[Federal Register Volume 68, Number 46 (Monday, March 10, 2003)]
[Rules and Regulations]
[Pages 11313-11316]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-5461]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9043]
RIN 1545-AY26


Disallowance of Deductions and Credits for Failure To File Timely 
Return

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations relating to the 
disallowance of deductions and credits for nonresident alien 
individuals and foreign corporations (collectively, foreign taxpayers) 
that fail to file a timely U.S. income tax return. The regulations 
affect foreign taxpayers that fail to file a return by the appropriate 
deadlines.

DATES: Effective Date: These regulations are effective March 10, 2003.
    Applicability Date: For dates of applicability, see Sec. Sec.  
1.874-1(b)(4) and 1.882-4(a)(3)(iv) of these regulations.

FOR FURTHER INFORMATION CONTACT: Nina E. Chowdhry, (202) 622-3880 (not 
a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1. On January 29, 
2002, final and temporary regulations (TD 8981) relating to the 
disallowance of deductions and credits for foreign taxpayers that fail 
to file a timely U.S. income tax return under sections 874 and 882 of 
the Internal Revenue Code (Code) were published in the Federal Register 
(67 FR 4173). A notice of proposed rulemaking (REG-107100-00) cross-
referencing the temporary regulations was also published in the Federal 
Register (67 FR 4217). No public hearing was requested or held. No 
written or electronic comments responding to the notice of proposed 
rulemaking were received. The proposed regulations are adopted by this 
Treasury decision, and the corresponding temporary regulations are 
removed.

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 the 
regulations do not impose a collection of information requirement 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 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 businesses.

Drafting Information

    The principal author of these regulations is Nina Chowdhry of the 
Office of 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 is amended by 
removing the entries for ``Section 1.874-1T'' and ``Section 1.882-4T'' 
and adding entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.874-1 also issued under 26 U.S.C. 874. * * *
    Section 1.882-4 also issued under 26 U.S.C. 882(c). * * *


    Par. 2. Section 1.874-1, paragraphs (b)(2) through (b)(4) are 
revised to read as follows:


Sec.  1.874-1  Allowance of deductions and credits to nonresident alien 
individuals.

* * * * *
    (b) * * *
    (2) Waiver. The filing deadlines set forth in paragraph (b)(1) of 
this section may be waived if the nonresident alien individual 
establishes to the satisfaction of the Commissioner or his or her 
delegate that the individual, based on the facts and circumstances, 
acted reasonably and in good faith in failing to file a U.S. income tax 
return (including a protective return (as described in paragraph (b)(6) 
of this section)). For this purpose, a nonresident alien individual 
shall not be considered to have acted reasonably and in good faith if 
the individual knew that he or she was required to file the return and 
chose not to do so. In addition, a nonresident alien individual shall 
not be granted a waiver unless the individual cooperates in determining 
his or her U.S. income tax liability for the taxable year for which the 
return was not filed. The Commissioner or his or her delegate shall 
consider the following factors in determining whether the nonresident 
alien individual, based on the facts and circumstances, acted 
reasonably and in good faith in failing to file a U.S. income tax 
return--
    (i) Whether the individual voluntarily identifies himself or 
herself to the Internal Revenue Service as having failed to file a U.S. 
income tax return before the Internal Revenue Service discovers the 
failure to file;
    (ii) Whether the individual did not become aware of his or her 
ability to file a protective return (as described in paragraph (b)(6) 
of this section) by the deadline for filing the protective return;
    (iii) Whether the individual had not previously filed a U.S. income 
tax return;
    (iv) Whether the individual failed to file a U.S. income tax return 
because, after exercising reasonable diligence (taking into account his 
or her relevant experience and level of sophistication), the individual 
was unaware of the necessity for filing the return;
    (v) Whether the individual failed to file a U.S. income tax return 
because of intervening events beyond the individual's control; and
    (vi) Whether other mitigating or exacerbating factors existed.

