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Subpart F Look-through Rule Lapses: Are You Prepared?

10 Mar 2012

International corporate tax policy often highlights the tension between promoting global competitiveness for US multinationals, on the one hand, and protecting the fiscal policy, on the other hand. Six years ago, the tax policy pendulum had swung towards fostering global competitiveness, and Congress enacted the Subpart F look-through rule as part of the Tax Increase Prevention and Reconciliation Act of 2005. It now appears the pendulum has swung in the opposite direction. Congressional efforts to extend the look-through rule to taxable years beginning after 1 January 2012 or to make it permanent were introduced as late as the fall - but ended up tabled. Taxand US reviews the likely impact of the lapse of the Subpart F Look-through rule on multinationals with operations in the US.

Overview of Subpart F and the Look-through Rule
Under the Subpart F tax rules, certain offshore earnings generated by US-controlled foreign corporation (CFC) subsidiaries are subject to a deemed dividend tax as if such earnings were repatriated to the US shareholders. One significant category of currently taxable Subpart F income is foreign personal holding company income (FPHCI) - generally, dividends, interest, rents, royalties and other types of passive income earned by CFCs is Subpart F income and taxable as a deemed dividend to the CFC's US shareholders. The look-through rule provided that payments of dividends, interest, rents and royalties between related CFCs were not FPHCI to the recipient to the extent the income could be traced to income that was neither Subpart F income nor effectively connected income (ECI) in the hands of the payor CFC. The Subpart F look-through regime provided multinationals with flexibility to move cash around from affiliate to affiliate in their deferral structures. Consider the following operational structure:

Taxand US explores this issue is greater detail

Taxand's Take

After six years of codification under IRC Section 954(c)(6), the Subpart F look-through rule went quietly into the night as the last extender lapsed in 2011. It is uncertain whether Congress during this election year, or in subsequent years, will decide to resurrect this significant provision in the Subpart F tax regime. If the look-through rule is not resurrected, we may see businesses return to traditional unrelated-to-unrelated commissionaire transaction flows in order to avoid Subpart F in situations where 954(c)(6) previously provided relief. What is certain, however, is that the lapse of this provision can have dramatic effects on your company's tax profile and global effective tax rate for 2012 and onward if you previously relied on 954(c)(6) to implement intercompany payments of income. Now is the time to take steps to assess your structure's exposure to this lapse, and to make efforts to remediate your Subpart F tax exposures.

Your Taxand contact for further queries is:

David Zaiken
T. +1 415 490 2255

Taxand's Take Author