---
kind: "range"
citation: "26 C.F.R. §§ 1.954-1–1.954-8"
title: "26"
from: "1.954-1"
to: "1.954-8"
count: 8
url: "https://uscodex.org/cfr/26/1.954-1..1.954-8"
---

# §1.954-1. Foreign base company income.

- (a) **In general—**
  - (1) **Purpose and scope.** [Section 954](/cfr/26/954.md) and §§ 1.954-1 and [1.954-2](/cfr/26/1.954-2.md) provide rules for computing the foreign base company income of a controlled foreign corporation. Foreign base company income is included in the [subpart F](/cfr/26/subpartF.md) income of a controlled foreign corporation under the rules of [section 952](/cfr/26/952.md). [Subpart F](/cfr/26/subpartF.md) income is included in the gross income of a United States shareholder of a controlled foreign corporation under the rules of [section 951](/cfr/26/951.md) and thus is subject to current taxation under section [1](/cfr/26/1.md), [11](/cfr/26/11.md) or [55](/cfr/26/55.md) of the Internal Revenue Code. The determination of whether a foreign corporation is a controlled foreign corporation, the [subpart F](/cfr/26/subpartF.md) income of which is included currently in the gross income of its United States shareholders, is made under the rules of [section 957](/cfr/26/957.md).
  - (2) **Gross foreign base company income.** The gross foreign base company income of a controlled foreign corporation consists of the following categories of gross income (determined after the application of [section 952(b)](/cfr/26/952.md?p=b))—
    - (i) Foreign personal holding company income, as defined in [section 954(c)](/cfr/26/954.md?p=c);
    - (ii) Foreign base company sales income, as defined in [section 954(d)](/cfr/26/954.md?p=d);
    - (iii) Foreign base company services income, as defined in [section 954(e)](/cfr/26/954.md?p=e);
    - (iv) Foreign base company shipping income, as defined in [section 954(f)](/cfr/26/954.md?p=f); and
    - (v) **Foreign base company oil related income, as defined in section 954(g).**
  - (3) **Adjusted gross foreign base company income.** The term adjusted gross foreign base company income means the gross foreign base company income of a controlled foreign corporation as adjusted by the de minimis and full inclusion rules of [paragraph (b)](#b) of this section.
  - (4) **Net foreign base company income.** The term net foreign base company income means the adjusted gross foreign base company income of a controlled foreign corporation reduced so as to take account of deductions (including taxes) properly allocable or apportionable to such income under the rules of [section 954(b)(5)](/cfr/26/954.md?p=b-5) and [paragraph (c)](#c) of this section.
  - (5) **Adjusted net foreign base company income.** The term adjusted net foreign base company income means the net foreign base company income of a controlled foreign corporation reduced, first, by any items of net foreign base company income excluded from [subpart F](/cfr/26/subpartF.md) income pursuant to [section 952(c)](/cfr/26/952.md?p=c) and, second, by any items excluded from [subpart F](/cfr/26/subpartF.md) income pursuant to the high tax exception of [section 954(b)](/cfr/26/954.md?p=b). See [paragraph (d)(4)(ii)](#d-4-ii) of this section. The term foreign base company income as used in the Internal Revenue Code and elsewhere in the Income Tax Regulations means adjusted net foreign base company income, unless otherwise provided.
  - (6) **Insurance income.** The term gross insurance income includes all gross income taken into account in determining insurance income under [section 953](/cfr/26/953.md). The term adjusted gross insurance income means gross insurance income as adjusted by the de minimis and full inclusion rules of [paragraph (b)](#b) of this section. The term net insurance income means adjusted gross insurance income reduced under [section 953](/cfr/26/953.md) so as to take into account deductions (including taxes) properly allocable or apportionable to such income. The term adjusted net insurance income means net insurance income reduced by any items of net insurance income that are excluded from [subpart F](/cfr/26/subpartF.md) income pursuant to [section 952(b)](/cfr/26/952.md?p=b) or pursuant to the high tax exception of [section 954(b)](/cfr/26/954.md?p=b). The term insurance income as used in [subpart F](/cfr/26/subpartF.md) of the Internal Revenue Code and in the regulations under that subpart means adjusted net insurance income, unless otherwise provided.
  - (7) **Additional items of adjusted net foreign base company income or adjusted net insurance income by reason of section 952(c).** Earnings and profits of the controlled foreign corporation that are recharacterized as foreign base company income or insurance income under [section 952(c)](/cfr/26/952.md?p=c) are items of adjusted net foreign base company income or adjusted net insurance income, respectively. Amounts subject to recharacterization under [section 952(c)](/cfr/26/952.md?p=c) are determined after adjusted net foreign base company income and adjusted net insurance income are otherwise determined under [subpart F](/cfr/26/subpartF.md) and are not again subject to any exceptions or special rules that would affect the amount of [subpart F](/cfr/26/subpartF.md) income. Thus, for example, items of gross foreign base company income or gross insurance income that are excluded from adjusted gross foreign base company income or adjusted gross insurance income because the de minimis test is met are subject to recharacterization under [section 952(c)](/cfr/26/952.md?p=c). Further, the de minimis and full inclusion tests of [paragraph (b)](#b) of this section, and the high tax exception of [paragraph (d)](#d) of this section, for example, do not apply to such amounts.
- (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.** Except as provided in [paragraph (b)(1)(i)(C)](#b-1-i-C) of this section, adjusted gross foreign base company income and adjusted gross insurance income are equal to zero if the sum of the gross foreign base company income and the gross insurance income of a controlled foreign corporation is less than the lesser of—

        (1) 5 percent of gross income; or

        (2) $1,000,000.

      - (B) **Currency translation.** Controlled foreign corporations having a functional currency other than the United States dollar shall translate the $1,000,000 threshold using the exchange rate provided under [section 989(b)(3)](/cfr/26/989.md?p=b-3) for amounts included in income under [section 951(a)](/cfr/26/951.md?p=a).
      - (C) **Coordination with sections 864(d) and 881(c).** Adjusted gross foreign base company income or adjusted gross insurance income of a controlled foreign corporation always includes income from trade or service receivables described in section [864(d)(1)](/cfr/26/864.md?p=d-1) or [(6)](/cfr/26/864.md?p=d-6), and portfolio interest described in [section 881(c)](/cfr/26/881.md?p=c), even if the de minimis test of this [paragraph (b)(1)(i)](#b-1-i) is otherwise satisfied.
    - (ii) **Seventy percent full inclusion test.** Except as provided in [section 953](/cfr/26/953.md), adjusted gross foreign base company income consists of all gross income of the controlled foreign corporation other than gross insurance income and amounts described in [section 952(b)](/cfr/26/952.md?p=b), and adjusted gross insurance income consists of all gross insurance income other than amounts described in [section 952(b)](/cfr/26/952.md?p=b), if the sum of the gross foreign base company income and the gross insurance income for the taxable year exceeds 70 percent of gross income. See [paragraph (d)(6)](#d-6) of this section, under which certain items of full inclusion foreign base company income may nevertheless be excluded from [subpart F](/cfr/26/subpartF.md) income.
  - (2) **Character of gross income included in adjusted gross foreign base company income.** The gross income included in the adjusted gross foreign base company income of a controlled foreign corporation generally retains its character as foreign personal holding company income, foreign base company sales income, foreign base company services income, foreign base company shipping income, or foreign base company oil related income. However, gross income included in adjusted gross foreign base company income because the full inclusion test of [paragraph (b)(1)(ii)](#b-1-ii) of this section is met is termed full inclusion foreign base company income, and constitutes a separate category of adjusted gross foreign base company income for purposes of allocating and apportioning deductions under [paragraph (c)](#c) of this section.
  - (3) **Coordination with section 952(c).** Income that is included in [subpart F](/cfr/26/subpartF.md) income because the full inclusion test of [paragraph (b)(1)(ii)](#b-1-ii) of this section is met does not reduce amounts that, under [section 952(c)](/cfr/26/952.md?p=c), are subject to recharacterization.
  - (4) **Anti-abuse rule—**
    - (i) **In general.** For purposes of applying the de minimis test of [paragraph (b)(1)(i)](#b-1-i) of this section, the income of two or more controlled foreign corporations shall be aggregated and treated as the income of a single corporation if a principal purpose for separately organizing, acquiring, or maintaining such multiple corporations is to prevent income from being treated as foreign base company income or insurance income under the de minimis test. A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately).
    - (ii) **Presumption.** Two or more controlled foreign corporations are presumed to have been organized, acquired or maintained to prevent income from being treated as foreign base company income or insurance income under the de minimis test of [paragraph (b)(1)(i)](#b-1-i) of this section if the corporations are related persons, as defined in [paragraph (b)(4)(iii)](#b-4-iii) of this section, and the corporations are described in paragraph [(b)(4)(ii)(A)](#b-4-ii-A), [(B)](#b-4-ii-B), or [(C)](#b-4-ii-C) of this section. This presumption may be rebutted by proof to the contrary.
      - (A) The activities carried on by the controlled foreign corporations, or the assets used in those activities, are substantially the same activities that were previously carried on, or assets that were previously held, by a single controlled foreign corporation. Further, the United States shareholders of the controlled foreign corporations or related persons (as determined under [paragraph (b)(4)(iii)](#b-4-iii) of this section) are substantially the same as the United States shareholders of the one controlled foreign corporation in a prior taxable year. A presumption made in connection with the requirements of this [paragraph (b)(4)(ii)(A)](#b-4-ii-A) may be rebutted by proof that the activities carried on by each controlled foreign corporation would constitute a separate branch under the principles of [§ 1.367(a)-6T(g)(2)](/cfr/26/1.367..6T.md) if carried on directly by a United States person.
      - (B) The controlled foreign corporations carry on a business, financial operation, or venture as partners directly or indirectly in a partnership (as defined in [section 7701(a)(2)](/cfr/26/7701.md?p=a-2) and [§ 301.7701-3](/cfr/26/301.7701-3.md) of this chapter) that is a related person (as defined in [paragraph (b)(4)(iii)](#b-4-iii) of this section) with respect to each such controlled foreign corporation.
      - (C) The activities carried on by the controlled foreign corporations would constitute a single branch operation under [§ 1.367(a)-6T(g)(2)](/cfr/26/1.367..6T.md) if carried on directly by a United States person.
    - (iii) **Related persons.** For purposes of this [paragraph (b)](#b), two or more persons are related persons if they are in a relationship described in [section 267(b)](/cfr/26/267.md?p=b). In determining for purposes of this [paragraph (b)](#b) whether two or more corporations are members of the same controlled group under [section 267(b)(3)](/cfr/26/267.md?p=b-3), a person is considered to own stock owned directly by such person, stock owned with the application of [section 1563(e)(1)](/cfr/26/1563.md?p=e-1), and stock owned with the application of [section 267(c)](/cfr/26/267.md?p=c). In determining for purposes of this [paragraph (b)](#b) whether a corporation is related to a partnership under [section 267(b)(10)](/cfr/26/267.md?p=b-10), a person is considered to own the partnership interest owned directly by such person and the partnership interest owned with the application of [section 267(e)(3)](/cfr/26/267.md?p=e-3).
    - (iv) **Example.** The following example illustrates the application of this [paragraph (b)(4)](#b-4).
- (c) **Computation of net foreign base company income—**
  - (1) **General rule.** The net foreign base company income of a controlled foreign corporation (as defined in [paragraph (a)(4)](#a-4) of this section) is computed under the rules of this [paragraph (c)(1)](#c-1). The principles of [§ 1.904-5(k)](/cfr/26/1.904-5.md?p=k) shall apply where payments are made between controlled foreign corporations that are related persons (within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3)). Consistent with these principles, only payments described in [§ 1.954-2(b)(4)(ii)(B)(2)](/cfr/26/1.954-2.md?p=b-4-ii-B-2) may be offset as provided in [§ 1.904-5(k)(2)](/cfr/26/1.904-5.md?p=k-2).
    - (i) **Deductions against gross foreign base company income.** The net foreign base company income of a controlled foreign corporation is computed first by taking into account deductions in the following manner:
      - (A) First, the gross amount of each item of income described in [paragraph (c)(1)(iii)](#c-1-iii) of this section is determined.
      - (B) Second, any expenses definitely related to less than all gross income as a class shall be allocated and apportioned under the principles of sections [861](/cfr/26/861.md), [864](/cfr/26/864.md) and [904(d)](/cfr/26/904.md?p=d) to the gross income described in [paragraph (c)(1)(i)(A)](#c-1-i-A) of this section.
      - (C) Third, foreign personal holding company income that is passive within the meaning of [section 904](/cfr/26/904.md) (determined before the application of the high-taxed income rule of [§ 1.904-4(c)](/cfr/26/1.904-4.md?p=c)) is reduced (but not below zero) by related person interest expense allocable to passive income under [§ 1.904-5(c)(2)](/cfr/26/1.904-5.md?p=c-2); such interest must be further allocated and apportioned to items described in [paragraph (c)(1)(iii)(B)](#c-1-iii-B) of this section.
      - (D) Fourth, the amount of each item of income described in [paragraph (c)(1)(iii)](#c-1-iii) of this section is reduced by other expenses allocable and apportionable to such income under the principles of sections [861](/cfr/26/861.md), [864](/cfr/26/864.md) and [904(d)](/cfr/26/904.md?p=d).
    - (ii) **Losses reduce subpart F income by operation of earnings and profits limitation.** Except as otherwise provided in [§ 1.954-2(g)(4)](/cfr/26/1.954-2.md?p=g-4), if after applying the rules of [paragraph (c)(1)(i)](#c-1-i) of this section, the amount remaining in any category of foreign base company income or foreign personal holding company income is less than zero, the loss in that category may not reduce any other category of foreign base company income or foreign personal holding company income except by operation of the earnings and profits limitation of [section 952(c)(1)](/cfr/26/952.md?p=c-1).
    - (iii) **Items of income—**
      - (A) **Income other than passive foreign personal holding company income.** A single item of income (other than foreign personal holding company income that is passive) is the aggregate amount from all transactions that falls within a single separate category (as defined in [§ 1.904-5(a)(4)(v)](/cfr/26/1.904-5.md?p=a-4-v)), and either—

        (1) Falls within a single category of foreign personal holding company income as—

        (i) Dividends, interest, rents, royalties and annuities;

        (ii) Gain from certain property transactions;

        (iii) Gain from commodities transactions;

        (iv) Foreign currency gain; or

        (v) Income equivalent to interest; or

        (2) Falls within a single category of foreign base company income, other than foreign personal holding company income, as—

        (i) Foreign base company sales income;

        (ii) Foreign base company services income; or

        (iii)—(iv) [Reserved]

        (v) Full inclusion foreign base company income.

        (3) For purposes of [paragraph (c)(1)(iii)(A)](#c-1-iii-A) of this section, the aggregate amount from all transactions that falls within a single separate category (as defined in [§ 1.904-5(a)(4)(v)](/cfr/26/1.904-5.md?p=a-4-v)) and is described in paragraph (c)(1)(iii)(A)(1)(i) of this section is a single item of income. Similarly, the aggregate amount from all transactions that falls within a single separate category (as defined in [§ 1.904-5(a)(4)(v)](/cfr/26/1.904-5.md?p=a-4-v)) and is described in each one of [paragraphs (c)(1)(iii)(A)(1)(ii) through (c)(1)(iii)(A)(1)(v)](#c-1-iii-A-1-ii..c-1-iii-A-1-v) of this section is in each case a separate single item of income. The same principles apply for transactions described in each one of [paragraphs (c)(1)(iii)(A)(2)(i) through (v)](#c-1-iii-A-2-i..c-1-iii-A-2-v) of this section.