[[Page 11314]]

    (3) Examples. The following examples illustrate the provisions of 
paragraph (b). In all examples, A is a nonresident alien individual and 
uses the calendar year as A's taxable year. The examples are as 
follows:

    Example 1. Nonresident alien individual discloses own failure to 
file. In Year 1, A became a limited partner with a passive 
investment in a U.S. limited partnership that was engaged in a U.S. 
trade or business. During Year 1 through Year 4, A incurred losses 
with respect to A's U.S. partnership interest. A's foreign tax 
advisor incorrectly concluded that because A was a limited partner 
and had only losses from A's partnership interest, A was not 
required to file a U.S. income tax return. A was aware neither of 
A's obligation to file a U.S. income tax return for those years nor 
of A's ability to file a protective return for those years. A had 
never filed a U.S. income tax return before. In Year 5, A began 
realizing a profit rather than a loss with respect to the 
partnership interest and, for this reason, engaged a U.S. tax 
advisor to handle A's responsibility to file U.S. income tax 
returns. In preparing A's U.S. income tax return for Year 5, A's 
U.S. tax advisor discovered that returns were not filed for Year 1 
through Year 4. Therefore, with respect to those years for which 
applicable filing deadlines in paragraph (b)(1) of this section were 
not met, A would be barred by paragraph (a) of this section from 
claiming any deductions that otherwise would have given rise to net 
operating losses on returns for these years, and that would have 
been available as loss carryforwards in subsequent years. At A's 
direction, A's U.S. tax advisor promptly contacted the appropriate 
examining personnel and cooperated with the Internal Revenue Service 
in determining A's income tax liability, for example, by preparing 
and filing the appropriate income tax returns for Year 1 through 
Year 4 and by making A's books and records available to an Internal 
Revenue Service examiner. A has met the standard described in 
paragraph (b)(2) of this section for waiver of any applicable filing 
deadlines in paragraph (b)(1) of this section.
    Example 2. Nonresident alien individual refuses to cooperate. 
Same facts as in Example 1, except that while A's U.S. tax advisor 
contacted the appropriate examining personnel and filed the 
appropriate income tax returns for Year 1 through Year 4, A refused 
all requests by the Internal Revenue Service to provide supporting 
information (for example, books and records) with respect to those 
returns. Because A did not cooperate in determining A's U.S. tax 
liability for the taxable years for which an income tax return was 
not timely filed, A is not granted a waiver as described in 
paragraph (b)(2) of this section of any applicable filing deadlines 
in paragraph (b)(1) of this section.
    Example 3. Nonresident alien individual fails to file a 
protective return. Same facts as in Example 1, except that in Year 1 
through Year 4, A also consulted a U.S. tax advisor, who advised A 
that it was uncertain whether U.S. income tax returns were necessary 
for those years and that A could protect A's right subsequently to 
claim the loss carryforwards by filing protective returns under 
paragraph (b)(6) of this section. A did not file U.S. income tax 
returns or protective returns for those years. A did not present 
evidence that intervening events beyond A's control prevented A from 
filing an income tax return, and there were no other mitigating 
factors. A has not met the standard described in paragraph (b)(2) of 
this section for waiver of any applicable filing deadlines in 
paragraph (b)(1) of this section.
    Example 4. Nonresident alien with effectively connected income. 
In Year 1, A, a computer programmer, opened an office in the United 
States to market and sell a software program that A had developed 
outside the United States. A had minimal business or tax experience 
internationally, and no such experience in the United States. 
Through A's personal efforts, U.S. sales of the software produced 
