[Code of Federal Regulations]
[Title 26, Volume 10]
[Revised as of April 1, 2004]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.954-0]

[Page 242-245]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1_INCOME TAXES--Table of Contents
 
Sec. 1.954-0  Introduction.

    (a) Effective dates--(1) Final regulations--(i) In general. Except 
as otherwise specifically provided, the provisions of Sec. Sec. 1.954-1 
and 1.954-2 apply to taxable years of a controlled foreign corporation 
beginning after November 6, 1995. If any of the rules described in 
Sec. Sec. 1.954-1 and 1.954-2 are inconsistent with provisions of other 
regulations under subpart F, these final regulations are intended to 
apply instead of such other regulations.
    (ii) Election to apply final regulations retroactively--(A) Scope of 
election. An election may be made to apply the final regulations 
retroactively with respect to any taxable year of the controlled foreign 
corporation beginning on or after January 1, 1987. If such an election 
is made, these final regulations must be applied in their entirety for 
such taxable year and all subsequent taxable years. All references to 
section 11 in the final regulations shall be deemed to include section 
15, where applicable.
    (B) Manner of making election. An election under this paragraph 
(a)(1)(ii) is binding on all United States shareholders of the 
controlled foreign corporation and must be made--
    (1) By the controlling United States shareholders, as defined in 
Sec. 1.964-1(c)(5), by attaching a statement to such effect with their 
original or amended income tax returns for the taxable year of such 
United States shareholders in which or with which the taxable year of 
the CFC ends, and including any additional information required by 
applicable administrative pronouncements, or
    (2) In such other manner as may be prescribed in applicable 
administrative pronouncements.
    (C) Time for making election. An election may be made under this 
paragraph (a)(1)(ii) with respect to a taxable year of the controlled 
foreign corporation beginning on or after January 1, 1987 only if the 
time for filing a return or claim for refund has not expired for the 
taxable year of any United States shareholder of the controlled foreign 
corporation in which or with which such taxable year of the controlled 
foreign corporation ends.
    (D) Revocation of election. An election made under this paragraph 
(a)(1)(ii) may not be revoked.
    (2) Temporary regulations. The provisions of Sec. Sec. 4.954-1 and 
4.954-2 of this chapter apply to taxable years of a controlled foreign 
corporation beginning after December 31, 1986 and on or before November 
6, 1995. However, the provisions of Sec. 4.954-2(b)(6) of this chapter 
continue to apply. For transactions entered into on or before October 
10, 1995, taxpayers may rely on Notice 89-90, 1989-2 C.B. 407, in 
applying the temporary regulations.
    (3) Sec. Sec. 1.954A-1 and 1.954A-2. The provisions of Sec. Sec. 
1.954A-1 and 1.954A-2 (as contained in 26 CFR part 1 edition revised 
April 1, 1995) apply to taxable years of a controlled foreign 
corporation beginning before January 1, 1987. All references therein to 
sections of the Code are to the Internal Revenue Code of 1954 prior to 
the amendments made by the Tax Reform Act of 1986.
    (b) Outline of Sec. Sec. 1.954-0, 1.954-1 and 1.954-2.

                       Sec. 1.954-0 Introduction.

    (a) Effective dates.
    (1) Final regulations.
    (i) In general.
    (ii) Election to apply final regulations retroactively.
    (A) Scope of election.
    (B) Manner of making election.
    (C) Time for making election.
    (D) Revocation of election.
    (2) Temporary regulations.
    (3) Sec. Sec. 1.954A-1 and 1.954A-2.
    (b) Outline of Sec. Sec. 1.954-0, 1.954-1, and 1.954-2.

               Sec. 1.954-1 Foreign base company income.

    (a) In general.
    (1) Purpose and scope.
    (2) Gross foreign base company income.
    (3) Adjusted gross foreign base company income.
    (4) Net foreign base company income.
    (5) Adjusted net foreign base company income.
    (6) Insurance income.
    (7) Additional items of adjusted net foreign base company income or 
adjusted net insurance income by reason of section 952(c).
    (b) Computation of adjusted gross foreign base company income and 
adjusted gross insurance income.
    (1) De minimis and full inclusion tests.
    (i) De minimis test.
    (A) In general.
    (B) Currency translation.