      - (B) **Passive foreign personal holding company income.** A single item of foreign personal holding company income that is passive is an amount of income that falls within a single group of passive income under the grouping rules of § [1.904-4(c)(3)](/cfr/26/1.904-4.md?p=c-3), [(4)](/cfr/26/1.904-4.md?p=c-4) and [(5)](/cfr/26/1.904-4.md?p=c-5) and a single category of foreign personal holding company income described in paragraphs (c)(1)(iii)(A)(1) (i) through (v).
    - (iv) **Treatment of deductions or loss attributable to disqualified basis.** For purposes of [paragraph (c)(1)(i)](#c-1-i) of this section (and in the case of insurance income, [paragraph (a)(6)](#a-6) of this section), in determining the amount of a net item of foreign base company income or insurance income, deductions or loss described in § [1.951A-2(c)(5)](/cfr/26/1.951A-2.md?p=c-5) or [(c)(6)](/cfr/26/1.951A-2.md?p=c-6) are not allocated and apportioned to gross foreign base company income or gross insurance income.
  - (2) **Computation of net foreign base company income derived from same country insurance income.** Deductions relating to foreign base company income attributable to the issuing (or reinsuring) of any insurance or annuity contract in connection with risks located in the country under the laws of which the controlled foreign corporation is created or organized shall be allocated and apportioned in accordance with the rules set forth in [section 953](/cfr/26/953.md).
- (d) **Computation of adjusted net foreign base company income or adjusted net insurance income—**
  - (1) **Application of high tax exception.** Adjusted net foreign base company income (or adjusted net insurance income) equals the net foreign base company income (or net insurance income) of a controlled foreign corporation, reduced by any net item of such income that qualifies for the high tax exception provided by [section 954(b)(4)](/cfr/26/954.md?p=b-4) and this [paragraph (d)](#d). Any item of income that is portfolio interest, as described in [section 881(c)](/cfr/26/881.md?p=c), does not qualify for the high tax exception. See [paragraph (c)(1)(iii)](#c-1-iii) of this section for the definition of the term item of income. For rules concerning the treatment for foreign tax credit purposes of amounts excluded from [subpart F](/cfr/26/subpartF.md) under [section 954(b)(4)](/cfr/26/954.md?p=b-4), see [§ 1.904-4(c)](/cfr/26/1.904-4.md?p=c). For rules concerning the application of the high-tax exception of sections [954(b)(4)](/cfr/26/954.md?p=b-4) and [951A(c)(2)(A)(i)(III)](/cfr/26/951A.md?p=c-2-A-i-III) to tentative gross tested income items, see § [1.951A-2(c)(1)(iii)](/cfr/26/1.951A-2.md?p=c-1-iii), [(c)(3)(ii)](/cfr/26/1.951A-2.md?p=c-3-ii), and [(c)(7)](/cfr/26/1.951A-2.md?p=c-c-7) and [(8)](/cfr/26/1.951A-2.md?p=c-c-8). A net item of income qualifies for the high tax exception only if—
    - (i) An election is made under [section 954(b)(4)](/cfr/26/954.md?p=b-4) and [paragraph (d)(5)](#d-5) of this section to exclude the income from the computation of [subpart F](/cfr/26/subpartF.md) income; and
    - (ii) It is established that the net item of income was subject to foreign income taxes at an effective rate that is greater than 90 percent of the maximum rate of tax specified in [section 11](/cfr/26/11.md) for the taxable year of the controlled foreign corporation.
  - (2) **Effective rate at which taxes are imposed.** The effective rate with respect to a net item of income shall be determined separately for each controlled foreign corporation. The effective rate at which taxes are imposed on a net item of income is—
    - (i) The United States dollar amount of foreign income taxes paid or accrued with respect to the net item of income, determined under [paragraph (d)(3)](#d-3) of this section; divided by
    - (ii) The United States dollar amount of the net item of foreign base company income or insurance income, described in [paragraph (c)(1)(iii)](#c-1-iii) of this section, increased by the amount of foreign income taxes referred to in [paragraph (d)(2)(i)](#d-2-i) of this section.
  - (3) **Taxes paid or accrued with respect to an item of income—**
    - (i) **In general.** The amount of foreign income taxes paid or accrued by a controlled foreign corporation with respect to a net item of income for purposes of [section 954(b)(4)](/cfr/26/954.md?p=b-4) and this [paragraph (d)](#d) is the U.S. dollar amount of the controlled foreign corporation's current year taxes (as defined in [§ 1.960-1(b)(4)](/cfr/26/1.960-1.md?p=b-4)) that are allocated and apportioned under [§ 1.960-1(d)(3)(ii)](/cfr/26/1.960-1.md?p=d-3-ii) to the [subpart F](/cfr/26/subpartF.md) income group (as defined in [§ 1.960-1(d)(2)(ii)(B)](/cfr/26/1.960-1.md?p=d-2-ii-B)) that corresponds with the net item of income.
    - (ii) [Reserved]
    - (iii) **Effect of potential and actual changes in taxes paid or accrued.** Except as otherwise provided in this [paragraph (d)(3)(iii)](#d-3-iii), the amount of foreign income taxes paid or accrued with respect to a net item of income, determined in the manner provided in this [paragraph (d)](#d), does not take into account any potential reduction in foreign income taxes that may occur by reason of a future distribution to shareholders of all or part of such income. However, to the extent the foreign income taxes paid or accrued by the controlled foreign corporation are reasonably certain to be returned by the foreign jurisdiction imposing such taxes to a shareholder, directly or indirectly, through any means (including, but not limited to, a refund, credit, payment, discharge of an obligation, or any other method) on a subsequent distribution to such shareholder, the foreign income taxes are not treated as paid or accrued for purposes of this [paragraph (d)(3)](#d-3). In addition, foreign income taxes that have not been paid or accrued because they are contingent on a future distribution of earnings are not taken into account for purposes of this [paragraph (d)(3)](#d-3). If, pursuant to [section 905(c)](/cfr/26/905.md?p=c) and [§ 1.905-3(b)(2)](/cfr/26/1.905-3.md?p=b-2), a redetermination of U.S. tax liability is required to account for the effect of a foreign tax redetermination (as defined in [§ 1.905-3(a)](/cfr/26/1.905-3.md?p=a)), this [paragraph (d)](#d) is applied in the adjusted year taking into account the adjusted amount of the redetermined foreign tax.
  - (4) **Special rules—**
    - (i) **Consistency rule.** An election to exclude income from the computation of subpart F income for a taxable year must be made consistently with respect to all items of passive foreign personal holding company income eligible to be excluded for the taxable year. Thus, high-taxed passive foreign personal holding company income of a controlled foreign corporation must either be excluded in its entirety, or remain subject to subpart F in its entirety.
    - (ii) **Coordination with earnings and profits limitation.** If the amount of income included in [subpart F](/cfr/26/subpartF.md) income for the taxable year is reduced by the earnings and profits limitation of [section 952(c)(1)](/cfr/26/952.md?p=c-1), the amount of income that is a net item of income, within the meaning of [paragraph (c)(1)(iii)](#c-1-iii) of this section, is determined after the application of the rules of [section 952(c)(1)](/cfr/26/952.md?p=c-1).
    - (iii) **Example.** The following example illustrates the provisions of [paragraph (d)(4)(ii)](#d-4-ii) of this section. All of the taxes referred to in the following example are foreign income taxes. For simplicity, this example assumes that the amount of taxes that are taken into account as a deduction under [section 954(b)(5)](/cfr/26/954.md?p=b-5) and the amount of the gross-up required under sections [960](/cfr/26/960.md) and [78](/cfr/26/78.md) are equal. Therefore, this example does not separately illustrate the deduction for taxes and gross-up.
  - (5) **Procedure.** An election made under the procedure provided by this [paragraph (d)(5)](#d-5) is binding on all United States shareholders of the controlled foreign corporation and must be made—
    - (i) By the controlling United States shareholders, as defined in [§ 1.964-1(c)(5)](/cfr/26/1.964-1.md?p=c-5), by attaching a statement to such effect with their original or amended income tax returns, and including any additional information required by applicable administrative pronouncements; or
    - (ii) In such other manner as may be prescribed in applicable administrative pronouncements.
  - (6) **Coordination of full inclusion and high tax exception rules.** Notwithstanding [paragraph (b)(1)(ii)](#b-1-ii) of this section, full inclusion foreign base company income will be excluded from [subpart F](/cfr/26/subpartF.md) income if more than 90 percent of the adjusted gross foreign base company income and adjusted gross insurance company income of a controlled foreign corporation (determined without regard to the full inclusion test of [paragraph (b)(1)](#b-1) of this section) is attributable to net amounts excluded from [subpart F](/cfr/26/subpartF.md) income pursuant to an election to have the high tax exception described in [section 954(b)(4)](/cfr/26/954.md?p=b-4) and this [paragraph (d)](#d) apply.
- (e) **Character of income—**
  - (1) **Substance of the transaction.** For purposes of [section 954](/cfr/26/954.md), income shall be characterized in accordance with the substance of the transaction, and not in accordance with the designation applied by the parties to the transaction. For example, an amount that is designated as rent by the taxpayer but actually constitutes income from the sale of property, royalties, or income from services shall not be characterized as rent but shall be characterized as income from the sale of property, royalties or income from services, as the case may be. Local law shall not be controlling in characterizing income.
  - (2) **Separable character.** To the extent the definitional provisions of section [953](/cfr/26/953.md) or [954](/cfr/26/954.md) describe the income or gain derived from a transaction, or any portion or portions thereof, that income or gain, or portion or portions thereof, is so characterized for purposes of subpart F. Thus, a single transaction may give rise to income in more than one category of foreign base company income described in [paragraph (a)(2)](#a-2) of this section. For example, if a controlled foreign corporation, in its business of purchasing personal property and selling it to related persons outside its country of incorporation, also performs services outside its country of incorporation with respect to the property it sells, the sales income will be treated as foreign base company sales income and the services income will be treated as foreign base company services income for purposes of these rules.
  - (3) **Predominant character.** The portion of income or gain derived from a transaction that is included in the computation of foreign personal holding company income is always separately determinable and thus must always be segregated from other income and separately classified under [paragraph (e)(2)](#e-2) of this section. However, the portion of income or gain derived from a transaction that would meet a particular definitional provision under section [954](/cfr/26/954.md) or [953](/cfr/26/953.md) (other than the definition of foreign personal holding company income) in unusual circumstances may not be separately determinable. If such portion is not separately determinable, it must be classified in accordance with the predominant character of the transaction. For example, if a controlled foreign corporation engineers, fabricates, and installs a fixed offshore drilling platform as part of an integrated transaction, and the portion of income that relates to services is not accounted for separately from the portion that relates to sales, and is otherwise not separately determinable, then the classification of income from the transaction shall be made in accordance with the predominant character of the arrangement.
  - (4) **Coordination of categories of gross foreign base company income or gross insurance income—**
    - (i) **In general.** The computations of gross foreign base company income and gross insurance income are limited by the following rules:
      - (A) If income is foreign base company shipping income, pursuant to [section 954(f)](/cfr/26/954.md?p=f), it shall not be considered insurance income or income in any other category of foreign base company income.
      - (B) If income is foreign base company oil related income, pursuant to [section 954(g)](/cfr/26/954.md?p=g), it shall not be considered insurance income or income in any other category of foreign base company income, except as provided in [paragraph (e)(4)(i)(A)](#e-4-i-A) of this section.
      - (C) If income is insurance income, pursuant to [section 953](/cfr/26/953.md), it shall not be considered income in any category of foreign base company income except as provided in paragraph [(e)(4)(i)(A)](#e-4-i-A) or [(B)](#e-4-i-B) of this section.
      - (D) If income is foreign personal holding company income, pursuant to [section 954(c)](/cfr/26/954.md?p=c), it shall not be considered income in any other category of foreign base company income, other than as provided in paragraph [(e)(4)(i)(A)](#e-4-i-A), [(B)](#e-4-i-B) or [(C)](#e-4-i-C) of this section.
    - (ii) **Income excluded from other categories of gross foreign base company income.** Income shall not be excluded from a category of gross foreign base company income or gross insurance income under this [paragraph (e)(4)](#e-4) by reason of being included in another category of gross foreign base company income or gross insurance income, if the income is excluded from that other category by a more specific provision of section [953](/cfr/26/953.md) or [954](/cfr/26/954.md). For example, income derived from a commodity transaction that is excluded from foreign personal holding company income under [§ 1.954-2(f)](/cfr/26/1.954-2.md?p=f) as income from a qualified active sale may be included in gross foreign base company income if it also meets the definition of foreign base company sales income. See [§ 1.954-2(a)(2)](/cfr/26/1.954-2.md?p=a-2) for the coordination of overlapping categories within the definition of foreign personal holding company income.
- (f) **Definition of related person—**
  - (1) **Persons related to controlled foreign corporation.** Unless otherwise provided, for purposes of [section 954](/cfr/26/954.md) and [§§ 1.954-1 through 1.954-8](/cfr/26/1.954-1..1.954-8.md) inclusive, the following persons are considered under [section 954(d)(3)](/cfr/26/954.md?p=d-3) to be related persons with respect to a controlled foreign corporation:
    - (i) **Individuals.** An individual, whether or not a citizen or resident of the United States, who controls the controlled foreign corporation.
    - (ii) **Other persons.** A foreign or domestic corporation, partnership, trust or estate that controls or is controlled by the controlled foreign corporation, or is controlled by the same person or persons that control the controlled foreign corporation.
  - (2) **Control—**
    - (i) **Corporations.** With respect to a corporation, control means the ownership, directly or indirectly, of stock possessing more than 50 percent of the total voting power of all classes of stock entitled to vote or of the total value of the stock of the corporation.
    - (ii) **Partnerships.** With respect to a partnership, control means the ownership, directly or indirectly, of more than 50 percent (by value) of the capital or profits interest in the partnership.
    - (iii) **Trusts and estates.** With respect to a trust or estate, control means the ownership, directly or indirectly, of more than 50 percent (by value) of the beneficial interest in the trust or estate.
    - (iv) **Direct or indirect ownership.** For purposes of [section 954(d)(3)](/cfr/26/954.md?p=d-3) and this [paragraph (f)](#f), to determine direct or indirect ownership—
      - (A) The principles of [§ 1.958-1](/cfr/26/1.958-1.md) and [section 958(a)](/cfr/26/958.md?p=a) apply without regard to whether a corporation, partnership, trust, or estate is foreign or domestic or whether an individual is a citizen or resident of the United States; and
      - (B) The principles of [§ 1.958-2](/cfr/26/1.958-2.md) and [section 958(b)](/cfr/26/958.md?p=b) apply, except that—

        (1) Neither [section 318(a)(3)](/cfr/26/318.md?p=a-3), nor [§ 1.958-2(d)](/cfr/26/1.958-2.md?p=d) or the principles thereof, applies to attribute stock or other interests to a corporation, partnership, estate, or trust; and

        (2) Neither [section 318(a)(4)](/cfr/26/318.md?p=a-4), nor [§ 1.958-2(e)](/cfr/26/1.958-2.md?p=e) or the principles thereof, applies to treat dividends, interest, rents, or royalties received or accrued from a foreign corporation as received or accrued from a controlled foreign corporation payor if a principal purpose of the use of an option to acquire stock or an equity interest, or an interest similar to such an option, that causes the foreign corporation to be a controlled foreign corporation payor is to qualify dividends, interest, rents, or royalties paid by the foreign corporation for the [section 954(c)(6)](/cfr/26/954.md?p=c-6) exception. For purposes of this paragraph (f)(2)(iv)(B)(2), an interest that is similar to an option to acquire stock or an equity interest includes, but is not limited to, a warrant, a convertible debt instrument, an instrument other than debt that is convertible into stock or an equity interest, a put, a stock or equity interest subject to risk of forfeiture, and a contract to acquire or sell stock or an equity interest.

        (3) Neither [section 318(a)(4)](/cfr/26/318.md?p=a-4), nor [§ 1.958-2(e)](/cfr/26/1.958-2.md?p=e) or the principles thereof, applies to treat a person that has an option to acquire stock or an equity interest, or an interest similar to such an option, as owning the stock or equity interest if a principal purpose for the use of the option or similar interest is to treat a person as a related person with respect to a controlled foreign corporation under this [paragraph (f)](#f). For purposes of this paragraph (f)(2)(iv)(B)(3), an interest that is similar to an option to acquire stock or an equity interest includes, but is not limited to, a warrant, a convertible debt instrument, an instrument other than debt that is convertible into stock or an equity interest, a put, a stock or equity interest subject to risk of forfeiture, and a contract to acquire or sell stock or an equity interest.

  - (3) **Applicability dates—**
    - (i) **General rule.** Except as otherwise provided in this [paragraph (f)(3)](#f-3), [paragraph (f)(2)(iv)](#f-2-iv) of this section applies to taxable years of controlled foreign corporations ending on or after November 19, 2019, and taxable years of United States shareholders in which or with which such taxable years end.
    - (ii) **Option rule in paragraph (f)(2)(iv)(B)(2) of this section.** Paragraph (f)(2)(iv)(B)(2) of this section applies to taxable years of controlled foreign corporations beginning after December 31, 2006, and ending before November 19, 2019, and taxable years of United States shareholders in which or with which such taxable years end.
    - (iii) **Anti-abuse rule.** Paragraphs (f)(2)(iv)(B)(1) and (3) of this section apply to taxable years of controlled foreign corporations ending on or after May 17, 2019, and to taxable years of United States shareholders in which or with which such taxable years end, with respect to amounts that are received or accrued by a controlled foreign corporation on or after May 17, 2019 to the extent the amounts are received or accrued in advance of the period to which such amounts are attributable with a principal purpose of avoiding the application of paragraph (f)(2)(iv)(B)(1) or (3) of this section with respect to such amounts.
- (g) **Distributive share of partnership income—**
  - (1) **Application of related person and country of organization tests.** Unless otherwise provided, to determine the extent to which a controlled foreign corporation's distributive share of any item of gross income of a partnership would have been [subpart F](/cfr/26/subpartF.md) income if received by it directly, under [§ 1.952-1(g)](/cfr/26/1.952-1.md?p=g), if a provision of [subpart F](/cfr/26/subpartF.md) requires a determination of whether an entity is a related person, within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3), or whether an activity occurred within or outside the country under the laws of which the controlled foreign corporation is created or organized, this determination shall be made by reference to such controlled foreign corporation and not by reference to the partnership.
  - (2) **Application of related person test for sales and purchase transactions between a partnership and its controlled foreign corporation partner.** For purposes of determining whether a controlled foreign corporation's distributive share of any item of gross income of a partnership is foreign base company sales income under [section 954(d)(1)](/cfr/26/954.md?p=d-1) when the item of income is derived from the sale by the partnership of personal property purchased by the partnership from (or sold by the partnership on behalf of) the controlled foreign corporation; or the sale by the partnership of personal property to (or the purchase of personal property by the partnership on behalf of) the controlled foreign corporation (CFC-partnership transaction), the CFC-partnership transaction will be treated as a transaction with an entity that is a related person, within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3), under [paragraph (g)(1)](#g-1) of this section, if—
    - (i) The controlled foreign corporation purchased such personal property from (or sold it to the partnership on behalf of), or sells such personal property to (or purchases it from the partnership on behalf of), a related person with respect to the controlled foreign corporation (other than the partnership), within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3); or
    - (ii) The branch rule of [section 954(d)(2)](/cfr/26/954.md?p=d-2) applies to treat as foreign base company sales income the income of the controlled foreign corporation from selling to the partnership (or a third party) personal property that the controlled foreign corporation has manufactured, in the case where the partnership purchases personal property from (or sells personal property on behalf of) the controlled foreign corporation.
  - (3) **Examples.** The application of this [paragraph (g)](#g) is illustrated by the following examples:
- (h) **Applicability dates—**
  - (1) **Paragraph (d)(3) of this section.** [Paragraph (d)(3)](#d-3) of this section applies to taxable years of a controlled foreign corporation ending on or after December 16, 2019. For taxable years of a controlled foreign corporation ending on or after December 4, 2018, but ending before December 16, 2019, see [§ 1.954-1(d)(3)](#d-3) as contained in [26 CFR part 1](/cfr/26/part1.md) revised as of April 1, 2019.
  - (2) **Paragraph (g) of this section.** [Paragraph (g)](#g) of this section applies to taxable years of a controlled foreign corporation beginning on or after July 23, 2002.
  - (3) **Paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this section for taxable years beginning on or after—** July 23, 2020. Paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this section apply to taxable years of a controlled foreign corporation beginning on or after July 23, 2020, and to taxable years of United States shareholders in which or with which such taxable years of foreign corporations end. In addition, taxpayers may choose to apply the rules in paragraphs (c)(1)(iii)(A)(3), (c)(1)(iv), and (d)(3)(i) of this section to taxable years of controlled foreign corporations that begin after December 31, 2017, and before July 23, 2020, and to taxable years of United States shareholders in which or with which such taxable years of the controlled foreign corporations end, provided that they consistently apply those rules and the rules in § [1.951A-2(c)(1)(iii)](/cfr/26/1.951A-2.md?p=c-1-iii), [(c)(3)(ii)](/cfr/26/1.951A-2.md?p=c-3-ii), and [(c)(7)](/cfr/26/1.951A-2.md?p=c-c-7) and [(8)](/cfr/26/1.951A-2.md?p=c-c-8) to such taxable years.

