PORTFOLIO

CFCs — Foreign Personal Holding Company Income (Portfolio 6220)

Tax Management Portfolio, CFCs — Foreign Personal Holding Company Income, analyzes the rules for U.S. federal income taxation of United States shareholders of controlled foreign corporations (CFCs) under “Subpart F” of the Internal Revenue Code.

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DESCRIPTION

This Portfolio provides a detailed analysis of one of the categories of foreign base company income: foreign personal holding company income, which includes certain dividends, interest, related person factoring income, rents, royalties, income from annuities, commodities transactions, and foreign currency transactions, and certain other income. The other categories of foreign base company income – foreign base company sales income, foreign base company services income, and foreign base company oil related income – are analyzed in detail in related Portfolio 928 T.M., CFCs — Foreign Base Company Income (Other than FPHCI).


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AUTHORS

CFCs — Foreign Personal Holding Company Income was authored by the following experts.
LOWELL D. YODER, ESQ.
Lowell D. Yoder, B.A. (1979, with highest distinction) and J.D. (1982, magna cum laude, Law Review Editor), University of Illinois; Law Clerk, The Honorable James M. Sprouse, Federal Court of Appeals for the Fourth Circuit; member, Panel of Leading International Tax Practitioners, Tax Management International Journal; member, Tax Management U.S. International Advisory Board; Editor-in-Chief, CCH International Tax Journal and member of the Board of Advisors; Adjunct Professor of Law, Northwestern University School of Law, teaching Advanced International Taxation; member, American Bar Association (Tax Section); frequent speaker on international tax topics; author of numerous articles on international taxation.

DAMON M. LYON, ESQ.
Damon M. Lyon, B.A. (1997, with highest honors), Michigan State University; J.D. (2000, cum laude), University of Michigan Law School; frequent speaker on international tax topics; author of articles on international taxation.

DAVID G. NOREN, ESQ.
David G. Noren, A.B. (1993, with distinction, Phi Beta Kappa), Stanford University; J.D. (1996, magna cum laude, Harvard Law Review), Harvard Law School; Legislation Counsel to the Joint Committee on Taxation, U.S. Congress (2001–2006); Acting Assistant Professor of Law, New York University School of Law (1999–2001), Associate, Baker & McKenzie, Chicago (1996–1999); frequent speaker and writer on international tax topics.

TABLE OF CONTENTS

Portfolio 6220-1st: CFCs — Foreign Personal Holding Company Income

Portfolio Description

Authors

Technical Advisors

Description

Detailed Analysis

I. Introduction

II. Legislative and Regulatory History

A. General

B. Legislative History

C. Regulatory History

III. Overview

Introductory Material

A. Categories of FPHCI

B. Exceptions to FPHCI

IV. General Rules and Definitions

Introductory Material

A. Coordination of Overlapping Definitions

1. Priority Rules

2. Application of Exceptions

B. Changes in the Use or Purpose for Which Property Is Held

1. General

2. Majority Use

3. Anti-Abuse Rule

4. Hedging Transactions

C. Bona Fide Hedging Transactions

1. Background

2. Definition

a. General

b. Related Person Risks

c. Change in Purpose of Hedging Transaction

3. Section 1221 Hedging Definition

a. General

b. Rules of Application

(1) General

(2) Normal Course of Taxpayer's Trade or Business

(3) Risk Reduction

(4) Ordinary Property, Ordinary Obligation, or Borrowing Defined

(5) Ineligible Hedges

4. Identification and Recordkeeping Requirements

a. Background

b. General Identification Requirements

c. Specific Identification Requirements for Certain Hedges

d. Manner of Identification

e. Effect of Misidentification and Nonidentification

(1) General

(2) Misidentification of Transaction that Does Not Qualify as a Hedging Transaction

(3) Nonidentification of Hedging Transaction

(4) Anti-Abuse Rule

D. Inventory and Similar Property

E. Dealer Definitions

1. Regular Dealer

a. General Definition

b. Related Persons

2. Dealer Property

a. General Definition

b. Securities Dealer

c. Hedging Transaction

V. Dividends, Interest, Rents, Royalties, and Annuities

A. Dividends

1. General Rule

2. Definition of Dividend

a. General

b. Earnings and Profits Limitation

c. Other Transactions Treated as Dividends

d. Section 964(e)

