PORTFOLIO

CFCs — Foreign Base Company Income Other than FPHCI (Portfolio 928)

Tax Management Portfolio, CFCs — Foreign Base Company Income (Other than FPHCI), focuses on the provisions of §954 other than those pertaining to foreign personal holding company income. Section 954 forms the functional heart of “Subpart F,” which relates to U.S. taxation of shareholders of controlled foreign corporations (“CFCs”).

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DESCRIPTION

This Portfolio provides a detailed analysis of three of the four categories of foreign base company income: (1) foreign base company sales income, (2) foreign base company services income, and (3) foreign base company oil related income. It also analyzes foreign base company shipping income, which was a category of foreign base company income until its repeal by the American Jobs Creation Act of 2004. The exceptions to these categories and special rules relating thereto are also discussed in detail, including the de minimis rule, full inclusion rule, and high-tax exception. Moreover, the application of the foreign base company income rules to partnerships with CFC partners is analyzed. The fourth category of foreign base company income is foreign personal holding company income (including dividends, interest, related person factoring income, rents, royalties, annuities, commodities gains, foreign currency gains, and other income), and is analyzed in detail in 6220 T.M., CFCs — Foreign Personal Holding Company Income.


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AUTHORS

CFCs — Foreign Base Company Income (Other than FPHCI) was authored by the following experts.
LOWELL D. YODER
Lowell D. Yoder, B.A. (1979, with highest distinction) and J.D. (1982, magna cum laude), University of Illinois; Order of the Coif; Law Review Editor; Law Clerk, The Honorable James M. Sprouse, Federal Court of Appeals for the Fourth Circuit; frequent lecturer and author of numerous articles on international taxation; Fellow of the American College of Tax Counsel; Editor-in-Chief of the Journal of Taxation of Global Transactions; Counsel Member of the International Fiscal Association; member of the Tax Management International Journal Advisory Board, member of Editorial Board of the Journal of International Taxation, and member of the University of Chicago Law School's Federal Tax Conference Planning Committee; Adjunct Professor of Law at University of Illinois Law School and Chicago-Kent College of Law, and Assisting Practitioner for the Graduate Tax Program of Northwestern University School of Law.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

