United States Property Held by Controlled Foreign Corporations in Transactions Involving Partnerships; Rents and Royalties Derived in the Active Conduct of a Trade or Business, 76497-76512 [2016-26425]

Download as PDF Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations to buy new hardware to expand the computing power. * * * * * * * * Martin V. Franks, Chief, Publications and Regulations Branch, Legal Processing Division, Associate Chief Counsel, (Procedure and Administration). [FR Doc. 2016–26522 Filed 10–31–16; 4:15 pm] BILLING CODE 4830–01–P DEPARTMENT OF THE TREASURY Internal Revenue Service 26 CFR Part 1 [TD 9792] RIN 1545–BJ48 United States Property Held by Controlled Foreign Corporations in Transactions Involving Partnerships; Rents and Royalties Derived in the Active Conduct of a Trade or Business Internal Revenue Service (IRS), Treasury. ACTION: Final regulations and removal of temporary regulations. AGENCY: This document contains final regulations that provide rules regarding the treatment as United States property of property held by a controlled foreign corporation (CFC) in connection with certain transactions involving partnerships. In addition, the final regulations provide rules for determining whether a CFC is considered to derive rents and royalties in the active conduct of a trade or business for purposes of determining foreign personal holding company income (FPHCI), as well as rules for determining whether a CFC holds United States property as a result of certain related party factoring transactions. This document finalizes proposed regulations, and withdraws temporary regulations, published on September 2, 2015. It also finalizes proposed regulations, and withdraws temporary regulations, published on June 14, 1988. The final regulations affect United States shareholders of CFCs. SUMMARY: mstockstill on DSK3G9T082PROD with RULES DATES: Effective Date: These regulations are effective on November 3, 2016. Applicability Dates: For dates of applicability, see §§ 1.954–2(i), 1.956– 1(g), 1.956–2(h), 1.956–3(d), and 1.956– 4(f). FOR FURTHER INFORMATION CONTACT: Rose E. Jenkins, (202) 317–6934 (not a tollfree number). SUPPLEMENTARY INFORMATION: VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 Background On September 2, 2015, the Department of the Treasury (Treasury Department) and the IRS published final and temporary regulations under sections 954 and 956 (TD 9733) (the 2015 temporary regulations) in the Federal Register (80 FR 52976, as corrected at 80 FR 66415 and 80 FR 66416). On the same date, the Treasury Department and the IRS published a notice of proposed rulemaking (REG– 155164–09) (the 2015 proposed regulations) in the Federal Register (80 FR 53058, as corrected at 80 FR 66485) cross-referencing the temporary regulations and proposing additional regulations under section 956 regarding the treatment as United States property of property held by a CFC in connection with certain transactions involving partnerships. No public hearing was requested or held. Formal written comments were received with respect to the 2015 proposed regulations under section 956 and are available at www.regulations.gov or upon request. No comments were received with respect to the 2015 proposed regulations under section 954. This Treasury decision adopts the 2015 proposed regulations, with the changes described in the Summary of Comments and Explanation of Revisions section of this preamble, as final regulations and removes the corresponding temporary regulations. No changes are made to the regulations under section 954. Additionally, on June 14, 1988, the Treasury Department and the IRS published temporary regulations under sections 304, 864, and 956 (TD 8209) in the Federal Register (53 FR 22163), which included guidance under section 956(c)(3) treating as United States property certain trade or service receivables acquired by a CFC from a related United States person in certain factoring transactions (the 1988 temporary regulations). On the same date, the Treasury Department and the IRS published a notice of proposed rulemaking (INTL–49–86, subsequently converted to REG–209001–86) (the 1988 proposed regulations) in the Federal Register (53 FR 22186) cross-referencing the 1988 temporary regulations. Although formal written comments were received on the 1988 proposed regulations, none relate to the specific issues addressed in these final regulations. This Treasury decision adopts § 1.956–3 of the 1988 proposed regulations without substantive change as a final regulation (together with the 2015 proposed regulations adopted as final regulations, these final regulations) and removes the corresponding PO 00000 Frm 00003 Fmt 4700 Sfmt 4700 76497 temporary regulations. This preamble does not discuss the formal written comments concerning other rules in the 1988 proposed regulations, which are beyond the scope of these final regulations. The other portions of the 1988 proposed regulations remain in proposed form, except to the extent withdrawn in the partial withdrawal of the notice of proposed rulemaking published in the Proposed Rules section of this issue of the Federal Register (REG–122387–16). The Treasury Department and the IRS published Revenue Ruling 90–112 (1990–2 CB 186) (see § 601.601(d)(2)(ii)(b)), on December 31, 1990, before promulgating the rule in § 1.956–2(a)(3) that, prior to modification by this document, addressed the application of section 956 when a CFC is a partner in a partnership that holds property that would be United States property if owned directly by the CFC. This Treasury decision withdraws Revenue Ruling 90–112. Summary of Comments and Explanation of Revisions Section 956 determines the amount that a United States shareholder (as defined in section 951(b)) of a CFC must include in gross income with respect to the CFC under section 951(a)(1)(B). This amount is determined, in part, based on the average of the amounts of United States property held, directly or indirectly, by the CFC at the close of each quarter during its taxable year. For this purpose, in general, the amount taken into account with respect to any United States property is the adjusted basis of the property, reduced by any liability to which the property is subject. See section 956(a) and § 1.956– 1(e). Section 956(e) grants the Secretary authority to prescribe such regulations as may be necessary to carry out the purposes of section 956, including regulations to prevent the avoidance of section 956 through reorganizations or otherwise. These final regulations retain the basic approach and structure of the 2015 proposed regulations and the portion of the 1988 proposed regulations that relates to § 1.956–3, with certain revisions, as discussed in this Summary of Comments and Explanation of Revisions. 1. Changes to § 1.956–1 To Conform to the Current Statute These final regulations take into account certain statutory changes in section 13232(a) of the Revenue Reconciliation Act of 1993 (Pub. L. 103– 66, 107 Stat. 312) (the 1993 Act) regarding the methodology for E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES 76498 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations calculating the amount determined under section 956 with respect to a United States shareholder of a CFC. As enacted in section 12 of the Revenue Act of 1962 (Pub. L. 87–834, 76 Stat. 960) (the 1962 Act), and prior to the modification made by the 1993 Act, section 951(a)(1)(B) required a United States shareholder to include an amount in income based on its pro rata share of the CFC’s ‘‘increase in earnings invested in United States property’’ for the relevant taxable year. Section 956 (as then in effect), in turn, defined the amount of earnings of a CFC invested in United States property at the close of a taxable year and set forth rules for determining a United States shareholder’s pro rata share of the CFC’s increase in earnings for a taxable year. The 1993 Act revised the structure and operating rules for determining amounts included in income under sections 951(a)(1)(B) and 956. In general, as revised in 1993, the amount determined under section 956 is based on a United States shareholder’s pro rata share of the average amount of United States property held by the CFC as of the close of each quarter of the relevant taxable year. The amendments made by the 1993 Act are effective for tax years of CFCs beginning after September 30, 1993, and for tax years of United States shareholders in which or with which such tax years of CFCs end. On February 20, 1964, the Treasury Department and the IRS published § 1.956–1 (TD 6704 (29 FR 2599), which was amended by TD 6795 (30 FR 933) in 1965, TD 7712 (45 FR 52373) in 1980, and TD 8209 (53 FR 22163) in 1988) when the section 956 amount was still determined based on the increase of a CFC’s earnings invested in United States property during the relevant tax year. Amendments to § 1.956–1 made after 1993 (TD 9402 (73 FR 35580) and TD 9530 (76 FR 36993, corrected at 76 FR 43891)) did not revise the regulation to reflect the changes to section 956(a) made by the 1993 Act. The Treasury Department and the IRS are aware that some taxpayers have attempted to apply parts of § 1.956–1 to tax years for which those parts were superseded by the 1993 Act. In order to avoid confusion, these final regulations revise the section heading of § 1.956–1 (as well as the parallel heading of § 1.956–1T), and the general rules in § 1.956–1(a), to reflect changes made in the 1993 Act. In addition, these final regulations remove the text in paragraphs (b)(1) through (3), (c), and (d) of § 1.956–1 in order to conform § 1.956–1 to the Code and reserve paragraphs (c) and (d). As a result, proposed § 1.956–1(b)(4) is VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 redesignated as § 1.956–1(b) in these final regulations. 2. Section 1.956–1(b) Anti-Avoidance Rule Prior to the 2015 temporary regulations, § 1.956–1T(b)(4) provided that a CFC would be considered to hold indirectly investments in United States property acquired by any other foreign corporation that is controlled by the foreign corporation if one of the principal purposes for creating, organizing, or funding (thorugh capital contributions or debt) such other foreign corporation is to avoid the application of section 956 with respect to the CFC. The 2015 temporary regulations modified the anti-avoidance rule in § 1.956–1T(b)(4) so that the rule can also apply when a foreign corporation controlled by a CFC is funded other than through capital contributions or debt and expanded the rule to apply to transactions involving partnerships that are controlled by a CFC. A. Definition of Funding In response to the additional guidance on the term funding, a comment suggested that the modification gives rise to uncertainty concerning the application of the anti-avoidance rule and requested that the anti-avoidance rule be revised in these final regulations in one of three alternative ways in order to clarify the application of the rule: (i) Reverting to the language in § 1.956– 1T(b)(4) in effect prior to the 2015 temporary regulations; (ii) defining the term funding as either a related CFC contributing capital to or holding debt of the funded entity, or an unrelated person contributing capital to or holding debt of the funded entity, provided that the contribution or loan would not have been made or maintained on the same terms but for the funding CFC contributing capital to or holding debt of the unrelated person; or (iii) clarifying the scope of the term funding with examples that depict when the rule applies and illustrating that common business transactions conducted on arm’s-length terms and certain other transactions would not be considered a funding for purposes of the rule. The Treasury Department and the IRS continue to be concerned about tax planning that is inconsistent with the policy underlying section 956. The policy concerns addressed by the antiavoidance rule are not limited to fundings by debt or equity; rather, the anti-avoidance rule should apply to all fundings with a principal purpose of avoiding the purposes of section 956, regardless of the form of the funding. The Treasury Department and the IRS PO 00000 Frm 00004 Fmt 4700 Sfmt 4700 have concluded that reverting to the prior formulation of the rule, which applied when there was a ‘‘funding (through capital contributions or debt),’’ or adopting the narrow definition of funding proposed in the comment could allow taxpayers to engage in planning that would inappropriately avoid the application of section 956. In addition, the Treasury Department and the IRS disagree with the view expressed in the comment that the expanded scope of fundings could result in common business transactions being subject to the anti-avoidance rule. Whether a transaction is a ‘‘funding’’ does not alone determine whether the transaction is subject to the antiavoidance rule because the rule applies only when a principal purpose of the funding is to avoid section 956 with respect to the funding CFC. Thus, although the 2015 temporary regulations broaden the funding standard, the ‘‘avoidance’’ requirement ensures that ordinary course transactions are not subject to the anti-avoidance rule. The Treasury Department and the IRS agree, however, that examples illustrating that the anti-avoidance rule should not apply to certain common transactions would be helpful. Accordingly, these final regulations add new examples that address common transactions highlighted by the comment to further illustrate the distinction between funding transactions that are subject to the antiavoidance rule and common business transactions to which the anti-avoidance rule does not apply. See Example 4 through Example 6 of § 1.956–1(b)(4). For example, Example 5 and Example 6 illustrate a sale of property for cash in the ordinary course of business and a repayment of a loan, respectively, to which the anti-avoidance rule does not apply. However, Example 4 illustrates that, consistent with the holding in situation 3 in Revenue Ruling 87–89 (1987–2 CB 195), a CFC may be treated as holding United States property as a result of a deposit with an unrelated bank if the unrelated bank would not have made a loan to another person on the same terms absent the CFC’s deposit. B. Application To Acquisitions of Property by a Partnership Controlled by a CFC Section 1.956–1(b)(4) of the 2015 proposed regulations expands the antiavoidance rule to include transactions involving partnerships that are controlled by a CFC that provides funding to the partnership. Proposed § 1.956–1(b)(4)(iii) contains a coordination rule that provides that this E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations new partnership rule applies only to the extent that the amount of United States property that a CFC would be treated as holding under the rule exceeds the amount that it would be treated as holding under proposed § 1.956–4(b). The coordination rule prevents a CFC from being treated as holding duplicative amounts of United States property as a result of a single partnership interest pursuant to the application of proposed §§ 1.956–1(b)(4) and 1.956–4(b). This rule is illustrated by Example 4 in proposed § 1.956– 1(b)(4)(iv), which is included as Example 7 in § 1.956–1(b)(4) of these final regulations. A comment recommended that the anti-avoidance rule should not apply in the case of a partnership in which the funding CFC is a partner, as in Example 4 in proposed § 1.956–1(b)(4)(iv). Noting that proposed § 1.956–4(b) would treat a funding CFC that is a partner in the funded partnership as owning a share of any United States property acquired by the partnership using the funding, the comment asserted that the inclusion resulting from proposed § 1.956–4(b) is sufficient and there is no need for the anti-avoidance rule to apply to create a disproportionate inclusion that would deter taxpayers from entering into transactions in order to avoid the application of section 956. The Treasury Department and the IRS, however, do not agree with the premise of this comment that the anti-avoidance rule results in a disproportionate inclusion in this case. Rather, the Treasury Department and the IRS consider that, in the circumstances in which the antiavoidance rule would apply, the funded entity, which is controlled by the CFC, essentially serves as a surrogate for the funding CFC with respect to the investment in United States property. Accordingly, the Treasury Department and the IRS have determined that, when a partnership acts as a surrogate for a CFC partner’s investment in United States property, the CFC partner’s interest in the United States property should not be limited to the CFC’s attributable share of the property as determined under § 1.956–4(b). For these reasons, the comment is not adopted. With respect to the coordination rule in proposed § 1.956–1(b)(4)(iii), another comment noted that a CFC also could be treated as holding duplicative amounts of United States property as a result of a single partnership obligation pursuant to the application of proposed §§ 1.956– 1(b)(4) and 1.956–4(c). For example, suppose a domestic corporation (P) wholly owns two controlled foreign corporations (FS1 and FS2), and P is a VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 40% partner in a foreign partnership (FPRS), while FS1 is a 60% partner. Suppose further that FS2 loans $100x to FPRS, which FPRS uses to acquire $100x of United States property. In these circumstances, FS2 would be treated as holding $40x of United States property under proposed § 1.956–4(c) and existing § 1.956–2(a) (and would not be treated as holding any United States property under proposed § 1.956– 4(b)) and could be treated under proposed § 1.956–1(b)(4) and existing § 1.956–2(a) as holding the $100x of United States property acquired by the partnership with its funding. The Treasury Department and the IRS have determined that it is appropriate to limit the amount of United States property that FS2 is treated as holding in the example to $100x, consistent with the result that would apply if FS2 had not funded FPRS’s acquisition of United States property and instead had acquired the United States property itself. (Note that, in a case where proposed § 1.956–1(b)(4) would apply, FPRS should not be treated as holding the United States property that would be treated under that rule as held by FS2, and accordingly, FS1 should not be treated as holding United States property under proposed § 1.956–4(b) in this example.) Accordingly, the coordination rule in proposed § 1.956– 1(b)(4)(iii) is expanded in final § 1.956– 1(b)(3) to prevent a CFC from being treated as holding duplicative amounts of United States property under the antiavoidance rule as a result of a partnership obligation, and an additional example is added to illustrate this rule. See § 1.956–1(b)(4), Example 8. Further, as noted in the preamble to the 2015 proposed regulations, the references to § 1.956–2(a)(3) in proposed § 1.956–1(b)(4)(iii) and in the examples in proposed § 1.956–1(b)(4)(iv) that illustrate the application of proposed § 1.956–1(b)(4)(i)(C) are supplanted in these final regulations with references to § 1.956–4(b), which replaces § 1.956– 2(a)(3) in these final regulations as the applicable rule concerning United States property held indirectly by a controlled foreign corporation through a partnership. 3. Factoring Rules As noted in the Background section of this preamble, in 1988, the Treasury Department and the IRS proposed § 1.956–3 to address the application of section 956 to property acquired by a CFC in certain related party factoring transactions. No comments were received on these proposed rules. The 2015 proposed regulations proposed PO 00000 Frm 00005 Fmt 4700 Sfmt 4700 76499 revisions to these proposed rules in § 1.956–3(b)(2)(ii) with respect to the application of section 956 to acquisitions of receivables indirectly through a nominee, pass-through entity, or related foreign corporation, and no comments were received on these proposed revisions. These final regulations adopt these portions of the 2015 proposed regulations without change, and also adopt the remainder of the rules in proposed § 1.956–3 that were proposed in the 1988 proposed regulations, with minor revisions to improve clarity and conform to existing regulations. 4. Partnership Property Indirectly Held by a CFC Partner Under proposed § 1.956–4(b)(1), a CFC partner in a partnership is treated as holding its attributable share of property held by the partnership. In addition, proposed § 1.956–4(b)(1) provides that, for purposes of section 956, a partner’s adjusted basis in the property of the partnership equals the partner’s attributable share of the partnership’s adjusted basis in the property. Under proposed § 1.956–4(b)(2), a CFC partner’s attributable share of partnership property is determined in accordance with the CFC partner’s liquidation value percentage with respect to the partnership, unless the partnership agreement contains a special allocation of income (or, where appropriate, gain) with respect to a particular item or items of partnership property that differs from the partner’s liquidation value percentage in a particular taxable year. In that case, the partner’s attributable share of the property is determined solely by reference to the partner’s special allocation with respect to the property, provided the special allocation does not have a principal purpose of avoiding the purposes of section 956. A. Revenue Ruling 90–112’s Outside Basis Limitation As noted in the Background section of this Preamble, in 1990, the Treasury Department and the IRS published Revenue Ruling 90–112, which addressed the treatment under section 956 of United States property held by a CFC indirectly through a partnership. The holding in the revenue ruling generally is consistent with § 1.956– 2(a)(3) (added by TD 9008, 67 FR 58020, in 2002), as well as proposed § 1.956– 4(b), in that a CFC that is a partner in a partnership is treated as indirectly holding property held by the partnership when the property would be United States property if the CFC held E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES 76500 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations it directly. However, the revenue ruling includes a limitation on the measurement of United States property that is not included in the final or proposed regulations. Specifically, the revenue ruling provides that the amount of United States property taken into account for purposes of section 956 when a CFC partner indirectly owns property through a partnership is limited by the CFC’s adjusted basis in the partnership. The outside basis limitation in Revenue Ruling 90–112 has resulted in a lack of clarity concerning the determination of the amount of United States property held by a CFC partner through a partnership because neither § 1.956–2(a)(3) nor proposed § 1.956– 4(b) include the limitation. A comment requested that proposed § 1.956–4(b)(1) be revised to add the outside basis limitation because the limitation is reflective of the underlying economics and consistent with the policy underlying section 956. After consideration of the comment, the Treasury Department and the IRS have concluded that the outside basis limitation is not warranted. The rule in proposed § 1.956–4(b)(1) is based on an aggregate approach to partnerships and measures the amount of United States property indirectly held by a CFC partner on a property-by-property basis. An overall limitation on the amount of United States property a CFC partner is considered to indirectly hold through a partnership is inconsistent with this property-by-property aggregate approach to United States property held by the partnership. Additionally, a limitation determined by reference to a CFC partner’s basis in its partnership interest is less consistent with section 956(a), which provides that the amount of United States property directly or indirectly held by a CFC is determined by reference to the adjusted basis of the United States property itself. Moreover, the Treasury Department and the IRS are concerned that, under the rules of subchapter K, adjustments may be made to outside basis through the allocation of liabilities pursuant to the regulations under section 752 that are inconsistent with the policy of section 956. Accordingly, the Treasury Department and the IRS have determined that an outside basis limitation should not be incorporated into the rule in proposed § 1.956–4(b)(1). Because proposed § 1.956–4(b)(1) indicates that, for purposes of section 956, a partner’s adjusted basis in the property of the partnership equals the partners’ attributable share of the partnership’s adjusted basis in the property, no revision to the rule is necessary to VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 clarify that there is no outside basis limitation. Revenue Ruling 90–112 is obsoleted in the Effect on Other Documents section of this preamble. For tax years ending prior to the obsolescence of the revenue ruling, taxpayers may rely on the outside basis limitation provided in the revenue ruling. B. Consistent Use of Liquidation Value Percentage Method for Purposes of Both § 1.956–4(b) and (c) In contrast to the rule provided in proposed § 1.956–4(b) providing that a CFC partner’s attributable share of partnership property is determined in accordance with the CFC partner’s liquidation value percentage, proposed § 1.956–4(c) provided that a partner’s share of a partnership obligation is determined in accordance with the partner’s interest in partnership profits. The preamble to the 2015 proposed regulations requested comments as to whether a single method should be used as the general rule for determining both a partner’s share of partnership assets under proposed § 1.956–4(b) and a partner’s share of a partnership obligation under proposed § 1.956–4(c), and, if so, whether the appropriate measure would be a partner’s interest in partnership profits, liquidation value percentage, or an alternative measure. Comments suggested that a liquidation value percentage method should be used for purposes of both sets of rules. In accordance with these comments, these final regulations retain the liquidation value percentage method set forth in proposed § 1.956–4(b), and, as discussed in Part 5.B of this Summary of Comments and Explanation of Revisions, revise the general rule in proposed § 1.956–4(c) to implement the liquidation value percentage method. C. Time for Determining the Liquidation Value Percentage A comment recommended that the liquidation value percentage of partners in a partnership should be determined on an annual basis, rather than upon formation and upon the occurrence of events described in § 1.704– 1(b)(2)(iv)(f)(5) or § 1.704– 1(b)(2)(iv)(s)(1) (revaluation events) as provided in proposed § 1.956–4(b)(2)(i). The comment noted that partnerships do not necessarily book up (or adjust) partnership capital accounts in connection with revaluation events and suggested that requiring a redetermination of liquidation value percentage regardless of whether a bookup occurs would impose a burden on such partnerships. The comment also noted that partners’ relative economic PO 00000 Frm 00006 Fmt 4700 Sfmt 4700 interests in the partnership may change for reasons unrelated to revaluation events, such as when a partnership agreement provides for different profit sharing percentages that apply based on different hurdles. The Treasury Department and the IRS continue to consider it appropriate for liquidation value percentage to be redetermined upon a revaluation event, which may result in a significant change in the partners’ relative economic interests in a partnership. Accordingly, upon a revaluation event, a partnership is required to determine the partnership’s capital accounts resulting from a hypothetical book up at such point in time even if the partnership did not actually book up capital accounts in connection with such an event. However, in light of the comment’s observation that partners’ relative economic interests in the partnership may change significantly as a result of allocations of income or other items under the partnership agreement even in the absence of a revaluation event, § 1.956–4(b)(2)(i) of these final regulations provides that a partner’s liquidation value percentage must be redetermined in certain additional circumstances. Specifically, if the liquidation value percentage determined for any partner on the first day of the partnership’s taxable year would differ from the most recently determined liquidation value percentage of that partner by more than 10 percentage points, then the liquidation value percentage must be redetermined on that day even in the absence of a revaluation event. For example, if the liquidation value percentage of a partner was determined upon a revaluation event to be 40 percent and, on the first day of a subsequent year before the occurrence of another revaluation event, would be less than 30 percent or more than 50 percent if redetermined on that day, then the liquidation value percentage must be redetermined on that day. D. Special Allocations Proposed § 1.956–4(b)(2)(ii) defines a special allocation as an allocation of income (or, where appropriate, gain) from partnership property to a partner under a partnership agreement that differs from the partner’s liquidation value percentage in a particular taxable year. In this regard, questions have arisen as to whether allocations pursuant to section 704(c) and the regulations thereunder constitute special allocations. Although a partnership agreement may reference section 704(c) or provide for the adoption of a particular section 704(c) E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations method, allocations under section 704(c) are tax allocations required by operation of the Code and regulations. In response to these questions, the Treasury Department and the IRS have revised the definition of special allocations in final § 1.956–4(b)(2)(ii) to clarify that a special allocation is an allocation of book income or gain, rather than a tax allocation such as the allocations required under section 704(c). Questions also have arisen as to whether certain allocations of income with respect to all of the property of a partnership, as opposed to allocations of income from a specific item or subset of partnership property, constitute special allocations described in proposed § 1.956–4(b)(2)(i). These final regulations clarify that, for purposes of these regulations, a special allocation means only an allocation of income (or, where appropriate, gain) from a subset of the property of the partnership to a partner other than in accordance with the partner’s liquidation value percentage in a particular taxable year. As noted in this Part 4 of this Summary of Comments and Explanation of Revisions, proposed § 1.956– 4(b)(2)(ii) states that a partner’s attributable share of an item of partnership property is not determined by reference to a special allocation with respect to the property if the special allocation has a principal purpose of avoiding the purposes of section 956. A comment requested that these final regulations provide guidance on the circumstances in which special allocations are treated as having a principal purpose of avoiding section 956. Specifically, the comment suggested that proposed § 1.956–4(b) be revised to include a presumption that a transaction does not have a principal purpose of avoiding section 956 when the allocation is respected under section 704(b) and is reasonable taking into account the facts and circumstances relating to the economic arrangement of the partners and the characteristics of the property at issue. The determination of whether a special allocation has a principal purpose of avoiding the purposes of section 956 must take into account all of the relevant facts and circumstances, which include the factors set forth in the comment. However, an allocation adopted with a principal purpose of avoiding the purposes of section 956 could nonetheless be respected under section 704(b), which is not based on, and does not take into account, section 956 policy considerations. In addition, it is not clear what additional clarity would be added by the reasonableness VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 requirement, which itself is necessarily a facts-and-circumstances determination. After consideration of the comment, the Treasury Department and the IRS have determined that the presumption requested by the comment is not appropriate, and the comment is not adopted. A comment noted that determining a partner’s attributable share of an item of property by reference to a special allocation of income or gain with respect to that property could produce results that are inconsistent with the liquidation value percentage approach because of the forward-looking nature of special allocations. The comment described, but did not explicitly recommend, an alternative approach that would limit the effect of a special allocation to the portion of the liquidation value that represents actual appreciation, as opposed to initial book value. The Treasury Department and the IRS recognize the conceptual issue highlighted by the comment but have determined that the alternative approach described by the comment would entail substantial administrative complexity. Additionally, the Treasury Department and the IRS continue to consider it appropriate, in cases in which special allocations are economically meaningful, to determine a partner’s attributable share of property in accordance with such special allocations, since such allocations replicate the effect of owning, outside of the partnership, an interest in the property that is proportional to the special allocation. However, the Treasury Department and the IRS have determined that special allocations with respect to a partnership controlled by a U.S. multinational group (a controlled partnership) and its CFCs are unlikely to have economic significance for the group as a whole and can facilitate inappropriate tax planning. Accordingly, the Treasury Department and the IRS are proposing a new rule in a notice of proposed rulemaking in the Proposed Rules section of this issue of the Federal Register (REG–114734–16) under which a partner’s attributable share of property of a controlled partnership is determined solely in accordance with the partner’s liquidation value percentage, without regard to any special allocations. 5. Obligations of Foreign Partnerships A. Use of an Aggregate Approach as the General Rule Pursuant to section 956(c), United States property includes an obligation of a United States person. In addition, PO 00000 Frm 00007 Fmt 4700 Sfmt 4700 76501 under section 956(d) and § 1.956–2(c), a CFC is treated as holding an obligation of a United States person if the CFC is a pledgor or guarantor of the obligation. Therefore, if a CFC makes or guarantees a loan to a United States person, an income inclusion may be required with respect to the CFC under sections 951(a)(1)(B) and 956. Under the general rule in proposed § 1.956–4(c)(1), an obligation of a foreign partnership would be treated as an obligation of its partners in proportion to the partners’ interest in partnership profits, unless the exception in proposed § 1.956– 4(c)(2) (for obligations of partnerships in which neither the lending CFC nor any person related to the lending CFC is a partner) or the special rule in proposed § 1.956–4(c)(3) (regarding certain partnership distributions) applies. Thus, the general rule adopts an aggregate approach that would treat an obligation of a foreign partnership as an obligation of its partners. A comment asserted that taking the aggregate approach to a foreign partnership for this purpose is overly broad and inconsistent with the policy underlying section 956. The comment states that a CFC loan to a foreign partnership results in a repatriation of CFC earnings to the United States partners in the partnership only when the loan proceeds either are used to acquire United States property or are distributed to the partners, which, according to the comment, are adequately addressed in § 1.956– 1T(b)(4) and (5). Accordingly, the comment requested that the rules in § 1.956–1T(b)(4) and (5) be finalized, but that the general rule in § 1.956–4(c)(1) be removed. Thus, the comment generally advocates for the treatment of a foreign partnership as an entity, with anti-abuse rules to address certain situations. In contrast, another comment indicated that the concerns identified in the preamble to the 2015 proposed regulations ‘‘constitute an appropriate basis for the general aggregate approach of [proposed § 1.956–4(c)(1)]’’. After consideration of the comments, the Treasury Department and the IRS have concluded that it is appropriate to retain the aggregate approach of the general rule in proposed § 1.956–4(c). The Treasury Department and the IRS disagree with the assertion that the aggregate approach is not supported by the policy of section 956. As discussed in the preamble to the 2015 proposed regulations, failing to treat an obligation of a foreign partnership as an obligation of its partners could allow for the deferral of U.S. taxation of CFC earnings and profits in a manner that is inconsistent with the purpose of section E:\FR\FM\03NOR1.SGM 03NOR1 76502 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations mstockstill on DSK3G9T082PROD with RULES 956. As discussed in that preamble, the legislative history provides that Congress intended section 956 to apply when deferred CFC earnings are made available to a United States shareholder, which occurs when a United States shareholder conducts operations through a foreign partnership that are funded by deferred CFC earnings, without regard to whether there is any distribution from the partnership to the United States shareholder. In addition, as described in Section C of this Part 5 of this Summary of Comments and Explanation of Revisions, there are exceptions from the treatment of obligations as United States property under § 1.956–4(c) that the Treasury Department and the IRS have determined mitigate some of the concerns about the breadth of the general rule raised by the comment. Accordingly, the final regulations do not adopt the recommendation to abandon the aggregate approach. B. Liquidation Value Percentage Method The preamble to the 2015 proposed regulations requested comments on whether the liquidation value percentage method or another method would be a more appropriate basis for determining a partner’s share of a foreign partnership’s obligation. In addition, as noted in Part 4.B of this Summary of Comments and Explanation of Revisions, the 2015 proposed regulations solicited comments on whether a single method should be used for determining both a partner’s share of partnership assets under proposed § 1.956–4(b) and a partner’s share of partnership obligations under proposed § 1.956–4(c). Comments highlighted a number of issues related to applying a rule based on a partner’s interest in partnership profits and noted the lack of guidance in the 2015 proposed regulations for applying this standard for purposes of proposed § 1.956–4(c). The comments stated that a partner’s interest in partnership profits would be a difficult standard to apply for partnerships other than simple partnerships, because a partner’s interest in partnership profits can fluctuate significantly from year to year, as well as during a taxable year. The comments noted that the proposed rule did not address whether the determination would be made based solely on the partnership’s profits in the current year or whether the determination would take into account the expected profits over the term of the partnership. Moreover, under section 956(a), the amount of United States property held by a CFC as a result of being treated as holding an obligation of VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 a related United States person under proposed § 1.956–4(c) would be the average of the amounts held by the CFC at the close of each quarter of its taxable year. Thus, under proposed § 1.956– 4(c), taxpayers would need to determine a CFC partner’s interest in partnership profits on a quarterly basis when a relevant partnership obligation is outstanding throughout a taxable year. As a result, calculating the amount of United States property held by a CFC in a taxable year could be complicated when a partner’s interest in partnership profits is not known until the end of the taxable year (such as when there are one or more tiers of