[Federal Register Volume 67, Number 141 (Tuesday, July 23, 2002)]
[Rules and Regulations]
[Pages 48020-48025]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-18453]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9008]
RIN 1545-AY45
Guidance Under Subpart F Relating to Partnerships
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final regulations.
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SUMMARY: This document contains final regulations providing guidance
under subpart F relating to partnerships. The final regulations are
necessary in order to clarify the treatment of a controlled foreign
corporation's (CFC) distributive share of partnership income under
subpart F. The final regulations will affect United States shareholders
of CFCs that have an interest in a partnership.
DATES: Effective Dates: July 23, 2002.
Applicability Dates: For dates of applicability, see Sec. 1.702-
1(a)(8)(ii), 1.952-1(g)(3), 1.954-1(g)(4), 1.954-2(a)(5)(v), 1.954-
3(a)(6)(iii), 1.954-4(b)(2)(iii), 1.956-2(a)(3).
FOR FURTHER INFORMATION CONTACT: Jonathan A. Sambur, (202) 622-3840
(not a toll-free number).
SUPPLEMENTARY INFORMATION:
Background
On September 20, 2000, the IRS and Treasury published in the
Federal Register (65 FR 56836) proposed amendments to the regulations
(REG-112502-00) under section 702 and subpart F of the Internal Revenue
Code (Code). Those proposed regulations substantially restated rules in
former proposed regulations, REG-104537-97 (63 FR 14613), that were
withdrawn in REG-113909-98 (64 FR 37727). Written comments were
solicited and a public hearing was scheduled for December 5, 2000.
Several comments were received and are discussed below. No public
hearing was requested, therefore the hearing was cancelled. After
consideration of all the comments, the proposed regulations under
section 702 and subpart F are adopted as revised by this Treasury
decision.
Summary of Public Comments and Explanation of Revisions
A. Sec. 1.702-1(a)(8)(ii) Characterization and Determination of Subpart
F Income
Under the proposed regulations, gross income is characterized at
the partnership level. If any part of the partnership's gross income is
a type of income that would be subpart F income if received directly by
partners that are CFCs, that part of the partnership's gross income
must be separately taken into account by each partner under section
702. To the extent that the separately stated income results in subpart
F income to the CFC partner, it will be taken into account in
determining the CFC's total subpart F income for the taxable year.
The proposed regulations under section 702 clarify that an item
must be separately taken into account when, if separately taken into
account by any partner, the item would result in an income tax
liability for that partner, or any other person, different from that
which would result if the partner did not take the item into account
separately.
One commentator noted that the proposed regulations are
inconsistent with section 702(b), which requires that the character and
source of an item of gross income be determined at the partnership
level, because the proposed regulations require the determination of
subpart F income as if the income had been earned by the CFC. That
commentator asserted further that the addition of the phrase ``or for
any other person'' in the first sentence of Sec. 1.702-1(a)(8)(ii) goes
beyond the regulatory authority provided in section 702(a)(7).
The IRS and Treasury believe there is ample statutory authority for
these regulations. The regulations are based upon the authority of
subchapter K and subpart F and the policies underlying those
provisions. The legislative history of subchapter K provides that, for
purposes of interpreting Internal Revenue Code provisions outside of
subchapter K, a partnership may be treated as either an entity separate
from its partners or an aggregate of its partners, depending on which
characterization is more appropriate to carry out the purpose of the
particular
[[Page 48021]]
Internal Revenue Code or regulation section under consideration. H.R.
Conf. Rep. No. 2543, 83rd Cong. 2d. Sess. 59 (1954).
To allow a CFC to avoid subpart F treatment for items of income
through the simple expedient of receiving them as distributive shares
of partnership income, rather than directly, is contrary to the intent
of subpart F. Subpart F was intended to limit deferral of U.S. income
tax on certain types of income received by CFCs. The IRS and Treasury
believe that the approach set out in these regulations (which treats
the partnership as an entity for certain purposes and as an aggregate
for certain purposes) best achieves the purposes of subpart F and is
consistent with the policies underlying subchapter K.
