26 CFR § 1.59A-9 - Anti-abuse and recharacterization rules.

§ 1.59A-9 Anti-abuse and recharacterization rules.

(a) Scope. This section provides rules for recharacterizing certain transactions according to their substance for purposes of applying section 59A and the section 59A regulations. Paragraph (b) of this section provides specific anti-abuse rules. Paragraph (c) of this section provides examples illustrating the rules of paragraph (b) of this section.

(b) Anti-abuse rules -

(1) Transactions involving unrelated persons, conduits, or intermediaries. If a taxpayer pays or accrues an amount to one or more intermediaries (including an intermediary unrelated to the taxpayer) that would have been a base erosion payment if paid or accrued to a foreign related party, and one or more of the intermediaries makes (directly or indirectly) corresponding payments to or for the benefit of a foreign related party as part of a transaction (or series of transactions), plan or arrangement that has as a principal purpose of avoiding a base erosion payment (or reducing the amount of a base erosion payment), the role of the intermediary or intermediaries is disregarded as a conduit, or the amount paid or accrued to the intermediary is treated as a base erosion payment, as appropriate.

(2) Transactions to increase the amount of deductions taken into account in the denominator of the base erosion percentage computation. A transaction (or component of a transaction or series of transactions), plan or arrangement that has a principal purpose of increasing the deductions taken into account for purposes of § 1.59A-2(e)(3)(i)(B) (the denominator of the base erosion percentage computation) is disregarded for purposes of § 1.59A-2(e)(3).

(3) Transactions to avoid the application of rules applicable to banks and registered securities dealers. A transaction (or series of transactions), plan or arrangement that occurs among related parties that has a principal purpose of avoiding the rules applicable to certain banks and registered securities dealers in § 1.59A-2(e)(2) (base erosion percentage test for banks and registered securities dealers) or § 1.59A-5(c)(2) (increased base erosion and anti-abuse tax rate for banks and registered securities dealers) is not taken into account for purposes of § 1.59A-2(e)(2) or § 1.59A-5(c)(2).

(4) Nonrecognition transactions. If a transaction (or series of transactions), plan or arrangement, has a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a specified nonrecognition transaction, then § 1.59A-3(b)(3)(viii)(A) will not apply to the specified nonrecognition transaction. For purposes of this paragraph (b)(4), if a transaction (or series of transactions), plan or arrangement between related parties increases the adjusted basis of property within the six month period before the taxpayer acquires the property in a specified nonrecognition transaction, the transaction (or series of transactions), plan or arrangement is deemed to have a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a nonrecognition transaction.

(c) Examples. The following examples illustrate the application of this section.

(1) Facts. The following facts are assumed for purposes of the examples.

(i) DC is a domestic corporation that is an applicable taxpayer for purposes section 59A.

(ii) FP is a foreign corporation that owns all the stock of DC.

(iii) None of the foreign corporations have income that is, or is treated as, effectively connected with the conduct of a trade or business in the United States under an applicable provision of the Internal Revenue Code or regulations thereunder.

(iv) All payments occur in a taxable year beginning after December 31, 2017.

(2) Example 1: Substitution of payments that are not base erosion payments for payments that otherwise would be base erosion payments through a conduit or intermediary -

(i) Facts. FP owns Property 1 with a fair market value of $95x, which FP intends to transfer to DC. A payment from DC to FP for Property 1 would be a base erosion payment. Corp A is a domestic corporation that is not a related party with respect to DC. As part of a plan with a principal purpose of avoiding a base erosion payment, FP enters into an arrangement with Corp A to transfer Property 1 to Corp A in exchange for $95x. Pursuant to the same plan, Corp A transfers Property 1 to DC in exchange for $100x. Property 1 is subject to the allowance for depreciation (or amortization in lieu of depreciation) in the hands of DC.

(ii) Analysis. The arrangement between FP, DC, and Corp A is deemed to result in a $95x base erosion payment under paragraph (b)(1) of this section because DC's payment to Corp A would have been a base erosion payment if paid to a foreign related party, and Corp A makes a corresponding payment to FP as part of the series of transactions that has as a principal purpose of avoiding a base erosion payment.

