Subpart F Income

Subpart F Income

October 01, 2004

“Subpart F income” had to be reported by a US company even though it could not have received it.

A US company owned common stock of a foreign corporation.  Someone else owned preferred stock in the same corporation.  The organizational documents for the foreign corporation barred it from paying any dividends to the common shareholders while the preferred shares were outstanding.

The United States looks through any foreign corporation that is more than 50% US owned and taxes any US shareholder who owns at least 10% of the foreign corporation on its share of the foreign corporation’s earnings.  However, not all earnings are exposed to tax like this.  The US will look through and tax only the passive earnings — like dividends, interest, rents and royalties — earned by the foreign corporation.  This is called “subpart F income.”

In this case, the US company argued that it should not have to pay tax on any part of the foreign corporation’s passive earnings because it could not receive them.

The IRS said no in a “technical advice memorandum,” or ruling issued by the IRS national office.  The national office called the circumstances that denied the US company access to the earnings a “voluntary” restriction.  It was something to which the shareholders agreed when they set up the company.  The IRS refused to give the restriction any significance, in part because the US parent company had the voting power to change the restriction if it wanted.

More importantly, the IRS said it would only have let the US parent company avoid reporting a share of the earnings if it was denied access by currency restrictions or other laws in the foreign country.  The ruling is TAM 200437033. The IRS made it public in September.

Keith Martin