income effectively connected with a U.S. trade or business. A, 
however, did not file U.S. income tax returns for Year 1 or Year 2. 
A was aware neither of A's obligation to file a U.S. income tax 
return for those years, nor of A's ability to file a protective 
return for those years. A had never filed a U.S. income tax return 
before. In November of Year 3, A engaged U.S. counsel in connection 
with licensing software to an unrelated U.S. company. U.S. counsel 
reviewed A's U.S. activities and advised A that A should have filed 
U.S. income tax returns for Year 1 and Year 2. A immediately engaged 
a U.S. tax advisor who, at A's direction, promptly contacted the 
appropriate examining personnel and cooperated with the Internal 
Revenue Service in determining A's income tax liability, for 
example, by preparing and filing the appropriate income tax returns 
for Year 1 and Year 2 and by making A's books and records available 
to an Internal Revenue Service examiner. A has met the standard 
described in paragraph (b)(2) of this section for waiver of any 
applicable filing deadlines in paragraph (b)(1) of this section.
    Example 5. IRS discovers nonresident alien's failure to file. In 
Year 1, A, a computer programmer, opened an office in the United 
States to market and sell a software program that A had developed 
outside the United States. Through A's personal efforts, U.S. sales 
of the software produced income effectively connected with a U.S. 
trade or business. A had extensive experience conducting similar 
business activities in other countries, including making the 
appropriate tax filings. A, however, was aware neither of A's 
obligation to file a U.S. income tax return for those years, nor of 
A's ability to file a protective return for those years. A had never 
filed a U.S. income tax return before. Despite A's extensive 
experience conducting similar business activities in other 
countries, A made no effort to seek advice in connection with A's 
U.S. tax obligations. A failed to file either U.S. income tax 
returns or protective returns for Year 1 and Year 2. In November of 
Year 3, an Internal Revenue Service examiner asked A for an 
explanation of A's failure to file U.S. income tax returns. A 
immediately engaged a U.S. tax advisor, and cooperated with the 
Internal Revenue Service in determining A's income tax liability, 
for example, by preparing and filing the appropriate income tax 
returns for Year 1 and Year 2 and by making A's books and records 
available to the examiner. A did not present evidence that 
intervening events beyond A's control prevented A from filing a 
return, and there were no other mitigating factors. A has not met 
the standard described in paragraph (b)(2) of this section for 
waiver of any applicable filing deadlines in paragraph (b)(1) of 
this section.
    Example 6. Nonresident alien with prior filing history. A began 
a U.S. trade or business in Year 1 as a sole proprietorship. A's tax 
advisor filed the appropriate U.S. income tax returns for Year 1 
through Year 6, reporting income effectively connected with A's U.S. 
trade or business. In Year 7, A replaced this tax advisor with a tax 
advisor unfamiliar with U.S. tax law. A did not file a U.S. income 
tax return for any year from Year 7 through Year 10, although A had 
effectively connected income for those years. A was aware of A's 
ability to file a protective return for those years. In Year 11, an 
Internal Revenue Service examiner contacted A and asked for an 
explanation of A's failure to file income tax returns after Year 6. 
A immediately engaged a U.S. tax advisor and cooperated with the 
Internal Revenue Service in determining A's income tax liability, 
for example, by preparing and filing the appropriate income tax 
returns for Year 7 through Year 10 and by making A's books and 
records available to the examiner. A did not present evidence that 
intervening events beyond A's control prevented A from filing a 
return, and there were no other mitigating factors. A has not met 
the standard described in paragraph (b)(2) of this section for 
waiver of any applicable filing deadlines in paragraph (b)(1) of 
this section.