# §1.954-2. Foreign personal holding company income.

- (a) **Computation of foreign personal holding company income—**
  - (1) **Categories of foreign personal holding company income.** For purposes of subpart F and the regulations under that subpart, foreign personal holding company income consists of the following categories of income—
    - (i) Dividends, interest, rents, royalties, and annuities as described in [paragraph (b)](#b) of this section;
    - (ii) Gain from certain property transactions as described in [paragraph (e)](#e) of this section;
    - (iii) Gain from commodities transactions as described in [paragraph (f)](#f) of this section;
    - (iv) Foreign currency gain as described in [paragraph (g)](#g) of this section; and
    - (v) **Income equivalent to interest as described in paragraph (h) of this section.**
  - (2) **Coordination of overlapping categories under foreign personal holding company provisions—**
    - (i) **In general.** If any portion of income, gain or loss from a transaction is described in more than one category of foreign personal holding company income (as described in [paragraph (a)(2)(ii)](#a-2-ii) of this section), that portion of income, gain or loss is treated solely as income, gain or loss from the category of foreign personal holding company income with the highest priority.
    - (ii) **Priority of categories.** The categories of foreign personal holding company income, listed from highest priority ([paragraph (a)(2)(ii)(A)](#a-2-ii-A) of this section) to lowest priority ([paragraph (a)(2)(ii)(E)](#a-2-ii-E) of this section), are—
      - (A) Dividends, interest, rents, royalties, and annuities, as described in [paragraph (b)](#b) of this section;
      - (B) Income equivalent to interest, as described in [paragraph (h)](#h) of this section without regard to the exceptions in [paragraph (h)(1)(ii)(A)](#h-1-ii-A) of this section;
      - (C) Foreign currency gain or loss, as described in [paragraph (g)](#g) of this section without regard to the exclusion in [paragraph (g)(2)(ii)](#g-2-ii) of this section;
      - (D) Gain or loss from commodities transactions, as described in [paragraph (f)](#f) of this section without regard to the exclusion in [paragraph (f)(1)(ii)](#f-1-ii) of this section; and
      - (E) Gain or loss from certain property transactions, as described in [paragraph (e)](#e) of this section without regard to the exceptions in [paragraph (e)(1)(ii)](#e-1-ii) of this section.
  - (3) **Changes in the use or purpose for which property is held—**
    - (i) **In general.** Under paragraphs [(e)](#e), [(f)](#f), [(g)](#g) and [(h)](#h) of this section, transactions in certain property give rise to gain or loss included in the computation of foreign personal holding company income if the controlled foreign corporation holds that property for a particular use or purpose. The use or purpose for which property is held is that use or purpose for which it was held for more than one- half of the period during which the controlled foreign corporation held the property prior to the disposition.
    - (ii) **Special rules—**
      - (A) **Anti-abuse rule.** If a principal purpose of a change in use or purpose of property was to avoid including gain or loss in the computation of foreign personal holding company income, all the gain or loss from the disposition of the property is treated as foreign personal holding company income. A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately).
      - (B) **Hedging transactions.** The provisions of [paragraph (a)(3)(i)](#a-3-i) of this section shall not apply to bona fide hedging transactions, as defined in [paragraph (a)(4)(ii)](#a-4-ii) of this section. A transaction will be treated as a bona fide hedging transaction only so long as it satisfies the requirements of [paragraph (a)(4)(ii)](#a-4-ii) of this section.
    - (iii) **Example.** The following example illustrates the application of this [paragraph (a)(3)](#a-3).
  - (4) **Definitions and special rules.** The following definitions and special rules apply for purposes of computing foreign personal holding company income under this section.
    - (i) **Interest.** The term interest includes all amounts that are treated as interest income (including interest on a tax-exempt obligation) by reason of the Internal Revenue Code or Income Tax Regulations or any other provision of law. For example, interest includes stated interest, acquisition discount, original issue discount, de minimis original issue discount, market discount, de minimis market discount, and unstated interest, as adjusted by any amortizable bond premium or acquisition premium.
    - (ii) **Bona fide hedging transaction—**
      - (A) **Definition.** The term bona fide hedging transaction means a transaction that meets the requirements of [§ 1.1221-2 (a) through (d)](/cfr/26/1.1221-2.md?p=a..d) and that is identified in accordance with the requirements of [paragraph (a)(4)(ii)(B)](#a-4-ii-B) of this section, except that in applying [§ 1.1221-2(b)(1)](/cfr/26/1.1221-2.md?p=b-1), the risk being hedged may be with respect to ordinary property, [section 1231](/cfr/26/1231.md) property, or a [section 988](/cfr/26/988.md) transaction. A transaction that hedges the liabilities, inventory or other assets of a related person (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)), that is entered into to assume or reduce risks of a related person, or that is entered into by a person other than a person acting in its capacity as a regular dealer (as defined in [paragraph (a)(4)(iv)](#a-4-iv) of this section) to reduce risks assumed from a related person, will not be treated as a bona fide hedging transaction. For an illustration of how this rule applies with respect to foreign currency transactions, see [paragraph (g)(2)(ii)(D)](#g-2-ii-D) of this section.
      - (B) **Identification.** The identification requirements of this section shall be satisfied if the taxpayer meets the identification and recordkeeping requirements of [§ 1.1221-2(f)](/cfr/26/1.1221-2.md?p=f). However, for bona fide hedging transactions entered into prior to March 7, 1996 the identification and recordkeeping requirements of [§ 1.1221-2](/cfr/26/1.1221-2.md) shall not apply. Rather, for bona fide hedging transactions entered into on or after July 22, 1988 and prior to March 7, 1996 the identification and recordkeeping requirements shall be satisfied if such transactions are identified by the close of the fifth day after the day on which they are entered into. For bona fide hedging transactions entered into prior to July 22, 1988, the identification and recordkeeping requirements shall be satisfied if such transactions are identified reasonably contemporaneously with the date they are entered into, but no later than within the normal period prescribed under the method of accounting of the controlled foreign corporation used for financial reporting purposes.
      - (C) **Effect of identification and non-identification—** (1) Transactions identified. If a taxpayer identifies a transaction as a bona fide hedging transaction for purposes of this section, the identification is binding with respect to any loss arising from such transaction whether or not all of the requirements of [paragraph (a)(4)(ii)(A)](#a-4-ii-A) of this section are satisfied. Accordingly, such loss will be allocated against income that is not [subpart F](/cfr/26/subpartF.md) income (or, in the case of an election under [paragraph (g)(3)](#g-3) of this section, against the category of [subpart F](/cfr/26/subpartF.md) income to which it relates) and apportioned among the categories of income described in [section 904(d)(1)](/cfr/26/904.md?p=d-1). If the transaction is not in fact a bona fide hedging transaction described in [paragraph (a)(4)(ii)(A)](#a-4-ii-A) of this section, however, then any gain realized with respect to such transaction shall not be considered as gain from a bona fide hedging transaction. Accordingly, such gain shall be treated as gain from the appropriate category of foreign personal holding company income. Thus, the taxpayer's identification of the transaction as a hedging transaction does not itself operate to exclude gain from the appropriate category of foreign personal holding company income.

        (2) Inadvertent identification. Notwithstanding paragraph (a)(4)(ii)(C)(1) of this section, if the taxpayer identifies a transaction as a bona fide hedging transaction for purposes of this section, the characterization of the loss is determined as if the transaction had not been identified as a bona fide hedging transaction if—

        (i) The transaction is not a bona fide hedging transaction (as defined in [paragraph (a)(4)(ii)(A)](#a-4-ii-A) of this section);

        (ii) The identification of the transaction as a bona fide hedging transaction was due to inadvertent error; and

        (iii) All of the taxpayer's transactions in all open years are being treated on either original or, if necessary, amended returns in a manner consistent with the principles of this section.

        (3) Transactions not identified. Except as provided in paragraphs (a)(4)(ii)(C)(4) and (5) of this section, the absence of an identification that satisfies the requirements of [paragraph (a)(4)(ii)(B)](#a-4-ii-B) of this section is binding and establishes that a transaction is not a bona fide hedging transaction. Thus, subject to the exceptions, the characterization of gain or loss is determined without reference to whether the transaction is a bona fide hedging transaction.

        (4) Inadvertent error. If a taxpayer does not make an identification that satisfies the requirements of [paragraph (a)(4)(ii)(B)](#a-4-ii-B) of this section, the taxpayer may treat gain or loss from the transaction as gain or loss from a bona fide hedging transaction if—

        (i) The transaction is a bona fide hedging transaction (as defined in [paragraph (a)(4)(ii)(A)](#a-4-ii-A) of this section);

        (ii) The failure to identify the transaction was due to inadvertent error; and

        (iii) All of the taxpayer's bona fide hedging transactions in all open years are being treated on either original or, if necessary, amended returns as bona fide hedging transactions in accordance with the rules of this section.

        (5) Anti-abuse rule. If a taxpayer does not make an identification that satisfies all the requirements of [paragraph (a)(4)(ii)(B)](#a-4-ii-B) of this section but the taxpayer has no reasonable grounds for treating the transaction as other than a bona fide hedging transaction, then loss from the transaction shall be treated as realized with respect to a bona fide hedging transaction. Thus, a taxpayer may not elect to exclude loss from its proper characterization as a bona fide hedging transaction. The reasonableness of the taxpayer's failure to identify a transaction is determined by taking into consideration not only the requirements of [paragraph (a)(4)(ii)(A)](#a-4-ii-A) of this section but also the taxpayer's treatment of the transaction for financial accounting or other purposes and the taxpayer's identification of similar transactions as hedging transactions.

    - (iii) **Inventory and similar property—**
      - (A) **Definition.** The term inventory and similar property (or inventory or similar property) means property that is stock in trade of the controlled foreign corporation or other property of a kind that would properly be included in the inventory of the controlled foreign corporation if on hand at the close of the taxable year (if the controlled foreign corporation were a domestic corporation), or property held by the controlled foreign corporation primarily for sale to customers in the ordinary course of its trade or business.
      - (B) **Hedging transactions.** A bona fide hedging transaction with respect to inventory or similar property (other than a transaction described in [section 988(c)(1)](/cfr/26/988.md?p=c-1) without regard to [section 988(c)(1)(D)(i)](/cfr/26/988.md?p=c-1-D-i)) shall be treated as a transaction in inventory or similar property.
    - (iv) **Regular dealer.** The term regular dealer means a controlled foreign corporation that—
      - (A) Regularly and actively offers to, and in fact does, purchase property from and sell property to customers who are not related persons (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to the controlled foreign corporation in the ordinary course of a trade or business; or
      - (B) Regularly and actively offers to, and in fact does, enter into, assume, offset, assign or otherwise terminate positions in property with customers who are not related persons (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to the controlled foreign corporation in the ordinary course of a trade or business.
    - (v) **Dealer property—**
      - (A) **Definition.** Property held by a controlled foreign corporation is dealer property if—

        (1) The controlled foreign corporation is a regular dealer in property of such kind (determined under [paragraph (a)(4)(iv)](#a-4-iv) of this section); and

        (2) The property is held by the controlled foreign corporation in its capacity as a dealer in property of such kind without regard to whether the property arises from a transaction with a related person (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to the controlled foreign corporation. The property is not held by the controlled foreign corporation in its capacity as a dealer if the property is held for investment or speculation on its own behalf or on behalf of a related person (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)).

      - (B) **Securities dealers.** If a controlled foreign corporation is a licensed securities dealer, only the securities that it has identified as held for investment in accordance with the provisions of [section 475(b)](/cfr/26/475.md?p=b) or [section 1236](/cfr/26/1236.md) will be considered to be property held for investment or speculation under this section. A licensed securities dealer is a controlled foreign corporation that is both a securities dealer, as defined in [section 475](/cfr/26/475.md), and a regular dealer, as defined in [paragraph (a)(4)(iv)](#a-4-iv) of this section, and that is either—

        (1) Registered as a securities dealer under section 15(a) of the Securities Exchange Act of 1934 or as a Government securities dealer under [section 15C(a)](/cfr/26/15C.md?p=a) of such Act; or

        (2) Licensed or authorized in the country in which it is chartered, incorporated, or organized to purchase and sell securities from or to customers who are residents of that country. The conduct of such securities activities must be subject to bona fide regulation, including appropriate reporting, monitoring, and prudential (including capital adequacy) requirements, by a securities regulatory authority in that country that regularly enforces compliance with such requirements and prudential standards.

      - (C) **Hedging transactions.** A bona fide hedging transaction with respect to dealer property shall be treated as a transaction in dealer property.
    - (vi) **Examples.** The following examples illustrate the application of paragraphs [(a)(4)(ii)](#a-4-ii), [(iv)](#a-4-iv) and [(v)](#a-4-v) of this section.
    - (vii) **Debt instrument.** The term debt instrument includes bonds, debentures, notes, certificates, accounts receivable, and other evidences of indebtedness.
  - (5) **Special rules applicable to distributive share of partnership income—**
    - (i) [Reserved]
    - (ii) **Certain other exceptions applicable to foreign personal holding company income.** To determine the extent to which a controlled foreign corporation's distributive share of an item of income of a partnership is foreign personal holding company income—
      - (A) The exceptions contained in [section 954(c)](/cfr/26/954.md?p=c) that are based on whether the controlled foreign corporation is engaged in the active conduct of a trade or business, including [section 954(c)(2)](/cfr/26/954.md?p=c-2) and paragraphs [(b)(2)](#b-2) and [(6)](#b-6), [(e)(1)(ii)](#e-1-ii) and [(3)(ii)](#e-3-ii), [(iii)](#e-3-iii) and [(iv)](#e-3-iv), [(f)(1)(ii)](#f-1-ii), [(g)(2)(ii)](#g-2-ii), and [(h)(3)(ii)](#h-3-ii) of this section, shall apply only if any such exception would have applied to exclude the income from foreign personal holding company income if the controlled foreign corporation had earned the income directly, determined by taking into account only the activities of, and property owned by, the partnership and not the separate activities or property of the controlled foreign corporation or any other person;
      - (B) A controlled foreign corporation's distributive share of partnership income will not be excluded from foreign personal holding company income under the exception contained in [section 954(h)](/cfr/26/954.md?p=h) unless the controlled foreign corporation is an eligible controlled foreign corporation within the meaning of [section 954(h)(2)](/cfr/26/954.md?p=h-2) (taking into account the income of the controlled foreign corporation and any partnerships or other qualified business units, within the meaning of [section 989(a)](/cfr/26/989.md?p=a), of the controlled foreign corporation, including the controlled foreign corporation's distributive share of partnership income) and the partnership, of which the controlled foreign corporation is a partner, generates qualified banking or financing income within the meaning of [section 954(h)(3)](/cfr/26/954.md?p=h-3) (taking into account only the income of the partnership);
      - (C) A controlled foreign corporation's distributive share of partnership income will not be excluded from foreign personal holding company income under the exception contained in [section 954(i)](/cfr/26/954.md?p=i) unless the controlled foreign corporation is a qualifying insurance company, as defined in [section 953(e)(3)](/cfr/26/953.md?p=e-3), and the income of the partnership would have been qualified insurance income, as defined in [section 954(i)(2)](/cfr/26/954.md?p=i-2), if received by the controlled foreign corporation directly. See [§ 1.952-1(g)(1)](/cfr/26/1.952-1.md?p=g-1).
    - (iii) **Examples.** The application of [paragraph (a)(5)(ii)](#a-5-ii) is demonstrated by the following examples:
    - (iv) [Reserved]
    - (v) **Effective date.** This [paragraph (a)(5)](#a-5) applies to taxable years of a controlled foreign corporation beginning on or after July 23, 2002.
- (b) **Dividends, interest, rents, royalties, and annuities—**
  - (1) **In general.** Foreign personal holding company income includes—
    - (i) Dividends, except certain dividends from related persons as described in [paragraph (b)(4)](#b-4) of this section and distributions of previously taxed income under [section 959(b)](/cfr/26/959.md?p=b);
    - (ii) Interest, except export financing interest as defined in [paragraph (b)(2)](#b-2) of this section and certain interest received from related persons as described in [paragraph (b)(4)](#b-4) of this section;
    - (iii) Rents and royalties, except certain rents and royalties received from related persons as described in [paragraph (b)(5)](#b-5) of this section and rents and royalties derived in the active conduct of a trade or business as defined in [paragraph (b)(6)](#b-6) of this section; and
    - (iv) **Annuities.**
  - (2) **Exclusion of certain export financing interest—**
    - (i) **In general.** Foreign personal holding company income does not include interest that is export financing interest. The term export financing interest means interest that is derived in the conduct of a banking business and is export financing interest as defined in [section 904(d)(2)(G)](/cfr/26/904.md?p=d-2-G). Solely for purposes of determining whether interest is export financing interest, property is treated as manufactured, produced, grown, or extracted in the United States if it is so treated under [§ 1.927(a)-1T(c)](/cfr/26/1.927..1T.md).
    - (ii) **Exceptions.** Export financing interest does not include income from related party factoring that is treated as interest under section [864(d)(1)](/cfr/26/864.md?p=d-1) or [(6)](/cfr/26/864.md?p=d-6) after the application of [section 864(d)(7)](/cfr/26/864.md?p=d-7).
    - (iii) **Conduct of a banking business.** For purposes of this section, export financing interest is considered derived in the conduct of a banking business if, in connection with the financing from which the interest is derived, the corporation, through its own officers or staff of employees, engages in all the activities in which banks customarily engage in issuing and servicing a loan.
    - (iv) **Examples.** The following examples illustrate the application of this [paragraph (b)(2)](#b-2).
  - (3) **Treatment of tax exempt interest.** For taxable years of a controlled foreign corporation beginning after March 3, 1997, foreign personal holding company income includes all interest income, including interest that is described in [section 103](/cfr/26/103.md) (see [§ 1.952-2(c)(1)](/cfr/26/1.952-2.md?p=c-1)).
  - (4) **Exclusion of dividends or interest from related persons—**
    - (i) **In general—**
      - (A) **Corporate payor.** Foreign personal holding company income received by a controlled foreign corporation does not include dividends or interest if the payor—

        (1) Is a corporation that is a related person with respect to the controlled foreign corporation, as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3);

        (2) Is created or organized under the laws of the same foreign country (the country of incorporation) as is the controlled foreign corporation; and

        (3) Uses a substantial part of its assets in a trade or business in its country of incorporation, as determined under this [paragraph (b)(4)](#b-4).

      - (B) **Payment by a partnership.** For purposes of this [paragraph (b)(4)](#b-4), if a partnership with one or more corporate partners makes a payment of interest, a corporate partner will be treated as the payor of the interest—

        (1) If the interest payment gives rise to a partnership item of deduction under the Internal Revenue Code or Income Tax Regulations, to the extent that the item of deduction is allocable to the corporate partner under [section 704(b)](/cfr/26/704.md?p=b); or

        (2) If the interest payment does not give rise to a partnership item of deduction under the Internal Revenue Code or Income Tax Regulations, to the extent that a partnership item reasonably related to the payment would be allocated to that partner under an existing allocation under the partnership agreement (made pursuant to [section 704(b)](/cfr/26/704.md?p=b)).

    - (ii) **Exceptions—**
      - (A) **Dividends.** Dividends are excluded from foreign personal holding company income under this [paragraph (b)(4)](#b-4) only to the extent that they are paid out of earnings and profits that are earned or accumulated during a period in which—

        (1) The stock on which dividends are paid with respect to which the exclusion is claimed was owned by the recipient controlled foreign corporation directly, or indirectly through a chain of one or more subsidiaries each of which meets the requirements of [paragraph (b)(4)(i)(A)](#b-4-i-A) of this section; and

        (2) Each of the requirements of [paragraph (b)(4)(i)(A)](#b-4-i-A) of this section is satisfied or, to the extent earned or accumulated during a taxable year of the related foreign corporation ending on or before December 31, 1962, during a period in which the payor was a related corporation as to the controlled foreign corporation and the other requirements of [paragraph (b)(4)(i)(A)](#b-4-i-A) of this section were substantially satisfied.

        (3) This [paragraph (b)(4)(ii)(A)](#b-4-ii-A) is illustrated by the following example:

      - (B) **Interest paid out of adjusted foreign base company income or insurance income—** (1) In general. Interest may not be excluded from the foreign personal holding company income of the recipient under this [paragraph (b)(4)](#b-4) to the extent that the deduction for the interest is allocated under § [1.954-1(a)(4)](/cfr/26/1.954-1.md?p=a-4) and [(c)](/cfr/26/1.954-1.md?p=a-c) to the payor's adjusted gross foreign base company income (as defined in [§ 1.954-1(a)(3)](/cfr/26/1.954-1.md?p=a-3)), adjusted gross insurance income (as defined in [§ 1.954-1(a)(6)](/cfr/26/1.954-1.md?p=a-6)), or any other category of income included in the computation of [subpart F](/cfr/26/subpartF.md) income under [section 952(a)](/cfr/26/952.md?p=a).

