[Code of Federal Regulations]
[Title 26, Volume 1]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.267(a)-3]

[Page 575-578]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.267(a)-3  Deduction of amounts owed to related foreign persons.

    (a) Purpose and scope. This section provides rules under section 
267(a) (2) and (3) governing when an amount owed to a related foreign 
person that is otherwise deductible under Chapter 1 may be deducted. 
Paragraph (b) of this section provides the general rules, and paragraph 
(c) of this section provides exceptions and special rules.
    (b) Deduction of amount owed to related foreign person--(1) In 
general. Except as provided in paragraph (c) of this section, section 
267(a)(3) requires a taxpayer to use the cash method of accounting with 
respect to the deduction of amounts owed to a related foreign person. An 
amount that is owed to a related foreign person and that is otherwise 
deductible under Chapter 1 thus may not be deducted by the taxpayer 
until such amount is paid to the related foreign person. For purposes of 
this section, a related foreign person is any person that is not a 
United States person within the meaning of section 7701(a)(30), and that 
is related (within the meaning of section 267(b)) to the taxpayer at the 
close of the taxable year in which the amount incurred by the taxpayer 
would otherwise be deductible. Section 267(f) defines controlled group 
for purposes of section 267(b) without regard to the limitations of 
section 1563(b). An amount is treated as paid for purposes of this 
section if the amount is considered paid for purposes of section 1441 or 
section 1442 (including an amount taken into account pursuant to section 
884(f)).

[[Page 576]]

    (2) Amounts covered. This section applies to otherwise deductible 
amounts that are of a type described in section 871(a)(1) (A), (B) or 
(D), or in section 881(a) (1), (2) or (4). The rules of this section 
also apply to interest that is from sources outside the United States. 
Amounts other than interest that are from sources outside the United 
States, and that are not income of a related foreign person effectively 
connected with the conduct by such related foreign person of a trade or 
business within the United States, are not subject to the rules of 
section 267(a) (2) or (3) or this section. See paragraph (c) of this 
section for rules governing the treatment of amounts that are income of 
a related foreign person effectively connected with the conduct of a 
trade or business within the United States by such related foreign 
person.
    (3) Change in method of accounting. A taxpayer that uses a method of 
accounting other than that required by the rules of this section must 
change its method of accounting to conform its method to the rules of 
this section. The taxpayer's change in method must be made pursuant to 
the rules of section 446(e), the regulations thereunder, and any 
applicable administrative procedures prescribed by the Commissioner. 
Because the rules of this section prescribe a method of accounting, 
these rules apply in the determination of taxpayer's earnings and 
profits pursuant to Sec. 1.1312-6(a).
    (4) Examples. The provisions of this paragraph (b) may be 
illustrated by the following examples:

    Example 1. (i) FC, a corporation incorporated in Country X, owns 100 
percent of the stock of C, a domestic corporation. C uses the accrual 
method of accounting in computing its income and deductions, and is a 
calendar year taxpayer. In Year 1, C accrues an amount owed to FC for 
interest. C makes an actual payment of the amount owed to FC in Year 2.
    (ii) Regardless of its source, the interest owed to FC is an amount 
to which this section applies. Pursuant to the rules of this paragraph 
(b), the amount owed to FC by C will not be allowable as a deduction in 
Year 1. Section 267 does not preclude the deduction of this amount in 
Year 2.
    Example 2. (i) RS, a domestic corporation, is the sole shareholder 
of FSC, a foreign sales corporation. Both RS and FSC use the accrual 
method of accounting. In Year 1, RS accrues $z owed to FSC for 
commissions earned by FSC in Year 1. Pursuant to the foreign sales 
company provisions, sections 921 through 927, a portion of this amount, 
$x, is treated as effectively connected income of FSC from sources 
outside the United States. Accordingly, the rules of section 267(a)(3) 
and paragraph (b) of this section do not apply. See paragraph (c) of 
this section for the rules governing the treatment of amounts that are 
effectively connected income of FSC.
    (ii) The remaining amount of the commission, $y, is classified as 
exempt foreign trade income under section 923(a)(3) and is treated as 
income of FSC from sources outside the United States that is not 
effectively connected income. This amount is one to which the provisions 
of this section do not apply, since it is an amount other than interest 
from sources outside the United States and is not effectively connected 
income. Therefore, a deduction for $y is allowable to RS as of the day 
on which it accrues the otherwise deductible amount, without regard to 
section 267 (a)(2) and (a)(3) and the regulations thereunder.

    (c) Exceptions and special rules--(1) Effectively connected income 
subject to United States tax. The provisions of section 267(a)(2) and 
the regulations thereunder, and not the provisions of paragraph (b) of 
this section, apply to an amount that is income of the related foreign 
person that is effectively connected with the conduct of a United States 
trade or business of such related foreign person. An amount described in 
this paragraph (c)(1) thus is allowable as a deduction as of the day on 
which the amount is includible in the gross income of the related 
foreign person as effectively connected income under sections 872(a)(2) 
or 882(b) (or, if later, as of the day on which the deduction would be 
so allowable but for section 267(a)(2)). However, this paragraph (c)(1) 
does not apply if the related foreign person is exempt from United 
States income tax on the amount owed, or is subject to a reduced rate of 
tax, pursuant to a treaty obligation of the United States (such as under 
an article relating to the taxation of business profits).
    (2) Items exempt from tax by treaty. Except with respect to 
interest, neither paragraph (b) of this section nor section 267 (a)(2) 
or (a)(3) applies to any amount that is income of a related foreign 
person with respect to which the related foreign person is exempt from 
United States taxation on the amount

