Rules for certain foreign corporations owning stock in 25-percent-owned domestic corporations
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(e) Anti-abuse rule.—
(2) Safe harbor.— Paragraph (e)(1) of this section will not apply if paragraph (e)(2)(i) or (e)(2)(ii) of this section applies.
(i) Active business within United States.— The value of the assets of the second-tier domestic corporation used or held for use in an active trade or business within the U.S. is more than 80 percent of the fair market value of the gross assets of such corporation. For purposes of this paragraph (e)(2)—
(A) The value of the assets of the second-tier domestic corporation takes into account its pro-rata share of the value of the assets of its domestic subsidiary qualified affiliates and does not take into account the stock of such affiliates;
(B) The term domestic subsidiary qualified affiliate means each member of the affiliated group (as defined in section 1504(a) applied by substituting “more than 50 percent” for “at least 80 percent” each place it appears), treating the second-tier domestic corporation as the common parent of such affiliated group; and
(C) For purposes of this paragraph (e)(2), the determination of the existence of an active trade or business and whether assets are used in an active trade or business is made under §1.367(a)-2(d)(2), (3), and (5) except that officers and employees of related entities as provided in §1.367(a)-2(d)(3) include only the officers and employees of related domestic entities within the meaning of section 267(b) or 707(b)(1).
(i) Businesses undergoing change and new businesses.—
(A) In general.— The second-tier domestic corporation engages in an active U.S. trade or business that satisfies paragraph (e)(2)(i) of this section by the end of the transition period following the testing date.
(B) Testing date.— For purposes of this paragraph (e)(2)(ii), the term testing date means the last day of the month in which either—
(1) The second-tier domestic corporation is created or organized or is acquired, directly or indirectly, by the tested foreign corporation; or
(2) A second-tier domestic corporation that previously satisfied (e)(2)(i) of this paragraph (e) disposes of, to a person that is not related within the meaning of section 267(b) or 707(b)(1), substantially all of the assets used or held for use in its active U.S. trade or business.
(C) Transition period.— For purposes of this paragraph (e)(2)(ii), the term transition period means thirty-six months after the testing date as defined in paragraph (e)(2)(ii)(B)(1) or (2) of this section.
(D) Inapplicability.— This paragraph (e)(2)(ii) does not apply for any taxable year (including previous taxable years) of the tested foreign corporation if the second-tier domestic corporation does not engage in an active U.S. trade or business that satisfies paragraph (e)(2)(i) of this section by the end of the transition period following a testing date.
(3) Examples.— The following examples illustrate the rules of this paragraph (e). For purposes of these examples, TFC is a foreign corporation that is not a controlled foreign corporation (within the meaning of section 957(a)) and that is subject to the section 531 tax, USS1 and USS2 are domestic corporations for TFC’s entire taxable year, TFC owns 100% of the single class of stock of USS1, and USS1 owns 100% of the single class of stock of USS2.
(i) Example 1.—
(A) Facts. USS2 operates an active trade or business within the United States within the meaning of §1.367(a)-2(d)(2), (3), and (5). Throughout TFC’s Year 1, the value of USS2’s assets is $100x, and the value of USS2’s assets that are used or held for use in its active trade or business within the United States is $20x. USS2 was not created, organized, or acquired within the preceding thirty-six months and has not disposed of an active trade or business within the United States within the preceding thirty-six months.
(B) Results. Paragraph (e)(2)(i) of this section does not apply in Year 1 even though USS2 is engaged in an active trade or business within the United States because only 20% ($20x/$100x) of its assets are used or held for use in an active U.S. trade or business within the meaning of §1.367(a)-2(d)(2), (3), and (5), an amount that is not more than 80% of the fair market value of the total gross assets of USS2. Accordingly, the general rule in paragraph (e)(1) of this section will apply if there is a principal purpose to hold passive assets through USS2, the second-tier domestic corporation, to avoid classification of TFC, the tested foreign corporation, as a PFIC.
