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AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

This document contains proposed regulations implementing section 1101 of the Bipartisan Budget Act of 2015 (BBA), which was enacted into law on November 2, 2015. Section 1101 of the BBA repeals the current rules governing partnership audits and replaces them with a new centralized partnership audit regime that, in general, assesses and collects tax at the partnership level. These proposed regulations provide rules addressing how certain international rules operate in the context of the centralized partnership audit regime, including rules relating to the withholding of tax on foreign persons, withholding of tax to enforce reporting on certain foreign accounts, and the treatment of creditable foreign tax expenditures of a partnership.

DATES:

Written or electronic comments and requests for a public hearing must be received by January 29, 2018.

ADDRESSES:

Send submissions to: CC:PA:LPD:PR (REG-119337-17), Room 5207, Internal Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8:00 a.m. and 4:00 p.m. to CC:PA:LPD:PR (REG-119337-17), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue NW., Washington, DC 20224, or sent electronically via the Federal eRulemaking Portal at www.regulations.gov (IRS REG-119337-17).

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FOR FURTHER INFORMATION CONTACT:

Concerning the proposed regulations relating to creditable foreign tax expenditures, Larry R. Pounders, Jr., of the Office of Associate Chief Counsel (International), (202) 317-5465; concerning the proposed regulations relating to chapters 3 and 4 of subtitle A of the Internal Revenue Code (other than section 1446), Subin Seth of the Office of Associate Chief Counsel (International), (202) 317-5003; concerning the proposed regulations relating to section 1446, Ronald M. Start Printed Page 56766Gootzeit of the Office of Associate Chief Counsel (International), (202) 317-4953; concerning the submission of comments or a request for a public hearing, Regina Johnson, (202) 317-6901 (not toll-free numbers).

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SUPPLEMENTARY INFORMATION:

Background

This document contains proposed amendments to 26 CFR part 301. These proposed regulations supplement the regulations proposed in the notice of proposed rulemaking (REG-136118-15) published in the Federal Register on June 14, 2017 (82 FR 27334) (the “June 14 NPRM”) and amend the Procedure and Administration Regulations (26 CFR part 301) under Subpart—Tax Treatment of Partnership Items to implement the centralized partnership audit regime.

1. The New Centralized Partnership Audit Regime

For information relating to (1) the new centralized partnership audit regime enacted by the BBA, Public Law 114-74 (129 Stat. 58 (2015)) (as amended by the Protecting Americans from Tax Hikes Act of 2015, Public Law 114-113 (129 Stat. 2242 (2015))); (2) Notice 2016-23 (2016-13 I.R.B. 490 (March 28, 2016)), which requested comments on the new partnership audit regime enacted by the BBA; and (3) the temporary regulations (TD 9780, 81 FR 51795) and a notice of proposed rulemaking (REG-105005-16, 81 FR 51835), which provided the time, form, and manner for a partnership to make an election into the centralized partnership audit regime for a partnership taxable year beginning before the general effective date of the regime, see the Background section of the June 14 NPRM.

2. Proposed Regulations Implementing the Centralized Partnership Audit Regime

The June 14 NPRM addresses various issues concerning the scope and process of the new centralized partnership audit regime. Unless otherwise noted, all references to proposed regulations in this Background refer to regulations proposed by the June 14 NPRM.

With respect to the scope of the centralized partnership audit regime, proposed § 301.6221(a)-1(a) provides that any adjustment to items of income, gain, loss, deduction, or credit of a partnership and any partner’s distributive share is determined at the partnership level. Proposed § 301.6221(a)-1(b)(1) broadly defines the phrase “items of income, gain, loss, deduction, or credit” to include all items and information required to be shown, or reflected, on a partnership return or maintained in the partnership’s books and records. For example, proposed § 301.6221(a)-1(b)(1)(i)(A) provides that the character, timing, source, and amount of the partnership’s income, gain, loss, deductions, and credits, including whether an item is deductible, tax-exempt, or a tax-preference item, must be determined under the centralized partnership audit regime. Similarly, proposed § 301.6221(a)-1(b)(1)(i)(F) provides that an adjustment to the separate category, timing, and amount of the partnership’s creditable foreign tax expenditures described in § 1.704-1(b)(4)(viii)(b), is included within the centralized partnership audit regime. Finally, proposed § 301.6221(a)-1(d) provides that the IRS is not precluded from making an adjustment to an item that must be determined under the centralized partnership audit regime for purposes of determining taxes imposed by provisions of the Internal Revenue Code (the Code) outside of chapter 1 of subtitle A (chapter 1).

Proposed § 301.6222-1 generally requires a partner to treat items consistently with the partnership’s return; however, a partner may take an inconsistent position on an original income tax return if the partner provides notice of the inconsistent position in accordance with proposed § 301.6222-1(c). If a partner treats an item inconsistently with the partnership return position without providing notice, the item may be adjusted to conform to the partnership return, and any underpayment resulting from that adjustment may be assessed and collected as if it were on account of a mathematical or clerical error appearing on the partner’s return.

Proposed § 301.6223-1 provides rules relating to the designation of the partnership representative. Proposed § 301.6223-2 provides rules relating to the authority of the partnership representative and the effect of actions taken by the partnership through the partnership representative. Partners are bound by the actions of the partnership representative and may not take a position that is inconsistent with the actions of the partnership (except with notice on the partner’s return, as provided under section 6222 and proposed § 301.6222-1).

Proposed §§ 301.6225-1, 301.6225-2, and 301.6225-3 provide rules relating to partnership adjustments, including the computation of the imputed underpayment, modification of the imputed underpayment, and the treatment of adjustments that do not result in an imputed underpayment. Under proposed § 301.6225-1(d), adjustments are separated into four groupings: the reallocation grouping, the credit grouping, the creditable expenditure grouping, and the residual grouping. The June 14 NPRM reserved § 301.6225-1(d)(2)(iv) for rules addressing the treatment of items in the creditable expenditure grouping. Each grouping is further divided into subgroupings of adjustments to account for preferences, restrictions, limitations, and conventions. For example, an adjustment in the residual grouping could be further divided into subgroupings by character, source, category, and other restrictions under the Code.

Under proposed § 301.6225-1, the net positive adjustments in all subgroupings of the residual and reallocation groupings are summed. The sum is the total netted partnership adjustment, which is multiplied by the highest applicable tax rate in effect for the reviewed year (as defined in proposed § 301.6241-1(a)(8)). The resulting figure is then increased, or decreased, by the net adjustments in the credit grouping to produce the imputed underpayment amount. A net non-positive adjustment in the reallocation grouping or the residual grouping (or any subgrouping thereof) is treated as an adjustment that does not result in an imputed underpayment and is taken into account in the adjustment year (as defined under proposed § 301.6241-1(a)(1)) under proposed § 301.6225-3.

The partnership may request a modification, under proposed § 301.6225-2, to adjust the imputed underpayment calculated under proposed § 301.6225-1. The modification rules set out in proposed § 301.6225-2 generally allow: (1) Modifications that result in the exclusion of certain adjustments, or portions thereof, from the calculation of the imputed underpayment (such as a modification under proposed § 301.6225-2(d)(2) (amended returns by partners), (d)(3) (tax-exempt partners), (d)(5) (certain passive losses of publicly traded partnerships), (d)(7) (partnerships with partners that are qualified investment entities described in section 860), (d)(8) (partner closing agreements), and, if applicable, (d)(9) (other modifications)); (2) rate modifications, which affect only the taxable rate applied to the total netted partnership adjustment (described in proposed § 301.6225-2(d)(4)); and (3) modifications to the number and composition of imputed underpayments (described in proposed § 301.6225-2(d)(6)).Start Printed Page 56767

Proposed § 301.6225-3 sets forth rules for the treatment of adjustments that do not result in an imputed underpayment. In general, pursuant to proposed § 301.6225-3(b)(1) the partnership takes the adjustment into account in the adjustment year as a reduction in non-separately stated income or as an increase in non-separately stated loss depending on whether the adjustment is to an item of income or loss. Proposed § 301.6225-3(b)(2) provides that if an adjustment is to an item that is required to be separately stated under section 702, the adjustment shall be taken into account by the partnership on its adjustment year return as an adjustment to such separately stated item. Proposed § 301.6225-3(b)(3) provides that an adjustment to a credit is taken into account as a separately stated item.