3. Exception: Related Corporation/Same Country

a. Basic Requirements

b. Related Corporation

c. Same Country of Organization

d. Same-Country Trade or Business Requirement

(1) General

(2) Trade or Business

(3) Location of Trade or Business

(4) Assets Used in a Trade or Business

(a) General

(b) When Property Considered Used in a Trade or Business

(c) Debt Instruments

(d) Stock Interests

(e) Interests in Partnerships

(5) Location of Assets

(a) Tangible Property

(b) Intangible Property

(c) Inventory and Dealer Property

(d) Debt Instruments

(e) Stock Interests

 (6) Substantial Assets Test

(a) 50% Threshold

(b) Value of Assets

e. Prior Year Satisfaction of Requirements

(1) General

(2) Same-Country Requirements

(3) Direct or Indirect Stock Ownership

(4) Order of Distributions

f. Limitations on the Application of the Same-Country Exception

(1) Section 964(e)

(2) Section 367 Inclusion

(3) Full Inclusion Rule

4. Exception: CFC Look-Through Exception

5. Other Exceptions

a. Dividends Out of Previously Taxed Income

b. Deemed § 367 Dividends

c. De Minimis and High-Tax Exceptions

d. Distributions in Tax-Free Liquidation

e. Branch and Partnership Distributions

f. Circular Flow of Cash

B. Interest

1. General Rule

2. Definition of Interest

3. Exception: Export Financing Interest

a. General Rule

b. Definition of Export Financing Interest

c. Conduct of Banking Business

d. Related Person Factoring Income

(1) Exception Inapplicable

(2) Same-Country Exception

(3) Financing Unrelated Distributor Sales

(4) Financing CFC's Own Sales

4. Exception: Related Corporation/Same-Country Interest

a. General Rule

b. Corporate Payor

(1) General

(2) Payments Received from Partnership

c. Related Corporation

d. Same Country of Organization

e. Same-Country Trade or Business Requirement

f. Exception Inapplicable

(1) General

(2) Expense Reduces Subpart F Income

(a) General

(b) Payment Reduces Payor's Subpart F Income

(c) Payment Creates or Increases Deficit

 (d) Offsetting Interest Expense/Payments

(3) Related Person Factoring Income

(4) Portfolio Interest

5. Exception: CFC Look-Through Exception

6. Planning Structures

a. Hybrid Entities

b. Reverse Hybrid Entities

c. High-Tax Exception

7. Tax-Exempt Interest

a. General

b. Background

c. Inclusion in Income

8. Related Person Factoring Income

a. General Rule

b. Legislative Background

c. Override of Subpart F Exceptions

d. Trade or Service Receivable

e. Definition of Related Person

f. Acquisition of a Trade or Service Receivable

(1) General Rule

(2) Indirect Acquisitions

(a) General

(b) Acquisition Through Unrelated Person

(c) Acquisition by Nominee or Pass-Through Entity

(d) Swap or Pooling Arrangements

(e) Financing Arrangements

g. CFC Loans

h. Same-Country Exception

(1) Income from Trade or Service Receivables

(2) Income from Financing Arrangements

C. Rents

1. General Rule

2. Definition of Rents

a. General

b. Lease vs. Sale

3. Exception: Active Leasing Exception

a. General

b. Unrelated Lessee

c. Active Trade or Business

(1) General

(2) Specific Trade or Business Cases

(a) Property Manufactured or Produced

(b) Real Property Managed by the CFC

(c) Personal Property Temporarily Leased

(d) Property Leased in Connection with Marketing Functions

(e) Special Safe Harbor for Aircraft and Vessel Leases

4. Exception: Same-Country Exception

a. General

b. Corporate Payor

(1) General

(2) Payments Received from Partnership

c. Related Lessee

d. Country of Organization

e. Place Property Used

(1) General

(2) Property Used Partially in Same Country

f. Exception Inapplicable: Payment Reduces Subpart F Income

5. Exception: CFC Look-Through Exception

6. Planning Structures

a. Active Leasing Income

b. Eliminate Related Person Rents

c. Qualify for Same-Country Exception

(1) Reverse Hybrid Entities

(2) Nonresident Corporation

d. Lease vs. Sale

D. Royalties

1. General Rule

2. Definition of Royalties

a. General

b. License vs. Sale

c. Royalties vs. Service

3. Exception: Active Licensing Exception

a. General

b. Unrelated Licensee

c. Active Trade or Business

(1) General