Another commentator stated that the requirement of a separate
statement of subpart F income by the partnership would be difficult to
administer because a foreign partnership generally is not required to
prepare a Schedule K for its foreign partners.
The IRS and Treasury do not believe that applying the rules in the
regulations will cause significant problems. Because the rules of
subpart F target certain specific types of income (e.g., passive
income, certain income earned from transactions with related persons),
the IRS and Treasury believe that, in most cases, either the
partnership, the CFC partner, or both, will be able to determine
without significant difficulty the income earned by the partnership
that must be separately stated by the CFC partner.
B. Sec. 1.952-1(g) Treatment of Distributive Share of Partnership
Income by a CFC Partner
The proposed regulations clarify that the definition of subpart F
income includes a CFC's distributive share of any item of gross income
of a partnership to the extent the income would have been subpart F
income if received directly by the CFC partner. The proposed
regulations apply to all partnership interests owned by CFC partners.
In the preamble to the proposed regulations, comments were requested
about whether these rules should apply for ownership interests that
fall below a minimum threshold. This comment was requested because the
IRS and Treasury were considering whether to provide that CFCs with a
de minimis interest in a partnership should not be subject to the
regulations (e.g., by analogy to the 10 percent ownership threshold
that is used to determine a U.S. shareholder of a CFC).
One comment was received in response to this request. The
commentator suggested that the proposed regulations should apply only
to controlling partners, i.e. partners that hold more than a 50 percent
interest. The commentator stated further that this result would be
consistent with the subpart F ownership rules and would limit the rule
to circumstances where the CFC partner could easily obtain the
necessary information to determine whether its distributive share was
subpart F income.
The commentator's suggestion of limiting the application of these
rules to controlled partnerships was not adopted. The IRS and Treasury
do not believe that the objective of the regulations (which, as noted
above, is to prevent CFCs from avoiding subpart F by receiving items of
income as distributive shares of partnership income, rather than
directly) can be achieved by limiting the application of these rules
only to controlled partnerships. Further, upon additional
consideration, the IRS and Treasury believe that requiring all
partnership interests held by a CFC to be subject to the rules of these
regulations best effectuates the legislative intent of subpart F and
generally should not give rise to significant difficulties for the CFC
partner.
C. Sec. 1.954-1(g) Test for Activity and Related Persons
Section 1.954-1(g) of the proposed regulations provides that,
generally, in determining whether a distributive share of partnership
income is subpart F income, whether an entity is a related person and
whether an activity takes place in or outside the country under the
laws of which the CFC is organized (e.g., for purposes of determining
whether the income qualifies for a ``same country'' exception to
subpart F), shall be determined with respect to the CFC partner and not
the partnership.
One commentator objected to the rules in Sec. 1.954-1(g)(1). This
commentator stated that the rule represented a ``reverse'' application
of the aggregate theory of partnerships, and was inconsistent with the
principles of subchapter K. The IRS and Treasury disagree with this
comment. As noted above, subchapter K contemplates applying either an
aggregate theory or an entity theory of partnerships, based on the
approach that best serves the underlying purposes of the Code or
regulations at issue. For purposes of applying the policies of subpart
F, which focus in part on whether income is being shifted between a CFC
and a related entity in a different country, the IRS and Treasury
believe it is appropriate to make the determination of whether an
entity is a related person with respect to the CFC, and whether an
activity takes place in or outside a CFC's country of incorporation, at
the CFC partner level.
The IRS and Treasury also have become aware that some uncertainty
exists under the proposed regulations with respect to the application
of the related person test to certain purchase and sales transactions
occurring between a partnership and its CFC partner. Specifically,
where a purchase or sales transaction occurs between the partnership
and its CFC partner, including sales or purchases on behalf of the CFC
by the partnership, the general rule fails to provide guidance on
whether the CFC partner's distributive share of the partnership income
is derived from a transaction with a related person. As a result, the
final regulations add a new rule for purposes of making that
determination. In general, the final regulations provide that where the
partnership enters into a purchase or sales transaction with the CFC
partner, the transaction will be treated as a purchase or sales
transaction with a related person where the CFC purchased the property
that it sells to the partnership from a person related to the CFC or
sells the property that it purchased from the partnership to such a
related person. This rule also applies to purchases or sales by the CFC
on behalf of a related person.
