TAX NEWS - January 2010

IRS extends temporary changes to section 956 definitions of 'U.S. obligation' and 'readily marketable securities'

The Internal Revenue Service on December 28 released Notice 2010-12, which, for purposes of section 956, extends for one year the temporary changes in the definitions of "U.S. obligation" and "readily marketable securities" that were issued in 2008 and modified in 2009, and were otherwise due to expire after December 31, 2009. In general, the changes now apply through December 31, 2010.


Background

The controlled foreign corporation (CFC) rules (specifically section 951(a)(1)) provide that a U.S. shareholder of a CFC must include in gross income the lesser of:

- The excess (if any) of the shareholder's pro rata share of the average of the amounts of U.S. property held by the CFC as of the close of each quarter of the CFC's taxable year over the amount of earnings and profits described in section 959(c)(1)(A) with respect to such shareholder or

- The U.S. shareholder's pro rata share of the CFC's applicable earnings.

The statutory definition of "U.S. property" includes an obligation of a U.S. person. However, section 956(c)(2)(J) provides an exception for an obligation of a U.S. person "to the extent the principal amount of the obligation does not exceed the fair market value of readily marketable securities sold or purchased pursuant to a sale and repurchase agreement or otherwise posted or received as collateral for the obligation in the ordinary course of its business by a U.S. or foreign person which is a dealer in securities or commodities."


U.S. obligation

The original changes to the definition of "U.S. obligation" were announced in Notice 2008-91 (issued in October 2008), which stated that the section 956 regulations would be modified to allow a CFC to elect to exclude certain obligations collected within 60 days from the definition of "U.S. property" for purposes of section 956.

Notice 2008-91 did not apply to taxable years of CFCs beginning after December 31, 2009, and thus was (for most CFCs) limited to two taxable years. This limitation created some ambiguity where a CFC had a third (short) taxable year that ended during the extension period. The ambiguity was resolved in February 2009, when the IRS issued Notice 2009-10 to provide that, under regulations to be issued, the election announced in Notice 2008-91 would also apply to such a short consecutive taxable year as long as that third year ended on or before December 31, 2009. In October 2009, the IRS issued generic legal advice (AM 2009-013) describing additional factors to be taken into account under these notices.

Notice 2010-12 has now extended the elective definition of "U.S. obligation" for one more year, so that it applies to taxable years beginning before January 1, 2011. The notice adds that Treasury and the IRS "do not anticipate extending the application of the regulations described in Notice 2008-91 to any additional periods."


Readily marketable securities

Section 956(c)(2)(J) excepts certain "readily marketable securities" from the section 956 definition of "U.S. property." Rev. Proc. 2008-26 provided additional temporary guidance under section 956, describing circumstances under which the IRS "will not challenge whether a security is readily marketable for purposes of section 956(c)(2)(J)" for "any day during calendar years 2007 or 2008 for which it is relevant whether securities are readily marketable for purposes of that section." Notice 2009-10 extended the effective date of the revenue procedure to any day during calendar year 2009.

Notice 2010-12 further extends the effective date of Rev. Proc. 2008-26 for an additional year. Thus, the IRS also will not challenge the status of securities as "readily marketable" for any day during calendar year 2010 for which the revenue procedure is relevant.