allocations of partnership profits based on various internal rate of return hurdles). Furthermore, the requirement to determine a CFC’s interest in United States property on a quarterly basis could result in the calculation of a section 956 amount that is inconsistent with the annual profit allocated to the partner from the partnership for that year. After consideration of these comments, the Treasury Department and the IRS have determined that the liquidation value percentage method should be used to determine a partner’s share of a foreign partnership’s obligation because of the potential for complexity in calculating a partner’s interest in partnership profits for purposes of proposed § 1.956–4(c) as well as the uncertainty inherent in the method. The liquidation value percentage method is a sound indicator of a partner’s interest in a partnership. Moreover, the objective rules provided in proposed § 1.956–4(b) for determining the liquidation value percentage provide more certainty than the rule in proposed § 1.956–4(c). In addition, using the same standard for determining a partner’s share of partnership property and a partner’s share of partnership obligations reduces complexity for taxpayers that must apply both sets of rules for purposes of section 956 with respect to a single partnership. Accordingly, these final regulations provide that an obligation of a foreign partnership is treated as an obligation of its partners in proportion to the partners’ liquidation value percentage with respect to the partnership. As described in Part 4.C of this Summary of Comments and Explanation of Revisions, a partner’s liquidation value percentage must be determined upon formation of a partnership and any revaluation events and in certain other circumstances in which redetermination of the liquidation value percentage would PO 00000 Frm 00008 Fmt 4700 Sfmt 4700 result in a significant change from the previously determined liquidation value percentage. C. Exceptions From General Rule of Aggregate Treatment Proposed § 1.956–4(c)(2) provides an exception from the aggregate treatment of proposed § 1.956–4(c)(1) that applies if neither the CFC that holds the obligation (or is treated as holding the obligation) nor any person related to the CFC (within the meaning of section 954(d)(3)) is a partner in the partnership on the CFC’s quarterly measuring date on which the treatment of the obligation as United States property is being determined. A comment suggested an additional exception from the general rule in proposed § 1.956–4(c)(1) providing for aggregate treatment of partnership obligations. The comment requested that an obligation of a foreign partnership not be treated as an obligation of its partners to the extent that the obligation arises from a routine, ordinary course transaction between the lending CFC and the foreign partnership. The comment highlighted a fact pattern involving an obligation arising from a deposit by a CFC with a foreign partnership that acts as a coordination center for a taxpayer’s cash pooling system. In this case, the comment asserted that any United States partners in the partnership should not be considered to have accessed the deferred earnings of the CFC deposited with the partnership and that, accordingly, the aggregate approach to partnership obligations should not apply to treat the CFC as holding an obligation of the United States partners for purposes of section 956. Regarding this fact pattern, the Treasury Department and the IRS observe that the short-term obligation exception in § 1.956–2T(d)(2)(iv), which applies when a CFC holds obligations of a United States person for a limited period of time during a taxable year, generally would prevent an inclusion under section 956 in the fact pattern described in the comment if the CFC had a net deposit with the partnership only for the limited period of time described in that exception. The Treasury Department and the IRS have concluded that there is no reason to provide a more expansive exception from United States property treatment for obligations of a foreign partnership with certain United States persons as partners than would apply with respect to obligations incurred directly by those same United States persons. Another comment recommended adding a new de minimis exception that E:\FR\FM\03NOR1.SGM 03NOR1 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations mstockstill on DSK3G9T082PROD with RULES would provide that an obligation of a foreign partnership is not treated as an obligation of a United States person that is a partner if the United States person and its related persons own less than a specified percentage, 10% or 20%, of the profits and capital interests in the foreign partnership. The comment noted that a U.S. partner with a relatively small interest in a partnership may lack the ability to cause the partnership to make a distribution to the U.S. partner. Although a U.S. partner with a relatively small partnership interest may not be able to compel a distribution from the partnership, the potential to directly access partnership assets is not, as the comment acknowledges, the sole or overriding consideration motivating the aggregate approach to partnerships under the proposed regulations and these final regulations. Even if the other partners in a partnership in which a United States shareholder of a CFC is a minority partner are unrelated to the United States shareholder, the United States shareholder would still benefit from the funding of the partnership’s business with deferred earnings of the CFC to the extent of its interest in the partnership. Additionally, as noted in the preamble to the 2015 proposed regulations, a standard based on whether the funding CFC or a related person is a partner in the partnership, rather than whether such persons own a certain minimum interest in the partnership, is consistent with the relevant exception adopted by Congress in section 956(c)(2)(L). Accordingly, the Treasury Department and the IRS have determined that the additional exceptions to aggregate treatment suggested in the comments are not warranted. D. Special Obligor Rule in the Case of Certain Distributions The 2015 proposed regulations include a special funded distribution rule that increases the amount of a foreign partnership obligation that is treated as United States property when the following requirements are satisfied: (i) A CFC lends funds (or is a pledgor or guarantor with respect to a loan) to a foreign partnership whose obligation is, in whole or in part, United States property with respect to the CFC pursuant to proposed § 1.956–4(c)(1) and existing § 1.956–2(a); (ii) the partnership distributes an amount of money or property to a partner that is related to the CFC (within the meaning of section 954(d)(3)) and whose obligation would be United States property if held (or treated as held) by the CFC; (iii) the foreign partnership would not have made the distribution VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 but for a funding of the partnership through an obligation held (or treated as held) by the CFC; and (iv) the distribution exceeds the partner’s share of the partnership obligation as determined in accordance with the partner’s interest in partnership profits. When these requirements are satisfied, proposed § 1.956–4(c)(3) provided that the amount of the partnership obligation that is treated as an obligation of the distributee partner (and thus as United States property held by the CFC) is the lesser of the amount of the distribution that would not have been made but for the funding of the partnership and the amount of the partnership obligation. Comments suggested that taxpayers might take the position that the ‘‘but for’’ requirement in proposed § 1.956– 4(c)(3) is not satisfied in certain situations in which CFC earnings are effectively repatriated to a partner that is a related United States person. For example, taxpayers might take the position that a partnership distribution could have been made without the funding by the CFC merely by establishing that a third party would have loaned the funds needed for the partnership to make the distribution. The Treasury Department and the IRS have determined that this position is inconsistent with the purposes of this rule. Accordingly, these final regulations clarify the funded distribution rule by providing with respect to the ‘‘but for’’ requirement in proposed § 1.956–4(c)(3) that a foreign partnership will be treated as if it would not have made a distribution of liquid assets but for a funding of the partnership through obligations held (or treated as held) by a CFC to the extent the foreign partnership did not have sufficient liquid assets to make the distribution immediately prior to the distribution, without taking into account the obligations. When a CFC holds (or is treated as holding) multiple obligations of the foreign partnership to which this rule could potentially apply, its applicability is determined first with respect to the obligation acquired (or treated as acquired) closest in time to the distribution, and then successively to other obligations further in time from the distribution until the distribution is fully accounted for. 6. Comments Concerning Multiple Inclusions Comments were received in response to the request for comments included in the preamble to the 2015 proposed regulations concerning whether the Treasury Department and the IRS should exercise the authority granted under section 956(e) to prescribe PO 00000 Frm 00009 Fmt 4700 Sfmt 4700 76503 regulations concerning situations in which multiple CFCs serve, or are treated, as pledgors or guarantors of a single obligation for purposes of section 956(d) in order to limit the aggregate inclusions of a United States shareholder with respect to a CFC under sections 951(a)(1)(B) and 956 to the unpaid principal amount of the obligation. The Treasury Department and the IRS continue to study the comments concerning multiple inclusions under section 956(d), which do not impact any of the proposed regulations adopted by this Treasury decision. Effective/Applicability Dates The rules in § 1.954–2(c)(1)(i) and (d)(1)(i) (regarding the active development test) apply to rents or royalties, as applicable, received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, but only with respect to property manufactured, produced, developed, or created, or, in the case of acquired property, property to which substantial value has been added, on or after September 1, 2015. The rules in § 1.954–2(c)(1)(iv), (c)(2)(ii), (d)(1)(ii), and (d)(2)(ii) (regarding the active marketing test), as well as the rules in § 1.954–2(c)(2)(iii)(E), (c)(2)(viii), (d)(2)(iii)(E), and (d)(2)(v) (regarding cost-sharing arrangements), apply to rents or royalties, as applicable, received or accrued during taxable years of CFCs ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, to the extent that such rents or royalties are received or accrued on or after September 1, 2015. The section 956 anti-avoidance rules in § 1.956–1(b) apply to taxable years of CFCs ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, with respect to property acquired, including property treated as acquired as the result of a deemed exchange of property pursuant to section 1001, on or after September 1, 2015. The rules regarding factoring transactions in § 1.956–3 (other than § 1.956–3(b)(2)(ii)) apply to trade or service receivables acquired (directly or indirectly) after March 1, 1984. The remaining rules in these final regulations apply to taxable years of CFCs ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end. In general, these remaining rules apply to property E:\FR\FM\03NOR1.SGM 03NOR1 76504 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations acquired, or pledges or guarantees entered into, on or after September 1, 2015, including property considered acquired, and pledges and guarantees considered entered into, on or after September 1, 2015, as a result of a deemed exchange pursuant to section 1001. See § 1.956–4(c) (dealing with obligations of foreign partnerships); §§ 1.956–2(c), 1.956–4(d), and 1.956– 1(e)(2) (dealing with pledges and guarantees, including pledges and guarantees by a partnership and with respect to obligations of a foreign partnership); and § 1.956–3(b)(2)(ii) (dealing with trade and service receivables acquired from related United States persons indirectly through nominees, pass-through entities, or related foreign corporations). Two rules, however, apply to all obligations held on or after November 3, 2016. See §§ 1.956–2(a)(3) and 1.956–4(e) (dealing with obligations of disregarded entities and domestic partnerships, respectively). Finally, § 1.956–4(b) (dealing with partnership property indirectly held by a CFC) applies to property acquired on or after November 3, 2016. No inference is intended as to the application of the provisions amended by these final regulations under prior law, including in transactions involving obligations of foreign partnerships. The IRS may, where appropriate, challenge transactions under the Code, regulatory provisions under prior law, or judicial doctrines. mstockstill on DSK3G9T082PROD with RULES Effect on Other Documents Rev. Rul. 90–112 (1990–2 CB 186) is obsolete as of November 3, 2016. Special Analyses Certain IRS regulations, including these regulations, are exempt from the requirements of Executive Order 12866, as supplemented and reaffirmed by Executive Order 13563. 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), the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel of Advocacy of the Small Business Administration for comment on its impact on small business. Drafting Information The principal author of these regulations is Rose E. Jenkins of the VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development. List of Subjects in 26 CFR Part 1 Income taxes, Reporting and recordkeeping requirements. Adoption of Amendments to the Regulations Accordingly, 26 CFR part 1 is amended as follows: PART 1—INCOME TAXES Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read in part as follows: ■ Authority: 26 U.S.C. 7805 * * * Section 1.956–1 also issued under 26 U.S.C. 956(d) and 956(e). Section 1.956–2 also issued under 26 U.S.C. 956(d) and 956(e). Section 1.956–3 also issued under 26 U.S.C. 864(d)(8) and 956(e). Section 1.956–4 also issued under 26 U.S.C. 956(d) and 956(e). * * * * * Par. 2. Section 1.954–2 is amended by: ■ 1. Revising paragraphs (c)(1)(i), (c)(1)(iv), and (c)(2)(ii). ■ 2. Removing the word ‘‘and’’ at the end of paragraph (c)(2)(iii)(C). ■ 3. Removing the period at the end of paragraph (c)(2)(iii)(D) and adding in its place a semicolon and the word ‘‘and’’. ■ 4. Revising paragraphs (c)(2)(iii)(E) and (c)(2)(viii). ■ 5. Revising paragraphs (d)(1)(i), (d)(1)(ii), and (d)(2)(ii). ■ 6. Removing the word ‘‘and’’ at the end of paragraph (d)(2)(iii)(C). ■ 7. Removing the period at the end of paragraph (d)(2)(iii)(D), and adding in its place a semicolon and the word ‘‘and’’. ■ 8. Revising paragraphs (d)(2)(iii)(E) and (d)(2)(v). ■ 9. Revising paragraph (i). The revisions and additions read as follows: ■ § 1.954–2 Foreign personal holding company income. * * * * * (c) * * * (1) * * * (i) Property that the lessor, through its own officers or staff of employees, has manufactured or produced, or property that the lessor has acquired and, through its own officers or staff of employees, added substantial value to, but only if the lessor, through its officers or staff of employees, is regularly engaged in the manufacture or PO 00000 Frm 00010 Fmt 4700 Sfmt 4700 production of, or in the acquisition and addition of substantial value to, property of such kind; * * * * * (iv) Property that is leased as a result of the performance of marketing functions by such lessor through its own officers or staff of employees located in a foreign country or countries, if the lessor, through its officers or staff of employees, maintains and operates an organization either in such country or in such countries (collectively), as applicable, that is regularly engaged in the business of marketing, or of marketing and servicing, the leased property and that is substantial in relation to the amount of rents derived from the leasing of such property. (2) * * * (ii) Substantiality of foreign organization. For purposes of paragraph (c)(1)(iv) of this section, whether an organization either in a foreign country or in foreign countries (collectively) is substantial in relation to the amount of rents is determined based on all the facts and circumstances. However, such an organization will be considered substantial in relation to the amount of rents if active leasing expenses, as defined in paragraph (c)(2)(iii) of this section, equal or exceed 25 percent of the adjusted leasing profit, as defined in paragraph (c)(2)(iv) of this section. In addition, for purposes of aircraft or vessels leased in foreign commerce, an organization will be considered substantial if active leasing expenses, as defined in paragraph (c)(2)(iii) of this section, equal or exceed 10 percent of the adjusted leasing profit, as defined in paragraph (c)(2)(iv) of this section. For purposes of paragraphs (c)(1)(iv) and (c)(2) of this section and § 1.956– 2(b)(1)(vi), the term aircraft or vessels includes component parts, such as engines that are leased separately from an aircraft or vessel. (iii) * * * (E) Deductions for CST Payments or PCT Payments (as defined in § 1.482– 7(b)). * * * * * (viii) Cost sharing arrangements (CSAs). For purposes of paragraphs (c)(1)(i) and (iv) of this section, CST Payments or PCT Payments (as defined in § 1.482–7(b)(1)) made by the lessor to another controlled participant (as defined in § 1.482–7(j)(1)(i)) pursuant to a CSA (as defined in § 1.482–7(a)) do not cause the activities undertaken by that other controlled participant to be considered to be undertaken by the lessor’s own officers or staff of employees. * * * * * E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations (d) * * * (1) * * * (i) Property that the licensor, through its own officers or staff of employees, has developed, created, or produced, or property that the licensor has acquired and, through its own officers or staff of employees, added substantial value to, but only so long as the licensor, through its officers or staff of employees, is regularly engaged in the development, creation, or production of, or in the acquisition and addition of substantial value to, property of such kind; or (ii) Property that is licensed as a result of the performance of marketing functions by such licensor through its own officers or staff of employees located in a foreign country or countries, if the licensor, through its officers or staff of employees, maintains and operates an organization either in such foreign country or in such foreign countries (collectively), as applicable, that is regularly engaged in the business of marketing, or of marketing and servicing, the licensed property and that is substantial in relation to the amount of royalties derived from the licensing of such property. (2) * * * (ii) Substantiality of foreign organization. For purposes of paragraph (d)(1)(ii) of this section, whether an organization either in a foreign country or in foreign countries (collectively) is substantial in relation to the amount of royalties is determined based on all of the facts and circumstances. However, such an organization will be considered substantial in relation to the amount of royalties if active licensing expenses, as defined in paragraph (d)(2)(iii) of this section, equal or exceed 25 percent of the adjusted licensing profit, as defined in paragraph (d)(2)(iv) of this section. (iii) * * * (E) Deductions for CST Payments or PCT Payments (as defined in § 1.482– 7(b)). * * * * * (v) Cost sharing arrangements (CSAs). For purposes of paragraphs (d)(1)(i) and (ii) of this section, CST Payments or PCT Payments (as defined in § 1.482– 7(b)(1)) made by the licensor to another controlled participant (as defined in § 1.482–7(j)(1)(i)) pursuant to a CSA (as defined in § 1.482–7(a)) do not cause the activities undertaken by that other controlled participant to be considered to be undertaken by the licensor’s own officers or staff of employees. * * * * * (i) Effective/applicability dates—(1) Paragraphs (c)(2)(v) through (vii). Paragraphs (c)(2)(v) through (vii) of this section and Example 6 of paragraph VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 (c)(3) of this section apply to taxable years of controlled foreign corporations beginning on or after May 2, 2006, and for taxable years of United States shareholders with or within which such taxable years of the controlled foreign corporations end. Taxpayers may elect to apply paragraphs (c)(2)(v) through (vii) to taxable years of controlled foreign corporations beginning after December 31, 2004, and for taxable years of United States shareholders with or within which such taxable years of the controlled foreign corporations end. If an election is made to apply § 1.956– 2(b)(1)(vi) to taxable years beginning after December 31, 2004, then the election must also be made for paragraphs (c)(2)(v) through (vii) of this section. (2) Other paragraphs. Paragraphs (c)(1)(i) and (d)(1)(i) of this section apply to rents or royalties, as applicable, received or accrued during taxable years of controlled foreign corporations ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, but only with respect to property manufactured, produced, developed, or created, or in the case of acquired property, property to which substantial value has been added, on or after September 1, 2015. Paragraphs (c)(1)(iv), (c)(2)(ii), (c)(2)(iii)(E), (c)(2)(viii), (d)(1)(ii), (d)(2)(ii), (d)(2)(iii)(E), and (d)(2)(v) of this section apply to rents or royalties, as applicable, received or accrued during taxable years of controlled foreign corporations ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, to the extent that such rents or royalties are received or accrued on or after September 1, 2015. See § 1.954– 2(c)(1)(i), (c)(1)(iv), (c)(2)(ii), (c)(2)(iii), (d)(1)(i), (d)(1)(ii), (d)(2)(ii), and (d)(2)(iii), as contained in 26 CFR part 1 revised as of April 1, 2015, for rules applicable to rents or royalties, as applicable, received or accrued before September 1, 2015. * * * * * § 1.954–2T ■ [Removed] Par. 3. Section 1.954–2T is removed. Par. 4. Section 1.956–1 is amended by: ■ 1. Revising the section heading and paragraphs (a) and (b). ■ 2. Removing and reserving paragraphs (c) and (d). ■ 3. Revising paragraphs (e)(2) and (g). The revisions read as follows: ■ PO 00000 Frm 00011 Fmt 4700 Sfmt 4700 76505 § 1.956–1 Shareholder’s pro rata share of the average of the amounts of United States property held by a controlled foreign corporation. (a) In general. Subject to the provisions of section 951(a) and the regulations thereunder, a United States shareholder of a controlled foreign corporation is required to include in gross income the amount determined under section 956 with respect to the shareholder for the taxable year but only to the extent not excluded from gross income under section 959(a)(2) and the regulations thereunder. (b) Amount of United States property held indirectly by a controlled foreign corporation—(1) General rule. For purposes of section 956, United States property held indirectly by a controlled foreign corporation includes— (i) United States property held on behalf of the controlled foreign corporation by a trustee or a nominee; (ii) United States property acquired by any other foreign corporation that is controlled by the controlled foreign corporation if a principal purpose of creating, organizing, or funding by any means (including through capital contributions or debt) the other foreign corporation is to avoid the application of section 956 with respect to the controlled foreign corporation; and (iii) Property acquired by a partnership that is controlled by the controlled foreign corporation if the property would be United States property if held directly by the controlled foreign corporation, and a principal purpose of creating, organizing, or funding by any means (including through capital contributions or debt) the partnership is to avoid the application of section 956 with respect to the controlled foreign corporation. (2) Control. For purposes of paragraphs (b)(1)(ii) and (iii) of this section, a controlled foreign corporation controls a foreign corporation or partnership if the controlled foreign corporation and the other foreign corporation or partnership are related within the meaning of section 267(b) or section 707(b). For this purpose, in determining whether two corporations are members of the same controlled group under section 267(b)(3), a person is considered to own stock owned directly by such person, stock owned for the purposes of section 1563(e)(1), and stock owned with the application of section 267(c). (3) Coordination rule. Paragraph (b)(1)(iii) of this section applies only to the extent that the amount of United States property that is treated under that paragraph as held indirectly by a E:\FR\FM\03NOR1.SGM 03NOR1 76506 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations mstockstill on DSK3G9T082PROD with RULES controlled foreign corporation through the partnership exceeds the sum of— (i) The amount of United States property described in paragraph (b)(1)(iii) of this section that is treated as held by the controlled foreign corporation as a result of the application of § 1.956–4(b) with respect to the partnership; and (ii) The amount of United States property that is treated as held by the controlled foreign corporation as a result of the application of § 1.956–4(c) with respect to any portion of an obligation attributable to the funding described in paragraph (b)(1)(iii) of this section of the partnership by the controlled foreign corporation. (4) Examples. The following examples illustrate the rules of this paragraph (b). In each example, P is a domestic corporation that wholly owns two controlled foreign corporations, FS1 and FS2. Example 1. (i) Facts. FS1 sells inventory to FS2 in exchange for trade receivables due in 60 days. Avoiding the application of section 956 with respect to FS1 was not a principal purpose of establishing the trade receivables. FS2 has no earnings and profits, and FS1 has substantial accumulated earnings and profits. FS2 makes a loan to P equal to the amount it owes FS1 under the trade receivables. FS2 pays the trade receivables according to their terms. (ii) Result. FS1 will not be considered to indirectly hold United States property under this paragraph (b) because the funding of FS2 through the sale of inventory in exchange for the establishment of trade receivables was not undertaken with a principal purpose of avoiding the application of section 956 with respect to FS1. Example 2. (i) Facts. The facts are the same as in Example 1 of this paragraph (b)(4), except that, with a principal purpose of avoiding the application of section 956 with respect to FS1, FS1 and FS2 agree to defer FS2’s payment obligation, and FS2 does not timely pay the receivables. (ii) Result. FS1 is considered to hold indirectly United States property under this paragraph (b) and § 1.956–2(a) because there was a funding of FS2, a principal purpose of which was to avoid the application of section 956 with respect to FS1. Example 3. (i) Facts. FS1 has $100x of post-1986 undistributed earnings and profits and $100x post-1986 foreign income taxes, but does not have any cash. FS2 has earnings and profits of at least $100x, no post-1986 foreign income taxes, and substantial cash. Neither FS1 nor FS2 has earnings and profits described in section 959(c)(1) or section 959(c)(2). FS2 loans $100x to FS1. FS1 then loans $100x to P. An income inclusion by P of $100x under sections 951(a)(1)(B) and 956 with respect to FS1 would result in foreign income taxes deemed paid by P under section 960. A principal purpose of funding FS1 through the loan from FS2 is to avoid the application of section 956 with respect to FS2. VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 (ii) Result. Under paragraph (b)(1)(ii) of this section, FS2 is considered to indirectly hold the $100x obligation of P that is held by FS1. As a result, P has an income inclusion of $100x under sections 951(a)(1)(B) and 956 with respect to FS2, and the foreign income taxes deemed paid by P under section 960 is $0. P does not have an income inclusion under sections 951(a)(1)(B) and 956 with respect to FS1 related to the $100x loan from FS1 to P. Example 4. (i) Facts. FS1 deposits $100x with BK, an unrelated foreign financial institution. FS2 subsequently borrows $100x from BK. BK would not have loaned the $100x to FS2 on the same terms absent FS1’s deposit. FS2 loans the $100x borrowed from BK to P. FS2 has no earnings and profits, and FS1 has substantial accumulated earnings and profits. A principal purpose for the transactions is to avoid the application of section 956 with respect to FS1. (ii) Result. FS1 is considered to hold indirectly United States property under this paragraph (b) and § 1.956–2(a) because FS1’s deposit with BK, which facilitates BK’s loan to FS2, is considered a funding by FS1 of FS2, a principal purpose of which was to avoid the application of section 956 with respect to FS1. Example 5. (i) Facts. FS1 sells inventory to FS2 in exchange for $100x. The sale occurred in the ordinary course of FS1’s trade or business and FS2’s trade or business, and the terms of the sale are consistent with terms that would be observed among parties dealing at arm’s length. FS1 makes a $100x loan to P. FS2 has no earnings and profits, and FS1 has substantial accumulated earnings and profits. (ii) Result. FS2 will not be considered to indirectly hold United States property under this paragraph (b) because a sale in the ordinary course of business for cash on terms that are consistent with those that would be observed among parties dealing at arm’s length does not constitute a funding. Example 6. (i) Facts. In Year 1, FS2 loans $100x to FS1 to finance FS1’s trade or business. The terms of the loan are consistent with those that would be observed among parties dealing at arm’s length. In Year 2, FS1 repays the loan in accordance with the terms of the loan. Immediately after the repayment by FS1, FS2 loans $100x to P. FS2 has no earnings and profits, and FS1 has substantial accumulated earnings and profits. (ii) Result. FS1 will not be considered to indirectly hold United States property under this paragraph (b) because a repayment of a loan that has terms that are consistent with those that would be observed among parties dealing at arm’s length and that is repaid consistent with those terms does not constitute a funding. Example 7. (i) Facts. FS1 has substantial earnings and profits. P and FS1 are the only partners in FPRS, a foreign partnership. FS1 contributes $600x cash to FPRS in exchange for a 60% interest in the partnership, and P contributes real estate located outside the United States ($400x value) to FPRS in exchange for a 40% interest in the partnership. There are no special allocations in the FPRS partnership agreement. FPRS lends $100x to P. Under § 1.956–4(b) and PO 00000 Frm 00012 Fmt 4700 Sfmt 4700 § 1.956–2(a), FS1 is treated as holding United States property of $60x (60% x $100x) as a result of the FPRS loan to P. A principal purpose of creating, organizing, or funding FPRS is to avoid the application of section 956 with respect to FS1. (ii) Result. Before taking into account paragraph (b)(3) of this section, because FS1 controls FPRS and a principal purpose of creating, organizing, or funding FPRS was to avoid the application of section 956 with respect to FS1, FS1 is considered under paragraph (b)(1)(iii) of this section to indirectly hold the $100x obligation of P that would be United States property if held directly by FS1. However, under paragraph (b)(3) of this section, FS1 is treated as holding United States property under paragraph (b)(1)(iii) only to the extent the amount held indirectly under paragraph (b)(1)(iii) of this section exceeds the sum of the amount of the United States property that FS1 is treated as holding as a result of the application of § 1.956–4(b) with respect to FPRS. The amount of United States property that FS1 is treated as indirectly holding under paragraph (b)(1)(iii) of this section and § 1.956–2(a) ($100x) exceeds the amount determined under § 1.956–4(b) ($60x) by $40x. Thus, FS1 is considered to hold United States property within the meaning of section 956(c) in the amount of $100x ($60x under § 1.956–4(b) and $40x under paragraphs (b)(1)(iii) and (b)(3) of this section). Example 8. (i) Facts. FS1 and FS2 have substantial earnings and profits. P and FS1 are the only partners in FPRS, a foreign partnership. There are no special allocations in the FPRS partnership agreement. P’s liquidation value percentage with respect to FPRS is 40%, and FS1’s liquidation value percentage with respect to FPRS is 60%. FS2 lends $100x to FPRS, and FPRS lends $100x to P. Under § 1.956–4(c) and § 1.956–2(a), FS2 is treated as holding United States property of $40x (40% x $100x) as a result of its loan to FPRS. A principal purpose of funding FPRS is to avoid the application of section 956 with respect to FS2. (ii) Result. Before taking into account paragraph (b)(3) of this section, because FS2 controls FPRS and a principal purpose of funding FPRS was to avoid the application of section 956 with respect to FS2, FS2 is considered under paragraph (b)(1)(iii) of this section to indirectly hold the $100x obligation of P that would be United States property if held directly by FS2. However, under paragraph (b)(3) of this section, FS2 is treated as holding United States property under paragraph (b)(1)(iii) only to the extent the amount held indirectly under paragraph (b)(1)(iii) of this section exceeds the amount of United States property that FS2 is treated as holding as a result of the application of § 1.956–4(c) with respect to the obligation with which FS2 funds FPRS. The amount of United States property that FS2 is treated as indirectly holding under paragraph (b)(1)(iii) of this section and § 1.956–2(a) ($100x) exceeds the amount determined under § 1.956–4(c) ($40x) by $60x. Thus, FS2 is considered to hold United States property within the meaning of section 956(c) in the amount of $100x ($40x under § 1.956–4(c) and $60x under paragraphs (b)(1)(iii) and E:\FR\FM\03NOR1.SGM 03NOR1 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations (b)(3) of this section). P does not have an income inclusion under sections 951(a)(1)(B) and 956 with respect to FS1 related to the P obligation held by FPRS. mstockstill on DSK3G9T082PROD with RULES (c)–(d) [Reserved] (e) * * * (2) Rule for pledges and guarantees. For purposes of this section, the amount of an obligation treated as held (before application of § 1.956–4(b)) as a result of a pledge or guarantee described in § 1.956–2(c) is the unpaid principal amount of the obligation on the applicable determination date. * * * * * (g) Effective/applicability date. (1) Paragraph (a) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and to taxable years of United States shareholders in which or with which such taxable years end. (2) Paragraph (b) of this section applies to taxable years of controlled foreign corporations ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, with respect to property acquired on or after September 1, 2015. See paragraph (b)(4) of § 1.956–1T, as contained in 26 CFR part 1 revised as of April 1, 2015, for the rules applicable to taxable years of controlled foreign corporations ending before September 1, 2015, and property acquired before September 1, 2015. For purposes of this paragraph (g)(2), a deemed exchange of property pursuant to section 1001 on or after September 1, 2015 constitutes an acquisition of the property on or after that date. (3) Paragraph (e)(2) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to pledges or guarantees entered into on or after September 1, 2015. For purposes of this paragraph (g)(3), a pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor on or after September 1, 2015. * * * * * ■ Par. 5. Section 1.956–1T is revised to read as follows: § 1.956–1T Shareholder’s pro rata share of the average of the amounts of United States property held by a controlled foreign corporation. (a) through (e)(4) [Reserved] (5) Exclusion for certain recourse obligations. For purposes of § 1.956– VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 1(e)(1) of the regulations, in the case of an investment in United States property consisting of an obligation of a related person, as defined in section 954(d)(3) and paragraph (f) of § 1.954–1, a liability will not be recognized as a specific charge if the liability representing the charge is with recourse with respect to the general credit or other assets of the investing controlled foreign corporation. (e)(6) [Reserved]. For further guidance, see § 1.956–1(e)(6). (f) Effective/applicability date. Paragraph (e)(5) of this section applies to investments made on or after June 14, 1988. (g)–(h) [Reserved] ■ Par. 6. Section 1.956–2 is amended by: ■ 1. Revising paragraphs (a)(3), (c)(1), and (c)(2). ■ 2. Adding Example 4 to paragraph (c)(3). ■ 3. Adding paragraph (h). The revisions and addition read as follows: § 1.956–2 property. Definition of United States (a) * * * (3) Treatment of disregarded entities. For purposes of section 956, an obligation of a business entity (as defined in § 301.7701–2(a) of this chapter) that is disregarded as an entity separate from its owner for federal tax purposes under §§ 301.7701–1 through 301.7701–3 of this chapter is treated as an obligation of its owner. * * * * * (c) Treatment of pledges and guarantees—(1) General rule. Except as provided in paragraph (c)(4) of this section, for purposes of section 956, any obligation of a United States person with respect to which a controlled foreign corporation or a partnership is a pledgor or guarantor will be considered to be held by the controlled foreign corporation or the partnership, as the case may be. See § 1.956–1(e)(2) for rules that determine the amount of the obligation treated as held by a pledgor or guarantor under this paragraph (c). For rules that treat an obligation of a foreign partnership as an obligation of the partners in the foreign partnership for purposes of section 956, see § 1.956– 4(c). (2) Indirect pledge or guarantee. If the assets of a controlled foreign corporation or a partnership serve at any time, even though indirectly, as security for the performance of an obligation of a United States person, then, for purposes of paragraph (c)(1) of this section, the controlled foreign corporation or partnership will be considered a pledgor or guarantor of PO 00000 Frm 00013 Fmt 4700 Sfmt 4700 76507 that obligation. If a partnership is considered a pledgor or guarantor of an obligation, a controlled foreign corporation that is a partner in the partnership will not also be treated as a pledgor or guarantor of the obligation solely as a result of its ownership of an interest in the partnership. For purposes of this paragraph, a pledge of stock of a controlled foreign corporation representing at least 662⁄3 percent of the total combined voting power of all classes of voting stock of such corporation will be considered an indirect pledge of the assets of the controlled foreign corporation if the pledge is accompanied by one or more negative covenants or similar restrictions on the shareholder effectively limiting the corporation’s discretion to dispose of assets and/or incur liabilities other than in the ordinary course of business. See § 1.956–4(d) for guidance on the treatment of indirect pledges or guarantees of an obligation of a partnership attributed to its partners under § 1.956–4(c). (3) * * * Example 4. (i) Facts. USP, a domestic corporation, owns 70% of the stock of FS, a controlled foreign corporation, and a 90% interest in FPRS, a foreign partnership. X, an unrelated foreign person, owns 30% of the stock of FS. Y, an unrelated foreign person, owns a 10% interest in FPRS. There are no special allocations in the FPRS partnership agreement. FPRS borrows $100x from Z, an unrelated person. FS pledges its assets as security for FPRS’s performance of its obligation to repay the $100x loan. USP’s share of the $100x FPRS obligation, determined in accordance with its liquidation value percentage, is $90x. Under § 1.956–4(c), $90x of the FPRS obligation is treated as an obligation of USP for purposes of section 