CFC's treatment of partnership income.

• Author: Parmegiani, Leo
• Position: Controlled foreign corporations

In the midst of the media and political circus surrounding corporate expatriation to tax havens like Bermuda via so-called "inversion transactions," Treasury, on July 22, 2002, issued final regulations (TD 9008) intended to clarify the tax treatment of a controlled foreign corporation's (CFC's) distributive share of partnership income under subpart F. The timing seems ironic, because the subpart F income rules and the increasingly complex foreign tax credit system appear to be the most significant reasons that corporate America desires to move.

The final rules extend further the IRS's grip on the worldwide income of U.S. multinationals and also fuel claims that the U.S. tax system is anti-competitive. The proposed regulations published on Sept. 20, 2000 aimed to close an income-deferral loophole left by the Eighth Circuit's decision in Brown Group Inc., 77 F3d 217 (8th Cir. 1996). Treasury, in its nonacquiescence of that decision, was concerned that taxpayers could circumvent the subpart F regime (which was created to defeat income deferral, by doing indirectly through a partnership what could not be done directly via a CFC). Although the final regulations adopt the proposed regulations' concepts, they may have gone too far; income from even a nominal foreign partnership interest can result in current taxation.

Subpart F

Subpart F aims to prevent U.S. taxpayers from deferring recognition of certain categories of income from foreign subsidiaries incorporated outside the U.S. for the apparent sole purpose of reducing their U.S. tax liability.

Under Sec. 951(a), a U.S. shareholder of a CFC must include in gross income his or her pro-rata share of the CFC'S subpart F income. Sec. 957 defines a CFC as any foreign corporation in which more than 50% (by vote or value) of its total stock is owned by U.S. shareholders. According to Sec. 951(b), a U.S. shareholder is a U.S. person who owns (directly or indirectly) at least 10% of the total combined voting power of all CFC stock classes entitled to vote.

One category of subpart F income is foreign-base-company (FBC) in-come, which is subdivided into five categories, two of which are discussed in this item--FBC sales income and FBC services income. The former is generated from specific purchases and sales of personal property between a CFC and a related person located outside the CFC's country of incorporation. According to Sec. 954(d)(1), the specific transactions include a (1) purchase of personal...