For example, if a partnership sells goods to its CFC partner that
it bought from a person unrelated to the CFC, and the CFC partner then
sells the goods to a person related to the CFC partner, the sale of
goods by the partnership to the CFC will be treated as the sale of
personal property to a related person for purposes of determining
whether the CFC's distributive share of the partnership income relating
to the sale of goods by the partnership is foreign base company sales
income. An example has been included in the final regulations to
illustrate this rule. In addition, the final regulations provide that
when the CFC partner manufactures property that it sells to the
partnership and the CFC conducts sales or manufacturing activities
through a branch, if the CFC's income from the sale of property to the
partnership is foreign base company sales income under the branch rule
of section 954(d)(2), the partnership's purchase of this property from
the CFC will be treated as the purchase of personal property from a
related person. The effect of these two rules is to treat the CFC
partner's distributive share of the income earned by the partnership as
income earned from a related person
[[Page 48022]]
transaction if it would have been so treated if the CFC had purchased
or sold the property directly, rather than through a partnership.
D. Sec. 1.954-2(a)(5)(ii) Exceptions Applicable to Foreign Personal
Holding Company Income
Section 1.954-2(a)(5)(ii) of the proposed regulations provide that
only the activities of, and property owned by, the partnership will be
taken into account in determining whether the exceptions from foreign
personal holding company income contained in section 954(c)(2), (h) and
(i) apply.
One commentator argued that applying Sec. 1.954-2(a)(5)(ii) to a
CFC with a qualified business unit (QBU) partnership that is seeking to
qualify for the active financing exception under section 954(h)
produces a result that is inconsistent with the intent of section
954(h). Specifically, section 954(h)(2)(B)(i) provides that a CFC that
is engaged in a lending or finance business will be considered an
``eligible controlled foreign corporation'' for purposes of the active
financing exception if the CFC derives more than 70 percent of its
gross income directly from the active and regular conduct of a lending
or finance business from transactions with unrelated customers. In
addition, section 954(h)(3)(B) provides that, in the case of a CFC that
conducts a lending or finance business (other than a banking or
securities business), no income of the CFC (or QBU of the CFC) will
qualify for the active financing exception unless more than 30 percent
of the CFC's or QBU's gross income is derived directly from the active
conduct of a financing business from transactions with unrelated
customers in the CFC or QBU's home country. The commentator stated that
section 954(h) appears to provide that the 70 percent test must be
applied at the CFC level based on the CFC's income (including branches
and partnerships) and the 30 percent test must be applied at the
partnership or QBU level.
The proposed regulations, however, require that the determination
of whether the 70 percent test and the 30 percent test are met is based
solely by reference to the activities of the partnership. The
commentator concluded that the proposed regulations are inconsistent
with the two-part test in section 954(h) and that applying the rule of
the proposed regulations potentially could place a CFC that conducts a
financial services business through a partnership in a significantly
worse situation than a CFC that conducts a similar business through a
branch or disregarded entity.
In response to this comment, the IRS and Treasury have included a
new rule in the final regulations that applies the ``eligible
controlled foreign corporation'' requirement under section 954(h)(2),
including the 70 percent test of section 954(h)(2)(B)(i), at the CFC
partner level (by including in the gross income of the CFC partner any
gross income earned by partnerships or other QBUs of the CFC partner),
and applies the qualified banking and financing income test (the 30
percent test) under section 954(h)(3) at the partnership level (by
including only the gross income of the partnership). In addition, a new
rule has been added under Sec. 1.954-2(a)(5)(ii) to clarify that for
purposes of applying the special rule for income derived in the active
conduct of an insurance business under section 954(i), the exception
will apply only if the CFC partner is a qualifying insurance company,
as defined in section 953(e)(3) (determined by examining premiums
written by the CFC partner and any partnerships or other QBUs of the
CFC partner), and the partnership generates qualified insurance income,
as defined in section 954(i)(2) (determined by examining only the
income earned by the partnership). Two examples have been included in
the final regulations that illustrate the operation of these rules.
