Client Alert

Final and Proposed Regulations Address U.S. Property Held by CFCs in Transactions Involving Partnerships

November 11, 2016

By David Makso & James Grace

On November 3, 2016, the Department of the Treasury (“Treasury”) and the Internal Revenue Service (the “IRS”) issued final regulations under sections 954 and 956 of the Internal Revenue Code of 1986, as amended (the “Code”), which clarify the method for determining the amount of U.S. property held by controlled foreign corporations (“CFCs”) in transactions involving partnerships (the “Final Regulations”).[1] Treasury and the IRS generally adopted proposed regulations (the “2015 Proposed Regulations”) and withdrew temporary regulations (the “2015 Temporary Regulations”) that were issued on September 2, 2015.[2] In addition, proposed regulations under section 956 of the Code were issued to address the treatment of U.S. property held by CFCs through partnerships which utilize special allocations (the “2016 Proposed Regulations”).[3]


A U.S. shareholder[4] of a CFC is required to include in gross income the earnings of the CFC if such CFC invests in U.S. property even if such earnings are not distributed to the U.S. shareholder. Pursuant to section 956 of the Code, the amount that a U.S. shareholder of a CFC must include in gross income with respect to the CFC is determined, in part, based on the average of the amounts of U.S. property held, directly or indirectly, by the CFC at the close of each quarter of its taxable year. In general, the amount taken into account with respect to any U.S. property is the adjusted basis of the property, reduced by any liability to which the property is subject. Complexity arises where a CFC owns U.S. property through a partnership.

The Anti-Avoidance Rule

Prior to the 2015 Temporary Regulations, the anti-avoidance rule under Treas. Reg. §1.956-1T(b)(4) provided that a CFC would be considered to hold indirectly investments in U.S. property acquired by any other foreign corporation that is controlled by the CFC if one of the principal purposes for creating, organizing, or funding (through capital contributions or debt) such other foreign corporation is to avoid the application of section 956 of the Code. The Final Regulations adopted the 2015 Temporary Regulations which expanded the scope of the anti-avoidance rule to apply to situations involving funding other than through capital contributions or debt and to apply to transactions involving partnerships that are controlled by a CFC.[5] In adopting the Final Regulations, Treasury and the IRS dismissed concerns that the anti-avoidance rule was overly broad, and instead argued that adopting the prior, narrower definition of funding would allow taxpayers to engage in inappropriate tax planning. Treasury and the IRS, however, added examples that illustrate that the anti-avoidance rule should not apply to certain common business transactions such as sales of property for cash in the ordinary course of business or repayments of loans.

The Final Regulations contain a coordination rule which states that the application of the anti-avoidance rule to partnerships will only apply to the extent that the amount of U.S. property that a CFC would be treated as holding under the rule exceeds the amount that it would otherwise be treated as holding under Treas. Reg. §1.956-4(b) (discussed below).[6] The coordination rule thereby eliminates the risk of duplicative income allocations with respect to the same partnership property.

Partnership Property Indirectly Held by a CFC Partner

Limitation on Use of Special Allocations

Under Treas. Reg. §1.956-4(b), a CFC that is a partner in a partnership determines its share of U.S. property held by a partnership in accordance with the CFC’s liquidation value percentage with respect to such partnership, or when relevant, based on a special allocation of income or gain. The 2016 Proposed Regulations provide that a partner’s attributable share will not be determined by reference to special allocations if the partner controls the partnership (e.g., the CFC owns more than 50% of the partnership).[7] This change reflects the concern of Treasury and the IRS that special allocations with respect to a partnership which is controlled by a single multinational group are unlikely to have economic significance on a group-wide basis and create the potential for abusive tax planning.

Elimination of Outside Basis Limitation

In 1990, Revenue Ruling 90-112 held that the amount of U.S. property taken into account for purposes of section 956 of the Code when a CFC partner indirectly owns property through a partnership is limited by the CFC’s adjusted basis in the partnership. Treasury and the IRS concluded that this outside basis limitation was not warranted. Revenue Ruling 90-112 has been made obsolete and the outside basis limitation is not reflected in either the Final Regulations or 2016 Proposed Regulations.

