CFC's software leasing income determined to be foreign personal holding company income.

• Author: Chang, Anne
• Position: Controlled foreign corporation

On July 5, 2013, the IRS Office of Chief Counsel released Field Attorney Advice 20132702F, which addresses whether rental income from software leasing to third parties outside the country of a controlled foreign corporation (CFC) is foreign personal holding company income. In this memorandum, the IRS determined the leased software was a copyrighted article (as opposed to a copyright right) under Regs. Sec. 1.861-18, and the CFC did not satisfy the active-leasing exception. Therefore, the rental income was foreign personal holding company income under Sec. 954.

Facts

A U.S. software developer and a CFC entered into a cost-sharing agreement with respect to the developed software. Under the agreement, tie CFC received a limited, nonexclusive, nontransferable license to transfer the software to third-party customers outside the country where the CFC was organized. The developer retained title and ownership of the software. In consideration, the CFC paid the developer an agreed-upon percentage of profits as a "royalty." Upon termination of the agreement, the CFC was obligated to return to the developer all copies of and information pertaining to the software and delete any remaining software or information from the CFC's computer memory. However, the termination of the agreement would not affect any leases between the CFC and its customers in effect on the date of the termination.

Under the agreement, third-party customers or licensees received a perpetual, nonexclusive, transferable (but only among the licensees' affiliates) license to use, copy, load, execute, and store the soft-ware on their computers. Customers paid a one-time licensing fee, as well as annual fees for maintenance and other support services. After a year, customers could terminate the agreement by providing a written statement certifying that they no longer used the software. However, customers could elect to use the software again by either purchasing a new license or by paying all retroactive maintenance and support fees that would have been due between the time of termination and reinstatement.

The CFC had three employees with backgrounds in accounting, financing, or technology. Their job descriptions consisted mainly of administrative and bookkeeping duties. None of the employees were compensated for successful marketing. The CFC had seven customers during the years at issue. Two of them were taken from an affiliate.

Foreign Personal Holding Company Income

Under Sec...