[[Page 243]]

    (C) Coordination with sections 864(d) and 881(c).
    (ii) Seventy percent full inclusion test.
    (2) Character of gross income included in adjusted gross foreign 
base company income.
    (3) Coordination with section 952(c).
    (4) Anti-abuse rule.
    (i) In general.
    (ii) Presumption.
    (iii) Related persons.
    (iv) Example.
    (c) Computation of net foreign base company income.
    (1) General rule.
    (i) Deductions against gross foreign base company income.
    (ii) Losses reduce subpart F income by operation of earnings and 
profits limitation.
    (iii) Items of income.
    (A) Income other than passive foreign personal holding company 
income.
    (B) Passive foreign personal holding company income.
    (2) Computation of net foreign base company income derived from same 
country insurance income.
    (d) Computation of adjusted net foreign base company income or 
adjusted net insurance income.
    (1) Application of high tax exception.
    (2) Effective rate at which taxes are imposed.
    (3) Taxes paid or accrued with respect to an item of income.
    (i) Income other than passive foreign personal holding company 
income.
    (ii) Passive foreign personal holding company income.
    (4) Special rules.
    (i) Consistency rule.
    (ii) Coordination with earnings and profits limitation.
    (iii) Example.
    (5) Procedure.
    (6) Coordination of full inclusion and high tax exception rules.
    (7) Examples.
    (e) Character of income.
    (1) Substance of the transaction.
    (2) Separable character.
    (3) Predominant character.
    (4) Coordination of categories of gross foreign base company income 
or gross insurance income.
    (i) In general.
    (ii) Income excluded from other categories of gross foreign base 
company income.
    (f) Definition of related person.
    (1) Persons related to controlled foreign corporation.
    (i) Individuals.
    (ii) Other persons.
    (2) Control.
    (i) Corporations.
    (ii) Partnerships.
    (iii) Trusts and estates.
    (iv) Direct or indirect ownership.

         Sec. 1.954-2 Foreign personal holding company income.

    (a) Computation of foreign personal holding company income.
    (1) Categories of foreign personal holding company income.
    (2) Coordination of overlapping categories under foreign personal 
holding company provisions.
    (i) In general.
    (ii) Priority of categories.
    (3) Changes in the use or purpose for which property is held.
    (i) In general.
    (ii) Special rules.
    (A) Anti-abuse rule.
    (B) Hedging transactions.
    (iii) Example.
    (4) Definitions and special rules.
    (i) Interest.
    (ii) Bona fide hedging transaction.
    (A) Definition.
    (B) Identification.
    (C) Effect of identification and non-identification.
    (1) Transactions identified.
    (2) Inadvertent identification.
    (3) Transactions not identified.
    (4) Inadvertent error.
    (5) Anti-abuse rule.
    (iii) Inventory and similar property.
    (A) Definition.
    (B) Hedging transactions.
    (iv) Regular dealer.
    (v) Dealer property.
    (A) Definition.
    (B) Securities dealers.
    (C) Hedging transactions.
    (vi) Examples.
    (vii) Debt instrument.
    (b) Dividends, interest, rents, royalties and annuities.
    (1) In general.
    (2) Exclusion of certain export financing interest.
    (i) In general.
    (ii) Exceptions.
    (iii) Conduct of a banking business.
    (iv) Examples.
    (3) Treatment of tax-exempt interest. [Reserved]
    (4) Exclusion of dividends or interest from related persons.
    (i) In general.
    (A) Corporate payor.
    (B) Payment by a partnership.
    (ii) Exceptions.
    (A) Dividends.
    (B) Interest paid out of adjusted foreign base company income or 
insurance income.
    (1) In general.
    (2) Rule for corporations that are both recipients and payors of 
interest.
    (C) Coordination with sections 864(d) and 881(c).
    (iii) Trade or business requirement.

