IRS Notice 2010-41, 2010-22 IRB 715: Regulations Will be Issued That Will Classify Some Domestic Partnerships as Foreign Partnerships for Applying the Controlled Foreign Corporation Rules.
On May 14, 2010, the IRS and Treasury announced in Notice 2010-41, that they will issue regulations classifying certain domestic partnerships as foreign partnerships for the purpose of identifying the US shareholders of a CFC with respect to income inclusions (for Subpart F income) in accordance with §951(a). This announcement continues to reflect the Service’s concern, as set forth in Notice 2009-7, 2009-1 C.B. 312, identifying the following transaction (and substantially similar transactions) as a "transaction of interest" for purposes of Treas. Reg. § 1.6011-4(b)(6) and §§ 6111 and 6112. Notice 2009-7 continues in effect. Basic Scenario Under Question by Service CFC3 has amounts described in § 951(a)(1). Taxpayers have taken the position that this structure avoids the flow through of Subpart F income under §951(a) with respect to CFC 3Taxpayer takes the position that it does not have an income inclusion under § 951(a) with respect to CFC3 because the domestic partnership is the first United States person in the chain of ownership of CFC3. This argument finds substance in a literal application of the Code. For starters, §957(c) defines a United States person by reference to § 7701(a)(30). Section 7701(a)(30)(B) defines a US person to include a domestic partnership. Section 7701(a)(5) defines the term "foreign" as applied to a corporation or partnership as a corporation or partnership that is not domestic. Section 7701(a)(4) provides that the term domestic when applied to a corporation or partnership means created or organized in the United States or under the law of the United States or of any State unless, in the case of a partnership, the Secretary provides otherwise by regulations. So far so good for the "literalists" view. However, § 7701(a) provides that any general definition included therein does not apply where such definition is manifestly incompatible with the intent of the relevant Code provision.
Notice 2009-7, supra, states, in challenging this construct, that the taxpayer’s argument of avoiding CFC status for CFC 3 is contrary to the purpose and intent of §951 and that regulations will be issued requiring the domestic partnership to be treated as a foreign partnership thereby requiring the Subpart F income of CFC 3 to be passed up with character intact to the CFC 1 and CFC 2. Thus, the Treasury is taking the view that the definition of a domestic partnership under §7701(a)(4), for certain partnerships wholly or partly owned by foreign corporations, is contrary to the legislative intent of §951. As set forth in the recent Notice 2010-41, which also announced that the regulations will apply for tax years of domestic partnerships ending after May 13, 2010, will treat domestic partnerships as foreign if certain conditions are met. Guidance will also address tiered partnership structures. On December 29, 2008, the Treasury Department and the IRS issued Notice 2009-7, 2009-1 C.B. 312, identifying the following transaction (and substantially similar transactions) as a transaction of interest for purposes of § 1.6011-4(b)(6) and §§ 6111 and 6112 of the Code. A United States taxpayer (Taxpayer) wholly owns two controlled foreign corporations (CFC1 and CFC2), each of which owns 50 percent of another controlled foreign corporation (CFC3) through a domestic partnership. CFC3 has amounts described in § 951(a)(1). Taxpayer takes the position that it does not have an income inclusion under § 951(a) with respect to CFC3 because the domestic partnership is the first United States person in the chain of ownership of CFC3. As stated in Notice 2009-7, the Treasury Department and IRS believe that Taxpayer's position is contrary to the purpose and intent of § 951 of the Code. The recent notice specifies that the regulations will treat a domestic partnership as foreign where: 1. The partnership is a US shareholder of a CFC per §§957(a) or 953(c); and 2. If the partnership were treated as foreign: (i) the FC would continue to be a CFC; and (ii)at least one United States shareholder of the CFC; (a) would be treated under § 958(a) as indirectly owning stock of the CFC owned by the partnership that is indirectly owned by a foreign corporation; and (b) it would be required to include an amount in gross income under § 951(a) with respect to the CFC. The regulations to be issued will provide similar results in the case of tiered-partnership structures. It should be noted that Notice 2009-7, supra, continues in effect treating the above structure, or one substantially similar to the structure, as a "transaction of interest". As further stated in Notice 2009-7, the IRS may challenge the positions taken by taxpayers with respect to such transactions, including under the provisions of subpart F and subchapter K of the Code, or under judicial doctrines including the sham transaction, substance over form, and economic substance doctrines. Note recent codification of §7701(o) and related strict liability penalty provision.
