n-07-13.pdf

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Part III - Administrative, Procedural, and Miscellaneous

Modification of the Substantial Assistance Rules

Notice 2007-13

SECTION 1. OVERVIEW

This notice announces that the Treasury Department and the Internal Revenue
Service (the IRS) will amend Treas. Reg. §1.954-4(b)(1)(iv) and (b)(2)(ii) and the
examples thereunder, which provide that substantial assistance rendered by a related
person or persons to a controlled foreign corporation (“CFC”) is included within the
definition of foreign base company services income under section 954(e) of the Internal
Revenue Code (Code). These amended regulations will limit the types of activities that
constitute substantial assistance to certain assistance rendered, directly or indirectly, by
a United States person or persons (as the term is defined in section 957(c) of the Code)
to a related CFC. Until regulations reflecting these changes are issued, taxpayers may
rely on this notice.
In addition, in light of the repeal of the foreign base company shipping income
rules under subpart F, this notice confirms that income that previously was foreign base
company shipping income will continue to be foreign base company income to the
extent that it is within the definition of a remaining category of foreign base company
income. This notice also clarifies that Treas. Reg. §1.954-6, which provides rules

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addressing foreign base company shipping income, is effective only for purposes of
applying the rules for the withdrawal of previously excluded subpart F income from
qualified investments under section 955.
SECTION 2. SUBSTANTIAL ASSISTANCE RULES
A. BACKGROUND
Under section 951(a)(1)(A)(i) of the Code, a United States shareholder of a CFC
includes in gross income each year its pro rata share of the CFC’s subpart F income for
the taxable year of the CFC which ends with or within such taxable year of the
shareholder. Section 952(a)(2) defines the term “subpart F income” to mean, in part,
foreign base company income (as defined under section 954).
Section 954(a)(3) of the Code defines “foreign base company income” to include
“foreign base company services income” for the taxable year. Section 954(e)(1) defines
“foreign base company services income” for purposes of section 954(a)(3) to mean
income derived in connection with the performance of services which are performed (1)
for, or on behalf of, any related person and (2) outside the country under the laws of
which the CFC is created or organized. The statute does not explicitly provide for
substantial assistance rules under section 954(e). Those rules are promulgated under
the Secretary’s authority under section 7805(a) to issue regulations interpreting the term
“for, or on behalf of, any related person” under section 954(a)(3).
Treas. Reg. §1.954-4(b)(1)(iv) defines “services which are performed for, or on
behalf of, a related person” to include substantial assistance contributing to the
performance of services by a CFC that has been furnished by a related person or

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persons. Treas. Reg. §1.954-4(b)(2)(ii) sets forth the rules for the application of the
substantial assistance test. Treas. Reg. §1.954-4(b)(2)(ii)(a) states, in general, that
assistance “shall include, but shall not be limited to, direction, supervision, services,
know-how, financial assistance (other than contributions to capital), and equipment,
material, or supplies.” Treas. Reg. §1.954-4(b)(2)(ii)(b) and (c) then provide separate
tests depending on whether the assistance provided by the related person or persons is
in the form of (1) direction, supervision, services or know-how, or (2) financial
assistance, equipment, material or supplies.
Treas. Reg. §1.954-4(b)(2)(ii)(b) provides that assistance in the form of direction,
supervision, services or know-how may be substantial under either a subjective or an
objective test. Under the subjective test, assistance in the form of direction,
supervision, services or know-how will be considered substantial if the assistance
provides the CFC with skills which are a principal element in producing the income from
the performance of such services by such CFC (the principal element test). For
example, a CFC enters into a contract with an unrelated person to drill an oil well. The
technical and supervisory personnel who oversee the drilling of the well are employees
of M, a person related to CFC. In such an instance, the services performed by CFC for
the unrelated party are considered foreign base company services because the services
performed by M substantially assist CFC in the performance of the contract and the
services performed by M are a principal element in producing the income from the
performance of the drilling contract. Cf
. Treas. Reg. §1.954-4(b)(3), Ex. 2.
Alternatively, under the objective test, assistance in the form of direction,

