TAX NEWS - January 2010

U.S. Tax Alert: Effective date of temporary changes to §956 definitions of "U.S. obligation" and "readily marketable securities" extended

On 28 December 2009, the Internal Revenue Service (IRS) released Notice 2010-12, which extends for one year the temporary changes in the definitions of "U.S. obligation" and "readily marketable securities" (for purposes of Internal Revenue Code §956) that were issued in 2008 and modified in 2009, and were otherwise due to expire after 31 December 2009. In general (and as described in more detail below), the changes now apply through 31 December 2010.

As background to the development, the controlled foreign corporation (CFC) rules (specifically §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 §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, §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" for purposes of §956 were announced in Notice 2008-91 (officially published on 27 October 2008, but released in advance on 3 October 2008). (This development, attached below, was discussed in a United States Tax Alert dated October 6, 2008, titled "IRS Responds to Liquidity Crisis in Notice 2008-91 – Modifies Definition of 'Obligation'.") The notice stated that the §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 §956.

Notice 2008-91 did not apply to taxable years of CFCs beginning after 31 December 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 Notice 2009-10 (2 February 2009) 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 31 December 2009. Later in 2009, the IRS described additional factors to be taken into account under these notices in a generic legal advice (AM 2009-013) published on 19 October 2009.

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 1 January 2011. The notice also states: "The Treasury Department and the Service 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 §956 definition of "U.S. property." Rev. Proc. 2008-26 (27 May 2008) provided additional temporary guidance under §956. The revenue procedure describes 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.