        (2) Rule for corporations that are both recipients and payors of interest. If a controlled foreign corporation is both a recipient and payor of interest, the interest that is received will be characterized before the interest that is paid. In addition, the amount of interest paid or accrued, directly or indirectly, by the controlled foreign corporation to a related person (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) shall be offset against and eliminate any interest received or accrued, directly or indirectly, by the controlled foreign corporation from that related person. In a case in which the controlled foreign corporation pays or accrues interest to a related person, as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3), and also receives or accrues interest indirectly from the related person, the smallest interest payment is eliminated and the amounts of all other interest payments are reduced by the amount of the smallest interest payment.

      - (C) **Coordination with sections 864(d) and 881(c).** Income of a controlled foreign corporation that is treated as interest under section [864(d)(1)](/cfr/26/864.md?p=d-1) or [(6)](/cfr/26/864.md?p=d-6), or that is portfolio interest, as defined by [section 881(c)](/cfr/26/881.md?p=c), is not excluded from foreign personal holding company income under [section 954(c)(3)(A)(i)](/cfr/26/954.md?p=c-3-A-i) and this [paragraph (b)(4)](#b-4).
    - (iii) **Trade or business requirement.** Except as otherwise provided under this [paragraph (b)(4)](#b-4), the principles of [section 367(a)](/cfr/26/367.md?p=a) apply for purposes of determining whether the payor has a trade or business in its country of incorporation and whether its assets are used in that trade or business. Property purchased or produced for use in a trade or business is not considered used in a trade or business before it is placed in service or after it is retired from service as determined in accordance with the principles of sections [167](/cfr/26/167.md) and [168](/cfr/26/168.md).
    - (iv) **Substantial assets test.** A substantial part of the assets of the payor will be considered to be used in a trade or business located in the payor's country of incorporation for a taxable year only if the average value of the payor's assets for such year that are used in the trade or business and are located in such country equals more than 50 percent of the average value of all the assets of the payor (including assets not used in a trade or business). The average value of assets for the taxable year is determined by averaging the values of assets at the close of each quarter of the taxable year. The value of assets is determined under [paragraph (b)(4)(v)](#b-4-v) of this section, and the location of assets used in a trade or business of the payor is determined under [paragraphs (b)(4)(vi) through (xi)](#b-4-vi..b-4-xi) of this section.
    - (v) **Valuation of assets.** For purposes of determining whether a substantial part of the assets of the payor are used in a trade or business in its country of incorporation, the value of assets shall be their fair market value (not reduced by liabilities), which, in the absence of affirmative evidence to the contrary, shall be deemed to be their adjusted basis.
    - (vi) **Location of tangible property—**
      - (A) **In general.** Tangible property (other than inventory and similar property as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section, and dealer property as defined in [paragraph (a)(4)(v)](#a-4-v) of this section) used in a trade or business is considered located in the country in which it is physically located.
      - (B) **Exception.** An item of tangible personal property that is used in the trade or business of a payor in the payor's country of incorporation is considered located within the payor's country of incorporation while it is temporarily located elsewhere for inspection or repair if the property is not placed in service in a country other than the payor's country of incorporation and is not to be so placed in service following the inspection or repair.
    - (vii) **Location of intangible property—**
      - (A) **In general.** Intangible property (other than inventory and similar property as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section, dealer property as defined in [paragraph (a)(4)(v)](#a-4-v) of this section, and debt instruments) is considered located entirely in the payor's country of incorporation for a quarter of the taxable year only if the payor conducts all of its activities in connection with the use or exploitation of the property in that country during that entire quarter. For this purpose, the country in which the activities connected to the use or exploitation of the property are conducted is the country in which the expenses associated with these activities are incurred. Expenses incurred in connection with the use or exploitation of an item of intangible property are included in the computation provided by this [paragraph (b)(4)](#b-4) if they would be deductible under [section 162](/cfr/26/162.md) or includible in inventory costs or the cost of goods sold if the payor were a domestic corporation. If the payor conducts such activities through an agent or independent contractor, then the expenses incurred by the payor with respect to the agent or independent contractor shall be deemed to be incurred by the payor in the country in which the expenses of the agent or independent contractor were incurred by the agent or independent contractor.
      - (B) **Exception for property located in part in the payor's country of incorporation.** If the payor conducts its activities in connection with the use or exploitation of an item of intangible property, including goodwill (other than inventory and similar property, dealer property and debt instruments) during a quarter of the taxable year both in its country of incorporation and elsewhere, then the value of the intangible considered located in the payor's country of incorporation during that quarter is a percentage of the value of the item as of the close of the quarter. That percentage equals the ratio that the expenses incurred by the payor (described in [paragraph (b)(4)(vii)(A)](#b-4-vii-A) of this section) during the entire quarter by reason of activities that are connected with the use or exploitation of the item of intangible property and are conducted in the payor's country of incorporation bear to all expenses incurred by the payor during the entire quarter by reason of all such activities worldwide.
    - (viii) **Location of inventory and dealer property—**
      - (A) **In general.** Inventory and similar property, as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section, and dealer property, as defined in [paragraph (a)(4)(v)](#a-4-v) of this section, are considered located entirely in the payor's country of incorporation for a quarter of the taxable year only if the payor conducts all of its activities in connection with the production and sale, or purchase and resale, of such property in its country of incorporation during that entire quarter. If the payor conducts such activities through an agent or independent contractor, then the location of such activities is the place in which they are conducted by the agent or independent contractor.
      - (B) **Inventory and dealer property located in part in the payor's country of incorporation.** If the payor conducts its activities in connection with the production and sale, or purchase and resale, of inventory or similar property or dealer property during a quarter of the taxable year both in its country of incorporation and elsewhere, then the value of the inventory or similar property or dealer property considered located in the payor's country of incorporation during each quarter is a percentage of the value of the inventory or similar property or dealer property as of the close of the quarter. That percentage equals the ratio that the costs and expenses incurred by the payor during the entire quarter by reason of activities connected with the production and sale, or purchase and resale, of inventory or similar property or dealer property that are conducted in the payor's country of incorporation bear to all costs or expenses incurred by the payor during the entire quarter by reason of all such activities worldwide. A cost incurred in connection with the production and sale or purchase and resale of inventory or similar property or dealer property is included in this computation if it—

        (1) Would be included in inventory costs or otherwise capitalized with respect to inventory or similar property or dealer property under section [61](/cfr/26/61.md), [263A](/cfr/26/263A.md), [471](/cfr/26/471.md), or [472](/cfr/26/472.md) if the payor were a domestic corporation; or

        (2) Would be deductible under [section 162](/cfr/26/162.md) if the payor were a domestic corporation and is definitely related to gross income derived from such property (but not to all classes of gross income derived by the payor) under the principles of [§ 1.861-8](/cfr/26/1.861-8.md).

    - (ix) **Location of debt instruments.** For purposes of this [paragraph (b)(4)](#b-4), debt instruments, other than debt instruments that are inventory or similar property (as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section) or dealer property (as defined in [paragraph (a)(4)(v)](#a-4-v) of this section) are considered to be used in a trade or business only if they arise from the sale of inventory or similar property or dealer property by the payor or from the rendition of services by the payor in the ordinary course of a trade or business of the payor, and only until such time as interest is required to be charged under [section 482](/cfr/26/482.md). Debt instruments that arise from the sale of inventory or similar property or dealer property during a quarter are treated as having the same location, proportionately, as the inventory or similar property or dealer property held during that quarter. Debt instruments arising from the rendition of services in the ordinary course of a trade or business are considered located on a proportionate basis in the countries in which the services to which they relate are performed.
    - (x) **Treatment of certain stock interests.** Stock in a controlled foreign corporation (lower-tier corporation) that is incorporated in the same country as the payor and that is more than 50-percent owned, directly or indirectly, by the payor within the meaning of [section 958(a)](/cfr/26/958.md?p=a) shall be considered located in the payor's country of incorporation and, solely for purposes of [section 954(c)(3)](/cfr/26/954.md?p=c-3), used in a trade or business of the payor in proportion to the value of the assets of the lower-tier corporation that are used in a trade or business in the country of incorporation. The location of assets used in a trade or business of the lower-tier corporation shall be determined under the rules of this [paragraph (b)(4)](#b-4).
    - (xi) **Treatment of banks and insurance companies.** [Reserved]
  - (5) **Exclusion of rents and royalties derived from related persons—**
    - (i) **In general—**
      - (A) **Corporate payor.** Foreign personal holding company income received by a controlled foreign corporation does not include rents or royalties if—

        (1) The payor is a corporation that is a related person with respect to the controlled foreign corporation, as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3); and

        (2) The rents or royalties are for the use of, or the privilege of using, property within the country under the laws of which the controlled foreign corporation receiving the payments is created or organized (the country of incorporation).

      - (B) **Payment by a partnership.** For purposes of this [paragraph (b)(5)](#b-5), if a partnership with one or more corporate partners makes a payment of rents or royalties, a corporate partner will be treated as the payor of the rents or royalties—

        (1) If the rent or royalty payment gives rise to a partnership item of deduction under the Internal Revenue Code or Income Tax Regulations, to the extent the item of deduction is allocable to the corporate partner under [section 704(b)](/cfr/26/704.md?p=b); or

        (2) If the rent or royalty payment does not give rise to a partnership item of deduction under the Internal Revenue Code or Income Tax Regulations, to the extent that a partnership item reasonably related to the payment would be allocated to that partner under an existing allocation under the partnership agreement (made pursuant to [section 704(b)](/cfr/26/704.md?p=b)).

    - (ii) **Exceptions—**
      - (A) **Rents or royalties paid out of adjusted foreign base company income or insurance income.** Rents or royalties may not be excluded from the foreign personal holding company income of the recipient under this [paragraph (b)(5)](#b-5) to the extent that deductions for the payments are allocated under [section 954(b)(5)](/cfr/26/954.md?p=b-5) and § [1.954-1(a)(4)](/cfr/26/1.954-1.md?p=a-4) and [(c)](/cfr/26/1.954-1.md?p=a-c) to the payor's adjusted gross foreign base company income (as defined in [§ 1.954-1(a)(3)](/cfr/26/1.954-1.md?p=a-3)), adjusted gross insurance income (as defined in [§ 1.954-1(a)(6)](/cfr/26/1.954-1.md?p=a-6)), or any other category of income included in the computation of [subpart F](/cfr/26/subpartF.md) income under [section 952(a)](/cfr/26/952.md?p=a).
      - (B) **Property used in part in the controlled foreign corporation's country of incorporation.** If the payor uses the property both in the controlled foreign corporation's country of incorporation and elsewhere, the part of the rent or royalty attributable (determined under the principles of [section 482](/cfr/26/482.md)) to the use of, or the privilege of using, the property outside such country of incorporation is included in the computation of foreign personal holding company income under this [paragraph (b)](#b).
  - (6) **Exclusion of rents and royalties derived in the active conduct of a trade or business.** Foreign personal holding company income shall not include rents or royalties that are derived in the active conduct of a trade or business and received from a person that is not a related person (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to the controlled foreign corporation. For purposes of this section, rents or royalties are derived in the active conduct of a trade or business only if the provisions of paragraph [(c)](#c) or [(d)](#d) of this section are satisfied.
- (c) **Excluded rents—**
  - (1) **Active conduct of a trade or business.** Rents will be considered for purposes of [paragraph (b)(6)](#b-6) of this section to be derived in the active conduct of a trade or business if such rents are derived by the controlled foreign corporation (the lessor) from leasing any of the following—
    - (i) Property that the lessor, through its own officers or staff of employees, has manufactured or produced, or property that the lessor has acquired and, through its own officers or staff of employees, added substantial value to, but only if the lessor, through its officers or staff of employees, is regularly engaged in the manufacture or production of, or in the acquisition and addition of substantial value to, property of such kind;
    - (ii) Real property with respect to which the lessor, through its own officers or staff of employees, regularly performs active and substantial management and operational functions while the property is leased;
    - (iii) Personal property ordinarily used by the lessor in the active conduct of a trade or business, leased temporarily during a period when the property would, but for such leasing, be idle; or
    - (iv) Property that is leased as a result of the performance of marketing functions by such lessor through its own officers or staff of employees located in a foreign country or countries, if the lessor, through its officers or staff of employees, maintains and operates an organization either in such country or in such countries (collectively), as applicable, that is regularly engaged in the business of marketing, or of marketing and servicing, the leased property and that is substantial in relation to the amount of rents derived from the leasing of such property.
  - (2) **Special rules—**
    - (i) **Adding substantial value.** For purposes of [paragraph (c)(1)(i)](#c-1-i) of this section, the performance of marketing functions will not be considered to add substantial value to property.
    - (ii) **Substantiality of foreign organization.** For purposes of [paragraph (c)(1)(iv)](#c-1-iv) of this section, whether an organization either in a foreign country or in foreign countries (collectively) is substantial in relation to the amount of rents is determined based on all the facts and circumstances. However, such an organization will be considered substantial in relation to the amount of rents if active leasing expenses, as defined in [paragraph (c)(2)(iii)](#c-2-iii) of this section, equal or exceed 25 percent of the adjusted leasing profit, as defined in [paragraph (c)(2)(iv)](#c-2-iv) of this section. In addition, for purposes of aircraft or vessels leased in foreign commerce, an organization will be considered substantial if active leasing expenses, as defined in [paragraph (c)(2)(iii)](#c-2-iii) of this section, equal or exceed 10 percent of the adjusted leasing profit, as defined in [paragraph (c)(2)(iv)](#c-2-iv) of this section. For purposes of paragraphs [(c)(1)(iv)](#c-1-iv) and (c)(2) of this section and [§ 1.956-2(b)(1)(vi)](/cfr/26/1.956-2.md?p=b-1-vi), the term aircraft or vessels includes component parts, such as engines that are leased separately from an aircraft or vessel.
    - (iii) **Active leasing expenses.** The term active leasing expenses means the deductions incurred by an organization of the lessor in a foreign country that are properly allocable to rental income and that would be allowable under [section 162](/cfr/26/162.md) to the lessor if it were a domestic corporation, other than—
      - (A) Deductions for compensation for personal services rendered by shareholders of, or related persons (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to, the lessor;
      - (B) Deductions for amounts (including rents and royalties) paid or incurred by the lessor for the right to use the property (or a component thereof) that generated the rental income;
      - (C) Deductions that, although generally allowable under [section 162](/cfr/26/162.md), would be specifically allowable to the lessor (if the lessor were a domestic corporation) under any section of the Internal Revenue Code other than [section 162](/cfr/26/162.md);
      - (D) Deductions for payments made to agents or independent contractors with respect to the leased property other than payments for insurance, utilities and other expenses for like services, or for capitalized repairs; and
      - (E) Deductions for CST Payments or PCT Payments (as defined in [§ 1.482-7(b)](/cfr/26/1.482-7.md?p=b)).
    - (iv) **Adjusted leasing profit.** The term adjusted leasing profit means the gross income of the lessor from rents, reduced by the sum of—
      - (A) Amounts (including rents and royalties) paid or incurred by the lessor for the right to use the property (or a component thereof) that generated the rental income;
      - (B) The amounts that would be allowable to such lessor (if the lessor were a domestic corporation) as deductions under sections [167](/cfr/26/167.md) or [168](/cfr/26/168.md) with respect to such rental income; and
      - (C) The amounts paid by the lessor to agents or independent contractors with respect to such rental income other than payments for insurance, utilities and other expenses for like services, or for capitalized repairs.
    - (v) **Leased in foreign commerce.** For purposes of paragraphs [(c)(1)(iv)](#c-1-iv) and [(c)(2)(ii)](#c-2-ii) of this section, an aircraft or vessel is considered to be leased in foreign commerce if the aircraft or vessel is used in foreign commerce and is used predominantly outside the United States. An aircraft or vessel is considered to be used in foreign commerce if it is used for the transportation of property or passengers between a port (or airport) in the United States and a port (or airport) in a foreign country or between foreign ports (or airports). An aircraft or vessel will be considered to be used predominantly outside the United States if more than 50 percent of the miles traversed during the taxable year in the use of the aircraft or vessel are traversed outside the United States or if the aircraft or vessel is located outside the United States more than 50 percent of the time during the taxable year.
    - (vi) **Leases acquired by the CFC lessor.** Except as provided in this [paragraph (c)(2)(vi)](#c-2-vi), the exception in [paragraph (c)(1)(iv)](#c-1-iv) of this section will also apply to rents from leases acquired from any person, if following the acquisition the lessor performs active and substantial management, operational, and remarketing (including remarketing for purposes of re-leasing or selling the property) functions with respect to the leased property. However, if any person is claiming a benefit with respect to an acquired lease pursuant to section 921 or 114 of the Internal Revenue Code or section 101(d) of the American Jobs Creation Act of 2004, (Pub. L. 108-357 (118 Stat. 1418) (2004)), the rents from such lease, notwithstanding paragraphs [(b)(6)](#b-6) and (c) of this section, are ineligible for the exception in [section 954(c)(2)(A)](/cfr/26/954.md?p=c-2-A).
    - (vii) **Marketing of leases.** [Paragraph (c)(1)(iv)](#c-1-iv) of this section can apply whether a lessor is engaged in the marketing of leases as a form of financing or is engaged in marketing the property as such, and regardless of whether the lease is classified as a finance lease or an operating lease for financial accounting purposes, so long as such lease is treated as a lease for Federal income tax purposes.
    - (viii) **Cost sharing arrangements (CSAs).** For purposes of paragraphs [(c)(1)(i)](#c-1-i) and [(iv)](#c-1-iv) of this section, CST Payments or PCT Payments (as defined in [§ 1.482-7(b)(1)](/cfr/26/1.482-7.md?p=b-1)) made by the lessor to another controlled participant (as defined in [§ 1.482-7(j)(1)(i)](/cfr/26/1.482-7.md?p=j-1-i)) pursuant to a CSA (as defined in [§ 1.482-7(a)](/cfr/26/1.482-7.md?p=a)) do not cause the activities undertaken by that other controlled participant to be considered to be undertaken by the lessor's own officers or staff of employees.
  - (3) **Examples.** The application of this [paragraph (c)](#c) is illustrated by the following examples.
- (d) **Excluded royalties—**
  - (1) **Active conduct of a trade or business.** Royalties will be considered for purposes of [paragraph (b)(6)](#b-6) of this section to be derived in the active conduct of a trade or business if such royalties are derived by the controlled foreign corporation (the licensor) from licensing—
    - (i) Property that the licensor, through its own officers or staff of employees, has developed, created, or produced, or property that the licensor has acquired and, through its own officers or staff of employees, added substantial value to, but only so long as the licensor, through its officers or staff of employees, is regularly engaged in the development, creation, or production of, or in the acquisition and addition of substantial value to, property of such kind; or
    - (ii) Property that is licensed as a result of the performance of marketing functions by such licensor through its own officers or staff of employees located in a foreign country or countries, if the licensor, through its officers or staff of employees, maintains and operates an organization either in such foreign country or in such foreign countries (collectively), as applicable, that is regularly engaged in the business of marketing, or of marketing and servicing, the licensed property and that is substantial in relation to the amount of royalties derived from the licensing of such property.
  - (2) **Special rules—**
    - (i) **Adding substantial value.** For purposes of [paragraph (d)(1)(i)](#d-1-i) of this section, the performance of marketing functions will not be considered to add substantial value to property.
    - (ii) **Substantiality of foreign organization.** For purposes of [paragraph (d)(1)(ii)](#d-1-ii) of this section, whether an organization either in a foreign country or in foreign countries (collectively) is substantial in relation to the amount of royalties is determined based on all of the facts and circumstances. However, such an organization will be considered substantial in relation to the amount of royalties if active licensing expenses, as defined in [paragraph (d)(2)(iii)](#d-2-iii) of this section, equal or exceed 25 percent of the adjusted licensing profit, as defined in [paragraph (d)(2)(iv)](#d-2-iv) of this section.
    - (iii) **Active licensing expenses.** The term active licensing expenses means the deductions incurred by an organization of the licensor in a foreign country that are properly allocable to royalty income and that would be allowable under [section 162](/cfr/26/162.md) to the licensor if it were a domestic corporation, other than—
      - (A) Deductions for compensation for personal services rendered by shareholders of, or related persons (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to, the licensor;
      - (B) Deductions for royalties paid or incurred;
      - (C) Deductions that, although generally allowable under [section 162](/cfr/26/162.md), would be specifically allowable to the licensor (if the controlled foreign corporation were a domestic corporation) under any section of the Internal Revenue Code other than [section 162](/cfr/26/162.md);
      - (D) Deductions for payments made to agents or independent contractors with respect to the licensed property; and
      - (E) Deductions for CST Payments or PCT Payments (as defined in [§ 1.482-7(b)](/cfr/26/1.482-7.md?p=b)).
    - (iv) **Adjusted licensing profit.** The term adjusted licensing profit means the gross income of the licensor from royalties, reduced by the sum of—
      - (A) The royalties paid or incurred by the licensor with respect to such royalty income;
      - (B) The amounts that would be allowable to such licensor as deductions under section [167](/cfr/26/167.md) or [197](/cfr/26/197.md) (if the licensor were a domestic corporation) with respect to such royalty income; and
      - (C) The amounts paid by the licensor to agents or independent contractors with respect to such royalty income.
    - (v) **Cost sharing arrangements (CSAs).** For purposes of paragraphs [(d)(1)(i)](#d-1-i) and [(ii)](#d-1-ii) of this section, CST Payments or PCT Payments (as defined in [§ 1.482-7(b)(1)](/cfr/26/1.482-7.md?p=b-1)) made by the licensor to another controlled participant (as defined in [§ 1.482-7(j)(1)(i)](/cfr/26/1.482-7.md?p=j-1-i)) pursuant to a CSA (as defined in [§ 1.482-7(a)](/cfr/26/1.482-7.md?p=a)) do not cause the activities undertaken by that other controlled participant to be considered to be undertaken by the licensor's own officers or staff of employees.
  - (3) **Examples.** The application of this [paragraph (d)](#d) is illustrated by the following examples.
- (e) **Certain property transactions—**
  - (1) **In general—**
    - (i) **Inclusions.** Gain from certain property transactions described in [section 954(c)(1)(B)](/cfr/26/954.md?p=c-1-B) includes the excess of gains over losses from the sale or exchange of—
      - (A) Property that gives rise to dividends, interest, rents, royalties or annuities, as described in [paragraph (e)(2)](#e-2) of this section;
      - (B) Property that is an interest in a partnership, trust or REMIC; and
      - (C) **Property that does not give rise to income, as described in paragraph (e)(3) of this section.**
    - (ii) **Exceptions.** Gain or loss from certain property transactions described in [section 954(c)(1)(B)](/cfr/26/954.md?p=c-1-B) and [paragraph (e)(1)(i)](#e-1-i) of this section does not include gain or loss from the sale or exchange of—
      - (A) Inventory or similar property, as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section;
      - (B) Dealer property, as defined in [paragraph (a)(4)(v)](#a-4-v) of this section; or
      - (C) Property that gives rise to rents or royalties described in [paragraph (b)(6)](#b-6) of this section that are derived in the active conduct of a trade or business from persons that are not related persons (as defined in [section 954(d)(3)](/cfr/26/954.md?p=d-3)) with respect to the controlled foreign corporation.
    - (iii) **Treatment of losses.** [Section 1.954-1(c)(1)(ii)](/cfr/26/1.954-1.md?p=c-1-ii) provides for the treatment of losses in excess of gains from the sale or exchange of property described in [paragraph (e)(1)(i)](#e-1-i) of this section.
    - (iv) **Dual character property.** Property may, in part, constitute property that gives rise to certain income as described in [paragraph (e)(2)](#e-2) of this section or, in part, constitute property that does not give rise to any income as described in [paragraph (e)(3)](#e-3) of this section. However, property that is described in [paragraph (e)(1)(i)(B)](#e-1-i-B) of this section cannot be dual character property. Dual character property must be treated as two separate properties for purposes of paragraph [(e)(2)](#e-2) or [(3)](#e-3) of this section. Accordingly, the sale or exchange of such dual character property will give rise to gain or loss that in part must be included in the computation of foreign personal holding company income under paragraph [(e)(2)](#e-2) or [(3)](#e-3) of this section, and in part is excluded from such computation. Gain or loss from the disposition of dual character property must be bifurcated under this [paragraph (e)(1)(iv)](#e-1-iv) pursuant to the method that most reasonably reflects the relative uses of the property. Reasonable methods may include comparisons in terms of gross income generated or the physical division of the property. In the case of real property, the physical division of the property will in most cases be the most reasonable method available. For example, if a controlled foreign corporation owns an office building, uses 60 percent of the building in its trade or business, and rents out the other 40 percent, then 40 percent of the gain recognized on the disposition of the property would reasonably be treated as gain that is included in the computation of foreign personal holding company income under this [paragraph (e)(1)](#e-1). This [paragraph (e)(1)(iv)](#e-1-iv) addresses the contemporaneous use of property for dual purposes. For rules concerning changes in the use of property affecting its classification for purposes of this [paragraph (e)](#e), see [paragraph (a)(3)](#a-3) of this section.
  - (2) **Property that gives rise to certain income—**
    - (i) **In general.** Property the sale or exchange of which gives rise to foreign personal holding company income under this [paragraph (e)(2)](#e-2) includes property that gives rise to dividends, interest, rents, royalties or annuities described in [paragraph (b)](#b) of this section, including—
      - (A) Property that gives rise to export financing interest described in [paragraph (b)(2)](#b-2) of this section; and
      - (B) Property that gives rise to income from related persons described in paragraph [(b)(4)](#b-4) or [(5)](#b-5) of this section.
    - (ii) **Gain or loss from the disposition of a debt instrument.** Gain or loss from the sale, exchange or retirement of a debt instrument is included in the computation of foreign personal holding company income under this [paragraph (e)](#e) unless—
      - (A) **In the case of gain—** (1) It is interest (as defined in [paragraph (a)(4)(i)](#a-4-i) of this section); or

