Guidance Under Subpart F Relating to Partnerships, 2462-2464 [06-355]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 71, Number 10 (Tuesday, January 17, 2006)]
[Rules and Regulations]
[Pages 2462-2464]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: 06-355]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9240]
RIN 1545-BF15


Guidance Under Subpart F Relating to Partnerships

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final and temporary regulations.

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SUMMARY: This document contains final and temporary regulations 
providing guidance under subpart F relating to partnerships. The 
temporary regulations add rules for determining whether a controlled 
foreign corporation's (CFC's) distributive share of partnership income 
is excluded from foreign personal holding company income under the 
exception contained in section 954(i). These temporary regulations will 
affect CFCs that are qualified insurance companies, as defined in 
section 953(e)(3), that have an interest in a partnership and U.S. 
shareholders of such CFCs. The text of these temporary regulations also 
serves as the text of the proposed regulations set forth in the 
Proposed Rules section in this issue of the Federal Register.

DATES: Effective Date: These regulations are effective January 17, 
2006.
    Applicability Date: For dates of applicability, see Sec.  1.954-
2T(a)(5)(v).

FOR FURTHER INFORMATION CONTACT: Concerning the regulations, Kate Y. 
Hwa, (202) 622-3840 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to 26 CFR part 1 relating to the 
rules under section 954(i) of the Internal Revenue Code (Code) for 
determining whether a controlled foreign corporation's (CFC's) 
distributive share of partnership income is excluded from foreign 
personal holding company income under the exception contained in 
section 954(i).

Need for Changes

    On July 23, 2002, the IRS and the Treasury Department published in 
the Federal Register (TD 9008, 67 FR 48020) final regulations under 
section 702 and subpart F. Since the publication of TD 9008, the IRS 
and the Treasury Department have received several comments relating to 
the rule in the final regulations regarding the application of section 
954(i) (special rule for income derived in the active conduct of an 
insurance business). These temporary regulations modify this rule in 
response to these comments.

Explanation of Revisions

    Section 1.954-2(a)(5)(ii) sets forth special rules for determining 
the extent to which a CFC's distributive share of an item of income of 
a partnership is foreign personal holding company income. Section 
1.954-2(a)(5)(ii)(C) addresses the exception contained in section 
954(i) for income derived in the active conduct of an insurance 
business. Investment income that is excluded from insurance income as 
exempt insurance income under section 953(e) may nevertheless be 
treated as subpart F income if it falls within the definition of 
foreign personal holding company income under section 954(c) and the 
exception contained in section 954(i) is

[[Page 2463]]

not satisfied. Section 1.954-2(a)(5)(ii)(C) provides that a CFC's 
distributive share of partnership income is excluded from foreign 
personal holding company income under the exception contained in 
section 954(i) only if the CFC is a qualifying insurance company, 
generally as defined in section 953(e)(3), and the partnership, of 
which the CFC is a partner, generates qualified insurance income within 
the meaning of section 954(i)(2), taking into account only the income 
of the partnership. Qualified insurance income is defined under section 
954(i)(2) as income of a qualifying insurance company that is derived 
from investment of certain of its reserves or surplus if certain other 
requirements are satisfied.
    Commentators expressed concern that Sec.  1.954-2(a)(5)(ii)(C) 
would never permit a CFC's distributive share of partnership income to 
qualify for the exclusion under section 954(i). Section 7701(a)(3) and 
the regulations provide that any entity that is an insurance company is 
treated as a corporation for Federal tax purposes. See Rev. Rul. 83-132 
(1983-2 C.B. 270). Thus, any entity engaged in an active insurance 
business generally would be treated as a corporation and therefore 
would not be subject to the rule in Sec.  1.954-2(a)(5)(ii)(C).
    Commentators also distinguished section 954(i) from the other 
exceptions to foreign personal holding company income in section 954, 
arguing that those exceptions do not provide the appropriate model for 
section 954(i). The special rules in the regulations regarding the 
exception to foreign personal holding company income contained in 
section 954(c), or the exception for income derived from the active 
conduct of a banking or similar business contained in section 954(h), 
turn on whether the income was generated from certain active business 
activities. In contrast, income that is excluded under section 954(i) 
may be generated from purely passive investments as long as the amount 
of the investments satisfies the requirements set forth in section 
954(i). Commentators asked for clarification of the regulations to take 
into account the purposes of section 954(i).
    In response to these comments, these temporary regulations provide 
that a CFC's distributive share of partnership income will qualify for 
the exception contained in section 954(i) if the CFC is a qualifying 
insurance company and the income of the partnership would have been 
qualified insurance income under section 954(i) if received by the CFC 
directly. Thus, whether the CFC partner's distributive share of 
partnership income is qualified insurance income is determined at the 
CFC partner level.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It has also been 
determined that section 553(b) of the Administrative Procedures Act (5 
U.S.C. chapter 5) does not apply to these regulations and, because the 
regulation does not impose a collection of information on small 
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not 
apply. Pursuant to section 7805(f) of the Code, this temporary 
regulation will be submitted to the Chief Counsel for Advocacy of the 
Small Business Administration for comment on its impact on small 
business.

