t c memo united_states tax_court vimal soni and kiran soni petitioners v commissioner of internal revenue respondent docket no filed date larry d vince for petitioners sebastian voth for respondent memorandum opinion kerrigan judge respondent determined penalties of dollar_figure pursuant to sec_6662 for dollar_figure pursuant to sec_6662a for and dollar_figure pursuant to sec_6662a for unless otherwise indicated all section references are to the internal_revenue_code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure monetary amounts have been rounded to the nearest dollar after concessions the issues for our consideration are whether petitioners are liable for the accuracy-related_penalty under sec_6662a for tax_year and whether petitioners may be granted relief from the penalty under sec_6664 background this case was fully stipulated under rule the stipulated facts are incorporated in our findings by this reference petitioners resided in california when they filed the petition petitioners husband and wife are the sole shareholders in an s_corporation vimal and kiran soni inc soni inc throughout each petitioner held a share in soni inc in soni inc sponsored the vimal and kiran soni inc defined_benefit_plan plan soni inc adopted the plan in soni inc funded the plan with life_insurance purchased from indianapolis life_insurance co paying annual premiums that it deducted shortly after adopting the plan on the advice of its accountant soni inc submitted information about the plan to respondent on date respondent sent soni inc a favorable determination_letter that specifically states continued qualification of the plan under its present form will depend on its effect in operation the letter directed petitioners to read irs publication favorable determination letters which was enclosed with the letter and explained the scope and limitations of the determination_letter soni inc did not hire an independent actuary to determine the amount needed to fund the benefits offered by the plan soni inc obtained neither legal advice nor tax_advice from a certified_public_accountant with expertise in the area of defined benefit plans regarding the tax implications of operating the plan in soni inc continued to sponsor the plan and made a contribution to it the plan used the contribution to purchase interest-sensitive whole_life_insurance policies and flexible-premium deferred_annuity policies in the death_benefits under the life_insurance policies purchased on both petitioners’ lives exceeded the death_benefits under the plan by more than dollar_figure per person on date petitioners filed their form_1040 u s individual_income_tax_return for tax_year petitioners claimed a dollar_figure flowthrough loss from soni inc on date soni inc filed its form_1120s u s income_tax return for an s_corporation for tax_year on its form_1120s soni inc claimed a dollar_figure pension contribution deduction and reported a dollar_figure loss soni inc did not attach a form_8886 reportable_transaction disclosure statement or any other reportable_transaction_disclosure_statement to its form_1120s on date pension professionals of america the plan promoter and administrator sent petitioner husband a letter and enclosed a form_8886 the letter states we strongly suggest that you file this form_8886 with an amended corporate tax_return the letter also states that your plan does not fall into the irs safe_harbor definitions with regard to the death_benefit on date respondent’s ogden service_center received soni inc ’s amended form_1120s for its tax_year which included form_8886 the office of tax_shelter analysis otsa has no record of soni inc ’s filing a form_8886 with the otsa for its tax_year neither petitioners nor soni inc have proof from any mail carrier including a private delivery service that form_8886 for petitioners’ or soni inc ’s tax_year was delivered to the otsa in respondent and petitioner husband as president of soni inc entered into a closing_agreement which addressed soni inc ’ sec_2001 sec_2002 and tax years for its tax_year soni inc claimed a dollar_figure pension contribution deduction and reported a dollar_figure loss on its form_1120s pursuant to the closing_agreement dollar_figure of the pension contribution deduction was disallowed and the corrected loss for soni inc ’s tax_year was dollar_figure as a result of the dollar_figure flowthrough loss that petitioners claimed petitioners understated their income by dollar_figure respondent audited petitioners’ and tax returns petitioners had deficiencies for the first three years the deficiency for was dollar_figure petitioners had overassessments for and in respondent issued petitioners a dollar_figure refund for these overassessments on date respondent issued petitioners a statutory_notice_of_deficiency determining that they were liable for a sec_6662a penalty for tax_year in computing this amount respondent assumed that the increase in petitioners’ taxable_income for is dollar_figure and the highest applicable tax_rate i sec_35 and he calculated the underpayment in tax as dollar_figure which i sec_35 of dollar_figure the sec_6662a penalty respondent determined is dollar_figure which i sec_30 of dollar_figure the notice_of_deficiency did not reflect that respondent determined a deficiency in income separate from the penalty petitioners concede that they engaged in a listed_transaction of the type described in revrul_2004_20 2004_1_cb_546 listed_transaction in petitioners also concede that they did not attach a form_8886 or any other reportable_transaction_disclosure_statement to their form_1040 and they did not file a copy of form_8886 or any other reportable_transaction_disclosure_statement with the otsa for tax_year discussion i sec_6662a penalty sec_6662a provides if a taxpayer has a reportable_transaction_understatement for any taxable_year there shall be added to the tax an amount equal to percent of the amount of such understatement sec_6662a the penalty applies to any deficiency that is attributable to any listed_transaction or any reportable_transaction if a significant purpose of the transaction is the avoidance or evasion of federal_income_tax sec_6662a the penalty is increased from to of the amount of the understatement if the disclosure requirements of sec_6664 are not met sec_6662a sec_6664 requires disclosure in accordance with the regulations under sec_6011 sec_6011 provides that taxpayers must file all forms and statements required by the regulations promulgated by the secretary sec_1_6011-4t a and d temporary income_tax regs fed reg date requires every taxpayer who has participated in a reportable_transaction including a listed_transaction to attach a form_8886 to its annual tax_return brennan v commissioner tcmemo_2011_276 slip op pincite the taxpayer must attach this disclosure statement to the tax_return for each taxable_year for which the taxpayer’s federal_income_tax liability is affected by the taxpayer’s participation in the reportable_transaction sec_1_6011-4t d temporary income_tax regs supra the taxpayer must also attach this disclosure statement to any amended_return that reflects the taxpayer’s participation in the reportable_transaction id see also t d 2004_1_cb_429 clarifying that a return includes amended returns for purposes of when disclosure must be made ii determination_letter petitioners concede that they engaged in a listed_transaction revrul_2004_20 supra which became effective date identifies certain sec_412 transactions as listed transactions the transaction at issue was a listed_transaction before petitioners filed their original form_1040 in petitioners contend that they met the disclosure requirements of sec_1_6011-4t temporary income_tax regs supra because soni inc sent information about the transaction to respondent and received the favorable determination_letter in return we disagree a determination_letter is a written_statement issued by a district_director in response to a written inquiry by an individual or an organization that applies to the particular facts involved sec_601_201 statement of procedural rules a determination_letter is issued only when a determination can be made on the basis of clearly established rules as set forth in the statute a treasury_decision or regulation or a ruling opinion or court decision published in the internal_revenue_bulletin id the determination_letter addresses only the qualified status of the plan under sec_401 and does not address plan operation a determination_letter does not address whether actuarial assumptions are reasonable for funding or deduction purposes or whether a specified contribution is deductible irs publ’n rev date this case involves the deductibility of contributions to the plan by soni inc which is not covered in the scope of the determination_letter iii revrul_2004_20 effective date petitioners assert that revrul_2004_20 supra was issued two years after soni inc entered into the plan in and cannot be applied retroactively petitioners also argue that they relied on the determination_letter which was issued approximately months before the issuance of revrul_2004_20 supra we have already established that petitioners may not rely on the determination_letter for purposes of plan operation and deductions this court has decided previously that taxpayers may be liable for a penalty arising from a transaction entered into before the penalty was enacted see 88_tc_1086 ndollar_figure aff’d