Q1. What should a partnership report? A1. Section 267A disallows a deduction for certain interest or royalty paid or accrued pursuant to a hybrid arrangement, to the extent that, under the foreign tax law, there is not a corresponding income inclusion (including long-term deferral). Report on line 22 the total amount of interest and royalty paid or accrued by the partnership for which the partnership knows, or has reason to know, that one or more partners' distributive share of deductions are disallowed under section 267A. Q2. To which partners does Section 267A apply? A2. Section 267A applies at the partner level. Section 267A only applies to partners that are (i) U.S. tax residents, (ii) controlled foreign corporations (CFCs) that have one or more United States shareholders that directly or indirectly own at least ten percent of the stock of the CFC, or (iii) foreign tax residents that are considered to have a U.S. taxable branch (for example, by reason of being a partner in a partnership that conducts a U.S. trade or business). See Regulations sections 1.267A-1(b) and 1.267A-5(a)(17). However, section 267A does not apply if a de minimis exception is satisfied. See Regulations section 1.267A-1(c). Q3. To which payments does Section 267A apply? A3. Section 267A applies to interest or royalties paid or accrued pursuant to a hybrid arrangement (such as, for example, a payment pursuant to a hybrid instrument, or a payment to a reverse hybrid), provided that the payment or accrual is to a related party (or pursuant to a structured arrangement). In addition, pursuant to an imported mismatch rule, section 267A applies to interest or royalties paid or accrued pursuant to a non-hybrid arrangement where the income attributable to that payment or accrual is directly or indirectly offset by certain deductions involving hybridity incurred by a related party or pursuant to a structured arrangement. For purposes of section 267A, interest and royalties are defined broadly. For additional information about arrangements subject to section 267A, see Regulations sections 1.267A-2 and 1.267A-4. Also see the anti-avoidance rule under Regulations section 1.267A-5(b)(6). Q4. To what extent is a deduction disallowed if it is subject to Section 267A? A4. When section 267A applies to interest or royalties paid or accrued pursuant to a hybrid arrangement, it generally disallows a deduction for the amount to the extent that, under the foreign tax law, there is not a corresponding income inclusion (including long-term deferral). However, the deduction is not disallowed to the extent the amount is directly or indirectly included in income in the United States, such as if the amount is taken into account with respect to a U.S. shareholder under section 951(a) or section 951A. For additional information, see Regulations sections 1.267A-2 through 1.267A-4. Q5. What if a partnership does not know if a partner's share of a deduction is disallowed under Section 267A? A5. A partnership need only report an amount of interest or royalties for which it knows, or has reason to know, that a partner's share of the deduction is disallowed under section 267A. For example, in the case of an interest payment by a partnership that is not pursuant to a structured arrangement, the partnership might not know, or have reason to know, that an unrelated partner is related to the party to which the partnership makes the payment; in such a case, the partnership would not be required to solicit information from the partner to determine whether section 267A's relatedness test is satisfied, and the partnership generally would need not conduct further analyses as to whether to include the partner's share of the payment on line 22. A partnership is considered to have reason to know that a partner's share of a deduction is disallowed under section 267A if, based on all the facts and circumstances (including whether the partner is related to the partnership, or whether the payment is pursuant to a structured arrangement), a reasonably prudent person in the position of the partnership could reasonably determine whether the partner's share of the deduction is disallowed under section 267A. In the case of a partner of a partnership that does not own a greater than 10% capital or profits interest in the partnership, the partnership is not considered to have reason to know whether the partner’s share of a deduction is disallowed under section 267A provided that the payment or accrual is not pursuant to a structured arrangement. For additional information on structured arrangements, see Regulations section 1.267A-5(a)(20)(ii). Examples of Partnership Reporting Example 1. FX1, a Country X corporation, owns all of the interests in US1, a domestic corporation, and all of the interests in FX2, a Country X corporation. US1 and FX2 own 60% and 40% of the interests, respectively, in PS, an entity that is a domestic partnership for U.S. tax purposes. Neither PS nor FX2 is engaged in a trade or business in the United States, and thus FX2 does not have a U.S. taxable branch. FX1 also owns FY, a Country Y entity that is a reverse hybrid (fiscally transparent for Country Y tax purposes but a corporation for Country X tax purposes). In the current tax year, PS pays $100,000 to FY pursuant to a debt instrument, which is treated as interest for U.S. tax purposes. With respect to PS's $100,000 payment, as a result of FY being a reverse hybrid, there is no corresponding inclusion in income in Country X, nor is there an income inclusion in Country Y. Pursuant to section 267A, US1 is not allowed a deduction for its share ($60,000) of PS's $100,000 payment. PS should report $60,000 on Schedule B, line 22. PS is not required to report FX2's share ($40,000) of PS's payment because FX2's share of the payment is not subject to the rules of section 267A. Example 2. The facts are the same as Example 1, except that FY is a corporation for Country Y tax purposes (and thus is not a reverse hybrid) and FY includes PS's $100,000 payment in income under Country Y tax law as interest. FY does not receive any other payments. In addition, pursuant to a hybrid instrument, FY makes a $100,000 payment to FX1. FY is allowed a $100,000 interest deduction for its payment under Country Y tax law, but there is no corresponding inclusion in income in Country X because under Country X tax law the payment is a dividend for which a participation exemption applies. Pursuant to section 267A's imported mismatch rule, US1 is not allowed a deduction for its share of PS's $100,000 payment, because the income attributable to US1's share of PS's payment is considered offset by FY's deduction for its payment to FX1. PS should report $60,000 on Schedule B, line 22. Example 3. The facts are the same as Example 1, except that PS is engaged in a trade or business in the United States. FX2, as a partner of PS, is considered to be engaged in a trade or business within the United States (see section 875(1)), and therefore FX2's activities conducted through PS are a U.S. taxable branch (see Regulation section 1.267A-5). FX2's share ($40,000) of PS's $100,000 interest payment is allocable to gross income of FX2 that is effectively connected with the conduct of a trade or business within the United States, and thus is a payment by a U.S. taxable branch. Pursuant to section 267A, neither US1 nor FX2 is allowed a deduction for its share ($60,000 for US1, $40,000 for FX2) of PS's payment. PS should report $100,000 on Schedule B, line 22.
