Revisions to Regulations Relating to Repeal of Tax on Interest of Nonresident Alien Individuals and Foreign Corporations Received From Certain Portfolio Debt Investments, 18386-18388 [E7-6766]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 70 (Thursday, April 12, 2007)]
[Rules and Regulations]
[Pages 18386-18388]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-6766]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9323]
RIN 1545-BF64


Revisions to Regulations Relating to Repeal of Tax on Interest of 
Nonresident Alien Individuals and Foreign Corporations Received From 
Certain Portfolio Debt Investments

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations under sections 871 
and 881 of the Internal Revenue Code (Code) relating to the exclusion 
from gross income of portfolio interest paid to a nonresident alien 
individual or foreign corporation. These regulations clarify how the 
portfolio interest rules apply with respect to interest paid to a 
partnership (or simple or grantor trust) that has foreign partners (or 
beneficiaries or owners). These regulations also retroactively remove 
the rule in Treasury Regulation Sec.  1.1441-1(b)(7)(iii) that would 
impose interest under section 6601 when no underlying tax liability is 
due.

DATES: Effective Date: These regulations are effective on April 12, 
2007.
    Applicability Dates: The regulations relating to the application of 
the 10-percent shareholder test for interest paid to partnerships 
applies to interest paid after April 12, 2007. However, taxpayers may 
choose to apply the rules in the final regulations to interest paid 
during any taxable year which is not closed by the period of 
limitations, provided they do so consistently with respect to all 
relevant partnerships during such years. The regulations removing the 
rule imposing interest and penalties on withholding agents when no 
underlying tax has in fact been imposed apply to payments made after 
December 31, 2000.

FOR FURTHER INFORMATION CONTACT: Kathryn Holman of the Office of the 
Associate Chief Counsel (International), (202) 622-3840 (not a toll-
free call).

SUPPLEMENTARY INFORMATION: 

Background

    Section 871(a) of the Code imposes a tax of 30 percent on U.S. 
source fixed or determinable annual or periodic (FDAP) income, 
including interest, received by a nonresident alien individual to the 
extent the amount so received is not effectively connected with the 
conduct of a trade or business within the United States. Section 881(a) 
imposes a similar tax with respect to FDAP income, including interest, 
received by a foreign corporation. Both sections 871(h)(3)(A) and 
881(c)(3)(B) provide, among other limitations, that portfolio interest 
does not include interest received by a 10-percent shareholder, as 
defined in section 871(h)(3)(B).

Explanation of Provisions and Summary of Comments

    The IRS and the Treasury Department issued proposed regulations 
(REG-118775-06) under sections 871(h) and 881(c) in the Federal 
Register (71 FR 34047) on June 13, 2006. The proposed regulations 
address the application of the 10-percent shareholder test when U.S. 
source interest is paid to a partnership that has a nonresident alien 
individual or foreign corporation as a partner. The proposed 
regulations provide that, for interest paid on obligations issued on or 
after the date that final regulations are published, the 10-percent 
shareholder test is to be applied only at the partner level and at the 
time that the withholding agent would otherwise be required to 
withhold.
    No public hearing was requested or held. However, a few comments 
were received. After consideration of the comments, the proposed 
regulations are adopted in these final regulations, with two 
modifications. In addition, these final regulations implement section 5 
of Notice 2006-99 (46 IRB 907) (See Sec.  601.601(d)(2) of this 
chapter), modifying Sec.  1.1441-1(b)(7)(iii), as discussed below.

1. Time for Applying the 10-Percent Shareholder Test

    The proposed regulations provide that the 10-percent shareholder 
test applies at the time the withholding agent would otherwise be 
required to withhold. The regulations then provide an example in which 
the test is stated to apply on the ``earliest'' of when the interest is 
distributed, the date the statement under section 6031(c) is mailed, or 
the due date for furnishing the statement. In order to make clear that 
the test may be applied on multiple dates (and not only on the date of 
a first partial distribution of such interest), the example has been

[[Page 18387]]

rephrased. The example now states that the 10-percent shareholder test 
is applied when any distributions that include the interest are made to 
a foreign partner and, to the extent that a foreign partner's 
distributive share of the interest has not actually been distributed, 
on the earlier of the date that the statement required under section 
6031(c) is mailed or otherwise provided to such partner, or the due 
date for furnishing such statement. This change conforms more closely 
to the language of Sec.  1.1441-5(c)(2).