Proposed §§ 301.6226-1, 301.6226-2, and 301.6226-3 provide rules relating to the election under section 6226 by a partnership to have its partners take into account the partnership adjustments in lieu of paying the imputed underpayment determined under section 6225, the statements the partnership must send to its partners (including the computation of the partners’ safe harbor amounts), and the computation and payment of the partners’ liability. If a partnership makes the election under section 6226 to “push out” adjustments to its reviewed year partners, the partnership is not liable for the imputed underpayment. Instead, under proposed § 301.6226-3, reviewed year partners must either pay any additional chapter 1 tax that results from taking the adjustments reflected on the statements into account in the reviewed year and from changes to the tax attributes in the intervening years, or pay a safe harbor amount, which is calculated based on rules similar to those used to calculate the imputed underpayment. In addition to being liable for the additional tax or safe harbor amount, the partner must also pay its allocable share of any penalties, additions to tax, or additional amounts reflected on the statement from the partnership, and any interest determined in accordance with proposed § 301.6226-3(d).

Proposed § 301.6227-1 provides rules for a partnership to file an administrative adjustment request (AAR). A partnership subject to the centralized partnership audit regime may file a request for an administrative adjustment to one or more items of income, gain, loss, deduction, or credit of the partnership for any partnership taxable year. Filing an AAR is the only mechanism provided by the centralized partnership audit regime to request a change to an item reported on a partnership return that has already been filed with the IRS. Proposed § 301.6227-1(a) provides that only a partnership representative acting on behalf of the partnership may file an AAR; a partner may not make a request for an item to be adjusted administratively, such as by filing an amended return to take a position that is inconsistent with the partnership return. However, this rule does not preclude a partner from taking an inconsistent position on an original income tax return if the partner provides notice of the inconsistent position in accordance with proposed § 301.6222-1(c).

Proposed §§ 301.6227-2 and 301.6227-3 provide rules for how the partnership accounts for adjustments in an AAR and for how partners must account for adjustments in an AAR, respectively. Subject to certain special rules, adjustments in an AAR are generally taken into account in a manner similar to IRS-initiated adjustments. For example, an adjustment requested in an AAR may result in an imputed underpayment calculated in a manner similar to the computation of the imputed underpayment under section 6225, although modification is more restricted in the context of an AAR (see proposed § 301.6227-2(a)(2)). The partnership must pay the imputed underpayment or elect to have it and its partners take the adjustments into account under rules similar to those under section 6226. One significant difference between an IRS-initiated adjustment and an adjustment requested in an AAR is that requested adjustments that do not result in an imputed underpayment are accounted for under rules similar to those under section 6226.

Finally, proposed § 301.6241-1 provides definitions for purposes of the centralized partnership audit regime.

Explanation of Provisions

1. In General

These proposed regulations provide guidance on certain international issues related to the centralized partnership audit regime. This Explanation of Provisions proceeds as follows: Part 2 discusses provisions related to chapters 3 and 4 of subtitle A of the Code. Part 3 discusses provisions related to creditable foreign tax expenditures and foreign tax credits. Part 4 discusses issues related to treaties and reductions to the rate of tax on foreign persons under the Code. Part 5 discusses issues related to certain foreign corporations.

Unless otherwise stated, all references to proposed regulations in this Explanation of Provisions are to the new proposed regulations in this Notice of Proposed Rulemaking. Because these regulations are supplementing the regulations published in the June 14 NPRM, the numbering and ordering of some of the provisions do not follow typical conventions. The Department of the Treasury (Treasury Department) and the IRS intend to appropriately integrate these provisions when both these regulations and the proposed regulations in the June 14 NPRM are finalized.

2. Provisions Related to Chapters 3 and 4 of Subtitle A of the Code

A. Background

Chapter 3 (Withholding of Tax on Nonresident Aliens and Foreign Corporations) of subtitle A of the Code imposes withholding requirements on payments or allocations of income to foreign persons (under sections 1441 through 1446) and provides rules regarding the application of those withholding provisions (under sections 1461 through 1464). Sections 1441 and 1442 require all persons having the control, receipt, custody, disposal, or payment of certain specified items of income of any nonresident alien, foreign partnership, or foreign corporation to withhold tax at a 30-percent rate from such items unless a reduced rate of withholding applies. Amounts subject to withholding under sections 1441 and 1442 include amounts from sources within the United States that constitute fixed or determinable annual or periodical income, which in turn is defined under § 1.1441-2(b)(1)(i) to include all income included in gross income under section 61, subject to certain exceptions. In addition to being required to withhold on a payment made to a foreign person, a domestic (U.S.) partnership is required to withhold under sections 1441 and 1442 on an amount subject to withholding that is includible in the gross income of a partner that is a foreign person. See § 1.1441-5(b)(2)(i). A foreign partnership may also be required to withhold with respect to its foreign partners under sections 1441 and 1442 if it is either a foreign withholding partnership as described in § 1.1441-5(c)(2), or fails to meet the requirements described in § 1.1441-5(c)(3)(v). A partnership satisfies its withholding requirements with respect to its foreign partners by withholding on distributions made to the partner that include amounts subject to withholding, or, to the extent the partnership’s withholding liability is not satisfied by withholding on distributions, by Start Printed Page 56768withholding on the partner’s distributive share. See § 1.1441-5(b)(2)(i).

Section 1446 requires a partnership to pay withholding tax to the extent that the partnership has effectively connected taxable income (ECTI) that is allocable to a foreign partner, at the highest rate applicable to that partner. See § 1.1446-3(a)(2). ECTI generally refers to the partnership’s taxable income as computed under section 703, with adjustments as provided in section 1446(c) and § 1.1446-2, and computed with consideration of only those partnership items that are effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States. See § 1.1446-2.

Section 1443 imposes withholding requirements on certain payments or allocations of income made to foreign tax-exempt organizations, including income includible under section 512 for computing unrelated business taxable income (subject to section 1443(a)) and income subject to tax under section 4948 (subject to section 1443(b)). Because the tax under section 4948 is not a chapter 1 tax, and therefore is not implicated by the centralized partnership audit regime, references to chapter 3 in this preamble and these proposed regulations refer to the provisions in chapter 3 of subtitle A of the Code, excluding section 1443(b). See proposed § 301.6225-1(a)(4).

Section 1445 imposes withholding requirements upon the disposition of a U.S. real property interest (as defined in section 897(c)) by a foreign person and certain related distributions. To the extent that a partnership’s income from the disposition of a U.S. real property interest is allocable to a foreign partner, the partnership is subject to the requirements under section 1446. See §§ 1.1446-2; 1.1446-3(c)(2).

Chapter 4 (Taxes to Enforce Reporting on Certain Foreign Accounts) of subtitle A of the Code (chapter 4) requires a withholding agent (as defined in § 1.1473-1(d)) to withhold tax at a 30-percent rate on a withholdable payment (as defined in § 1.1473-1(a)) made to a foreign financial institution (FFI) unless the FFI has entered into an agreement described in section 1471(b) to obtain status as a participating FFI, or the FFI is deemed to have satisfied the requirements of section 1471(b). A participating FFI is required to withhold tax with respect to payments made to recalcitrant account holders (as defined in § 1.1471-5(g)(2)) and nonparticipating FFIs (as defined in § 1.1471-1(b)(82)) to the extent required under § 1.1471-4(b). Chapter 4 also generally requires a withholding agent to withhold tax at a 30-percent rate on a withholdable payment made to a nonfinancial foreign entity (NFFE) unless the NFFE has provided information to the withholding agent with respect to the NFFE’s substantial U.S. owners or has certified that it has no such owners. See section 1472.

