Final regulations: Substantial business activities in a foreign country

Final regulations

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).


Related content

With today’s final regulations [PDF 261 KB], temporary regulations issued in 2012 are adopted as final, with certain modifications.

Section 7874

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:

  • The foreign corporation completes after March 4, 2003, a direct or indirect acquisition of substantially all of the properties held directly or indirectly by a domestic corporation.
  • After the acquisition, at least 60% of the stock (by vote or value) of the foreign corporation is held by former shareholders of the domestic corporation by reason of holding stock in the domestic corporation.
  • After the acquisition, the “expanded affiliated group” (EAG) that includes the foreign corporation does not have substantial business activities in the foreign country in which, or under the law of which, the foreign corporation is created or organized when compared to the total business activities of the expanded affiliated group.

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assets, and sales of the expanded affiliated group were in the relevant foreign country.The 2006 regulations were withdrawn and replaced with new temporary and proposed regulations in 2009.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:

  • An EAG will have substantial business activities in the relevant foreign country only if at least 25% of the group employees (by both number and compensation), group assets, and group income are located or derived in the relevant foreign country.
  • The items of a partnership must be taken into account for purposes of the substantial activities test only if one or more members of the EAG holds, in the aggregate, more than 50% (by value) of the interests in the partnership. If this ownership requirement is satisfied, then all the items of the partnership are to be taken into account for this purpose.

Final regulations

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.

  • With respect to an entity that is disposed of before the acquisition, the final regulations clarify that an entity that is not a member of the EAG on the acquisition date is not a member of the EAG, even if the entity would have qualified as a member of the EAG at some earlier point during the testing period.
  • The disposition of all assets of an entity may (or may not) cause it to cease to be a member of the EAG depending on whether the entity remains in existence on the acquisition date.
  • Consistent with the requirement under section 7874(a)(2)(B) to take into account all events that occur pursuant to a plan or a series of related transactions, for purposes of determining whether an entity is a surrogate foreign corporation, the regulations clarify that members of the EAG are determined taking into account all transactions related to the acquisition, even if they occur after the acquisition date. In other words, all transactions related to an acquisition must be taken into account for purposes of determining members of an EAG, a U.S.-parented group, and a foreign-parented group.
  • The final regulations provide that in determining corporations that are members of the EAG, each partner in a partnership is treated as holding its proportionate share of the stock held by the partnership—a look-through rule.
  • The final regulations coordinate application of the “deemed corporation rule”—i.e., a partnership is treated as a corporation that is a member of an EAG if more than 50% (by value) of its interests is owned by one or more members of the EAG—with the look-through rule by providing that the look-through rule applies first, and without regard to the deemed corporation rule. After all corporate entities are identified, the deemed corporation rule is applied to treat certain partnerships that have corporate entities as partners as corporations that are members of the EAG.
  • The final regulations revise the anti-abuse rule that disregards certain group assets, group employees, or group income for purposes of the substantial business activities determination by providing that any group assets, group employees, or group income attributable to business activities that are associated with property transferred to the EAG in a transaction that is part of a plan with a principal purpose of avoiding the purpose under section 7874 are not taken into account in the numerator or denominator of each of the substantial business activities tests.

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.

© 2017 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

The KPMG logo and name are trademarks of KPMG International. KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever. The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at: + 1 202 533 4366, 1801 K Street NW, Washington, DC 20006.

Connect with us


Request for proposal



KPMG's new digital platform

KPMG International has created a state of the art digital platform that enhances your experience, optimized to discover new and related content.