2. Effective Date of the Regulation

    The new provisions set forth in the proposed regulations were 
proposed to apply to interest paid on obligations issued after the date 
that final regulations are published. One commentator stated that, in 
order to provide for consistency and to eliminate uncertainty and avoid 
possible disputes with respect to interest paid to partnerships prior 
to the date that the final regulations are published, the final 
regulations should apply to interest paid after July 18, 1984, with 
respect to obligations issued after July 18, 1984, the effective date 
of the portfolio interest provisions. Another commentator stated that 
the final regulations should apply to interest paid after the date the 
final regulations are issued.
    The IRS and the Treasury Department agree that taxpayers should be 
able to apply the regulations to interest paid in certain prior taxable 
years. Accordingly, while the final regulations generally provide that 
the provisions relating to the 10-percent shareholder test for interest 
paid to partnerships are to apply to interest paid after the date the 
regulations are published as final regulations, the regulations also 
permit taxpayers to choose to apply the provisions to interest paid in 
any taxable year that is not closed by the period of limitations, 
provided that the taxpayer consistently applies the provisions to all 
relevant partnerships during such years.

3. Interest Imposed When No Tax Due

    Treasury Regulation Sec.  1.1441-1(b)(7)(iii) provides that a 
withholding agent that has failed to withhold tax other than based on 
reliance on the appropriate presumptions is not relieved from liability 
for interest under section 6601. It further provides that such 
liability exists even when there is no underlying tax that is 
ultimately shown to be due. That is, the regulation imposes an interest 
charge under section 6601 on a withholding agent for an amount of tax 
that has not in fact been imposed. Treasury Regulation Sec.  1.1441-
1(b)(7)(v) sets forth two examples that illustrate the operation of 
this rule.
    In Notice 2006-99 (2006-46 IRB 907), the IRS and the Treasury 
Department announced their intention to remove the rule in Treasury 
Regulation Sec.  1.1441-1(b)(7)(iii), and the accompanying examples 
illustrating the rule in Treasury Regulation Sec.  1.1441-1(b)(7)(v), 
that impose interest under section 6601 when no underlying tax 
liability is imposed. Further, the Notice announced that the IRS and 
the Treasury Department intend to clarify that, like interest, 
penalties that are computed based on underpayments of tax will not be 
imposed when no tax has in fact been imposed.
    These final regulations retroactively remove, in accordance with 
Notice 2006-99, the rule in Sec.  1.1441-1(b)(7)(iii) that would impose 
interest and penalties based on hypothetical underpayments of tax when 
in fact no tax has been imposed. The examples illustrating this rule in 
Treasury Regulation Sec.  1.1441-1(b)(7) are also removed.

Special Analyses

    It has been determined that these regulations are 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 Procedure Act (5 U.S.C. chapter 5) 
does not apply to these regulations, and because the regulations do 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, the proposed rulemaking preceding these 
regulations was 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 the proposed regulations is Kathryn Holman, 
Office of Associate Chief Counsel (International). 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.

Adoption of 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 part 1 continues to read in 
part as follows:

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


0
Par. 2. Section 1.871-14 is amended as follows:
0
1. Paragraphs (g) and (h) are redesignated as paragraphs (h) and (i), 
respectively.
0
2. New paragraph (g) is added.
0
3. Newly-designated paragraph (i)(1) is amended by adding two sentences 
at the end of the paragraph.
    The additions read as follows:


Sec.  1.871-14  Rules relating to repeal of tax on interest of 
nonresident alien individuals and foreign corporations received from 
certain portfolio debt investments.

* * * * *
    (g) Portfolio interest not to include interest received by 10-
percent shareholders--(1) In general. For purposes of section 871(h), 
the term portfolio interest shall not include any interest received by 
a 10-percent shareholder.
    (2) Ten-percent shareholder--(i) In general. The term 10-percent 
shareholder means--
    (A) In the case of an obligation issued by a corporation, any 
person who owns 10-percent or more of the total combined voting power 
of all classes of stock of such corporation entitled to vote; or
    (B) In the case of an obligation issued by a partnership, any 
person who owns 10-percent or more of the capital or profits interest 
in such partnership.
    (ii) Ownership--(A) Stock ownership. For purposes of paragraph 
(g)(2)(i)(A) of this section, stock owned means stock directly or 
indirectly owned and stock owned by reason of the attribution rules of 
section 318(a), as modified by section 871(h)(3)(C).
    (B) Ownership of partnership interest. For purposes of paragraph 
(g)(2)(i)(B) of this section, rules similar to the rules in paragraph 
(g)(2)(ii)(A) of this section shall be applied in determining the 
ownership of a capital or profits interest in a partnership.
    (3) Application of 10-percent shareholder test to partners 
receiving interest through a partnership--(i) Partner level test. 
Whether interest paid to a partnership and included in the distributive 
share of a partner that is a nonresident alien individual or foreign 
corporation is received by a 10 percent shareholder shall be determined 
by applying the rules of this paragraph (g) only at the partner level.
    (ii) Time at which 10-percent shareholder test is applied. The