II. Legislative History

Introductory Material

A. Revenue Act of 1962

1. General

2. Types of Income

3. Special Rules and Exceptions

B. Tax Reform Act of 1969

1. Overview

2. “Not-Formed-or-Availed-of” Exception

C. Tax Reduction Act of 1975

1. Foreign Base Company Shipping Income

2. Exception for Agricultural Commodities

3. Reduction of De Minimis Exception Threshold

D. Tax Reform Act of 1976

1. Overview

2. Shipping Income Exception

E. Tax Equity and Fiscal Responsibility Act of 1982

1. Overview

2. Foreign Oil Related Income

F. Tax Reform Act of 1984

1. Overview

2. Factoring Income

3. Foreign Base Company Oil Related Income

G. Tax Reform Act of 1986

1. Expansion of Types of FPHCI

a. Overview

b. Gains from Certain Property

c. Income from Commodities Transactions

d. Foreign Currency Gains

e. Banking and Insurance Income

f. Income Equivalent to Interest

g. Related Person Exceptions

(1) FPHCI Rules

(2) Related Person Factoring Income

2. Foreign Base Company Shipping Income

a. Repeal of Exclusion for Reinvested Shipping Income

b. Space or Ocean Income

3. Contraction of Exceptions and Limitations to Foreign Base Company Income

a. High-Tax Exception

b. De Minimis Exception

c. Full Inclusion Rule

4. Expansion of Definition of Related Person

H. Technical & Miscellaneous Revenue Act of 1988

1. Definition of Related Person

2. Related Person Exclusion from FPHCI

3. Gains as FPHCI

I. Revenue Reconciliation Act of 1989

J. Omnibus Budget Reconciliation Act of 1993

1. Overview

2. Limitation on Same-Country Dividend Exception

3. Expansion of Foreign Base Company Sales Income

4. FPHCI Priority Rule

a. Foreign Base Company Shipping Income

b. Foreign Base Company Oil Related Income

K. Taxpayer Relief Act of 1997

1. Overview

2. Expansion of Foreign Personal Holding Income

3. Dealer Exception

4. Active Financing and Insurance Exception

5. Dispositions of Lower-Tier CFCs

a. Application of Principles of 1248 to Gain from Stock Sales by CFCs

b. Basis Adjustments for Lower-Tier CFC

L. The Tax and Trade Relief Extension Act of 1998

M. The Tax Relief Extension Act of 1999

N. The Job Creation and Worker Assistance Act of 2002

O. American Jobs Creation Act of 2004

P. Tax Increase Prevention and Reconciliation Act of 2005

Q. Tax Extenders and Alternative Minimum Tax Relief Act of 2008

III. Overview

A. General

B. Categories of FBCI

C. Full Inclusion Rule

D. FBCI Exceptions

E. Net FBCI

IV. Character of Items of Income

A. General

B. Substance of the Transaction

C. Different Types of Income from a Single Transaction

1. General Segregation Rule

2. Predominant Character

D. Coordination of Categories of FBCI

1. Priority Rules

2. Application of Exceptions

E. Partnership Income

V. Definition of Related Person

A. General

B. Control Requirement

1. Individuals

2. Other Persons

C. Control Threshold

1. General

2. Related Corporations

3. Partnerships

4. Trusts and Estates

5. Direct, Indirect or Constructive Ownership

VI. Foreign Personal Holding Company Income

A. Overview

1. General

2. Categories of FPHCI

3. Exceptions to FPHCI

B. Dividends, Interest, Rents, Royalties and Annuities

1. Dividends

2. Interest

3. Rents

4. Royalties

5. Annuities

C. Gains from Certain Property Transactions

D. Gains from Commodities Transactions

E. Foreign Currency Gains

F. Income Equivalent to Interest

G. Income from Notional Principal Contracts

H. Income from Stock Lending Transactions

I. Contracts to Furnish Personal Services

J. Special Exceptions

1. Exception for Active Banking, Financing or Securities Income

2. Exception for Active Insurance Income

3. Exceptions for Dealers

VII. Foreign Base Company Sales Income

A. General

1. Overview

2. Legislative Background

a. The Revenue Act of 1962

b. Post-1962 Amendments

3. Basic Rules

4. Partnership Income

B. Purchase and/or Sale of Personal Property

1. General

2. Personal Property

3. Purchase and/or Sales Transactions

4. Commission and Fee Income

a. General

b. Distinguished from Services Income

5. Distinguished from Other Types of Income

C. Purchase and/or Sale Involving Related Person

1. General

2. Definition of Related Person

3. Purchases and Sales Involving Only Unrelated Persons

4. Planning Structures

a. Related Person Services

b. Contract Manufacturing

c. Commissionaire Structure

d. Sales to Disregarded Entities

D. Connection with CFC's Country

1. General

2. Property Manufactured in CFC's Country of Organization

a. General

b. Manufactured or Produced

c. CFC's Country of Organization

(1) General

(2) Dual Resident

3. Property Sold for Use Within the CFC's Country of Organization

a. General

b. Country of Use, Consumption or Disposition

(1) General

(2) Sales to Unrelated Persons

(3) Sales to Related Persons

(4) Sales to Retailers

(5) Fungible Goods

c. CFC's Country of Organization

E. Property Manufactured or Produced by the CFC

1. General

2. Definition of Manufacture

3. Substantial Transformation

4. Substantial Manufacturing Operations

a. General

b. Regulations

c. Cases

5. Safe-Harbor Test

6. Packaging, Labeling and Minor Assembly

7. Contract Manufacturing

a. Attribution of Manufacturing Activities

b. Branch Rule

c. Change in IRS Position

d. Substantial Contribution Test

F. Apportionment of Income Derived from Sale of Purchased Components Used in Property not Manufactured

G. Exceptions

1. Property Sold to Unrelated Person After Substantial Use

2. Property Sold as Part of Discontinuing the CFC's Trade or Business

3. Agricultural Commodities

a. General Rule

b. Definition of Agricultural Commodities

c. Agricultural Commodities Included Within Exception

d. Agricultural Commodities Excluded From Exception

(1) General

(2) Specific Commodities Excluded

(3) 50 Percent of Value Attributable to Manufacturing or Processing

H. Foreign Branch of CFC Treated as Separate Corporation

1. General

a. Basic Rule

b. Legislative Background

c. Overview

2. Definition of Branch

a. General

b. Contract Manufacturer Not a Branch

3. Purchasing, Selling or Manufacturing Activities

4. “Substantially the Same Tax Effect” Test

a. General

b. Comparison of Effective Tax Rates

(1) Purchase or Sales Branch

(2) Manufacturing Branch

c. Income Allocated to the CFC Branch or CFC Remainder

(1) Amounts of Income

(2) Foreign Base Company Sales Income Limitation

d. Tax on Income

e. Hypothetical Tax

(1) Purchase or Sales Branch

(2) Manufacturing Branch

f. Multiple Branches

5. Determination of Foreign Base Company Sales Income

a. General

b. Purchase or Sales Branch

c. Manufacturing Branch

d. Multiple Branches

e. Coordination Rules

(1) Application of Exceptions

(2) Items Not Included Twice

(3) Priority of 954(d)(1)