without published opinion 865_f2d_1264 5th cir and aff’d without published opinion sub nom hatheway v commissioner 865_f2d_186 4th cir and aff’d sub nom 864_f2d_93 9th cir and aff’d sub nom 868_f2d_865 6th cir mcgehee family clinic p a v commissioner tcmemo_2010_202 slip op pincite therefore it is irrelevant that revproc_2004_20 supra was issued after soni inc established the plan and after petitioners received the plan determination_letter petitioners assert that revrul_2004_20 supra did not put them on notice that they could no longer rely on the determination_letter revrul_2004_20 supra describes which types of transactions are listed transactions for purposes of sec_1_6011-4t b temporary income_tax regs fed reg date and sec_301_6111-2 and sec_301_6112-1 proced admin regs effective date the date revrul_2004_20 supra was released to the public listed transactions include transactions in which the employer uses deductible amounts to pay premiums on a life_insurance_contract for a participant with a death_benefit under the contract that exceeds the participants’s death_benefit under the plan by more than dollar_figure see revrul_2004_20 c b pincite petitioners concede that they engaged in this type of transaction in revrul_2004_20 supra had been in effect for months when petitioners filed their form_1040 ignorance of the law is no excuse for noncompliance with the applicable law mcgehee family clinic p a v commissioner slip op pincite petitioners failed to obtain independent tax_advice from a lawyer or accountant with expertise in the area of defined benefit plans before filing their form_1040 iv independent shareholder disclosure rules every individual trust partnership and s_corporation that has participated directly or indirectly in a reportable_transaction must attach to its return for each taxable_year in which the taxpayer’s federal_income_tax liability is affected a disclosure statement in the form prescribed sec_1_6011-4t a temporary income_tax regs supra a taxpayer has indirectly participated in a reportable_transaction if the taxpayer’s federal_income_tax liability is affected or in the case of an s_corporation if the shareholder’s federal_income_tax liability is reasonably expected to be affected by the transaction even if the taxpayer is not a direct party to the transaction id an individual taxpayer that owns shares in an s_corporation participates in a reportable_transaction when the tax benefits of the s corporation’s direct participation in the reportable_transaction flow through to the individual taxpayer see brennan v commissioner tcmemo_2011_276 the disclosure statement for a reportable_transaction must be attached to the taxpayer’s federal_income_tax return for each taxable_year in which the taxpayer’s federal_income_tax liability is affected sec_1_6011-4t d temporary income_tax regs supra when the disclosure statement is first attached to the taxpayer’s federal_income_tax return the taxpayer must file a copy of that disclosure statement with the otsa id petitioners failed to attach a form_8886 or any other reportable_transaction_disclosure_statement to their form_1040 petitioners failed to file a copy of form_8886 or any other reportable_transaction_disclosure_statement with the otsa therefore petitioners did not meet their reporting requirements under sec_1_6011-4t temporary income_tax regs supra petitioners contend that their transaction was disclosed because soni inc filed a form_8886 with its amended return for an s_corporation the disclosure statement for a listed_transaction must be attached to the s corporation’s federal_income_tax return for each taxable_year ending with or within the taxable_year of any shareholder whose income_tax_liability is affected or is reasonably expected to be affected by the s corporation’s participation sec_1_6011-4t d temporary income_tax regs supra at the same time a copy must be filed with the otsa id shareholders and s_corporations have separate reporting requirements see sec_1_6011-4t a d temporary income_tax regs supra even if an s_corporation files a disclosure statement for a listed_transaction the shareholder still has an obligation to file regardless of whether soni inc met its disclosure requirements petitioners did not meet theirs therefore we need not discuss whether soni inc met its disclosure requirements because it does not affect petitioners’ obligation to disclose v substantial compliance petitioners contend that they substantially complied with the sec_6011 disclosure requirements because soni inc attached a form_8886 to its amended_return a taxpayer may be deemed to satisfy a statute if the taxpayer substantially complies with the statute’s requirements see 100_tc_32 substantial compliance applies only when the requirement is procedural or directory and is not the essence of the statute’s purpose 67_tc_1071 this court has previously held that when a taxpayer has provided substantially_all of the information specified in certain regulations and the purpose of the statute had been substantially achieved the taxpayer has substantially complied with the regulation see 122_tc_115 bond v commissioner t c pincite smith v commissioner tcmemo_2007_368 aff’d 364_fedappx_317 9th cir substantial compliance is a narrow doctrine that may be applied to avoid hardship where a party establishes that the party intended to comply with a provision and did everything reasonably possible to comply with the provision but did not comply with the provision because of a failure to meet the provision’s specific requirements 132_tc_336 see also 136_tc_515 petitioners have not substantially complied with the requirements of sec_1_6011-4t temporary income_tax regs supra that section requires taxpayers to attach forms to their federal_income_tax returns and to file copies of the disclosure statements with the otsa see t d 2002_2_cb_87 petitioners did not provide any of the information required by sec_1_6011-4t temporary income_tax regs supra they failed to file any sort of disclosure with their form_1040 and they failed to attempt any disclosure of the transaction to the otsa we have already established that petitioners had a filing obligation separate from that of soni inc therefore any information presented about soni inc ’s filing_status has no bearing on petitioners’ compliance furthermore petitioners have not presented any evidence to show that they attempted to file a form_8886 with respondent vi burden_of_proof under sec_7491 the commissioner bears the burden of production with regard to the sec_6662a penalty this means that respondent must come forward with sufficient evidence indicating that a penalty is appropriate see 116_tc_438 the parties stipulated that petitioners engaged in a listed_transaction and that they did not disclose the transaction on their tax_return petitioners do not dispute that their taxable_income should be increased by dollar_figure as a result of their improper reporting the parties do not dispute the marginal tax_rate to be used in computing the reportable_transaction_understatement therefore respondent has met the burden of showing that there was a reportable_transaction_understatement for and therefore it is appropriate to impose a penalty on petitioners under sec_6662a see brennan v commissioner tcmemo_2011_276 vi reasonable_cause a taxpayer is not liable for the sec_6662a penalty if the taxpayer has reasonable_cause and acted in good_faith sec_6664 the taxpayer bears the burden of proving that the penalty is inappropriate because the taxpayer acted with reasonable_cause and in good_faith see 123_tc_144 higbee v commissioner t c pincite a taxpayer has reasonable_cause and acted in good_faith if the taxpayer followed the disclosure provisions of the sec_6011 regulations the taxpayer has substantial_authority for his or her position and the taxpayer reasonably believed that the position was more_likely_than_not the proper treatment sec_6664 the requirements of sec_6664 are stated in the conjunctive each requirement must be met to obtain relief petitioners failed to disclose the transaction which is the first requirement of sec_6664 so we do not need to discuss whether the other requirements were met petitioners do not qualify for the reasonable_cause exception under sec_6664 see sec_6664 brennan v commissioner slip op pincite congress has made clear that b ecause disclosure is so vital to combating abusive tax_avoidance transactions the committee believes that taxpayers should be subject_to a strict_liability penalty on an understatement_of_tax that is attributable to non-disclosed listed transactions or reportable_transactions that have a significant_purpose_of_tax_avoidance if the taxpayer does not adequately disclose the transaction the strengthened reasonable_cause exception is not available ie a strict- liability penalty applies and the taxpayer is subject_to an increased penalty rate equal to percent of the understatement h_r rept no part i pincite petitioners failed to disclose the transaction when they failed to attach a form_8886 to their federal_income_tax return and failed to send a copy to the otsa therefore relief is not available to petitioners under sec_6664 petitioners present several arguments to try to prove that they met their burden under sec_6664 petitioners contend that they may rely on the determination_letter as substantial_authority and that soni inc ’s filing form_8886 with its amended_return was more_likely_than_not