Initial IRS guidance addressing EU cap-and-trade systems, subpart F rules.

• Author: Janosy, Lauren M.

In Letter Ruling 200825009, the IRS addressed for the first time the subpart F treatment of gains on sale of surplus carbon dioxide (C[O.sub.2]) emissions allowances.

The taxpayer took the position that such gain does not give rise to foreign personal holding company income (FPHCI) within the meaning of Sec. 954(c). The taxpayer argued that C[O.sub.2] emissions allowances should be viewed as commodities for purposes of the Sec. 954(c)(1)(C) exception from FPHCI or, alternatively, that such allowances should be treated as property that does not give rise to income within the meaning of Sec. 954(c)(1)(B) (iii); The IRS specifically did not address the taxpayer's argument that the allowances should be viewed as commodities, instead adopting the taxpayer's alternative argument in concluding that the gain from the sale of surplus C[O.sub.2] emissions allowances does not give rise to FPHCI.

The Service indicated that although it currently was studying whether C[O.sub.2] emissions allowances are commodities, "[n]o inference is intended as to whether C[O.sub.2] allowances are properly considered commodities for purposes of Code section 954 or any other section of the Code." Pending any further IRS guidance, the inclusion of this "no-inference" language may be significant to many taxpayers who may seek to treat C[O.sub.2] emissions allowances as commodities under various Code sections. Moreover, the "no-inference" language suggests that the IRS may address in future guidance whether the definition of commodities under Sec. 954 (and other sections of the Code) includes C[O.sub.2] emissions allowances.

Facts

The letter ruling involved a U.S. corporation that indirectly owned a controlled foreign corporation (CFC) and a membership interest in a controlled foreign partnership (CFP), each of which had manufacturing operations within European Union (EU) member states. Both the CFC and the CFP were granted allowances under the EU's Emissions Trading Scheme (ETS), the cap-and-trade system implemented by EU member states to regulate C[O.sub.2] emissions and other greenhouse gases within certain industries.

The EU ETS required the CFC and CFP to surrender their allocated allowances on a yearly basis in amounts equal to their C[O.sub.2] emissions. If the businesses had excess allowances in a given year, they could sell the surpluses to another person; however, if they exceeded their allowances, the EU imposed a fine. During the years at issue, both the CFC and...