(3) Example 2: Alternative transaction to base erosion payment -

(i) Facts. The facts are the same as in paragraph (c)(2)(i) of this section (the facts in Example 1), except that DC does not purchase Property 1 from FP or Corp A. Instead, DC purchases Property 2 from Corp B, a domestic corporation that is not a related party with respect to DC and that originally produced or acquired Property 2 for Corp B's own account. Property 2 is substantially similar to Property 1, and DC uses Property 2 in substantially the same manner that DC would have used Property 1.

(ii) Analysis. Paragraph (b)(1) of this section does not apply to the transaction between DC and Corp B because Corp B does not make a corresponding payment to or for the benefit of FP as part of a transaction, plan or arrangement.

(4) Example 3: Alternative financing source -

(i) Facts. On Date 1, FP loaned $200x to DC in exchange for Note A. DC pays or accrues interest annually on Note A, and the payment or accrual is a base erosion payment within the meaning of § 1.59A-3(b)(1)(i). On Date 2, DC borrows $200x from Bank, a corporation that is not a related party with respect to DC, in exchange for Note B. The terms of Note B are substantially similar to the terms of Note A. DC uses the proceeds from Note B to repay Note A.

(ii) Analysis. Paragraph (b)(1) of this section does not apply to the transaction between DC and Bank because Bank does not make a corresponding payment to or for the benefit of FP as part of the series of transactions.

(5) Example 4: Alternative financing source that is a conduit -

(i) Facts. The facts are the same as in paragraph (c)(4)(i) of this section (the facts in Example 3) except that in addition, as part of the same plan or arrangement as the Note B transaction and with a principal purpose of avoiding a base erosion payment, FP deposits $250x with Bank. The difference between the interest rate paid by Bank to FP on FP's deposit and the interest rate paid by DC to Bank is less than one percentage point. The interest rate charged by Bank to DC would have differed absent the deposit by FP.

(ii) Analysis. The transactions between FP, DC, and Bank are deemed to result in a base erosion payment under paragraph (b)(1) of this section because DC's payment to Bank would have been a base erosion payment if paid to a foreign related party, and Bank makes a corresponding payment to FP as part of the series of transactions that has as a principal purpose of avoiding a base erosion payment. See Rev. Rul. 87-89, 1987-2 C.B. 195, Situation 3.

(6) Example 5: Intermediary acquisition -

(i) Facts. FP owns all of the stock of DC1 and DC2, each domestic corporations. FP is a manufacturer of lawn equipment. DC1 is in the trade or business of renting equipment to unrelated third parties. DC2 is a dealer in property that capitalizes its purchases into inventory and recovers the amount through cost of goods sold. Before Date 1, in the ordinary course of DC1's business, DC1 acquired depreciable property from FP that DC1 in turn rented to unrelated third parties. DC1's purchases from FP were base erosion payments within the meaning of § 1.59A-3(b)(1)(ii). On Date 1, with a principal purpose of avoiding a base erosion payment, FP and DC2 reorganized their operations so that DC2 acquires the lawn equipment from FP and immediately thereafter, DC2 resells the lawn equipment to DC1.

(ii) Analysis. The transactions between FP, DC1, and DC2 are deemed to result in a base erosion payment under paragraph (b)(1) of this section because DC1's payment to DC2 would have been a base erosion payment if paid directly to FP, and DC2 makes a corresponding payment to FP as part of a series of transactions, plan, or arrangement that has a principal purpose of avoiding a base erosion payment from DC1 to FP.

(7) Example 6: Offsetting transactions to increase the amount of deductions taken into account in the denominator of the base erosion percentage computation -

(i) Facts. With a principal purpose of increasing the deductions taken into account by DC for purposes of § 1.59A-2(e)(3)(i)(B), DC enters into a long position with respect to Asset with Financial Institution 1 and simultaneously enters into a short position with respect to Asset with Financial Institution 2. Financial Institution 1 and Financial Institution 2 are not related to DC and are not related to each other.

(ii) Analysis. Paragraph (b)(2) of this section applies to the transactions between DC and Financial Institution 1 and DC and Financial Institution 2. These transactions are not taken into account for purposes of § 1.59A-2(e)(3)(i)(B) because the transactions have a principal purpose of increasing the deductions taken into account for purposes of § 1.59A-2(e)(3)(i)(B).