        (2) It is income equivalent to interest (as described in [paragraph (h)](#h) of this section); and

      - (B) **In the case of loss—** (1) It is directly allocated to, or treated as an adjustment to, interest income (as described in [paragraph (a)(4)(i)](#a-4-i) of this section) or income equivalent to interest (as defined in [paragraph (h)](#h) of this section) under any provision of the Internal Revenue Code or Income Tax Regulations; or

        (2) It is required to be apportioned in the same manner as interest expense under [section 864(e)](/cfr/26/864.md?p=e) or any other provision of the Internal Revenue Code or Income Tax Regulations.

  - (3) **Property that does not give rise to income.** Except as otherwise provided in this [paragraph (e)(3)](#e-3), for purposes of this section, the term property that does not give rise to income includes all rights and interests in property (whether or not a capital asset) including, for example, forwards, futures and options. Property that does not give rise to income shall not include—
    - (i) Property that gives rise to dividends, interest, rents, royalties or annuities described in [paragraph (e)(2)](#e-2) of this section;
    - (ii) Tangible property (other than real property) used or held for use in the controlled foreign corporation's trade or business that is of a character that would be subject to the allowance for depreciation under section [167](/cfr/26/167.md) or [168](/cfr/26/168.md) and the regulations under those sections (including tangible property described in [§ 1.167(a)-2](/cfr/26/1.167..2.md));
    - (iii) Real property that does not give rise to rental or similar income, to the extent used or held for use in the controlled foreign corporation's trade or business;
    - (iv) Intangible property (as defined in [section 936(h)(3)(B)](/cfr/26/936.md?p=h-3-B)), goodwill or going concern value, to the extent used or held for use in the controlled foreign corporation's trade or business;
    - (v) Notional principal contracts (but see paragraphs [(f)(2)](#f-2), [(g)(2)](#g-2) and [(h)(3)](#h-3) of this section for rules that include income from certain notional principal contracts in gains from commodities transactions, foreign currency gains and income equivalent to interest, respectively); or
    - (vi) Other property that is excepted from the general rule of this [paragraph (e)(3)](#e-3) by the Commissioner in published guidance. See [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter.
- (f) **Commodities transactions—**
  - (1) **In general—**
    - (i) **Inclusion in foreign personal holding company income.** Foreign personal holding company income includes the excess of gains over losses from commodities transactions.
    - (ii) **Exception.** Gains and losses from qualified active sales and qualified hedging transactions are excluded from the computation of foreign personal holding company income under this [paragraph (f)](#f).
    - (iii) **Treatment of losses.** [Section 1.954-1(c)(1)(ii)](/cfr/26/1.954-1.md?p=c-1-ii) provides for the treatment of losses in excess of gains from commodities transactions.
  - (2) **Definitions—**
    - (i) **Commodity.** For purposes of this section, the term commodity includes tangible personal property of a kind that is actively traded or with respect to which contractual interests are actively traded.
    - (ii) **Commodities transaction.** The term commodities transaction means the purchase or sale of a commodity for immediate (spot) delivery or deferred (forward) delivery, or the right to purchase, sell, receive, or transfer a commodity, or any other right or obligation with respect to a commodity accomplished through a cash or off-exchange market, an interbank market, an organized exchange or board of trade, or an over-the-counter market, or in a transaction effected between private parties outside of any market. Commodities transactions include, but are not limited to—
      - (A) A futures or forward contract in a commodity;
      - (B) A leverage contract in a commodity purchased from a leverage transaction merchant;
      - (C) An exchange of futures for physical transaction;
      - (D) A transaction, including a notional principal contract, in which the income or loss to the parties is measured by reference to the price of a commodity, a pool of commodities, or an index of commodities;
      - (E) The purchase or sale of an option or other right to acquire or transfer a commodity, a futures contract in a commodity, or an index of commodities; and
      - (F) The delivery of one commodity in exchange for the delivery of another commodity, the same commodity at another time, cash, or nonfunctional currency.
    - (iii) **Qualified active sale—**
      - (A) **In general.** The term qualified active sale means the sale of commodities in the active conduct of a commodities business as a producer, processor, merchant or handler of commodities if substantially all of the controlled foreign corporation's business is as an active producer, processor, merchant or handler of commodities. The sale of commodities held by a controlled foreign corporation other than in its capacity as an active producer, processor, merchant or handler of commodities is not a qualified active sale. For example, the sale by a controlled foreign corporation of commodities that were held for investment or speculation would not be a qualified active sale.
      - (B) **Active conduct of a commodities business.** For purposes of this paragraph, a controlled foreign corporation is engaged in the active conduct of a commodities business as a producer, processor, merchant or handler of commodities only with respect to commodities for which each of the following conditions is satisfied—

        (1) It holds the commodities directly, and not through an agent or independent contractor, as inventory or similar property (as defined in [paragraph (a)(4)(iii)](#a-4-iii) of this section) or as dealer property (as defined in [paragraph (a)(4)(v)](#a-4-v) of this section); and

        (2) With respect to such commodities, it incurs substantial expenses in the ordinary course of a commodities business from engaging in one or more of the following activities directly, and not through an independent contractor—

        (i) Substantial activities in the production of the commodities, including planting, tending or harvesting crops, raising or slaughtering livestock, or extracting minerals;

        (ii) Substantial processing activities prior to the sale of the commodities, including the blending and drying of agricultural commodities, or the concentrating, refining, mixing, crushing, aerating or milling of commodities; or

        (iii) Significant activities as described in paragraph (f)(2)(iii)(B)(3) of this section.

        (3) For purposes of paragraph (f)(2)(iii)(B)(2)(iii) of this section, the significant activities must relate to—

        (i) The physical movement, handling and storage of the commodities, including preparation of contracts and invoices, arranging freight, insurance and credit, arranging for receipt, transfer or negotiation of shipping documents, arranging storage or warehousing, and dealing with quality claims;

        (ii) Owning and operating facilities for storage or warehousing; or

        (iii) Owning or chartering vessels or vehicles for the transportation of the commodities.

      - (C) **Substantially all.** Substantially all of the controlled foreign corporation's business is as an active producer, processor, merchant or handler of commodities if the sum of its gross receipts from all of its qualified active sales (as defined in this [paragraph (f)(2)(iii)](#f-2-iii) without regard to the substantially all requirement) of commodities and its gross receipts from all of its qualified hedging transactions (as defined in [paragraph (f)(2)(iv)](#f-2-iv) of this section, applied without regard to the substantially all requirement of this [paragraph (f)(2)(iii)(C)](#f-2-iii-C)) equals or exceeds 85 percent of its total gross receipts for the taxable year (computed as though the corporation were a domestic corporation). In computing gross receipts, the District Director may disregard any sale or hedging transaction that has as a principal purpose manipulation of the 85 percent gross receipts test. A purpose may be a principal purpose even though it is outweighed by other purposes (taken together or separately).
      - (D) **Activities of employees of a related entity.** For purposes of this [paragraph (f)](#f), activities of employees of an entity related to the controlled foreign corporation, who are made available to and supervised on a day-to-day basis by, and whose salaries are paid by (or reimbursed to the related entity by), the controlled foreign corporation, are treated as activities engaged in directly by the controlled foreign corporation.
    - (iv) **Qualified hedging transaction entered into prior to January 31, 2003—**
      - (A) **In general.** The term qualified hedging transaction means a bona fide hedging transaction, as defined in [paragraph (a)(4)(ii)](#a-4-ii) of this section, with respect to qualified active sales (other than transactions described in [section 988(c)(1)](/cfr/26/988.md?p=c-1) without regard to [section 988(c)(1)(D)(i)](/cfr/26/988.md?p=c-1-D-i)).
      - (B) **Exception.** The term qualified hedging transaction does not include transactions that are not reasonably necessary to the conduct of business of the controlled foreign corporation as a producer, processor, merchant or handler of a commodity in the manner in which such business is customarily and usually conducted by others.
      - (C) **Effective date.** This [paragraph (f)(2)(iv)](#f-2-iv) applies to gain or loss realized by a controlled foreign corporation with respect to a qualified hedging transaction entered into prior to January 31, 2003.
    - (v) **Qualified hedging transaction entered into on or after January 31, 2003—**
      - (A) **In general.** The term qualified hedging transaction means a bona fide hedging transaction, as defined in [paragraph (a)(4)(ii)](#a-4-ii) of this section, with respect to one or more commodities transactions reasonably necessary to the conduct of any business by a producer, processor, merchant or handler of commodities in a manner in which such business is customarily and usually conducted by others. For purposes of this [paragraph (f)(2)(v)](#f-2-v), a producer, processor, merchant or handler of commodities includes a controlled foreign corporation that regularly uses commodities in a manufacturing, construction, utilities, or transportation business.
      - (B) **Exception.** The term qualified hedging transaction does not include a transaction described in [section 988(c)(1)](/cfr/26/988.md?p=c-1) (without regard to [section 988(c)(1)(D)(i)](/cfr/26/988.md?p=c-1-D-i)).
      - (C) **Examples.** The following examples illustrate the provisions of this [paragraph (f)(2)(v)](#f-2-v):
      - (D) **Effective date.** This [paragraph (f)(2)(v)](#f-2-v) applies to gain or loss realized by a controlled foreign corporation with respect to a qualified hedging transaction entered into on or after January 31, 2003.
    - (vi) **Financial institutions not a producer, etc.** For purposes of this [paragraph (f)](#f), a corporation is not a producer, processor, merchant or handler of commodities if its business is primarily financial. For example, the business of a controlled foreign corporation is primarily financial if its principal business is making a market in notional principal contracts based on a commodities index.
- (g) **Foreign currency gain or loss—**
  - (1) **Scope and purpose.** This [paragraph (g)](#g) provides rules for the treatment of foreign currency gains and losses. [Paragraph (g)(2)](#g-2) of this section provides the general rule. [Paragraph (g)(3)](#g-3) of this section provides an election to include foreign currency gains or losses that would otherwise be treated as foreign personal holding company income under this [paragraph (g)](#g) in the computation of another category of [subpart F](/cfr/26/subpartF.md) income. [Paragraph (g)(4)](#g-4) of this section provides an alternative election to treat any net foreign currency gain or loss as foreign personal holding company income. [Paragraph (g)(5)](#g-5) of this section provides rules for certain gains and losses not subject to this [paragraph (g)](#g).
  - (2) **In general—**
    - (i) **Inclusion.** Except as otherwise provided in this [paragraph (g)](#g), foreign personal holding company income includes the excess of foreign currency gains over foreign currency losses attributable to any [section 988](/cfr/26/988.md) transactions (foreign currency gain or loss). [Section 1.954-1(c)(1)(ii)](/cfr/26/1.954-1.md?p=c-1-ii) provides rules for the treatment of foreign currency losses in excess of foreign currency gains. However, if an election is made under [paragraph (g)(4)](#g-4) of this section, the excess of foreign currency losses over foreign currency gains to which the election would apply may be apportioned to, and offset, other categories of foreign personal holding company income.
    - (ii) **Exclusion for business needs—**
      - (A) **General rule.** Foreign currency gain or loss directly related to the business needs of the controlled foreign corporation is excluded from foreign personal holding company income.
      - (B) **Business needs.** Foreign currency gain or loss is directly related to the business needs of a controlled foreign corporation if—

        (1) The foreign currency gain or loss—

        (i) Arises from a transaction (other than a hedging transaction) entered into, or property used or held for use, in the normal course of the controlled foreign corporation's trade or business, other than the trade or business of trading foreign currency;

        (ii) Arises from a transaction or property that does not itself (and could not reasonably be expected to) give rise to [subpart F](/cfr/26/subpartF.md) income other than foreign currency gain or loss;

        (iii) Does not arise from a transaction described in [section 988(c)(1)(B)(iii)](/cfr/26/988.md?p=c-1-B-iii); and

        (iv) Is clearly determinable from the records of the controlled foreign corporation as being derived from such transaction or property; or

        (2) The foreign currency gain or loss arises from a bona fide hedging transaction, as defined in [paragraph (a)(4)(ii)](#a-4-ii) of this section, with respect to a transaction or property that satisfies the requirements of paragraphs (g)(2)(ii)(B)(1) (i) through (iii) of this section, provided that any gain or loss arising from such transaction or property that is attributable to changes in exchange rates is clearly determinable from the records of the CFC as being derived from such transaction or property. For purposes of this paragraph (g)(2)(ii)(B)(2), a hedging transaction will satisfy the aggregate hedging rules of [§ 1.1221-2(c)(3)](/cfr/26/1.1221-2.md?p=c-3) only if all (or all but a de minimis amount) of the aggregate risk being hedged arises in connection with transactions or property that satisfy the requirements of paragraphs (g)(2)(ii)(B)(1) (i) through (iii) of this section, provided that any gain or loss arising from such transactions or property that is attributable to changes in exchange rates is clearly determinable from the records of the CFC as being derived from such transactions or property.