956. (ii) Result. For purposes of section 956, under paragraph (c)(1) of this section, FS is considered to hold an obligation of USP in the amount of $90x, and thus is treated as holding United States property in the amount of $90x. * * * * * (h) Effective/applicability date. (1) Paragraph (a)(3) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to obligations held on or after November 3, 2016. (2) Paragraphs (c)(1), (c)(2), and Example 4 of paragraph (c)(3) of this section apply to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which E:\FR\FM\03NOR1.SGM 03NOR1 76508 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations such taxable years end, with respect to pledges and guarantees entered into on or after September 1, 2015. For purposes of this paragraph (h)(2), a pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor on or after September 1, 2015. * * * * * ■ Par. 7. Section § 1.956–3 is added to read as follows: mstockstill on DSK3G9T082PROD with RULES § 1.956–3 Certain trade or service receivables acquired from United States persons. (a) In general. For purposes of section 956(a) and § 1.956–1, the term ‘‘United States property’’ also includes any trade or service receivable if the trade or service receivable is acquired (directly or indirectly) from a related person who is a United States person (as defined in section 7701(a)(30)) (a related United States person) and the obligor under the receivable is a United States person. A trade or service receivable described in this paragraph is considered to be United States property notwithstanding the exceptions (other than subparagraph (H)) contained in section 956(c)(2). The terms ‘‘trade or service receivable’’ and ‘‘related person’’ have the respective meanings given to the terms by section 864(d) and the regulations thereunder, including § 1.864–8T(b). For purposes of this section, the exception in § 1.956– 2T(d)(2)(ii) does not apply to trade or service receivables described in this paragraph. (b) Acquisition of a trade or service receivable—(1) General rule. The rules of § 1.864–8T(c)(1) apply to determine whether a controlled foreign corporation has acquired a trade or service receivable. (2) Indirect acquisitions—(i) Acquisition through unrelated person. A trade or service receivable is considered acquired from a related person when it is acquired from an unrelated person who acquired (directly or indirectly) the receivable from a person who is a related person to the acquiring person. (ii) Acquisition by nominee, passthrough entity, or related foreign corporation. A controlled foreign corporation is treated as holding a trade or service receivable that is held by a nominee on its behalf, or by a simple trust or other pass-through entity (other than a partnership) to the extent of its direct or indirect ownership or beneficial interest in such simple trust or other pass-through entity. See §§ 1.956–1(b) and 1.956–4(b) for rules that may treat a controlled foreign VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 corporation as indirectly holding a trade or service receivable held by a foreign corporation or partnership. A controlled foreign corporation that is treated as holding a trade or service receivable held by another person (the direct holder) (or that would be treated as holding the receivable if the receivable were United States property or would be United States property if held directly by the controlled foreign corporation) is considered to have acquired the receivable from the person from whom the direct holder acquired the receivable. This paragraph (b)(2)(ii) does not limit the application of paragraph (b)(2)(iii) of this section. The following examples illustrate the application of this paragraph (b)(2)(ii): Example 1. (i) Facts. A domestic corporation, P, wholly owns a controlled foreign corporation, FS, with substantial earnings and profits. FS contributes $200x of cash to a partnership, PRS, in exchange for an 80% partnership interest. An unrelated foreign person contributes real estate located in a foreign country with a fair market value of $50x to PRS for the remaining 20% partnership interest. There are no special allocations in the PRS partnership agreement. PRS uses the $200x of cash received from FS to purchase trade receivables from P. The obligors with respect to the trade receivables are United States persons that are not related to any partner in PRS. The liquidation value percentage, as determined under § 1.956– 4(b), for FS with respect to PRS is 80%. A principal purpose of funding PRS (through FS’s cash contribution) is to avoid the application of section 956 with respect to FS. (ii) Result. Under § 1.956–4(b)(1), FS is treated as holding 80% of the trade receivables acquired by PRS from P, with a basis equal to $160x (80% × $200x, PRS’s basis in the trade receivables). However, because FS controls PRS and a principal purpose of FS funding PRS was to avoid the application of section 956 with respect to FS, under § 1.956–1(b), if the trade receivables would be United States property if held directly by FS, FS additionally would be treated as holding the trade receivables to the extent that they exceed the amount of the receivables it holds under § 1.956–4(b), which is $40x ($200x¥$160x). Accordingly, under this paragraph (b)(2)(ii), FS is treated as having acquired from P, a related United States person, the trade receivables that it is treated as holding with a basis equal to $200x ($160x + $40x). Thus, FS is treated as holding United States property with a basis of $200x under paragraph (a) of this section. Example 2. (i) Facts. A domestic corporation, P, wholly owns a controlled foreign corporation, FS1, that has earnings and profits of at least $300x. FS1 organizes a foreign corporation, FS2, with a $200x cash contribution. FS2 uses the cash contribution to purchase trade receivables from P. The obligors with respect to the trade receivables are unrelated United States persons. A principal purpose of funding FS2 (through FS1’s cash contribution) is to avoid the PO 00000 Frm 00014 Fmt 4700 Sfmt 4700 application of section 956 with respect to FS1. (ii) Result. Under § 1.956–1(b), if the trade receivables held by FS2 were United States property, FS1 would be treated as holding the trade receivables held by FS2 because FS1 controls FS2 and a principal purpose of FS1 funding FS2 was to avoid the application of section 956 with respect to FS1. Accordingly, under this paragraph (b)(2)(ii), FS1 is treated as having acquired from P, a related United States person, the trade receivables that it would be treated as holding with a basis equal to $200x. Thus, FS1 is treated as holding United States property with a basis of $200x under paragraph (a) of this section. (iii) Swap or pooling arrangements. A trade or service receivable of a United States person is considered to be a trade or service receivable acquired from a related United States person and subject to the rules of this section when it is acquired in accordance with an arrangement that involves two or more groups of related persons, if the groups are unrelated to each other and the effect of the arrangement is that one or more persons in each group acquire (directly or indirectly) trade or service receivables from one or more unrelated United States persons who are also parties to the arrangement in exchange for reciprocal purchases of receivables from related United States persons. The following example illustrates the application of this paragraph (b)(2)(iii): Example. (i) Facts. Controlled foreign corporations A, B, C, and D are whollyowned subsidiaries of domestic corporations M, N, O, and P, respectively. M, N, O, and P are not related persons. According to a prearranged plan, A, B, C, and D each acquire trade or service receivables from M, N, O, and/or P. The obligors under some or all of the receivables acquired by each of A, B, C, and D are United States persons. (ii) Result. The effect of the prearranged plan is that each of A, B, C, and D acquires trade or service receivables of United States persons from one or more unrelated United States persons who are also parties to the arrangement, in exchange for reciprocal purchases of receivables from a related United States person. Accordingly, each of A, B, C, and D is treated as holding a trade or service receivable acquired from a related United States person and is subject to the rules of this section. As a result, each of A, B, C, and D is treated as holding an amount of United States property equal to its adjusted basis in the receivables acquired pursuant to the arrangement with respect to which the obligors are United States persons. (iv) Financing arrangements. If a controlled foreign corporation participates (directly or indirectly) in a lending transaction that results in a loan to a United States person who purchases property described in section 1221(a)(1) (inventory property) or services from a related United States person, or to any E:\FR\FM\03NOR1.SGM 03NOR1 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations mstockstill on DSK3G9T082PROD with RULES person who purchases from a related United States person trade or service receivables under which the obligor is a United States person, or to a person who is a related person with respect to the purchaser, and if the loan would not have been made or maintained on the same terms but for the corresponding purchase, then the controlled foreign corporation is considered to have indirectly acquired a trade or service receivable described in paragraph (a) of this section. For purposes of this paragraph (b)(2)(iv), it is immaterial that the sums lent are not, in fact, the sums used to finance the purchase of the inventory property or services or trade or service receivables from a related United States person. The amount to be taken into account with respect to the United States property treated as held by a controlled foreign corporation as a result of the application of this paragraph (b)(2)(iv) is the lesser of the amount lent pursuant to a lending transaction described in this paragraph (b)(2)(iv) and the purchase price of the inventory property, services, or trade or service receivables. The following examples illustrate the application of this paragraph (b)(2)(iv): Example 1. (i) Facts. P, a domestic corporation, owns all of the outstanding stock of FS1, a controlled foreign corporation. P sells inventory property for $200x to X, an unrelated United States person. FS1 makes a $100x short-term loan to X, which loan would not have been made or maintained on the same terms but for X’s purchase of P’s inventory property. (ii) Result. FS1 directly participates in a lending transaction described in this paragraph (b)(2)(iv). Thus, FS1 is considered to have acquired a trade or service receivable described in paragraph (a) of this section. That is, FS1 is considered to have acquired a trade or service receivable of a United States person from a related United States person. As a result, FS1 is treated as holding United States property in the amount of $100x. Example 2. (i) Facts. The facts are the same as in Example 1 of this paragraph (b)(2)(iv), except that instead of loaning money to X directly, FS1 deposits $300x with an unrelated financial institution that loans $200x to X in order for X to purchase P’s inventory property. The loan would not have been made or maintained on the same terms but for the corresponding deposit. (ii) Result. FS1 is considered to have acquired a trade or service receivable described in paragraph (a) of this section because FS1 indirectly participates in a lending transaction described in this paragraph (b)(2)(iv). See Rev. Rul. 87–89, 1987–2 CB 195. That is, FS1 is considered to have acquired a trade or service receivable of a United States person from a related United States person. Thus, FS1 is treated as holding United States property in the amount of $200x. VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 Example 3. (i) Facts. P, a domestic corporation, owns all of the outstanding stock of FS1, a controlled foreign corporation. FS1 makes a $300x loan to U, an unrelated foreign corporation, in connection with U’s purchase from P of receivables from the sale of inventory property by P to United States obligors for $200x. (ii) Result. FS1 is considered to have acquired a trade or service receivable described in paragraph (a) of this section because FS1 directly participates in a lending transaction described in this paragraph (b)(2)(iv). That is, FS1 is considered to have acquired a trade or service receivable of a United States person from a related United States person. Thus, FS1 is treated as holding United States property in the amount of $200x. (c) Substitution of obligor. For purposes of this section, the substitution of another person for a United States obligor is disregarded, unless it can be demonstrated by the parties to the transaction that the primary purpose for the arrangement was not the avoidance of section 956. The following example illustrates the application of this paragraph (c): Example. (i) Facts. P, a domestic corporation, owns all of the outstanding stock of FS1, a controlled foreign corporation with substantial accumulated earnings and profits. P sells inventory property to X, a domestic corporation unrelated to P. To pay for the inventory property, X arranges for a foreign financing entity to issue a note to P. P then sells the note to FS1. P and X cannot demonstrate that the primary purpose for X’s assignment of the payment obligation to the foreign financing entity was not the avoidance of section 956. (ii) Result. The substitution of the foreign financing entity for X is disregarded, and FS1 is treated as holding an obligation of a United States person acquired from a related United States person. Thus, FS1 is treated as holding United States property in the amount of the purchase price of the note. (d) Effective/applicability date—(1) Except as provided in paragraph (d)(2) of this section, this section applies to trade or service receivables acquired (directly or indirectly) after March 1, 1984. (2) Paragraph (b)(2)(ii) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to trade or service receivables acquired on or after September 1, 2015. For purposes of this paragraph (d), a significant modification, within the meaning of § 1.1001–3(e), of a trade or service receivable on or after September 1, 2015, constitutes an acquisition of the trade or service receivable on or after that date. PO 00000 Frm 00015 Fmt 4700 Sfmt 4700 § 1.956–3T 76509 [Removed] Par. 8. Section 1.956–3T is removed. Par. 9. Section 1.956–4 is added to read as follows: ■ ■ § 1.956–4 Certain rules applicable to partnerships. (a) Overview. This section provides rules concerning the application of section 956 to certain obligations of and property held by a partnership. Paragraph (b) of this section provides rules concerning United States property held indirectly by a controlled foreign corporation through a partnership. Paragraph (c) of this section provides rules that generally treat obligations of a foreign partnership as obligations of the partners in the foreign partnership, as well as a special rule that treats a partner that is a United States person as owing additional amounts of a partnership obligation in certain circumstances. Paragraph (d) of this section sets forth a rule concerning the application of the indirect pledge or guarantee rule to obligations of partnerships. Paragraph (e) of this section provides that obligations of a domestic partnership are obligations of a United States person. Paragraph (f) of this section provides effective and applicability dates. See §§ 1.956–1(b) and 1.956–2(c) for additional rules applicable to partnerships. (b) Property held indirectly through a partnership—(1) General rule. For purposes of section 956, a partner in a partnership is treated as holding its attributable share of any property held by the partnership (including an obligation that the partnership is treated as holding as a result of the application of § 1.956–2(c)). A partner’s attributable share of partnership property is determined under the rules set forth in paragraph (b)(2) of this section. An upper-tier partnership’s attributable share of the property of a lower-tier partnership is treated as property of the upper-tier partnership for purposes of applying this paragraph (b)(1) to the partners of the upper-tier partnership. For purposes of section 956, a partner’s adjusted basis in the property of the partnership equals the partner’s attributable share of the partnership’s adjusted basis in the property, as determined under the rules set forth in paragraph (b)(2) of this section, taking into account any adjustments to basis under section 743(b) (with respect to the partner) or section 734(b) or any similar adjustments to basis. The rules in § 1.956–1(e)(2) apply to determine the amount of an obligation treated as held by a partnership as a result of the application of § 1.956–2(c). See § 1.956– E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES 76510 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations 1(b) for special rules that may treat a controlled foreign corporation as holding a greater amount of United States property held by a partnership than the amount determined under this section. (2) Methodology—(i) Liquidation value percentage—(A) Calculation. Except as otherwise provided in paragraph (b)(2)(ii) of this section, for purposes of paragraph (b)(1) of this section, a partner’s attributable share of partnership property is determined in accordance with the partner’s liquidation value percentage. For purposes of this paragraph (b)(2)(i) and paragraph (c)(1) of this section, the liquidation value of a partner’s interest in a partnership is the amount of cash the partner would receive with respect to the interest if, on the applicable determination date, as provided in paragraph (b)(2)(i)(B) of this section, the partnership sold all of its assets for cash equal to the fair market value of such assets (taking into account section 7701(g)), satisfied all of its liabilities (other than those described in § 1.752– 7), paid an unrelated third party to assume all of its § 1.752–7 liabilities in a fully taxable transaction, and then liquidated. A partner’s liquidation value percentage is the ratio (expressed as a percentage) of the liquidation value of the partner’s interest in the partnership divided by the aggregate liquidation value of all of the partners’ interests in the partnership. (B) Determination date. The determination date with respect to a partnership is the most recent of— (1) The formation of the partnership; (2) An event described in § 1.704– 1(b)(2)(iv)(f)(5) or § 1.704– 1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether the capital accounts of the partners are adjusted in accordance with § 1.704–1(b)(2)(iv)(f); or (3) The first day of the partnership’s taxable year, as determined under section 706, provided the liquidation value percentage determined for any partner on that day would differ from the most recently determined liquidation value percentage of that partner by more than 10 percentage points. (ii) Special allocations. For purposes of paragraph (b)(1) of this section, if a partnership agreement provides for the allocation of book income (or, where appropriate, book gain) from a subset of the property of the partnership to a partner other than in accordance with the partner’s liquidation value percentage in a particular taxable year (a special allocation), then the partner’s attributable share of that property is determined solely by reference to the VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 partner’s special allocation with respect to the property, provided the special allocation does not have a principal purpose of avoiding the purposes of section 956. (3) Examples. The following examples illustrate the rule of this paragraph (b): Example 1. (i) Facts. USP, a domestic corporation, wholly owns FS, a controlled foreign corporation, which, in turn, owns an interest in FPRS, a foreign partnership. The remaining interest in FPRS is owned by an unrelated foreign person. FPRS holds nondepreciable property with an adjusted basis of $100x (the ‘‘FPRS property’’) that would be United States property if held by FS directly. At the close of quarter 1 of year 1, the liquidation value percentage, as determined under paragraph (b)(2) of this section, for FS with respect to FPRS is 25%. There are no special allocations in the FPRS partnership agreement. (ii) Result. Under paragraph (b)(1) of this section, for purposes of section 956, FS is treated as holding its attributable share of the property held by FPRS with an adjusted basis equal to its attributable share of FPRS’s adjusted basis in such property. Under paragraph (b)(2) of this section, FS’s attributable share of property held by FPRS is determined in accordance with FS’s liquidation value percentage, which is 25%. Thus, FS’s attributable share of the FPRS property is 25%, and its attributable share of FPRS’s basis in the FPRS property is $25x. Accordingly, for purposes of determining the amount of United States property held by FS as of the close of quarter 1 of year 1, FS is treated as holding United States property with an adjusted basis of $25x. Example 2. (i) Facts. The facts are the same as in Example 1 of this paragraph (b)(3), except that the FPRS partnership agreement, which satisfies the requirements of section 704(b), specially allocates 80% of the income with respect to the FPRS property to FS. The special allocation does not have a principal purpose of avoiding the purposes of section 956. (ii) Result. Under paragraph (b)(1) of this section, for purposes of section 956, FS is treated as holding its attributable share of property held by FPRS with an adjusted basis equal to its attributable share of FPRS’s adjusted basis in such property. In general, FS’s attributable share of property held by FPRS is determined in accordance with FS’s liquidation value percentage. However, because the special allocation does not have a principal purpose of avoiding the purposes of section 956, under paragraph (b)(2)(ii) of this section, FS’s attributable share of the FPRS property is determined by reference to its special allocation. FS’s special allocation percentage for the FPRS property is 80%, and thus FS’s attributable share of the FPRS property is 80% and its attributable share of FPRS’s basis in the FPRS property is $80x. Accordingly, for purposes of determining the amount of United States property held by FS as of the close of quarter 1 of year 1, FS is treated as holding United States property with an adjusted basis of $80x. Example 3. (i) Facts. USP, a domestic corporation, wholly owns FS, a controlled PO 00000 Frm 00016 Fmt 4700 Sfmt 4700 foreign corporation, which, in turn, owns an interest in FPRS, a foreign partnership. USP owns the remaining interest in FPRS. FPRS holds property (the ‘‘FPRS property’’) that would be United States property if held by FS directly. The FPRS property has an adjusted basis of $100x and is anticipated to appreciate in value but generate relatively little income. The FPRS partnership agreement, which satisfies the requirements of section 704(b), specially allocates 80% of the income with respect to the FPRS property to USP and 80% of the gain with respect to the disposition of FPRS property to FS. The special allocation does not have a principal purpose of avoiding the purposes of section 956. (ii) Result. Because the special allocation does not have a principal purpose of avoiding the purposes of section 956, under paragraph (b)(2)(ii) of this section, FS’s attributable share of the FPRS property is determined by reference to a special allocation with respect to the FPRS property. Given the income and gain anticipated with respect to the FPRS property, it is appropriate to determine FS’s attributable share of the property in accordance with the special allocation of gain. Accordingly, for purposes of determining the amount of United States property held by FS in each year that FPRS holds the FPRS property, FS’s attributable share of the FPRS property is 80% and its attributable share of FPRS’s basis in the FPRS property is $80x. Thus, FS is treated as holding United States property with an adjusted basis of $80x. (c) Obligations of a foreign partnership—(1) In general. Except as provided in paragraphs (c)(2) and (c)(3) of this section, for purposes of section 956, an obligation of a foreign partnership is treated as a separate obligation of each of the partners in the partnership to the extent of each partner’s share of the obligation. A partner’s share of the partnership’s obligation is determined in accordance with the partner’s liquidation value percentage, as determined under the rules set forth in paragraph (b)(2)(i) of this section, without regard to the rules set forth in paragraph (b)(2)(ii) of this section. An upper-tier partnership’s share of an obligation of a lower-tier partnership is treated as an obligation of the upper-tier partnership for purposes of applying this paragraph (c)(1) to the partners of the upper-tier partnership. (2) Exception for obligations of partnerships in which neither the lending controlled foreign corporation nor any person related to the lending controlled foreign corporation is a partner. For purposes of applying section 956 with respect to a controlled foreign corporation, an obligation of a foreign partnership is treated as an obligation of a foreign partnership, and not as an obligation of its partners, if neither the controlled foreign corporation nor any person related to E:\FR\FM\03NOR1.SGM 03NOR1 mstockstill on DSK3G9T082PROD with RULES Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations the controlled foreign corporation within the meaning of section 954(d)(3) is a partner in the partnership. For purposes of section 956, an obligation treated as an obligation of a foreign partnership pursuant to this paragraph (c)(2) is not an obligation of a United States person. (3) Special obligor rule in the case of certain partnership distributions—(i) General rule. For purposes of determining a partner’s share of a foreign partnership’s obligation under section 956, if the foreign partnership distributes an amount of money or property to a partner that is related to a controlled foreign corporation within the meaning of section 954(d)(3) and whose obligation would be United States property if held (or if treated as held) by the controlled foreign corporation, and the foreign partnership would not have made the distribution but for a funding of the partnership through an obligation held (or treated as held) by a controlled foreign corporation, notwithstanding § 1.956– 1(e), the partner’s share of the partnership obligation is the greater of— (A) The partner’s share of the partnership obligation as determined under paragraph (c)(1) of this section; and (B) The lesser of the amount of the distribution to the partner that would not have been made but for the funding of the partnership and the amount of the obligation (as determined under § 1.956–1(e)). (ii) Deemed treatment—(A) For purposes of applying paragraph (c)(3)(i) of this section, in the case of a distribution of liquid assets by a foreign partnership to a partner, the foreign partnership is treated as if it would not have made the distribution of liquid assets to the partner but for the funding of the partnership through an obligation or obligations held (or treated as held) by the controlled foreign corporation to the extent the foreign partnership does not have sufficient liquid assets to make the distribution immediately prior to the distribution, without taking into account the obligation or obligations. (B) If the controlled foreign corporation holds (or is treated as holding) multiple obligations of the foreign partnership, paragraph (c)(3)(ii)(A) of this section applies to the obligations in reverse chronological order starting with the obligation that was acquired (or the obligation with respect to which a pledge or guarantee was entered into) closest in time to the distribution. Paragraph (c)(3)(ii)(A) of this section applies to an obligation only to the extent that the full amount of the distribution is not otherwise treated, VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 pursuant to paragraph (c)(3)(ii)(A) of this section, as if it would not have been made but for the funding of the partnership through one or more other obligations. (C) For purposes of paragraph (c)(3)(ii) of this section, a significant modification, within the meaning of § 1.1001–3(e), of an obligation constitutes an acquisition of the obligation on or after that date, and a pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor. (D) For purposes of paragraph (c)(3)(ii) of this section, liquid assets means cash or cash equivalents, marketable securities within the meaning of section 453(f)(2), or an obligation owed by a related person (within the meaning of section 954(d)(3)). (4) Examples. The following examples illustrate the rules of this paragraph (c): Example 1. (i) Facts. USP, a domestic corporation, wholly owns FS, a controlled foreign corporation, and owns an interest in FPRS, a foreign partnership. At the close of quarter 1 of year 1, the liquidation value percentage, as determined under paragraph (b)(2)(i) of this section, for USP with respect to FPRS is 90%. X, a foreign person that is unrelated to USP or FS, owns the remaining interest in FPRS. FPRS borrows $100x from FS. FS’s basis in the FPRS obligation is $100x. (ii) Result. Under paragraph (c)(1) of this section, for purposes of section 956, the obligation of FPRS is treated as obligations of its partners (USP and X) in proportion to each partner’s liquidation value percentage with respect to FPRS. Because USP, a partner in FPRS, is related to FS within the meaning of section 954(d)(3), the exception in paragraph (c)(2) of this section does not apply. Based on its liquidation value percentage, USP’s share of the FPRS obligation is $90x. Accordingly, for purposes of section 956, $90x of the FPRS obligation held by FS is treated as an obligation of USP and is United States property within the meaning of section 956(c). Therefore, on the date the loan is made, FS is treated as holding United States property of $90x. Example 2. (i) Facts. The facts are the same as in Example 1 of this paragraph (c)(4), except that USP owns 40% of the stock of FS and is not a related person (as defined in section 954(d)(3)) with respect to FS. Y, a United States person that is unrelated to USP or X, owns the remaining 60% of the stock of FS. (ii) Result. Because neither FS nor any person related to FS within the meaning of section 954(d)(3) is a partner in FPRS, the exception in paragraph (c)(2) of this section applies to treat the FPRS obligation as an obligation of a foreign partnership and not an obligation of a United States person. Therefore, paragraph (c)(1) of this section PO 00000 Frm 00017 Fmt 4700 Sfmt 4700 76511 does not apply, and FS is not treated as holding United States property. Example 3. (i) Facts. USP, a domestic corporation, wholly owns FS, a controlled foreign corporation. USP and FS own interests in FPRS, a foreign partnership. USP’s liquidation value percentage with respect to FPRS is 60%, and FS’s liquidation value percentage with respect to FPRS is 30%. U.S.C., a domestic corporation that is unrelated to USP and FS, also owns an interest in FPRS; its liquidation value percentage is 10%. FPRS borrows $100x from an unrelated person. FS guarantees the FPRS obligation. (ii) Result. Under paragraph (c)(1) of this section, for purposes of section 956, the obligation of FPRS is treated as obligations of its partners (USP, FS, and U.S.C.) in proportion to each partner’s liquidation value percentage. Because USP, a partner in FPRS, is related to FS within the meaning of section 954(d)(3), and because FS is a partner in FPRS, the exception in paragraph (c)(2) of this section does not apply. Based on their liquidation value percentages, USP’s share of the FPRS obligation is $60x, and U.S.C.’s share of the FPRS obligation is $10x. For purposes of section 956, $60x of the FPRS obligation is treated as an obligation of USP, and $10x of the FPRS obligation is treated as an obligation of U.S.C. Under § 1.956–2(c)(1), FS is treated as holding the obligations of USP and U.S.C. that FS guaranteed. All of the exceptions to the definition of United States property contained in section 956 and § 1.956–2 must be considered to determine whether the obligations of USP and U.S.C. that are treated as held by FS constitute United States property. Accordingly, the obligation of U.S.C. is not United States property under section 956(c)(2)(F) and § 1.956–2(b)(1)(viii). The obligation of USP, however, is United States property within the meaning of section 956(c). Therefore, on the date the guarantee is made, FS is treated as holding United States property of $60x. Example 4. (i) Facts. USP, a domestic corporation, wholly owns FS, a controlled foreign corporation. USP owns an interest in FPRS, a foreign partnership; its liquidation value percentage with respect to FPRS is 70%. A domestic corporation that is unrelated to USP and FS owns the remaining interest in FPRS; its liquidation value percentage is 30%. FPRS borrows $100x from FS and makes a distribution of $80x to USP. FPRS would not have made the distribution to USP but for the funding of FPRS by FS. (ii) Result. Because USP, a partner in FPRS, is related to FS within the meaning of section 954(d)(3), the exception in paragraph (c)(2) of this section does not apply. Moreover, an obligation of USP held by FS would be United States property. USP’s share of the FPRS obligation as determined under paragraph (c)(1) of this section in accordance with USP’s liquidation value percentage is $70x. Under paragraph (c)(3) of this section, USP’s share of the FPRS obligation is the greater of (i) USP’s attributable share of the obligation, $70x, or (ii) the lesser of the amount of the distribution, $80x, or the amount of the obligation, $100x. For purposes of section 956, therefore, $80x of the FPRS obligation is treated as an E:\FR\FM\03NOR1.SGM 03NOR1 76512 Federal Register / Vol. 81, No. 213 / Thursday, November 3, 2016 / Rules and Regulations mstockstill on DSK3G9T082PROD with RULES obligation of USP and is United States property within the meaning of section 956(c). Thus, on the date the loan is made, FS is treated as holding United States property of $80x. (d) Limitation on a partner’s indirect pledge or guarantee. For purposes of section 956 and § 1.956–2(c), a controlled foreign corporation that is a partner in a partnership is not considered a pledgor or guarantor of the portion of an obligation of the partnership attributed to its partners that are United States persons under paragraph (c) of this section solely as a result of the attribution of a portion of the partnership’s assets to the controlled foreign corporation under paragraph (b) of this section. (e) Obligations of a domestic partnership. For purposes of section 956, an obligation of a domestic partnership is an obligation of a United States person. See section 956(c)(2)(L) for an exception from the treatment of such an obligation as United States property. (f) Effective/applicability dates. (1) Paragraph (b) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to property acquired on or after November 3, 2016. For purposes of this paragraph (f)(1), a deemed exchange of property pursuant to section 1001 on or after November 3, 2016, constitutes an acquisition of the property on or after that date. See § 1.956–2(a)(3), as contained in 26 CFR part 1 revised as of April 1, 2016, for the rules applicable to taxable years of a controlled foreign corporation beginning on or after July 23, 2002, and ending before November 3, 2016, and with respect to property acquired before November 3, 2016, to taxable years of a controlled foreign corporation beginning on or after July 23, 2002. (2) Except as otherwise provided in this paragraph (f)(2), paragraph (c) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to obligations acquired, or pledges or guarantees entered into, on or after September 1, 2015, and, for purposes of paragraph (c)(3) of this section, in the case of distributions made on or after September 1, 2015. Paragraph (c)(3)(ii) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States VerDate Sep<11>2014 16:18 Nov 02, 2016 Jkt 241001 shareholders in which or with which such taxable years end, with respect to obligations acquired, or pledges or guarantees entered into, on or after September 1, 2015, and distributions made on or after November 3, 2016. For purposes of this paragraph (f)(2), a significant modification, within the meaning of § 1.1001–3(e), of an obligation on or after September 1, 2015 constitutes an acquisition of the obligation on or after that date. Furthermore, for purposes of this paragraph (f)(2), a pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor on or after September 1, 2015. See § 1.956–1T(b)(5), as contained in 26 CFR part 1 revised as of April 1, 2016, for rules applicable to taxable years of controlled foreign corporations ending on or after September 1, 2015, and before November 3, 2016, and to taxable years of United States shareholders in which or with which such taxable years end, in the case of distributions made on or after September 1, 2015. (3) Paragraph (d) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and taxable years of United States shareholders in which or with which such taxable years end, with respect to pledges or guarantees entered into on or after September 1, 2015. For purposes of this paragraph (f)(3), a pledgor or guarantor is treated as entering into a pledge or guarantee when there is a significant modification, within the meaning of § 1.1001–3(e), of an obligation with respect to which it is a pledgor or guarantor on or after September 1, 2015. (4) Paragraph (e) of this section applies to taxable years of controlled foreign corporations ending on or after November 3, 2016, and to taxable years of United States shareholders in which or with which such taxable years end, with respect to obligations held on or after November 3, 2016. John Dalrymple, Deputy Commissioner for Services and Enforcement. Approved: October 17, 2016. Mark J. Mazur, Assistant Secretary of the Treasury (Tax Policy). [FR Doc. 2016–26425 Filed 11–2–16; 8:45 am] BILLING CODE 4830–01–P PO 00000 Frm 00018 Fmt 4700 Sfmt 4700 DEPARTMENT OF HOMELAND SECURITY Coast Guard 33 CFR Part 117 [Docket No. USCG–2016–0966] Drawbridge Operation Regulation; Harlem River, New York City, NY Coast Guard, DHS. Notice of deviation from drawbridge regulation. AGENCY: ACTION: The Coast Guard has issued a temporary deviation from the operating schedule that governs the Spuyten Duyvil Bridge across the Harlem River, mile 7.9, New York City, New York. This deviation is necessary to allow the bridge owner to perform a test of the submarine cables at the bridge. DATES: This deviation is effective from 10 p.m. on December 9, 2016 to 7 a.m. on December 11, 2016. ADDRESSES: The docket for this deviation, [USCG–2016–0966] is available at http://www.regulations.gov. Type the docket number in the ‘‘SEARCH’’ box and click ‘‘SEARCH’’. Click on Open Docket Folder on the line associated with this deviation. FOR FURTHER INFORMATION CONTACT: If you have questions on this temporary deviation, call or email Judy Leung-Yee, Project Officer, First Coast Guard District, telephone (212) 514–4330, email judy.k.leung-yee@uscg.mil. SUPPLEMENTARY INFORMATION: The Spuyten Duyvil Bridge, mile 7.9, across the Harlem River, has a vertical clearance in the closed position of 5 feet at mean high water and 9 feet at mean low water. The existing bridge operating regulations are found at 33 CFR 117.789(d). The waterway is transited by commercial vessels. The bridge owner, National Railroad Passenger Corporation (Amtrak), requested a temporary deviation from the normal operating schedule to perform a test of the submarine cables at the bridge. Under this temporary deviation, the Spuyten Duyvil Bridge shall remain in the closed position from 10 p.m. on December 9, 2016 to 7 a.m. on December 11, 2016. Vessels able to pass under the bridge in the closed position may do so at any time. The bridge will be able to open for emergencies and there is an alternate route for vessels to pass. The Coast Guard will inform the users of the waterways through our Local and Broadcast Notices to Mariners of the SUMMARY: E:\FR\FM\03NOR1.SGM 03NOR1

