Treasury and the IRS Withdraw Proposed 2006 Previously Taxed Earnings and Profits Regulations
Introduction: 2006 Previously Taxed Earnings and Profits Regulations Withdrawn
On October 20, 2022, the Treasury and IRS published in the Federal Register a “withdrawal of notice of proposed rulemaking” regarding the exclusion from gross income of previously taxed earnings and profits (“PTEP”) under section 959 and related basis adjustments under section 961 (the “Withdrawal Notice”).
On August 29, 2006, the Treasury Department and the IRS issued a notice of proposed rulemaking relating to the exclusion from gross income of PTEP under section 959 and related basis adjustments under section 961 (71 FR 51155), to which corrections were published in the Federal Register on December 8, 2006 (71 FR 71116 (together, the “2006 Proposed Regulations”)). On December 14, 2018, the Treasury and the IRS issued Notice 2019-001, which announced the intention to withdraw the 2006 Proposed Regulations and issue a new notice of proposed rulemaking under sections 959 and 961.
The Withdrawal Notice stated that the 2006 Proposed Regulations “were never finalized, never went into effect, and did not indicate that taxpayers could rely on them.” The Withdrawal Notice states that the government is withdrawing the 2006 Proposed Regulations to “help prevent possible abuse or misuse of them–such as inappropriate basis adjustments in certain stock acquisitions to which section 304(a)(1) applies–while the Treasury Department and the IRS continue to develop the new proposed regulations.” The Withdrawal Notice goes on to state that the IRS may, where appropriate, challenge taxpayer positions giving rise to “inappropriate results.”
Background on the 2006 Proposed PTEP Regulations
The 2006 Proposed Regulations permitted basis (and PTEP) sharing as between members of the same consolidated group and with respect to basis and PTEP held by the U.S. shareholder in different blocks of stock. The overarching principle of the basis and PTEP sharing in the 2006 Proposed Regulations rules was to prevent double taxation of amounts that had been previously included in gross income by a U.S. shareholder under section 951(a), and, to prevent such double taxation at the earliest possible time. Consistent with legislative intent of avoiding double taxation, the 2006 Proposed Regulations sought to allow U.S. persons to receive the full benefit of their PTEP at the earliest possible time. The rules accomplished this by requiring the U.S. shareholder to maintain shareholder accounts for PTEP.
As discussed, the 2006 Proposed Regulations did not contain reliance language. However, some taxpayers relied on them, in combination with certain other guidance and authorities, to execute certain transactions that resulted in basis shifting as between CFCs owned by the same U.S. shareholder through different section 958(a) ownership chains. Despite the guidance in the 2006 Proposed Regulations, in the regulation withdrawal, Treasury and the IRS stated that they believe that the result from certain cross-chain section 304(a)(1) transactions is “inappropriate.” Accordingly, the Treasury and the IRS withdrew the 2006 Proposed Regulations. The reference to “inappropriate results” may have been to certain loss planning transactions where PTEP and basis was shifted, cross-chain, for the purpose of claiming a loss. Note that the forthcoming PTEP regulations which are expected to be released sometime in 2023 are expected to provide guidance on many of the unanswered issues under section 959 and 961. During a recent ABA panel, an IRS official suggested that the forthcoming PTEP regulations are expected to address minimizing section 961(b)(2) gain. This suggests that sharing PTEP/basis for purposes of minimizing section 961(b)(2) gain is not an “inappropriate result.” The forthcoming PTEP regulations are also expected to address mid-year distributions and corresponding basis adjustments. These forthcoming regulations may provide final rules for portions of the guidance that was contained within the 2006 Proposed Regulations and further define the contours of what types of PTEP and basis sharing are permissible. If they do, they will likely contain broad anti-abuse rules to prevent results that Treasury and the IRS view as “inappropriate.”
Conclusion
Taxpayers that relied on the 2006 Proposed Regulations for PTEP and basis sharing are on notice that the IRS may challenge these transactions. They should discuss these positions with their advisors and closely evaluate the forthcoming PTEP guidance once it is released.
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