Another comment was received suggesting that the proposed
regulations inappropriately require the partnership, not the CFC
partner, to satisfy the active trade or business tests to qualify for
the exceptions to the foreign personal holding company rules. The
commentator stated that such a rule allows a purely passive investor in
a partnership to qualify for the exceptions, contrary to the purposes
of subpart F. The commentator argued that, instead, the regulations
should apply the active trade or business tests at the CFC partner
level, but should provide a rule that limits the attribution of
partnership activities to the CFC partners.
This suggestion was not adopted. In general, the IRS and Treasury
believe that the policies underlying subpart F are best served by
applying the relevant active trade or business tests at the level of
the entity that actually earns the income (i.e., the partnership). As
noted above, however, the IRS and Treasury believe that, for purposes
of determining whether a CFC qualifies for the active financing
exception, applying the 70 percent test of section 954(h)(2) (and
determining a CFC's qualification as a qualifying insurance company
under section 954(i)(2)) at the CFC partner level is consistent with
the statutory language of these provisions and best effectuates the
legislative intent behind these provisions.
E. Sec. 1.954-4(b)(2)(iii) Application of the Substantial Assistance
Rule
The proposed regulations describe how the substantial assistance
rules of Sec. 1.954-4(b)(1)(iv) apply when the CFC partner earns
services income through the partnership. When the partnership is
performing services for a person unrelated to the CFC partner, but the
CFC partner, or a related person, provides substantial assistance to
the partnership, the CFC partner and the partnership are regarded as
separate entities and the substantial assistance provided to the
partnership by the CFC partner, or a related person, cause the CFC
partner's distributive share of the services income to be treated as
foreign base company services income.
Commentators argued that the proposed regulations should not treat
the distributive share of the partnership's income as subpart F income
if only the CFC partner provides substantial assistance to the
partnership because, in that case, under an aggregate theory the CFC
does not receive substantial assistance from a related person. This
suggestion has not been adopted because the IRS and Treasury believe
that excluding the CFC partner from the substantial assistance rule
could potentially allow the CFC partner to circumvent the foreign base
company service rules with respect to the services it is performing.
Special Analyses
It has been determined that this final regulation is not a
significant regulatory action as defined in Executive Order 12866.
Therefore, a regulatory assessment is not required. It has also been
determined that section 553(b) and (d) of the Administrative Procedures
Act (5 U.S.C. chapter 5) does not apply to these regulations and,
because the regulation does not impose a collection of information on
small entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6)
does not apply. Pursuant to section 7805(f) of the Code, the proposed
regulations preceding these regulations were submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small business.
Drafting Information
The principal author of these regulations is Jonathan A. Sambur of
the Office of the Associate Chief Counsel (International), IRS.
However, other personnel from the IRS and Treasury
[[Page 48023]]
Department participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
1. The authority citation for 26 CFR part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
2. Section 1.702-1 is amended as follows:
1. Paragraph (a)(8)(ii) is revised.
2. Paragraph (c)(1)(iii) is amended by removing the word ``and'.
3. Paragraph (c)(1)(iv) is amended by removing the period at the
end and adding ``; and'' in its place.
4. Paragraph (c)(1)(v) is added.
The addition and revision read as follows:
Sec. 1.702-1 Income and credits of partner.
(a) * * *
(8) * * *
(ii) Each partner must also take into account separately the
partner's distributive share of any partnership item which, if
separately taken into account by any partner, would result in an income
tax liability for that partner, or for any other person, different from
that which would result if that partner did not take the item into
account separately. Thus, if any partner is a controlled foreign
corporation, as defined in section 957, items of income that would be
gross subpart F income if separately taken into account by the
controlled foreign corporation must be separately stated for all
partners. Under section 911(a), if any partner is a bona fide resident
of a foreign country who may exclude from gross income the part of the
partner's distributive share which qualifies as earned income, as
defined in section 911(b), the earned income of the partnership for all
partners must be separately stated. Similarly, all relevant items of
income or deduction of the partnership must be separately stated for
all partners in determining the applicability of section 183 (relating
to activities not engaged in for profit) and the recomputation of tax
thereunder for any partner. This paragraph (a)(8)(ii) applies to
taxable years beginning on or after July 23, 2002.