Under sections 1461 and 1474, any person required to withhold tax under chapters 3 and 4 is made liable for such tax, and may also be liable for any penalties, additions to tax, additional amounts, and interest that may apply for failure to timely pay the tax required to be withheld. To the extent that the tax required to be withheld is paid by the beneficial owner of the income (as defined in §§ 1.1441-1(c)(6) and 1.1471-1(b)(8)) or by the withholding agent (as defined in §§ 1.1441-7(a)(1) and 1.1473-1(d)), the tax will not be collected a second time from the other; however, the person that did not pay the tax is not relieved from liability for any penalties, additions to tax, or interest that may apply. See §§ 1.1446-3(e); 1.1463-1; 1.1474-4.

Under §§ 1.1462-1 and 1.1474-3, a beneficial owner is required to include in gross income the entire amount of income from which tax is required to be withheld, but the amount of any tax actually withheld (including any amount withheld on a partner’s distributive share) is allowed as a credit under section 33 against the beneficial owner’s income tax liability. Similarly, under § 1.1446-3(d)(2)(i), the amount of section 1446 tax paid by the partnership that is allocable to a foreign partner is allowed as a credit under section 33 against the partner’s income tax liability. In general, because the beneficial owner will have gross income during the taxable year when the withholding occurs, the beneficial owner will be required to file a U.S. income tax return for that year. See section 6012. However, a beneficial owner’s requirement to file a return is waived when it is not engaged in a U.S. trade or business and its tax liability has been fully satisfied through withholding at source. See §§ 1.6012-1(b)(2)(i); 1.6012-2(g)(2)(i).

B. Coordination of the Centralized Partnership Audit Regime With Chapters 3 and 4

Proposed § 301.6221(a)-1(a) (June 14 NPRM) provides that all adjustments to items of income, gain, loss, deduction, or credit of a partnership, and any partner’s distributive share of those adjusted items are determined, and any tax attributable thereto is assessed and collected, at the partnership level under the centralized partnership audit regime. Proposed § 301.6221(a)-1(b)(1)(i) (June 14 NPRM) broadly defines the phrase “items of income, gain, loss, deduction, or credit” to include all items and information required to be shown, or reflected, on a partnership return or maintained in the partnership’s books and records. Proposed § 301.6221(a)-1(b)(3) (June 14 NPRM) defines tax for purposes of the centralized partnership audit regime to be the tax imposed by chapter 1. Proposed § 301.6221(a)-1(d) (June 14 NPRM), however, provides that nothing in subchapter C of chapter 63 and the regulations thereunder (the centralized partnership audit regime) precludes the IRS from making any adjustment to any of these items for purposes of determining taxes imposed by other chapters of the Code. The preamble to the June 14 NPRM explains that those taxes that are not covered by the centralized partnership audit regime include taxes imposed by chapters 3 and 4. Accordingly, the IRS will continue to examine a partnership’s compliance with its obligations under chapters 3 and 4 in a proceeding outside of the centralized partnership audit regime.

As discussed in Part 2.A of this Explanation of Provisions, a partnership that receives a payment or has income allocable to a partner that is a foreign person, an FFI, or an NFFE may have withholding requirements under chapters 3 and 4. These requirements are imposed on the partnership to ensure that any chapter 1 tax owed by its partners with respect to the item of income is collected, or in the case of chapter 4, to ensure compliance with certain information reporting obligations regarding U.S. persons that hold foreign financial accounts or interests in passive foreign entities. The provisions of chapters 3 and 4, therefore, create a collection mechanism for tax that would otherwise be due from the beneficial owner of the income under chapter 1. This could potentially result in taxes being collected twice and, for this reason, and as discussed in Part 2.A of this Explanation of Provisions, chapters 3 and 4 provide that the tax is collected only once—either from the withholding agent or from the beneficial owner of the income. Similarly, because an imputed underpayment may now be assessed and collected at the partnership level under the centralized partnership audit regime, and is designed to closely reflect the chapter 1 tax that the partners would have reported and paid had the partnership and partners reported Start Printed Page 56769correctly, coordination rules are necessary to clarify how the centralized partnership audit regime interacts with a partnership’s obligations under chapters 3 and 4, and to ensure that tax is collected only once with respect to the same item of income.

To demonstrate the rules regarding the scope of the centralized partnership audit regime and the examination of the partnership’s obligations under chapters 3 and 4 outside of the centralized partnership audit regime, these proposed regulations provide examples that illustrate what occurs when (1) a partnership fails to withhold at the correct rate on an item of income allocable to a foreign partner, and (2) a partnership fails to report an item of income and, therefore, also fails to withhold on the additional income allocable to a foreign partner. Example 1 under proposed § 301.6221(a)-1(f) clarifies that a partnership’s withholding tax liability for failure to withhold at the correct rate on an item of income that the partnership received and properly reported on its partnership return may be adjusted by the IRS under the procedures applicable to an examination under chapter 3 or chapter 4, and that the procedures under the centralized partnership audit regime do not apply to the adjustment. The same result would occur on a partnership’s failure to withhold at the correct rate under section 1441 on a payment made to an unrelated foreign person, or upon a partnership’s failure to withhold as a transferee of a U.S. real property interest at the correct rate under section 1445. Example 2 under proposed § 301.6221(a)-1(f) presents a case in which the partnership has failed to report on its partnership return an item of income that it received for which it would have had a withholding obligation under chapters 3 and 4, and the failure to report the item is discovered in an examination of the partnership’s compliance with its obligations under chapters 3 and 4. Because an adjustment to increase the partnership’s income would be an adjustment to an item of income of the partnership, it would be subject to the centralized partnership audit regime. See proposed § 301.6221(a)-1(a) (June 14 NPRM). However, under proposed § 301.6221(a)-1(d) (June 14 NPRM), the IRS is not precluded from determining an adjustment to the same item under chapters 3 and 4 outside of the centralized partnership audit regime.

To address situations in which an item subject to the centralized partnership audit regime is also subject to the rules under chapters 3 and 4, these proposed regulations provide rules that coordinate the interaction between the separate regimes, and ensure that tax is collected only once with respect to the same adjustment. When an examination of the partnership’s obligations under chapters 3 and 4 is conducted before the initiation of an administrative proceeding under the centralized partnership audit regime, proposed § 301.6225-1(c)(5) provides that to the extent that the IRS has collected tax under chapter 3 or chapter 4 attributable to an adjustment to an amount subject to withholding (as defined in § 301.6226-2(h)(3)(i)), that adjustment (or portion thereof) will be disregarded for purposes of calculating the total netted partnership adjustment (upon which the imputed underpayment amount is determined) under the centralized partnership audit regime. When the IRS has not collected tax under chapter 3 or chapter 4 on an amount subject to withholding, and the partnership is subject to examination under the centralized audit partnership regime, proposed § 301.6225-1(a)(4) provides that if the partnership pays the imputed underpayment pursuant to section 6225, and the total netted partnership adjustment (upon which the imputed underpayment amount is determined) includes an adjustment to an amount subject to withholding under chapter 3 or chapter 4, the partnership is treated as having paid the amount required to be withheld with respect to that adjustment under chapter 3 or chapter 4 for purposes of applying § 1.1463-1 or § 1.1474-4. Therefore, the partnership is considered to have satisfied its withholding tax liability associated with the adjustment. The partnership, however, is not relieved from any interest, penalties, or additions to tax that may otherwise apply under current rules for failure to withhold under chapters 3 and 4. See §§ 1.1461-1(a)(2); 1.1461-3; 1.1474-1(h). Under proposed § 301.6227-2(b)(3), this same rule applies when the partnership pays the imputed underpayment in an AAR pursuant to section 6227.