sufficient disclosure however these arguments are irrelevant each requirement of sec_6664 must be met to obtain relief petitioners failed to disclose the transaction which is the first requirement of sec_6664 and therefore we do not need to discuss whether the other requirements are met we hold that petitioners do not qualify for the sec_6664 reasonable_cause exception to the sec_6662a penalty and that they are liable for the penalty in reaching our decision we have considered all arguments made by the parties to the extent not mentioned or addressed they are irrelevant or without merit vii abatement under sec_6404 sec_6404 provides that subject_to certain limitations the commissioner may abate a penalty attributable to his own erroneous written advice petitioners argue that the favorable determination_letter soni inc received is included under sec_6404 and therefore the sec_6662a penalty must be abated this issue however is not ripe the sec_6662a penalty is currently before this court and respondent has not yet assessed it this court does not have jurisdiction to consider a failure by the commissioner to abate a penalty that has not been assessed friedland v commissioner tcmemo_2011_217 slip op pincite moreover the penalty at issue did not result from any advice provided by respondent soni inc ’s determination_letter did not address plan contributions or deductions by participants which are at issue in this case to reflect the foregoing decision will be entered under rule


internal_revenue_service number release date index number ---------------------------------------------------- ----------------------- ---------------------------------------------------------- --------------------------------- ------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ------------------------------ id no ---------------- telephone number ---------------------- refer reply to cc psi b01 plr-130062-18 date date legend x ---------------------------------------------------------------- ------------------------------------------------------- country date date -------------------------- --------------------------- ----------------------- dear ----------------- this responds to a letter dated date submitted on behalf of x requesting an extension of time under sec_301_9100-3 of the procedure and administration regulations to file an election under sec_301_7701-3 to be treated as a disregarded_entity for federal tax purposes facts according to the information submitted x was organized under the laws of country on date x represents that it is a foreign_entity eligible to elect to be classified as a disregarded_entity x failed to timely file form_8832 entity classification election to be treated as a disregarded_entity for federal tax purposes effective date x represents that it acted reasonably and in good_faith x also represents that granting the relief requested will not prejudice the interests of the government plr-130062-18 law and analysis sec_301_7701-3 provides in part that a business_entity that is not classified as a corporation under sec_301_7701-2 or an eligible_entity can elect its classification for federal tax purposes an eligible_entity with at least two members can elect to be classified as either an association or a partnership and an eligible_entity with a single owner can elect to be classified as an association or to be disregarded as an entity separate from its owner sec_301_7701-3 provides guidance on the classification of a foreign eligible_entity for federal tax purposes generally a foreign eligible_entity is treated as an association if all members have limited_liability unless the entity makes an election to be treated otherwise a foreign eligible_entity with a single member having limited_liability may elect to be treated as a disregarded_entity pursuant to the rules of sec_301_7701-3 sec_301_7701-3 provides that an entity classification election must be filed on form_8832 and can be effective up to days prior to the date the form is filed or up to months after the date the form is filed under sec_301_9100-1 the commissioner may grant a reasonable extension of time to make a regulatory election or a statutory election but no more than six months except in the case of a taxpayer who is abroad under all subtitles of the internal_revenue_code except subtitles e g h and i sec_301_9100-1 defines the term regulatory election as including an election whose due_date is prescribed by a regulation published in the federal_register or a revenue_ruling revenue_procedure notice or announcement published in the internal_revenue_bulletin sec_301_9100-1 through provide the standards the commissioner will use to determine whether to grant an extension of time to make an election sec_301_9100-2 provides automatic extensions of time for making certain elections sec_301_9100-3 provides extensions of time for making elections that do not meet the requirements of sec_301_9100-2 requests for relief under sec_301_9100-3 will be granted when the taxpayer provides evidence to establish that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government conclusion based solely on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied as a result x is granted an extension of time of days from the date of this letter to make an election to be treated as a disregarded_entity for federal tax purposes effective date x should make the election by filing a properly executed form_8832 with the appropriate service_center a copy of this letter should be attached to the form plr-130062-18 this ruling is contingent on the owners of x filing within days of this letter all required returns for all open years consistent with the requested relief these returns may include but are not limited to the following forms i forms information_return of u s persons with respect to certain foreign_corporations ii forms return of u s persons with respect to certain foreign_partnerships and iii forms information_return of u s persons with respect to disregarded entities such that these forms reflect the consequences of the relief granted in this letter a copy of this letter should be attached to any such returns if applicable this election is disregarded for purposes of determining the amounts of all sec_965 elements of all united_states_shareholders of x if the election otherwise would change the amount of any sec_965 element of any such united_states_shareholder see sec_1_965-4 except as specifically set forth above we express no opinion concerning the federal tax consequences of the facts described above under any other provision of the internal_revenue_code the ruling contained in this letter is based upon information and representations submitted by the taxpayer an accompanied by a penalty of perjury statement executed by the appropriate party while this office has not verified any of the material submitted in support of the ruling_request it is subject_to verification or examination this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-130062-18 in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to x’s authorized representatives sincerely holly porter associate chief_counsel passthroughs special industries by laura c fields laura c fields senior technician reviewer branch office of associate chief_counsel passthroughs special industries enclosures copy of this letter copy of this letter for sec_6110 purposes


internal_revenue_service number release date index number ---------------------- ------------------------------ ---------------------------------- ------------------------------ department of the treasury washington dc third party communication none date of communication not applicable_person to contact ---------------- id no ------------------ telephone number ---------------------- refer reply to cc psi plr-135153-16 date date -------------------------------------------------- ------------------------------------------------ --------------------------- ------------------------------------- -------------------------- ------- -------------- legend husband wife date trust attorney year x dear -------------- this letter responds to the letter dated date submitted by your authorized representative requesting an extension of time pursuant to sec_2642 of the internal_revenue_code and sec_301_9100-3 of the procedure and administration regulations to allocate generation-skipping_transfer gst_exemption to transfers to a_trust facts the facts and representations submitted are as follows on date husband created an irrevocable_trust trust trust has gst potential on the same date husband plr-135153-16 transferred all of his interest in certain real_estate to trust date is after date but before date attorney prepared and timely filed husband’s and wife’s respective form_709 united_states gift_tax_return reporting the transfers to trust on the form sec_709 husband and wife signified their consent to treat the transfer made one-half by each spouse pursuant to sec_2513 the applicability of the generation-skipping_transfer gst tax to trust and the failure to allocate gst_exemption to the date transfer made to trust was discovered in year it has been represented that husband and wife have allocated dollar_figurex of their respective gst exemptions to date husband and wife each represent they have sufficient gst_exemption available to allocate to the date transfer to trust husband and wife request an extension of time to make an election under sec_2642 and