(ii) Example 2.—
(A) Facts.The facts are the same as in as in paragraph (e)(4)(i)(A) of this section (the facts in Example 1), except that USS2 also has an investment in USS3, a wholly owned domestic subsidiary of USS2. Throughout TFC’s taxable Year 1, the value of USS3’s assets is $400x and USS3 uses 100% of its assets in an active trade or business within the United States within the meaning of §1.367(a)-2(d)(2), (3), and (5).
(B) Results. Because USS3 is a domestic subsidiary qualified affiliate of USS2, USS2’s pro-rata share of the assets of USS3 is taken into account to determine whether USS2 satisfies paragraph (e)(2)(i) of this section. Accordingly, USS2 takes into account $400x (its pro-rata share) of USS3’s assets in addition to the $100x of its own assets and, thus, is treated for purposes of paragraph (e)(2)(i) of this section as owning $500x of assets, with 84% ($420x/$500x) of such assets being used or held for use in an active trade or business within the United States within the meaning of §1.367(a)-2(d)(2), (3), and (5). Therefore, paragraph (e)(2)(i) of this section applies in Year 1 and the general rule in paragraph (e)(1) of this section does not apply.
(iii) Example 3.—
(A) Facts. Throughout Year 1, USS2 uses 100% of its assets in an active trade or business within the United States within the meaning of §1.367(a)-2(d)(2), (3), and (5), and thus satisfied paragraph (e)(2)(i) of this section in Year 1. On the first day of Year 2, USS2 disposes of all of those assets for cash. On the seventh day of Year 5 (before the end of the first month in Year 5), USS2 invests the cash in assets that it immediately begins to use in an active trade or business in the United States.
(B) Results. Because USS2, the second-tier domestic corporation, engages in an active U.S. trade or business that satisfies paragraph (e)(2)(i) of this section by the end of thirty-six months after the last day of the month in which it disposed of its entire active U.S. trade or business that previously satisfied paragraph (e)(2)(i) of this section, paragraph (e)(2)(ii) of this section applies in Year 2, Year 3, and Year 4, and the general rule in paragraph (e)(1) of this section does not apply.
(iv) Example 4.—
(A) Facts. The facts are the same as in paragraph (e)(4)(iii)(A) of this section (the facts in Example 3), except that at the end of the first month of Year 5, USS2 is still in negotiations to purchase assets to be used in an active trade or business in the United States within the meaning of §1.367(a)-2(d)(2), (3), and (5), and USS2 does not complete the purchase of such assets until the third month of Year 5.
(B) Results. The safe harbor in paragraph (e)(2)(ii) of this section does not apply for Year 2, Year 3, or Year 4, because USS2, the second tier domestic corporation, did not engage in an active U.S. trade or business that satisfied paragraph (e)(2)(i) of this section by the end of the thirty six month transition period after the end of the month in which it sold its prior active trade or business. Accordingly, the general rule in paragraph (e)(1) of this section will apply if there is a principal purpose to hold passive assets through USS2, the second-tier domestic corporation, to avoid classification of TFC, the tested foreign corporation, as a PFIC.
(f) Applicability date.— Except as otherwise provided, the rules of this section apply to taxable years of shareholders beginning on or after January 14, 2021. *** Paragraphs (e)(2) and (3) of this section apply to taxable years of shareholders beginning on or after [DATE OF FILING OF FINAL RULE IN THE FEDERAL REGISTER]. A shareholder may choose to apply the paragraphs in the preceding sentence for any open taxable year beginning before [DATE OF FILING OF FINAL RULE IN THE FEDERAL REGISTER] without regard to whether the rules of this section are applied consistently, provided that once applied, each rule must be applied for each subsequent taxable year beginning before [DATE OF FILING OF FINAL RULE IN THE FEDERAL REGISTER]. [Prop. Reg. §1.1298-4.]
[Proposed 1-15-2021.]