Proposed Regulations Issued on CFC Related Person Rules and Active Trade or Business Exception
Proposed regulations provide rules on the attribution of ownership of
stock or other interests for determining whether a person is a related
person with respect to a controlled foreign corporation (CFC) under the
foreign base company sales income rules.
The proposed regulations also provide rules to determine whether a
CFC receives rents in the active conduct of a trade or business, for
determining the exception from foreign per
The proposed regulations provide specific rules for applying
principles similar to those in the Code Sec. 958(b) constructive
ownership rules when determining related person status under the foreign
base company sales rules. Determining related person status is relevant
for many purposes, including whether certain types of income can be
characterized as subpart F foreign base company sales or service income.
A person is a related person with respect to a CFC if the person is:
Under current Reg. §1.954-1(f), the Code Sec. 318(a)(3) downward
attribution rules, which attribute ownership downward from the owner of
an entity to an entity, apply by reference to the Code Sec. 958stock
ownership rules. These rules are applied regardless of the size of the
ownership interest in a partnership, estate or trust, but are applied to
corporations based on a 50-percent or more ownership interest.
- an individual who controls the CFC;
- an entity that controls or is controlled by the CFC; or
- an entity that is controlled by the same person that controls the CFC.
Based on concern that the downward attribution rules could produce
inappropriate results, the proposed regulations provide that the
downward attribution rule of Code Sec. 318(a)(3) and Reg.
§1.958-2(d) will not apply for purposes of determining related person
status under the foreign base company sales income rules.
This change does not preclude a corporation, partnership, trust, or
estate from being treated as controlled by the same person or persons
that control the CFC under other rules that remain applicable for the
related person rules.
Additionally, an anti-abuse rule is provided with respect to the
option attribution rule in Code Sec. 318(a)(4). The option attribution
rule will not be applied to treat a person with an option as owning the
stock or equity interest for purposes of the related person rule if the
principal purpose of using the option was to cause a person to be
treated as a related person.
The proposed regulations also incorporate a similar rule issued
in Notice 2007-9, 2007-1 CB 401. The rule applies if the principal
purpose for the use of an option is to qualify dividends, interest,
rents or royalties paid by a foreign corporation for the Code Sec.
954(c)(6) CFC look-through exception from foreign personal holding
company income. The rule is proposed to apply for tax years of CFCs
beginning after December 31, 2006, and ending before the date that final
regulation are published in the Federal Register, and for tax year of
U.S. shareholders in which or with which such tax years end.Foreign Personal Holding Company Rules
The proposed regulations modify the foreign personal holding company
rules on amounts paid or incurred by a CFC in connection with the CFC’s
rental income and the active rents exception. Rents are excluded from
foreign personal holding company income if they are:
- received from a person other than a related person; and
- from the active conduct of a trade or business.
If rents are from leasing property as a result of marketing
activities, there must be a substantial marketing organization in order
to meet the active trade or business test. Under a safe harbor, an
organization is substantial if active leasing expenses equal or exceed
25 percent of adjusted leasing profit. If the CFC receives rents from
property it does not own, the substantiality of the organization is
determined net of those rent payments.
The propose regulations extend the rule to apply to royalties, in
addition to rents. As a result, the substantiality of the organization
is determined under the safe harbor, net of the rents or royalties paid
or incurred by the lessor CFC, for the right to use the property (or a
component part of the property) that generated the rental income.
The proposed regulations are generally proposed to apply to tax years
of CFCs ending on or after the date the final regulations are published
in the Federal Register, and for tax year of U.S. shareholders in which
or with which such tax years end.