Drafting Information

    The principal author of these regulations is Kate Y. Hwa of the 
Office of the Associate Chief Counsel (International), IRS. However, 
other personnel from the IRS and the Treasury Department participated 
in their development.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Amendments to the Regulations

0
Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for 26 CFR part 1 continues to 
read, in part, as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.954-2 is amended by revising paragraphs (a)(5)(ii)(C) 
and (a)(5)(iii) Example 2, to read as follows:


Sec.  1.954-2  Foreign personal holding company income.

    (a) * * *
    (5) * * *
    (C) [Reserved]. For further guidance, see Sec.  1.954-
2T(a)(5)(ii)(C).
* * * * *
    (iii) * * *

    Example 2. [Reserved]. For further guidance, see Sec.  1.954-
2T(a)(5)(iii) Example 2.
* * * * *

0
Par. 3. Section 1.954-2T is added as follows:


Sec.  1.954-2T  Foreign personal holding company income (temporary).

    (a)(1) through (5)(ii)(B) [Reserved]. For further guidance, see 
Sec.  1.954-2(a)(1) through (5)(ii)(B).
    (C) A controlled foreign corporation's distributive share of 
partnership income will not be excluded from foreign personal holding 
company income under the exception contained in section 954(i) unless 
the controlled foreign corporation is a qualifying insurance company, 
as defined in section 953(e)(3), and the income of the partnership 
would have been qualified insurance income, as defined in section 
954(i)(2), if received by the controlled foreign corporation directly. 
See Sec.  1.952-1(g)(1).
    (iii) Examples. [Reserved] For further guidance, see Sec.  1.954-
2(a)(5)(iii).

    Example 1. [Reserved] For further guidance, see Sec.  1.954-
2(a)(5)(iii) Example 1.
    Example 2. D Corp, a Country F corporation, is a controlled 
foreign corporation within the meaning of section 957(a). D Corp is 
a qualifying insurance company, within the meaning of section 
953(e)(3), that is engaged in the business of issuing life insurance 
contracts. D Corp has reserves of $100x, all of which are allocable 
to exempt contracts, and $10x of surplus, which is equal to 10 
percent of the reserves allocable to exempt contracts. D Corp 
contributed the $100x of reserves and $10x of surplus to DJ 
Partnership in exchange for a 40-percent partnership interest. DJ 
Partnership is an entity organized under the laws of Country G and 
is treated as a partnership under the laws of Country G and Country 
F. DJ Partnership earns $30x of investment income during the taxable 
year that is received from persons who are not related persons with 
respect to D Corp, within the meaning of section 954(d)(3). D Corp's 
distributive share of this investment income is $12x. This income is 
treated as earned by D Corp in Country F under the tax laws of 
Country F and meets the definition of exempt insurance income in 
section 953(e)(1). This $12x of investment income would be qualified 
insurance income, under section 954(i)(2), if D Corp had received 
the income directly, because the $110x invested by D Corp in DJ 
Partnership is equal to D Corp's reserves allocable to exempt 
contracts under section 954(i)(2)(A) and allowable surplus under 
section 954(i)(2)(B)(ii). Thus, D Corp's distributive share of DJ 
Partnership's income will be excluded from foreign personal holding 
company income under section 954(i).

    (iv) [Reserved].

[[Page 2464]]

    (v) Effective date. [Reserved]. See Sec.  1.954-2(a)(5)(v).

Mark E. Matthews,
Deputy Commissioner for Services and Enforcement.
Eric Solomon,
Acting Deputy Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 06-355 Filed 1-13-06; 8:45 am]
BILLING CODE 4830-01-P