Potential impact of sec. 1503(d) rules on losses incurred through a domestic partnership.

• Author: Zarzar, Robert
• Position: Field Service Advice

Field Service Advice (FSA) 200101007 applied the dual consolidated loss (DCL) rules to deny the use of losses incurred through a domestic partnership. The FSA may have implications for any domestic corporation that holds an interest in a partnership with losses, regardless of whether the partnership has a foreign presence or files foreign income tax returns.

DCL Rules and Terminology

The DCL rules are designed primarily to prevent dual resident corporations (DRCs) from using a single economic loss in two different jurisdictions. The term "dual consolidated loss" generally means the net operating loss (NOL) of a domestic corporation incurred in a year in which the corporation is a DRC. The term "dual resident corporation" generally means a domestic corporation subject to the income tax of a foreign country on its worldwide income or on a residence basis. A corporation is taxed on a residence basis if it is taxed as a resident under a foreign country's laws.

In addition, any "separate unit" of a domestic corporation is treated as a separate domestic corporation and a DRC. The term "separate unit" includes an interest in a partnership (as well as a "hybrid entity separate unit" which is treated as a partnership for Federal tax purposes and a corporation under foreign law). Thus, the term literally appears to include any interest in a partnership, including an interest in a domestic partnership engaged only in domestic business activities.

Application to Partnerships

Prior to finalization of the DCL regulations in 1992, commentators suggested that the rules should not be applied to partnership interests--apart from cases in which a partnership qualified as a hybrid entity separate unit--on the general ground that a loss of a passthrough entity cannot be used twice. Such comments were not reflected in the final DCL regulations, however, because the IRS had concerns about the potential for abusive double-dipping even with respect to interests in ordinary partnerships.

According to the preamble to the final DCL regulations, the Service is considering whether special rules are needed for items of partnership loss in at least two circumstances in, which, because of a special allocation, the loss is used to offset one income stream for U.S. tax purposes and a separate income stream for foreign tax purposes. The final regulations reserved a paragraph to address the treatment of such loss allocations. Accordingly, it appears that the IRS had not fully...