Interest paid to a foreign subsidiary of a foreign leasing company involved in commercial lending qualifies as portfolio interest.

• Author: Layden, Michael

The IRS has ruled, in Letter Rulings (TAMs) 9822007 and 9822008, that interest paid to a foreign subsidiary of a foreign leasing company qualified as portfolio interest under Sec. 881 (c) and, therefore, was not subject to withholding tax. The Service argued in each case that the true lender was the leasing company, not the subsidiary, and that the leasing company, which made commercial loans in the ordinary course of its business, was a bank. Thus, the interest paid would not qualify for the portfolio interest exception under Sec. 881(c)(3)(A), because it was received by a bank on an extension of credit made pursuant to a loan entered into in the ordinary course of its trade or business. However, the TAMs concluded that the leasing companies were not "banks" as defined in Sec. 581; therefore, the interest qualified as portfolio interest and was not subject to withholding tax.

The facts in the two rulings are nearly identical. The first transaction, discussed in both ruling requests, involved a loan from a Country Y corporation, which was a subsidiary of a Country X corporation engaged in the leasing business. The Country X leasing corporation was regularly engaged in various financing activities, including commercial lending, equipment and real property leasing, installment financing, and other forms of financing and credit support; neither the Country X leasing corporation nor its Country Y subsidiary received deposits from customers.

The second transaction (discussed only in Letter Ruling (TAM) 9822008) involved a loan from a Country Y corporation, which was the subsidiary of a Country X corporation engaged in leasing. However, the Country X corporation was 70% owned by Corporation E, a commercial bank.

In both rulings, the loans by the taxpayer from the wholly owned Country Y subsidiaries of the leasing companies were registered obligations as defined by Regs. Sec. 5f.103-1. To avoid Country X restrictions on lending to nonresidents, the Country Y subsidiaries were designated as "special purpose vehicles."

Generally, Sec. 881(a) imposes a 30% tax on certain types of income received by a foreign corporation from U.S. sources...