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supervision, services or know-how may be substantial if the cost to the CFC of the
assistance furnished by persons related to the CFC equals 50 percent or more of the
total cost to the CFC of performing the services performed by such CFC (the cost test).
For these purposes, costs are determined after taking into account adjustments (if any)
made under section 482. See
Treas. Reg. §1.954-4(b)(2)(ii)(b).
Treas. Reg. §1.954-4(b)(2)(ii)(c) states, in general, that financial assistance,
equipment, material, or supplies furnished by a person related to the CFC shall be
considered assistance only in the amount, after taking into account adjustments (if any)
made under section 482, by which the consideration actually paid by the CFC to the
related person for the purchase or use of such item is less than the arm’s length charge
for such purchase or use. The total of all such amounts from all related persons is
compared with the profits derived by the CFC from the performance of the services to
determine whether the related party’s contributions qualify as substantial assistance.
Treas. Reg. §1.954-4(b)(2)(ii)(d) expands on the tests in Treas. Reg. §1.954-
4(b)(2)(ii)(b) and (c) by providing that, even if assistance furnished by a related person
or persons to a CFC is not considered substantial under paragraphs (b) or (c) in
isolation, it may nevertheless constitute substantial assistance when taken together or
in combination with other assistance furnished by a related person or persons to the
CFC. Treas. Reg. §1.954-4(b)(2)(ii)(e) provides that, in applying Treas. Reg. §1.954-
4(b)(2)(ii)(b) and (d), assistance in the form of direction, supervision, services, or know-
how shall not be taken into account, unless the assistance so furnished assists the CFC
directly in the performance of the services performed. Treas. Reg. §1.954-4(b)(3) sets

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forth examples, including examples addressing the application of the substantial
assistance test.
B. DISCUSSION
The substantial assistance rules were published as final regulations in 1968 (TD
6981). The purpose of the substantial assistance rules is to treat as foreign base
company services income, income received by a CFC from rendering services to an
unrelated person where in rendering those services a related person substantially
contributes to the CFC’s performance of such services in a manner that suggests that
the CFC, rather than the related party, entered into the contract to obtain a lower rate of
tax on the service income. Since the regulations were published in 1968, there has
been a substantial expansion in the reach of the global economy, particularly in the
provision of global services. As a result, many of the U.S. multinationals that provide
services outside of the United States currently have globally integrated businesses with
support capabilities for unrelated customer projects in different geographic locations,
largely based on factors such as expertise and cost efficiencies.
For example, a CFC may contract with an unrelated person to provide installation
and subsequent repair services. A related CFC, however, is the foreign corporation that
provides the repair services. Although the foreign related CFC that is providing the
support services will continue to have foreign base company services income to the
extent that it performs those services outside of its country of incorporation, it does not
seem appropriate in the current global economy to continue to treat the profits of the
CFC contracting to furnish services to the unrelated person as foreign base company

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services income because of the support services provided by a related foreign person.
If the substantial assistance regulations are not amended to deal with these types of
businesses structures, the regulations may cause taxpayers to change the way they do
business or structure their operations in light of the substantial assistance rules, even if
such a structure would be less efficient from a business perspective by, for example,
requiring a taxpayer to duplicate a full service infrastructure in each country.
The Treasury Department and the IRS, however, remain concerned about the
ability of related United States persons to shift profits offshore to CFCs organized in low
tax jurisdictions in cases where the related United States person or persons provides so
much assistance to the CFC that the CFC cannot be said to be providing services on its
own account and thus acting as an independent entity. Accordingly, the Treasury
Department and the IRS will revise the regulations to eliminate the substantial
assistance rules, except in certain limited instances in which a United States person or
persons provide sufficient assistance directly or indirectly to a related CFC.
C. PROPOSED GUIDANCE
The Treasury Department and the IRS will amend Treas. Reg. §1.954-4(b)(1)(iv)
and (b)(2)(ii) and the examples thereunder. Treas. Reg. §1.954-4(b)(1)(iv) as amended
will provide that services performed by a CFC in a case where substantial assistance by
a related United States person or persons (as the term is defined in section 957(c) of
the Code) contributes to the performance of such service will constitute “services which
are performed for, or on behalf of, a related person.” Treas. Reg. §1.954-4(b)(2)(ii) as
amended will provide that “substantial assistance” consists of assistance furnished