sec_301_9100-1 and sec_301_9100-3 to allocate gst_exemption to their transfers to trust effective as of the date of the transfers to trust law and analysis sec_2513 provides that a gift made by one spouse to any person other than his spouse shall be considered as made one-half by him and one-half by his spouse but only if at the time of the gift each spouse is a citizen or resident_of_the_united_states sec_2513 only applies if both spouses have signified their consent to the application of this section in the case of all such gifts made during the calendar_year by either while married to the other sec_2601 imposes a tax on every gst a gst is defined under sec_2611 as a taxable_distribution a taxable_termination and a direct_skip sec_26_2601-1 of the generation-skipping_transfer_tax regulations provides that except as otherwise provided in this section the provisions of chapter apply to any gst as defined in sec_2611 made after date sec_26_2601-1 provides that solely for purposes of chapter an inter_vivos transfer is treated as if it were made on date if it was i subject_to chapter regardless of whether a tax was actually incurred or paid and ii made after date but before date for purposes of this paragraph the value of the property transferred shall be the value of the property on the date the property was transferred sec_2602 provides that the amount of the tax imposed by sec_2601 is the taxable_amount multiplied by the applicable_rate sec_2641 defines the applicable_rate as the product of the maximum_federal_estate_tax_rate and the inclusion_ratio with respect to the transfer plr-135153-16 under sec_2642 the inclusion_ratio with respect to any property transferred in a gst is the excess if any of one over the applicable_fraction the applicable_fraction as defined in sec_2642 is a fraction the numerator of which is the amount of the gst_exemption under sec_2631 allocated to the trust and the denominator of which is the value of the property transferred to the trust sec_2631 in effect at the time of the transfer provided that for purposes of determining the inclusion_ratio every individual shall be allowed a gst_exemption of dollar_figure which may be allocated by such individual or his executor to any property with respect to which such individual is the transferor sec_2631 provides that any allocation under sec_2631 once made shall be irrevocable sec_2632 provides that any allocation by an individual of his or her gst_exemption under sec_2631 may be made at any time on or before the date prescribed for filing the estate_tax_return for such individual’s estate determined with regard to extensions regardless of whether such a return is required to be filed sec_26_2632-1 provides that an allocation of gst_exemption to property transferred during the transferor's lifetime other than in a direct_skip is made on form_709 sec_2632 provides that for purposes of sec_2632 the term indirect_skip means any transfer of property other than a direct_skip subject_to the tax imposed by chapter made to a gst_trust as defined in sec_2632 sec_2642 provides that the secretary shall by regulation prescribe such circumstances and procedures under which extensions of time will be granted to make an allocation of gst_exemption described in sec_2642 or and an election under sec_2632 or c such regulations shall include procedures for requesting comparable relief with respect to transfers made before the date of the enactment of this paragraph sec_2642 provides that in determining whether to grant relief under sec_2642 the secretary shall take into account all relevant circumstances including evidence of intent contained in the trust instrument or instrument of transfer and such other factors as the secretary deems relevant for purposes of determining whether to grant relief the time for making the allocation or election shall be treated as if not expressly prescribed by statute sec_2652 provides that if under sec_2513 one-half of a gift is treated as made by an individual and one-half of the gift is treated as made by the spouse of such individual such gift shall be so treated for purposes of the gst tax plr-135153-16 notice_2001_50 2001_2_cb_189 provides that under sec_2642 the time for allocating the gst_exemption to lifetime transfers and transfers at death the time for electing out of the automatic allocation rules and the time for electing to treat any trust as a gst_trust are to be treated as if not expressly prescribed by statute the notice further provides that taxpayers may seek an extension of time to make an allocation described in sec_2642 or b or an election described in sec_2632 or c under the provisions of sec_301_9100-1 through sec_301_9100-3 provides the standards used to determine whether to grant an extension of time to make an election whose due_date is prescribed by a regulation and not expressly provided by statute sec_301_9100-3 provides in part that requests for relief under sec_301_9100-3 will be granted when the taxpayer provides the evidence to establish to the satisfaction of the commissioner that the taxpayer acted reasonably and in good_faith and that granting relief will not prejudice the interests of the government sec_301_9100-3 provides that a taxpayer is deemed to have acted reasonably and in good_faith if the taxpayer reasonably relied on a qualified_tax professional including a tax professional employed by the taxpayer and the tax professional failed to make or advise the taxpayer to make the election in this case trust was established and the transfers to trust were made before the enactment of the gst tax on date pursuant to sec_26_2601-1 and however the transfers to trust are deemed to have been made after the enactment of the gst tax based on the facts submitted and the representations made we conclude that the requirements of sec_301_9100-3 have been satisfied husband and wife are granted an extension of time of days from the date of this letter to allocate their respective available gst_exemption to the transfers made to trust on date the allocations will be based on the value of the property transferred to trust on date and effective as of the date of date the allocations should be made on supplemental form sec_709 and filed with the cincinnati service_center at the following address internal_revenue_service cincinnati service_center - stop cincinnati oh a copy of this letter should be attached to the returns except as expressly provided herein no opinion is expressed or implied concerning the tax consequences of any aspect of any transaction or item discussed or referenced in this letter this ruling is directed only to the taxpayer requesting it sec_6110 of the code provides that it may not be used or cited as precedent plr-135153-16 the rulings contained in this letter are based upon information and representations submitted by the taxpayer and accompanied by a penalty of perjury statement executed by an appropriate party while this office has not verified any of the material submitted in support of the request for rulings it is subject_to verification on examination in accordance with the power_of_attorney on file with this office a copy of this letter is being sent to your authorized representative sincerely associate chief_counsel passthroughs special industries by lorraine e gardner lorraine e gardner senior counsel branch office of associate chief_counsel passthroughs special industries enclosures copy of the letter copy for sec_6110 purposes


department of the treasury internal_revenue_service washington d c date number release date cc intl br4 tl-n-346-00 uilc internal_revenue_service national_office field_service_advice memorandum for from subject this field_service_advice responds to your memorandum dated date field_service_advice is not binding on examination or appeals and is not a final case determination this document is not to be cited as precedent field_service_advice is chief_counsel_advice and is open to public inspection pursuant to the provisions of sec_6110 the provisions of sec_6110 require the service to remove taxpayer identifying information and provide the taxpayer with notice of intention to disclose before it is made available for public inspection sec_6110 and i sec_6110 also authorizes the service to delete information from field_service_advice that is protected from disclosure under u s c sec_552 b and c before the document is provided to the taxpayer with notice of intention to disclose only the national_office function issuing the field_service_advice is authorized to make such deletions and to make the redacted document available for public inspection accordingly the examination appeals or counsel recipient of this document may not provide a copy of this unredacted document to the taxpayer or their representative the recipient of this document may share this unredacted document only with those persons whose official tax_administration duties with respect to the case and the issues discussed in the document require inspection or disclosure of the field_service_advice legend parent dsub1 dsub2 dsub3 dsub4 dsub5 dsub6 dsub7 dsub8 dsub9 dsub10 pship1 pship2 trust bank1 trust bank2 trust bank3 fgova fgovb fgovbm1 fgovbm2 fc1 fc2 flender1 flender2 flender3 country a country b country c asset groupa asset groupb asset groupc asset groupd asset groupe trust estatec trust estated trust estatee year year year year a b issues whether the internal_revenue_code code sec_1503 