(2) Specific Trade or Business Cases

(a) Property Developed, Created, or Produced

(b) Property Licensed in Connection with Marketing Functions

4. Exception: Same-Country Exception

a. General

b. Corporate Payor

(1) General

(2) Payments Received from Partnership

c. Related Licensee

d. Country of Organization

e. Place Property Used

(1) General

(2) Property Used Partially in Same Country

f. Limitation: Payment Reduces Subpart F Income

5. Exception: CFC Look-Through Exception

6. Exception: Intangible Profits Embedded in Sales or Services Income

7. Planning Structures

a. Same-Country IP Companies

b. Joint Ventures

c. Active Royalty Income

d. Eliminate Related Party License

e. Other Structures

E. Annuities

1. General

2. Contracts Governed by § 72

3. Inclusion of Annuities in Gross Income

a. General

b. Treatment of an Annuity Held by an Entity

c. Amounts Received as an Annuity

d. Amounts Not Received as an Annuity

F. Exception: CFC Look-Through Exception

1. General

2. Payments Eligible for § 954(c)(6)

3. CFC Payor and Related Person Requirements

4. Limitation: Interest, Rents, and Royalties

a. General

b. Expenses Allocable to Subpart F Income or ECI

c. Section 952(c) Limitation

5. Limitation: Dividends

6. Payments Received from and Made to Partnerships

7. Anti-Abuse Rules

a. Amounts that Reduce the U.S. Income Tax Base

b. Use of § 954(c)(6) to Avoid § 956

c. Use of Options or Similar Interests

d. Change of Character of Income Through the Use of a Conduit Entity

e. Other Potentially Abusive Transactions

VI. Gains from Certain Property Transactions

A. General

1. Overview

2. Legislative Background

3. Basic Rules

4. Exceptions

a. Dealer Property

b. Inventory and Similar Property

c. Property Giving Rise to Active Rents and Royalties

d. Active Banking, Finance, Securities, and Insurance Income

e. Trade or Business Property

5. Losses

B. Property that Gives Rise to Certain Income

1. General

2. Stock in Subsidiary

3. Debt Instruments

a. General

b. Exceptions

(1) Gain

(2) Loss

C. Property that Does Not Give Rise to Any Income

1. General Rule

2. Forwards, Futures, and Options

3. Exceptions to Avoid Double Inclusion

4. Exception for Trade or Business Property

a. General

b. Tangible Property Subject to Depreciation

c. Real Property

d. Intangible Property

e. Disregarded Entity

5. Exception for Notional Principal Contracts

D. Interests in Pass-Through Entities

1. General

2. Exception: Section 954(c)(4) Look-Through Rule

a. In General

b. Ownership Requirement

c. Application of Trade or Business Exception

d. Other Exceptions

3. Exception: Hybrid Branches

E. Dual Character Property

1. General Rule

2. Change in Use

F. Planning for the Sale of Lower-Tier CFC Stock

1. Amount of Gain

a. General Rule

b. Adjustments for Previously Taxed Income

2. Characterization of Gain

3. Subpart F Income

a. Capital Gains

b. Dividend Income

4. Foreign Tax Credits

a. Capital Gain

b. Dividend Income

5. Pre-Sale Conversion to Hybrid Branch

a. Conversion to Hybrid Branch

b. Treatment of Liquidation

c. Tax Consequences of Sale

d. The Dover Case

e. Other Potential Obstacles to Check-and-Sell Transactions

6. Section 338 Election

G. Coordination with Other FBCI Categories

1. FPHCI Categories

2. Foreign Base Company Sales Income

3. Foreign Base Company Shipping Income

4. Foreign Base Company Oil Related Income

VII. Commodities Transactions

A. General

1. Overview

2. Legislative Background

3. Basic Rules

4. Commodities Losses

B. Definition of Commodity

C. Commodities Transactions

1. General

2. Futures or Forward Contract in a Commodity

3. Leverage Contract in a Commodity

4. Exchange of Futures for Physical Transaction

5. Transaction in Which Income or Loss Is Measured by Reference to a Commodity, Pool of Commodities, or Index of Commodities

6. Purchase or Sale of Option or Other Right to Acquire or Transfer a Commodity, Futures Contract in a Commodity, or Index of Commodities

7. Delivery of One Commodity in Exchange for Delivery of Another Commodity, Same Commodity at Another Time, Cash, or Nonfunctional Currency