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(directly or indirectly) by a related United States person or persons to the CFC if the
assistance satisfies an objective cost test. The subjective “principal element” test will no
longer apply to determine substantial assistance. For purposes of the objective cost
test, the definition of the term “assistance” will include, but will not be limited to,
direction, supervision, services, know-how, financial assistance (other than contributions
to capital), and equipment, material, or supplies provided directly or indirectly by a
related United States person to a CFC.
The cost test will be satisfied if the cost to the CFC of the assistance furnished by
the related United States person or persons equals or exceeds 80 percent of the total
cost to the CFC of performing the services. The term “cost” will be determined after
taking into account adjustments, if any, made under section 482 of the Code.
Taxpayers may apply the cost test either by demonstrating that the assistance provided,
directly or indirectly, by related United States persons is below the 80 percent cost
threshold, or, alternatively, by demonstrating that the cost of the services provided by
the CFC itself, and/or by a related CFC, is more than 20 percent of the total cost to the
CFC of performing the services. For this purpose, services provided by a CFC itself are
not assistance provided “indirectly” by a related United States person (or persons).
However, employees, officers, or directors of the CFC who are concurrently employees,
officers, or directors of a related United States person during a taxable year of the CFC
will be considered employees, officers or directors solely of the related United States
person for such taxable year for purposes of this Notice.

The examples under Treas. Reg. §1.954-4(b)(2)(ii) will be amended to reflect the

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amendments to the regulations. The application of the proposed cost test is illustrated
by the following examples.
Example 1: USP, a U.S. corporation, wholly owns CFC1 and CFC2, each a
foreign corporation. CFC1 enters into a contract with FP, an unrelated foreign person,
to design a bridge for FP in Country Y, a foreign country that is not CFC1’s country of
organization. CFC1 incurs a total of $100x of costs to design the bridge for FP. USP
performs supervisory services in Country Y for CFC1 with respect to the contract for
which CFC1 pays USP a fee. CFC1 directly performs services related to the
performance of that contract that cost CFC1 $15x. CFC2 performs centralized support
services related to the performance of that contract in Country X, its country of
organization, for which CFC1 pays CFC2 $10x. CFC1 is not treated as receiving
substantial assistance in the performance of that contract because more than 20% of
the cost of that contract is attributable to services furnished directly by CFC1 or a
related CFC (CFC2).
Example 2
: USP, a U.S. corporation, wholly owns CFC1 and CFC2, each a
foreign corporation. CFC2 enters into a contract with FP, an unrelated person, to
design a bridge in Country Y, a foreign country that is not CFC2’s country of
organization. With respect to the contract with FP, USP performs services in Country Y
for CFC1 in the form of design and technical services for which CFC1 pays USP $85x.
CFC1 contracts with CFC2 to provide those services and others to CFC2 for $90x.
CFC2 uses those services together with services it performs itself that cost CFC2 $10x
to design the bridge for FP. Pursuant to the cost test, USP provides substantial