Time for Determining the Liquidation Value Percentage

The 2015 Proposed Regulations required the liquidation value percentage to be determined upon formation and subsequently upon the occurrence of specified revaluation events. In response to comments that partners’ relative economic interests in a partnership may change significantly in the absence of a revaluation event, the Final Regulations provide that if a partner’s liquidation value percentage on the first day of the partnership’s taxable year differs from the most recently determined liquidation value percentage by more than 10 percentage points, then the liquidation value percentage must be re-determined on that day.[8]

Obligations of Foreign Partnerships

Consistent Use of Liquidation Value Percentage with Respect to U.S. Property and Obligations

Under the CFC rules, if a CFC makes, or is a guarantor or pledgor with respect to, a loan to a U.S. person, the CFC is treated as making an investment in U.S. property. To ensure that this rule cannot be avoided through the use of foreign partnerships, proposed Treas. Reg. §1.956-4(c) of the 2015 Proposed Regulations provided that an obligation of a foreign partnership would be treated as an obligation of its partners in proportion to the partners’ interest in partnership profits unless certain exceptions apply. Due to the complexity and uncertainty inherent in assessing a partner’s interest in partnership profits, Treasury and the IRS determined that the liquidation value percentage method is preferable for determining a partner’s share of a foreign partnership’s obligations. Thus, the Final Regulations require the consistent use of the liquidation value percentage method for the purposes of determining a partner’s share of partnership property under Treas. Reg. §1.956-4(b) and a partner’s share of partnership obligations under Treas. Reg. §1.956-3(b).

Special Funded Distribution Rule

The Final Regulations also adopt a special funded distribution rule from the 2015 Proposed Regulations that increases the amount of a foreign partnership obligation that is treated as U.S. property when, among other requirements, a CFC makes, or is a guarantor or pledgor with respect to, a loan to a foreign partnership, such proceeds are distributed to a U.S. partner related to the CFC, and the obligation would be treated in whole or in part as U.S. property if held by the CFC.[9]

Comments Concerning Multiple Inclusions

Treasury and the IRS announced that they will continue to study the need to prescribe regulations to limit the aggregate inclusions of a U.S. shareholder with respect to a CFC to the unpaid principal amount of the obligation in situations where multiple CFCs provide a guarantee or pledge assets in support of a single U.S. obligation of a U.S. person.


The Final Regulations are generally applicable for tax years of CFCs ending on or after November 3, 2016. Certain sections of the Final Regulations have earlier effective dates, including the anti-avoidance rule of Treas. Reg. §1.956-1(b), which is applicable for tax years of CFCs ending on or after September 1, 2015.

The 2016 Proposed Regulations will be effective with respect to tax years of CFCs ending on or after their final publication and will only apply with respect to property acquired on or after such date.

[1] TD 9792, 81 FR 76497 (Nov. 3, 2016).

[2]   TD 9733, 80 FR 52976 (Sept. 2, 2015); REG-155164-09, 80 FR 53058 (Sept. 2, 2015). TD 9792 also finalizes proposed regulations, and withdraws temporary regulations, published on June 14, 1988. TD 8209, 53 FR 22171 (June 14, 1988); INTL-49-86, subsequently converted to REG-209001-86, 53 FR 22186 (June 14, 1988).

[3]  REG-114734-16, 81 FR 76542 (Nov. 3, 2016).

[4]  The term “U.S. shareholder” means any U.S. person who owns at least 10% of the total combined voting power of all classes of stock of a CFC entitled to vote.

[5]   Treas. Reg. §1.956-1(b)(1)(ii) and (iii).

[6]  Treas. Reg. §1.956-1(b)(3).

[7]  Treas. Reg. §1.956-4(b)(2)(iii). A partner is treated as controlling a partnership if the partner and the partnership are related within the meaning of section 707(b), substituting “at least 80%” for “more than 50 percent”.

[8] Treas. Reg. §1.956-4(b)(2)(i).

[9]  Treas. Reg. §1.956-4(c)(3).

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