n-06-43.pdf

Preserve advance releases and the authoritative Internal Revenue Bulletin rendition; directory timestamps are file-publication metadata, not legal effective dates. HTML bulletins begin June 2003; earlier available issues require full PDF parsing.

This collection currently includes the publisher’s available advance-release directory. Historical bulletin renditions are discovered separately; an advance-release record alone does not certify the collection archive complete.

1

Part III - Administrative, Procedural, and Miscellaneous

Interim Guidance With Respect to the Application of Treas. Reg. §1.883-3

Notice 2006-43

SECTION I. PURPOSE
This notice announces that the Treasury Department (Treasury) and the Internal
Revenue Service (IRS) will amend the regulations under section 883 of the Internal
Revenue Code (Code) to provide guidance regarding the proper interpretation of
§1.883-3(b) in light of the repeal of section 954(a)(4) and (f) (foreign base company
shipping provisions) by section 415 of the American Jobs Creation Act of 2004, Pub. L.
No. 108-357, 118 Stat. 1418 (2004) (“AJCA”). Until such regulations are issued,
taxpayers may rely on the rules set forth in this notice.
SECTION 2. BACKGROUND
.01 Section 883(a) and (c)
Section 883(a)(1) and (a)(2) of the Code generally provide that income from the
international operation of ships or aircraft derived by a corporation organized in a
foreign country shall be excluded from gross income and exempt from U.S. taxation if
the foreign country in which such corporation is organized grants an equivalent
exemption to corporations organized in the United States. Section 883(c)(1) provides

2
that the section 883(a)(1) and (2) exclusion will not apply if 50 percent or more of the
value of the stock of the foreign corporation is owned by individuals who are not
residents of a country that grants an equivalent exemption to U.S. corporations (the
section 883(c)(1) limitation). Under section 883(c)(2), the section 883(c)(1) limitation
does not apply to any foreign corporation that is a CFC. Under section 883(c)(3), the
section 883(c)(1) limitation does not apply if the stock of the foreign corporation is
primarily and regularly traded on an established securities market in the United States
or in a foreign country that grants an equivalent exemption to U.S. corporations.
.02 Treasury Regulations under Section 883(a) and (c)
On August 26, 2003, Treasury and the IRS issued Treasury Decision 9087,
2003-2 C.B. 781. Treasury Decision 9087 included final regulations implementing
section 883(a) and (c) and provided that the section 883(a)(1) and (2) exclusion is
conditioned on the corporation satisfying certain stock ownership and related
substantiation and reporting requirements.
Under § 1.883-3(a), a CFC satisfies the stock ownership requirement if it meets
the “income inclusion test” of §1.883-3(b) and satisfies certain substantiation and
reporting requirements. The income inclusion test requires that more than 50 percent
of the CFC’s adjusted net foreign base company income (as defined in 1.954-1(d) and
as increased or decreased by section 952(c)) derived from the international operation of
ships or aircraft is includible in the gross income of one or more United States citizens,
individual residents of the United States, or domestic corporations.
.03 AJCA Shipping Income Provisions

3
Section 415 of the AJCA eliminated foreign base company shipping income as a
type of subpart F income, effective for taxable years of foreign corporations beginning
after December 31, 2004, and taxable years of U.S. shareholders with or within which
such taxable years of the foreign corporations end. The legislative history to section
415 of the AJCA indicates that Congress believed the elimination of foreign base
company shipping income as a type of subpart F income would provide “U.S. shippers
the opportunity to be competitive with their tax-advantaged foreign competitors.” See H.
Rep. No. 548, Part I, 108
th
Cong., 2
nd
Sess. 209 (2004).
Commentators requested guidance on the proper interpretation of §1.883-3(b) in
light of the repeal of the foreign base company shipping provisions. Commentators also
expressed concern that foreign corporations may no longer satisfy the income inclusion
test if they no longer derive foreign base company shipping income from the
international operation of their ships or aircraft as a result of the statutory amendments
to sections 954(a)(4) and (f).
Section 423 of the AJCA delayed the applicability date of the final regulations
under section 883(a) and (c) for one year, until taxable years beginning after September
24, 2004.
.04 T.D. 9218
On August 5, 2005, Treasury and the IRS issued T.D. 9218, 2005-37 I.R.B. 503,
to conform the applicability date of the section 883(a) and (c) final regulations in light of
section 423 of the AJCA. In the preamble to T.D. 9218, Treasury and the IRS also
addressed the interpretation of the income inclusion test in light of the AJCA. The

4
preamble stated that the better interpretation of §1.883-3(b) is that a CFC that satisfied
the income inclusion test prior to the effective date of the AJCA may continue to satisfy
it after the effective date of the legislation, provided the CFC can demonstrate that had
section 954(a)(4) and (f) of the Code not been repealed, more than 50 percent of its
current earnings and profits derived from its international operation of ships or aircraft
would have been attributable to amounts includible in the gross income of one or more
U.S. citizens, individual residents of the United States or domestic corporations
(pursuant to section 951(a)(1)(A) or another provision of the Code) for the taxable years
of such persons in which the taxable year of the CFC ends. The preamble to T.D. 9218
stated that Treasury and the IRS would issue regulations to clarify the application of the
income inclusion test and invited comments on the most appropriate way to accomplish
this clarification consistent with the principles of the existing section 883 regulations and
the AJCA.
Treasury and the IRS received a number of comments in response to T.D. 9218.
Generally, commentators suggested that the test proposed in the preamble to T.D. 9218
was too complex because it required CFCs to calculate hypothetical amounts of subpart
F income as though sections 954(a)(4) and (f) had not been repealed. Commentators
proposed several alternative approaches they viewed as simpler than the approach
described in T.D. 9218, including replacing the income inclusion test with a test that
determines whether certain U.S. persons, who are not flow-through entities own,
directly or indirectly, more than 50 percent of the value of the CFC for more than half of
the days in the CFC’s taxable year. Some commentators suggested that CFCs