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assistance to CFC2 in the performance of its contract for FP because USP indirectly
furnishes assistance to CFC2 (through CFC1) that exceed 80 percent of the total cost to
CFC2 for performing the contract.
Example 3: USP, a U.S. corporation, wholly owns CFC1 and CFC2, each a
foreign corporation. CFC2 enters into a contract with FP, an unrelated person, to
design a bridge in Country Y, a foreign country that is not CFC2’s country of
organization. With respect to the contract with FP, USP performs services in Country Y
for CFC1 in the form of design and technical services for which CFC1 pays USP $60x.
CFC1 contracts with CFC2 to provide those services and others to CFC2 for $70x.
CFC2 uses those services together with services it performs itself that cost CFC2 $30x
to design the bridge for FP. CFC2 is not treated as receiving substantial assistance in
the performance of that contract because more than 20% of the cost of that contract is
attributable to services furnished directly by CFC2.
D. EFFECTIVE DATE
Regulations to be issued incorporating the guidance set forth in this notice will
apply to taxable years of foreign corporations beginning on or after January 1, 2007 and
to taxable years of United States shareholders in which or with which such taxable
years of the foreign corporations end. Until such regulations are issued, taxpayers may
rely on this notice.
SECTION 3. FOREIGN BASE COMPANY SHIPPING RULES
Section 415 of the American Jobs Creations Act (“AJCA”) repealed sections
954(a)(4) and 954(f) of the Code, (the foreign base company shipping rules). It also

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made conforming amendments by repealing sections 954(b)(6) and (b)(7) and striking a
reference to foreign base company shipping income in section 954(b)(5). These
changes are effective for taxable years of foreign corporations beginning after
December 31, 2004, and taxable years of U.S. shareholders in which or with which such
taxable years of the foreign corporations end. Further, section 415 of the AJCA enacted
a special safe harbor for certain leasing activities under section 954(c)(2)(A). The
special safe harbor rule has been addressed in a separate published guidance project.
See
Notice 2006-48, 2006-21 I.R.B. 1.
As a result of, and as of the effective date of, the repeal of the foreign base
company shipping income rules, Treas. Reg. §1.954-1(e)(4)(i)(A), which provides that
income that qualifies as foreign base company shipping income will not be considered
insurance income or income in any other category of foreign base company income, is
obsolete and Treas. Reg. §1.954-6, which prescribes rules for determining foreign base
company shipping income, is only effective for purposes of applying the rules for the
withdrawal of previously excluded subpart F income from qualified investments under
section 955. Accordingly, Treas. Reg. §1.954-6 will be amended to include new
applicability language.
Moreover, the repeal of sections 954(a)(4) and 954(f) of the Code was only
intended to eliminate the separate category of foreign base company shipping income.
It was not intended to exclude income from subpart F that would otherwise qualify under
another category of foreign base company income. Income that might have been
described in sections 954(a)(4) and 956(f) before the AJCA still must be tested under

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the remaining categories of foreign base company income. Consequently, this notice
confirms that income described in section 954(f) as it existed before its repeal will
continue to constitute subpart F income to the extent that it falls within another category
of foreign base company income.
SECTION 4. REQUEST FOR COMMENTS
The Treasury Department and the IRS request comments on the new substantial
assistance rules proposed in this notice. Comments are requested on whether the new
rules are appropriately targeted and whether any modifications to the rules should be
made before they are promulgated as regulations. In particular, comments are
requested on whether the proposed cost test is appropriate for certain industries, and if
not, how the rules could be modified or supplemented to properly address those
industries while still addressing the Treasury Department’s and the IRS’ concerns about
shifting profits offshore to CFCs organized in low tax jurisdictions. In addition, the
Treasury Department and the IRS understand that taxpayers are also concerned with
the special rule concerning a guaranty of performance contained in Treas. Reg. §1.954-
4(b)(2)(i). The Treasury Department and the IRS are reviewing this rule, particularly in
light of Treas. Reg. §1.482-9T, and request comments on whether changes to this rule
are warranted and, if so, how it should be modified.
Written comments on the issues addressed in this notice may be submitted to the
Office of Associate Chief Counsel International, Attention: Notice 2007-13, room 4710,
CC:INTL:BR2, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington,
DC, 20224. Alternatively, taxpayers may submit comments electronically to

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Notice.Comments@m1.irscounsel.treas.gov. Comments will be available for public
inspection and copying.
SECTION 5. DRAFTING INFORMATION
The principal author of this notice is Ethan Atticks of the Office of Associate Chief
Counsel (International). For further information regarding this notice contact Ethan
Atticks at (202) 622-3840 (not a toll-free call).