Agencies

[Federal Register Volume 81, Number 213 (Thursday, November 3, 2016)]
[Rules and Regulations]
[Pages 76497-76512]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-26425]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9792]
RIN 1545-BJ48


United States Property Held by Controlled Foreign Corporations in 
Transactions Involving Partnerships; Rents and Royalties Derived in the 
Active Conduct of a Trade or Business

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations that provide rules 
regarding the treatment as United States property of property held by a 
controlled foreign corporation (CFC) in connection with certain 
transactions involving partnerships. In addition, the final regulations 
provide rules for determining whether a CFC is considered to derive 
rents and royalties in the active conduct of a trade or business for 
purposes of determining foreign personal holding company income 
(FPHCI), as well as rules for determining whether a CFC holds United 
States property as a result of certain related party factoring 
transactions. This document finalizes proposed regulations, and 
withdraws temporary regulations, published on September 2, 2015. It 
also finalizes proposed regulations, and withdraws temporary 
regulations, published on June 14, 1988. The final regulations affect 
United States shareholders of CFCs.

DATES: 
    Effective Date: These regulations are effective on November 3, 
2016.
    Applicability Dates: For dates of applicability, see Sec. Sec.  
1.954-2(i), 1.956-1(g), 1.956-2(h), 1.956-3(d), and 1.956-4(f).

FOR FURTHER INFORMATION CONTACT: Rose E. Jenkins, (202) 317-6934 (not a 
toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    On September 2, 2015, the Department of the Treasury (Treasury 
Department) and the IRS published final and temporary regulations under 
sections 954 and 956 (TD 9733) (the 2015 temporary regulations) in the 
Federal Register (80 FR 52976, as corrected at 80 FR 66415 and 80 FR 
66416). On the same date, the Treasury Department and the IRS published 
a notice of proposed rulemaking (REG-155164-09) (the 2015 proposed 
regulations) in the Federal Register (80 FR 53058, as corrected at 80 
FR 66485) cross-referencing the temporary regulations and proposing 
additional regulations under section 956 regarding the treatment as 
United States property of property held by a CFC in connection with 
certain transactions involving partnerships. No public hearing was 
requested or held. Formal written comments were received with respect 
to the 2015 proposed regulations under section 956 and are available at 
www.regulations.gov or upon request. No comments were received with 
respect to the 2015 proposed regulations under section 954. This 
Treasury decision adopts the 2015 proposed regulations, with the 
changes described in the Summary of Comments and Explanation of 
Revisions section of this preamble, as final regulations and removes 
the corresponding temporary regulations. No changes are made to the 
regulations under section 954.
    Additionally, on June 14, 1988, the Treasury Department and the IRS 
published temporary regulations under sections 304, 864, and 956 (TD 
8209) in the Federal Register (53 FR 22163), which included guidance 
under section 956(c)(3) treating as United States property certain 
trade or service receivables acquired by a CFC from a related United 
States person in certain factoring transactions (the 1988 temporary 
regulations). On the same date, the Treasury Department and the IRS 
published a notice of proposed rulemaking (INTL-49-86, subsequently 
converted to REG-209001-86) (the 1988 proposed regulations) in the 
Federal Register (53 FR 22186) cross-referencing the 1988 temporary 
regulations. Although formal written comments were received on the 1988 
proposed regulations, none relate to the specific issues addressed in 
these final regulations. This Treasury decision adopts Sec.  1.956-3 of 
the 1988 proposed regulations without substantive change as a final 
regulation (together with the 2015 proposed regulations adopted as 
final regulations, these final regulations) and removes the 
corresponding temporary regulations. This preamble does not discuss the 
formal written comments concerning other rules in the 1988 proposed 
regulations, which are beyond the scope of these final regulations. The 
other portions of the 1988 proposed regulations remain in proposed 
form, except to the extent withdrawn in the partial withdrawal of the 
notice of proposed rulemaking published in the Proposed Rules section 
of this issue of the Federal Register (REG-122387-16).
    The Treasury Department and the IRS published Revenue Ruling 90-112 
(1990-2 CB 186) (see Sec.  601.601(d)(2)(ii)(b)), on December 31, 1990, 
before promulgating the rule in Sec.  1.956-2(a)(3) that, prior to 
modification by this document, addressed the application of section 956 
when a CFC is a partner in a partnership that holds property that would 
be United States property if owned directly by the CFC. This Treasury 
decision withdraws Revenue Ruling 90-112.