dual_consolidated_loss dcl provisions apply to a partnership or a_trust that is not a member of a foreign tax group and that is ineligible to file any consolidated_group relief election in particular whether an entity that does not have a permanent_establishment in a foreign_country under the foreign country’s tax laws and that is not required to file income_tax returns in the foreign_country is exempt from the sec_1503 dcl provisions whether an entity that is subject_to sec_1503 mirror legislation and thus is subject_to a foreign country’s tax laws that prohibit the net operating losses of the dual_resident_corporation drc from offsetting the income of other persons in the foreign_country is exempt from the sec_1503 provisions can parent use the year and year net operating losses from the leasing arrangements as described below to offset the income of other persons within the parent consolidated_group conclusion sec_1 a domestic corporation’s foreign_branch interest in a partnership or interest in a_trust is subject_to the sec_1503 dcl provisions to the extent net operating losses are dcls neither a domestic corporation’s foreign_branch nor a domestic corporation’s interest in a partnership or in a_trust is required to constitute a permanent_establishment to be considered a drc moreover whether a foreign_branch a partnership or a_trust is able to file a consolidated tax_return or any_tax return in the foreign_country is not determinative of the existence of a drc a drc is defined as a separate_unit of a domestic_corporation or a domestic_corporation that is subject_to the income_tax of a foreign_country on its worldwide income or on a residence basis separate units include foreign branches interests in partnerships and interests in trusts whether a domestic corporation’s foreign activities constitute a foreign_branch is determined based on all the facts and circumstances an entity is not exempt from the sec_1503 dcl provisions because it is subject_to a foreign country’s sec_1503 mirror legislation tax laws that prohibit the net operating losses of the drc from offsetting the income of another person in the foreign_country instead except when the united_states and a foreign_country have an agreement under sec_1_1503-2 when a foreign country’s sec_1503 mirror legislation applies to the dcls of a drc the dcls are treated as offsetting the income of another person under that foreign country’s tax laws there are no sec_1_1503-2 agreements into which the united_states has entered with a foreign_country parent cannot use the year and year net operating losses derived from the leasing arrangements to offset the income of other persons within the parent consolidated_group the year and year net operating losses derived from the leasing arrangements are dcls to which the sec_1503 loss limitation rules apply parent has not filed the sec_1_1503-2 agreements for the year and year dcls from the leasing arrangements furthermore parent has not established that the year and year dcls from the leasing arrangements have not been used by any other person to offset income for foreign tax purposes facts parent is a domestic_corporation and the common parent of an affiliated_group_of_corporations that files a consolidated federal_income_tax return the parent consolidated_group parent is directly and indirectly through its domestic subsidiaries engaged in various leasing and subleasing arrangements in country a and country b a revenue_agent has proposed sec_1503 adjustments to the parent consolidated_group year and year federal_income_tax returns that would disallow the use of the parent dcls described below to offset income of other members of the parent consolidated_group the aggregate amounts of such proposed disallowances are dollar_figurea for year and dollar_figureb for year the revenue_agent believes that parent’s leasing arrangements are tax_avoidance transactions referred to as lease-in lease-out transactions or lilo transactions or are sale leaseback transactions the leasing arrangements are described below a leasing arrangement a dsub3 and dsub4 domestic corporations and members of the parent consolidated_group are equal partners in pship1 a domestic_partnership dsub1 a domestic_corporation and member of the parent consolidated_group owns both dsub3 and dsub4 pship1 signed a_trust indenture as a country a company in year and is a lessor in a lease arrangement with fgova involving certain buildings used by fgova in the industry asset groupa parent has provided only a_trust indenture as documentation related to the leasing arrangement involving asset groupa leasing arrangement a the trust_indenture for leasing arrangement a provides that pship1 as lessor the lessee the vendor the indenture trustee and the loan participants have entered into a participation_agreement the vendor lessee and the guarantor have entered into an occupational lease pship1 and the guarantor have entered into a reversionary rights agreement and pship1 will provide for the issuance of one or more secured notes to each loan participant b leasing arrangement b dsub5 and dsub6 domestic corporations and members of the parent consolidated_group are equal partners in pship2 a domestic_partnership pship2 signed a_trust indenture as a country a company in year and is a lessor in a lease arrangement with fgova involving certain buildings used by fgova in the industry asset groupb parent has provided only a_trust indenture that has provisions similar to those in the trust_indenture for leasing arrangement a as documentation related to the leasing arrangement involving asset groupb leasing arrangement b c leasing arrangement c and leasing arrangement d dsub7 and dsub8 are domestic corporations and members of the parent consolidated_group dsub1 a domestic_corporation and a member of the parent consolidated_group owns dsub7 as the equity participant dsub7 funded trust estatec a_trust estate established by trust bank1 a domestic national banking association similarly as the equity participant dsub8 funded trust estated a_trust estate established by trust bank1 trust bank1 serves as the trustee of both trust estatec and trust estated trust estatec and trust estated are treated as grantor trusts for u s federal_income_tax purposes in year trust bank1 entered into participation agreements with fc1 a country b limited_liability_company for leasing arrangements involving certain equipment asset groupc and asset groupd fgovb fgovbm1 and fgovbm2 the federal government of country b and two of its municipalities own fc1 under the year participation agreements trust bank1 agreed to be lessee and sub lessor of both the asset groupc and the asset groupd properties while fc1 agreed to be lessor and sub lessee of such properties because fgovb fgovbm1 and fgovbm2 own fc1 trust bank1's lease arrangements are effectively with fgovb fgovbm1 and fgovbm2 parent has provided only the participation agreements as documentation related to the leasing arrangement involving asset groupc leasing arrangement c and the leasing arrangement involving asset groupd leasing arrangement d under the year participation agreements for leasing arrangement c and leasing arrangement d flender1 a country b limited_liability_company agreed to make secured loans to trust bank1 trust bank1 agreed to transfer the equity funds from dsub7 and dsub8 to trust estatec and trust estated respectively and trust bank1 agreed to use the equity investments from dsub7 and dsub8 first to pay all transaction expenses second to prepay the basic rents under the leases with fc1 and third to remit the balances to fc1 as security deposits under the leases in addition under the year participation agreements fc1 agreed to execute payment agreements and make payments to flender2 a country b limited_liability_company fc1 and trust bank1 agreed to execute and deliver debt security agreements and dsub1 agreed to be a guarantor for leasing arrangement c and for leasing arrangement d d leasing arrangement e dsub9 and dsub10 are domestic corporations that are owned by dsub2 a domestic_corporation dsub2 dsub9 and dsub10 are members of the parent consolidated_group dsub9 and dsub10 are equal equity investors in funding trust estatee a_trust estate established by trust bank2 trust bank2 a domestic national banking association serves as trust estatee’s trustee trust estatee is treated as a grantor_trust for u s federal_income_tax purposes fc2 is a country b corporation that is owned by fgovb in year trust bank2 entered into participation agreements with fc2 for a leasing arrangement involving certain asset groupe under the year participation agreements trust bank2 agreed to purchase asset groupe from fc2 to lease asset groupe to fc2 and to issue loan certificates because fgovb owns fc2 trust bank2's lease arrangement is effectively with fgovb parent has provided only the participation agreements as documentation related to the leasing arrangement involving asset groupe leasing arrangement e under the leasing arrangement e participation agreements flender3 a joint_stock_company organized under an international convention in country c agreed to make a secured loan to trust bank2 and dsub2 and trust bank3 a domestic_corporation agreed to be guarantors of leasing arrangement e the participation agreements through the definition sections include a provision for fc2 to purchase asset groupe at the end of a specified term e other leasing arrangements