[Federal Register Volume 68, Number 204 (Wednesday, October 22, 2003)]
[Rules and Regulations]
[Pages 60296-60299]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 03-26547]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

[TD 9093]
RIN 1545-AX39


Special Rules for Certain Foreign Business Entities

AGENCY: Internal Revenue Service (IRS), Treasury.

[[Page 60297]]


ACTION: Final regulations.

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SUMMARY: This document contains final regulations providing rules 
regarding the application of the general entity classification rules to 
certain foreign business entities, in particular providing a rule that 
terminates the grandfathered status of certain foreign business 
entities upon a 50 percent change of ownership and a special rule that 
clarifies and further modifies the rules relating to whether the 
classification of certain foreign eligible entities is relevant for 
Federal tax purposes.

EFFECTIVE DATES: These regulations are effective as of October 22, 
2003.

FOR FURTHER INFORMATION CONTACT: Ronald M. Gootzeit, (202) 622-3860 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    On December 18, 1996, Treasury and IRS published in the Federal 
Register (61 FR 66584) final regulations relating to the classification 
of business entities under section 7701 (check-the-box regulations). On 
November 29, 1999, Treasury and the IRS published in the Federal 
Register (64 FR 66591) a notice of proposed rulemaking (REG-110385-99) 
proposing to amend Sec. Sec.  301.7701-2 and 301.7701-3 of the current 
check-the-box regulations (proposed regulations). A public hearing on 
the proposed regulations was held on January 31, 2000. In addition, 
written comments were received. Most of the written and oral comments 
related to proposed Sec.  301.7701-3(h), which provided a rule that 
would have operated to change the classification of a foreign 
disregarded entity if a so-called ``extraordinary transaction'' 
occurred one day before or within one year after the election to treat 
the entity as disregarded. On June 26, 2003, Treasury and the IRS 
issued Notice 2003-46 (2003-28 IRB 53) announcing the intention to 
withdraw this extraordinary transaction rule of proposed Sec.  
301.7701-3(h) and to finalize the remaining provisions of the proposed 
regulations.
    With the publication of a notice of withdrawal elsewhere in this 
issue of the Federal Register, proposed Sec.  301.7701-3(h) is 
withdrawn. This Treasury decision adopts without substantive change the 
remaining provisions of the proposed regulations. The final regulations 
thus adopt the following provisions from the proposed regulations: (1) 
The rule that terminates the grandfathered status of certain foreign 
business entities when there has been a 50 percent change of ownership 
of such entity; (2) the provision clarifying that a foreign eligible 
entity with respect to which an entity classification election is made 
and which is not otherwise relevant for Federal tax purposes is deemed 
so relevant only on the effective date specified on a Form 8832, 
``Entity Classification Election'; and (3) the modifications to the 
classification rules for certain foreign eligible entities that have 
never been relevant or are no longer relevant for Federal tax purposes.

Explanation of Provisions

A. Grandfathered Foreign Per Se Entities

    The check-the-box regulations allow certain foreign business 
entities that were in existence and treated as partnerships prior to 
the date the check-the-box regulations were proposed (PS-43-95, 61 FR 
21989) and that would otherwise be classified as per se corporations 
under Sec.  301.7701-2(b)(8)(i) to remain classified as partnerships if 
the conditions enumerated in Sec.  301.7701-2(d)(1) are satisfied. 
These rules also provide that the occurrence of certain events results 
in a termination of this grandfathered status. See Sec.  301.7701-
2(d)(3)(i). The final regulations adopt the rule in the proposed 
regulations at Sec.  301.7701-2(d)(3)(i) that provides an additional 
event resulting in the termination of an entity's grandfathered status. 
Under this rule, an entity's grandfathered status is terminated on the 
date when one or more persons who were not owners of the entity as of 
November 29, 1999, own in the aggregate a 50 percent or greater 
interest in the entity. Consistent with the proposed regulations, the 
final regulations provide that this rule will apply as of the date the 
final regulations are published in the Federal Register; therefore, if 
persons that were not owners of a grandfathered entity on November 29, 
1999, obtain a greater than 50 percent ownership interest between 
November 29, 1999, and October 22, 2003, the grandfathered entity will 
cease to have that status on October 22, 2003.
    Several commentators requested clarification as to whether this 
rule takes into account changes in direct ownership only or also 
changes in indirect ownership, and they suggested that the rule should 
take into account only changes in direct ownership. Treasury and the 
IRS believe that for purposes of grandfathered foreign per se entities 
a rule that took only direct changes of ownership into account could be 
easily circumvented in inappropriate cases. Therefore, this rule has 
not been modified in these final regulations. Some commentators 
requested that the rule be limited to significant changes in ownership 
within a specified period of time. For example, one commentator 
suggested that the rule be limited to situations where persons obtained 
a 50 percent or greater ownership interest within a 12-month period. 
The final regulations do not adopt this suggestion because Treasury and 
the IRS believe that an entity should retain grandfathered status only 
if there have been no significant changes in the ownership of that 
entity.

