.954-4(b) (1) (iv) and (b) (2) (ii) will be amended accordingly, effective for tax years of foreign corporations beginning on or after January 1, 2007. Taxpayers may rely on the guidance in the notice as of January 1, 2007. The Notice also requests comments on a number of issues, including the treatment of performance guarantees. Given this and related developments, taxpayers should take a fresh look at their international tax planning and ensure that their current structures are optimal in light of the new environment.
Elimination of Substantial Assistance Rules - Foreign-to-Foreign Context
The substantial assistance rules have been in place since 1968 and were intended to prevent a perceived taxpayer end-run around the foreign base company services rules. In general, the foreign base company services rules treat as Subpart F income any income earned by a controlled foreign corporation (“CFC”) from the performance of services outside of the CFC’s home country for a related person. The substantial assistance rules generally treated as Subpart F income any service-related income of a CFC, including income from unrelated persons, where a related person substantially contributed to the CFC’s performance of such services.
Under the new guidance, the substantial assistance rules will no longer apply where one CFC earns income from services with respect to which a related CFC provided substantial assistance. The Notice generally attributes this change in policy to the increasing global integration of business since the promulgation of the substantial assistance rules in 1968. The IRS acknowledged that the existing substantial assistance rules could affect the manner in which such multinationals structure their operations. In particular, although many taxpayers have been able to plan around the substantial assistance rules by using check-the-box structures and contractual arrangements, others have been limited by their existing structures, use of per se entities, and incompatible foreign tax credit planning. The rollback of the substantial assistance rules in the Notice will level the playing field for such taxpayers.
Limitation of Substantial Assistance Rules - U.S.-to-Foreign Context
Under the Notice, direct or indirect substantial assistance by a U.S. person to a CFC will continue to give rise to Subpart F income, but only to the extent that the cost of such assistance is 80 percent or more of the total cost of performing the services. The substantial assistance rules will be retained in these limited circumstances to prevent taxpayers from shifting assistance-related profits from the U.S. taxpayers to related CFCs in low-tax jurisdictions. The Notice requests comments on whether the 80-percent cost test is appropriate for certain industries.
New Environment for International Tax Planning
In conjunction with the temporary Subpart F look-through rules of section 954(c)(6) and the proposed guidance in the section 959 PTI area, the elimination of the substantial assistance rules in Notice 2007-13 represents a significant liberalization of the Subpart F rules applicable to foreign-to-foreign transactions. The evolution of the government’s view in recent years regarding the underlying policies of Subpart F has been remarkable. Given this and related developments, taxpayers should take a fresh look at their international tax planning and ensure that their current structures are optimal in light of the new environment.
For further information, please contact any of the following lawyers:
Rocco Femia, firstname.lastname@example.org, 202-626-5823
Marc Gerson, email@example.com, 202-626-1475
Layla Asali, firstname.lastname@example.org, 202-626-5866