Attribution rules applicable to commercial activities or controlled commercial entities of a foreign government for sec. 163(j) purposes.

• Author: Sams, Jim

Until recently, a foreign person subject to tax in the United States was required to consider the U.S. related party rules only in a fairly narrow set of circumstances, for example, for purposes of the deduction deferral rules of Sec. 267(a)(2), the reporting requirements of Sec. 6038A and the regulations thereunder, and the transfer pricing provisions of Sec. 482. Since 1986, however, several provisions have been added to the Code and regulations that significantly increase the complexity of - and administrative burden of complying with - the U.S. income tax laws by expanding the circumstances under which application of ownership attribution rules is required; notably, under the foreign tax credit rules of Sec. 904(i) and the earnings stripping rules of Sec. 163(j). In the case of foreign governments particularly, these new requirements involve issues that historically have not been considered and on which there is little substantive guidance. This discussion focuses on the attribution requirements imposed by the proposed regulations under Sec. 163(j).

Sec. 163(j) defers a deduction for interest paid to a related person on which no U.S. tax is imposed, subject to certain thresholds and limitations. Pursuant to Sec. 163(j)(6)(C), the computation of these thresholds and limitations must be made as if all members of the same affiliated group (within the meaning of Sec. 1504(a)) were a single taxpayer. Prop. Regs. Sec. 1.163(j)-5(a)(3) goes further, providing that an includible corporation (as defined in Sec. 1504(b)) that owns directly or indirectly at least 80% of another includible corporation is treated as a member of the same affiliated group; for purposes of these rules, the provisions of Sec. 318 are applied to determine indirect ownership. The example illustrating this requirement makes clear that a domestic subsidiary of a foreign corporation is a member of the same affiliated group as its domestic sister corporation that is a subsidiary of the common foreign parent, even though these corporations would not be affiliated within the meaning of Sec. 1504(a) because their common ownership is through a nonincludible corporation.

Assume a foreign government, rather than a foreign corporation, owns two domestic corporations, A and B. Sec. 318(a)(3)(C) provides that if 50% of the value of the stock of a corporation is owned, directly or indirectly, by any "person," the corporation will be treated as owning the stock owned by such person...