C. Requirement To Withhold and Report Under Chapters 3 and 4 Upon a Section 6226 Election

Under section 6226, a partnership may elect to “push out” adjustments to its reviewed year partners rather than paying an imputed underpayment determined under section 6225. If a partnership makes a valid election under section 6226 (a section 6226 election), proposed § 301.6226-2 (June 14 NPRM) requires it to furnish a statement to each reviewed year partner that includes information regarding the partner’s allocable share of partnership adjustments with respect to the imputed underpayment for which the election is made and the partner’s share of any penalties, additions to tax, or additional amounts (a section 6226 statement). The partnership must also calculate and include on each section 6226 statement a safe harbor amount and, for each reviewed year partner that is an individual, an interest safe harbor amount. Under proposed § 301.6226-3 (June 14 NPRM), each reviewed year partner must increase its tax imposed under chapter 1 by its additional reporting year tax for the taxable year that includes the date on which the section 6226 statement is furnished (the reporting year). The additional reporting year tax is either the aggregate of the adjustment amounts (as computed under proposed § 301.6226-3(b) (June 14 NPRM)) or the safe harbor amount. In addition, each reviewed year partner must also pay its share of any penalties, additions to tax, additional amounts, and interest (either as computed at the partner level under proposed § 301.6226-3(d)(1) (June 14 NPRM) or, if applicable, the interest safe harbor amount).

As discussed in the preamble to the June 14 NPRM, it is the view of the Treasury Department and the IRS that, consistent with the purposes of chapters 3 and 4, if adjustments reflected on a section 6226 statement represent additional income allocable to a foreign or domestic partner that was not properly accounted for in the reviewed year, and the partnership makes a section 6226 election to have the partners take the adjustments into account, these allocations of income should be subject to the rules in chapters 3 and 4 to the same extent that these amounts would have been if they had been properly accounted for by the partnership in the reviewed year. Accordingly, these proposed regulations provide rules that apply withholding and reporting requirements under chapters 3 and 4 to a partnership that makes a section 6226 election with respect to a reviewed year partner that would have been subject to withholding in the reviewed year, and rules that apply to the reviewed year partner when taking these adjustments into account. Under proposed § 301.6227-2(b)(4), these same rules apply when a partnership elects to have its reviewed year partners take into account adjustments requested in an AAR.

Proposed § 301.6226-2(h)(3)(i) requires a partnership that makes a section 6226 election to pay the amount of tax required to be withheld under chapters 3 and 4 on any adjustment Start Printed Page 56770allocable to a reviewed year partner that would have been subject to withholding in the reviewed year. The partnership must pay the withholding tax (in the manner prescribed by the IRS in forms, instructions, and other guidance) on or before the due date for furnishing the section 6226 statement that reports the adjusted item. Proposed § 301.6226-2(h)(3)(iii) clarifies the reporting requirements of chapters 3 and 4, including a requirement to file an applicable return (Form 1042, Annual Withholding Tax Return for U.S. Source Income of Foreign Persons, or Form 8804, Annual Return for Partnership Withholding Tax (Section 1446)) and any associated information returns (Forms 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, or Forms 8805, Foreign Partner’s Information Statement of Section 1446 Withholding Tax). The partnership must file the return and issue information returns for the partnership’s taxable year (for withholding reported on Forms 8804 and 8805) or the calendar year (for withholding reported on Forms 1042 and 1042-S) that includes the date on which the partnership furnishes the section 6226 statement.

Proposed § 301.6226-2(h)(3)(ii) allows a partnership that is required to pay withholding tax under proposed § 301.6226-2(h)(3)(i) to reduce the amount of that tax to the extent that the reviewed year partner provides valid documentation to establish that it is entitled to a reduced rate of tax under chapters 3 and 4. For this purpose, these proposed regulations allow the partnership to rely on documentation that the partnership possesses that is valid with respect to the reviewed year (determined without regard to the expiration after the reviewed year of any validity period prescribed in chapters 3 and 4), or new documentation that the partnership obtains from the reviewed year partner if the partner includes a signed affidavit stating that the associated information and representations are accurate with respect to the reviewed year. However, proposed § 301.6226-2(h)(3)(ii) does not allow the partnership to reduce the amount of withholding tax due based on partner-level items as provided in § 1.1446-6. Consideration of these partner-level items raises administrability issues given the partner’s activities in the intervening taxable years between the reviewed year and the reporting year. For example, partner-level deductions and losses certified to the partnership for the reviewed year may have been used in a subsequent year to offset the partner’s allocable share of partnership ECTI or income effectively connected (or treated as effectively connected) with the conduct of a trade or business in the United States from other sources. Accordingly, reductions to the amount of withholding tax a partnership is required to pay under proposed § 301.6226-2(h)(3)(i) are limited to those based on a reduced rate of tax. The procedures under proposed § 301.6226-2(h)(3)(ii) do not constitute a modification as described in section 6225.

Proposed § 301.6226-3(f) requires a reviewed year partner that is subject to withholding under proposed § 301.6226-2(h)(3)(i) to file a return for the reporting year to report its additional reporting year tax and its share of penalties, additions to tax, additional amounts, and interest, notwithstanding any filing exception in § 1.6012-1(b)(2)(i) or § 1.6012-2(g)(2)(i). Therefore, a reviewed year partner whose allocable share of adjustments is subject to withholding under chapters 3 and 4 must file a federal income tax return for the reporting year and pay its allocable share of penalties, additions to tax, additional amounts, and interest, even if the partner’s additional reporting year tax has been satisfied by the partnership through withholding at source and the partner would not otherwise be required to file a federal income tax return under an exception in the section 6012 regulations.

In certain circumstances, the reviewed year partner is allowed a credit under section 33 for tax paid by the partnership under proposed § 301.6226-2(h)(3)(i) that the partner may apply against its income tax liability for its reporting year. For purposes of sections 1441 through 1443 and 1471 through 1474, a reviewed year partner is allowed a credit for the amount of tax actually withheld from that partner (including any amounts withheld on the partner’s distributive share). To the extent the tax is not withheld, but is instead paid by the partnership (because, for example, the reviewed year partner is no longer a partner in the partnership), the partnership (rather than the partner) is allowed a credit against its withholding tax liability for the amount of tax paid. In that case, the tax will not be collected a second time from the partner, but the partner would remain liable for any applicable penalties, additions to tax, or interest. See §§ 1.1463-1; 1.1464-1; 1.1474-4. For purposes of section 1446, a reviewed year partner is allowed a credit for the tax paid by the partnership with respect to ECTI allocable to the partner. See § 1.1446-3(d)(2). A partner claiming a credit under section 33 must properly report the additional reporting year tax on its return and substantiate the credit with the appropriate information return (Form 1042-S or Form 8805), as well as any other requirements prescribed by the IRS in forms, instructions, and other guidance.

Because § 301.6226-1(c)(1) (June 14 NPRM) requires a partnership to satisfy the provisions of proposed §§ 301.6226-1 and 301.6226-2 (June 14 NPRM) to make a valid section 6226 election, a partnership must pay the tax due under proposed § 301.6226-2(h)(3)(i) and meet the reporting obligations under proposed § 301.6226-2(h)(3)(iii) to satisfy this requirement. However, a partnership that anticipates making a section 6226 election may instead request during the modification process that the IRS determine a specific imputed underpayment (as defined in § 301.6225-1(e)(2)(iii) (June 14 NPRM)) with respect to adjustments allocated to reviewed year partners that would have been subject to withholding in the reviewed year, and a general imputed underpayment (as defined in § 301.6225-1(e)(2)(ii) (June 14 NPRM)) with respect to all other adjustments. If the IRS agrees with the modification request, upon receipt of the notice of final partnership adjustment the partnership could then (1) pay under section 6225 the specific imputed underpayment that includes adjustments subject to withholding, and (2) make a timely section 6226 election with respect to the adjustments that result in the general imputed underpayment. A partnership might make such a request so that its partners subject to withholding under chapters 3 and 4 would not need to file a return as they would under proposed § 301.6226-3(f) when the partnership makes a section 6226 election with respect to those adjustments.

