[Federal Register Volume 68, Number 21 (Friday, January 31, 2003)]
[Rules and Regulations]
[Pages 4916-4918]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-2209]


=======================================================================
-----------------------------------------------------------------------

DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9039]
RIN 1545-BA33


Guidance Regarding the Definition of Foreign Personal Holding 
Company Income

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

-----------------------------------------------------------------------

SUMMARY: This document contains final regulations that provide that 
gain or loss arising from certain commodities

[[Page 4917]]

hedging transactions and currency gain or loss arising from certain 
interest-bearing liabilities do not constitute (or are not netted 
against) foreign personal holding company income. This treatment is 
implemented because the applicable commodities hedging transactions and 
interest-bearing liabilities typically offset transactions that do not 
generate foreign personal holding company income.

DATES: Effective Date: These regulations are effective January 31, 
2003.
    Applicability Date: For dates of applicability, see Sec.  1.954-
2(f)(2)(iv)(C), (v)(D), and (g)(2)(ii)(C)(2)(iii).

FOR FURTHER INFORMATION CONTACT: Kenneth Christman or Gregory Spring at 
(202) 622-3870 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Background

    On May 13, 2002, proposed regulations (REG-154920-01) were 
published in the Federal Register (67 FR 31995) under section 954 
governing the definition of foreign base company income and foreign 
personal holding company income of a controlled foreign corporation (a 
CFC). These regulations addressed, among other matters, the 
circumstances in which income from transactions in commodities will be 
treated as foreign personal holding company income.
    Following the publication of the proposed regulations, the IRS 
scheduled a public hearing and requested written comments on the 
regulations. The public hearing was canceled because no one requested 
to speak at the hearing. The IRS received one written comment, which 
recommended the proposed regulations be finalized as written.

Explanation of Revisions

    The language of the proposed regulations is unchanged except for 
nonsubstantive changes to Sec. Sec.  1.954-2(g)(2)(ii)(C)(2)(i) and 
(ii) that more explicitly set out the relationship between those 
paragraphs and Sec.  1.954-2(g)(2)(ii)(C)(1).

Special Analyses

    It has been determined that this Treasury decision 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) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations, and because 
these regulations do not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Therefore, a Regulatory Flexibility Analysis is not required. 
Pursuant to section 7805(f) of the Internal Revenue Code, the notice of 
proposed rulemaking preceding these regulations was submitted to the 
Chief Counsel for Advocacy of the Small Business Administration for 
comment on its impact on small business.

Drafting Information

    The principal authors of these regulations are Kenneth Christman 
and Ted Setzer of the Office of the Associate Chief Counsel 
(International). However, other personnel from the IRS and Treasury 
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

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


    Par. 2. In Sec.  1.954-0, paragraph (b) is amended by:
    1. Removing the entry for Sec.  1.954-2(f)(2)(iii)(E).
    2. Revising the entry for Sec.  1.954-2(f)(2)(iv).
    3. Adding entries for Sec.  1.954-2(f)(2)(iv)(C), and (f)(2)(v) 
through (f)(2)(vi).
    4. Adding entries for Sec.  1.954-2(g)(2)(ii)(C)(1) through 
(g)(2)(ii)(C)(2)(iii).
    The additions and revisions read as follows:


Sec.  1.954-0  Introduction.

* * * * *
    (b) * * *


Sec.  1.954-2  Foreign personal holding company income.

* * * * *
    (f) * * *
    (2) * * *
    (iv) Qualified hedging transaction entered into prior to January 
31, 2003.
* * * * *
    (C) Effective date.
    (v) Qualified hedging transaction entered into on or after 
January 31, 2003.
    (A) In general.
    (B) Exception.
    (C) Examples.
    (D) Effective date.
    (vi) Financial institutions not a producer, etc.
    (g) * * *
    (2) * * *
    (ii) * * *
    (C) Regular dealers.
    (1) General rule.
    (2) Certain interest-bearing liabilities treated as dealer 
property.
    (i) In general.
    (ii) Failure to identify certain liabilities.
    (iii) Effective date.

* * * * *

    Par. 3. Section 1.954-2 is amended by:
    1. Removing paragraph (f)(2)(iii)(E).
    2. Revising the heading of paragraph (f)(2)(iv).
    3. Adding paragraphs (f)(2)(iv)(C) and (f)(2)(v) through 
(f)(2)(vi).
    4. Adding paragraphs (g)(2)(ii)(C)(1) through 
(g)(2)(ii)(C)(2)(iii).
    5. Revising paragraph (g)(2)(iii).
    The revisions and additions read as follows:


Sec.  1.954-2  Foreign personal holding company income.

* * * * *
    (f) * * *
    (2) * * *
    (iv) Qualified hedging transaction entered into prior to January 
31, 2003.
* * * * *
    (C) Effective date. This paragraph (f)(2)(iv) applies to gain or 
loss realized by a controlled foreign corporation with respect to a 
qualified hedging transaction entered into prior to January 31, 2003.
    (v) Qualified hedging transaction entered into on or after January 
31, 2003--(A) In general. The term qualified hedging transaction means 
a bona fide hedging transaction, as defined in paragraph (a)(4)(ii) of 
this section, with respect to one or more commodities transactions 
reasonably necessary to the conduct of any business by a producer, 
processor, merchant or handler of commodities in a manner in which such 
business is customarily and usually conducted by others. For purposes 
of this paragraph (f)(2)(v), a producer, processor, merchant or handler 
of commodities includes a controlled foreign corporation that regularly 
uses commodities in a manufacturing, construction, utilities, or 
transportation business.
    (B) Exception. The term qualified hedging transaction does not 
include a transaction described in section 988(c)(1) (without regard to 
section 988(c)(1)(D)(i)).
    (C) Examples. The following examples illustrate the provisions of 
this paragraph (f)(2)(v):