other members of the parent consolidated_group are involved in leasing arrangements in country a and country b through partnerships and grantor trusts the revenue_agent has identified as some of the property involved in such leasing arrangements collectively leasing arrangement f parent has provided incomplete documentation about leasing arrangement f f background of lilo transactions considering the limited documentation provided by the parent the revenue_agent believes that leasing arrangement a leasing arrangement b leasing arrangement c leasing arrangement d leasing arrangement e and leasing arrangement f collectively the leasing arrangements have features of lilo transactions as background in a typical lilo_transaction a domestic pass-through entity a partnership or grantor_trust leases an asset like a power plant an airplane or a railroad from a foreign government and then leases the property back to the foreign government the main purpose of the lilo_transaction is to produce rent deductions for u s investor taxpayers while providing funding to the foreign government taxpayers often structure a lilo_transaction as described below see revrul_99_14 1999_13_irb_3 a domestic pass-through entity leases property from a foreign government under a long-term master lease for a term of for example years simultaneously subleases the property back to the foreign government for a term shorter than under the master lease and provides the foreign government sub lessee with an option to renew the lease or buy its way out of the master lease the lilo_transaction is structured to use a pass-through entity as an investment vehicle to allow investor taxpayers to benefit from tax losses under the master lease of a typical lilo_transaction the domestic pass-through entity has to make only two rental payments the domestic pass-through entity makes the first rent payment at the beginning of the lease_term in the form of a prepayment that approximately equal sec_90 percent of the then current fair_market_value of the property under the master lease the domestic pass-through entity will make the second rental payment at the end of a specified period in the lease under the sublease the foreign government will make level annual sublease rental payments to the domestic pass-through entity to fund its first rent payment to the foreign government under the master lease the domestic pass-through entity typically borrows most of the rent from a large foreign bank the foreign government then deposits the first rent payment with the foreign bank that made the loan to the domestic pass-through entity or one of the foreign bank’s affiliates the domestic pass-through entity’s first rent payment is structured to take care of everyone’s obligations in the lilo_transaction as all other_payments including the sublease rent are part of a circular cash_flow for u s federal_income_tax purposes the u s investor taxpayers claim rent and interest deductions related to the domestic pass-through entity’s rental payments under the master lease and the related loan the investor taxpayers include in gross_income the rents the domestic pass-through entity receives under the sublease and if and when exercised the payment the domestic pass-through entity receives on the fixed payment option the lilo is structured to generate a stream of substantial net deductions in the early years of the transaction followed by net_income inclusions on or after the conclusion of some specified period under the sublease term consequently the u s investor taxpayers anticipate a substantial net after-tax return from a lilo_transaction law and analysis the treasury_department and the service have taken the position that lilo transactions may be tax_avoidance transactions see notice_2000_15 2000_12_irb_826 and revrul_99_14 1999_13_irb_3 consequently the service may disallow the deductions arising from the leasing arrangements based on statutory or regulatory tax_avoidance provisions or economic_substance judicial doctrines this document does not analyze such legal suppositions the analysis below considers only the legal bases of using the sec_1503 dcl limitation provisions to disallow the year and year net operating losses arising from the leasing arrangements a parent’s assertions parent takes the position that the sec_1503 provisions do not apply to the year and year net operating losses arising from the leasing arrangements because such net operating losses are not dcls in addition parent argues that it does not have to make any filings under sec_1_1503-2 in year or in year related to the leasing arrangements although parent has not provided a comprehensive legal analyses of its assertions considering both the relevant tax laws of country a or country b and of the united_states parent supports its claimed tax treatment of leasing arrangement a and leasing arrangement b as follows because pship1 and pship2 are not members of a country a tax group and are currently unable to file group relief elections any net operating losses_incurred by pship1 and pship2 cannot offset the income of any other person in country a parent further notes that under the country a tax laws country a group companies must file an election to obtain group relief ie consolidation and because pship1 and pship2 are not members of a country a tax group the group relief election is not possible pship1 and pship2 are not permitted under the income_tax laws of country a to use their losses to offset the income of any other person that is recognized in the same taxable_year in which the losses are incurred parent further notes that under country a’s tax laws the pship1 and pship2 net operating losses cannot be used to offset the income of any other member’s future or prior year’s income pship1 and pship2 file stand alone country a tax returns and are exempt from the sec_1503 provisions under the stand alone exception parent supports its claimed tax treatment of leasing arrangement c leasing arrangement d leasing arrangement e and leasing arrangement f by asserting that because the various companies ie trust estatec trust estated trust estatee and leasing arrangement f partnerships and trusts are not regarded as permanent establishments in country a or country b the companies are not required to file foreign tax returns and are not drcs b general background of the dual_consolidated_loss provisions the united_states taxes the worldwide income of domestic corporations the united_states generally allows domestic corporations to file consolidated_returns with other commonly owned domestic corporations when two or more domestic corporations file a consolidated_return losses that one corporation incurs generally may reduce or eliminate tax on income that another corporation earns because other countries may apply a different standard for determining the residence and taxability of a corporation eg based on the management and control of the corporation some domestic corporations are drcs and as such are also subject_to the income_tax of a foreign_country on their worldwide income or on a residence basis and not on a source basis also some foreign countries have provisions that permit commonly controlled entities to combine their income and losses though consolidation or some other form of combination prior to the tax_reform_act_of_1986 if a drc were a resident of a foreign_country with tax laws that permitted the losses of the corporation to offset the income of another person eg under a consolidated_return provision then the drc could use a single economic loss to offset two separate items of income in two jurisdictions once to offset the income of affiliates resident in the united_states but not abroad and again to offset the income of affiliates resident only in the other country congress expressed concerns that this type of dual use of a loss could result in an undue tax advantage to certain foreign investors that made investments in domestic corporations and could create an undue incentive for certain foreign_corporations to acquire domestic corporations and for domestic corporations to acquire foreign rather than domestic assets staff of joint_committee on taxation 99th cong 2nd sess general explanation of the tax_reform_act_of_1986 pincite - as part of the tax_reform_act_of_1986 congress enacted sec_1503 to prevent this type of double dipping under sec_1503 except as provided in regulations a dcl of a drc may not be used to reduce the taxable_income of any other member of the corporation’s domestic affiliated_group for any taxable_year sec_1503 generally defines a dcl as a net_operating_loss of any domestic_corporation that is subject_to the income_tax of a foreign_country without regard to country source or on a residence basis sec_1503 the u s treasury_department and the service issued temporary regulations under sec_1503 in t d c b and final regulations in t d c b the final regulations contained in sec_1_1503-2 generally are effective for taxable years beginning on or after date the temporary regulations contained in sec_1_1503-2a are effective for taxable years beginning after date and before date because year and year are taxable years beginning after date the final regulations found in sec_1_1503-2 would apply to the year and year parent consolidated_group net operating losses arising from the leasing arrangements c dual resident corporations sec_1_1503-2 of the final regulations defines the term