Summary of Comments and Explanation of Revisions

    Section 956 determines the amount that a United States shareholder 
(as defined in section 951(b)) of a CFC must include in gross income 
with respect to the CFC under section 951(a)(1)(B). This amount is 
determined, in part, based on the average of the amounts of United 
States property held, directly or indirectly, by the CFC at the close 
of each quarter during its taxable year. For this purpose, in general, 
the amount taken into account with respect to any United States 
property is the adjusted basis of the property, reduced by any 
liability to which the property is subject. See section 956(a) and 
Sec.  1.956-1(e). Section 956(e) grants the Secretary authority to 
prescribe such regulations as may be necessary to carry out the 
purposes of section 956, including regulations to prevent the avoidance 
of section 956 through reorganizations or otherwise.
    These final regulations retain the basic approach and structure of 
the 2015 proposed regulations and the portion of the 1988 proposed 
regulations that relates to Sec.  1.956-3, with certain revisions, as 
discussed in this Summary of Comments and Explanation of Revisions.

1. Changes to Sec.  1.956-1 To Conform to the Current Statute

    These final regulations take into account certain statutory changes 
in section 13232(a) of the Revenue Reconciliation Act of 1993 (Pub. L. 
103-66, 107 Stat. 312) (the 1993 Act) regarding the methodology for

[[Page 76498]]

calculating the amount determined under section 956 with respect to a 
United States shareholder of a CFC. As enacted in section 12 of the 
Revenue Act of 1962 (Pub. L. 87-834, 76 Stat. 960) (the 1962 Act), and 
prior to the modification made by the 1993 Act, section 951(a)(1)(B) 
required a United States shareholder to include an amount in income 
based on its pro rata share of the CFC's ``increase in earnings 
invested in United States property'' for the relevant taxable year. 
Section 956 (as then in effect), in turn, defined the amount of 
earnings of a CFC invested in United States property at the close of a 
taxable year and set forth rules for determining a United States 
shareholder's pro rata share of the CFC's increase in earnings for a 
taxable year.
    The 1993 Act revised the structure and operating rules for 
determining amounts included in income under sections 951(a)(1)(B) and 
956. In general, as revised in 1993, the amount determined under 
section 956 is based on a United States shareholder's pro rata share of 
the average amount of United States property held by the CFC as of the 
close of each quarter of the relevant taxable year. The amendments made 
by the 1993 Act are effective for tax years of CFCs beginning after 
September 30, 1993, and for tax years of United States shareholders in 
which or with which such tax years of CFCs end.
    On February 20, 1964, the Treasury Department and the IRS published 
Sec.  1.956-1 (TD 6704 (29 FR 2599), which was amended by TD 6795 (30 
FR 933) in 1965, TD 7712 (45 FR 52373) in 1980, and TD 8209 (53 FR 
22163) in 1988) when the section 956 amount was still determined based 
on the increase of a CFC's earnings invested in United States property 
during the relevant tax year. Amendments to Sec.  1.956-1 made after 
1993 (TD 9402 (73 FR 35580) and TD 9530 (76 FR 36993, corrected at 76 
FR 43891)) did not revise the regulation to reflect the changes to 
section 956(a) made by the 1993 Act. The Treasury Department and the 
IRS are aware that some taxpayers have attempted to apply parts of 
Sec.  1.956-1 to tax years for which those parts were superseded by the 
1993 Act. In order to avoid confusion, these final regulations revise 
the section heading of Sec.  1.956-1 (as well as the parallel heading 
of Sec.  1.956-1T), and the general rules in Sec.  1.956-1(a), to 
reflect changes made in the 1993 Act. In addition, these final 
regulations remove the text in paragraphs (b)(1) through (3), (c), and 
(d) of Sec.  1.956-1 in order to conform Sec.  1.956-1 to the Code and 
reserve paragraphs (c) and (d). As a result, proposed Sec.  1.956-
1(b)(4) is redesignated as Sec.  1.956-1(b) in these final regulations.

2. Section 1.956-1(b) Anti-Avoidance Rule

    Prior to the 2015 temporary regulations, Sec.  1.956-1T(b)(4) 
provided that a CFC would be considered to hold indirectly investments 
in United States property acquired by any other foreign corporation 
that is controlled by the foreign corporation if one of the principal 
purposes for creating, organizing, or funding (thorugh capital 
contributions or debt) such other foreign corporation is to avoid the 
application of section 956 with respect to the CFC. The 2015 temporary 
regulations modified the anti-avoidance rule in Sec.  1.956-1T(b)(4) so 
that the rule can also apply when a foreign corporation controlled by a 
CFC is funded other than through capital contributions or debt and 
expanded the rule to apply to transactions involving partnerships that 
are controlled by a CFC.
A. Definition of Funding
    In response to the additional guidance on the term funding, a 
comment suggested that the modification gives rise to uncertainty 
concerning the application of the anti-avoidance rule and requested 
that the anti-avoidance rule be revised in these final regulations in 
one of three alternative ways in order to clarify the application of 
the rule: (i) Reverting to the language in Sec.  1.956-1T(b)(4) in 
effect prior to the 2015 temporary regulations; (ii) defining the term 
funding as either a related CFC contributing capital to or holding debt 
of the funded entity, or an unrelated person contributing capital to or 
holding debt of the funded entity, provided that the contribution or 
loan would not have been made or maintained on the same terms but for 
the funding CFC contributing capital to or holding debt of the 
unrelated person; or (iii) clarifying the scope of the term funding 
with examples that depict when the rule applies and illustrating that 
common business transactions conducted on arm's-length terms and 
certain other transactions would not be considered a funding for 
purposes of the rule.
    The Treasury Department and the IRS continue to be concerned about 
tax planning that is inconsistent with the policy underlying section 
956. The policy concerns addressed by the anti-avoidance rule are not 
limited to fundings by debt or equity; rather, the anti-avoidance rule 
should apply to all fundings with a principal purpose of avoiding the 
purposes of section 956, regardless of the form of the funding. The 
Treasury Department and the IRS have concluded that reverting to the 
prior formulation of the rule, which applied when there was a ``funding 
(through capital contributions or debt),'' or adopting the narrow 
definition of funding proposed in the comment could allow taxpayers to 
engage in planning that would inappropriately avoid the application of 
section 956.
    In addition, the Treasury Department and the IRS disagree with the 
view expressed in the comment that the expanded scope of fundings could 
result in common business transactions being subject to the anti-
avoidance rule. Whether a transaction is a ``funding'' does not alone 
determine whether the transaction is subject to the anti-avoidance rule 
because the rule applies only when a principal purpose of the funding 
is to avoid section 956 with respect to the funding CFC. Thus, although 
the 2015 temporary regulations broaden the funding standard, the 
``avoidance'' requirement ensures that ordinary course transactions are 
not subject to the anti-avoidance rule.
    The Treasury Department and the IRS agree, however, that examples 
illustrating that the anti-avoidance rule should not apply to certain 
common transactions would be helpful. Accordingly, these final 
regulations add new examples that address common transactions 
highlighted by the comment to further illustrate the distinction 
between funding transactions that are subject to the anti-avoidance 
rule and common business transactions to which the anti-avoidance rule 
does not apply. See Example 4 through Example 6 of Sec.  1.956-1(b)(4). 
For example, Example 5 and Example 6 illustrate a sale of property for 
cash in the ordinary course of business and a repayment of a loan, 
respectively, to which the anti-avoidance rule does not apply. However, 
Example 4 illustrates that, consistent with the holding in situation 3 
in Revenue Ruling 87-89 (1987-2 CB 195), a CFC may be treated as 
holding United States property as a result of a deposit with an 
unrelated bank if the unrelated bank would not have made a loan to 
another person on the same terms absent the CFC's deposit.
B. Application To Acquisitions of Property by a Partnership Controlled 
by a CFC
    Section 1.956-1(b)(4) of the 2015 proposed regulations expands the 
anti-avoidance rule to include transactions involving partnerships that 
are controlled by a CFC that provides funding to the partnership. 
Proposed Sec.  1.956-1(b)(4)(iii) contains a coordination rule that 
provides that this

[[Page 76499]]

new partnership rule applies only to the extent that the amount of 
United States property that a CFC would be treated as holding under the 
rule exceeds the amount that it would be treated as holding under 
proposed Sec.  1.956-4(b). The coordination rule prevents a CFC from 
being treated as holding duplicative amounts of United States property 
as a result of a single partnership interest pursuant to the 
application of proposed Sec. Sec.  1.956-1(b)(4) and 1.956-4(b). This 
rule is illustrated by Example 4 in proposed Sec.  1.956-1(b)(4)(iv), 
which is included as Example 7 in Sec.  1.956-1(b)(4) of these final 
regulations.
    A comment recommended that the anti-avoidance rule should not apply 
in the case of a partnership in which the funding CFC is a partner, as 
in Example 4 in proposed Sec.  1.956-1(b)(4)(iv). Noting that proposed 
Sec.  1.956-4(b) would treat a funding CFC that is a partner in the 
funded partnership as owning a share of any United States property 
acquired by the partnership using the funding, the comment asserted 
that the inclusion resulting from proposed Sec.  1.956-4(b) is 
sufficient and there is no need for the anti-avoidance rule to apply to 
create a disproportionate inclusion that would deter taxpayers from 
entering into transactions in order to avoid the application of section 
956. The Treasury Department and the IRS, however, do not agree with 
the premise of this comment that the anti-avoidance rule results in a 
disproportionate inclusion in this case. Rather, the Treasury 
Department and the IRS consider that, in the circumstances in which the 
anti-avoidance rule would apply, the funded entity, which is controlled 
by the CFC, essentially serves as a surrogate for the funding CFC with 
respect to the investment in United States property. Accordingly, the 
Treasury Department and the IRS have determined that, when a 
partnership acts as a surrogate for a CFC partner's investment in 
United States property, the CFC partner's interest in the United States 
property should not be limited to the CFC's attributable share of the 
property as determined under Sec.  1.956-4(b). For these reasons, the 
comment is not adopted.
    With respect to the coordination rule in proposed Sec.  1.956-
1(b)(4)(iii), another comment noted that a CFC also could be treated as 
holding duplicative amounts of United States property as a result of a 
single partnership obligation pursuant to the application of proposed 
Sec. Sec.  1.956-1(b)(4) and 1.956-4(c). For example, suppose a 
domestic corporation (P) wholly owns two controlled foreign 
corporations (FS1 and FS2), and P is a 40% partner in a foreign 
partnership (FPRS), while FS1 is a 60% partner. Suppose further that 
FS2 loans $100x to FPRS, which FPRS uses to acquire $100x of United 
States property. In these circumstances, FS2 would be treated as 
holding $40x of United States property under proposed Sec.  1.956-4(c) 
and existing Sec.  1.956-2(a) (and would not be treated as holding any 
United States property under proposed Sec.  1.956-4(b)) and could be 
treated under proposed Sec.  1.956-1(b)(4) and existing Sec.  1.956-
2(a) as holding the $100x of United States property acquired by the 
partnership with its funding. The Treasury Department and the IRS have 
determined that it is appropriate to limit the amount of United States 
property that FS2 is treated as holding in the example to $100x, 
consistent with the result that would apply if FS2 had not funded 
FPRS's acquisition of United States property and instead had acquired 
the United States property itself. (Note that, in a case where proposed 
Sec.  1.956-1(b)(4) would apply, FPRS should not be treated as holding 
the United States property that would be treated under that rule as 
held by FS2, and accordingly, FS1 should not be treated as holding 
United States property under proposed Sec.  1.956-4(b) in this 
example.) Accordingly, the coordination rule in proposed Sec.  1.956-
1(b)(4)(iii) is expanded in final Sec.  1.956-1(b)(3) to prevent a CFC 
from being treated as holding duplicative amounts of United States 
property under the anti-avoidance rule as a result of a partnership 
obligation, and an additional example is added to illustrate this rule. 
See Sec.  1.956-1(b)(4), Example 8.
    Further, as noted in the preamble to the 2015 proposed regulations, 
the references to Sec.  1.956-2(a)(3) in proposed Sec.  1.956-
1(b)(4)(iii) and in the examples in proposed Sec.  1.956-1(b)(4)(iv) 
that illustrate the application of proposed Sec.  1.956-1(b)(4)(i)(C) 
are supplanted in these final regulations with references to Sec.  
1.956-4(b), which replaces Sec.  1.956-2(a)(3) in these final 
regulations as the applicable rule concerning United States property 
held indirectly by a controlled foreign corporation through a 
partnership.

3. Factoring Rules

    As noted in the Background section of this preamble, in 1988, the 
Treasury Department and the IRS proposed Sec.  1.956-3 to address the 
application of section 956 to property acquired by a CFC in certain 
related party factoring transactions. No comments were received on 
these proposed rules. The 2015 proposed regulations proposed revisions 
to these proposed rules in Sec.  1.956-3(b)(2)(ii) with respect to the 
application of section 956 to acquisitions of receivables indirectly 
through a nominee, pass-through entity, or related foreign corporation, 
and no comments were received on these proposed revisions. These final 
regulations adopt these portions of the 2015 proposed regulations 
without change, and also adopt the remainder of the rules in proposed 
Sec.  1.956-3 that were proposed in the 1988 proposed regulations, with 
minor revisions to improve clarity and conform to existing regulations.

4. Partnership Property Indirectly Held by a CFC Partner

    Under proposed Sec.  1.956-4(b)(1), a CFC partner in a partnership 
is treated as holding its attributable share of property held by the 
partnership. In addition, proposed Sec.  1.956-4(b)(1) provides that, 
for purposes of section 956, a partner's adjusted basis in the property 
of the partnership equals the partner's attributable share of the 
partnership's adjusted basis in the property.
    Under proposed Sec.  1.956-4(b)(2), a CFC partner's attributable 
share of partnership property is determined in accordance with the CFC 
partner's liquidation value percentage with respect to the partnership, 
unless the partnership agreement contains a special allocation of 
income (or, where appropriate, gain) with respect to a particular item 
or items of partnership property that differs from the partner's 
liquidation value percentage in a particular taxable year. In that 
case, the partner's attributable share of the property is determined 
solely by reference to the partner's special allocation with respect to 
the property, provided the special allocation does not have a principal 
purpose of avoiding the purposes of section 956.
A. Revenue Ruling 90-112's Outside Basis Limitation
    As noted in the Background section of this Preamble, in 1990, the 
Treasury Department and the IRS published Revenue Ruling 90-112, which 
addressed the treatment under section 956 of United States property 
held by a CFC indirectly through a partnership. The holding in the 
revenue ruling generally is consistent with Sec.  1.956-2(a)(3) (added 
by TD 9008, 67 FR 58020, in 2002), as well as proposed Sec.  1.956-
4(b), in that a CFC that is a partner in a partnership is treated as 
indirectly holding property held by the partnership when the property 
would be United States property if the CFC held

[[Page 76500]]

it directly. However, the revenue ruling includes a limitation on the 
measurement of United States property that is not included in the final 
or proposed regulations. Specifically, the revenue ruling provides that 
the amount of United States property taken into account for purposes of 
section 956 when a CFC partner indirectly owns property through a 
partnership is limited by the CFC's adjusted basis in the partnership.
    The outside basis limitation in Revenue Ruling 90-112 has resulted 
in a lack of clarity concerning the determination of the amount of 
United States property held by a CFC partner through a partnership 
because neither Sec.  1.956-2(a)(3) nor proposed Sec.  1.956-4(b) 
include the limitation. A comment requested that proposed Sec.  1.956-
4(b)(1) be revised to add the outside basis limitation because the 
limitation is reflective of the underlying economics and consistent 
with the policy underlying section 956.
    After consideration of the comment, the Treasury Department and the 
IRS have concluded that the outside basis limitation is not warranted. 
The rule in proposed Sec.  1.956-4(b)(1) is based on an aggregate 
approach to partnerships and measures the amount of United States 
property indirectly held by a CFC partner on a property-by-property 
basis. An overall limitation on the amount of United States property a 
CFC partner is considered to indirectly hold through a partnership is 
inconsistent with this property-by-property aggregate approach to 
United States property held by the partnership. Additionally, a 
limitation determined by reference to a CFC partner's basis in its 
partnership interest is less consistent with section 956(a), which 
provides that the amount of United States property directly or 
indirectly held by a CFC is determined by reference to the adjusted 
basis of the United States property itself. Moreover, the Treasury 
Department and the IRS are concerned that, under the rules of 
subchapter K, adjustments may be made to outside basis through the 
allocation of liabilities pursuant to the regulations under section 752 
that are inconsistent with the policy of section 956. Accordingly, the 
Treasury Department and the IRS have determined that an outside basis 
limitation should not be incorporated into the rule in proposed Sec.  
1.956-4(b)(1). Because proposed Sec.  1.956-4(b)(1) indicates that, for 
purposes of section 956, a partner's adjusted basis in the property of 
the partnership equals the partners' attributable share of the 
partnership's adjusted basis in the property, no revision to the rule 
is necessary to clarify that there is no outside basis limitation.
    Revenue Ruling 90-112 is obsoleted in the Effect on Other Documents 
section of this preamble. For tax years ending prior to the 
obsolescence of the revenue ruling, taxpayers may rely on the outside 
basis limitation provided in the revenue ruling.
B. Consistent Use of Liquidation Value Percentage Method for Purposes 
of Both Sec.  1.956-4(b) and (c)
    In contrast to the rule provided in proposed Sec.  1.956-4(b) 
providing that a CFC partner's attributable share of partnership 
property is determined in accordance with the CFC partner's liquidation 
value percentage, proposed Sec.  1.956-4(c) provided that a partner's 
share of a partnership obligation is determined in accordance with the 
partner's interest in partnership profits. The preamble to the 2015 
proposed regulations requested comments as to whether a single method 
should be used as the general rule for determining both a partner's 
share of partnership assets under proposed Sec.  1.956-4(b) and a 
partner's share of a partnership obligation under proposed Sec.  1.956-
4(c), and, if so, whether the appropriate measure would be a partner's 
interest in partnership profits, liquidation value percentage, or an 
alternative measure. Comments suggested that a liquidation value 
percentage method should be used for purposes of both sets of rules. In 
accordance with these comments, these final regulations retain the 
liquidation value percentage method set forth in proposed Sec.  1.956-
4(b), and, as discussed in Part 5.B of this Summary of Comments and 
Explanation of Revisions, revise the general rule in proposed Sec.  
1.956-4(c) to implement the liquidation value percentage method.
C. Time for Determining the Liquidation Value Percentage
    A comment recommended that the liquidation value percentage of 
partners in a partnership should be determined on an annual basis, 
rather than upon formation and upon the occurrence of events described 
in Sec.  1.704-1(b)(2)(iv)(f)(5) or Sec.  1.704-1(b)(2)(iv)(s)(1) 
(revaluation events) as provided in proposed Sec.  1.956-4(b)(2)(i). 
The comment noted that partnerships do not necessarily book up (or 
adjust) partnership capital accounts in connection with revaluation 
events and suggested that requiring a redetermination of liquidation 
value percentage regardless of whether a book-up occurs would impose a 
burden on such partnerships. The comment also noted that partners' 
relative economic interests in the partnership may change for reasons 
unrelated to revaluation events, such as when a partnership agreement 
provides for different profit sharing percentages that apply based on 
different hurdles.
    The Treasury Department and the IRS continue to consider it 
appropriate for liquidation value percentage to be redetermined upon a 
revaluation event, which may result in a significant change in the 
partners' relative economic interests in a partnership. Accordingly, 
upon a revaluation event, a partnership is required to determine the 
partnership's capital accounts resulting from a hypothetical book up at 
such point in time even if the partnership did not actually book up 
capital accounts in connection with such an event. However, in light of 
the comment's observation that partners' relative economic interests in 
the partnership may change significantly as a result of allocations of 
income or other items under the partnership agreement even in the 
absence of a revaluation event, Sec.  1.956-4(b)(2)(i) of these final 
regulations provides that a partner's liquidation value percentage must 
be redetermined in certain additional circumstances. Specifically, if 
the liquidation value percentage determined for any partner on the 
first day of the partnership's taxable year would differ from the most 
recently determined liquidation value percentage of that partner by 
more than 10 percentage points, then the liquidation value percentage 
must be redetermined on that day even in the absence of a revaluation 
event. For example, if the liquidation value percentage of a partner 
was determined upon a revaluation event to be 40 percent and, on the 
first day of a subsequent year before the occurrence of another 
revaluation event, would be less than 30 percent or more than 50 
percent if redetermined on that day, then the liquidation value 
percentage must be redetermined on that day.
D. Special Allocations
    Proposed Sec.  1.956-4(b)(2)(ii) defines a special allocation as an 
allocation of income (or, where appropriate, gain) from partnership 
property to a partner under a partnership agreement that differs from 
the partner's liquidation value percentage in a particular taxable 
year. In this regard, questions have arisen as to whether allocations 
pursuant to section 704(c) and the regulations thereunder constitute 
special allocations. Although a partnership agreement may reference 
section 704(c) or provide for the adoption of a particular section 
704(c)

[[Page 76501]]

method, allocations under section 704(c) are tax allocations required 
by operation of the Code and regulations. In response to these 
questions, the Treasury Department and the IRS have revised the 
definition of special allocations in final Sec.  1.956-4(b)(2)(ii) to 
clarify that a special allocation is an allocation of book income or 
gain, rather than a tax allocation such as the allocations required 
under section 704(c).
    Questions also have arisen as to whether certain allocations of 
income with respect to all of the property of a partnership, as opposed 
to allocations of income from a specific item or subset of partnership 
property, constitute special allocations described in proposed Sec.  
1.956-4(b)(2)(i). These final regulations clarify that, for purposes of 
these regulations, a special allocation means only an allocation of 
income (or, where appropriate, gain) from a subset of the property of 
the partnership to a partner other than in accordance with the 
partner's liquidation value percentage in a particular taxable year.
    As noted in this Part 4 of this Summary of Comments and Explanation 
of Revisions, proposed Sec.  1.956-4(b)(2)(ii) states that a partner's 
attributable share of an item of partnership property is not determined 
by reference to a special allocation with respect to the property if 
the special allocation has a principal purpose of avoiding the purposes 
of section 956. A comment requested that these final regulations 
provide guidance on the circumstances in which special allocations are 
treated as having a principal purpose of avoiding section 956. 
Specifically, the comment suggested that proposed Sec.  1.956-4(b) be 
revised to include a presumption that a transaction does not have a 
principal purpose of avoiding section 956 when the allocation is 
respected under section 704(b) and is reasonable taking into account 
the facts and circumstances relating to the economic arrangement of the 
partners and the characteristics of the property at issue.
    The determination of whether a special allocation has a principal 
purpose of avoiding the purposes of section 956 must take into account 
all of the relevant facts and circumstances, which include the factors 
set forth in the comment. However, an allocation adopted with a 
principal purpose of avoiding the purposes of section 956 could 
nonetheless be respected under section 704(b), which is not based on, 
and does not take into account, section 956 policy considerations. In 
addition, it is not clear what additional clarity would be added by the 
reasonableness requirement, which itself is necessarily a facts-and-
circumstances determination. After consideration of the comment, the 
Treasury Department and the IRS have determined that the presumption 
requested by the comment is not appropriate, and the comment is not 
adopted.
    A comment noted that determining a partner's attributable share of 
an item of property by reference to a special allocation of income or 
gain with respect to that property could produce results that are 
inconsistent with the liquidation value percentage approach because of 
the forward-looking nature of special allocations. The comment 
described, but did not explicitly recommend, an alternative approach 
that would limit the effect of a special allocation to the portion of 
the liquidation value that represents actual appreciation, as opposed 
to initial book value. The Treasury Department and the IRS recognize 
the conceptual issue highlighted by the comment but have determined 
that the alternative approach described by the comment would entail 
substantial administrative complexity. Additionally, the Treasury 
Department and the IRS continue to consider it appropriate, in cases in 
which special allocations are economically meaningful, to determine a 
partner's attributable share of property in accordance with such 
special allocations, since such allocations replicate the effect of 
owning, outside of the partnership, an interest in the property that is 
proportional to the special allocation.
    However, the Treasury Department and the IRS have determined that 
special allocations with respect to a partnership controlled by a U.S. 
multinational group (a controlled partnership) and its CFCs are 
unlikely to have economic significance for the group as a whole and can 
facilitate inappropriate tax planning. Accordingly, the Treasury 
Department and the IRS are proposing a new rule in a notice of proposed 
rulemaking in the Proposed Rules section of this issue of the Federal 
Register (REG-114734-16) under which a partner's attributable share of 
property of a controlled partnership is determined solely in accordance 
with the partner's liquidation value percentage, without regard to any 
special allocations.