    (4) Effective date. Paragraphs (b)(2) and (3) of this section are 
applicable to open years for which a request for a waiver is filed on 
or after January 29, 2002.
* * * * *


Sec.  1.874-1T  [Removed]

    Par. 3. Section 1.874-1T is removed.

    Par. 4. Section 1.882-4, paragraphs (a)(3)(ii) through (a)(3)(iv) 
are revised to read as follows:


Sec.  1.882-4  Allowance of deductions and credits to foreign 
corporations.

    (a) * * *
    (3) * * *
    (ii) The filing deadlines set forth in paragraph (a)(3)(i) of this 
section may be waived if the foreign corporation establishes to the 
satisfaction of the Commissioner or his or her delegate that the 
corporation, based on the facts and circumstances, acted reasonably and 
in good faith in failing to file a U.S. income tax return (including a 
protective return (as described in paragraph (a)(3)(vi) of this 
section)). For this purpose, a foreign corporation shall not be 
considered to have acted reasonably and in good faith

[[Page 11315]]

if it knew that it was required to file the return and chose not to do 
so. In addition, a foreign corporation shall not be granted a waiver 
unless it cooperates in the process of determining its income tax 
liability for the taxable year for which the return was not filed. The 
Commissioner or his or her delegate shall consider the following 
factors in determining whether the foreign corporation, based on the 
facts and circumstances, acted reasonably and in good faith in failing 
to file a U.S. income tax return--
    (A) Whether the corporation voluntarily identifies itself to the 
Internal Revenue Service as having failed to file a U.S. income tax 
return before the Internal Revenue Service discovers the failure to 
file;
    (B) Whether the corporation did not become aware of its ability to 
file a protective return (as described in paragraph (a)(3)(vi) of this 
section) by the deadline for filing a protective return;
    (C) Whether the corporation had not previously filed a U.S. income 
tax return;
    (D) Whether the corporation failed to file a U.S. income tax return 
because, after exercising reasonable diligence (taking into account its 
relevant experience and level of sophistication), the corporation was 
unaware of the necessity for filing the return;
    (E) Whether the corporation failed to file a U.S. income tax return 
because of intervening events beyond its control; and
    (F) Whether other mitigating or exacerbating factors existed.
    (iii) The following examples illustrate the provisions of this 
section. In all examples, FC is a foreign corporation and uses the 
calendar year as its taxable year. The examples are as follows:

    Example 1. Foreign corporation discloses own failure to file. In 
Year 1, FC became a limited partner with a passive investment in a 
U.S. limited partnership that was engaged in a U.S. trade or 
business. During Year 1 through Year 4, FC incurred losses with 
respect to its U.S. partnership interest. FC's foreign tax director 
incorrectly concluded that because it was a limited partner and had 
only losses from its partnership interest, FC was not required to 
file a U.S. income tax return. FC's management was aware neither of 
FC's obligation to file a U.S. income tax return for those years, 
nor of its ability to file a protective return for those years. FC 
had never filed a U.S. income tax return before. In Year 5, FC began 
realizing a profit rather than a loss with respect to its 
partnership interest and, for this reason, engaged a U.S. tax 
advisor to handle its responsibility to file U.S. income tax 
returns. In preparing FC's income tax return for Year 5, FC's U.S. 
tax advisor discovered that returns were not filed for Year 1 
through Year 4. Therefore, with respect to those years for which 
applicable filing deadlines in paragraph (a)(3)(i) of this section 
were not met, FC would be barred by paragraph (a)(2) of this section 
from claiming any deductions that otherwise would have given rise to 
net operating losses on returns for those years, and that would have 
been available as loss carryforwards in subsequent years. At FC's 
direction, its U.S. tax advisor promptly contacted the appropriate 
examining personnel and cooperated with the Internal Revenue Service 
in determining FC's income tax liability, for example, by preparing 
and filing the appropriate income tax returns for Year 1 through 
Year 4 and by making FC's books and records available to an Internal 
Revenue Service examiner. FC has met the standard described in 
paragraph (a)(3)(ii) of this section for waiver of any applicable 
filing deadlines in paragraph (a)(3)(i) of this section.
    Example 2. Foreign corporation refuses to cooperate. Same facts 
as in Example 1, except that while FC's U.S. tax advisor contacted 
the appropriate examining personnel and filed the appropriate income 
tax returns for Year 1 through Year 4, FC refused all requests by 
the Internal Revenue Service to provide supporting information (for 
example, books and records) with respect to those returns. Because 
FC did not cooperate in determining its U.S. tax liability for the 
taxable years for which an income tax return was not timely filed, 
FC is not granted a waiver as described in paragraph (a)(3)(ii) of 
this section of any applicable filing deadlines in paragraph 
(a)(3)(i) of this section.
    Example 3. Foreign corporation fails to file a protective 
return. Same facts as in Example 1, except that in Year 1 through 
Year 4, FC's tax director also consulted a U.S. tax advisor, who 
advised FC's tax director that it was uncertain whether U.S. income 
tax returns were necessary for those years and that FC could protect 