    Example 1. CFC1 is a controlled foreign corporation located in 
country A. CFC1 manufactures and sells machinery in country B using 
aluminum and component parts

[[Page 4918]]

purchased from third parties that contain significant amounts of 
aluminum. CFC1 conducts its manufacturing business in a manner in 
which such business is customarily and usually conducted by others. 
To protect itself against increases in the price of aluminum used in 
the machinery it manufactures, CFC1 enters into futures purchase 
contracts for the delivery of aluminum. These futures purchase 
contracts are bona fide hedging transactions. As CFC1 purchases 
aluminum and component parts containing significant amounts of 
aluminum in the spot market for use in its business, it closes out 
an equivalent amount of aluminum futures purchase contracts by 
entering into offsetting aluminum futures sales contracts. The 
aluminum futures purchase contracts are qualified hedging 
transactions as defined in paragraph (f)(2)(v)(A) of this section. 
Accordingly, any gain or loss on such aluminum futures purchase 
contracts is excluded from the computation of foreign personal 
holding company income.
    Example 2. CFC2 is a controlled foreign corporation located in 
country B. CFC2 operates an airline business within country B in a 
manner in which such business is customarily and usually conducted 
by others. To protect itself against increases in the price of 
aviation fuel, CFC2 enters into forward contracts for the purchase 
of aviation fuel. These forward purchase contracts are bona fide 
hedging transactions. As CFC2 purchases aviation fuel in the spot 
market for use in its business, it closes out an equivalent amount 
of its forward purchase contracts for cash pursuant to a contractual 
provision that permits CFC2 to terminate the contract and make or 
receive a one-time payment representing the contract's fair market 
value. The aviation fuel forward purchase contracts are qualified 
hedging transactions as defined in paragraph (f)(2)(v)(A) of this 
section. Accordingly, any gain or loss on such aviation fuel forward 
purchase contracts is excluded from the computation of foreign 
personal holding company income.

    (D) Effective date. This paragraph (f)(2)(v) applies to gain or 
loss realized by a controlled foreign corporation with respect to a 
qualified hedging transaction entered into on or after January 31, 
2003.
    (vi) Financial institutions not a producer, etc. For purposes of 
this paragraph (f), a corporation is not a producer, processor, 
merchant or handler of commodities if its business is primarily 
financial. For example, the business of a controlled foreign 
corporation is primarily financial if its principal business is making 
a market in notional principal contracts based on a commodities index.
* * * * *
    (g) * * *
    (2) * * *
    (ii) * * *
    (C) Regular dealers--(1) General rule. Transactions in dealer 
property (as defined in paragraph (a)(4)(v) of this section) described 
in section 988(c)(1)(B) or (C) that are entered into by a controlled 
foreign corporation that is a regular dealer (as defined in paragraph 
(a)(4)(iv) of this section) in such property in its capacity as a 
dealer will be treated as directly related to the business needs of the 
controlled foreign corporation under paragraph (g)(2)(ii)(A) of this 
section.
    (2) Certain interest-bearing liabilities treated as dealer 
property--(i) In general. For purposes of this paragraph (g)(2)(ii)(C), 
an interest-bearing liability incurred by a controlled foreign 
corporation that is denominated in (or determined by reference to) a 
non-functional currency shall be treated as dealer property of the type 
described in paragraph (g)(2)(ii)(C)(1) of this section if the 
liability, by being denominated in such currency, reduces the 
controlled foreign corporation's currency risk with respect to dealer 
property, and the liability is identified on the controlled foreign 
corporation's records as a liability treated as dealer property before 
the close of the day on which the liability is incurred.
    (ii) Failure to identify certain liabilities. If a controlled 
foreign corporation identifies certain interest-bearing liabilities as 
liabilities treated as dealer property under paragraph 
(g)(2)(ii)(C)(2)(i) of this section but fails to so identify other 
interest-bearing liabilities that manage its currency risk with respect 
to assets held that constitute dealer property, the Commissioner may 
treat such other liabilities as properly identified as dealer property 
under paragraph (g)(2)(ii)(C)(2)(i) of this section if the Commissioner 
determines that the failure to identify such other liabilities had as 
one of its principal purposes the avoidance of Federal income tax.
    (iii) Effective date. This paragraph (g)(2)(ii)(C)(2) applies only 
to gain or loss from an interest-bearing liability entered into by a 
controlled foreign corporation on or after January 31, 2003.
* * * * *
    (iii) Special rule for foreign currency gain or loss from an 
interest-bearing liability. Except as provided in paragraph 
(g)(2)(ii)(C)(2) or (g)(5)(iv) of this section, foreign currency gain 
or loss arising from an interest-bearing liability is characterized as 
subpart F income and non-subpart F income in the same manner that 
interest expense associated with the liability would be allocated and 
apportioned between subpart F income and non-subpart F income under 
Sec. Sec.  1.861-9T and 1.861-12T.
* * * * *

David A. Mader,
Assistant Deputy Commissioner of Internal Revenue.
    Approved: January 17, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-2209 Filed 1-30-03; 8:45 am]
BILLING CODE 4830-01-P