      - (C) **Regular dealers—(1) General rule.** Transactions in dealer property (as defined in [paragraph (a)(4)(v)](#a-4-v) of this section) described in section [988(c)(1)(B)](/cfr/26/988.md?p=c-1-B) or [(C)](/cfr/26/988.md?p=c-1-C) that are entered into by a controlled foreign corporation that is a regular dealer (as defined in [paragraph (a)(4)(iv)](#a-4-iv) of this section) in such property in its capacity as a dealer will be treated as directly related to the business needs of the controlled foreign corporation under [paragraph (g)(2)(ii)(A)](#g-2-ii-A) of this section.

        (2) Certain interest-bearing liabilities treated as dealer property—(i) In general. For purposes of this [paragraph (g)(2)(ii)(C)](#g-2-ii-C), an interest-bearing liability incurred by a controlled foreign corporation that is denominated in (or determined by reference to) a non-functional currency shall be treated as dealer property of the type described in paragraph (g)(2)(ii)(C)(1) of this section if the liability, by being denominated in such currency, reduces the controlled foreign corporation's currency risk with respect to dealer property, and the liability is identified on the controlled foreign corporation's records as a liability treated as dealer property before the close of the day on which the liability is incurred.

        (ii) Failure to identify certain liabilities. If a controlled foreign corporation identifies certain interest-bearing liabilities as liabilities treated as dealer property under paragraph (g)(2)(ii)(C)(2)(i) of this section but fails to so identify other interest-bearing liabilities that manage its currency risk with respect to assets held that constitute dealer property, the Commissioner may treat such other liabilities as properly identified as dealer property under paragraph (g)(2)(ii)(C)(2)(i) of this section if the Commissioner determines that the failure to identify such other liabilities had as one of its principal purposes the avoidance of Federal income tax.

        (iii) Effective date. This paragraph (g)(2)(ii)(C)(2) applies only to gain or loss from an interest-bearing liability entered into by a controlled foreign corporation on or after January 31, 2003.

      - (D) **Example.** The following example illustrates the provisions of this [paragraph (g)(2)](#g-2).
    - (iii) **Special rule for foreign currency gain or loss from an interest-bearing liability.** Except as provided in paragraph (g)(2)(ii)(C)(2) or (g)(5)(iv) of this section, foreign currency gain or loss arising from an interest-bearing liability is characterized as [subpart F](/cfr/26/subpartF.md) income and non-[subpart F](/cfr/26/subpartF.md) income in the same manner that interest expense associated with the liability would be allocated and apportioned between [subpart F](/cfr/26/subpartF.md) income and non-[subpart F](/cfr/26/subpartF.md) income under §§ [1.861-9T](/cfr/26/1.861-9T.md) and [1.861-12T](/cfr/26/1.861-12T.md).
  - (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.** For taxable years of a controlled foreign corporation beginning on or after November 6, 1995, the controlling United States shareholders of the controlled foreign corporation may elect, under this [paragraph (g)(3)](#g-3), to exclude foreign currency gain or loss otherwise includible in the computation of foreign personal holding company income under this [paragraph (g)](#g) from the computation of foreign personal holding company income under this [paragraph (g)](#g) and include such foreign currency gain or loss in the category (or categories) of [subpart F](/cfr/26/subpartF.md) income (described in [section 952(a)](/cfr/26/952.md?p=a), or, in the case of foreign base company income, described in [§ 1.954-1(c)(1)(iii)(A)](/cfr/26/1.954-1.md?p=c-1-iii-A) (1) or (2)) to which such gain or loss relates. If an election is made under this [paragraph (g)(3)](#g-3) with respect to a category (or categories) of [subpart F](/cfr/26/subpartF.md) income described in [section 952(a)](/cfr/26/952.md?p=a), or, in the case of foreign base company income, described in [§ 1.954-1(c)(1)(iii)(A)](/cfr/26/1.954-1.md?p=c-1-iii-A) (1) or (2), the election shall apply to all foreign currency gain or loss that arises from—
      - (A) A transaction (other than a hedging transaction) entered into, or property used or held for use, in the normal course of the controlled foreign corporation's trade or business that gives rise to income in that category (or categories) and that is clearly determinable from the records of the controlled foreign corporation as being derived from such transaction or property; and
      - (B) A bona fide hedging transaction, as defined in [paragraph (a)(4)(ii)](#a-4-ii) of this section, with respect to a transaction or property described in [paragraph (g)(3)(i)(A)](#g-3-i-A) of this section. For purposes of this [paragraph (g)(3)(i)(B)](#g-3-i-B), a hedging transaction will satisfy the aggregate hedging rules of [§ 1.1221-2(c)(3)](/cfr/26/1.1221-2.md?p=c-3) only if all (or all but a de minimis amount) of the aggregate risk being hedged arises in connection with transactions or property that generate the same category of [subpart F](/cfr/26/subpartF.md) income described in [section 952(a)](/cfr/26/952.md?p=a), or, in the case of foreign base company income, described in [§ 1.954-1(c)(1)(iii)(A)](/cfr/26/1.954-1.md?p=c-1-iii-A) (1) or (2).
    - (ii) **Time and manner of election.** The controlling United States shareholders, as defined in [§ 1.964-1(c)(5)](/cfr/26/1.964-1.md?p=c-5), make the election on behalf of the controlled foreign corporation by filing a statement with their original income tax returns for the taxable year of such United States shareholders ending with or within the taxable year of the controlled foreign corporation for which the election is made, clearly indicating that such election has been made. If the controlling United States shareholders elect to apply these regulations retroactively, under [§ 1.954-0(a)(1)(ii)](/cfr/26/1.954-0.md?p=a-1-ii), the election under this [paragraph (g)(3)](#g-3) may be made by the amended return filed pursuant to the election under [§ 1.954-0(a)(1)(ii)](/cfr/26/1.954-0.md?p=a-1-ii). The controlling United States shareholders filing the election statement described in this [paragraph (g)(3)(ii)](#g-3-ii) must provide copies of the election statement to all other United States shareholders of the electing controlled foreign corporation. Failure to provide copies of such statement will not cause an election under this [paragraph (g)(3)](#g-3) to be voidable by the controlled foreign corporation or the controlling United States shareholders. However, the District Director has discretion to void the election if it is determined that three was no reasonable cause for the failure to provide copies of such statement. The statement shall include the following information—
      - (A) The name, address, taxpayer identification number, and taxable year of such United States shareholder;
      - (B) The name, address, and taxable year of the controlled foreign corporation for which the election is effective; and
      - (C) **Any additional information required by the Commission by administrative pronouncement.**
    - (iii) **Revocation of election.** This election is effective for the taxable year of the controlled foreign corporation for which it is made and all subsequent taxable years of such corporation unless revoked by or with the consent of the Commissioner.
    - (iv) **Example.** The following example illustrates the provisions of this [paragraph (g)(3)](#g-3).
  - (4) **Election to treat all foreign currency gains or losses as foreign personal holding company income—**
    - (i) **In general.** If the controlling United States shareholders make an election under this [paragraph (g)(4)](#g-4), the controlled foreign corporation shall include in its computation of foreign personal holding company income the excess of foreign currency gains over losses or the excess of foreign currency losses over gains attributable to any [section 988](/cfr/26/988.md) transaction (except those described in [paragraph (g)(5)](#g-5) of this section) and any [section 1256](/cfr/26/1256.md) contract that would be a [section 988](/cfr/26/988.md) transaction but for [section 988(c)(1)(D)](/cfr/26/988.md?p=c-1-D). Separate elections for [section 1256](/cfr/26/1256.md) contracts and [section 988](/cfr/26/988.md) transactions are not permitted. An election under this [paragraph (g)(4)](#g-4) supersedes an election under [paragraph (g)(3)](#g-3) of this section.
    - (ii) **Time and manner of election.** The controlling United States shareholders, as defined in [§ 1.964-1(c)(5)](/cfr/26/1.964-1.md?p=c-5), make the election on behalf of the controlled foreign corporation in the same time and manner as provided in [paragraph (g)(3)(ii)](#g-3-ii) of this section.
    - (iii) **Revocation of election.** This election is effective for the taxable year of the controlled foreign corporation for which it is made and all subsequent taxable years of such corporation unless revoked by or with the consent of the Commissioner.
  - (5) **Gains and losses not subject to this paragraph—**
    - (i) **Capital gains and losses.** Gain or loss that is treated as capital gain or loss under [section 988(a)(1)(B)](/cfr/26/988.md?p=a-1-B) is not foreign currency gain or loss for purposes of this [paragraph (g)](#g). Such gain or loss is treated as gain or loss from the sale or exchange of property that is included in the computation of foreign personal holding company income under [paragraph (e)(1)](#e-1) of this section. [Paragraph (a)(2)](#a-2) of this section provides other rules concerning income described in more than one category of foreign personal holding company income.
    - (ii) **Income not subject to section 988.** Gain or loss that is not treated as foreign currency gain or loss by reason of section [988 (a)(2)](/cfr/26/988.md?p=a-2) or [(d)](/cfr/26/988.md?p=a-d) is not foreign currency gain or loss for purposes of this [paragraph (g)](#g). However, such gain or loss may be included in the computation of other categories of foreign personal holding company income in accordance with its characterization under section [988 (a)(2)](/cfr/26/988.md?p=a-2) or [(d)](/cfr/26/988.md?p=a-d) (for example, foreign currency gain that is treated as interest income under [section 988(a)(2)](/cfr/26/988.md?p=a-2) will be included in the computation of foreign personal holding company income under paragraph (b)(ii) of this section).
    - (iii) **Qualified business units using the dollar approximate separate transactions method.** This [paragraph (g)](#g) does not apply to any DASTM gain or loss computed under [§ 1.985-3(d)](/cfr/26/1.985-3.md?p=d). Such gain or loss is allocated under the rules of § [1.985-3 (e)(2)(iv)](/cfr/26/1.985-3.md?p=e-2-iv) or [(e)(3)](/cfr/26/1.985-3.md?p=e-e-3). However, the provisions of this [paragraph (g)](#g) do apply to [section 988](/cfr/26/988.md) transactions denominated in a currency other than the United States dollar or the currency that would be the qualified business unit's functional currency were it not hyperinflationary.
    - (iv) **Gain or loss allocated under § 1.861-9.** [Reserved]
- (h) **Income equivalent to interest—**
  - (1) **In general—**
    - (i) **Inclusion in foreign personal holding company income.** Except as provided in this [paragraph (h)](#h), foreign personal holding company income includes income equivalent to interest as defined in [paragraph (h)(2)](#h-2) of this section.
    - (ii) **Exceptions—**
      - (A) **Liability hedging transactions.** Income, gain, deduction or loss that is allocated and apportioned in the same manner as interest expense under the provisions of [§ 1.861-9T](/cfr/26/1.861-9T.md) is not income equivalent to interest for purposes of this [paragraph (h)](#h).
      - (B) **Interest.** Amounts treated as interest under [section 954(c)(1)(A)](/cfr/26/954.md?p=c-1-A) and [paragraph (b)](#b) of this section are not income equivalent to interest for purposes of this [paragraph (h)](#h).
  - (2) **Definition of income equivalent to interest—**
    - (i) **In general.** The term income equivalent to interest includes income that is derived from—
      - (A) A transaction or series of related transactions in which the payments, net payments, cash flows or return predominantly reflect the time value of money;
      - (B) Transactions in which the payments (or a predominant portion thereof) are, in substance, for the use or forbearance of money;
      - (C) Notional principal contracts, to the extent provided in [paragraph (h)(3)](#h-3) of this section;
      - (D) Factoring, to the extent provided in [paragraph (h)(4)](#h-4) of this section;
      - (E) Conversion transactions, but only to the extent that gain realized with respect to such a transaction is treated as ordinary income under [section 1258](/cfr/26/1258.md);
      - (F) The performance of services, to the extent provided in [paragraph (h)(5)](#h-5) of this section;
      - (G) The commitment by a lender to provide financing, if any portion of such financing is actually provided;
      - (H) Transfers of debt securities subject to [section 1058](/cfr/26/1058.md);
      - (I) Any guaranteed payments for the use of capital under [section 707(c)](/cfr/26/707.md?p=c); and
      - (J) **Other transactions, as provided by the Commissioner in published guidance.** See [§ 601.601(d)(2)](/cfr/26/601.601.md?p=d-2) of this chapter.
    - (ii) **Income from the sale of property.** Income from the sale of property will not be treated as income equivalent to interest by reason of paragraph [(h)(2)(i)(A)](#h-2-i-A) or [(B)](#h-2-i-B) of this section. Income derived by a controlled foreign corporation will be treated as arising from the sale of property only if the corporation in substance carries out sales activities. Accordingly, an arrangement that is designed to lend the form of a sales transaction to a transaction that in substance constitutes an advance of funds will be disregarded. For example, if a controlled foreign corporation acquires property on 30-day payment terms from one person and sells that property to another person on 90-day payment terms and at prearranged prices and terms such that the foreign corporation bears no substantial economic risk with respect to the purchase and sale other than the risk of non-payment, the foreign corporation has not in substance derived income from the sale of property.
  - (3) **Notional principal contracts—**
    - (i) **In general.** Income equivalent to interest includes income from notional principal contracts denominated in the functional currency of the taxpayer (or a qualified business unit of the taxpayer, as defined in [section 989(a)](/cfr/26/989.md?p=a)), the value of which is determined solely by reference to interest rates or interest rate indices, to the extent that the income from such transactions accrues on or after August 14, 1989.
    - (ii) **Regular dealers.** Income equivalent to interest does not include income earned by a regular dealer (as defined in [paragraph (a)(4)(iv)](#a-4-iv) of this section) from notional principal contracts that are dealer property (as defined in [paragraph (a)(4)(v)](#a-4-v) of this section).
  - (4) **Income equivalent to interest from factoring—**
    - (i) **General rule.** Income equivalent to interest includes factoring income. Except as provided in [paragraph (h)(4)(ii)](#h-4-ii) of this section, the term factoring income includes any income (including any discount income or service fee, but excluding any stated interest) derived from the acquisition and collection or disposition of a factored receivable. The amount of income equivalent to interest realized with respect to a factored receivable is the difference (if a positive number) between the amount paid for the receivable by the foreign corporation and the amount that it collects on the receivable (or realizes upon its sale of the receivable). The rules of this [paragraph (h)(4)](#h-4) apply only with respect to the tax treatment of factoring income derived from the acquisition and collection or disposition of a factored receivable and shall not affect the characterization of an expense or loss of either the person whose goods or services gave rise to a factored receivable or the obligor under a receivable.
    - (ii) **Exceptions.** Factoring income shall not include—
      - (A) Income treated as interest under section [864(d)(1)](/cfr/26/864.md?p=d-1) or [(6)](/cfr/26/864.md?p=d-6) (relating to income derived from trade or service receivables of related persons), even if such income is treated as not described in [section 864(d)(1)](/cfr/26/864.md?p=d-1) by reason of the same-country exception of [section 864(d)(7)](/cfr/26/864.md?p=d-7);
      - (B) Income derived from a factored receivable if payment for the acquisition of the receivable is made on or after the date on which stated interest begins to accrue, but only if the rate of stated interest equals or exceeds 120 percent of the Federal short-term rate (as defined under [section 1274](/cfr/26/1274.md)) (or the analogous rate for a currency other than the dollar) as of the date on which the receivable is acquired by the foreign corporation; or
      - (C) Income derived from a factored receivable if payment for the acquisition of the receivable by the foreign corporation is made only on or after the anticipated date of payment of all principal by the obligor (or the anticipated weighted average date of payment of a pool of purchased receivables).
    - (iii) **Factored receivable.** For purposes of this [paragraph (h)(4)](#h-4), the term factored receivable includes any account receivable or other evidence of indebtedness, whether or not issued at a discount and whether or not bearing stated interest, arising out of the disposition of property or the performance of services by any person, if such account receivable or evidence of indebtedness is acquired by a person other than the person who disposed of the property or provided the services that gave rise to the account receivable or evidence of indebtedness. For purposes of this [paragraph (h)(4)](#h-4), it is immaterial whether the person providing the property or services agrees to transfer the receivable at the time of sale (as by accepting a third-party charge or credit card) or at a later time.
    - (iv) **Examples.** The following examples illustrate the application of this [paragraph (h)(4)](#h-4).
  - (5) **Receivables arising from performance of services.** If payment for services performed by a controlled foreign corporation is not made until more than 120 days after the date on which such services are performed, then the income derived by the controlled foreign corporation constitutes income equivalent to interest to the extent that interest income would be imputed under the principles of [section 483](/cfr/26/483.md) or the original issue discount provisions ([sections 1271 through 1275](/cfr/26/1271..1275.md)), if—
    - (i) Such provisions applied to contracts for the performance of services;
    - (ii) The time period referred to in sections [483(c)(1)](/cfr/26/483.md?p=c-1) and [1274(c)(1)(B)](/cfr/26/1274.md?p=c-1-B) were 120 days rather than six months; and
    - (iii) **The time period referred to in section 483(c)(1)(A) were 120 days rather than one year.**
  - (6) **Examples.** The following examples illustrate the application of this [paragraph (h)](#h).
    - (i) **Applicability dates—**
  - (1) **Paragraphs (c)(2)(v) through (vii).** [Paragraphs (c)(2)(v) through (vii)](#c-2-v..c-2-vii) of this section and Example 6 of [paragraph (c)(3)](#c-3) of this section apply to taxable years of controlled foreign corporations beginning on or after May 2, 2006, and for taxable years of United States shareholders with or within which such taxable years of the controlled foreign corporations end. Taxpayers may elect to apply [paragraphs (c)(2)(v) through (vii)](#c-2-v..c-2-vii) to taxable years of controlled foreign corporations beginning after December 31, 2004, and for taxable years of United States shareholders with or within which such taxable years of the controlled foreign corporations end. If an election is made to apply [§ 1.956-2(b)(1)(vi)](/cfr/26/1.956-2.md?p=b-1-vi) to taxable years beginning after December 31, 2004, then the election must also be made for [paragraphs (c)(2)(v) through (vii)](#c-2-v..c-2-vii) of this section.
  - (2) **Paragraphs (c)(2)(iii)(B) and (c)(2)(iv)(A) of this section.** Paragraphs [(c)(2)(iii)(B)](#c-2-iii-B) and [(c)(2)(iv)(A)](#c-2-iv-A) of this section apply for taxable years of controlled foreign corporations ending on or after November 19, 2019, and for the taxable years of United States shareholders in which or with which such taxable years end.
  - (3) **Other paragraphs.** Paragraphs [(c)(1)(i)](#c-1-i) and [(d)(1)(i)](#d-1-i) of this section apply to rents or royalties, as applicable, received or accrued during taxable years of controlled foreign corporations ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, but only with respect to property manufactured, produced, developed, or created, or in the case of acquired property, property to which substantial value has been added, on or after September 1, 2015. Paragraphs (c)(1)(iv), (c)(2)(ii), (c)(2)(iii)(E), (c)(2)(viii), (d)(1)(ii), (d)(2)(ii), [(d)(2)(iii)(E)](#d-2-iii-E), and (d)(2)(v) of this section apply to rents or royalties, as applicable, received or accrued during taxable years of controlled foreign corporations ending on or after September 1, 2015, and to taxable years of United States shareholders in which or with which such taxable years end, to the extent that such rents or royalties are received or accrued on or after September 1, 2015. See § [1.954-2(c)(1)(i)](#c-1-i), [(c)(1)(iv)](#c-1-iv), [(c)(2)(ii)](#c-2-ii), [(c)(2)(iii)](#c-2-iii), [(d)(1)(i)](#d-1-i), [(d)(1)(ii)](#d-1-ii), [(d)(2)(ii)](#d-2-ii), and [(d)(2)(iii)](#d-2-iii), as contained in [26 CFR part 1](/cfr/26/part1.md) revised as of April 1, 2015, for rules applicable to rents or royalties, as applicable, received or accrued before September 1, 2015. [Paragraph (h)(2)(i)(I)](#h-2-i-I) of this section applies to taxable years of controlled foreign corporations ending on or after December 16, 2019, and to taxable years of United States shareholders in which or with which such taxable years end.