dual_resident_corporation to include a separate_unit of a domestic_corporation including a hybrid_entity_separate_unit and a domestic_corporation that is subject_to the income_tax of a foreign_country on its worldwide income or on a residence basis a domestic corporation’s separate_unit is treated as if it were a wholly-owned subsidiary of the corporation sec_1_1503-2 the temporary regulations were initially designated as sec_1_1503-2t but were redesignated as sec_1_1503-2a by the final regulations t d 1992_2_cb_240 foreign branches as defined in sec_1_367_a_-6t interests in partnerships interests in trusts and interests in hybrid_entity separate units are separate units sec_1_1503-2 a hybrid_entity_separate_unit is an interest held by a domestic_corporation in an entity that is not taxable as an association for u s tax purposes but is subject_to income_tax in the foreign_country at the entity level or on a residence basis sec_1_1503-2 sec_1_367_a_-6t defines the term foreign_branch as follows the term foreign_branch means an integral business operation carried on by a u_s_person outside the united_states whether the activities of a u_s_person outside the united_states constitute a foreign_branch operation must be determined under all the facts and circumstances evidence of the existence of a branch includes but is not limited to the existence of a separate set of books_and_records and the existence of an office or other fixed place of business used by employees or officers of the u_s_person in carrying out business activities outside the united_states activities outside the united_states shall be deemed to constitute a foreign_branch for purposes of this section if the activities constitute a permanent_establishment under the terms of a treaty between the united_states and the country in which the activities are carried out any u_s_person may be treated as having a foreign_branch for purposes of this section whether that person is a corporation partnership trust estate or individual parent asserts that because trust estatec trust estated and trust estatee are not permanent establishments under country b’s tax laws and are not required to file country b tax returns drc7 drc8 drc9 and drc10 are not drcs in addition parent asserts that pship1 and pship2 are not able to file consolidated_returns in country a however there is neither a requirement that a separate_unit be a permanent_establishment under a foreign country’s tax laws to constitute a drc nor a requirement that a separate_unit file tax returns in a foreign_country to be a drc see t d 1992_2_cb_240 sec_1_1503-2 and sec_1_1503-2 merely require that a domestic_corporation have a foreign_branch or have an interest in a partnership or in a_trust to constitute a drc accordingly trust estatec trust estated and trust estatee are not required to be permanent establishments under country b’s tax laws for dsub7's dsub8's dsub9's and dsub10's interests in the trusts to constitute drcs presumably parent’s permanent_establishment position is based on the reference in sec_1_1503-2 to sec_1_367_a_-6t that reference in sec_1_1503-2 applies only to foreign branches sec_1_367_a_-6t requires that all the facts and circumstances be considered in determining whether activities of a u_s_person outside the united_states constitute a foreign_branch operation sec_1_367_a_-6t further provides that activities outside the united_states are deemed to constitute a foreign_branch when the activities constitute a permanent_establishment under the terms of a treaty between the united_states and the country in which the activities are conducted sec_1_367_a_-6t does not provide that activities outside the united_states will constitute a foreign_branch only if the activities constitute a permanent_establishment under foreign laws considering the definition of a drc the drcs in the leasing arrangements are as follows leasing arrangement a and leasing arrangement b dsub3 and dsub4's interests in pship1 are drcs as they are interests in a partnership held by domestic corporations drc3 and drc4 respectively a domestic corporation’s interest in a partnership is a drc sec_1_1503-2 - similarly dsub5 and dsub6's interests in pship2 are interests in a partnership held by domestic corporations and thus are drcs drc5 and drc6 respectively even if pship1 and pship2 were treated as corporations under country a’s tax laws and as partnerships under u s tax laws dsub3 and dsub4's interests in pship1 and dsub5 and dsub6's interests in pship2 would be hybrid_entity separate units and as such would be drcs sec_1_1503-2 - leasing arrangement c because dsub7's interest in trust estatec is an interest in a_trust it is a drc drc7 a domestic corporation’s interest in a_trust is a drc sec_1_1503-2 - even if trust estatec were taxable at the entity level under country b’s tax laws and as a grantor_trust for u s federal_income_tax purposes dsub7's interest in trust estatec would be a hybrid_entity_separate_unit and as such would be a drc sec_1_1503-2 - leasing arrangement d dsub8 is a domestic_corporation that owns an interest in trust estated because dsub8's interest in trust estated is an interest in a_trust dsub8's interest in trust estated is a drc drc8 sec_1_1503-2 - even if trust estated were taxable at the entity level under country b’s tax laws and as a grantor_trust for u s federal_income_tax purposes dsub8's interest in trust estated would be a hybrid_entity_separate_unit and as such would be a drc sec_1_1503-2 - leasing arrangement e because dsub9 and dsub10's interests in trust estatee are interests in a_trust dsub9 and dsub10's interests in trust estatee are drcs drc9 and drc10 respectively sec_1_1503-2 - even if trust estatee were taxable at the entity level under country b’s tax laws and as a grantor_trust for u s federal_income_tax purposes dsub9 and dsub10's interests in trust estatee would be hybrid_entity separate units and as such would be drcs sec_1_1503-2 - leasing arrangement f other members of the parent consolidated_group are involved in leasing arrangements in country a and country b through partnerships and grantor trusts the sec_1503 provisions would apply to leasing arrangement f because a domestic corporation’s foreign_branch and a domestic corporation’s interests in a partnership or in a_trust are drcs sec_1_1503-2 - d general_rule limiting losses sec_1_1503-2 of the final regulations provides the general_rule that a corporation may not use a dcl of a drc to offset its income or the income of any other member of the corporation's consolidated_group in addition a dcl of a drc cannot offset the income of another corporation by means of a transaction in which the other corporation succeeds to the tax_attributes of the drc under code sec_381 nor can a dcl of a separate_unit of a domestic_corporation be used to offset income of the corporation following the termination liquidation sale_or_other_disposition of the separate_unit sec_1_1503-2 sec_1_1503-2 provides an exception to the general sec_1503 loss_disallowance_rule and permits a taxpayer to elect to use a dcl of a drc by entering into an agreement under which the taxpayer certifies that the dcl has not been and will not be used to offset the income of another person under the laws of the foreign_country and agrees to recapture the dcl if a triggering event occurs within fifteen years of the loss if foreign law allows a drc to combine its income and losses with other persons by making an election a drc’s losses are considered to offset income of another person only when the election is made sec_1_1503-2 for the sec_1_1503-2 exception to apply no other person can use any part of the dcl in another country to offset income sec_1_1503-2 if another person uses any portion of the dcl in a foreign_country the entire amount of the dcl is treated as having been used in the foreign_country sec_1_1503-2 parent has refused to enter into sec_1_1503-2 agreements in year and year for the year and year net operating losses of drc3 drc4 drc5 drc6 drc7 drc8 drc9 and drc10 the parent dcls even if parent files sec_1_1503-2 agreements parent must prove that the parent dcls do not actually offset the income of any other person for foreign tax purposes in year or year in general losses taken into account in computing a dcl are treated as offsetting income of another person under foreign tax law in the year the dcl is made available for offset sec_1_1503-2 it is irrelevant that the other person does not have enough income in the year to benefit from the offset sec_1_1503-2 for leasing arrangement a and leasing arrangement b parent must prove that no other person in a foreign_country used the year or year dcls of drc3 drc4 drc5 or drc6 also parent must prove that to the extent that the tax allocations of pship1 or pship2 are different under country a’s tax laws than under u s tax laws the dcls of drc3 drc4 drc5 and drc6 are not partially used to offset the income of another person for foreign tax purposes if the losses are partially used the dcl s would be treated as used by another person for foreign tax purposes and parent would be prohibited from using any amount of the dcl s to offset the income of any other member of the parent consolidated_group see sec_1_1503-2 and t d 1992_2_cb_240 similarly for leasing arrangement c leasing arrangement d and leasing arrangement e parent must prove that no other person in a foreign_country used the year or year dcls of drc7 drc8 drc9 