The Treasury Department and the IRS are considering additional ways to alleviate the filing obligation in proposed § 301.6226-3(f) for foreign persons when a partnership pushes out its adjustments and does not make a specific imputed underpayment for adjustments subject to withholding. Specifically, the Treasury Department and the IRS are considering whether to allow a partnership that pays the withholding tax required under proposed § 301.6226-2(h)(3)(i) to elect to pay the share of penalties, additions to tax, additional amounts, and interest attributable to a partner that would have been subject to withholding in the reviewed year. Under this approach, if the partner’s additional reporting year tax and the partner’s share of penalties, Start Printed Page 56771additions to tax, additional amounts, and interest have been satisfied by the partnership, the partner’s tax liability would be treated as having been fully satisfied through withholding at source with respect to the adjustments on its section 6226 statement. In that case, the partner may be relieved of any filing obligation that would otherwise arise upon receiving a section 6226 statement if the foreign partner otherwise qualifies for a filing exception under § 1.6012-1(b)(2)(i) or § 1.6012-2(g)(2)(i). Comments are requested regarding this approach and how it should operate.

In the June 14 NPRM, the Treasury Department and the IRS requested comments on how the rules under chapters 3 and 4 should apply when a section 6226 statement includes income allocable to a foreign partner that is an intermediary or flow through entity. The Treasury Department and the IRS continue to study this issue in conjunction with the broader issue of how to treat pass-through partners generally under the section 6226 regime. Specifically, comments are still requested regarding the application of chapters 3 and 4 to section 6226 in the case of partners that are foreign flow through entities, including partners that assume primary withholding responsibility as withholding foreign partnerships or withholding foreign trusts.

3. Provisions Related to U.S. Foreign Tax Credits

A. Background

Subject to limitations, a taxpayer may elect to claim a credit under section 901 for income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or possession of the United States. This credit is generally referred to as the foreign tax credit (FTC). Under section 902, certain corporations are deemed, for FTC purposes, to have paid the foreign taxes that are paid or accrued by foreign subsidiaries from which they receive a dividend. Under section 960, inclusions under subpart F of part III of subchapter N of chapter 1 of the Code (subpart F) are treated as dividends for purposes of computing the foreign taxes deemed paid under section 902.

A partnership is not eligible to claim an FTC under section 901 (or a deduction for foreign taxes under section 164). See section 703(b)(3). Instead, under sections 702(a)(6), 706(a), and 901(b)(5) each partner takes into account its distributive share of the creditable foreign taxes paid or accrued by the partnership in the partner’s tax year with or within which the partnership’s tax year ends. See § 1.702-1(a)(6). Under section 702(a)(6), this amount, known as a creditable foreign tax expenditure (CFTE), is accounted for as a separately stated item. Similarly, under section 902(c)(7), a partner is treated as owning a proportional share of stock owned by or for the partnership for purposes of computing a deemed paid credit under section 902. Therefore, while a partnership is not deemed to pay foreign taxes paid by a foreign corporation in which it holds stock, each of its domestic corporate partners, if eligible, independently calculates foreign taxes deemed paid with respect to dividends or subpart F inclusions relating to stock owned by or for the partnership.

The amount of FTC allowed against a taxpayer’s U.S. tax in a given year is limited to the amount of pre-credit U.S. tax on the taxpayer’s foreign source income. See section 904. This FTC limitation is applied separately to foreign source income in each of the separate categories described in section 904(d)(1) (i.e., the passive category and general category) and additional separate categories described in § 1.904-4(m). The components of the FTC limitation computation are maintained and adjusted at the partner level; several of these attributes must be tracked from year to year and can affect the computation of the partner’s FTC and FTC limitation (e.g., FTC carrybacks or carryovers under section 904(c) and overall foreign loss accounts or overall domestic loss accounts under section 904(f) and (g)). Other specific rules may further limit a taxpayer’s utilization of FTCs (e.g., sections 901, 907, 908, and 909). If a taxpayer pays or accrues creditable foreign tax in excess of the limitation, the taxpayer may not use the excess credits in that year. However, section 904(c) provides that excess FTCs are first carried back one year and then forward for up to 10 years and are utilized in the first year in which the taxpayer has sufficient excess limitation to use the FTCs.

Given the nature and purpose of the FTC to mitigate the effects of double taxation and the importance of preventing the inappropriate use of the credit, special procedural rules often apply. For example, because the amount of foreign tax may change as the result of a foreign audit, refund claim, or other dispute resolution process involving a foreign tax authority, taxpayers are required to notify the IRS if a foreign tax for which credit is claimed is refunded (in whole or in part), if an accrued tax remains unpaid after two years, or if the amount of taxes paid differs from the amount accrued. See section 905(c). Any underpayment resulting from a change to the amount of creditable foreign tax paid or accrued is collectable upon notice and demand, without regard to the generally applicable statute of limitations. See section 6501(c)(5). Moreover, taxpayers have a special ten-year period of limitations under section 6511(d)(3) for claiming refunds of overpayments attributable to the application of an FTC. The IRS also permits a taxpayer to accrue a contested foreign tax if the amount of the tax has actually been paid to the foreign tax authority. Rev. Rul. 70-290 (1970-1 C.B. 160). These special rules allow increased flexibility with regard to the timing of adjustments in order to better match foreign income and the foreign tax on that income and thereby mitigate double taxation of income.

Neither the statutory text of the centralized partnership audit regime nor the explanation of that text prepared by the staff of the Joint Committee on Taxation explicitly addresses coordination with the FTC rules. Joint Comm. on Taxation, JCS-1-16, General Explanations of Tax Legislation Enacted in 2015, 57 (2016) (JCS-1-16). Nothing in the BBA indicates that the new procedures should increase the incidence of double taxation or alter the pre-existing restrictions, limitations, or obligations affecting a taxpayer’s right to claim (or retain) an FTC. It is also unlikely that the enactment of the new centralized partnership audit regime was meant to change significant and well-established FTC rules without any explicit reference to those rules in the statutory text.

The view of the Treasury Department and the IRS is that, to the maximum extent possible, the long-standing FTC rules should be preserved while implementing the broader purpose of the centralized partnership audit regime. In order to coordinate these provisions in a manner that is administrable and fair, rules should be promulgated to clarify the appropriate interaction of these two regimes. Some of these issues are discussed in this preamble and addressed in the regulations proposed herein, such as the treatment of CFTEs under the imputed underpayment provisions of the centralized partnership audit regime. Additionally, this preamble discusses the application of the FTC limitation of partners in a partnership subject to the centralized partnership audit regime, certain special procedural FTC rules (including those under sections 905(c) and 6511(d)(3)), and the treatment of credits under sections 902 and 960 (which are not themselves items of the partnership, but the calculation of Start Printed Page 56772which turns on certain items of the partnership, such as the amount and separate category of dividend or subpart F inclusion). The Treasury Department and the IRS request comments both with respect to the items specifically identified and also with respect to any additional issues regarding the coordination of the FTC regime and the new centralized partnership audit regime that warrant clarification or additional guidance.

B. Adjustments Affecting the Category or Amount of CFTEs of a BBA Partnership

A partnership reports CFTEs to its partners as separately stated items, allowing each partner to elect either a credit under section 901 or a deduction under section 164(a)(3). See Sections 702(a)(6) and 901(b)(5). Under current rules, the partnership is not required to maintain records or report to the IRS whether its partners claimed credits or deductions with respect to their CFTEs or the extent to which any such credits are subject to a partner’s FTC limitation. Accordingly, the tax effects of an adjustment to the CFTEs reported by a partnership cannot be determined solely by examining the return and other records of the partnership. Similarly, the partnership lacks the necessary information to determine those tax effects in connection with an AAR.

Proposed § 301.6225-1(a)(2) (June 14 NPRM) provides that for purposes of determining the imputed underpayment, all applicable preferences, restrictions, limitations, and conventions will be taken into account to disallow netting of adjustments as if the adjusted item was originally taken into account in the manner most beneficial to the partners. Similarly, proposed § 301.6225-1(d)(1) (June 14 NPRM) provides that items within each grouping are divided into subgroups, for netting purposes, based on preferences, limitations, restrictions, and conventions, such as source, character, holding period, or restrictions under the Code applicable to such items.