D. Exception: Qualified Active Sales

1. General

2. Sale of Commodities

3. Active Conduct of a Commodities Business

a. General

b. Inventory or Dealer Property

c. Substantial Commodities Business Activities

d. Investment or Financial Transactions

4. Substantially All

E. Exception: Qualified Hedging Transactions

F. Exception: Dealer Transactions

G. Exception: Foreign Currency Transactions

H. Coordination with Other FBCI Categories

1. Foreign Personal Holding Company Income

2. Foreign Base Company Sales Income

3. Foreign Base Company Oil Related Income

VIII. Foreign Currency Gains

A. General

1. Overview

2. Legislative Background

3. Basic Rules

4. Foreign Currency Losses

B. Foreign Currency Gains or Losses

1. General

2. Section 988 Transactions

3. Functional Currency

4. Amount of Foreign Currency Gain or Loss

5. Non-Section 988 Transactions

a. General

b. Investments

c. Limitation for Derivative Instruments

d. Regulated Futures Contracts and Nonequity Options

(1) General Rules

(2) FPHCI Commodities Gains or Losses

C. Exclusions for Certain Foreign Currency Gains or Losses

1. General

2. Capital Gains or Losses

3. Foreign Currency Gain or Loss Treated as Interest Income or Expense

a. Interest Under § 988(a)(2)

b. Interest-Bearing Liabilities

c. Gain or Loss Allocated Under Regs. § 1.861-9

4. Section 988 Hedging Transactions

5. DASTM Gains or Losses

a. General

b. U.S. Dollar Functional Currency

c. Subpart F Treatment

(1) General

(2) DASTM Allocation Rules

(3) Non-DASTM Currency Gains and Losses

D. Business Needs Exception

1. Overview

a. General Rules

b. Scope of Application

c. FPHCI Priority Rules and Exceptions

2. Business Transactions

a. General

b. Specific Business Transactions

(1) Acquisition of Debt Instruments

(2) Becoming the Obligor Under Debt Instruments

(3) Accrual of Items of Gross Income

(4) Accrual of Items of Expense

(5) Entering into Forward Contracts, Futures Contracts, Options, and Similar Instruments

