The Treasury Department and IRS today released for publication in the Federal Register final regulations (T.D. 9720) concerning when a foreign corporation has substantial business activities in a foreign country for purposes of whether the foreign corporation is treated as a “surrogate foreign corporation” under section 7874(a)(2)(B).
With today’s final regulations [PDF 261 KB], temporary regulations issued in 2012 are adopted as final, with certain modifications.
A foreign corporation is generally treated as a surrogate foreign corporation under section 7874 if pursuant to a plan (or a series of related transactions), three conditions are satisfied:
Similar provisions apply to transactions involving the acquisition by a foreign corporation of substantially all of the properties constituting a trade or business of a domestic partnership.
Temporary and proposed regulations were issued in June 2006 and provided that the determination of whether the “expanded affiliated group” (EAG) has substantial business activities in the relevant foreign country is based on all the facts and circumstances.
The 2006 temporary regulations also provided a safe harbor, which generally was satisfied if at least 10% of the employees, assets, and sales of the expanded affiliated group were in the relevant foreign country.The 2006 regulations were withdrawn and replaced with new temporary and proposed regulations in 2009. The 2009 temporary regulations retained the facts and circumstances general rule provided in the 2006 temporary regulations, with certain modifications, but removed the safe harbor.
After consideration of the comments and the underlying policies of section 7874, the IRS and Treasury Department determined that the facts-and-circumstances test of the 2009 temporary regulations needed to be replaced with a “bright-line rule” describing the threshold of activities required for an EAG to have substantial business activities in the relevant foreign country. Hence, new temporary regulations were issued in 2012.
The 2012 temporary regulations provided that:
The preamble to today’s final regulations explains that, because the bright-line rule is consistent with section 7874 and its underlying policies, and is “more administrable” than a facts-and-circumstances test, the final regulations retain the bright-line rule, with the following modifications made in response to comments.
The final regulations also reflect changes made in response to comments concerning the specific tests used to determine whether the EAG has substantial business activities in the relevant foreign country. These changes include rules regarding how to determine: (1) whether individuals are group employees; (2) when group employee compensation is incurred; (3) the location of mobile assets; and (4) group income.
The final regulations will appear in the Federal Register on Thursday, June 4, 2015.
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