* * * * *
(c) * * *
(1) * * *
(v) In determining whether the de minimis or full inclusion rules
of section 954(b)(3) apply.
* * * * *
3. In Sec. 1.952-1, paragraph (g) is added to read as follows:
Sec. 1.952-1 Subpart F income defined.
* * * * *
(g) Treatment of distributive share of partnership income--(1) In
general. A controlled foreign corporation's distributive share of any
item of income of a partnership is income that falls within a category
of subpart F income described in section 952(a) to the extent the item
of income would have been income in such category if received by the
controlled foreign corporation directly. For specific rules regarding
the treatment of a distributive share of partnership income under
certain provisions of subpart F, see Secs. 1.954-1(g), 1.954-2(a)(5),
1.954-3(a)(6), and 1.954-4(b)(2)(iii).
(2) Example. The application of this paragraph (g) may be
illustrated by the following example:
Example. CFC, a controlled foreign corporation, is an 80-percent
partner in PRS, a foreign partnership. PRS earns $100 of interest
income that is not export financing interest as defined in section
954(c)(2)(B), or qualified banking or financing income as defined in
section 954(h)(3)(A), from a person unrelated to CFC. This interest
income would have been foreign personal holding company income to
CFC, under section 954(c), if it had received this income directly.
Accordingly, CFC's distributive share of this interest income, $80,
is foreign personal holding company income.
(3) Effective date. This paragraph (g) applies to taxable years of
a controlled foreign corporation beginning on or after July 23, 2002.
4. In Sec. 1.954-1, paragraph (g) is added to read as follows:
Sec. 1.954-1 Foreign base company income.
* * * * *
(g) Distributive share of partnership income--(1) Application of
related person and country of organization tests. Unless otherwise
provided, to determine the extent to which a controlled foreign
corporation's distributive share of any item of gross income of a
partnership would have been subpart F income if received by it
directly, under Sec. 1.952-1(g), if a provision of subpart F requires a
determination of whether an entity is a related person, within the
meaning of section 954(d)(3), or whether an activity occurred within or
outside the country under the laws of which the controlled foreign
corporation is created or organized, this determination shall be made
by reference to such controlled foreign corporation and not by
reference to the partnership.
(2) Application of related person test for sales and purchase
transactions between a partnership and its controlled foreign
corporation partner. For purposes of determining whether a controlled
foreign corporation's distributive share of any item of gross income of
a partnership is foreign base company sales income under section
954(d)(1) when the item of income is derived from the sale by the
partnership of personal property purchased by the partnership from (or
sold by the partnership on behalf of) the controlled foreign
corporation; or the sale by the partnership of personal property to (or
the purchase of personal property by the partnership on behalf of) the
controlled foreign corporation (CFC-partnership transaction), the CFC-
partnership transaction will be treated as a transaction with an entity
that is a related person, within the meaning of section 954(d)(3),
under paragraph (g)(1) of this section, if--
(i) The controlled foreign corporation purchased such personal
property from (or sold it to the partnership on behalf of), or sells
such personal property to (or purchases it from the partnership on
behalf of), a related person with respect to the controlled foreign
corporation (other than the partnership), within the meaning of section
954(d)(3); or
(ii) The branch rule of section 954(d)(2) applies to treat as
foreign base company sales income the income of the controlled foreign
corporation from selling to the partnership (or a third party) personal
property that the controlled foreign corporation has manufactured, in
the case where the partnership purchases personal property from (or
sells personal property on behalf of) the controlled foreign
corporation.