Consistent with this general approach, proposed rules are added in the paragraph reserved in the June 14 NPRM for the creditable expenditure grouping, proposed § 301.6225-1(d)(2)(iv)(A), relating to the treatment of adjustments to CFTEs made in an administrative proceeding under the centralized partnership audit regime. Proposed § 301.6225-1(d)(2)(iv)(A)(1) provides that the creditable expenditure grouping includes all adjustments to CFTEs, as defined in § 1.704-1(b)(4)(viii)(b). Proposed § 301.6225-1(d)(2)(iv)(A)(2) further provides that adjustments to CFTEs are included in subgroupings based on the category of income to which the CFTEs relate in accordance with section 904(d) and the regulations thereunder and in order to account for different allocations of CFTEs between partners. Proposed § 301.6225-1(d)(2)(iv)(A)(3) provides rules used in computing the imputed underpayment when there are one or more adjustments to CFTEs. Specifically, proposed § 301.6225-1(d)(2)(iv)(A)(3) provides that a net reduction to CFTEs in any subgrouping is treated as a decrease to credits in the credits grouping and therefore increases the imputed underpayment (and safe harbor amount) on a dollar-for-dollar basis. A net increase to CFTEs in any subgrouping is an adjustment that does not result in an imputed underpayment and is therefore taken into account in the adjustment year in accordance with proposed § 301.6225-3 (June 14 NPRM). Examples 6, 7, 8, and 9 are added to proposed § 301.6225-1(f) to illustrate the application of the rules in proposed § 301.6225-1(d)(2)(iv).

These CFTE subgrouping rules serve several goals. First, subgrouping prevents netting of CFTEs between partners, or between separate categories with respect to the same partner, a restriction which is necessary to preserve the application of the category-by-category limitation required under section 904 and the regulations thereunder. Second, by subgrouping based on the sharing ratio of the partners in the reviewed year, adjustments that would be allocable to one partner cannot be netted against adjustments to CFTEs that would be allocable to another partner. This is intended to provide greater consistency with the requirement that CFTEs be allocated in accordance with the partners’ interests in the partnership under section 704 and the regulations thereunder. Subgrouping based on the category and allocation of the adjustment between the partners is necessary to avoid a net reduction in the U.S. tax collected as the result of adjustments to CFTEs for which no credit would have been allowed to the partner if the CFTEs had been correctly reported in the reviewed year.

One comment received in response to Notice 2016-23 addressed the treatment of adjustments to CFTEs in calculating the imputed underpayment. Specifically, the comment noted the complex FTC limitation computation which must be made at the partner level, based on components maintained and adjusted each year by the partner. After discussing several possible approaches, the comment recommended that CFTEs be treated as a credit for purposes of computing the imputed underpayment, increasing the imputed underpayment to account for any decrease to CFTEs, but suggested that the regulations disallow any reduction to the imputed underpayment based on an increase to CFTEs, since they may be subject to limitation at the partner level. The comment explained that while this treatment may cause the imputed underpayment to overstate the correct tax amount, this overstatement can be remedied if the partnership provides additional information through the modification process.

Proposed § 301.6225-1(d)(2)(iv) generally adopts the recommended approach. If the amount of CFTEs is decreased on audit, the proposed regulations treat the item as if the partners had reduced their U.S. tax by that amount and, therefore, increase the imputed underpayment by the amount of the CFTE reduction. Conversely, if the amount of CFTEs is increased on audit, the proposed regulations treat the item as if the FTC limitation would prevent use of the increased credit and, therefore, do not reduce the imputed underpayment.

The Treasury Department and the IRS recognize that the rules proposed in § 301.6225-1(d)(2)(iv) may cause the amount of the imputed underpayment to exceed the amount of tax that would have been due if the partnership had accurately reported in the reviewed year, either because CFTEs reported in the reviewed year were not claimed by all partners as FTCs or because any additional CFTEs agreed to on audit could be claimed as FTCs. However, because the partners’ FTC posture is neither reflected on the partnership returns nor required to be maintained in the partnership’s books and records, the only practical way to maintain the efficacy of the FTC rules is to assume both that the partners claimed FTCs for all CFTEs originally reported and that the FTC limitation would prevent any additional CFTEs from being claimed as credits. This approach preserves the long-standing principles underlying the FTC regime, especially the FTC limitation rules in section 904 and the regulations thereunder, and is consistent with the general rule in § 301.6225-1(a)(2) (June 14 NPRM) which explicitly provides that the adjusted items are treated as if they were originally taken into account by the partnership or the partners, as applicable, in the manner most beneficial to the partnership and the partners. The modification process under section 6225 (including Start Printed Page 56773modification resulting from a partner filing an amended return or entering into a closing agreement) will generally provide an opportunity for the partnership to take the partners particular facts and circumstances into account when determining the imputed underpayment, while at the same time adhering to those long-standing principles.

In addition to the amended return modification or section 6226 election available under the current rules, additional types of modification may be appropriate with respect to some CFTEs under section 6225(c)(6) and proposed § 301.6225-2(d)(9) (June 14 NPRM). For example, not all partners are eligible to look through the partnership for purposes of determining the separate category of their CFTEs. See § 1.904-5(h). Such partners have only passive category CFTEs, regardless of the category of those items at the partnership level. Under these circumstances, a partnership may request modification under section 6225(c)(6) by providing sufficient evidence that a particular portion of CFTEs would be allocable to a partner or group of partners who cannot look through the partnership to characterize such CFTEs, so that all adjustments to CFTEs allocable to that partner or group of partners may be netted without regard to separate category. Similarly, if different sharing ratios apply to the allocation of adjusted CFTEs, some portion of the adjustments subject to different sharing ratios may still ultimately be allocable to the same partner or group of partners. Under these circumstances, the partnership may request modification by providing sufficient evidence of the portion of each adjustment that is allocable to the same partner or group of partners in order to allow netting of those CFTEs by modification, where appropriate.

The Treasury Department and the IRS request comments on the application of the netting rules to CFTEs and the related computation of the imputed underpayment, including any special modification rules that may be appropriate with respect to CFTEs. The Treasury Department and the IRS also request comments regarding circumstances in which the grouping and subgrouping of CFTE adjustments could be improved while preserving the FTC limitation rules.

These proposed regulations continue to reserve the rules on creditable expenditures other than CFTEs. The Treasury Department and the IRS request comments as to whether special rules are needed to address any other creditable expenditures and if so, whether those rules should follow or differ from the grouping and netting rules for CFTEs set forth in these proposed regulations.

C. Preserving FTC Limitation Rules Under Section 904

Under the principles of proposed section 301.6225-1 (June NPRM), an adjustment decreasing the amount of foreign source income would not offset an adjustment increasing the amount of U.S. source income under the netting process described in proposed § 301.6225-1(c) (June 14 NPRM). Instead, these items, the foreign source income adjustment (which is negative) and the U.S. source income adjustment (which is positive), would be in separate subgroups. Assuming no other adjustments, the decrease in foreign source income would be treated as an adjustment which does not result in an imputed underpayment, and the increase in U.S. source income would be a net positive adjustment included in computing the imputed underpayment. This is an appropriate result.

Without a subgrouping requirement, the netting of U.S. and foreign source items would circumvent FTC limitation calculations under section 904 by effectively ignoring the potential impact of changes to foreign source income on FTCs. Specifically, netting U.S. and foreign source items at the partnership level would, in many cases, understate the true underpayment of tax caused by the partnership treating these items incorrectly in the reviewed year and, in other cases, would cause a permanent reduction in the partners’ FTC limitation over time. Similarly, in the case of adjustments to items allocable to foreign partners, because foreign partners typically owe tax only with respect to U.S. source income, netting adjustments to U.S. source items against adjustments to foreign source items may understate the tax owed. Grouping adjustments by source may also facilitate modification requests with respect to amounts allocable to foreign partners.