or drc10 except as provided in sec_1_1503-2 a taxpayer has to file annual certifications that the losses expenses and deductions that make up the dcls have not been used to offset the income of another person for foreign tax purposes sec_1_1503-2 failure_to_file the annual certifications is a triggering event that requires the taxpayer to recapture the loss and pay an interest charge sec_1_1503-2 if a taxpayer fails to comply with the sec_1503 recapture provisions upon the occurrence of a triggering event then the drc that incurred the dcl or a successor-in-interest will not be eligible for relief to use any dcls incurred in the five taxable years beginning with the year in which recapture is required sec_1_1503-2 this means that the year and year dcls of drc3 drc4 drc5 and drc6 cannot generally be used to offset the income of dsub3 dsub4 dsub5 dsub6 or any other corporation under sec_1_1503-2 drc3 drc4 drc5 and drc6 are treated as separate corporations from dsub3 dsub4 dsub5 and dsub6 for the parent consolidated_group to be able to use the parent dcls no portion of the net operating losses related to the leasing arrangements can be used to offset the income of any other person for foreign tax purposes in addition parent must file agreements under sec_1_1503-2 for the parent consolidated_group to be able to use the parent dcls parent however might not be able to file agreements under sec_1_1503-2 for the year and year dcls of drc3 drc4 drc5 and drc6 a drc is treated as if it actually uses its dcls to offset the income of another person in a foreign_country when the foreign_country has income_tax laws that deny the use of the losses expenses or deductions of the drc to offset the income of another person because the drc is also subject_to income_taxation by another country on its worldwide income or on a residence basis this type of foreign_country tax law is often referred to as sec_1503 mirror legislation sec_1_1503-2 t d 1992_2_cb_240 the only way that the sec_1503 provisions will not apply to the net operating losses related to the leasing arrangements is if parent can prove that the net operating losses are not dcls under sec_1_1503-2 when a country’s sec_1503 mirror legislation applies to losses of a drc a taxpayer cannot file an agreement under sec_1_1503-2 to use the dcls to offset the income of other u s consolidated_group members see 35_fedclaims_123 aff’d without op 116_f3d_1497 fed cir see also sec_1_1503-2 and staff of joint_committee on taxation 99th cong 2nd sess general explanation of the tax_reform_act_of_1986 pincite - country a has a form of sec_1503 mirror legislation and parent must prove that country a’s mirror legislation does not apply to the year and year dcls of drc3 drc4 drc5 and drc6 finally parent contends that because pship1 and pship2 are not members of a country a tax group and currently are unable to file group relief elections any dcls related to pship1 and pship2 cannot offset the income of any other person in country a partnerships generally are not permitted to file consolidated_returns the issue for purposes of sec_1503 is whether the year and year dcls of drc3 drc4 drc5 and drc6 may be used to offset the income of any other person for foreign tax purposes also the issue is not whether pship1 and pship2 can carry the losses forward or back for tax purposes but whether any taxpayer can carryforward or back or otherwise use the year or year losses of drc3 drc4 drc5 or drc6 see sec_1_1503-2 if the united_states and a foreign_country have entered into a sec_1_1503-2 agreement the mirror legislation deemed use provision will not apply sec_1_1503-2 there are no sec_1_1503-2 agreements between the united_states and a foreign_country e determining whether losses are dual consolidated losses the term dual_consolidated_loss is defined as the net_operating_loss of a domestic_corporation computed under u s tax principles incurred in a year in which the corporation is a drc sec_1_1503-2 parent takes the position that the year and year net operating losses from the leasing arrangements are not dcls parent is correct that both the final and temporary regulations contain an exception to the sec_1503 general loss limitation rule by excluding certain net operating losses from the definition of a dcl see sec_1_1503-2 and sec_1_1503-2a c the exception does not apply to the parent dcls under the final regulations a dcl does not include a net_operating_loss incurred by a drc in a foreign_country with income_tax laws that do not permit the drc to use its losses expenses or deductions to offset the income of any other person that is recognized in the same taxable_year in which the drc incurs the losses expenses or deductions and do not permit the losses expenses or deductions of the drc to be carried over or back to be used by any means to offset the income of any other person in other taxable years sec_1_1503-2 the temporary regulations also include an exception to the general sec_1503 loss limitation provisions through what is often referred to as the stand alone exception to qualify for the stand alone exception the income_tax laws of the foreign_country must have at no time since date permitted any other person corporation or entity by any means to use the losses expenses or deductions of the drc to offset income and in taxable years beginning after date the losses expenses or deductions of the drc cannot under the income_tax laws of the foreign_country be carried forward or back to offset the income of another person corporation or entity in other years sec_1_1503-2a c i because most foreign countries permit some use of net operating losses by other entities as a result of corporate_reorganizations the exception from the definition of dcls under the final regulations rarely applies see generally sec_1_1503-2 both country a and country b allow some form of use of net operating losses as a result of corporate_reorganizations also both country a and country b allow some form of combination or consolidation of income and losses for income_tax purposes unless parent proves that the year and year parent dcls can never be used to offset income of another person for foreign tax purposes including that the losses can never be carried over or carried back as a result of a corporate_reorganization the sec_1_1503-2 exception does not apply to the parent dcls see generally sec_1_1503-2 parent contends that the stand alone exception under sec_1_1503-2a c applies to leasing arrangement a and leasing arrangement b because pship1 and pship2 file stand alone country a tax returns first the stand alone exception is an exception under the temporary sec_1503 regulations but not under the final regulations see t d 1992_2_cb_240 and sec_1_1503-2a c i the final regulations apply to the year and year parent dcls second even if the temporary regulations applied to the year and year losses parent would have to prove that the stand alone exception applies to the year and year net operating losses of drc3 drc4 drc5 and drc6 for the stand alone exception to apply to leasing arrangement a and leasing arrangement b parent would have to prove that the relevant net operating losses were incurred in taxable years beginning before date the country a income_tax laws did not at any time since date permit any other person corporation or entity by any means to use the losses expenses and deductions of drc3 drc4 drc5 or drc6 to offset income and in taxable years beginning after date the losses expenses and deductions of drc3 drc4 drc5 and drc6 cannot be carried forward or back to offset the income of any other person corporation or entity in other years under the income_tax laws of a foreign_country sec_1_1503-2a c i case development hazards and other considerations revenue agents can apply the sec_1503 dcl provisions to lilo transactions to disallow dcls a revenue_agent merely has to identify the relevant drcs and determine that it is possible for some other person in the other country to use the dcls for tax purposes or that sec_1503 mirror legislation could apply to the dcls the taxpayer such as parent then must prove that no other person used the losses to offset income for foreign tax purposes and that the foreign_country does not have sec_1503 mirror legislation that applies to the dcls at issue also even when a revenue_agent can disallow losses related to lilo transactions by applying the sec_1503 dcl provisions a taxpayer such as parent can use the losses on a separate_return_limitation_year basis to offset generally only the income generated by that drc the net present_value of the use of the losses on a separate_return_limitation_year basis is likely to be nominal however as lilo transactions typically do not result in net taxable_income for many years disallowing losses arising from lilo transactions by using the sec_1503 provisions may be effective in the short-run but with knowledge of the service’s application of the sec_1503 provisions and with careful planning taxpayers may be able to avoid having the sec_1503 provisions apply to disallow the use of net operating losses by a domestic consolidated_group therefore when appropriate losses arising from lilo transactions should also be disallowed because of statutory or regulatory tax_avoidance provisions or because of economic_substance judicial doctrines please call camille evans if you have any further questions michael h frankel assistant to branch chief cc regional_counsel