5. Obligations of Foreign Partnerships

A. Use of an Aggregate Approach as the General Rule
    Pursuant to section 956(c), United States property includes an 
obligation of a United States person. In addition, under section 956(d) 
and Sec.  1.956-2(c), a CFC is treated as holding an obligation of a 
United States person if the CFC is a pledgor or guarantor of the 
obligation. Therefore, if a CFC makes or guarantees a loan to a United 
States person, an income inclusion may be required with respect to the 
CFC under sections 951(a)(1)(B) and 956. Under the general rule in 
proposed Sec.  1.956-4(c)(1), an obligation of a foreign partnership 
would be treated as an obligation of its partners in proportion to the 
partners' interest in partnership profits, unless the exception in 
proposed Sec.  1.956-4(c)(2) (for obligations of partnerships in which 
neither the lending CFC nor any person related to the lending CFC is a 
partner) or the special rule in proposed Sec.  1.956-4(c)(3) (regarding 
certain partnership distributions) applies. Thus, the general rule 
adopts an aggregate approach that would treat an obligation of a 
foreign partnership as an obligation of its partners.
    A comment asserted that taking the aggregate approach to a foreign 
partnership for this purpose is overly broad and inconsistent with the 
policy underlying section 956. The comment states that a CFC loan to a 
foreign partnership results in a repatriation of CFC earnings to the 
United States partners in the partnership only when the loan proceeds 
either are used to acquire United States property or are distributed to 
the partners, which, according to the comment, are adequately addressed 
in Sec.  1.956-1T(b)(4) and (5). Accordingly, the comment requested 
that the rules in Sec.  1.956-1T(b)(4) and (5) be finalized, but that 
the general rule in Sec.  1.956-4(c)(1) be removed. Thus, the comment 
generally advocates for the treatment of a foreign partnership as an 
entity, with anti-abuse rules to address certain situations. In 
contrast, another comment indicated that the concerns identified in the 
preamble to the 2015 proposed regulations ``constitute an appropriate 
basis for the general aggregate approach of [proposed Sec.  1.956-
4(c)(1)]''.
    After consideration of the comments, the Treasury Department and 
the IRS have concluded that it is appropriate to retain the aggregate 
approach of the general rule in proposed Sec.  1.956-4(c). The Treasury 
Department and the IRS disagree with the assertion that the aggregate 
approach is not supported by the policy of section 956. As discussed in 
the preamble to the 2015 proposed regulations, failing to treat an 
obligation of a foreign partnership as an obligation of its partners 
could allow for the deferral of U.S. taxation of CFC earnings and 
profits in a manner that is inconsistent with the purpose of section

[[Page 76502]]

956. As discussed in that preamble, the legislative history provides 
that Congress intended section 956 to apply when deferred CFC earnings 
are made available to a United States shareholder, which occurs when a 
United States shareholder conducts operations through a foreign 
partnership that are funded by deferred CFC earnings, without regard to 
whether there is any distribution from the partnership to the United 
States shareholder. In addition, as described in Section C of this Part 
5 of this Summary of Comments and Explanation of Revisions, there are 
exceptions from the treatment of obligations as United States property 
under Sec.  1.956-4(c) that the Treasury Department and the IRS have 
determined mitigate some of the concerns about the breadth of the 
general rule raised by the comment. Accordingly, the final regulations 
do not adopt the recommendation to abandon the aggregate approach.
B. Liquidation Value Percentage Method
    The preamble to the 2015 proposed regulations requested comments on 
whether the liquidation value percentage method or another method would 
be a more appropriate basis for determining a partner's share of a 
foreign partnership's obligation. In addition, as noted in Part 4.B of 
this Summary of Comments and Explanation of Revisions, the 2015 
proposed regulations solicited comments on whether a single method 
should be used for determining both a partner's share of partnership 
assets under proposed Sec.  1.956-4(b) and a partner's share of 
partnership obligations under proposed Sec.  1.956-4(c).
    Comments highlighted a number of issues related to applying a rule 
based on a partner's interest in partnership profits and noted the lack 
of guidance in the 2015 proposed regulations for applying this standard 
for purposes of proposed Sec.  1.956-4(c). The comments stated that a 
partner's interest in partnership profits would be a difficult standard 
to apply for partnerships other than simple partnerships, because a 
partner's interest in partnership profits can fluctuate significantly 
from year to year, as well as during a taxable year. The comments noted 
that the proposed rule did not address whether the determination would 
be made based solely on the partnership's profits in the current year 
or whether the determination would take into account the expected 
profits over the term of the partnership. Moreover, under section 
956(a), the amount of United States property held by a CFC as a result 
of being treated as holding an obligation of a related United States 
person under proposed Sec.  1.956-4(c) would be the average of the 
amounts held by the CFC at the close of each quarter of its taxable 
year. Thus, under proposed Sec.  1.956-4(c), taxpayers would need to 
determine a CFC partner's interest in partnership profits on a 
quarterly basis when a relevant partnership obligation is outstanding 
throughout a taxable year. As a result, calculating the amount of 
United States property held by a CFC in a taxable year could be 
complicated when a partner's interest in partnership profits is not 
known until the end of the taxable year (such as when there are one or 
more tiers of allocations of partnership profits based on various 
internal rate of return hurdles). Furthermore, the requirement to 
determine a CFC's interest in United States property on a quarterly 
basis could result in the calculation of a section 956 amount that is 
inconsistent with the annual profit allocated to the partner from the 
partnership for that year.
    After consideration of these comments, the Treasury Department and 
the IRS have determined that the liquidation value percentage method 
should be used to determine a partner's share of a foreign 
partnership's obligation because of the potential for complexity in 
calculating a partner's interest in partnership profits for purposes of 
proposed Sec.  1.956-4(c) as well as the uncertainty inherent in the 
method. The liquidation value percentage method is a sound indicator of 
a partner's interest in a partnership. Moreover, the objective rules 
provided in proposed Sec.  1.956-4(b) for determining the liquidation 
value percentage provide more certainty than the rule in proposed Sec.  
1.956-4(c). In addition, using the same standard for determining a 
partner's share of partnership property and a partner's share of 
partnership obligations reduces complexity for taxpayers that must 
apply both sets of rules for purposes of section 956 with respect to a 
single partnership. Accordingly, these final regulations provide that 
an obligation of a foreign partnership is treated as an obligation of 
its partners in proportion to the partners' liquidation value 
percentage with respect to the partnership. As described in Part 4.C of 
this Summary of Comments and Explanation of Revisions, a partner's 
liquidation value percentage must be determined upon formation of a 
partnership and any revaluation events and in certain other 
circumstances in which redetermination of the liquidation value 
percentage would result in a significant change from the previously 
determined liquidation value percentage.
C. Exceptions From General Rule of Aggregate Treatment
    Proposed Sec.  1.956-4(c)(2) provides an exception from the 
aggregate treatment of proposed Sec.  1.956-4(c)(1) that applies if 
neither the CFC that holds the obligation (or is treated as holding the 
obligation) nor any person related to the CFC (within the meaning of 
section 954(d)(3)) is a partner in the partnership on the CFC's 
quarterly measuring date on which the treatment of the obligation as 
United States property is being determined. A comment suggested an 
additional exception from the general rule in proposed Sec.  1.956-
4(c)(1) providing for aggregate treatment of partnership obligations. 
The comment requested that an obligation of a foreign partnership not 
be treated as an obligation of its partners to the extent that the 
obligation arises from a routine, ordinary course transaction between 
the lending CFC and the foreign partnership.
    The comment highlighted a fact pattern involving an obligation 
arising from a deposit by a CFC with a foreign partnership that acts as 
a coordination center for a taxpayer's cash pooling system. In this 
case, the comment asserted that any United States partners in the 
partnership should not be considered to have accessed the deferred 
earnings of the CFC deposited with the partnership and that, 
accordingly, the aggregate approach to partnership obligations should 
not apply to treat the CFC as holding an obligation of the United 
States partners for purposes of section 956. Regarding this fact 
pattern, the Treasury Department and the IRS observe that the short-
term obligation exception in Sec.  1.956-2T(d)(2)(iv), which applies 
when a CFC holds obligations of a United States person for a limited 
period of time during a taxable year, generally would prevent an 
inclusion under section 956 in the fact pattern described in the 
comment if the CFC had a net deposit with the partnership only for the 
limited period of time described in that exception. The Treasury 
Department and the IRS have concluded that there is no reason to 
provide a more expansive exception from United States property 
treatment for obligations of a foreign partnership with certain United 
States persons as partners than would apply with respect to obligations 
incurred directly by those same United States persons.
    Another comment recommended adding a new de minimis exception that

[[Page 76503]]

would provide that an obligation of a foreign partnership is not 
treated as an obligation of a United States person that is a partner if 
the United States person and its related persons own less than a 
specified percentage, 10% or 20%, of the profits and capital interests 
in the foreign partnership. The comment noted that a U.S. partner with 
a relatively small interest in a partnership may lack the ability to 
cause the partnership to make a distribution to the U.S. partner.
    Although a U.S. partner with a relatively small partnership 
interest may not be able to compel a distribution from the partnership, 
the potential to directly access partnership assets is not, as the 
comment acknowledges, the sole or overriding consideration motivating 
the aggregate approach to partnerships under the proposed regulations 
and these final regulations. Even if the other partners in a 
partnership in which a United States shareholder of a CFC is a minority 
partner are unrelated to the United States shareholder, the United 
States shareholder would still benefit from the funding of the 
partnership's business with deferred earnings of the CFC to the extent 
of its interest in the partnership. Additionally, as noted in the 
preamble to the 2015 proposed regulations, a standard based on whether 
the funding CFC or a related person is a partner in the partnership, 
rather than whether such persons own a certain minimum interest in the 
partnership, is consistent with the relevant exception adopted by 
Congress in section 956(c)(2)(L).
    Accordingly, the Treasury Department and the IRS have determined 
that the additional exceptions to aggregate treatment suggested in the 
comments are not warranted.
D. Special Obligor Rule in the Case of Certain Distributions
    The 2015 proposed regulations include a special funded distribution 
rule that increases the amount of a foreign partnership obligation that 
is treated as United States property when the following requirements 
are satisfied: (i) A CFC lends funds (or is a pledgor or guarantor with 
respect to a loan) to a foreign partnership whose obligation is, in 
whole or in part, United States property with respect to the CFC 
pursuant to proposed Sec.  1.956-4(c)(1) and existing Sec.  1.956-2(a); 
(ii) the partnership distributes an amount of money or property to a 
partner that is related to the CFC (within the meaning of section 
954(d)(3)) and whose obligation would be United States property if held 
(or treated as held) by the CFC; (iii) the foreign partnership would 
not have made the distribution but for a funding of the partnership 
through an obligation held (or treated as held) by the CFC; and (iv) 
the distribution exceeds the partner's share of the partnership 
obligation as determined in accordance with the partner's interest in 
partnership profits. When these requirements are satisfied, proposed 
Sec.  1.956-4(c)(3) provided that the amount of the partnership 
obligation that is treated as an obligation of the distributee partner 
(and thus as United States property held by the CFC) is the lesser of 
the amount of the distribution that would not have been made but for 
the funding of the partnership and the amount of the partnership 
obligation.
    Comments suggested that taxpayers might take the position that the 
``but for'' requirement in proposed Sec.  1.956-4(c)(3) is not 
satisfied in certain situations in which CFC earnings are effectively 
repatriated to a partner that is a related United States person. For 
example, taxpayers might take the position that a partnership 
distribution could have been made without the funding by the CFC merely 
by establishing that a third party would have loaned the funds needed 
for the partnership to make the distribution. The Treasury Department 
and the IRS have determined that this position is inconsistent with the 
purposes of this rule. Accordingly, these final regulations clarify the 
funded distribution rule by providing with respect to the ``but for'' 
requirement in proposed Sec.  1.956-4(c)(3) that a foreign partnership 
will be treated as if it would not have made a distribution of liquid 
assets but for a funding of the partnership through obligations held 
(or treated as held) by a CFC to the extent the foreign partnership did 
not have sufficient liquid assets to make the distribution immediately 
prior to the distribution, without taking into account the obligations. 
When a CFC holds (or is treated as holding) multiple obligations of the 
foreign partnership to which this rule could potentially apply, its 
applicability is determined first with respect to the obligation 
acquired (or treated as acquired) closest in time to the distribution, 
and then successively to other obligations further in time from the 
distribution until the distribution is fully accounted for.

6. Comments Concerning Multiple Inclusions

    Comments were received in response to the request for comments 
included in the preamble to the 2015 proposed regulations concerning 
whether the Treasury Department and the IRS should exercise the 
authority granted under section 956(e) to prescribe regulations 
concerning situations in which multiple CFCs serve, or are treated, as 
pledgors or guarantors of a single obligation for purposes of section 
956(d) in order to limit the aggregate inclusions of a United States 
shareholder with respect to a CFC under sections 951(a)(1)(B) and 956 
to the unpaid principal amount of the obligation. The Treasury 
Department and the IRS continue to study the comments concerning 
multiple inclusions under section 956(d), which do not impact any of 
the proposed regulations adopted by this Treasury decision.

Effective/Applicability Dates

    The rules in Sec.  1.954-2(c)(1)(i) and (d)(1)(i) (regarding the 
active development test) apply to rents or royalties, as applicable, 
received or accrued during taxable years of CFCs ending on or after 
September 1, 2015, and to taxable years of United States shareholders 
in which or with which such taxable years end, but only with respect to 
property manufactured, produced, developed, or created, or, in the case 
of acquired property, property to which substantial value has been 
added, on or after September 1, 2015. The rules in Sec.  1.954-
2(c)(1)(iv), (c)(2)(ii), (d)(1)(ii), and (d)(2)(ii) (regarding the 
active marketing test), as well as the rules in Sec.  1.954-
2(c)(2)(iii)(E), (c)(2)(viii), (d)(2)(iii)(E), and (d)(2)(v) (regarding 
cost-sharing arrangements), apply to rents or royalties, as applicable, 
received or accrued during taxable years of CFCs ending on or after 
September 1, 2015, and to taxable years of United States shareholders 
in which or with which such taxable years end, to the extent that such 
rents or royalties are received or accrued on or after September 1, 
2015. The section 956 anti-avoidance rules in Sec.  1.956-1(b) apply to 
taxable years of CFCs ending on or after September 1, 2015, and to 
taxable years of United States shareholders in which or with which such 
taxable years end, with respect to property acquired, including 
property treated as acquired as the result of a deemed exchange of 
property pursuant to section 1001, on or after September 1, 2015. The 
rules regarding factoring transactions in Sec.  1.956-3 (other than 
Sec.  1.956-3(b)(2)(ii)) apply to trade or service receivables acquired 
(directly or indirectly) after March 1, 1984.
    The remaining rules in these final regulations apply to taxable 
years of CFCs ending on or after November 3, 2016, and taxable years of 
United States shareholders in which or with which such taxable years 
end. In general, these remaining rules apply to property

[[Page 76504]]

acquired, or pledges or guarantees entered into, on or after September 
1, 2015, including property considered acquired, and pledges and 
guarantees considered entered into, on or after September 1, 2015, as a 
result of a deemed exchange pursuant to section 1001. See Sec.  1.956-
4(c) (dealing with obligations of foreign partnerships); Sec. Sec.  
1.956-2(c), 1.956-4(d), and 1.956-1(e)(2) (dealing with pledges and 
guarantees, including pledges and guarantees by a partnership and with 
respect to obligations of a foreign partnership); and Sec.  1.956-
3(b)(2)(ii) (dealing with trade and service receivables acquired from 
related United States persons indirectly through nominees, pass-through 
entities, or related foreign corporations). Two rules, however, apply 
to all obligations held on or after November 3, 2016. See Sec. Sec.  
1.956-2(a)(3) and 1.956-4(e) (dealing with obligations of disregarded 
entities and domestic partnerships, respectively). Finally, Sec.  
1.956-4(b) (dealing with partnership property indirectly held by a CFC) 
applies to property acquired on or after November 3, 2016. No inference 
is intended as to the application of the provisions amended by these 
final regulations under prior law, including in transactions involving 
obligations of foreign partnerships. The IRS may, where appropriate, 
challenge transactions under the Code, regulatory provisions under 
prior law, or judicial doctrines.

Effect on Other Documents

    Rev. Rul. 90-112 (1990-2 CB 186) is obsolete as of November 3, 
2016.

Special Analyses

    Certain IRS regulations, including these regulations, are exempt 
from the requirements of Executive Order 12866, as supplemented and 
reaffirmed by Executive Order 13563. 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), 
the notice of proposed rulemaking preceding these regulations was 
submitted to the Chief Counsel of Advocacy of the Small Business 
Administration for comment on its impact on small business.

Drafting Information

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

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 is amended by adding 
entries in numerical order to read in part as follows:

    Authority: 26 U.S.C. 7805 * * *
    Section 1.956-1 also issued under 26 U.S.C. 956(d) and 956(e).
    Section 1.956-2 also issued under 26 U.S.C. 956(d) and 956(e).
    Section 1.956-3 also issued under 26 U.S.C. 864(d)(8) and 
956(e).
    Section 1.956-4 also issued under 26 U.S.C. 956(d) and 956(e).
* * * * *

0
 Par. 2. Section 1.954-2 is amended by:
0
 1. Revising paragraphs (c)(1)(i), (c)(1)(iv), and (c)(2)(ii).
0
 2. Removing the word ``and'' at the end of paragraph (c)(2)(iii)(C).
0
 3. Removing the period at the end of paragraph (c)(2)(iii)(D) and 
adding in its place a semicolon and the word ``and''.
0
 4. Revising paragraphs (c)(2)(iii)(E) and (c)(2)(viii).
0
5. Revising paragraphs (d)(1)(i), (d)(1)(ii), and (d)(2)(ii).
0
 6. Removing the word ``and'' at the end of paragraph (d)(2)(iii)(C).
0
 7. Removing the period at the end of paragraph (d)(2)(iii)(D), and 
adding in its place a semicolon and the word ``and''.
0
 8. Revising paragraphs (d)(2)(iii)(E) and (d)(2)(v).
0
 9. Revising paragraph (i).
    The revisions and additions read as follows:


Sec.  1.954-2   Foreign personal holding company income.

* * * * *
    (c) * * *
    (1) * * *
    (i) Property that the lessor, through its own officers or staff of 
employees, has manufactured or produced, or property that the lessor 
has acquired and, through its own officers or staff of employees, added 
substantial value to, but only if the lessor, through its officers or 
staff of employees, is regularly engaged in the manufacture or 
production of, or in the acquisition and addition of substantial value 
to, property of such kind;
* * * * *
    (iv) Property that is leased as a result of the performance of 
marketing functions by such lessor through its own officers or staff of 
employees located in a foreign country or countries, if the lessor, 
through its officers or staff of employees, maintains and operates an 
organization either in such country or in such countries 
(collectively), as applicable, that is regularly engaged in the 
business of marketing, or of marketing and servicing, the leased 
property and that is substantial in relation to the amount of rents 
derived from the leasing of such property.
    (2) * * *
    (ii) Substantiality of foreign organization. For purposes of 
paragraph (c)(1)(iv) of this section, whether an organization either in 
a foreign country or in foreign countries (collectively) is substantial 
in relation to the amount of rents is determined based on all the facts 
and circumstances. However, such an organization will be considered 
substantial in relation to the amount of rents if active leasing 
expenses, as defined in paragraph (c)(2)(iii) of this section, equal or 
exceed 25 percent of the adjusted leasing profit, as defined in 
paragraph (c)(2)(iv) of this section. In addition, for purposes of 
aircraft or vessels leased in foreign commerce, an organization will be 
considered substantial if active leasing expenses, as defined in 
paragraph (c)(2)(iii) of this section, equal or exceed 10 percent of 
the adjusted leasing profit, as defined in paragraph (c)(2)(iv) of this 
section. For purposes of paragraphs (c)(1)(iv) and (c)(2) of this 
section and Sec.  1.956-2(b)(1)(vi), the term aircraft or vessels 
includes component parts, such as engines that are leased separately 
from an aircraft or vessel.
    (iii) * * *
    (E) Deductions for CST Payments or PCT Payments (as defined in 
Sec.  1.482-7(b)).
* * * * *
    (viii) Cost sharing arrangements (CSAs). For purposes of paragraphs 
(c)(1)(i) and (iv) of this section, CST Payments or PCT Payments (as 
defined in Sec.  1.482-7(b)(1)) made by the lessor to another 
controlled participant (as defined in Sec.  1.482-7(j)(1)(i)) pursuant 
to a CSA (as defined in Sec.  1.482-7(a)) do not cause the activities 
undertaken by that other controlled participant to be considered to be 
undertaken by the lessor's own officers or staff of employees.
* * * * *

[[Page 76505]]

    (d) * * *
    (1) * * *
    (i) Property that the licensor, through its own officers or staff 
of employees, has developed, created, or produced, or property that the 
licensor has acquired and, through its own officers or staff of 
employees, added substantial value to, but only so long as the 
licensor, through its officers or staff of employees, is regularly 
engaged in the development, creation, or production of, or in the 
acquisition and addition of substantial value to, property of such 
kind; or
    (ii) Property that is licensed as a result of the performance of 
marketing functions by such licensor through its own officers or staff 
of employees located in a foreign country or countries, if the 
licensor, through its officers or staff of employees, maintains and 
operates an organization either in such foreign country or in such 
foreign countries (collectively), as applicable, that is regularly 
engaged in the business of marketing, or of marketing and servicing, 
the licensed property and that is substantial in relation to the amount 
of royalties derived from the licensing of such property.
    (2) * * *
    (ii) Substantiality of foreign organization. For purposes of 
paragraph (d)(1)(ii) of this section, whether an organization either in 
a foreign country or in foreign countries (collectively) is substantial 
in relation to the amount of royalties is determined based on all of 
the facts and circumstances. However, such an organization will be 
considered substantial in relation to the amount of royalties if active 
licensing expenses, as defined in paragraph (d)(2)(iii) of this 
section, equal or exceed 25 percent of the adjusted licensing profit, 
as defined in paragraph (d)(2)(iv) of this section.
    (iii) * * *
    (E) Deductions for CST Payments or PCT Payments (as defined in 
Sec.  1.482-7(b)).
* * * * *
    (v) Cost sharing arrangements (CSAs). For purposes of paragraphs 
(d)(1)(i) and (ii) of this section, CST Payments or PCT Payments (as 
defined in Sec.  1.482-7(b)(1)) made by the licensor to another 
controlled participant (as defined in Sec.  1.482-7(j)(1)(i)) pursuant 
to a CSA (as defined in Sec.  1.482-7(a)) do not cause the activities 
undertaken by that other controlled participant to be considered to be 
undertaken by the licensor's own officers or staff of employees.
* * * * *
    (i) Effective/applicability dates--(1) Paragraphs (c)(2)(v) through 
(vii). Paragraphs (c)(2)(v) through (vii) of this section and Example 6 
of paragraph (c)(3) of this section apply to taxable years of 
controlled foreign corporations beginning on or after May 2, 2006, and 
for taxable years of United States shareholders with or within which 
such taxable years of the controlled foreign corporations end. 
Taxpayers may elect to apply paragraphs (c)(2)(v) through (vii) to 
taxable years of controlled foreign corporations beginning after 
December 31, 2004, and for taxable years of United States shareholders 
with or within which such taxable years of the controlled foreign 
corporations end. If an election is made to apply Sec.  1.956-
2(b)(1)(vi) to taxable years beginning after December 31, 2004, then 
the election must also be made for paragraphs (c)(2)(v) through (vii) 
of this section.
    (2) Other paragraphs. Paragraphs (c)(1)(i) and (d)(1)(i) of this 
section apply to rents or royalties, as applicable, received or accrued 
during taxable years of controlled foreign corporations ending on or 
after September 1, 2015, and to taxable years of United States 
shareholders in which or with which such taxable years end, but only 
with respect to property manufactured, produced, developed, or created, 
or in the case of acquired property, property to which substantial 
value has been added, on or after September 1, 2015. Paragraphs 
(c)(1)(iv), (c)(2)(ii), (c)(2)(iii)(E), (c)(2)(viii), (d)(1)(ii), 
(d)(2)(ii), (d)(2)(iii)(E), and (d)(2)(v) of this section apply to 
rents or royalties, as applicable, received or accrued during taxable 
years of controlled foreign corporations ending on or after September 
1, 2015, and to taxable years of United States shareholders in which or 
with which such taxable years end, to the extent that such rents or 
royalties are received or accrued on or after September 1, 2015. See 
Sec.  1.954-2(c)(1)(i), (c)(1)(iv), (c)(2)(ii), (c)(2)(iii), (d)(1)(i), 
(d)(1)(ii), (d)(2)(ii), and (d)(2)(iii), as contained in 26 CFR part 1 
revised as of April 1, 2015, for rules applicable to rents or 
royalties, as applicable, received or accrued before September 1, 2015.
* * * * *


 Sec.  1.954-2T  [Removed]

0
 Par. 3. Section 1.954-2T is removed.

0
 Par. 4. Section 1.956-1 is amended by:
0
 1. Revising the section heading and paragraphs (a) and (b).
0
 2. Removing and reserving paragraphs (c) and (d).
0
 3. Revising paragraphs (e)(2) and (g).
    The revisions read as follows:


Sec.  1.956-1  Shareholder's pro rata share of the average of the 
amounts of United States property held by a controlled foreign 
corporation.

