New subpart F lookthrough rules.

• Author: Landreneau, Frank

A single provision that will have a powerful effect on U.S. multinationals involves the new subpart F lookthrough rules. On May 17, 2006, Congress passed the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). One of the TIPRA's provisions allows related parties of certain controlled foreign corporations (CFCs) to transfer international earnings without triggering subpart F income. In general, this new provision provides an exception from the subpart F rules for dividends, interest, rents and royalties received from related CFCs, if the income that gives rise to the repatriated earnings does not originate from subpart F income when earned by the CFC.

Overview

In general, under subpart F, U.S. persons who are 10% shareholders ("U.S. shareholders") of a CFC are required to recognize their pro-rata share of subpart F income under Sec. 951 (a) (1). Such income includes foreign personal holding company income (FPHCI), generally consisting of dividends, interest, rents and royalties. Sec. 957(a) provides that a foreign corporation is a CFC if it is owned more than 50% by U.S. shareholders. If a CFC generates subpart F income, typically its U.S. shareholders must include a "deemed dividend" in income in the year the CFC earns the subpart F income (rather than when the CFC distributes the income).

An exception to subpart F income inclusion occurs (and, thus, a U.S. shareholder need not recognize the income) if the CFC's dividends or interest arise from a related corporation organized and operating in the same foreign country in which the CFC is organized. The "same country exception," included in Sec. 954(c)(3), also applies to a CFC's receipt of rent and royalties from a related corporation for the use of property within the country in which the CFC is organized. This exception does not apply if the payer's subpart F income is reduced by the interest, rent or royalty payments.

New Sec. 954(c)(6), enacted by TIPRA Section 103(b), treats dividends, interest, rent and royalties received or accrued from a related CFC to be outside the definition of FPHCI, to the extent attributable or properly allocable to the related person's income that is not subpart F income. This expansion of the law is meant to level the playing field for U.S. multinationals, as most foreign countries allow multinational companies to reinvest their active foreign earnings without an additional tax burden. The law will now provide U.S. multinational companies the same...