The taxpayer tried to release the credits by having its offshore subsidiary make a “section 956 loan” back to the United States.

A US parent company owned two US subsidiaries, US1 and US2. US2 owned, in turn, a foreign subsidiary, FC1. FC1 owned FC2. US1 made a loan to FC1 which onlent the cash to FC2. FC2 then immediately onlent it to US2. FC2 had “earnings and profits” that had not been taxed yet in the United States. The loan by FC2 back to US2 is treated under section 956 of the tax code as “dividend” of the earnings back to the United States so that the earnings became subject immediately to tax. However, any credits for foreign taxes already paid by FC2 on the earnings became available for use at the same time in the US.

US companies often make section 956 loans as a way to release foreign tax credits. However, the IRS national office recast the transaction in this case as a loan from US1 to US2. The internal IRS memo discussing the transaction is ILM 200137005. The agency made it public in September.

The company probably tried the scheme in an effort to avoid “pooling” problems if the foreign tax credits had had to follow the more normal path of moving up to US2 via FC1.