[[Page 577]]

owed pursuant to a treaty obligation of the United States (such as under 
an article relating to the taxation of business profits). Interest that 
is effectively connected income of the related foreign person under 
sections 872(a)(2) or 882(b) is an amount covered by paragraph (c)(1) of 
this section. Interest that is not effectively connected income of the 
related foreign person is an amount covered by paragraph (b) of this 
section, regardless of whether the related foreign person is exempt from 
United States taxation on the amount owed pursuant to a treaty 
obligation of the United States.
    (3) Items subject to reduced rate of tax by treaty. Paragraph (b) of 
this section applies to amounts that are income of a related foreign 
person with respect to which the related foreign person claims a reduced 
rate of United States income tax on the amount owed pursuant to a treaty 
obligation of the United States (such as under an article relating to 
the taxation of royalties).
    (4) Amounts owed to a foreign personal holding company, controlled 
foreign corporation, or passive foreign investment company--(i) Foreign 
personal holding companies. If an amount to which paragraph (b) of this 
section otherwise applies is owed to a related foreign person that is a 
foreign personal holding company within the meaning of section 552, then 
the amount is allowable as a deduction as of the day on which the amount 
is includible in the income of the foreign personal holding company. The 
day on which the amount is includible in income is determined with 
reference to the method of accounting under which the foreign personal 
holding company computes its taxable income and earnings and profits for 
purposes of sections 551 through 558. See section 551(c) and the 
regulations thereunder for the reporting requirements of the foreign 
personal holding company provisions (sections 551 through 558).
    (ii) Controlled foreign corporations. If an amount to which 
paragraph (b) of this section otherwise applies is owed to a related 
foreign person that is a controlled foreign corporation within the 
meaning of section 957, then the amount is allowable as a deduction as 
of the day on which the amount is includible in the income of the 
controlled foreign corporation. The day on which the amount is 
includible in income is determined with reference to the method of 
accounting under which the controlled foreign corporation computes its 
taxable income and earnings and profits for purposes of sections 951 
through 964. See section 6038 and the regulations thereunder for the 
reporting requirements of the controlled foreign corporation provisions 
(sections 951 through 964).
    (iii) Passive foreign investment companies. If an amount to which 
paragraph (b) of this section otherwise applies is owed to a related 
foreign person that is a passive foreign investment company within the 
meaning of section 1296, then the amount is allowable as a deduction as 
of the day on which amount is includible in the income of the passive 
foreign investment company. The day on which the amount is includible in 
income is determined with reference to the method of accounting under 
which the earnings and profits of the passive foreign investment company 
are computed for purposes of sections 1291 through 1297. See sections 
1291 through 1297 and the regulations thereunder for the reporting 
requirements of the passive foreign investment company provisions. This 
exception shall apply, however, only if the person that owes the amount 
at issue has made and has in effect an election pursuant to section 1295 
with respect to the passive foreign investment company to which the 
amount at issue is owed.
    (iv) Examples. The rules of this paragraph (c)(4) may be illustrated 
by the following examples. Application of the provisions of sections 951 
through 964 are provided for illustration only, and do not provide 
substantive rules concerning the operation of those provisions. The 
principles of these examples apply equally to the provisions of 
paragraphs (c)(4) (i) through (iii) of this section.

    Example 1. P, a domestic corporation, owns 100 percent of the total 
combined voting power and value of the stock of both FC1 and FC2. P is a 
calendar year taxpayer that uses the accrual method of accounting in 
computing its income and deductions. FC1 is incorporated in Country X, 
and FC2 is incorporated in Country Y. FC1 and FC2 are controlled foreign 
corporations within the

[[Page 578]]

meaning of section 957, and are both calendar year taxpayers. FC1 
computes its taxable income and earnings and profits, for purposes of 
sections 951 through 964, using the accrual method of accounting, while 
FC2 uses the cash method. In Year 1 FC1 has gross income of $10,000 that 
is described in section 952 (a) (``subpart F income''), and which 
includes interest owed to FC1 by P that is described in paragraph (b) of 
this section and that is otherwise allowable as a deduction to P under 
chapter 1. The interest owed to FC1 is allowable as a deduction to P in 
Year 1.
    Example 2. The facts are the same as in Example 1, except that in 
Year 1 FC1 reports no subpart F income because of the application of 
section 954 (b)(3)(A) (the subpart F de minimis rule). Because the 
amount owed to FC1 by P is includible in FC1's gross income in Year 1, 
the interest owed to FC1 is allowable as a deduction to P in Year 1.
    Example 3. The facts are the same as in Example 1. In Year 1, FC1 
accrues interest owed to FC2 that would be allowable as a deduction by 
FC1 under chapter 1 if FC1 were a domestic corporation. The interest 
owed to FC2 by FC1 is paid by FC1 in Year 2. Because FC2 uses the cash 
method of accounting in computing its taxable income for purposes of 
subpart F, the interest owed by FC1 is allowable as a deduction by FC1 
in Year 2, and not in Year 1.

    (d) Effective date. The rules of this section are effective with 
respect to interest that is allowable as a deduction under chapter 1 
(without regard to the rules of this section) in taxable years beginning 
after December 31, 1983, but are not effective with respect to interest 
that is incurred with respect to indebtedness incurred on or before 
September 29, 1983, or incurred after that date pursuant to a contract 
that was binding on that date and at all times thereafter (unless the 
indebtedness or the contract was renegotiated, extended, renewed, or 
revised after that date). The regulations in this section issued under 
section 267 apply to all other deductible amounts that are incurred 
after July 31, 1989, but do not apply to amounts that are incurred 
pursuant to a contract that was binding on September 29, 1983, and at 
all times thereafter (unless the contract was renegotiated, extended, 
renewed, or revised after that date).

[T.D. 8465, 58 FR 237, Jan. 5, 1993]