B. Relevance of Classification

    The check-the-box regulations provide that if the classification of 
a foreign eligible entity that was previously relevant for Federal tax 
purposes ceases to be relevant for 60 consecutive months and then 
subsequently becomes relevant again, the entity's classification at the 
start of the subsequent period of relevance will be determined under 
the default classification rules (60-month rule).
    These final regulations adopt the two rules in the proposed 
regulations that relate to the application of the 60-month rule. First, 
these final regulations adopt the rule providing that the 
classification of a foreign eligible entity that files an entity 
classification election is deemed to be relevant for Federal tax 
purposes on the effective date of the election for purposes of the 60-
month rule. Second, these final regulations adopt the rule providing 
that the classification of a foreign eligible entity whose 
classification has never been relevant for Federal tax purposes will 
initially be determined pursuant to the default classification 
provisions of Sec.  301.7701-3(b)(2) at the time the classification of 
the entity first becomes relevant.
    Commentators generally agreed with and supported the approach taken 
in the proposed regulations with respect to the relevance issues, and 
several commentators requested that these provisions be retroactive 
when finalized. These final regulations do not adopt the suggestion 
that these provisions be applied retroactively because Treasury and the 
IRS believe that it is not in the interest of sound tax administration.
    One commentator requested that the provisions be revised to clarify 
that it is the Federal tax classification of the foreign eligible 
entity, and not the entity itself, that is deemed to be relevant. 
Treasury and the IRS have adopted this clarifying change in these final 
regulations.
    One commentator requested that the regulations clarify why the 
classification of a foreign eligible entity, not otherwise

[[Page 60298]]

relevant, that files Form 8832, ``Entity Classification Election'', is 
deemed relevant only on the date the entity classification election is 
effective. The commentator neither suggested what the period of deemed 
relevance should be if not limited to one day nor suggested a principle 
for when the deemed relevance should terminate such that the 60-month 
rule would be triggered. In the interest of certainty and 
administrability of the application of the 60-month rule, Treasury and 
the IRS have retained the limitation of deemed relevance to the day on 
which the entity's classification is effective.
    One commentator requested further guidance on when and under what 
circumstances the classification of a foreign eligible entity that was 
previously relevant ceases to be relevant under the 60-month rule. 
Treasury and the IRS believe Sec.  301.7701-3(d)(1) and (3) provide 
sufficient guidance on when an entity's classification becomes relevant 
and, accordingly, when an entity's classification ceases to be 
relevant.
    One commentator suggested that the regulations be revised to 
provide that an election by a non-relevant foreign entity to continue 
its current classification may be filed at any time within the 60-month 
period starting on the day after the date of the most recent election 
for that entity, and that such election will start a new 60-month 
period. Section 301.7701-3(c) provides that an eligible entity may 
elect to be classified other than as provided under the default 
classification rules of Sec.  301.7701-3(b), or to change its election. 
Allowing an eligible entity whose classification is not relevant to 
renew its election for purposes of the 60-month rule would frustrate 
the policies underlying that rule. Accordingly, the suggestion was not 
adopted.
    One commentator requested clarification and examples regarding the 
determination of the classification of a foreign eligible entity whose 
classification was never relevant or whose classification has not been 
relevant for 60 months and therefore has lapsed under the 60-month 
rule. In either case (assuming in the latter case that no election is 
made following the lapse of the classification), the entity's 
classification initially will be determined under the default 
classification rules of Sec.  301.7701-3(b)(2) when the classification 
of the entity becomes relevant. Under the general rules of Sec.  
301.7701-3(c), an eligible entity may elect at such time to be 
classified other than as provided under the default classification 
rules, and may elect at some later time to change its classification. 
Treasury and the IRS do not believe at this time that further guidance 
or examples are needed to illustrate these general rules.