[[Page 18388]]

determination of whether a nonresident alien individual or foreign 
corporation that is a partner in a partnership is a 10-percent 
shareholder under the rules of section 871(h)(3), section 881(c)(3), 
and this paragraph (g) with respect to interest paid to such 
partnership shall be made at the time that the withholding agent, 
absent the provisions of section 871(h), 881(c) and the rules of this 
paragraph, would otherwise be required to withhold under sections 1441 
and 1442 with respect to such interest. For example, in the case of 
U.S. source interest paid by a domestic corporation to a domestic 
partnership or withholding foreign partnership (as defined in Sec.  
1.1441-5(c)(2)), the 10-percent shareholder test is applied when any 
distributions that include the interest are made to a foreign partner 
and, to the extent that a foreign partner's distributive share of the 
interest has not actually been distributed, on the earlier of the date 
that the statement required under section 6031(c) is mailed or 
otherwise provided to such partner, or the due date for furnishing such 
statement. See Sec.  1.1441-5(b)(2) and (c)(2)(iii).
    (4) Application of 10-percent shareholder test to interest paid to 
a simple trust or grantor trust. Whether interest paid to a simple 
trust or grantor trust and distributed to or included in the gross 
income of a nonresident alien individual or foreign corporation that is 
a beneficiary or owner of such trust, as the case may be, is received 
by a 10-percent shareholder shall be determined by applying the rules 
of this paragraph (g) only at the beneficiary or owner level. The 10-
percent shareholder test is applied with respect to a nonresident alien 
individual or foreign corporation that is a beneficiary of a simple 
trust or an owner of a grantor trust at the time that a withholding 
agent, absent any exceptions, would otherwise be required to withhold 
under sections 1441 and 1442 with respect to such interest.
* * * * *
    (i) * * * (1) * * * The rules of paragraph (g) apply to interest 
paid after April 12, 2007. Taxpayers may choose to apply the rules of 
paragraph (g) to interest paid in any taxable year not closed by the 
period of limitations as of April 12, 2007, provided they do so 
consistently for all relevant partnerships during such years.

0
Par. 3. Section 1.881-2 (a)(6) is added to read as follows:


Sec.  1.881-2  Taxation of foreign corporations not engaged in U.S. 
business.

    (a) * * *
    (6) Interest received by a foreign corporation pursuant to certain 
portfolio debt instruments is not subject to the flat tax of 30 percent 
described in paragraph (a)(1) of this section. For rules applicable to 
a foreign corporation's receipt of interest on certain portfolio debt 
instruments, see sections 871(h), 881(c), and Sec.  1.871-14.
* * * * *

0
Par. 4. Section 1.1441-1(b)(7) is amended as follows:
0
1. Paragraph (b)(7)(iii) is revised.
0
2. Paragraph (b)(7)(v) is removed.
    The revision reads as follows:


Sec.  1.1441-1  Requirement for the deduction and withholding of tax on 
payments to foreign persons.

* * * * *
    (b) * * *
    (7) * * *
    (iii) Liability for interest and penalties. For payments made after 
December 31, 2000, if a withholding agent fails to deduct and withhold 
any tax imposed under sections 1441 or 1442, and the tax against which 
such tax may be credited under section 1462 is paid, then the amount of 
tax required to be deducted and withheld shall not be collected from 
the withholding agent. However, the withholding agent is not relieved 
from liability for interest or any penalties or additions to the tax 
otherwise applicable in respect of the failure to deduct and withhold. 
See section 1463. Further, in the event that a tax liability is 
assessed against the beneficial owner under section 871, 881, or 882 
and interest under section 6601(a) is assessed against, and collected 
from, the beneficial owner, the interest charge imposed on the 
withholding agent shall be abated to that extent so as to avoid the 
imposition of a double interest charge.
* * * * *

Kevin M. Brown,
Deputy Commissioner for Services and Enforcement.
    Approved: March 30, 2007.
Eric Solomon,
Assistant Secretary of the Treasury (Tax Policy).
 [FR Doc. E7-6766 Filed 4-11-07; 8:45 am]
BILLING CODE 4830-01-P