(8) Example 7: Ordinary course transactions that increase the amount of deductions taken into account in the denominator of the base erosion percentage computation -

(i) Facts. DC, a financial institution, enters into a long position with respect to stock in Corporation with Person 1 and later on the same day enters into a short position with respect to stock in Corporation with Person 2. Person 1 and Person 2 are not related to DC and are not related to each other. DC entered into the positions in the ordinary course of its business and did not have a principal purpose of increasing the deductions taken into account by DC for purposes of § 1.59A-2(e)(3)(i)(B).

(ii) Analysis. Paragraph (b)(2) of this section does not apply because the transactions between DC and Person 1 and Person 2 were not entered into with a principal purpose of increasing the deductions taken into account by DC for purposes of § 1.59A-2(e)(3)(i)(B).

(9) Example 8: Transactions to avoid the application of rules applicable to banks and registered securities dealers -

(i) Facts. DC owns all of the stock of DC1 and Bank (an entity defined in section 581). DC, DC1, and Bank are members of an affiliated group of corporations within the meaning of section 1504(a) that elect to file a consolidated U.S. federal income tax return. With a principal purpose of avoiding the rules of § 1.59A-2(e)(2) or § 1.59A-5(c)(2), DC and DC1 form a new partnership (PRS). DC contributes all of its stock of Bank, and DC1 contributes cash, to PRS. DC, DC1, and Bank do not materially change their business operations following the formation of PRS.

(ii) Analysis. Paragraph (b)(3) of this section applies to transactions with respect to Bank because the transactions with respect to PRS were entered into with a principal purpose of avoiding the rules of § 1.59A-2(e)(2) or § 1.59A-5(c)(2). The contribution of Bank to a PRS is not taken into account, and Bank will be deemed to be part of the affiliated group including DC and DC1 for purposes of § 1.59A-2(e)(2) and § 1.59A-5(c)(2).

(10) Example 9: Transactions that do not avoid the application of rules applicable to banks and registered securities dealers -

(i) Facts. The facts are the same as the facts of paragraph (c)(9)(i) of this section (the facts of Example 8), except that DC sells 90 percent of the stock of Bank to an unrelated party in exchange for cash.

(ii) Analysis. Paragraph (b)(3) of this section does not apply to DC's sale of the stock of Bank because the sale was not made with a principal purpose of avoiding the rules of § 1.59A-2(e)(2) or § 1.59A-5(c)(2). Bank will not be treated as part of the affiliated group including DC and DC1 for purposes of § 1.59A-2(e)(2) and § 1.59A-5(c)(2).

(11) Example 10: Acquisition of depreciable property in a nonrecognition transaction -

(i) Facts. U, which is not a related party with respect to FP or DC, owns Property 1 with an adjusted basis of $50x and a fair market value of $100x. On Date 1, FP purchases property, including Property 1, from U in exchange for cash, and then FP contributes Property 1 to DC in an exchange described in section 351. Following the exchange, DC's basis in Property 1 is $100x.

(ii) Analysis. Paragraph (b)(4) of this section does not apply to DC's acquisition of Property 1 because the purchase of Property 1 from U (along with the purchase of other property from U that FP did not contribute to DC) did not have a principal purpose of increasing the adjusted basis of property that was subsequently transferred to DC. The transaction is economically equivalent to an alternative transaction under which FP contributed $100x to DC and then DC purchased Property 1 from U. Further, the second sentence of paragraph (b)(4) of this section (providing that certain transactions are deemed to have a principal purpose of increasing the adjusted basis of property that a taxpayer acquires in a nonrecognition transaction) does not apply because FP purchased Property 1 from an unrelated party.

(12) Example 11: Transactions between related parties with a principal purpose of increasing the adjusted basis of property -

(i) Facts. The facts are the same as paragraph (c)(11)(i) of this section (the facts in Example 10), except that U is related to FP and DC.

(ii) Analysis. Paragraph (b)(4) of this section applies to DC's acquisition of Property 1 because the transaction that increased the adjusted basis of Property 1 (the purchase of Property 1 from U) was between related parties, and within six months DC acquired Property 1 from FP in a specified nonrecognition transaction. Accordingly, the purchase of property from U is deemed to have a principal purpose of increasing the adjusted basis of Property 1, the exception in § 1.59A-3(b)(3)(viii)(A) for specified nonrecognition transactions will not apply to the contribution of Property 1 to DC, and DC's depreciation deductions with respect to Property 1 will be base erosion tax benefits.

[T.D. 9885, 84 FR 67017, Dec. 6, 2019, as amended at 85 FR 9370, Feb. 19, 2020]