# §1.954-3. Foreign base company sales income.

- (a) **Income included—**
  - (1) **In general—**
    - (i) **General rules.** Foreign base company sales income of a controlled foreign corporation shall, except as provided in paragraphs [(a)(2)](#a-2), [(a)(3)](#a-3) and [(a)(4)](#a-4) of this section, consist of gross income (whether in the form of profits, commissions, fees or otherwise) derived in connection with the purchase of personal property from a related person and its sale to any person, the sale of personal property to any person on behalf of a related person, the purchase of personal property from any person and its sale to a related person, or the purchase of personal property from any person on behalf of a related person. See [section 954(d)(1)](/cfr/26/954.md?p=d-1). For purposes of the preceding sentence, except as provided in paragraphs [(a)(2)](#a-2) and [(a)(4)](#a-4) of this section, personal property sold by a controlled foreign corporation will be considered to be the same property that was purchased by the controlled foreign corporation regardless of whether the personal property is sold in the same form in which it was purchased, in a different form than the form in which it was purchased, or as a component part of a manufactured product. This section shall apply to the purchase and/or sale of personal property, whether or not such property was purchased and/or sold in the ordinary course of trade or business, except that income derived in connection with the sale of tangible personal property will not be considered to be foreign base company sales income if such property is sold to a person that is not a related person, as defined in [§ 1.954-1(f)](/cfr/26/1.954-1.md?p=f), after substantial use has been made of the property by the controlled foreign corporation in its trade or business. This section shall not apply to the excess of gains over losses from sales or exchanges of securities or from futures transactions, to the extent such excess gains are includible in foreign personal holding company income of the controlled foreign corporation under [§ 1.954-2](/cfr/26/1.954-2.md); nor shall it apply to the sale of the controlled foreign corporation's property (other than its stock in trade or other property of a kind which would properly be included in its inventory if on hand at the close of the taxable year, or property held primarily for sale to customers in the ordinary course of its business) if substantially all the property of such corporation is sold pursuant to the discontinuation of the trade or business previously carried on by such corporation. The term “any person” as used in this [paragraph (a)(1)(i)](#a-1-i) includes a related person as defined in [§ 1.954-1(f)](/cfr/26/1.954-1.md?p=f).
    - (ii) **Special rule—(a) In general.** The term “personal property” as used in [section 954(d)](/cfr/26/954.md?p=d) and this section shall not include agricultural commodities which are not grown in the United States (within the meaning of [section 7701(a)(9)](/cfr/26/7701.md?p=a-9)) in commercially marketable quantities. All of the agricultural commodities listed in table I shall be considered grown in the United States in commercially marketable quantities. Bananas, black pepper, cocoa, coconut, coffee, crude rubber, and tea shall not be considered grown in the United States in commercially marketable quantities. All other agricultural commodities shall not be considered grown in the United States in commercially marketable quantities when, in consideration of all of the facts and circumstances of the individual case, such commodities are shown to be produced in the United States in insufficient quantity and quality to be marketed commercially. The term “agricultural commodities” includes, but is not limited to, livestock, poultry, fish produced in fish farms, fruit, furbearing animals as well as the products of truck farms, ranches, nurseries, ranges, and orchards. A fish farm is an area where fish are grown or raised (artificially protected and cared for), as opposed to merely caught or harvested. However, the term “agricultural commodities” shall not include timber (either standing or felled), or any commodity at least 50 percent of the fair market value of which is attributable to manufacturing or processing, determined in a manner consistent with the regulations under [section 993(c)](/cfr/26/993.md?p=c) (relating to the definition of export property). For purposes of applying such regulations, the term “processing” shall be deemed not to include handling, packing, packaging, grading, storing, transporting, slaughtering, and harvesting. Subdivision (ii) shall apply in the computation of foreign base company sales income for taxable years of controlled foreign corporations beginning after December 31, 1975, and to taxable years of U.S. shareholders (within the meaning of [section 951(b)](/cfr/26/951.md?p=b)) within which or with which such taxable years of such foreign corporations end.

      (b) Table.

    - (iii) The application of this subparagraph may be illustrated by the following examples:
  - (2) **Property manufactured, produced, constructed, grown, or extracted within the country in which the controlled foreign corporation is created or organized.** Foreign base company sales income does not include income derived in connection with the purchase and sale of personal property (or purchase or sale of personal property on behalf of a related person) in a transaction described in [paragraph (a)(1)](#a-1) of this section if the property is manufactured, produced, constructed, grown, or extracted in the country under the laws of which the controlled foreign corporation which purchases and sells the property (or acts on behalf of a related person) is created or organized. See [section 954(d)(1)(A)](/cfr/26/954.md?p=d-1-A). The principles set forth in paragraphs [(a)(4)(ii)](#a-4-ii) and [(a)(4)(iii)](#a-4-iii) of this section apply under this [paragraph (a)(2)](#a-2) in determining what constitutes the manufacture, production, or construction of personal property, excluding the requirement set forth in [paragraph (a)(4)(i)](#a-4-i) of this section that the provisions of paragraphs [(a)(4)(ii)](#a-4-ii) and [(a)(4)(iii)](#a-4-iii) of this section may only be satisfied through the activities of employees of the corporation manufacturing, producing, or constructing the personal property. The principles of [paragraph (a)(4)(iv)](#a-4-iv) of this section apply under this [paragraph (a)(2)](#a-2) in determining what constitutes the manufacture, production, or construction of personal property but only when the personal property is manufactured, produced, or constructed by a person related to the controlled foreign corporation within the meaning of [§ 1.954-1(f)](/cfr/26/1.954-1.md?p=f). The application of this [paragraph (a)(2)](#a-2) may be illustrated by the following examples:
  - (3) **Property sold for use, consumption, or disposition within the country in which the controlled foreign corporation is created or organized—**
    - (i) **In general.** Foreign base company sales income does not include income derived in connection with the purchase and sale of personal property (or purchase or sale of personal property on behalf of a related person) in a transaction described in [subparagraph (1)](#a-1) of this paragraph, (a) if the property is sold for use, consumption, or disposition in the country under the laws of which the controlled foreign corporation which purchases and sells the property (or sells on behalf of a related person) is created or organized or (b), where the property is purchased by the controlled foreign corporation on behalf of a related person, if such property is purchased for use, consumption, or disposition in the country under the laws of which such controlled foreign corporation is created or organized. See [section 954(d)(1)(B)](/cfr/26/954.md?p=d-1-B).
    - (ii) **Rules for determining country of use, consumption, or disposition.** As a general rule, personal property which is sold to an unrelated person will be presumed for purposes of this subparagraph to have been sold for use, consumption, or disposition in the country of destination of the property sold; for such purpose, the occurrence in a country of a temporary interruption in shipment of goods shall not constitute such country the country of destination. However, if at the time of a sale of personal property to an unrelated person the controlled foreign corporation knew, or should have known from the facts and circumstances surrounding the transaction, that the property probably would not be used, consumed, or disposed of in the country of destination, the controlled foreign corporation must determine the country of ultimate use, consumption, or disposition of the property or the property will be presumed to have been used, consumed, or disposed of outside the country under the laws of which the controlled foreign corporation is created or organized. A controlled foreign corporation which sells personal property to a related person is presumed to sell such property for use, consumption, or disposition outside the country under the laws of which the controlled foreign corporation is created or organized unless such corporation establishes the use made of the property by the related person; once it has established that the related person has disposed of the property, the rules in the two preceding sentences relating to sales by a controlled foreign corporation to an unrelated person will apply at the first stage in the chain of distribution at which a sale is made by a related person to an unrelated person. Notwithstanding the preceding provisions of this subdivision, a controlled foreign corporation which sells personal property to any person all of whose business except for an insubstantial part consists of selling from inventory to retail customers at retail outlets all within one country may assume at the time of such sale to such person that such property will be used, consumed, or disposed of within such country.
    - (iii) **Fungible goods.** For purposes of this subparagraph, a controlled foreign corporation which sells to a purchaser personal property which because of its fungible nature cannot reasonable be specifically traced to other purchasers and to the countries of ultimate use, consumption, or disposition shall, unless such corporation establishes a different disposition as being proper, treat such property as being sold, for ultimate use, consumption, or disposition in those countries, and to those other purchasers, in the same proportions in which property from the fungible mass of the first purchaser is sold in the regular course of business by such first purchaser. No apportionment need be made, however, on the basis of sporadic sales by the first purchaser. This subdivision shall apply only in a case where the controlled foreign corporation knew, or should have known from the facts and circumstances surrounding the transaction, the manner in which the first purchaser disposes of goods from the fungible mass.
    - (iv) **Illustrations.** The application of this subparagraph may be illustrated by the following examples:
  - (4) **Property manufactured, produced, or constructed by the controlled foreign corporation—**
    - (i) **In general.** Foreign base company sales income does not include income of a controlled foreign corporation derived in connection with the sale of personal property manufactured, produced, or constructed by such corporation. A controlled foreign corporation will have manufactured, produced, or constructed personal property which the corporation sells only if such corporation satisfies the provisions of paragraph [(a)(4)(ii)](#a-4-ii), [(a)(4)(iii)](#a-4-iii), or [(a)(4)(iv)](#a-4-iv) of this section through the activities of its employees (as defined in [§ 31.3121(d)-1(c)](/cfr/26/31.3121..1.md) of this chapter) with respect to such property. A controlled foreign corporation will not be treated as having manufactured, produced, or constructed personal property which the corporation sells merely because the property is sold in a different form than the form in which it was purchased. For rules of apportionment in determining foreign base company sales income derived from the sale of personal property purchased and used as a component part of property which is not manufactured, produced, or constructed, see [paragraph (a)(5)](#a-5) of this section.
    - (ii) **Substantial transformation of property.** If personal property purchased by a foreign corporation is substantially transformed by such foreign corporation prior to sale, the property sold by the selling corporation is manufactured, produced, or constructed by such selling corporation. The application of this [paragraph (a)(4)(ii)](#a-4-ii) may be illustrated by the following examples:
    - (iii) **Manufacture of a product when purchased components constitute part of the property sold.** If purchased property is used as a component part of personal property which is sold, the sale of the property will be treated as the sale of a manufactured product, rather than the sale of component parts, if the assembly or conversion of the component parts into the final product by the selling corporation involves activities that are substantial in nature and generally considered to constitute the manufacture, production, or construction of property. Without limiting this substantive test, which is dependent on the facts and circumstances of each case, the operations of the selling corporation in connection with the use of the purchased property as a component part of the personal property which is sold will be considered to constitute the manufacture of a product if in connection with such property conversion costs (direct labor and factory burden) of such corporation account for 20 percent or more of the total cost of goods sold. In no event, however, will packaging, repackaging, labeling, or minor assembly operations constitute the manufacture, production, or construction of property for purposes of [section 954(d)(1)](/cfr/26/954.md?p=d-1). The application of this [paragraph (a)(4)(iii)](#a-4-iii) may be illustrated by the following examples:
    - (iv) **Substantial contribution to manufacturing of personal property—** (a) In general. If an item of personal property would be considered manufactured, produced, or constructed (under the principles of paragraph [(a)(4)(ii)](#a-4-ii) or [(a)(4)(iii)](#a-4-iii) of this section) prior to sale by the controlled foreign corporation had all of the manufacturing, producing, and constructing activities undertaken with respect to that property prior to sale been undertaken by the controlled foreign corporation through the activities of its employees, then this [paragraph (a)(4)(iv)](#a-4-iv) applies. If this [paragraph (a)(4)(iv)](#a-4-iv) applies and if the facts and circumstances evince that the controlled foreign corporation makes a substantial contribution through the activities of its employees to the manufacture, production, or construction of the personal property sold, then the personal property sold by the controlled foreign corporation is manufactured, produced, or constructed by such controlled foreign corporation.

      (b) Activities. The determination of whether a controlled foreign corporation makes a substantial contribution through the activities of its employees to the manufacture, production, or construction of the personal property sold involves, but will not necessarily be limited to, consideration of the following activities:

      (1) Oversight and direction of the activities or process pursuant to which the property is manufactured, produced, or constructed (under the principles of paragraph [(a)(4)(ii)](#a-4-ii) or [(a)(4)(iii)](#a-4-iii) of this section).

      (2) Activities that are considered in, but that are insufficient to satisfy, the tests provided in paragraphs [(a)(4)(ii)](#a-4-ii) and [(a)(4)(iii)](#a-4-iii) of this section.

      (3) Material selection, vendor selection, or control of the raw materials, work-in-process or finished goods.

      (4) Management of manufacturing costs or capacities (for example, managing the risk of loss, cost reduction or efficiency initiatives associated with the manufacturing process, demand planning, production scheduling, or hedging raw material costs).

      (5) Control of manufacturing related logistics.

      (6) Quality control (for example, sample testing or establishment of quality control standards).

      (7) Developing, or directing the use or development of, product design and design specifications, as well as trade secrets, technology, or other intellectual property for the purpose of manufacturing, producing, or constructing the personal property.

      (c) Application of substantial contribution test. When considering whether a controlled foreign corporation makes a substantial contribution to the manufacture, production, or construction of the personal property, the performance of any activity in paragraph (a)(4)(iv)(b) of this section will be taken into account. The performance or lack of performance of any particular activity in paragraph (a)(4)(iv)(b) of this section, or of a particular number of activities in (a)(4)(iv)(b) of this section, is not determinative. The weight accorded to the performance of any quantum of any activity (whether or not specified in paragraph (a)(4)(iv)(b) of this section) will vary with the facts and circumstances of the particular business. See paragraph (a)(4)(iv)(d) Examples 8, 10 and 11 of this section. In determining whether the activities of the controlled foreign corporation constitute a substantial contribution, there is no minimum performance threshold before an activity can be considered. The fact that other persons make a substantial contribution to the manufacture, production, or construction of the personal property prior to sale does not preclude the controlled foreign corporation from making a substantial contribution to the manufacture, construction, or production of that property through the activities of its employees. See paragraph (a)(4)(iv)(d) Example 9 of this section.

      (d) Examples. The rules of this [paragraph (a)(4)(iv)](#a-4-iv) are illustrated by the following examples:

  - (5) **Rules for apportionment of income derived from the sale of purchased components used in property not manufactured, produced, or constructed.** The foreign base company sales income derived by a controlled foreign corporation for the taxable year from sales of personal property purchased and used as a component part of property which is not manufactured, produced, or constructed by such corporation within the meaning of [subparagraph (4)](#a-4) of this paragraph shall, unless the records of the controlled foreign corporation show that a different apportionment of income is proper or unless all the income from such sales is treated as foreign base company sales income, be determined by first making for such year the following separate classifications and subclassifications with respect to the property which is sold and then by apportioning the income for such year from such sales in accordance with the rules of this subparagraph:
    - (i) A classification of the cost of components used in the property which is sold into two classes consisting of the cost of components manufactured, produced, constructed, grown, or extracted—

      (a) Within the country under the laws of which the controlled foreign corporation is created or organized, and

      (b) Outside such country;

    - (ii) **A subclassification of the class described in subdivision (i) (<I>b</I>) of this subparagraph into—** (a) The cost of such components purchased from unrelated persons, and

      (b) The cost of such components purchased from related persons;

    - (iii) A classification of the income derived from such sales into two classes consisting of income derived from sales for use, consumption, or disposition—

      (a) Within the country under the laws of which the controlled foreign corporation is created or organized, and

      (b) Outside such country; and

    - (iv) A subclassification of the class described in subdivision (iii) (b) of this subparagraph into income from—

      (a) Sales to unrelated persons, and

      (b) Sales to related persons.

  - (6) **Special rule applicable to distributive share of partnership income—**
    - (i) **In general.** To determine the extent to which a controlled foreign corporation's distributive share of any item of gross income of a partnership would have been foreign base company sales income if received by it directly, under [§ 1.952-1(g)](/cfr/26/1.952-1.md?p=g), the property sold will be considered to be manufactured, produced, or constructed by the controlled foreign corporation, within the meaning of [paragraph (a)(4)(i)](#a-4-i) of this section, only if the manufacturing exception of [paragraph (a)(4)(i)](#a-4-i) of this section would have applied to exclude the income from foreign base company sales income if the controlled foreign corporation had earned the income directly, determined by taking into account only the activities of the employees of, and property owned by, the partnership.
    - (ii) **Example.** The application of [paragraph (a)(6)(i)](#a-6-i) of this section is illustrated by the following example:
    - (iii) **Effective date.** This [paragraph (a)(6)](#a-6) applies to taxable years of a controlled foreign corporation beginning on or after July 23, 2002.
- (b) **Branches of controlled foreign corporation treated as separate corporations—**
  - (1) **General rules for determining when to apply separate treatment—**
    - (i) **Sales or purchase branch—(a) In general.** If a controlled foreign corporation carries on purchasing or selling activities by or through a branch or similar establishment located outside the country under the laws of which such corporation is created or organized and the use of the branch or similar establishment for such activities has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of such controlled foreign corporation, the branch or similar establishment and the remainder of the controlled foreign corporation will be treated as separate corporations for purposes of determining foreign base company sales income of such corporation. See [section 954(d)(2)](/cfr/26/954.md?p=d-2).

      (b) Allocation of income and comparison of effective rates of tax. The determination as to whether such use of the branch or similar establishment has the same tax effect as if it were a wholly owned subsidiary corporation of the controlled foreign corporation shall be made by allocating to such branch or similar establishment only that income derived by the branch or establishment which, when the special rules of [subparagraph (2)(i)](#b-2-i) of this paragraph are applied, is described in [paragraph (a)](#a) of this section (but determined without applying subparagraphs [(2)](#b-2), [(3)](#b-3), and [(4)](#b-4) of such paragraph). The use of the branch or similar establishment for such activities will be considered to have substantially the same tax effect as if it were a wholly owned subsidiary corporation of the controlled foreign corporation if the income allocated to the branch or similar establishment under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, taxed in the year when earned at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the controlled foreign corporation is created or organized, if, under the laws of such country, the entire income of the controlled foreign corporation were considered derived by the corporation from sources within such country from doing business through a permanent establishment therein, received in such country, and allocable to such permanent establishment, and the corporation were managed and controlled in such country.

      (c) Use of more than one branch. If a controlled foreign corporation carries on purchasing or selling activities by or through more than one branch or similar establishment located outside the country under the laws of which such corporation is created or organized, then paragraph (b)(1)(i)(b) of this section shall be applied separately to the income derived by each such branch or similar establishment (by treating such purchasing or selling branch or similar establishment as if it were the only branch or similar establishment of the controlled foreign corporation and as if any such other branches or similar establishments were separate corporations) in determining whether the use of such branch or similar establishment has substantially the same tax effect as if such branch or similar establishment were a wholly owned subsidiary corporation of the controlled foreign corporation. See paragraph (b)(1)(ii)(c)(1) of this section for rules applicable to a controlled foreign corporation that carries on purchase or sales activities by or through one or more branches or similar establishments in addition to carrying on manufacturing activities by or through one or more branches or similar establishments.

