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International Tax Bulletin (January 1999)

IRS Proposes Modification of
Revenue Procedure 65-17

By William E. Bonano, a tax partner in the San Francisco office of Pillsbury Winthrop Shaw Pittman LLP. If you have or can obtain the Acrobat Reader, you may wish to download the printed versions of the bulletin containing this article, a 123K pdf file, or of Announcement 99-1, a 38K pdf file which includes the text of the proposed Revenue Procedure modifying Revenue Procedure 65-17.

This bulletin concerning recent tax law developments is part of the Pillsbury Winthrop Shaw Pittman LLP Tax Page, a World Wide Web demonstration project. Comments are welcome on the design or content of this material.

In the Internal Revenue Bulletin for January 11, 1999, the United States Internal Revenue Service (the "Service" or "IRS") published Announcement 99-1 containing its proposed modification of Revenue Procedure 65-17.[fn. 1]

For a number of years the Service and taxpayer groups have discussed the need to update Revenue Procedure 65-17. That revenue procedure, as amended and modified over the years, generally allows taxpayers to repatriate cash in the amount of a section 482 allocation without additional tax consequences. It accomplishes this result by allowing a controlled taxpayer subject to a section 482 allocation to establish a receivable in the amount of the allocation. The allocated amounts may then be paid to the controlled taxpayer and will be treated as nontaxable payments in satisfaction of the receivable.

Significantly, Revenue Procedure 65-17 also allows taxpayers to avoid withholding liability under Internal Revenue Code section 1442 as a consequence of a section 482 allocation. Typically, the IRS asserts such withholding liability when it makes an allocation from a foreign parent to its domestic subsidiary.

Announcement 99-1 provides that the account receivable treatment discussed above will apply only if the taxpayer subject to the section 482 allocation is not also subject to a penalty under Internal Revenue Code sections 6662(e)(1)(B) or 6662(h).[fn. 2] The Announcement also provides that relief will not be granted if any part of the allocation is due to fraud.[fn. 3]

The requirement that taxpayers must not be subject to section 6662 to qualify for relief is a significant change from prior practice. Under Revenue Procedure 65-17, as initially promulgated, relief is permitted as long as the pricing transaction does not have "the avoidance of federal income tax" as one of its "principal purposes." The "background" discussion in Announcement 99-1 states that the "factual nature" of the "tax avoidance" inquiry under Revenue Procedure 65-17 caused significant "difficulty" for both taxpayers and the Service. The background discussion further states that a change to the section 6662 requirement "focuses the inquiry on the objective adequacy of the taxpayer's documentation."

It is unlikely that taxpayers will blithely accept the Service's characterization of this new approach as an "objective analysis." For example, the question of whether a taxpayer's documentation is adequate under the penalty regulations is far from an "objective inquiry." There are significant questions concerning both quantitative and qualitative requirements under those regulations. Indeed, it is doubtful that any taxpayer could ever be in literal compliance with every requirement of the penalty regulations. Thus, the IRS could no doubt find fault with almost any taxpayer's documentation, belying the "objective adequacy" characterization.

Another significant change from past practice is that the proposed revenue procedure eliminates dividend offset treatment. The "background" portion of the Announcement states that the dividend offset treatment is "inconsistent with the current policy under sections 482 and 6662(e) that taxpayers should strive up front to price their related party transactions in compliance with the arms'-length standard." That statement presupposes that taxpayers who have made dividend distributions are less likely to have made an "up front" effort to comply with the arm's-length standard. Clearly, significant doubt exists as to the validity of that premise.

Finally, Announcement 99-1 clarifies that a foreign tax credit will be allowed for any foreign tax that is withheld with respect to a payment made in satisfaction of a repatriation receivable. The announcement provides, however, that taxpayers must exhaust all practical remedies, including invocation of competent authority procedures, if available, in order to qualify for the credit, citing Income Tax Regulations section 1.901-2(e)(5).

Announcement 99-1 provides that the proposed changes to Revenue Procedure 65-17 will become effective for taxable years beginning after the date of publication of the final revenue procedure.


  1. 1965-1 C.B. 833.[return to text]

  2. Ann. 99-1, § 3.[return to text]

  3. Id.[return to text]

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