One obstacle to subgrouping foreign source and U.S. source items is that the source (or allocation and apportionment) of certain partnership items is determinable only by the partners. In this regard, section 861 and the regulations thereunder provide that deductible expenses, including interest expense and research and experimentation (R&E) expense, are allocated and apportioned between foreign source gross income and other income on the basis of partner-level attributes. For example, § 1.861-9(e) provides that, subject to certain exceptions, a partner’s distributive share of the interest expense of a partnership is considered to be related to all income-producing activities and assets of the partner and is apportioned between a partner’s U.S. and foreign source income based on the relative values of the partner’s assets. See also, for example, § 1.871-17 (providing rules for the allocation and apportionment of R&E expense).

Therefore, these expense items, when allocated and apportioned, affect the partners’ net foreign and U.S. source income (and therefore the partner’s FTC limitation), in amounts that cannot be determined at the partnership level. Similarly, items of gain or loss attributable to sales of non-inventory property are sourced at the partner level. See section 865(i)(5). Because the source of certain items cannot be accurately established at the partnership level (and because certain expenses must be allocated and apportioned at the partner level), those items cannot definitively be included in either foreign or U.S. source income subgroupings for purposes of computing the imputed underpayment. Moreover, if an adjustment to items sourced (or allocated and apportioned) at the partner level can offset other adjustments not sourced (or allocated and apportioned) in that manner, the purposes of the FTC limitation rules could effectively be circumvented.

Under the proposed regulations in the June 14 NPRM, adjustments to items that may be sourced (or allocated and apportioned) at the partner level will generally be divided into subgroups in accordance with the specific method applicable for the sourcing (or allocation and apportionment) of those items in order to avoid netting that would undermine the application of the FTC limitation under section 904 unless the IRS determines otherwise. See proposed § 301.6225-1(a)(2) (June 14 NPRM). This would prevent, for example, an increase to interest expense from being netted against an increase to U.S. source income. However, netting of an increase to interest expense from one activity against a decrease to interest expense from another activity would generally be permissible because netting these adjustments would not typically affect the partners’ section 904 limitation.

The Treasury Department and the IRS recognize that subgrouping significant items of expense, such as R&E or interest, may cause imputed underpayments to exceed the tax that would have been owed had all items been treated correctly in the reviewed year. While the partnership can attempt to reduce this distortion during the Start Printed Page 56774modification process or by making a section 6226 election, the Treasury Department and the IRS request comments regarding whether such distortions can be reduced when computing the imputed underpayment before the modification process, while remaining consistent with the purpose of the source and allocation and apportionment rules under sections 861 and 865, as well as the application of the FTC limitation under section 904.

The Treasury Department and the IRS request comments with respect to the grouping and subgrouping of items of income, gain, loss, or deduction based on source and separate category. Specifically, the Treasury Department and the IRS request comments on any rule or modification method that would allow the calculation of the imputed underpayment to more accurately reflect the amount of tax that would have been due if the partnership had reported correctly in the reviewed year. The Treasury Department and the IRS also specifically request comments relating to any rules that would preserve the potential effects of adjustments to partnership items that are sourced (or allocated and apportioned) at the partner level in determining the imputed underpayment without requiring that all of these items be assigned to separate subgroupings.

D. Application of Section 905(c) to Creditable Foreign Tax Expenditures

Section 905(c) generally requires a taxpayer to notify the IRS in the event of certain changes to creditable foreign taxes. A taxpayer must notify the IRS if any foreign tax claimed as a credit is refunded in whole or in part. Similarly, a taxpayer must notify the IRS if an accrued foreign tax claimed as a credit remains unpaid after two years or if the amount when paid differs from the amount accrued. The notice requirement under section 905(c) is generally satisfied by the taxpayer filing an amended return for the year or years to which the foreign tax relates and paying any underpayment that results from the adjustment to the amount of creditable foreign tax. If such an adjustment results in an overpayment of tax, a taxpayer may generally claim a refund or credit within the 10-year period described in section 6511(d)(3). See section 905(c)(3). In the context of a partnership, the partner who claimed the FTC has historically borne the primary obligation to notify the IRS if there was a change in the foreign tax liability described in section 905(c) (and to pay any underpayment, upon notice and demand, or timely file a claim for refund of any overpayment). However, several aspects of the centralized partnership audit regime make it difficult to determine the most appropriate application of section 905(c) with respect to CFTEs reported by a partnership subject to the centralized partnership audit regime.

Neither the statutory text of the centralized partnership audit regime, nor the explanation of that text prepared by the staff of the Joint Committee on Taxation, explicitly addresses section 905(c). See JCS-1-16. There is no indication that the new procedures were intended to restrict either the taxpayer’s or the government’s right to recoup any overpayment or underpayment of U.S. tax resulting from a redetermination required under section 905(c). It is also unlikely that Congress would effectuate a change to long-standing principles through generic procedural provisions without any specific discussion of section 905(c) in the statutory text.

Generally, if a partnership reports CFTEs and has an adjustment described in section 905(c), there are two ways of viewing the adjustment required under section 905(c): It is either an adjustment at the partnership level, which is subject to the centralized partnership audit regime, or it is an adjustment at the partner level, which is subject to the historic application of this provision in the partnership context. Either of these two approaches presents administrative challenges. Therefore, the Treasury Department and the IRS request comments addressing coordination and administration of section 905(c) and the centralized partnership audit regime. Specifically, the Treasury Department and the IRS request comments on using the AAR process for purposes of satisfying the requirements of section 905(c) with respect to changes to the foreign tax liability reported by a partnership as a CFTE.

E. Foreign Taxes Deemed Paid Under Sections 902 and 960

Under sections 902 and 960, certain domestic corporations are permitted to claim credits for foreign taxes “deemed paid” corresponding to foreign taxes paid by a foreign subsidiary from which the domestic corporation receives a dividend or with respect to which the domestic corporation has a subpart F inclusion. As discussed in Part 3.A. of this Explanation of Provisions, section 902(c)(7) provides that stock of a foreign corporation held by or on behalf of a partnership will be treated as if it was actually owned (proportionally) by the partners for purposes of computing the foreign taxes deemed paid under sections 902 and 960. Thus, qualifying partners are generally entitled to claim FTCs for deemed paid taxes attributable to their allocable share of partnership dividend income and subpart F inclusions.

Section 6221(a) provides that any adjustment to an item of income, gain, loss, deduction, or credit of a partnership for a partnership taxable year must be determined, and any tax attributable thereto must be assessed and collected, at the partnership level pursuant to the centralized partnership audit regime. Further, proposed § 301.6221(a)-1 (June 14 NPRM) provides that all items required to be shown or reflected on the partnership’s return and information in the partnership’s books and records related to a determination of these items, as well as factors that affect the determination of items of income, gain, loss, deduction, or credit, are subject to determination and adjustment at the partnership level under the centralized partnership audit regime.

Under existing filing requirements, a partnership reports dividends from its subsidiaries, foreign and domestic, and domestic (U.S.) partnerships also report subpart F inclusions, but neither foreign nor domestic partnerships are required to report the amount of foreign taxes deemed paid by a partner with respect to stock held by or for the partnership. Further, a partnership is generally not required to maintain or report all information upon which the computations of those amounts are based (for example, the foreign subsidiary’s pools of post-1986 undistributed earnings and post-1986 foreign income taxes). Accordingly, the amount of any deemed paid foreign tax computed with respect to stock owned by or for a partnership cannot be determined based on existing partnership reporting requirements.

The centralized partnership audit regime did not explicitly address the treatment of FTCs allowed with respect to deemed paid foreign taxes under the centralized partnership audit regime. However, the dividends and subpart F inclusions that trigger the availability of the deemed paid FTC are subject to that regime. Therefore, in order to preserve the IRS’s ability to audit FTCs for deemed paid taxes claimed with respect to stock owned through partnerships subject to the centralized partnership audit regime, coordinating rules are necessary. These rules should ensure that all restrictions and limitations on the FTC allowed under sections 902 and 960 are given effect with respect to both the items giving rise to FTCs and the FTCs themselves.