(3) Examples. The application of this paragraph (g) is illustrated
by the following examples:
Example 1. CFC, a controlled foreign corporation organized in
Country A, is an 80-percent partner in Partnership, a partnership
organized in Country A. All of the stock of CFC is owned by USP, a
U.S. corporation. Partnership earns commission income from
purchasing Product O on behalf of USP, from unrelated manufacturers
in Country B, for sale in the United States. To determine whether
CFC's distributive share of Partnership's commission income is
foreign base company sales income under section 954(d), CFC is
treated as if it purchased Product O on behalf of USP. Under section
954(d)(3), USP is a related person with respect to CFC. Thus, with
respect to CFC, the sales income is deemed to be derived from the
purchase of personal property on
[[Page 48024]]
behalf of a related person. Because the property purchased is both
manufactured and sold for use outside of Country A, CFC's country of
organization, CFC's distributive share of the sales income is
foreign base company sales income.
Example 2. (i) CFC1, a controlled foreign corporation organized
in Country A, is an 80-percent partner in Partnership, a partnership
organized in Country B. CFC2, a controlled foreign corporation
organized in Country B, owns the remaining 20 percent interest in
Partnership. CFC1 and CFC2 are owned by a common U.S. parent, USP.
CFC2 manufactures Product A in Country B. Partnership earns sales
income from purchasing Product A from CFC2 and selling it to third
parties located in Country B that are not related persons with
respect to CFC1 or CFC2. To determine whether CFC1's distributive
share of Partnership's sales income is foreign base company sales
income under section 954(d), CFC1 is treated as if it purchased
Product A from CFC2 and sold it to third parties in Country B. Under
section 954(d)(3), CFC2 is a related person with respect to CFC1.
Thus, with respect to CFC1, the sales income is deemed to be derived
from the purchase of personal property from a related person.
Because the property purchased is both manufactured and sold for use
outside of Country A, CFC1's country of organization, CFC1's
distributive share of the sales income is foreign base company sales
income.
(ii) Because Product A is both manufactured and sold for use
within CFC2's country of organization, CFC2's distributive share of
Partnership's sales income is not foreign base company sales income.
Example 3. CFC, a controlled foreign corporation organized in
Country A, is an 80 percent partner in MJK Partnership, a Country B
partnership. CFC purchased goods from J Corp, a Country C
corporation that is a related person with respect to CFC. CFC sold
the goods to MJK Partnership. In turn, MJK Partnership sold the
goods to P Corp, a Country D corporation that is unrelated to CFC. P
Corp sold the goods to unrelated customers in Country D. The goods
were manufactured in Country C by persons unrelated to J Corp .
CFC's distributive share of the income of MJK Partnership from the
sale of goods to P Corp will be treated as income from the sale of
goods purchased from a related person for purposes of section
954(d)(1) because CFC purchased the goods from J Corp, a related
person. Because the goods were both manufactured and sold for use
outside of Country A, CFC's distributive share of the income
attributable to the sale of the goods is foreign base company sales
income. Further, CFC's income from the sale of the goods to MJK
Partnership will also be foreign base company sales income.
Example 4. The facts are the same as Example 3, except that MJK
Partnership purchased the goods from P Corp and sold those goods to
CFC. CFC sold the goods to J Corp. J Corp sold the goods to
unrelated customers in Country C. CFC's distributive share of the
income of MJK Partnership from the sale of the goods by the
partnership to itself will be treated as income from the sale of
goods to a related person, for purposes of section 954(d)(1).
Because the goods were both manufactured and sold for use outside of
Country A, CFC's distributive share of income attributable to the
sale of the goods is foreign base company sales income. Further,
CFC's income from the sale of the goods to J Corp is also foreign
base company sales income.
(4) Effective date. This paragraph (g) applies to taxable years of
a controlled foreign corporation beginning on or after July 23, 2002.
5. In Sec. 1.954-2, paragraph (a)(5) is added to read as follows:
Sec. 1.954-2 Foreign personal holding company income.
(a) * * *
(5) Special rules applicable to distributive share of partnership
income--(i) [Reserved].