Special Analyses

    It has been determined that this notice of proposed rulemaking is 
not a significant regulatory action as defined in Executive Order 
12866. Therefore, a regulatory assessment is not required. It also has 
been determined that section 553(b) of the Administrative Procedure Act 
(5 U.S.C. chapter 5) does not apply to these final 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.

Drafting Information

    The principal authors of these regulations are Aaron A. Farmer and 
Ronald M. Gootzeit, Office of Associate Chief Counsel (International). 
However, other personnel from Treasury and the IRS participated in 
their development.

List of Subjects in 26 CFR Part 301

    Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income 
taxes, Penalties, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

0
Accordingly, 26 CFR part 301 is proposed to be amended as follows:

PART 301--PROCEDURE AND ADMINISTRATION

0
Paragraph 1. The authority citation for part 301 continues to read in 
part as follows:

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


0
Par. 2. Section 301.7701-2 is amended by:
0
1. Removing the language ``or'' at the end of paragraph (d)(3)(i)(B).
0
2. Removing the period at the end of paragraph (d)(3)(i)(C) and adding 
``; or'' in its place.
0
3. Adding paragraph (d)(3)(i)(D).
0
4. Adding a sentence at the end of paragraph (e).
    The additions read as follows:


Sec.  301.7701-2  Business entities; definitions.

* * * * *
    (d) * * *
    (3) * * *
    (i) * * *
    (D) The date any person or persons, who were not owners of the 
entity as of November 29, 1999, own in the aggregate a 50 percent or 
greater interest in the entity.
* * * * *
    (e) Effective date. * * * However, paragraph (d)(3)(i)(D) of this 
section applies on or after October 22, 2003.
0
Par. 3. Section 301.7701-3 is amended as follows:
0
1. The text of paragraph (d)(1) following the paragraph heading is 
redesignated as paragraph (d)(1)(i), and a paragraph heading is added 
for paragraph (d)(1)(i).
0
2. Paragraph (d)(1)(ii) is added.
0
3. Paragraph (d)(2) is revised.
0
4. Paragraphs (d)(3) and (d)(4) are added.
    The revision and additions read as follows:


Sec.  301.7701-3  Classification of certain business entities.

* * * * *
    (d) Special rules for foreign eligible entities--(1) Definition of 
relevance--(i) General rule. * * *
    (ii) Deemed relevance--(A) General rule. For purposes of this 
section, except as provided in paragraph (d)(1)(ii)(B) of this section, 
the classification for Federal tax purposes of a foreign eligible 
entity that files Form 8832, ``Entity Classification Election'', shall 
be deemed to be relevant only on the date the entity classification 
election is effective.
    (B) Exception. If the classification of a foreign eligible entity 
is relevant within the meaning of paragraph (d)(1)(i) of this section, 
then the rule in paragraph (d)(1)(ii)(A) of this section shall not 
apply.
    (2) Entities the classification of which has never been relevant. 
If the classification of a foreign eligible entity has never been 
relevant (as defined in paragraph (d)(1) of this section), then the 
entity's classification will initially be determined pursuant to the 
provisions of paragraph (b)(2) of this section when the classification 
of the entity first becomes relevant (as defined in paragraph (d)(1)(i) 
of this section).
    (3) Special rule when classification is no longer relevant. If the 
classification of a foreign eligible entity is not relevant (as defined 
in paragraph (d)(1) of this section) for 60 consecutive months, then 
the entity's classification will initially be determined pursuant to 
the provisions of paragraph (b)(2) of this section when the 
classification of the foreign eligible entity becomes relevant (as 
defined in paragraph (d)(1)(i) of this section). The date that the 
classification of a foreign entity is not relevant is the date an event 
occurs that causes the classification to no longer be relevant, or, if 
no event occurs in a taxable year

[[Page 60299]]

that causes the classification to be relevant, then the date is the 
first day of that taxable year.
    (4) Effective date. Paragraphs (d)(1)(ii), (d)(2), and (d)(3) of 
this section apply on or after October 22, 2003.
* * * * *

Robert E. Wenzel,
Deputy Commissioner for Services and Enforcement.
    Approved: October 8, 2003.
Pamela F. Olson,
Assistant Secretary of the Treasury.
[FR Doc. 03-26547 Filed 10-21-03; 8:45 am]
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