The broad scope of the centralized partnership audit regime contemplates Start Printed Page 56775that all tax effects, including FTCs for deemed paid taxes, are considered during a centralized partnership audit. However, in the case of sections 902 and 960, the current rules require the partners, and not the partnership, to maintain and report the relevant information. Therefore, the Treasury Department and the IRS request comments on whether it would be appropriate to require a partnership, as opposed to the individual partners, to maintain and report the information necessary to compute deemed paid foreign taxes with respect to foreign corporations in which the partnership owns shares, so that the IRS can audit foreign tax credits under section 902 and 960 entirely at the partnership level. The Treasury Department and IRS request comments on how this information-reporting requirement could be crafted to minimize compliance costs and burdens, especially for partnerships whose partners are not eligible to compute deemed paid taxes. Alternatively, the Treasury Department and the IRS request comments on any approach, consistent with the statutory principles of the centralized partnership audit regime and the FTC regime, whereby the IRS could effectively adjust credits for deemed paid foreign taxes at either the partnership level or at the partner level, without creating unreasonable distortions or undue burdens on taxpayers or tax administration.

4. Modification of an Imputed Underpayment Based on the Status of a Foreign Partner and Other Treaty Issues

Proposed § 301.6225-2(d)(2) through (8) (June 14 NPRM) provides seven enumerated types of modifications the IRS will consider if requested by the partnership. The preamble to the June 14 NPRM requested comments on modifications that could be considered appropriate where a partner is a foreign person and thus may be subject to gross basis taxation under section 871(a) or 881(a), or where a partnership, partner, or indirect partner is entitled to a reduced rate of tax under the Code or as a resident of a country that has in effect an income tax treaty with the United States.

Under U.S. tax treaties, a foreign partner or partnership may be entitled to benefits with respect to an item of income, profit, or gain paid to an entity that is fiscally transparent under the laws of the United States to the extent it is treated as an item of income, profit, or gain of a resident of the applicable treaty jurisdiction. See also section 894. Thus, for example, the Treasury Department and the IRS are considering providing a modification in proposed § 301.6225-2(d) (June 14 NPRM) that would apply as illustrated in the following example: The IRS initiates an administrative proceeding with respect to a domestic partnership, and determines a single partnership adjustment increasing the U.S. source dividend income received by the partnership. The partnership had two equal partners during the reviewed year: A, a U.S. citizen, and B, a nonresident alien individual resident in Country X. The United States has in effect an income tax treaty with Country X, and Country X treats the partnership as fiscally transparent. Assuming that the other requirements set forth in the regulations for modifications are satisfied, if the partnership provides documentation demonstrating to the IRS’s satisfaction the amount of the adjustment that is allocable to B under the partnership agreement and B’s entitlement to a reduced rate of tax on dividends in the reviewed year pursuant to the income tax treaty between Country X and the United States, the IRS could agree to a modification to the imputed underpayment with respect to the amount of the adjustment allocable to B that is subject to a reduced rate of tax under the income tax treaty. Additionally, other methods for modifications could be provided in future guidance with respect to other Code-based exemptions from tax applicable to foreign persons, including sections 871(h) and 881(c), which provide an exemption from tax for foreign persons with respect to interest on certain portfolio debt investments. See also sections 871(a)(2) and 881(a) (limiting taxation of foreign persons on U.S. source capital gains).

The Treasury Department and the IRS are still considering additional modifications to address circumstances where a partnership, partner, or indirect partner is a foreign person, and which potential modifications, such as modifications for portfolio interest and U.S. source capital gains, may already be addressed by one of the seven types of modifications included in the June 14 NPRM. See proposed § 301.6225-2(d)(3) (June 14 NPRM) (providing rules for modifications for tax-exempt partners which, as defined, includes certain foreign persons or entities). Accordingly, the Treasury Department and the IRS continue to request comments on what specific types of modifications available to partners or partnerships that are foreign persons (including partners that are foreign persons described under section 501(c)) should be included in proposed § 301.6225-2(d) (June 14 NPRM).

The June 14 NPRM also requested comments on the coordination of the proposed rules with the mutual agreement procedures (MAP) available under income tax treaties that a partnership, partner, or indirect partner may invoke in order to determine eligibility for treaty benefits that may affect the calculation of the imputed underpayment. Pursuant to income tax treaties in effect between the United States and other jurisdictions, the Treasury Department and the IRS intend to allow access to MAP, when and where appropriate, for a partnership, partner, or indirect partner that is subject to the centralized partnership audit regime. However, the Treasury Department and the IRS are continuing to study this issue and request comments on how to coordinate MAP with the centralized partnership audit regime.

5. Foreign Corporations

The preamble to the June 14 NPRM stated that the Treasury Department and the IRS intend to issue regulations to address situations where a partnership pushes out an adjustment under section 6226 to a direct partner in the partnership that is a foreign entity, such as a trust or corporation, that may not be liable for U.S. federal income tax with respect to one or more adjustments, but an owner of the direct partner is or could be liable for tax with respect to that amount. For example, if a direct partner in the audited partnership is a controlled foreign corporation, the foreign corporation as a direct partner may not have a U.S. tax liability with respect to a given adjustment; however, the adjustment may impact the tax liability of its U.S. shareholder(s) by increasing the subpart F income of the CFC that is included in the income of the U.S. shareholder(s) under section 951(a). The Treasury Department and the IRS continue to study this issue and continue to request comments both on how the reporting obligations concerning foreign entities should be modified to ensure that statements issued under section 6226 are reflected on the returns of the U.S. owners of these entities, and more generally, on how to incorporate rules governing foreign corporations into the centralized partnership audit regime.

Special Analyses

Certain IRS regulations, including these, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. Therefore, a Start Printed Page 56776regulatory impact assessment is not required. Because the regulations would not impose a collection of information on small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not apply.

Pursuant to section 7805(f) of the Code, these regulations have been submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

Statement of Availability of IRS Documents

IRS Revenue Procedures, Revenue Rulings, Notices and other guidance cited in this preamble are published in the Internal Revenue Bulletin (or Cumulative Bulletin) and are available from the Superintendent of Documents, U.S. Government Publishing Office, Washington, DC 20402, or by visiting the IRS Web site at www.irs.gov.

Comments and Requests for Public Hearing

Before these proposed regulations are adopted as final regulations, consideration will be given to any electronic and written comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules. All comments will be available at www.regulations.gov or upon request. A public hearing will be scheduled if requested in writing by any person that timely submits written comments. If a public hearing is scheduled, then notice of the date, time, and place for the public hearing will be published in the Federal Register.

Drafting Information

The principal authors of these proposed regulations are Larry R. Pounders, Jr., Ronald M. Gootzeit, and Subin Seth of the Office of the Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.

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List of Subjects in 26 CFR Part 301

• Employment taxes
• Estate taxes
• Excise taxes
• Gift taxes
• Income taxes
• Penalties
• Reporting and recordkeeping requirements

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Proposed Amendments to the Regulations

Accordingly, 26 CFR part 301, as proposed to be amended June 14, 2017 (82 FR 27334), is proposed to be further amended as follows:

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PART 301—PROCEDURE AND ADMINISTRATION

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Paragraph 1. The authority citation for part 301 continues to read in part as follows:

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Authority:
26 U.S.C. 7805 * * *

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Par. 2. Section 301.6221(a)-1 is amended by adding paragraph (f) to read as follows:

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Par. 3. Section 301.6225-1 is amended by adding paragraphs (a)(4) and (c)(5), revising paragraph (d)(2)(iv), and adding Examples 6 through 9 to paragraph (f) to read as follows:

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Par. 4. Section 301.6226-2 is amended by revising paragraph (h)(3) to read as follows:

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Par. 5. Section 301.6226-3 is amended by revising paragraph (f), and adding Example 6 to paragraph (g) to read as follows:

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Par. 6. Section 301.6227-2 is amended by adding paragraphs (b)(3) and (4) to read as follows.

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