    (a) In general. Subject to the provisions of section 951(a) and the 
regulations thereunder, a United States shareholder of a controlled 
foreign corporation is required to include in gross income the amount 
determined under section 956 with respect to the shareholder for the 
taxable year but only to the extent not excluded from gross income 
under section 959(a)(2) and the regulations thereunder.
    (b) Amount of United States property held indirectly by a 
controlled foreign corporation--(1) General rule. For purposes of 
section 956, United States property held indirectly by a controlled 
foreign corporation includes--
    (i) United States property held on behalf of the controlled foreign 
corporation by a trustee or a nominee;
    (ii) United States property acquired by any other foreign 
corporation that is controlled by the controlled foreign corporation if 
a principal purpose of creating, organizing, or funding by any means 
(including through capital contributions or debt) the other foreign 
corporation is to avoid the application of section 956 with respect to 
the controlled foreign corporation; and
    (iii) Property acquired by a partnership that is controlled by the 
controlled foreign corporation if the property would be United States 
property if held directly by the controlled foreign corporation, and a 
principal purpose of creating, organizing, or funding by any means 
(including through capital contributions or debt) the partnership is to 
avoid the application of section 956 with respect to the controlled 
foreign corporation.
    (2) Control. For purposes of paragraphs (b)(1)(ii) and (iii) of 
this section, a controlled foreign corporation controls a foreign 
corporation or partnership if the controlled foreign corporation and 
the other foreign corporation or partnership are related within the 
meaning of section 267(b) or section 707(b). For this purpose, in 
determining whether two corporations are members of the same controlled 
group under section 267(b)(3), a person is considered to own stock 
owned directly by such person, stock owned for the purposes of section 
1563(e)(1), and stock owned with the application of section 267(c).
    (3) Coordination rule. Paragraph (b)(1)(iii) of this section 
applies only to the extent that the amount of United States property 
that is treated under that paragraph as held indirectly by a

[[Page 76506]]

controlled foreign corporation through the partnership exceeds the sum 
of--
    (i) The amount of United States property described in paragraph 
(b)(1)(iii) of this section that is treated as held by the controlled 
foreign corporation as a result of the application of Sec.  1.956-4(b) 
with respect to the partnership; and
    (ii) The amount of United States property that is treated as held 
by the controlled foreign corporation as a result of the application of 
Sec.  1.956-4(c) with respect to any portion of an obligation 
attributable to the funding described in paragraph (b)(1)(iii) of this 
section of the partnership by the controlled foreign corporation.
    (4) Examples. The following examples illustrate the rules of this 
paragraph (b). In each example, P is a domestic corporation that wholly 
owns two controlled foreign corporations, FS1 and FS2.

    Example 1.  (i) Facts. FS1 sells inventory to FS2 in exchange 
for trade receivables due in 60 days. Avoiding the application of 
section 956 with respect to FS1 was not a principal purpose of 
establishing the trade receivables. FS2 has no earnings and profits, 
and FS1 has substantial accumulated earnings and profits. FS2 makes 
a loan to P equal to the amount it owes FS1 under the trade 
receivables. FS2 pays the trade receivables according to their 
terms.
    (ii) Result. FS1 will not be considered to indirectly hold 
United States property under this paragraph (b) because the funding 
of FS2 through the sale of inventory in exchange for the 
establishment of trade receivables was not undertaken with a 
principal purpose of avoiding the application of section 956 with 
respect to FS1.
    Example 2.  (i) Facts. The facts are the same as in Example 1 of 
this paragraph (b)(4), except that, with a principal purpose of 
avoiding the application of section 956 with respect to FS1, FS1 and 
FS2 agree to defer FS2's payment obligation, and FS2 does not timely 
pay the receivables.
    (ii) Result. FS1 is considered to hold indirectly United States 
property under this paragraph (b) and Sec.  1.956-2(a) because there 
was a funding of FS2, a principal purpose of which was to avoid the 
application of section 956 with respect to FS1.
    Example 3.  (i) Facts. FS1 has $100x of post-1986 undistributed 
earnings and profits and $100x post-1986 foreign income taxes, but 
does not have any cash. FS2 has earnings and profits of at least 
$100x, no post-1986 foreign income taxes, and substantial cash. 
Neither FS1 nor FS2 has earnings and profits described in section 
959(c)(1) or section 959(c)(2). FS2 loans $100x to FS1. FS1 then 
loans $100x to P. An income inclusion by P of $100x under sections 
951(a)(1)(B) and 956 with respect to FS1 would result in foreign 
income taxes deemed paid by P under section 960. A principal purpose 
of funding FS1 through the loan from FS2 is to avoid the application 
of section 956 with respect to FS2.
    (ii) Result. Under paragraph (b)(1)(ii) of this section, FS2 is 
considered to indirectly hold the $100x obligation of P that is held 
by FS1. As a result, P has an income inclusion of $100x under 
sections 951(a)(1)(B) and 956 with respect to FS2, and the foreign 
income taxes deemed paid by P under section 960 is $0. P does not 
have an income inclusion under sections 951(a)(1)(B) and 956 with 
respect to FS1 related to the $100x loan from FS1 to P.
     Example 4.  (i) Facts. FS1 deposits $100x with BK, an unrelated 
foreign financial institution. FS2 subsequently borrows $100x from 
BK. BK would not have loaned the $100x to FS2 on the same terms 
absent FS1's deposit. FS2 loans the $100x borrowed from BK to P. FS2 
has no earnings and profits, and FS1 has substantial accumulated 
earnings and profits. A principal purpose for the transactions is to 
avoid the application of section 956 with respect to FS1.
    (ii) Result. FS1 is considered to hold indirectly United States 
property under this paragraph (b) and Sec.  1.956-2(a) because FS1's 
deposit with BK, which facilitates BK's loan to FS2, is considered a 
funding by FS1 of FS2, a principal purpose of which was to avoid the 
application of section 956 with respect to FS1.
    Example 5.  (i) Facts. FS1 sells inventory to FS2 in exchange 
for $100x. The sale occurred in the ordinary course of FS1's trade 
or business and FS2's trade or business, and the terms of the sale 
are consistent with terms that would be observed among parties 
dealing at arm's length. FS1 makes a $100x loan to P. FS2 has no 
earnings and profits, and FS1 has substantial accumulated earnings 
and profits.
    (ii) Result. FS2 will not be considered to indirectly hold 
United States property under this paragraph (b) because a sale in 
the ordinary course of business for cash on terms that are 
consistent with those that would be observed among parties dealing 
at arm's length does not constitute a funding.
     Example 6.  (i) Facts. In Year 1, FS2 loans $100x to FS1 to 
finance FS1's trade or business. The terms of the loan are 
consistent with those that would be observed among parties dealing 
at arm's length. In Year 2, FS1 repays the loan in accordance with 
the terms of the loan. Immediately after the repayment by FS1, FS2 
loans $100x to P. FS2 has no earnings and profits, and FS1 has 
substantial accumulated earnings and profits.
    (ii) Result. FS1 will not be considered to indirectly hold 
United States property under this paragraph (b) because a repayment 
of a loan that has terms that are consistent with those that would 
be observed among parties dealing at arm's length and that is repaid 
consistent with those terms does not constitute a funding.
     Example 7.  (i) Facts. FS1 has substantial earnings and 
profits. P and FS1 are the only partners in FPRS, a foreign 
partnership. FS1 contributes $600x cash to FPRS in exchange for a 
60% interest in the partnership, and P contributes real estate 
located outside the United States ($400x value) to FPRS in exchange 
for a 40% interest in the partnership. There are no special 
allocations in the FPRS partnership agreement. FPRS lends $100x to 
P. Under Sec.  1.956-4(b) and Sec.  1.956-2(a), FS1 is treated as 
holding United States property of $60x (60% x $100x) as a result of 
the FPRS loan to P. A principal purpose of creating, organizing, or 
funding FPRS is to avoid the application of section 956 with respect 
to FS1.
    (ii) Result. Before taking into account paragraph (b)(3) of this 
section, because FS1 controls FPRS and a principal purpose of 
creating, organizing, or funding FPRS was to avoid the application 
of section 956 with respect to FS1, FS1 is considered under 
paragraph (b)(1)(iii) of this section to indirectly hold the $100x 
obligation of P that would be United States property if held 
directly by FS1. However, under paragraph (b)(3) of this section, 
FS1 is treated as holding United States property under paragraph 
(b)(1)(iii) only to the extent the amount held indirectly under 
paragraph (b)(1)(iii) of this section exceeds the sum of the amount 
of the United States property that FS1 is treated as holding as a 
result of the application of Sec.  1.956-4(b) with respect to FPRS. 
The amount of United States property that FS1 is treated as 
indirectly holding under paragraph (b)(1)(iii) of this section and 
Sec.  1.956-2(a) ($100x) exceeds the amount determined under Sec.  
1.956-4(b) ($60x) by $40x. Thus, FS1 is considered to hold United 
States property within the meaning of section 956(c) in the amount 
of $100x ($60x under Sec.  1.956-4(b) and $40x under paragraphs 
(b)(1)(iii) and (b)(3) of this section).
     Example 8.  (i) Facts. FS1 and FS2 have substantial earnings 
and profits. P and FS1 are the only partners in FPRS, a foreign 
partnership. There are no special allocations in the FPRS 
partnership agreement. P's liquidation value percentage with respect 
to FPRS is 40%, and FS1's liquidation value percentage with respect 
to FPRS is 60%. FS2 lends $100x to FPRS, and FPRS lends $100x to P. 
Under Sec.  1.956-4(c) and Sec.  1.956-2(a), FS2 is treated as 
holding United States property of $40x (40% x $100x) as a result of 
its loan to FPRS. A principal purpose of funding FPRS is to avoid 
the application of section 956 with respect to FS2.
    (ii) Result. Before taking into account paragraph (b)(3) of this 
section, because FS2 controls FPRS and a principal purpose of 
funding FPRS was to avoid the application of section 956 with 
respect to FS2, FS2 is considered under paragraph (b)(1)(iii) of 
this section to indirectly hold the $100x obligation of P that would 
be United States property if held directly by FS2. However, under 
paragraph (b)(3) of this section, FS2 is treated as holding United 
States property under paragraph (b)(1)(iii) only to the extent the 
amount held indirectly under paragraph (b)(1)(iii) of this section 
exceeds the amount of United States property that FS2 is treated as 
holding as a result of the application of Sec.  1.956-4(c) with 
respect to the obligation with which FS2 funds FPRS. The amount of 
United States property that FS2 is treated as indirectly holding 
under paragraph (b)(1)(iii) of this section and Sec.  1.956-2(a) 
($100x) exceeds the amount determined under Sec.  1.956-4(c) ($40x) 
by $60x. Thus, FS2 is considered to hold United States property 
within the meaning of section 956(c) in the amount of $100x ($40x 
under Sec.  1.956-4(c) and $60x under paragraphs (b)(1)(iii) and

[[Page 76507]]

(b)(3) of this section). P does not have an income inclusion under 
sections 951(a)(1)(B) and 956 with respect to FS1 related to the P 
obligation held by FPRS.

    (c)-(d) [Reserved]
    (e) * * *
    (2) Rule for pledges and guarantees. For purposes of this section, 
the amount of an obligation treated as held (before application of 
Sec.  1.956-4(b)) as a result of a pledge or guarantee described in 
Sec.  1.956-2(c) is the unpaid principal amount of the obligation on 
the applicable determination date.
* * * * *
    (g) Effective/applicability date. (1) Paragraph (a) of this section 
applies to taxable years of controlled foreign corporations ending on 
or after November 3, 2016, and to taxable years of United States 
shareholders in which or with which such taxable years end.
    (2) Paragraph (b) of this section applies to taxable years of 
controlled foreign corporations ending on or after September 1, 2015, 
and to taxable years of United States shareholders in which or with 
which such taxable years end, with respect to property acquired on or 
after September 1, 2015. See paragraph (b)(4) of Sec.  1.956-1T, as 
contained in 26 CFR part 1 revised as of April 1, 2015, for the rules 
applicable to taxable years of controlled foreign corporations ending 
before September 1, 2015, and property acquired before September 1, 
2015. For purposes of this paragraph (g)(2), a deemed exchange of 
property pursuant to section 1001 on or after September 1, 2015 
constitutes an acquisition of the property on or after that date.
    (3) Paragraph (e)(2) of this section applies to taxable years of 
controlled foreign corporations ending on or after November 3, 2016, 
and taxable years of United States shareholders in which or with which 
such taxable years end, with respect to pledges or guarantees entered 
into on or after September 1, 2015. For purposes of this paragraph 
(g)(3), a pledgor or guarantor is treated as entering into a pledge or 
guarantee when there is a significant modification, within the meaning 
of Sec.  1.1001-3(e), of an obligation with respect to which it is a 
pledgor or guarantor on or after September 1, 2015.
* * * * *

0
 Par. 5. Section 1.956-1T is revised to read as follows:


Sec.  1.956-1T  Shareholder's pro rata share of the average of the 
amounts of United States property held by a controlled foreign 
corporation.

    (a) through (e)(4) [Reserved]
    (5) Exclusion for certain recourse obligations. For purposes of 
Sec.  1.956-1(e)(1) of the regulations, in the case of an investment in 
United States property consisting of an obligation of a related person, 
as defined in section 954(d)(3) and paragraph (f) of Sec.  1.954-1, a 
liability will not be recognized as a specific charge if the liability 
representing the charge is with recourse with respect to the general 
credit or other assets of the investing controlled foreign corporation.
    (e)(6) [Reserved]. For further guidance, see Sec.  1.956-1(e)(6).
    (f) Effective/applicability date. Paragraph (e)(5) of this section 
applies to investments made on or after June 14, 1988.
    (g)-(h) [Reserved]

0
Par. 6. Section 1.956-2 is amended by:
0
1. Revising paragraphs (a)(3), (c)(1), and (c)(2).
0
2. Adding Example 4 to paragraph (c)(3).
0
3. Adding paragraph (h).
    The revisions and addition read as follows:


Sec.  1.956-2  Definition of United States property.

    (a) * * *
    (3) Treatment of disregarded entities. For purposes of section 956, 
an obligation of a business entity (as defined in Sec.  301.7701-2(a) 
of this chapter) that is disregarded as an entity separate from its 
owner for federal tax purposes under Sec. Sec.  301.7701-1 through 
301.7701-3 of this chapter is treated as an obligation of its owner.
* * * * *
    (c) Treatment of pledges and guarantees--(1) General rule. Except 
as provided in paragraph (c)(4) of this section, for purposes of 
section 956, any obligation of a United States person with respect to 
which a controlled foreign corporation or a partnership is a pledgor or 
guarantor will be considered to be held by the controlled foreign 
corporation or the partnership, as the case may be. See Sec.  1.956-
1(e)(2) for rules that determine the amount of the obligation treated 
as held by a pledgor or guarantor under this paragraph (c). For rules 
that treat an obligation of a foreign partnership as an obligation of 
the partners in the foreign partnership for purposes of section 956, 
see Sec.  1.956-4(c).
    (2) Indirect pledge or guarantee. If the assets of a controlled 
foreign corporation or a partnership serve at any time, even though 
indirectly, as security for the performance of an obligation of a 
United States person, then, for purposes of paragraph (c)(1) of this 
section, the controlled foreign corporation or partnership will be 
considered a pledgor or guarantor of that obligation. If a partnership 
is considered a pledgor or guarantor of an obligation, a controlled 
foreign corporation that is a partner in the partnership will not also 
be treated as a pledgor or guarantor of the obligation solely as a 
result of its ownership of an interest in the partnership. For purposes 
of this paragraph, a pledge of stock of a controlled foreign 
corporation representing at least 66\2/3\ percent of the total combined 
voting power of all classes of voting stock of such corporation will be 
considered an indirect pledge of the assets of the controlled foreign 
corporation if the pledge is accompanied by one or more negative 
covenants or similar restrictions on the shareholder effectively 
limiting the corporation's discretion to dispose of assets and/or incur 
liabilities other than in the ordinary course of business. See Sec.  
1.956-4(d) for guidance on the treatment of indirect pledges or 
guarantees of an obligation of a partnership attributed to its partners 
under Sec.  1.956-4(c).
    (3) * * *

    Example 4.  (i) Facts. USP, a domestic corporation, owns 70% of 
the stock of FS, a controlled foreign corporation, and a 90% 
interest in FPRS, a foreign partnership. X, an unrelated foreign 
person, owns 30% of the stock of FS. Y, an unrelated foreign person, 
owns a 10% interest in FPRS. There are no special allocations in the 
FPRS partnership agreement. FPRS borrows $100x from Z, an unrelated 
person. FS pledges its assets as security for FPRS's performance of 
its obligation to repay the $100x loan. USP's share of the $100x 
FPRS obligation, determined in accordance with its liquidation value 
percentage, is $90x. Under Sec.  1.956-4(c), $90x of the FPRS 
obligation is treated as an obligation of USP for purposes of 
section 956.
    (ii) Result. For purposes of section 956, under paragraph (c)(1) 
of this section, FS is considered to hold an obligation of USP in 
the amount of $90x, and thus is treated as holding United States 
property in the amount of $90x.

* * * * *
    (h) Effective/applicability date. (1) Paragraph (a)(3) of this 
section applies to taxable years of controlled foreign corporations 
ending on or after November 3, 2016, and taxable years of United States 
shareholders in which or with which such taxable years end, with 
respect to obligations held on or after November 3, 2016.
    (2) Paragraphs (c)(1), (c)(2), and Example 4 of paragraph (c)(3) of 
this section apply to taxable years of controlled foreign corporations 
ending on or after November 3, 2016, and taxable years of United States 
shareholders in which or with which

[[Page 76508]]

such taxable years end, with respect to pledges and guarantees entered 
into on or after September 1, 2015. For purposes of this paragraph 
(h)(2), a pledgor or guarantor is treated as entering into a pledge or 
guarantee when there is a significant modification, within the meaning 
of Sec.  1.1001-3(e), of an obligation with respect to which it is a 
pledgor or guarantor on or after September 1, 2015.
* * * * *

0
Par. 7. Section Sec.  1.956-3 is added to read as follows:


Sec.  1.956-3  Certain trade or service receivables acquired from 
United States persons.

    (a) In general. For purposes of section 956(a) and Sec.  1.956-1, 
the term ``United States property'' also includes any trade or service 
receivable if the trade or service receivable is acquired (directly or 
indirectly) from a related person who is a United States person (as 
defined in section 7701(a)(30)) (a related United States person) and 
the obligor under the receivable is a United States person. A trade or 
service receivable described in this paragraph is considered to be 
United States property notwithstanding the exceptions (other than 
subparagraph (H)) contained in section 956(c)(2). The terms ``trade or 
service receivable'' and ``related person'' have the respective 
meanings given to the terms by section 864(d) and the regulations 
thereunder, including Sec.  1.864-8T(b). For purposes of this section, 
the exception in Sec.  1.956-2T(d)(2)(ii) does not apply to trade or 
service receivables described in this paragraph.
    (b) Acquisition of a trade or service receivable--(1) General rule. 
The rules of Sec.  1.864-8T(c)(1) apply to determine whether a 
controlled foreign corporation has acquired a trade or service 
receivable.
    (2) Indirect acquisitions--(i) Acquisition through unrelated 
person. A trade or service receivable is considered acquired from a 
related person when it is acquired from an unrelated person who 
acquired (directly or indirectly) the receivable from a person who is a 
related person to the acquiring person.
    (ii) Acquisition by nominee, pass-through entity, or related 
foreign corporation. A controlled foreign corporation is treated as 
holding a trade or service receivable that is held by a nominee on its 
behalf, or by a simple trust or other pass-through entity (other than a 
partnership) to the extent of its direct or indirect ownership or 
beneficial interest in such simple trust or other pass-through entity. 
See Sec. Sec.  1.956-1(b) and 1.956-4(b) for rules that may treat a 
controlled foreign corporation as indirectly holding a trade or service 
receivable held by a foreign corporation or partnership. A controlled 
foreign corporation that is treated as holding a trade or service 
receivable held by another person (the direct holder) (or that would be 
treated as holding the receivable if the receivable were United States 
property or would be United States property if held directly by the 
controlled foreign corporation) is considered to have acquired the 
receivable from the person from whom the direct holder acquired the 
receivable. This paragraph (b)(2)(ii) does not limit the application of 
paragraph (b)(2)(iii) of this section. The following examples 
illustrate the application of this paragraph (b)(2)(ii):

    Example 1. (i) Facts. A domestic corporation, P, wholly owns a 
controlled foreign corporation, FS, with substantial earnings and 
profits. FS contributes $200x of cash to a partnership, PRS, in 
exchange for an 80% partnership interest. An unrelated foreign 
person contributes real estate located in a foreign country with a 
fair market value of $50x to PRS for the remaining 20% partnership 
interest. There are no special allocations in the PRS partnership 
agreement. PRS uses the $200x of cash received from FS to purchase 
trade receivables from P. The obligors with respect to the trade 
receivables are United States persons that are not related to any 
partner in PRS. The liquidation value percentage, as determined 
under Sec.  1.956-4(b), for FS with respect to PRS is 80%. A 
principal purpose of funding PRS (through FS's cash contribution) is 
to avoid the application of section 956 with respect to FS.
    (ii) Result. Under Sec.  1.956-4(b)(1), FS is treated as holding 
80% of the trade receivables acquired by PRS from P, with a basis 
equal to $160x (80% x $200x, PRS's basis in the trade receivables). 
However, because FS controls PRS and a principal purpose of FS 
funding PRS was to avoid the application of section 956 with respect 
to FS, under Sec.  1.956-1(b), if the trade receivables would be 
United States property if held directly by FS, FS additionally would 
be treated as holding the trade receivables to the extent that they 
exceed the amount of the receivables it holds under Sec.  1.956-
4(b), which is $40x ($200x-$160x). Accordingly, under this paragraph 
(b)(2)(ii), FS is treated as having acquired from P, a related 
United States person, the trade receivables that it is treated as 
holding with a basis equal to $200x ($160x + $40x). Thus, FS is 
treated as holding United States property with a basis of $200x 
under paragraph (a) of this section.
    Example 2.  (i) Facts. A domestic corporation, P, wholly owns a 
controlled foreign corporation, FS1, that has earnings and profits 
of at least $300x. FS1 organizes a foreign corporation, FS2, with a 
$200x cash contribution. FS2 uses the cash contribution to purchase 
trade receivables from P. The obligors with respect to the trade 
receivables are unrelated United States persons. A principal purpose 
of funding FS2 (through FS1's cash contribution) is to avoid the 
application of section 956 with respect to FS1.
    (ii) Result. Under Sec.  1.956-1(b), if the trade receivables 
held by FS2 were United States property, FS1 would be treated as 
holding the trade receivables held by FS2 because FS1 controls FS2 
and a principal purpose of FS1 funding FS2 was to avoid the 
application of section 956 with respect to FS1. Accordingly, under 
this paragraph (b)(2)(ii), FS1 is treated as having acquired from P, 
a related United States person, the trade receivables that it would 
be treated as holding with a basis equal to $200x. Thus, FS1 is 
treated as holding United States property with a basis of $200x 
under paragraph (a) of this section.

    (iii) Swap or pooling arrangements. A trade or service receivable 
of a United States person is considered to be a trade or service 
receivable acquired from a related United States person and subject to 
the rules of this section when it is acquired in accordance with an 
arrangement that involves two or more groups of related persons, if the 
groups are unrelated to each other and the effect of the arrangement is 
that one or more persons in each group acquire (directly or indirectly) 
trade or service receivables from one or more unrelated United States 
persons who are also parties to the arrangement in exchange for 
reciprocal purchases of receivables from related United States persons. 
The following example illustrates the application of this paragraph 
(b)(2)(iii):

    Example. (i) Facts. Controlled foreign corporations A, B, C, and 
D are wholly-owned subsidiaries of domestic corporations M, N, O, 
and P, respectively. M, N, O, and P are not related persons. 
According to a prearranged plan, A, B, C, and D each acquire trade 
or service receivables from M, N, O, and/or P. The obligors under 
some or all of the receivables acquired by each of A, B, C, and D 
are United States persons.
    (ii) Result. The effect of the prearranged plan is that each of 
A, B, C, and D acquires trade or service receivables of United 
States persons from one or more unrelated United States persons who 
are also parties to the arrangement, in exchange for reciprocal 
purchases of receivables from a related United States person. 
Accordingly, each of A, B, C, and D is treated as holding a trade or 
service receivable acquired from a related United States person and 
is subject to the rules of this section. As a result, each of A, B, 
C, and D is treated as holding an amount of United States property 
equal to its adjusted basis in the receivables acquired pursuant to 
the arrangement with respect to which the obligors are United States 
persons.