(ii) Certain other exceptions applicable to foreign personal
holding company income. To determine the extent to which a controlled
foreign corporation's distributive share of an item of income of a
partnership is foreign personal holding company income --
(A) The exceptions contained in section 954(c) that are based on
whether the controlled foreign corporation is engaged in the active
conduct of a trade or business, including section 954(c)(2) and
paragraphs (b)(2) and (6), (e)(1)(ii) and (3)(ii), (iii) and (iv),
(f)(1)(ii), (g)(2)(ii), and (h)(3)(ii) of this section, shall apply
only if any such exception would have applied to exclude the income
from foreign personal holding company income if the controlled foreign
corporation had earned the income directly, determined by taking into
account only the activities of, and property owned by, the partnership
and not the separate activities or property of the controlled foreign
corporation or any other person;
(B) A controlled foreign corporation's distributive share of
partnership income will not be excluded from foreign personal holding
company income under the exception contained in section 954(h) unless
the controlled foreign corporation is an eligible controlled foreign
corporation within the meaning of section 954(h)(2) (taking into
account the income of the controlled foreign corporation and any
partnerships or other qualified business units, within the meaning of
section 989(a), of the controlled foreign corporation, including the
controlled foreign corporation's distributive share of partnership
income) and the partnership, of which the controlled foreign
corporation is a partner, generates qualified banking or financing
income within the meaning of section 954(h)(3) (taking into account
only the income of the partnership);
(C) A controlled foreign corporation's distributive share of
partnership income will not be excluded from foreign personal holding
company income under the exception contained in section 954(i) unless
the controlled foreign corporation partner is a qualifying insurance
company, as defined in section 953(e)(3) (determined by examining
premiums written by the controlled foreign corporation and any
partnerships or other qualified business units, within the meaning of
section 989(a), of the CFC partner), and the partnership, of which the
controlled foreign corporation is a partner, generates qualified
insurance income within the meaning of section 954(i)(2) (taking into
account only the income of the partnership).
(iii) Examples. The application of paragraph (a)(5)(ii) is
demonstrated by the following examples:
Example 1. B Corp, a Country C corporation, is a controlled
foreign corporation within the meaning of section 957(a). B Corp is
an 80 percent partner of RKS Partnership, a Country D partnership
whose principal office is located in Country D. RKS Partnership is a
qualified business unit of B Corp, within the meaning of section
989(a). B Corp, including income earned through RKS Partnership,
derives more than 70 percent of its gross income directly from the
active and regular conduct of a lending or finance business, within
the meaning of section 954(h)(4), from transactions in various
countries with customers which are not related persons. Thus, B Corp
is predominantly engaged in the active conduct of a banking,
financing, or similar business within the meaning of section
954(h)(2)(A)(i). B Corp conducts substantial activity with respect
to such business within the meaning of section 954(h)(2)(A)(ii). RKS
Partnership derives more than 30 percent of its income from the
active and regular conduct of a lending or finance business, within
the meaning of section 954(h)(4), from transactions with customers
which are not related persons and which are located solely within
the home country of RKS Partnership, Country D. B Corp's
distributive share of RKS Partnership's income from its lending or
finance business will satisfy the special rule for income derived in
the active conduct of banking, financing, or similar business of
section 954(h). B Corp is an eligible controlled foreign corporation
within the meaning of section 954(h)(2) and RKS Partnership
generates qualified banking or financing income within the meaning
of section 954(h)(3). B Corp does not have any foreign personal
holding company income with respect to its distributive share of RKS
Partnership income attributable to its lending or finance business
income earned in Country D.
Example 2. D Corp, a Country F corporation, is a controlled
foreign corporation within the meaning of section
[[Page 48025]]
957(a). D Corp satisfies the requirements of section 953(e)(3) and
is a qualifying insurance company. D Corp is a 40 percent partner of
DJ Partnership, a Country G partnership. DJ Partnership is a
qualified business unit of D Corp, within the meaning of section
989(a), and is licensed by the applicable insurance regulatory body
for Country G to sell insurance to persons other than related
persons in its home country within the meaning of section
953(e)(4)(A). DJ Partnership receives income from persons who are
not related persons, within the meaning of section 954(d)(3), from
investments that satisfy the requirements of section 954(i)(2). D
Corp's distributive share of DJ Partnership's income from
investments that satisfy the requirements of section 954(i)(2) will
not be treated as foreign personal holding company income because D
Corp will satisfy the special rule of section 954(i) for income
derived in the active conduct of insurance business. DJ Partnership
is a qualifying insurance company branch within the meaning of
section 953(e)(4) and its income is qualified insurance income
within the meaning of section 954(i)(2). D Corp does not have any
foreign personal holding company income as a result of its
distributive share of DJ Partnership income that is attributable to
the partnership's qualifying insurance income.