6. Scope of Branch Rule

a. General

b. Application of De Minimis and Full Inclusion Rules

I. Special Rule for Certain Timber Products

J. Coordination with Other Foreign Base Company Income Rules

1. General

2. Foreign Personal Holding Company Rules

a. Priority Rule

b. Single Transaction

3. Foreign Base Company Services Income

a. General

b. Predominant Characteristic

c. Commissions and Fees

d. Tested Once

4. Foreign Base Company Shipping Income

5. Foreign Base Company Oil Related Income Exception

VIII. Foreign Base Company Services Income

A. General

1. Overview

2. Legislative Background

a. 1962 Tax Act

b. Post-1962 Amendments

(1) Insurance Income

(2) Active Finance, Insurance and Dealer Income

3. Basic Rules

4. Partnership Income

B. Definition of Services Income

1. General

2. Types of Services

3. Service Income Distinguished from Other Types of Income

a. Substance of Transaction

b. Purchase and Sales Commissions

c. Coordination Rules

4. Form of Remuneration

C. Services Performed for, or on Behalf of, a Related Person

1. General

2. Related Person Requirement

3. “For, or on behalf of”

a. General

(1) Code

(2) Current Regulations

(3) Prior Regulations

b. CFC Paid by Related Person for Performing Services

c. Related Person Obligated to Perform Services

(1) General Rule

(2) Exception for Related Person Guaranty of Performance

d. Services Are a Condition or Material Term of a Related Person Property Sale

e. Substantial Assistance Furnished by Related Person

(1) General Rule

(2) Prior Regulations

(3) Assistance

(a) General

(b) Direction, Supervision, Services and Know-How

(c) Financial Assistance, Equipment, Material, or Supplies

(4) Substantial Assistance

(a) General

(b) Direction, Supervision, Services or Know-How

(c) Financial Assistance, Equipment, Materials and Supplies

(d) Aggregation of Assistance

(5) Use of Personnel of Related Person

D. Services Performed Outside the CFC's Country of Organization

1. General

2. Country of Organization

3. Physical Location Rule

4. Apportionment of Services Income

E. Exceptions from Foreign Base Company Services Income

1. General

2. Pre-Sale Services

3. Offers to Sell

4. Securities Dealers

5. Active Finance Income

6. Active Insurance Income

F. Coordination with Other Foreign Base Company Income Rules

1. General

2. Foreign Personal Holding Company Rules

a. Priority Rule

b. Single Transaction

3. Foreign Base Company Sales Income

a. General

b. Predominant Characteristic

c. Commissions and Fees

d. Tested Once

4. Foreign Base Company Shipping Income

5. Foreign Base Company Oil Related Income

G. Planning Structures

1. Hybrid Entities

2. Services vs. Sales

3. Provision of Services to Related Persons

IX. Foreign Base Company Shipping Income

A. General

1. Overview

2. Legislative History

3. Basic Rules

B. Vessel or Aircraft

C. Foreign Commerce

1. General Definition

2. Services to Vessels Used in Foreign Commerce

D. Categories of Foreign Base Company Shipping Income

1. Overview

2. Aircraft or Vessel Used in Foreign Commerce

3. Directly Related Services

a. General

b. Related Persons

c. Intragroup Services

d. Services for Passengers, Consignors or Consignees

e. 70-Percent Test

4. Incidental Income

5. Sale of an Aircraft or Vessel

6. Dividends, Interest, and Gains

a. General

b. Types of Corporations

c. Dividends

d. Interest and Gains

7. Income from Partnerships and Trusts

8. Foreign Exchange Gain or Loss

E. Same Country Exception

F. Space or Ocean Activity

1. General

2. Types of Income Covered

3. Exceptions

a. General

b. Transportation Income

c. International Communications Income

d. Activity with Respect to Mines, Oil and Gas Wells

G. Losses Allocable to Foreign Base Company Shipping Income

H. Coordination with Other Foreign Base Company Income Categories

1. Overview

2. Foreign Personal Holding Company Income

3. Foreign Base Company Sales Income

4. Foreign Base Company Services Income

5. Foreign Base Company Oil Related Income

X. Foreign Base Company Oil Related Income

A. General

1. Overview

2. Legislative History

3. Basic Rules

B. Definition of Foreign Base Company Oil Related Income

1. General

2. Minerals: Oil or Gas