5
organized in a foreign country that provides a reciprocal exemption to U.S. corporations
on their income from the international operation of their ships or aircraft should be
eligible for the exclusion under section 883(a)(1) and (2) without further limitation.
SECTION 3. NEW RULE: QUALIFIED U.S. PERSON OWNERSHIP TEST
Treasury and the IRS have considered the comments received in response to
T.D. 9218. Treasury and the IRS continue to believe that residents of countries that do
not provide a reciprocal exemption to U.S. corporations on their income from the
international operation of their ships or aircraft might attempt to use the CFC exception
to circumvent the rules of section 883(c)(1) by owning more than 50 percent of the value
of a foreign corporation through a U.S. fiscally transparent entity, such as a U.S.
partnership. Treasury and the IRS continue to believe that this is contrary to the
Congressional intent to ensure that the exclusion provided in section 883(a)(1) and (2)
is provided only to foreign corporations that are owned by residents of foreign countries
that provide a reciprocal exemption to U.S. corporations. See S. Rep. No. 313, 99
th

Cong., 2
nd
Sess. 340-41 (1986); see also Joint Committee on Taxation, General
Explanation of the Tax Reform Act of 1986, at 927-928. In addition, Treasury and the
IRS continue to believe this result is also contrary to the Conference report
accompanying the legislation that added the CFC exception, which states that:
“corporations are not considered residents of countries that exempt U.S. persons unless
50 percent or more of the ultimate individual owners are U.S. shareholders of controlled
foreign corporations.” H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. 598 (1986).
However, Treasury and the IRS agree that the income inclusion test, as it was

6
interpreted in T.D. 9218, is overly complex and unnecessary. As a result, based on the
comments received and Congressional intent to increase the competitiveness of U.S.
shippers through the elimination of foreign base company shipping income as a type of
subpart F income, Treasury and the IRS intend to amend §1.883-3 to replace the
income inclusion test with a new ownership based test. Under the new test, a foreign
corporation will satisfy the stock ownership test of §1.883-1(c)(2) if it meets a “qualified
U.S. person ownership test” and satisfies the substantiation and reporting requirements
of paragraphs 1.883-3(c) and (d), respectively.
A foreign corporation shall satisfy the “qualified U.S. person ownership test” if, for
more than half the days of the corporation’s taxable year: (i) it is a CFC, and (ii) more
than 50 percent of the total value of all the outstanding stock of the CFC is owned
(within the meaning of section 958(a), as modified for purposes of applying this notice)
by one or more “qualified U.S. persons.”
A “qualified U.S. person” is a U.S. person (as defined in section 7701(a)(30)) that
is a U.S. citizen, resident alien, or a domestic corporation. For purposes of applying the
“qualified U.S. person ownership test,” the value of the stock in the CFC that is owned
(directly or indirectly) through bearer shares shall not be considered in the numerator or
denominator of the ownership fraction. In addition, for purposes of applying this test,
stock owned by a domestic partnership, domestic trust or domestic estate, shall be
treated as owned by its partners, beneficiaries or owners, respectively, applying the
rules of section 958(a) as if such domestic entity were a foreign partnership, foreign
trust, or foreign estate, respectively.

7
SECTION 4. EFFECTIVE DATE
Regulations to be issued incorporating the guidance set forth in this notice will
apply for taxable years beginning after the May 2, 2006. Taxpayers also may apply the
provisions of this notice to taxable years beginning before May 2, 2006, but after
December 31, 2004. Taxpayers applying this notice, however, must do so consistently
for all taxable years for which this notice is applied and for which it is in effect.
SECTION 5. REQUEST FOR COMMENTS
Treasury and the IRS request further comments from interested persons on the
rules announced in this notice. Written comments may be submitted to CC:INTL:Br1
(Notice 2006-XX), room 4607, Internal Revenue Service, P.O. Box 7604, Ben Franklin
Station, Washington, DC 20224. Submissions may be hand delivered Monday through
Friday between the hours of 8 am and 5 pm to: CC:INTL:Br1 (Notice 2006-XX) Courier’s
desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington DC
20224. Alternatively, taxpayers may submit comments electronically via the following e-
mail address: Notice.Comments@irscounsel.treas.gov. Please include “Notice 2006-
XX” in the subject line of any electronic communications.
DRAFTING INFORMATION
The principal author of this notice is Patricia A. Bray of the Office of Associate
Chief Counsel (International). However, other personnel from Treasury and the IRS
participated in its development. For further information regarding this notice
contact Patricia A. Bray at (202) 622-3880 (not a toll-free call).

8