(6) Disposition of Nonfunctional Currency

(7) Transactions in Business Assets

c. Limitations on Scope of Exception

(1) Subpart F Income

(2) Financial Contracts

d. Identification Requirements

3. Bona Fide Hedging Transactions

a. General

b. Temporary Regulations

(1) General Rules

(2) Change in Purpose of Hedging Transaction

c. Final Regulations

(1) General Rules

(2) Hedges of Business Transactions

(3) Bona Fide Hedging Transaction

(4) Identification

(5) Change in Purpose of Hedging Transaction

4. Dealer Transactions

5. Currency Coordination Centers

E. Special Elections

1. Reclassification in Another Subpart F Category

2. Inclusion of All Foreign Currency Gains and Losses

F. Coordination with Other FPHCI Categories

IX. Income Equivalent to Interest

A. Overview

B. Legislative History

C. Definition

1. General

2. Items Excluded

a. Interest

b. Liability Hedging Transactions

3. Exceptions for Interest Generally Inapplicable

D. Transactions in Which Payments Reflect Use of Money

E. Factoring Income

1. Definition

2. Factored Receivable

3. Amount Realized

4. Exceptions

a. Related Person Receivables

b. Acquisition After Interest Begins to Accrue

c. Acquisition After Principal Due

F. Income from Certain Integrated Sales Transactions

G. Certain Income from Services Transactions

H. Loan Commitment Fees

I. Conversion Transactions

J. Income Attributable to the Transfer of Debt Securities Under § 1058

X. Income from Notional Principal Contracts

A. General Rules

B. Definition of NPC

C. Subpart F Treatment of NPCs Under Pre-1997 Law

1. General

2. Foreign Currency Gains or Losses

3. Commodities Gains or Losses

4. Income Equivalent to Interest

a. Temporary Regulations

b. Notice 89-90

c. Final Regulations

(1) General

(2) Dealer Exception

(3) Liability Hedging Transactions

D. Subpart F Treatment of NPCs Under 1997 Law

1. 1997 TRA

2. General Rules

3. Hedging NPC

4. Dealer Exception

XI. Income from Stock Lending Transactions

XII. Income from Personal Service Contracts

XIII. Special Exceptions

A. Exception for Active Banking, Financing, or Securities Income

1. General

a. Overview

b. Legislative Background

(1) General

(2) Treatment of Finance Income Under Prior Law

(a) Revenue Act of 1962

(b) Tax Reform Act of 1986

(c) Taxpayer Relief Act of 1997

(3) Current Exception for Financing Income

(a) Tax and Trade Relief Extension Act of 1998

(b) Extension and Subsequent Modification of Exception

c. Basic Rules

2. Eligible CFC

a. General

b. Predominantly Engaged Requirement

(1) General

(2) Lending or Finance Business

(a) 70% Gross Income Test

(b) Lending or Finance Business

(c) Unrelated Foreign Customers

(d) Direct, Active, and Regular Business

(3) Banking Business

(4) Securities Business

c. Substantial Business Activity Requirement

(1) Substantial Activity

(2) Substantially All Activities

(3) Performance of Activities

(a) Activities of QBUs

(b) Activities of Related Persons

3. Qualified Banking or Financing Income

a. General

b. Activities Generating Qualifying Income

c. Foreign Customers

(1) Transactions with Customers

(2) Non-U.S. Customers

d. Substantially All Activities

(1) General

(2) Connection with Transaction

(3) Conducted Directly

(4) Performed in Home Country

(5) Separate Determination

e. Taxed in Home Country

f. Illustration

4. Income from Cross-Border Transactions

a. General

b. Cross-Border Transactions

(1) General

(2) Home Country

(3) Location of Customers

c. Substantial Activity in Home Country

d. Lending or Finance Business: 30% Test

5. Anti-Abuse Rules

6. Coordination with Other Rules

a. Securities Dealers

b. Sale of Assets of an Active Financing Business

c. Exception from Foreign Base Company Services Income

d. Same-Country Exception

B. Exception for Active Insurance Income

1. General

2. Exempt Insurance Income

a. General

b. Exempt Insurance Income

c. Qualifying Insurance Company and Branch

3. FPHCI Exception

a. General

b. Qualifying Insurance Company

c. Qualified Insurance Income

d. Unearned Premiums and Reserves

(1) Property and Casualty Contracts

(2) Life Insurance and Annuity Contracts

(3) Limitation on Reserves

C. Exceptions for Dealers

1. General

2. Regular Dealers

3. Securities Dealer

XIV. CFC-Owned Partnerships

A. General

B. Overview of Partnership Regulations

1. Section 702 Regulations

a. Character of Partnership Gross Income

b. Partners Separately Take into Account Subpart F Items

2. Subpart F Regulations

a. General Aggregate Rule

b. FBCI Entity Rules

3. Partnership Matters Unaddressed

a. CFC's Transactions with Partnership

b. Partnership Deductions

C. Related Person and Country Determinations

1. Related Person

a. General Rules

b. Partner/Partnership Transactions

(1) CFC Partner's Distributive Share

(2) CFC Partner's Own Income

2. Country of Incorporation

D. Application of FPHCI Rules

1. General Aggregate Approach

2. Related Person/Same-Country Exceptions

a. General

b. Payments Received by Partnership

c. Payments Made by Partnership

3. Business Exceptions to FPHCI

4. Exception for Active Banking and Financing Income

a. General Rules

b. Proposed Regulations

c. Final Regulations

E. Sale of Interest in Partnership


WORKING PAPERS

Working Papers

Table of Worksheets

Other Sources

Worksheet 1 Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986, 99th Cong., May 4, 1987 (Excerpts)

Worksheet 2 H.R. (Conf.) Rep. No. 220, 105th Cong., 1st Sess. (1997) (Excerpts)

Worksheet 3 H.R. (Conf.) Rep. No. 105-825, 105th Cong., 2d Sess. (1998) (Excerpts)

Worksheet 4 Staff of the Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 109th Congress (Excerpts)

Worksheet 5 Preamble to Regs. § § 1.954-1T and -2T, T.D. 8216,1988-2 C.B. 257

Worksheet 6 Preamble to Regs. § § 1.954-1 and -2, T.D. 8618, 1995-2 C.B. 89

Worksheet 7 Preamble to T.D. 8704, 1997-1 C.B. 154

Worksheet 8 Preamble to Prop. Regs. § 1.954-9, REG-113909-98, 1999-30 I.R.B. 125 (7/26/99)

Worksheet 9 Notice 2007-9, 2007-5 I.R.B. 401

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