3. Processing Income

4. Transportation Income

5. Distribution or Sales Income

6. Gain from Disposition of Assets

7. Directly Related Services Income

8. Dividends, Interest, Partnership Income

a. General

b. FPHCI Priority

C. Same Country Exceptions

1. General

2. Same Country of Use

3. Same Country of Extraction

4. Source Rules

D. Small Oil Producer Exception

E. Coordination with Foreign Base Company Income Categories

1. General

2. Foreign Personal Holding Company Income

3. Foreign Base Company Sales and Services Income

4. Foreign Base Company Shipping Income

XI. FBCI Special Rules and Exceptions

A. General

B. De Minimis Rule

1. General

2. Five Percent/$1 Million Threshold

a. General

b. Gross Income

c. Currency Translation

3. Separate Application to a Branch

4. Exclusion Inapplicable

a. General

b. Factoring Income

c. Portfolio Interest

5. Anti-Abuse Rule

a. General

b. Principal Purpose Test

c. Rebuttable Presumption

(1) Related Person CFCs

(2) Circumstances Creating Presumption

(a) Same Assets or Activities

(b) CFCs as Partners in a Partnership

(c) Activities Constitute Single Branch

(d) Rebutting Presumption

6. Coordination with 952(c)

C. Full Inclusion Rule

1. General

2. Character of Full Inclusion FBCI

3. Exclusion: U.S.-Source Effectively Connected Income

4. Separate Application to a Branch

5. Anti-Abuse Rule

6. Coordination with High-Tax Exception

7. Coordination with 952(c)

D. High-Tax Exception

1. General

a. Overview

b. Legislative Background

2. Computational Rules

a. General Rule

b. Item-by-Item

c. De Minimis/Full Inclusion Rules

(1) General

(2) Exclusion for Full Inclusion Income

d. Net Income

e. Income First Reduced by 952(c) Limitation

3. Definition of “Item of Income”

a. General

b. Passive FPHCI

(1) General Definition

(2) Item Classification Rules

(3) FPHCI Categories

(4) Section 904 Passive Groups

(a) General Rules

(b) Income from Other Sources

(c) Separate QBUs

(d) Special Classification Rules

c. Income Other Than Passive FPHCI

4. Taxes Paid or Accrued With Respect to an Item of Income

a. General Rules

b. Section 960

(1) General

(2) Separate Categories

(3) Allocation of Taxes

(4) No Direct Tracing Rule

c. Passive FPHCI

d. Taxes Taken into Account

(1) Actually Paid or Accrued

(2) Taxes Paid to Several Countries

(3) Taxes Deemed-Paid by CFC

(4) Subsequent Reduction of Taxes

(5) No 904 Limitation

e. Individual Shareholders

5. Effective Foreign Tax Rate

6. 90 Percent of U.S. Corporate Tax Rate

7. Making the Election

a. Procedures

b. Consistency Rules

8. Exception Inapplicable

a. Portfolio Interest

b. Foreign Base Company Oil Related Income

c. Section 952(c) Recapture

E. Coordination with Earnings and Profits Limitations

1. E& P Limitations

a. General Rules

b. Recapture

c. Separate Category Loss Disallowance

(1) General Rule

(2) E& P Limitation

(3) Recapture

2. De Minimis Rule

a. General Rule

b. E& P Limitation

c. Recapture

3. Full Inclusion Rule

a. General Rule

b. E& P Limitation

c. Recapture

4. High-Tax Exception

a. General Rule

b. E& P Limitation

c. Recapture

XII. CFC Owned Partnerships

A. General

B. Background

1. Developments Leading to Partnership Regulations

a. Rev. Rul. 89-72

b. The Brown Group Case

c. Notice 96-39

2. Overview of Partnership Regulations

a. Section 702 Regulations

(1) Character of Partnership Gross Income

(2) Partners Separately Take into Account Subpart F Items

b. Subpart F Regulations

(1) General Aggregate Rule

(2) FBCI Entity Rules

(3) Partnership Investments in U.S. Property

c. Partnership Matters Unaddressed

(1) CFC's Transactions with Partnership

(2) Partnership Deductions

C. FBCI 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. Foreign Base Company Sales Income

1. General Rules

2. General Aggregate Approach

3. Manufacturing Exception

a. General Rules

b. Application to Partnership Income

(1) General Rule

(2) Contract Manufacturing

4. Branch Rule

a. General Rule

b. Partnership Regulations

c. Possible Applications of Branch Rule

5. CFC Partner/Partnership Transactions

a. General

b. Distributive Share

(1) Purchase/Sales Transactions

(a) General Rules - 954(d)(1)