    (iv) Financing arrangements. If a controlled foreign corporation 
participates (directly or indirectly) in a lending transaction that 
results in a loan to a United States person who purchases property 
described in section 1221(a)(1) (inventory property) or services from a 
related United States person, or to any

[[Page 76509]]

person who purchases from a related United States person trade or 
service receivables under which the obligor is a United States person, 
or to a person who is a related person with respect to the purchaser, 
and if the loan would not have been made or maintained on the same 
terms but for the corresponding purchase, then the controlled foreign 
corporation is considered to have indirectly acquired a trade or 
service receivable described in paragraph (a) of this section. For 
purposes of this paragraph (b)(2)(iv), it is immaterial that the sums 
lent are not, in fact, the sums used to finance the purchase of the 
inventory property or services or trade or service receivables from a 
related United States person. The amount to be taken into account with 
respect to the United States property treated as held by a controlled 
foreign corporation as a result of the application of this paragraph 
(b)(2)(iv) is the lesser of the amount lent pursuant to a lending 
transaction described in this paragraph (b)(2)(iv) and the purchase 
price of the inventory property, services, or trade or service 
receivables. The following examples illustrate the application of this 
paragraph (b)(2)(iv):

    Example 1.  (i) Facts. P, a domestic corporation, owns all of 
the outstanding stock of FS1, a controlled foreign corporation. P 
sells inventory property for $200x to X, an unrelated United States 
person. FS1 makes a $100x short-term loan to X, which loan would not 
have been made or maintained on the same terms but for X's purchase 
of P's inventory property.
    (ii) Result. FS1 directly participates in a lending transaction 
described in this paragraph (b)(2)(iv). Thus, FS1 is considered to 
have acquired a trade or service receivable described in paragraph 
(a) of this section. That is, FS1 is considered to have acquired a 
trade or service receivable of a United States person from a related 
United States person. As a result, FS1 is treated as holding United 
States property in the amount of $100x.
    Example 2.  (i) Facts. The facts are the same as in Example 1 of 
this paragraph (b)(2)(iv), except that instead of loaning money to X 
directly, FS1 deposits $300x with an unrelated financial institution 
that loans $200x to X in order for X to purchase P's inventory 
property. The loan would not have been made or maintained on the 
same terms but for the corresponding deposit.
    (ii) Result. FS1 is considered to have acquired a trade or 
service receivable described in paragraph (a) of this section 
because FS1 indirectly participates in a lending transaction 
described in this paragraph (b)(2)(iv). See Rev. Rul. 87-89, 1987-2 
CB 195. That is, FS1 is considered to have acquired a trade or 
service receivable of a United States person from a related United 
States person. Thus, FS1 is treated as holding United States 
property in the amount of $200x.
    Example 3. (i) Facts. P, a domestic corporation, owns all of the 
outstanding stock of FS1, a controlled foreign corporation. FS1 
makes a $300x loan to U, an unrelated foreign corporation, in 
connection with U's purchase from P of receivables from the sale of 
inventory property by P to United States obligors for $200x.
    (ii) Result. FS1 is considered to have acquired a trade or 
service receivable described in paragraph (a) of this section 
because FS1 directly participates in a lending transaction described 
in this paragraph (b)(2)(iv). That is, FS1 is considered to have 
acquired a trade or service receivable of a United States person 
from a related United States person. Thus, FS1 is treated as holding 
United States property in the amount of $200x.

    (c) Substitution of obligor. For purposes of this section, the 
substitution of another person for a United States obligor is 
disregarded, unless it can be demonstrated by the parties to the 
transaction that the primary purpose for the arrangement was not the 
avoidance of section 956. The following example illustrates the 
application of this paragraph (c):

    Example. (i) Facts. P, a domestic corporation, owns all of the 
outstanding stock of FS1, a controlled foreign corporation with 
substantial accumulated earnings and profits. P sells inventory 
property to X, a domestic corporation unrelated to P. To pay for the 
inventory property, X arranges for a foreign financing entity to 
issue a note to P. P then sells the note to FS1. P and X cannot 
demonstrate that the primary purpose for X's assignment of the 
payment obligation to the foreign financing entity was not the 
avoidance of section 956.
    (ii) Result. The substitution of the foreign financing entity 
for X is disregarded, and FS1 is treated as holding an obligation of 
a United States person acquired from a related United States person. 
Thus, FS1 is treated as holding United States property in the amount 
of the purchase price of the note.

    (d) Effective/applicability date--(1) Except as provided in 
paragraph (d)(2) of this section, this section applies to trade or 
service receivables acquired (directly or indirectly) after March 1, 
1984.
    (2) Paragraph (b)(2)(ii) of this section applies to taxable years 
of controlled foreign corporations ending on or after November 3, 2016, 
and taxable years of United States shareholders in which or with which 
such taxable years end, with respect to trade or service receivables 
acquired on or after September 1, 2015. For purposes of this paragraph 
(d), a significant modification, within the meaning of Sec.  1.1001-
3(e), of a trade or service receivable on or after September 1, 2015, 
constitutes an acquisition of the trade or service receivable on or 
after that date.


Sec.  1.956-3T  [Removed]

0
Par. 8. Section 1.956-3T is removed.

0
Par. 9. Section 1.956-4 is added to read as follows:


Sec.  1.956-4   Certain rules applicable to partnerships.

    (a) Overview. This section provides rules concerning the 
application of section 956 to certain obligations of and property held 
by a partnership. Paragraph (b) of this section provides rules 
concerning United States property held indirectly by a controlled 
foreign corporation through a partnership. Paragraph (c) of this 
section provides rules that generally treat obligations of a foreign 
partnership as obligations of the partners in the foreign partnership, 
as well as a special rule that treats a partner that is a United States 
person as owing additional amounts of a partnership obligation in 
certain circumstances. Paragraph (d) of this section sets forth a rule 
concerning the application of the indirect pledge or guarantee rule to 
obligations of partnerships. Paragraph (e) of this section provides 
that obligations of a domestic partnership are obligations of a United 
States person. Paragraph (f) of this section provides effective and 
applicability dates. See Sec. Sec.  1.956-1(b) and 1.956-2(c) for 
additional rules applicable to partnerships.
    (b) Property held indirectly through a partnership--(1) General 
rule. For purposes of section 956, a partner in a partnership is 
treated as holding its attributable share of any property held by the 
partnership (including an obligation that the partnership is treated as 
holding as a result of the application of Sec.  1.956-2(c)). A 
partner's attributable share of partnership property is determined 
under the rules set forth in paragraph (b)(2) of this section. An 
upper-tier partnership's attributable share of the property of a lower-
tier partnership is treated as property of the upper-tier partnership 
for purposes of applying this paragraph (b)(1) to the partners of the 
upper-tier partnership. For purposes of section 956, a partner's 
adjusted basis in the property of the partnership equals the partner's 
attributable share of the partnership's adjusted basis in the property, 
as determined under the rules set forth in paragraph (b)(2) of this 
section, taking into account any adjustments to basis under section 
743(b) (with respect to the partner) or section 734(b) or any similar 
adjustments to basis. The rules in Sec.  1.956-1(e)(2) apply to 
determine the amount of an obligation treated as held by a partnership 
as a result of the application of Sec.  1.956-2(c). See Sec.  1.956-

[[Page 76510]]

1(b) for special rules that may treat a controlled foreign corporation 
as holding a greater amount of United States property held by a 
partnership than the amount determined under this section.
    (2) Methodology--(i) Liquidation value percentage--(A) Calculation. 
Except as otherwise provided in paragraph (b)(2)(ii) of this section, 
for purposes of paragraph (b)(1) of this section, a partner's 
attributable share of partnership property is determined in accordance 
with the partner's liquidation value percentage. For purposes of this 
paragraph (b)(2)(i) and paragraph (c)(1) of this section, the 
liquidation value of a partner's interest in a partnership is the 
amount of cash the partner would receive with respect to the interest 
if, on the applicable determination date, as provided in paragraph 
(b)(2)(i)(B) of this section, the partnership sold all of its assets 
for cash equal to the fair market value of such assets (taking into 
account section 7701(g)), satisfied all of its liabilities (other than 
those described in Sec.  1.752-7), paid an unrelated third party to 
assume all of its Sec.  1.752-7 liabilities in a fully taxable 
transaction, and then liquidated. A partner's liquidation value 
percentage is the ratio (expressed as a percentage) of the liquidation 
value of the partner's interest in the partnership divided by the 
aggregate liquidation value of all of the partners' interests in the 
partnership.
    (B) Determination date. The determination date with respect to a 
partnership is the most recent of--
    (1) The formation of the partnership;
    (2) An event described in Sec.  1.704-1(b)(2)(iv)(f)(5) or Sec.  
1.704-1(b)(2)(iv)(s)(1) (a revaluation event), irrespective of whether 
the capital accounts of the partners are adjusted in accordance with 
Sec.  1.704-1(b)(2)(iv)(f); or
    (3) The first day of the partnership's taxable year, as determined 
under section 706, provided the liquidation value percentage determined 
for any partner on that day would differ from the most recently 
determined liquidation value percentage of that partner by more than 10 
percentage points.
    (ii) Special allocations. For purposes of paragraph (b)(1) of this 
section, if a partnership agreement provides for the allocation of book 
income (or, where appropriate, book gain) from a subset of the property 
of the partnership to a partner other than in accordance with the 
partner's liquidation value percentage in a particular taxable year (a 
special allocation), then the partner's attributable share of that 
property is determined solely by reference to the partner's special 
allocation with respect to the property, provided the special 
allocation does not have a principal purpose of avoiding the purposes 
of section 956.
    (3) Examples. The following examples illustrate the rule of this 
paragraph (b):

    Example 1.  (i) Facts. USP, a domestic corporation, wholly owns 
FS, a controlled foreign corporation, which, in turn, owns an 
interest in FPRS, a foreign partnership. The remaining interest in 
FPRS is owned by an unrelated foreign person. FPRS holds non-
depreciable property with an adjusted basis of $100x (the ``FPRS 
property'') that would be United States property if held by FS 
directly. At the close of quarter 1 of year 1, the liquidation value 
percentage, as determined under paragraph (b)(2) of this section, 
for FS with respect to FPRS is 25%. There are no special allocations 
in the FPRS partnership agreement.
    (ii) Result. Under paragraph (b)(1) of this section, for 
purposes of section 956, FS is treated as holding its attributable 
share of the property held by FPRS with an adjusted basis equal to 
its attributable share of FPRS's adjusted basis in such property. 
Under paragraph (b)(2) of this section, FS's attributable share of 
property held by FPRS is determined in accordance with FS's 
liquidation value percentage, which is 25%. Thus, FS's attributable 
share of the FPRS property is 25%, and its attributable share of 
FPRS's basis in the FPRS property is $25x. Accordingly, for purposes 
of determining the amount of United States property held by FS as of 
the close of quarter 1 of year 1, FS is treated as holding United 
States property with an adjusted basis of $25x.
    Example 2.  (i) Facts. The facts are the same as in Example 1 of 
this paragraph (b)(3), except that the FPRS partnership agreement, 
which satisfies the requirements of section 704(b), specially 
allocates 80% of the income with respect to the FPRS property to FS. 
The special allocation does not have a principal purpose of avoiding 
the purposes of section 956.
    (ii) Result. Under paragraph (b)(1) of this section, for 
purposes of section 956, FS is treated as holding its attributable 
share of property held by FPRS with an adjusted basis equal to its 
attributable share of FPRS's adjusted basis in such property. In 
general, FS's attributable share of property held by FPRS is 
determined in accordance with FS's liquidation value percentage. 
However, because the special allocation does not have a principal 
purpose of avoiding the purposes of section 956, under paragraph 
(b)(2)(ii) of this section, FS's attributable share of the FPRS 
property is determined by reference to its special allocation. FS's 
special allocation percentage for the FPRS property is 80%, and thus 
FS's attributable share of the FPRS property is 80% and its 
attributable share of FPRS's basis in the FPRS property is $80x. 
Accordingly, for purposes of determining the amount of United States 
property held by FS as of the close of quarter 1 of year 1, FS is 
treated as holding United States property with an adjusted basis of 
$80x.
    Example 3.  (i) Facts. USP, a domestic corporation, wholly owns 
FS, a controlled foreign corporation, which, in turn, owns an 
interest in FPRS, a foreign partnership. USP owns the remaining 
interest in FPRS. FPRS holds property (the ``FPRS property'') that 
would be United States property if held by FS directly. The FPRS 
property has an adjusted basis of $100x and is anticipated to 
appreciate in value but generate relatively little income. The FPRS 
partnership agreement, which satisfies the requirements of section 
704(b), specially allocates 80% of the income with respect to the 
FPRS property to USP and 80% of the gain with respect to the 
disposition of FPRS property to FS. The special allocation does not 
have a principal purpose of avoiding the purposes of section 956.
    (ii) Result. Because the special allocation does not have a 
principal purpose of avoiding the purposes of section 956, under 
paragraph (b)(2)(ii) of this section, FS's attributable share of the 
FPRS property is determined by reference to a special allocation 
with respect to the FPRS property. Given the income and gain 
anticipated with respect to the FPRS property, it is appropriate to 
determine FS's attributable share of the property in accordance with 
the special allocation of gain. Accordingly, for purposes of 
determining the amount of United States property held by FS in each 
year that FPRS holds the FPRS property, FS's attributable share of 
the FPRS property is 80% and its attributable share of FPRS's basis 
in the FPRS property is $80x. Thus, FS is treated as holding United 
States property with an adjusted basis of $80x.

    (c) Obligations of a foreign partnership--(1) In general. Except as 
provided in paragraphs (c)(2) and (c)(3) of this section, for purposes 
of section 956, an obligation of a foreign partnership is treated as a 
separate obligation of each of the partners in the partnership to the 
extent of each partner's share of the obligation. A partner's share of 
the partnership's obligation is determined in accordance with the 
partner's liquidation value percentage, as determined under the rules 
set forth in paragraph (b)(2)(i) of this section, without regard to the 
rules set forth in paragraph (b)(2)(ii) of this section. An upper-tier 
partnership's share of an obligation of a lower-tier partnership is 
treated as an obligation of the upper-tier partnership for purposes of 
applying this paragraph (c)(1) to the partners of the upper-tier 
partnership.
    (2) Exception for obligations of partnerships in which neither the 
lending controlled foreign corporation nor any person related to the 
lending controlled foreign corporation is a partner. For purposes of 
applying section 956 with respect to a controlled foreign corporation, 
an obligation of a foreign partnership is treated as an obligation of a 
foreign partnership, and not as an obligation of its partners, if 
neither the controlled foreign corporation nor any person related to

[[Page 76511]]

the controlled foreign corporation within the meaning of section 
954(d)(3) is a partner in the partnership. For purposes of section 956, 
an obligation treated as an obligation of a foreign partnership 
pursuant to this paragraph (c)(2) is not an obligation of a United 
States person.
    (3) Special obligor rule in the case of certain partnership 
distributions--(i) General rule. For purposes of determining a 
partner's share of a foreign partnership's obligation under section 
956, if the foreign partnership distributes an amount of money or 
property to a partner that is related to a controlled foreign 
corporation within the meaning of section 954(d)(3) and whose 
obligation would be United States property if held (or if treated as 
held) by the controlled foreign corporation, and the foreign 
partnership would not have made the distribution but for a funding of 
the partnership through an obligation held (or treated as held) by a 
controlled foreign corporation, notwithstanding Sec.  1.956-1(e), the 
partner's share of the partnership obligation is the greater of--
    (A) The partner's share of the partnership obligation as determined 
under paragraph (c)(1) of this section; and
    (B) The lesser of the amount of the distribution to the partner 
that would not have been made but for the funding of the partnership 
and the amount of the obligation (as determined under Sec.  1.956-
1(e)).
    (ii) Deemed treatment--(A) For purposes of applying paragraph 
(c)(3)(i) of this section, in the case of a distribution of liquid 
assets by a foreign partnership to a partner, the foreign partnership 
is treated as if it would not have made the distribution of liquid 
assets to the partner but for the funding of the partnership through an 
obligation or obligations held (or treated as held) by the controlled 
foreign corporation to the extent the foreign partnership does not have 
sufficient liquid assets to make the distribution immediately prior to 
the distribution, without taking into account the obligation or 
obligations.
    (B) If the controlled foreign corporation holds (or is treated as 
holding) multiple obligations of the foreign partnership, paragraph 
(c)(3)(ii)(A) of this section applies to the obligations in reverse 
chronological order starting with the obligation that was acquired (or 
the obligation with respect to which a pledge or guarantee was entered 
into) closest in time to the distribution. Paragraph (c)(3)(ii)(A) of 
this section applies to an obligation only to the extent that the full 
amount of the distribution is not otherwise treated, pursuant to 
paragraph (c)(3)(ii)(A) of this section, as if it would not have been 
made but for the funding of the partnership through one or more other 
obligations.
    (C) For purposes of paragraph (c)(3)(ii) of this section, a 
significant modification, within the meaning of Sec.  1.1001-3(e), of 
an obligation constitutes an acquisition of the obligation on or after 
that date, and a pledgor or guarantor is treated as entering into a 
pledge or guarantee when there is a significant modification, within 
the meaning of Sec.  1.1001-3(e), of an obligation with respect to 
which it is a pledgor or guarantor.
    (D) For purposes of paragraph (c)(3)(ii) of this section, liquid 
assets means cash or cash equivalents, marketable securities within the 
meaning of section 453(f)(2), or an obligation owed by a related person 
(within the meaning of section 954(d)(3)).
    (4) Examples. The following examples illustrate the rules of this 
paragraph (c):

    Example 1.  (i) Facts. USP, a domestic corporation, wholly owns 
FS, a controlled foreign corporation, and owns an interest in FPRS, 
a foreign partnership. At the close of quarter 1 of year 1, the 
liquidation value percentage, as determined under paragraph 
(b)(2)(i) of this section, for USP with respect to FPRS is 90%. X, a 
foreign person that is unrelated to USP or FS, owns the remaining 
interest in FPRS. FPRS borrows $100x from FS. FS's basis in the FPRS 
obligation is $100x.
    (ii) Result. Under paragraph (c)(1) of this section, for 
purposes of section 956, the obligation of FPRS is treated as 
obligations of its partners (USP and X) in proportion to each 
partner's liquidation value percentage with respect to FPRS. Because 
USP, a partner in FPRS, is related to FS within the meaning of 
section 954(d)(3), the exception in paragraph (c)(2) of this section 
does not apply. Based on its liquidation value percentage, USP's 
share of the FPRS obligation is $90x. Accordingly, for purposes of 
section 956, $90x of the FPRS obligation held by FS is treated as an 
obligation of USP and is United States property within the meaning 
of section 956(c). Therefore, on the date the loan is made, FS is 
treated as holding United States property of $90x.
    Example 2.  (i) Facts. The facts are the same as in Example 1 of 
this paragraph (c)(4), except that USP owns 40% of the stock of FS 
and is not a related person (as defined in section 954(d)(3)) with 
respect to FS. Y, a United States person that is unrelated to USP or 
X, owns the remaining 60% of the stock of FS.
    (ii) Result. Because neither FS nor any person related to FS 
within the meaning of section 954(d)(3) is a partner in FPRS, the 
exception in paragraph (c)(2) of this section applies to treat the 
FPRS obligation as an obligation of a foreign partnership and not an 
obligation of a United States person. Therefore, paragraph (c)(1) of 
this section does not apply, and FS is not treated as holding United 
States property.
    Example 3.  (i) Facts. USP, a domestic corporation, wholly owns 
FS, a controlled foreign corporation. USP and FS own interests in 
FPRS, a foreign partnership. USP's liquidation value percentage with 
respect to FPRS is 60%, and FS's liquidation value percentage with 
respect to FPRS is 30%. U.S.C., a domestic corporation that is 
unrelated to USP and FS, also owns an interest in FPRS; its 
liquidation value percentage is 10%. FPRS borrows $100x from an 
unrelated person. FS guarantees the FPRS obligation.
    (ii) Result. Under paragraph (c)(1) of this section, for 
purposes of section 956, the obligation of FPRS is treated as 
obligations of its partners (USP, FS, and U.S.C.) in proportion to 
each partner's liquidation value percentage. Because USP, a partner 
in FPRS, is related to FS within the meaning of section 954(d)(3), 
and because FS is a partner in FPRS, the exception in paragraph 
(c)(2) of this section does not apply. Based on their liquidation 
value percentages, USP's share of the FPRS obligation is $60x, and 
U.S.C.'s share of the FPRS obligation is $10x. For purposes of 
section 956, $60x of the FPRS obligation is treated as an obligation 
of USP, and $10x of the FPRS obligation is treated as an obligation 
of U.S.C. Under Sec.  1.956-2(c)(1), FS is treated as holding the 
obligations of USP and U.S.C. that FS guaranteed. All of the 
exceptions to the definition of United States property contained in 
section 956 and Sec.  1.956-2 must be considered to determine 
whether the obligations of USP and U.S.C. that are treated as held 
by FS constitute United States property. Accordingly, the obligation 
of U.S.C. is not United States property under section 956(c)(2)(F) 
and Sec.  1.956-2(b)(1)(viii). The obligation of USP, however, is 
United States property within the meaning of section 956(c). 
Therefore, on the date the guarantee is made, FS is treated as 
holding United States property of $60x.
    Example 4.  (i) Facts. USP, a domestic corporation, wholly owns 
FS, a controlled foreign corporation. USP owns an interest in FPRS, 
a foreign partnership; its liquidation value percentage with respect 
to FPRS is 70%. A domestic corporation that is unrelated to USP and 
FS owns the remaining interest in FPRS; its liquidation value 
percentage is 30%. FPRS borrows $100x from FS and makes a 
distribution of $80x to USP. FPRS would not have made the 
distribution to USP but for the funding of FPRS by FS.
    (ii) Result. Because USP, a partner in FPRS, is related to FS 
within the meaning of section 954(d)(3), the exception in paragraph 
(c)(2) of this section does not apply. Moreover, an obligation of 
USP held by FS would be United States property. USP's share of the 
FPRS obligation as determined under paragraph (c)(1) of this section 
in accordance with USP's liquidation value percentage is $70x. Under 
paragraph (c)(3) of this section, USP's share of the FPRS obligation 
is the greater of (i) USP's attributable share of the obligation, 
$70x, or (ii) the lesser of the amount of the distribution, $80x, or 
the amount of the obligation, $100x. For purposes of section 956, 
therefore, $80x of the FPRS obligation is treated as an

[[Page 76512]]

obligation of USP and is United States property within the meaning 
of section 956(c). Thus, on the date the loan is made, FS is treated 
as holding United States property of $80x.

    (d) Limitation on a partner's indirect pledge or guarantee. For 
purposes of section 956 and Sec.  1.956-2(c), a controlled foreign 
corporation that is a partner in a partnership is not considered a 
pledgor or guarantor of the portion of an obligation of the partnership 
attributed to its partners that are United States persons under 
paragraph (c) of this section solely as a result of the attribution of 
a portion of the partnership's assets to the controlled foreign 
corporation under paragraph (b) of this section.
    (e) Obligations of a domestic partnership. For purposes of section 
956, an obligation of a domestic partnership is an obligation of a 
United States person. See section 956(c)(2)(L) for an exception from 
the treatment of such an obligation as United States property.
    (f) Effective/applicability dates. (1) Paragraph (b) of this 
section applies to taxable years of controlled foreign corporations 
ending on or after November 3, 2016, and taxable years of United States 
shareholders in which or with which such taxable years end, with 
respect to property acquired on or after November 3, 2016. For purposes 
of this paragraph (f)(1), a deemed exchange of property pursuant to 
section 1001 on or after November 3, 2016, constitutes an acquisition 
of the property on or after that date. See Sec.  1.956-2(a)(3), as 
contained in 26 CFR part 1 revised as of April 1, 2016, for the rules 
applicable to taxable years of a controlled foreign corporation 
beginning on or after July 23, 2002, and ending before November 3, 
2016, and with respect to property acquired before November 3, 2016, to 
taxable years of a controlled foreign corporation beginning on or after 
July 23, 2002.
    (2) Except as otherwise provided in this paragraph (f)(2), 
paragraph (c) of this section applies to taxable years of controlled 
foreign corporations ending on or after November 3, 2016, and taxable 
years of United States shareholders in which or with which such taxable 
years end, with respect to obligations acquired, or pledges or 
guarantees entered into, on or after September 1, 2015, and, for 
purposes of paragraph (c)(3) of this section, in the case of 
distributions made on or after September 1, 2015. Paragraph (c)(3)(ii) 
of this section applies to taxable years of controlled foreign 
corporations ending on or after November 3, 2016, and taxable years of 
United States shareholders in which or with which such taxable years 
end, with respect to obligations acquired, or pledges or guarantees 
entered into, on or after September 1, 2015, and distributions made on 
or after November 3, 2016. For purposes of this paragraph (f)(2), a 
significant modification, within the meaning of Sec.  1.1001-3(e), of 
an obligation on or after September 1, 2015 constitutes an acquisition 
of the obligation on or after that date. Furthermore, for purposes of 
this paragraph (f)(2), a pledgor or guarantor is treated as entering 
into a pledge or guarantee when there is a significant modification, 
within the meaning of Sec.  1.1001-3(e), of an obligation with respect 
to which it is a pledgor or guarantor on or after September 1, 2015. 
See Sec.  1.956-1T(b)(5), as contained in 26 CFR part 1 revised as of 
April 1, 2016, for rules applicable to taxable years of controlled 
foreign corporations ending on or after September 1, 2015, and before 
November 3, 2016, and to taxable years of United States shareholders in 
which or with which such taxable years end, in the case of 
distributions made on or after September 1, 2015.
    (3) Paragraph (d) of this section applies to taxable years of 
controlled foreign corporations ending on or after November 3, 2016, 
and taxable years of United States shareholders in which or with which 
such taxable years end, with respect to pledges or guarantees entered 
into on or after September 1, 2015. For purposes of this paragraph 
(f)(3), a pledgor or guarantor is treated as entering into a pledge or 
guarantee when there is a significant modification, within the meaning 
of Sec.  1.1001-3(e), of an obligation with respect to which it is a 
pledgor or guarantor on or after September 1, 2015.
    (4) Paragraph (e) of this section applies to taxable years of 
controlled foreign corporations ending on or after November 3, 2016, 
and to taxable years of United States shareholders in which or with 
which such taxable years end, with respect to obligations held on or 
after November 3, 2016.

John Dalrymple,
Deputy Commissioner for Services and Enforcement.
    Approved: October 17, 2016.
 Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-26425 Filed 11-2-16; 8:45 am]
BILLING CODE 4830-01-P