Understanding Synthetic Dispositions – Holding Period Rules

We conclude our Synthetic Dispositions series this week with a look at holding period rules.

Example: Synthetic Disposition –
Holding Period Rules and Foreign Tax Credit

Issue: IJK Bank purchased shares in a foreign corporation or $1,000,000 which paid $10,000 in dividends in 2013 with $4,000 income tax withheld. In 2013, the bank entered into a forward sale agreement for $1,005,000 that would result in the disposition of the shares in 2014. How would these dividends be taxed?

Answer: If the arrangement was made before budget day (March 21, 2013), IJK Bank would report the foreign dividends in income and claim the foreign tax credit for the foreign taxes paid ($4,000).

If the arrangement was made after budget day, then IJK Bank would be deemed to have disposed of the shares at the time of the agreement and reacquired them at their fair market value. The foreign tax credit that the bank could claim would be limited to 15% x ( $1,005,000 + $10,000 - $1,000,000) x $10,000/$10,000 = $22,500. This 15% limitation is based on the holding period of less than one year from the purchase date to the deemed disposition date.

If the taxpayer later regains the risk of loss or the opportunity for gain or profit, the property would be considered to be owned from that point onward for the purposes of the holding-period tests.

Example: Synthetic Disposition –
Holding Period Rules and Foreign Tax Credit Where Risk of Loss Regained

Issue: IJK Bank (previous example) was not able to dispose of the foreign corporation shares in 2014 because the buyer had declared bankruptcy. How will this affect future foreign tax credit claims.

Answer: At the time that the agreement is voided, IJK Bank is considered to have become the owner of the shares again for the holding period test. Where the bank continues to hold the shares for at least one year, earns dividend income from the shares, and pays foreign taxes, there is no longer a 15% restriction on the foreign tax credit claim.

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