The current economic crisis has resulted in substantial illiquidity in the commercial paper and other key credit markets, thus creating significant challenges for companies that normally rely on these markets to fund their operations. Policy makers are considering and implementing a number of different responses to this problem. The Internal Revenue Service (IRS) recently offered one potentially helpful response in this regard by issuing Notice 2008-91, which temporarily liberalizes section 956 of the Internal Revenue Code, thereby making it easier for U.S. companies to meet U.S. liquidity needs by accessing funds accumulated by foreign subsidiaries.
Under section 956, U.S. shareholders of controlled foreign corporations (CFCs) are subject to U.S. tax on a current basis with respect to certain investments made by CFCs in U.S. property, including obligations of related U.S. persons (e.g., debt issued by the U.S. shareholder). The law generally characterizes these investments as effective repatriations of CFC earnings and seeks to tax them accordingly. At the same time, it has long been recognized that it may be appropriate for business reasons for a CFC to own certain short-term obligations of a U.S. person, and that such short-term obligations generally do not present the effective-repatriation concerns that section 956 was enacted to address. Prior to 1988, the applicable regulations excluded from section 956 obligations with a term of one year or less.
This one-year exception was eliminated in 1988 and later that year was replaced with a narrower short-term exception under Notice 88-108. Under Notice 88-108, the IRS excludes from the section 956 definition of “obligation” any obligation that is collected within 30 days from the time it is incurred, provided that the CFC does not hold obligations that would otherwise constitute investments in U.S. property for 60 or more calendar days during the taxable year (the 30/60 rule).
Notice 2008-91 effectively expands this short-term financing exception on an elective basis to obligations that are collected within 60 days, provided that the CFC does not hold obligations that would otherwise constitute investments in U.S. property for 180 or more calendar days during the taxable year (the 60/180 rule). Notice 2008-91 will apply for the first two taxable years ending after October 3, 2008 (i.e., 2008 and 2009 in the case of a calendar-year taxpayer). Each CFC can choose between applying the 30/60 rule of Notice 88-108 and applying the 60/180 rule of Notice 2008-91. Different CFCs under the same U.S. shareholder can make different choices in this regard—e.g., if it is desirable to trigger a section 956 inclusion with respect to one CFC but not with respect to another—but no one CFC can apply both rules.
Notice 2008-91 does not specify the time and manner of electing to apply the new 60/180 rule. It appears that no special form will be provided, but rather that taxpayers will simply reflect on their tax returns the application of the regimes chosen. It may be desirable for the IRS to issue additional guidance clarifying the proper time and manner of electing the new regime, as well as addressing other technical questions that have arisen regarding the scope and effect of such an election.
Potential Aggregation of Obligations
Although Notice 2008-91 and the surrounding circumstances reflect an intent to allow U.S. shareholders to access CFC earnings as a source of liquidity for up to 179 days without triggering a section 956 inclusion, it must be noted that certain case law and other IRS guidance, if asserted vigorously and without regard to the context of Notice 2008-91, could undermine this intent. Specifically, under the Jacobs Engineering case and Rev. Rul. 89-73, multiple obligations entered into seriatim may be treated as a single, integrated obligation for section 956 purposes in certain circumstances, under substance-over-form and step-transaction principles.
If applied in the present context, such a theory could support an IRS position on audit that, say, two successive 59-day obligations that are outstanding for a total of 118 days should be treated as a single obligation that is outstanding for more than 60 days, thereby triggering a section 956 inclusion. There is no reason to expect that the IRS would administer the new rule in such a manner, as this would of course defeat the purpose of the rule, and taxpayers in any event would have strong arguments to make against such a position. Nevertheless, it may be desirable for the IRS to issue further guidance confirming its intentions in this regard, so that this uncertainty does not discourage taxpayers from using Notice 2008-91 as intended.
Will It Be Enough?
The IRS is to be commended for taking this important step to facilitate liquidity for U.S.-based multinationals dealing with crisis conditions in the credit markets. Notice 2008-91 will undoubtedly be of significant help to many companies. That said, it is possible that the expansion of the 30/60 rule to a 60/180 rule may still provide too short-term a source of liquidity to be adequate under the circumstances, thus necessitating further notices extending or otherwise modifying the rule on an incremental basis. A potentially more effective (as well as simpler) alternative might be to reintroduce the original short-term obligation exception as it applied prior to 1988, under which obligations were excluded from section 956 if repaid within one year. This alternative would provide more substantial and more certain relief, while still not undermining the basic policy of section 956 against allowing truly long-term effective repatriations to escape current U.S. tax.
In addition, in light of the seriousness of the current crisis, it is possible that the Congress could consider more significant measures to boost liquidity by facilitating access to CFC earnings. For example, recently introduced legislation would re-enact the temporary repatriation incentive of section 965. This incentive and its effects have been the subject of considerable controversy, but even opponents of the measure under more “normal” economic conditions may re-examine it in the context of a crisis in which companies are having trouble accessing cash through the commercial paper and other key credit markets. The politics of considering such a measure in the current political environment would be complex to say the least, but the same could be said of the measures already taken by the Congress in response to this crisis.