its right subsequently to claim the loss carryforwards by filing 
protective returns under paragraph (a)(3)(vi) of this section. FC 
did not file U.S. income tax returns or protective returns for those 
years. FC did not present evidence that intervening events beyond 
FC's control prevented it from filing an income tax return, and 
there were no other mitigating factors. FC has not met the standard 
described in paragraph (a)(3)(ii) of this section for waiver of any 
applicable filing deadlines in paragraph (a)(3)(i) of this section.
    Example 4. Foreign corporation with effectively connected 
income. In Year 1, FC, a technology company, opened an office in the 
United States to market and sell a software program that FC had 
developed outside the United States. FC had minimal business or tax 
experience internationally, and no such experience in the United 
States. Through FC's direct efforts, U.S. sales of the software 
produced income effectively connected with a U.S. trade or business. 
FC, however, did not file U.S. income tax returns for Year 1 or Year 
2. FC's management was aware neither of FC's obligation to file a 
U.S. income tax return for those years, nor of its ability to file a 
protective return for those years. FC had never filed a U.S. income 
tax return before. In January of Year 4, FC engaged U.S. counsel in 
connection with licensing software to an unrelated U.S. company. 
U.S. counsel reviewed FC's U.S. activities and advised FC that it 
should have filed U.S. income tax returns for Year 1 and Year 2. FC 
immediately engaged a U.S. tax advisor who, at FC's direction, 
promptly contacted the appropriate examining personnel and 
cooperated with the Internal Revenue Service in determining FC's 
income tax liability, for example, by preparing and filing the 
appropriate income tax returns for Year 1 and Year 2 and by making 
FC's books and records available to an Internal Revenue Service 
examiner. FC has met the standard described in paragraph (a)(3)(ii) 
of this section for waiver of any applicable filing deadlines in 
paragraph (a)(3)(i) of this section.
    Example 5. IRS discovers foreign corporation's failure to file. 
In Year 1, FC, a technology company, opened an office in the United 
States to market and sell a software program that FC had developed 
outside the United States. Through FC's direct efforts, U.S. sales 
of the software produced income effectively connected with a U.S. 
trade or business. FC had extensive experience conducting similar 
business activities in other countries, including making the 
appropriate tax filings. However, FC's management was aware neither 
of FC's obligation to file a U.S. income tax return for those years, 
nor of its ability to file a protective return for those years. FC 
had never filed a U.S. income tax return before. Despite FC's 
extensive experience conducting similar business activities in other 
countries, it made no effort to seek advice in connection with its 
U.S. tax obligations. FC failed to file either U.S. income tax 
returns or protective returns for Year 1 and Year 2. In January of 
Year 4, an Internal Revenue Service examiner asked FC for an 
explanation of FC's failure to file U.S. income tax returns. FC 
immediately engaged a U.S. tax advisor, and cooperated with the 
Internal Revenue Service in determining FC's income tax liability, 
for example, by preparing and filing the appropriate income tax 
returns for Year 1 and Year 2 and by making FC's books and records 
available to the examiner. FC did not present evidence that 
intervening events beyond its control prevented it from filing a 
return, and there were no other mitigating factors. FC has not met 
the standard described in paragraph (a)(3)(ii) of this section for 
waiver of any applicable filing deadlines in paragraph (a)(3)(i) of 
this section.
    Example 6. Foreign corporation with prior filing history. FC 
began a U.S. trade or business in Year 1. FC's tax advisor filed the 
appropriate U.S. income tax returns for Year 1 through Year 6, 
reporting income effectively connected with FC's U.S. trade or 
business. In Year 7, FC replaced its tax advisor with a tax advisor 
unfamiliar with U.S. tax law. FC did not file a U.S. income tax 
return for any year from Year 7 through Year 10, although it had 
effectively connected income for those years. FC's management was 
aware of FC's ability to file a protective return for those years. 
In Year 11, an Internal Revenue Service examiner contacted FC and 
asked its chief financial

[[Page 11316]]

officer for an explanation of FC's failure to file U.S. income tax 
returns after Year 6. FC immediately engaged a U.S. tax advisor and 
cooperated with the Internal Revenue Service in determining FC's 
income tax liability, for example, by preparing and filing the 
appropriate income tax returns for Year 7 through Year 10 and by 
making FC's books and records available to the examiner. FC did not 
present evidence that intervening events beyond its control 
prevented it from filing a return, and there were no other 
mitigating factors. FC has not met the standard described in 
paragraph (a)(3)(ii) of this section for waiver of any applicable 
filing deadlines in paragraph (a)(3)(i) of this section.

    (iv) Paragraphs (a)(3)(ii) and (iii) of this section are applicable 
to open years for which a request for a waiver is filed on or after 
January 29, 2002.
* * * * *


Sec.  1.882-4T  [Removed]

    Par. 5. Section 1.882-4T is removed.

    Approved: January 17, 2003.
David A. Mader,
Assistant Deputy Commissioner.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-5461 Filed 3-07-03; 8:45 am]
BILLING CODE 4830-01-P