US power companies that used such structures are assessing whether to unwind them. The IRS made an announcement in late July in Notice 2003-50.

The United States taxes American companies on worldwide income. It tries to prevent double taxation of income from foreign sources by allowing a credit in theory for any taxes that had to be paid to another country, but the foreign tax credit rules are so full of fine print that few American companies are able to claim such credits in practice.

One problem is the IRS treats a US company’s borrowing costs at home — even for purely domestic purposes — as a cost partly of its foreign operations. A portion of this domestic interest expense is allocated to foreign operations in the same ratio as the company’s assets are deployed at home and abroad. The effect is that a company is not viewed as having earned much money abroad after this allocated interest expense is subtracted. Smaller foreign earnings mean fewer foreign tax credits. In fact, most US power companies are in an “overall foreign loss” position, meaning that they have millions of dollars in allocated interest expense to burn off before they are viewed as having earned anything abroad.

Some US companies resort to self-help remedies. One such remedy was stapled stock. A US company might “staple” the shares of a foreign subsidiary to one of its US subsidiaries. This means that the shares of the two companies cannot be sold separately. It has the effect of subjecting the foreign subsidiary to US income taxes as if it were a standalone US company. The key word was standalone. Although the foreign subsidiary must pay US income taxes, it could calculate its own foreign tax credits unhindered by any allocated interest expense from its US parent company.

The IRS said in July that it will require in the future that stapled foreign companies take into account allocated interest expense. The new policy applies to foreign companies that are newly stapled to US companies after July 22, 2003. It will not apply to companies that were already stapled on July 22 until after the current tax year ends, giving US multinationals time to unravel existing structures.

Meanwhile, the IRS is challenging some existing stapled stock structures on audit. It said that it will continue to assert on audit that stock was not effectively stapled where there was nothing to prevent the US parent from breaking the staple at will.