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Hurricane relief: IRS provides safe harbor to qualify for CFC U.S. property exception

In a Notice, IRS has provided that obligations of a U.S. person received in exchange for certain property that was located in an area designated by the Federal Emergency Management Agency (FEMA) as subject to damage from Hurricane Irma or Hurricane Irma will be considered to qualify for the exception from U.S. property in Code Sec. 956(c)(2)(C) and Reg. § 1.956-2(b)(1)(v) if repaid by Mar. 31, 2018.

Background. A U.S. shareholder of a controlled foreign corporation (CFC) is taxed on an amount equal to the lesser of (1) the U.S. shareholder’s pro rata share of the average amount of U.S. property held (directly or indirectly) by the CFC as of the close of each quarter of the tax year, less that portion of the CFC’s earnings and profits attributable to amounts included previously in that shareholder’s gross income on account of investment in U.S. property (or which would have been so included except that it had already been included under another provision of the CFC rules), or (2) that shareholder’s pro rata share of the CFC’s applicable earnings. (Code Sec. 956(a))

Under Code Sec. 956(c)(1)(C), U.S. property generally includes obligations of a U.S. person. However, Code Sec. 956(c)(2)(C) provides an exception from U.S. property for an obligation of a U.S. person arising in connection with the sale or processing of property if: (i) the amount of such obligation outstanding at no time during the tax year exceeds the amount which would be ordinary and necessary to carry on the trade or business of both the other party to the sale or processing transaction, and (ii) the U.S. person had the sale or processing transaction been made between unrelated persons. Under Reg. § 1.956-2(b)(1)(v), whether an obligation of a U.S. person received in exchange for a sale of such property would be excluded from U.S. property under Code Sec. 956(c)(2)(C) is determined based on all of the facts and circumstances.

Prior relief. In Notice 2017-55, 2017-42 IRB, IRS provided relief to certain CFCs that may need to transport property described in Code Sec. 1221(a)(1) (generally, inventory-type property) located in areas affected by Hurricane Irma and Hurricane Maria to the U.S. for safekeeping. Under that relief, for tax quarters of a CFC ending on or after Sept. 5, 2017 and on or before Jan. 31, 2018, a CFC will not be treated as holding U.S. property for purposes of Code Sec. 956 as a result of temporarily storing that property in the U.S. (See Weekly Alert ¶  21  10/05/2017 for more details.)

IRS provides further relief. IRS noted that, in response to the damage caused by Hurricane Irma and Hurricane Maria, including in the Commonwealth of Puerto Rico and the U.S. Virgin Islands, certain CFCs may need to sell, or may have sold, substantial amounts of property located in affected areas to related U.S. persons and may do (or have done) so in exchange for obligations of such persons.

To provide certainty and further facilitate the safekeeping and ongoing distribution of property in imperiled areas, IRS provided that for purposes of Code Sec. 956, if a CFC holds an obligation of a U.S. person, such obligation will be considered to satisfy the requirements of Code Sec. 956(c)(2)(C) and Reg. § 1.956-2(b)(1)(v) to be excluded from U.S. property, if:

1. the obligation was received in exchange for property that, if transported to the U.S. for temporary storage for safekeeping in anticipation of, or as a result of, Hurricane Irma or Hurricane Maria, would not cause a CFC to be treated as holding U.S. property pursuant to Notice 2017-55, and
2. the obligation ceases to be outstanding on or before Mar. 31, 2018.

IRS further noted that an obligation of a U.S. person that does not meet the conditions set out above may nevertheless be excludable from U.S. property under Code Sec. 956(c)(2)(C) and Reg. § 1.956-2(b)(1)(v) depending on all of the facts and circumstances.

References: For the definition of “U.S. property” for CFC purposes, see FTC 2d/FIN ¶  O-2763; United States Tax Reporter ¶  9564.
Notice 2017-68, 2017-46 IRB