Forms of Overseas Operations (Part II) — footnotes

²⁰ For further discussion, see Lemein and McDonald, “International Tax Watch—Interest Apportionment Rules Can Double-Count Foreign Source Assets in Certain Joint Venture Transactions,” 81 Taxes 5 (September 2003).

²¹ TD 9121 (4/20/04).

²² See the potential income recapture under (1) the foreign asset disposition rules of Sec. 904(f)(3) and (5)(F) and Regs. Sec. 1.904(f)-2(d); (2) the branch loss recapture rules of Sec. 367(a)(3)(C) and Temp. Regs. Sec. 1.367(a)-6T; and (3) the DCL recapture rules of Regs. Sec. 1.1503-2(g)(2)(iii)(A)(5) and (7).

²³ See Secs. 957(a) and 958. Indirect ownership is beneficial ownership through foreign intermediaries and applies until a U.S. person is deemed to own the CFC’s stock; see Sec. 958(a)(2). Constructive ownership is beneficial ownership attributed from related persons or entities under Sec. 318(a), subject to certain modifications under Sec. 958(b). Special rules apply to foreign insurance operations under Secs. 957(b) and 953(c).

²⁴ See Secs. 952(a)(2) and 954(a). Other components of subpart F income are (1) income from “blacklisted” countries; (2) income connected with international boycotts; (3) illegal payments to government officials; and (4) insurance income. Special industries are shipping and oil-related industries. Shipping income includes the use (or hiring or leasing for use) of any aircraft or vessel and services directly related to such use; see Secs. 954(f) and (g). For tax years beginning after 2004, shipping income is no longer subpart F income.

²⁵ There are exceptions to the passive income provisions. For example, under Sec. 954(c)(2)(B), export financing interest received in the active conduct of a banking business is not passive income. Qualified banking, financing or insurance income is also excluded; see Sec. 954(h) and (i). Under Sec. 954(c)(3), interest received from a related person can be excluded as passive income if the (1) related borrower and lender are corporations created or organized in the same foreign country, (2) borrower uses a substantial part of its assets in a trade or business located in that country and (3) interest payment does not reduce the related borrower’s subpart F income. Rents and royalties may be excluded from passive income if (1) derived from the active conduct of a trade or business and not received from a related person or a related corporation for the use of property in the same country in which the CFC is organized and (2) the payments do not reduce the related payer’s subpart F income; see Sec. 954(c)(2)(A) and (3). Income from certain commodities transactions is also excluded, under Sec. 954(c)(1)(C). Exceptions are available under Sec. 954(c)(2)(C) for securities dealers.

²⁶ To prevent a CFC from using a branch in another country to avoid subpart F income, Sec. 954(d)(2) treats a branch as the CFC’s wholly owned subsidiary. Under Regs. Sec. 1.954-3(b), a sale branch is treated as the CFC’s wholly owned subsidiary if it is located in another country and its income is subject to a materially lower effective tax rate than the CFC’s income. A tax is “materially lower” if the income attributed to the sales is taxed at an effective rate less than 90% of, and at least five percentage points less than, the effective rate that would apply to the sales income if it were earned in the country in which the manufacturing activity is located. Conversely, if the branch is engaged in manufacturing and the CFC is engaged in sales, the manufacturing branch is treated as a wholly owned subsidiary if the CFC’s effective tax rate is materially lower than the branch’s.

²⁷ See Sec. 954(b)(3)(A) and Regs. Sec. 1.954-1(b)(1). Under Regs. Sec. 1.954-1(b)(1)(i)(C), the de minimis rule does not apply to income earned from trade or services receivables acquired from a CFC’s related party, or to loans to finance the purchase of goods or services from a related party. Accordingly, income from these sources is FBC income reportable by U.S. shareholders.

²⁸ See Regs. Sec. 1.959-1, et seq. and Notice 88-71, 1988-2 CB 374.

²⁹ Notice 88-71, note 28 supra.

³⁰ See Sec. 956(b)(1). Current earnings are not reduced by the accumulated deficit of prior years. Thus, a U.S. shareholder can have income even if the CFC had current earnings, but an overall accumulated deficit.

³¹ The 60% income threshold was reduced to 50% after the first year the foreign corporation was an FPHC.

³² See Notice 88-22, 1988-1 CB 489.

³³ See Sec. 1291(d)(1) and Prop. Regs. Sec. 1.1291-1(c)(2).

³⁴ See Sec. 1291(d)(2)(A) and Regs. Sec. 1.1291-10(a).

³⁵ See Sec. 1291(d)(2)(B) and Regs. Sec. 1.1291-9(a).

³⁶ See Prop. Regs. Sec. 1.1293-1(a) and Temp. Regs. Sec. 1.1297-3T(a).