Domestication does not work, the IRS said.
US companies that invest in infrastructure projects in other countries often do so in a manner that lets them defer US taxes on the earnings until the earnings are repatriated to the United States. This requires investing through an offshore holding company treated as a corporation for US tax purposes and then exercising care to ensure that all entities below this offshore holding company are transparent for US tax purposes.
Transparency is normally a matter of sending a form — called a “check-the-box” election — to the IRS.
However, the IRS maintains a list of types of entities — one per country — that cannot be treated as transparent. For example, an SA in any country in Latin America cannot be transparent. Thus, if a power plant in Argentina is owned by an SA, then US tax deferral will be harder to achieve.
Some tax counsel have tried to get around this problem by “domesticating” the project company, or reorganizing it under Delaware law. The project company remains an Argentine SA as far as Argentina is concerned, but Delaware will also recognize it as a Delaware company.
The IRS issued temporary regulations in early August to put a halt to this practice. The IRS said it will treat any company that is chartered in more than one country as a corporation for US tax purposes if it appears on the per se corporations list in any of its forms.
These rules are retroactive. The tax agency said the new regulations merely “clarify current law and do not change the outcome that would result under a proper application of existing rules.”
It said this rule will not be used to determine where a company has its tax residence. Its tax residence determines whether it can take advantage of benefits under a tax treaty between the United States and another country.
The IRS also said it is studying whether to change how it defines a partnership as US or “foreign.” At present, the agency simply looks at the law under which the partnership was formed. It said it is considering “under what circumstances a different definition may be appropriate.” This can be important for partnerships that receive payments from the US, as US taxes are more likely to be withheld from payments to a foreign partnership. Also, US persons making capital contributions or sales of interests in “foreign” partnerships must report them.
Any change in the treatment of partnerships as US or foreign would only apply to new partnerships formed after the new rules are issued. A change in ownership of an existing partnership could bring it under the new rules.