[[Page 244]]

    (iv) Substantial assets test.
    (v) Valuation of assets.
    (vi) Location of tangible property.
    (A) In general.
    (B) Exception.
    (vii) Location of intangible property.
    (A) In general.
    (B) Exception for property located in part in the payor's country of 
incorporation.
    (viii) Location of inventory and dealer property.
    (A) In general.
    (B) Inventory and dealer property located in part in the payor's 
country of incorporation.
    (ix) Location of debt instruments.
    (x) Treatment of certain stock interests.
    (xi) Treatment of banks and insurance companies. [Reserved]
    (5) Exclusion of rents and royalties derived from related persons.
    (i) In general.
    (A) Corporate payor.
    (B) Payment by a partnership.
    (ii) Exceptions.
    (A) Rents or royalties paid out of adjusted foreign base company 
income or insurance income.
    (B) Property used in part in the controlled foreign corporation's 
country of incorporation.
    (6) Exclusion of rents and royalties derived in the active conduct 
of a trade or business.
    (c) Excluded rents.
    (1) Active conduct of a trade or business.
    (2) Special rules.
    (i) Adding substantial value.
    (ii) Substantiality of foreign organization.
    (iii) Active leasing expenses.
    (iv) Adjusted leasing profit.
    (3) Examples.
    (d) Excluded royalties.
    (1) Active conduct of a trade or business.
    (2) Special rules.
    (i) Adding substantial value.
    (ii) Substantiality of foreign organization.
    (iii) Active licensing expenses.
    (iv) Adjusted licensing profit.
    (3) Examples.
    (e) Certain property transactions.
    (1) In general.
    (i) Inclusions.
    (ii) Exceptions.
    (iii) Treatment of losses.
    (iv) Dual character property.
    (2) Property that gives rise to certain income.
    (i) In general.
    (ii) Gain or loss from the disposition of a debt instrument.
    (3) Property that does not give rise to income.
    (f) Commodities transactions.
    (1) In general.
    (i) Inclusion in foreign personal holding company income.
    (ii) Exception.
    (iii) Treatment of losses.
    (2) Definitions.
    (i) Commodity.
    (ii) Commodities transaction.
    (iii) Qualified active sale.
    (A) In general.
    (B) Active conduct of a commodities business.
    (C) Substantially all.
    (D) Activities of employees of a related entity.
    (iv) Qualified hedging transaction entered into prior to January 31, 
2003.
    (A) In general.
    (B) Exception.
    (C) Effective date.
    (v) Qualified hedging transaction entered into on or after January 
31, 2003.
    (A) In general.
    (B) Exception.
    (C) Examples.
    (D) Effective date.
    (vi) Financial institutions not a producer, etc.
    (g) Foreign currency gain or loss.
    (1) Scope and purpose.
    (2) In general.
    (i) Inclusion.
    (ii) Exclusion for business needs.
    (A) General rule.
    (B) Business needs.
    (C) Regular dealers.
    (1) General rule.
    (2) Certain interest-bearing liabilities treated as dealer property.
    (i) In general.
    (ii) Failure to identify certain liabilities.
    (iii) Effective date.
    (D) Example.
    (iii) Special rule for foreign currency gain or loss from an 
interest-bearing liability.
    (3) Election to characterize foreign currency gain or loss that 
arises from a specific category of subpart F income as gain or loss in 
that category.
    (i) In general.
    (ii) Time and manner of election.
    (iii) Revocation of election.
    (iv) Example.
    (4) Election to treat all foreign currency gains or losses as 
foreign personal holding company income.
    (i) In general.
    (ii) Time and manner of election.
    (iii) Revocation of election.
    (5) Gains and losses not subject to this paragraph.
    (i) Capital gains and losses.
    (ii) Income not subject to section 988.
    (iii) Qualified business units using the dollar approximate separate 
transactions method.
    (iv) Gain or loss allocated under Sec. 1.861-9. [Reserved]
    (h) Income equivalent to interest.
    (1) In general.

[[Page 245]]

    (i) Inclusion in foreign personal holding company income.
    (ii) Exceptions.
    (A) Liability hedging transactions.
    (B) Interest.
    (2) Definition of income equivalent to interest.
    (i) In general.
    (ii) Income from the sale of property.
    (3) Notional principal contracts.
    (i) In general.
    (ii) Regular dealers.
    (4) Income equivalent to interest from factoring.
    (i) General rule.
    (ii) Exceptions.
    (iii) Factored receivable.
    (iv) Examples.
    (5) Receivables arising from performance of services.
    (6) Examples.

[T.D. 8618, 60 FR 46508, Sept. 7, 1995; T.D. 8618, 60 FR 62024, Dec. 4, 
1995; T.D. 8767, 63 FR 14615, Mar. 26, 1998; T.D. 9039, 68 FR 4917, Jan. 
31, 2003]