(iv) [Reserved].
(v) Effective date. This paragraph (a)(5) applies to taxable years
of a controlled foreign corporation beginning on or after July 23,
2002.
* * * * *
6. In Sec. 1.954-3, paragraph (a)(6) is added to read as follows:
Sec. 1.954-3 Foreign base company sales income.
(a) * * *
(6) Special rule applicable to distributive share of partnership
income--(i) In general. To determine the extent to which a controlled
foreign corporation's distributive share of any item of gross income of
a partnership would have been foreign base company sales income if
received by it directly, under Sec. 1.952-1(g), the property sold will
be considered to be manufactured, produced or constructed by the
controlled foreign corporation, within the meaning of paragraph (a)(4)
of this section, only if the manufacturing exception of paragraph
(a)(4) of this section would have applied to exclude the income from
foreign base company sales income if the controlled foreign corporation
had earned the income directly, determined by taking into account only
the activities of, and property owned by, the partnership and not the
separate activities or property of the controlled foreign corporation
or any other person.
(ii) Example. The application of paragraph (a)(6)(i) of this
section is illustrated by the following example:
Example. CFC, a controlled foreign corporation organized under
the laws of Country A, is an 80 percent partner in Partnership X, a
partnership organized under the laws of Country B. Partnership X
performs activities in Country B that would constitute the
manufacture of Product O, within the meaning of paragraph (a)(4) of
this section, if performed directly by CFC. Partnership X, through
its sales offices in Country B, then sells Product O to Corp D, a
corporation that is a related person with respect to CFC, within the
meaning of section 954(d)(3), for use within Country B. CFC's
distributive share of Partnership X's sales income is not foreign
base company sales income because the manufacturing exception of
paragraph (a)(4) of this section would have applied to exclude the
income from foreign base company sales income if CFC had earned the
income directly.
(iii) Effective date. This paragraph (a)(6) applies to taxable
years of a controlled foreign corporation beginning on or after July
23, 2002.
* * * * *
7. In Sec. 1.954-4, paragraph (b)(2)(iii) is added to read as
follows:
Sec. 1.954-4 Foreign base company services income.
* * * * *
(b) * * *
(2) * * *
(iii) Special rule applicable to distributive share of partnership
income. A controlled foreign corporation's distributive share of a
partnership's services income will be deemed to be derived from
services performed for or on behalf of a related person, within the
meaning of section 954(e)(1)(A), if the partnership is a related person
with respect to the controlled foreign corporation, under section
954(d)(3), and, in connection with the services performed by the
partnership, the controlled foreign corporation, or a person that is a
related person with respect to the controlled foreign corporation,
provided assistance that would have constituted substantial assistance
contributing to the performance of such services, under paragraph
(b)(2)(ii) of this section, if furnished to the controlled foreign
corporation by a related person. This paragraph (b)(2)(iii) applies to
taxable years of a controlled foreign corporation beginning on or after
July 23, 2002.
* * * * *
8. In Sec. 1.956-2, paragraph (a)(3) is added to read as follows:
Sec. 1.956-2 Definition of United States property.
(a) * * *
(3) Property owned through partnership. For purposes of section
956, if a controlled foreign corporation is a partner in a partnership
that owns property that would be United States property, within the
meaning of paragraph (a)(1) of this section, if owned directly by the
controlled foreign corporation, the controlled foreign corporation will
be treated as holding an interest in the property equal to its interest
in the partnership and such interest will be treated as an interest in
United States property. This paragraph (a)(3) applies to taxable years
of a controlled foreign corporation beginning on or after July 23,
2002.
* * * * *
David A. Mader,
Deputy Commissioner of Internal Revenue.
Approved: July 16, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury.
[FR Doc. 02-18453 Filed 7-22-02; 8:45 am]
BILLING CODE 4830-01-P