Application of CFC lookthrough rule to payments made by a partnership to its CFC partner.

• Author: Smith, Annette B.
• Position: Controlled foreign corporation

Sec. 952(a)(2) defines subpart F income to include foreign base company income, which includes foreign personal holding company income (FPHCI) under Sec. 954(a)(1). Under Sec. 954(c)(1)(A), FPHCI generally includes dividends, interest, royalties, rents, and annuities, unless an exception applies. Under one exception--the controlled foreign corporation (CFC) lookthrough rule of Sec. 954(c)(6)--dividends, interest, rents, or royalties received from a CFC that is a related person with respect to the recipint CFC are not treated as FPHCI to the extent attributable or properly allocable to income of the payer CFC that is neither subpart F income nor income effectively connected with a trade or business in the United States. The CFC lookthrough rule applies to CFC tax years beginning after December 31, 2005, and before January 1, 2012.

Partnership Applicability

While the CFC lookthrough rule applies to payments received by a CFC from a related CFC, how does the rule apply to payments made by a partnership to its more-than-50% partner that is a CFC? The IRS has not directly answered that question in formal or informal guidance, although it issued guidance on the application of the CFC lookthrough rule to partnerships in general in Notice 2007-9.

Section 4 of Notice 2007-9 contains parallel provisions for interest income and rent or royalty income:

* If interest is received or accrued from a partnership with one or more partners that are CFCs, such interest will be treated as received or accrued from a CFC for purposes of the CFC lookthrough rule of Sec. 954(c)(6) to the extent that such CFC partner would be treated as the payer of the rents or royalties under Regs. Sec. 1.954-2(b) (4)(i)(B).

* If rents or royalties are received or accrued from a partnership with one or more partners that are CFCs, such rents or royalties will be treated as received or accrued from a CFC for purposes of the CFC lookthrough rule of Sec. 954(c)(6) to the extent that the CFC partner would be treated as the payer of the rents or royalties under Regs. Sec. 1.954-2(b)(5)(i)(B).

Under the cited regulations, if a partnership pays interest and rents or royalties, its CFC partner will be treated as the payer of the payment to the extent that the item of deduction is allocable to the corporate partner under Sec. 704(b) if the payment gives rise to a partnership item of deduction. Therefore, if the partnership's deduction arising as a result of the related-party payment is...