(b) Sales Branch Rule - 954(d)(2)

(2) Manufactured Property

(a) Property Manufactured by CFC Partner

(b) Property Manufactured by Partnership

c. CFC Partner's Income

(1) General Rules

(2) Purchase/Sales Transactions

(a) Sale of Products to a Partnership

(b) Purchase of Products from Partnership

(c) Branch Rule

(3) Manufactured Property

(a) Property Manufactured by CFC

(b) Property Manufactured by Partnership

(c) Branch Rule

E. Foreign Base Company Services Income

1. General Rules

2. Distributive Share of Services Income

a. General Aggregate Rule

b. Substantial Assistance

(1) General Rules

(2) Special Entity Rule

F. Foreign Base Company Shipping Income

1. General Rules

2. Distributive Share of Shipping Income

G. Foreign Base Company Oil Related Income

1. General Rules

2. Distributive Share of FORI

H. Special FBCI Rules and Exception

1. General

2. General Aggregate Approach

a. FBCI Special Rules

b. High-Tax Exception

3. De Minimis Anti-Abuse Rule: Entity Approach


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 P.L. 94-12, H.R. Conf. Rep. No. 120, 94th Cong., 1st Sess. (1975) (Excerpts)

Worksheet 2 General Explanation of the Tax Reform Act of 1976 (H.R. 10612, 94th Cong., P.L. 94-455) prepared by the Staff of the Joint Committee on Taxation, December 29, 1976 ( 1021, 1024)

Worksheet 3 Tax Equity and Fiscal Responsibility Act of 1982, Report of the Committee on Finance, United States Senate, on H.R. 4961, 97th Cong., 2d Sess., Rept. 97-494, Vol. 1, July 12, 1982 ( 217)

Worksheet 4 Tax Equity and Fiscal Responsibility Act of 1982, Conference Report, 97th Cong., 2d Sess., Report No. 97-760, August 17, 1982

Worksheet 5 General Explanation of the Revenue Provisions of the Deficit Reduction Act of 1984 (H.R. 4170, 98th Cong.; P.L. 98-369) prepared by the Staff of the Joint Committee on Taxation, December 31, 1984 ( 121, 123)

Worksheet 6 H.R. Rep. No. 111, 103d Cong., 1st Sess. (1993) ( 14231-14233)

Worksheet 7 H.R. (Conf.) Rep. No. 213, 103d Cong., 1st Sess. (1993)

Worksheet 8 Prop. Regs. 1.954-1 through -5, 27 Fed. Reg. 12,759 (12/27/62)

Worksheet 9 Regs. 1.954-1 through -5, T.D. 6734, 1964-1 C.B. (Part 1) 237

Worksheet 10 Prop. Regs. 1.954-4, 32 Fed. Reg. 3,155 (2/27/67)

Worksheet 11 Regs. 1.954-4, T.D. 6981, 1968-2 C.B. 314

Worksheet 12 Technical Memorandum attached to T.D. 6981, 1968 TM Lexis 11 (11/5/68)

Worksheet 13 Technical Memorandum accompanying T.D. 7503, 1976 TM Lexis 77 (4/12/76)

Worksheet 14 Preamble to T.D. 7894, 1983-1 C.B. 149

Worksheet 15 REG-104537-97, 1998-16 I.R.B. 21 (4/20/98)

Worksheet 16 REG-112502-00, 65 Fed. Reg. 56,836 (9/20/00)

Worksheet 17 T.D. 9008, 67 Fed. Reg. 48,020 (7/23/02)

Worksheet 18 Election for High-Tax Exception

Bibliography

OFFICIAL

Statutes:

Treasury Regulations:

Public Laws:

Legislative History:

Joint Committee on Taxation Reports:

Treasury Rulings and Procedures:

Miscellaneous

Cases:

UNOFFICIAL

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1976 - 1981

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