    - (ii) **Manufacturing branch—** (a) In general. If a controlled foreign corporation carries on manufacturing, producing, constructing, growing, or extracting activities by or through a branch or similar establishment located outside the country under the laws of which such corporation is created or organized and the use of the branch or similar establishment for such activities with respect to personal property purchased or sold by or through the remainder of the controlled foreign corporation has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of such controlled foreign corporation, the branch or similar establishment and the remainder of the controlled foreign corporation will be treated as separate corporations for purposes of determining the foreign base company sales income of such corporation. See [section 954(d)(2)](/cfr/26/954.md?p=d-2). The provisions of this [paragraph (b)(1)(ii)](#b-1-ii) will apply only if the controlled foreign corporation (including any branches or similar establishments of such controlled foreign corporation) manufactures, produces, or constructs such personal property within the meaning of [paragraph (a)(4)(i)](#a-4-i) of this section, or carries on growing or extracting activities with respect to such personal property.

      (b) Allocation of income and comparison of effective rates of tax. The determination as to whether such use of the branch or similar establishment has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of the controlled foreign corporation shall be made by allocating to the remainder of such controlled foreign corporation only that income derived by the remainder of such corporation, which, when the special rules of [subparagraph (2)(i)](#b-2-i) of this paragraph are applied, is described in [paragraph (a)](#a) of this section (but determined without applying subparagraphs [(2)](#b-2), [(3)](#b-3), and [(4)](#b-4) of such paragraph). The use of the branch or similar establishment for such activities will be considered to have substantially the same tax effect as if it were a wholly owned subsidiary corporation of the controlled foreign corporation if income allocated to the remainder of the controlled foreign corporation under the immediately preceding sentence is, by statute, treaty obligation, or otherwise, taxed in the year when earned at an effective rate of tax that is less than 90 percent of, and at least 5 percentage points less than, the effective rate of tax which would apply to such income under the laws of the country in which the branch or similar establishment is located, if, under the laws of such country, the entire income of the controlled foreign corporation were considered derived by such corporation from sources within such country from doing business through a permanent establishment therein, received in such country, and allocable to such permanent establishment, and the corporation were created or organized under the laws of, and managed and controlled in, such country.

      (c) Use of more than one branch—(1) Use of one or more sales or purchase branches in addition to a manufacturing branch. If, with respect to personal property manufactured, produced, constructed, grown, or extracted by or through a branch or similar establishment located outside the country under the laws of which the controlled foreign corporation is created or organized, purchasing or selling activities are carried on by or through more than one branch or similar establishment, or by or through one or more branches or similar establishments located outside such country, of such corporation, then paragraph (b)(1)(ii)(b) of this section shall be applied separately to the income derived by each such purchasing or selling branch or similar establishment (by treating such purchasing or selling branch or similar establishment as though it alone were the remainder of the controlled foreign corporation) for purposes of determining whether the use of such manufacturing, producing, constructing, growing, or extracting branch or similar establishment has substantially the same tax effect as if such branch or similar establishment were a wholly owned subsidiary corporation of the controlled foreign corporation. If this rule applies, the sales or purchase branch rules contained in [paragraph (b)(1)(i)](#b-1-i) of this section do not apply. The application of this paragraph (b)(1)(ii)(c)(1) is illustrated by the following example:

      (2) Use of more than one branch to manufacture, produce, construct, grow, or extract separate items of personal property. If a controlled foreign corporation carries on manufacturing, producing, constructing, growing, or extracting activities with respect to separate items of personal property by or through more than one branch or similar establishment located outside the country under the laws of which such corporation is created or organized, then paragraphs (b)(1)(ii)(b) and (c) of this section will be applied separately to each such branch or similar establishment (by treating such manufacturing branch or similar establishment as if it were the only such branch or similar establishment of the controlled foreign corporation and as if any other such branches or similar establishments were separate corporations) for purposes of determining whether the use of such branch or similar establishment has substantially the same tax effect as if such branch or similar establishment were a wholly owned subsidiary corporation of the controlled foreign corporation. The application of this paragraph (b)(1)(ii)(c)(2) is illustrated by the following example:

      (3) Use of more than one manufacturing branch, or one or more manufacturing branches and the remainder of the controlled foreign corporation, to manufacture, produce, or construct the same item of personal property—(i) In general. This paragraph (b)(1)(ii)(c)(3) applies to determine the location of manufacture, production, or construction of personal property for purposes of applying paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section where more than one branch or similar establishment of a controlled foreign corporation, or one or more branches or similar establishments of a controlled foreign corporation and the remainder of the controlled foreign corporation, each engage in manufacturing, producing, or constructing activities with respect to the same item of personal property which is then sold by the controlled foreign corporation. This paragraph (b)(1)(ii)(c)(3) is applied separately with respect to the income derived by each purchasing or selling branch or similar establishment or purchasing or selling remainder of the controlled foreign corporation as provided under paragraphs [(b)(1)(i)](#b-1-i) and [(b)(1)(ii)](#b-1-ii) of this section. The location of manufacture, production, or construction is determined under paragraph (b)(1)(ii)(c)(3)(ii) of this section if one or more branches or similar establishments or the remainder of the controlled foreign corporation independently satisfies [paragraph (a)(4)(i)](#a-4-i) of this section with respect to an item of personal property. The location of manufacture, production, or construction is determined under paragraph (b)(1)(ii)(c)(3)(iii) of this section if none of the branches or similar establishments or the remainder of the controlled foreign corporation independently satisfies [paragraph (a)(4)(i)](#a-4-i) of this section with respect to an item of personal property, but the controlled foreign corporation as a whole makes a substantial contribution to the manufacture, production or construction of that property within the meaning of [paragraph (a)(4)(iv)](#a-4-iv) of this section. For purposes of this paragraph (b)(1)(ii)(c)(3), the location of any activity with respect to the manufacture, production, or construction of an item of personal property is determined under paragraph (b)(1)(ii)(c)(3)(iv) of this section. For purposes of this paragraph (b)(1)(ii)(c)(3), if multiple branches or similar establishments are located in a single jurisdiction, then the activities of those branches will be aggregated for purposes of determining whether a branch or remainder of the controlled foreign corporation satisfies [paragraph (a)(4)(i)](#a-4-i) of this section.

      (ii) Manufacture, production, or construction in one or more locations. If only one branch or similar establishment or only the remainder of a controlled foreign corporation independently satisfies [paragraph (a)(4)(i)](#a-4-i) of this section with respect to an item of personal property, then that branch or similar establishment or the remainder of the controlled foreign corporation will be the location of manufacture, production, or construction of that property for purposes of applying paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section to the income from the sale of that property. See paragraph (b)(1)(ii)(c)(3)(v) Example 1 of this section. If more than one branch or similar establishment or one or more branches or similar establishments and the remainder of the controlled foreign corporation, each independently satisfy [paragraph (a)(4)(i)](#a-4-i) of this section with respect to an item of personal property, then the location of manufacture, production, or construction of that property for purposes of applying paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section will be the location of that branch or similar establishment or the jurisdiction under the laws of which the remainder of the controlled foreign corporation is organized that satisfies [paragraph (a)(4)(i)](#a-4-i) of this section and that would, after applying paragraph (b)(1)(ii)(b) of this section to such branch or similar establishment or paragraph (b)(1)(i)(b) of this section to the remainder of the controlled foreign corporation, impose the lowest effective rate of tax on the income allocated to such branch or the remainder of the controlled foreign corporation under such section (that is, either paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section). See paragraph (b)(1)(ii)(c)(3)(v) Example 2 of this section.

      (iii) No location independently satisfies manufacturing test. If no branch or similar establishment or the remainder of the controlled foreign corporation independently satisfies [paragraph (a)(4)(i)](#a-4-i) of this section with respect to an item of personal property but the controlled foreign corporation as a whole makes a substantial contribution to the manufacture, production, or construction of that property within the meaning of [paragraph (a)(4)(iv)](#a-4-iv) of this section, then for purposes of applying paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section, the location of manufacture, production, or construction with respect to the income derived by a purchasing or selling branch or similar establishment or the purchasing or selling remainder of the controlled foreign corporation in connection with the purchase or sale of that property will be the “tested manufacturing location” unless the “tested sales location” provides a greater contribution to the manufacture, production, or construction of the property. The tested manufacturing location is the location of any branch or similar establishment or remainder of the controlled foreign corporation that contributes to the manufacture, production, or construction of the personal property, if any, that would, after applying paragraph (b)(1)(ii)(b) of this section to such branch or similar establishment or paragraph (b)(1)(i)(b) of this section to the remainder of the controlled foreign corporation, be treated as a separate corporation and would impose the lowest effective rate of tax on the income allocated to such branch or similar establishment or to the remainder of the controlled foreign corporation under such section (that is, either paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section). The tested sales location is the location of the purchasing or selling branch or similar establishment or the remainder of the controlled foreign corporation by or through which the purchasing or selling activities are carried on with respect to the personal property. For purposes of this paragraph (b)(1)(ii)(c)(3)(iii), the contribution to the manufacture, production, or construction of the personal property by the tested sales location will be deemed to include the activities of any branch or similar establishment or remainder of the controlled foreign corporation that would not be treated as a corporation separate from the tested sales location after the application of paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section. For purposes of this paragraph (b)(1)(ii)(c)(3)(iii), the contribution of the tested manufacturing location to the manufacture, production, or construction of the personal property will be deemed to include any activities of any branch or similar establishment or remainder of the controlled foreign corporation that would be treated as a corporation separate from the tested sales location after the application of paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section. Whether the tested sales location provides a greater contribution to the manufacture, production, or construction of the personal property is determined by weighing the relative contributions to the manufacture, production, or construction of that property by the tested sales location and the tested manufacturing location under the facts and circumstances test provided in [paragraph (a)(4)(iv)](#a-4-iv) of this section. See paragraph (b)(1)(ii)(c)(3)(v) Examples 3, 4, 5, and 6 of this section. If the tested sales location provides a greater contribution to the manufacture, production, or construction of the personal property than the tested manufacturing location or if there is no tested manufacturing location, then the tested sales location is the location of manufacture, production, or construction of that property and the rules of paragraphs (b)(1)(i)(a) and (b)(1)(ii)(a) of this section will not apply with respect to the income derived by the tested sales location in connection with the purchase or sale of that property and the use of that purchasing or selling branch or similar establishment or the purchasing or selling remainder will not result in a branch being treated as a separate corporation for purposes of [paragraph (b)(2)(ii)](#b-2-ii) of this section.

      (iv) Location of activity. For purposes of paragraph (b)(1)(ii)(c)(3) of this section, the location of any activity with respect to the manufacture, production, or construction of an item of personal property is the location where the employees of the controlled foreign corporation perform such activity. For example, the location of any activity concerning intellectual property is determined based on where employees of the controlled foreign corporation develop or direct the use or development of the intellectual property, not on the formal assignment of that intellectual property.

      (v) Examples. The following examples illustrate the application of this paragraph (b)(1)(ii)(c)(3):

      (4) Use of more than one branch to manufacture, produce, construct, grow, or extract separate items of personal property. For purposes of paragraphs (b)(1)(ii)(c)(2) and (b)(1)(ii)(c)(3) of this section, an item of personal property refers to an individual unit of personal property rather than a type or class of personal property.

  - (2) **Special rules—**
    - (i) **Determination of treatment as a wholly owned subsidiary corporation.** For purposes of determining under this paragraph whether the use of a branch or similar establishment which is treated as a separate corporation has substantially the same tax effect as if the branch or similar establishment were a wholly owned subsidiary corporation of a controlled foreign corporation—

      (a) Treatment as separate corporations. The branch or similar establishment will be treated as a wholly owned subsidiary corporation of the controlled foreign corporation, and such branch or similar establishment will be deemed to be incorporated in the country in which it is located.

      (b) Activities treated as performed on behalf of the remainder of corporation. (1) With respect to purchasing or selling activities performed by or through the branch or similar establishment, such purchasing or selling activities will, with respect to personal property manufactured, produced, constructed, grown, or extracted by the remainder of the controlled foreign corporation, be treated as performed on behalf of the remainder of the controlled foreign corporation.

      (2) With respect to purchasing or selling activities performed by or through the branch or similar establishment, such purchasing or selling activities will, with respect to personal property (other than property described in paragraph (b)(2)(i)(b)(1) of this section) purchased or sold, or purchased and sold, by the remainder of the controlled foreign corporation (or any branch treated as the remainder of the controlled foreign corporation), be treated as performed on behalf of the remainder of the controlled foreign corporation.

      (c) Activities treated as performed on behalf of branch. With respect to manufacturing, producing, constructing, growing, or extracting activities performed by or through the branch or similar establishment, purchasing or selling activities performed by or through the remainder of the controlled foreign corporation with respect to the personal property manufactured, produced, constructed, grown, or extracted by or through the branch or similar establishment shall be treated as performed on behalf of the branch or similar establishment.

      (d) [Reserved] For further guidance, see [§ 1.954-3T(b)(2)(i)(d)](/cfr/26/1.954-3T.md?p=b-2-i-d).

      (e) Tax laws to be taken into account. Tax determinations shall be made by taking into account only the income, war profits, excess profits, or similar tax laws (or the absence of such laws) of the countries involved.

    - (ii) **Determination of foreign base company sales income.** Once it has been determined under [subparagraph (1)](#b-1) of this paragraph that a branch or similar establishment and the remainder of the controlled foreign corporation are to be treated as separate corporations, the determination of whether such branch or similar establishment, or the remainder of the controlled foreign corporation, as the case may be, has foreign base company sales income shall be made by applying the following rules:

      (a) Treatment as separate corporations. The branch or similar establishment will be treated as a wholly owned subsidiary corporation of the controlled foreign corporation, and such branch or similar establishment will be deemed to be incorporated in the country in which it is located. For purposes of applying the rules of this [paragraph (b)(2)(ii)](#b-2-ii), a branch or similar establishment of a controlled foreign corporation treated as a separate corporation purchasing or selling on behalf of the remainder of the controlled foreign corporation under paragraph (b)(2)(ii)(b) of this section, or the remainder of the controlled foreign corporation treated as a separate corporation purchasing or selling on behalf of a branch or similar establishment of the controlled foreign corporation under paragraph (b)(2)(ii)(c) of this section, will include the activities of any other branch or similar establishment or remainder of the controlled foreign corporation that would not be treated as a separate corporation (apart from the branch or similar establishment of a controlled foreign corporation that is treated as performing purchasing or selling activities on behalf of the remainder of the controlled foreign corporation under paragraph (b)(2)(ii)(b) of this section or the remainder of the controlled foreign corporation that is treated as performing purchasing or selling activities on behalf of the branch or similar establishment under paragraph (b)(2)(ii)(c) of this section) if the effective rate of tax imposed on the income of the purchasing or selling branch or similar establishment, or purchasing or selling remainder of the controlled foreign corporation, were tested under the principles of paragraph (b)(1)(i)(b) or (b)(1)(ii)(b) of this section against the effective rate of tax that would apply to such income if it were considered derived by such other branch or similar establishment or the remainder of the controlled foreign corporation.

      (b) Activities treated as performed on behalf of the remainder of corporation. (1) With respect to purchasing or selling activities performed by or through the branch or similar establishment, such purchasing or selling activities will, with respect to personal property manufactured, produced, constructed, grown, or extracted by the remainder of the controlled foreign corporation, be treated as performed on behalf of the remainder of the controlled foreign corporation.

      (2) With respect to purchasing or selling activities performed by or through the branch or similar establishment, such purchasing or selling activities will, with respect to personal property (other than property described in paragraph (b)(2)(ii)(b)(1) of this section) purchased or sold, or purchased and sold, by the remainder of the controlled foreign corporation (or any branch treated as the remainder of the controlled foreign corporation), be treated as performed on behalf of the remainder of the controlled foreign corporation.

      (c) Activities treated as performed on behalf of branch. With respect to manufacturing, producing, constructing, growing, or extracting activities performed by or through the branch or similar establishment, purchasing or selling activities performed by or through the remainder of the controlled foreign corporation with respect to the personal property manufactured, produced, constructed, grown, or extracted by or through the branch or similar establishment shall be treated as performed on behalf of the branch or similar establishment.

      (d) [Reserved]

      (e) Comparison with ordinary treatment. Income derived by a branch or similar establishment, or by the remainder of the controlled foreign corporation, will not be foreign base company sales income under [paragraph (b)](#b) of this section if the income would not be foreign base company sales income if it were derived by a separate controlled foreign corporation under like circumstances.

      (f) Priority of application. If income derived by the branch or similar establishment, or by the remainder of the controlled foreign corporation, from a transaction would be classified as foreign base company sales income of such controlled foreign corporation under [section 954(d)(1)](/cfr/26/954.md?p=d-1) and [paragraph (a)](#a) of this section, the income shall, notwithstanding this paragraph, be treated as foreign base company sales income under [paragraph (a)](#a) of this section and the branch or similar establishment shall not be treated as a separate corporation with respect to such income.

  - (3) **Inclusion of amounts in gross income of United States shareholders.** A branch or similar establishment of a controlled foreign corporation and the remainder of such corporation shall be treated as separate corporations under this paragraph solely for purposes of determining the foreign base company sales income of each such corporation and for purposes of including an amount in [subpart F](/cfr/26/subpartF.md) income of the controlled foreign corporation under [section 953(a)](/cfr/26/953.md?p=a). See [section 954(b)(3)](/cfr/26/954.md?p=b-3) and [paragraph (d)(4)](/cfr/26/1.954-1.md?p=d-4) of § 1.954-1 for rules relating to the treatment of a branch or similar establishment of a controlled foreign corporation and the remainder of such corporation as separate corporations for purposes of independently determining if the foreign base company income of each such corporation is less than 10 percent, or more than 70 percent, of its gross income. For all other purposes, however, a branch or similar establishment of a controlled foreign corporation and the remainder of such corporation shall not be treated as separate corporations. For example, if the controlled foreign corporation has a deficit in earnings and profits to which [section 952(c)](/cfr/26/952.md?p=c) applies, the limitation of such section on the amount includable in the [subpart F](/cfr/26/subpartF.md) income of such corporation will apply. Moreover, income, war profits, or excess profits taxes paid by a branch or similar establishment to a foreign country will be treated as having been paid by the controlled foreign corporation for purposes of [section 960](/cfr/26/960.md) (relating to special rules for foreign tax credit) and the regulations thereunder. Also, income of a branch or similar establishment, treated as a separate corporation under this paragraph, will not be treated as dividend income of the controlled foreign corporation of which it is a branch or similar establishment.
  - (4) **Illustrations.** The application of this [paragraph (b)](#b) may be illustrated by the following examples:
- (c) **Effective/applicability date.** Paragraphs [(a)(1)(i)](#a-1-i), [(a)(1)(iii)](#a-1-iii) Example 1, (a)(1)(iii) Example 2, (a)(2), (a)(4)(i), (a)(4)(ii), (a)(4)(iii), (a)(4)(iv), (a)(6)(i), (b)(1)(i)(c), (b)(1)(ii)(a), (b)(1)(ii)(c), (b)(2)(i)(b), (b)(2)(ii)(a), (b)(2)(ii)(b), (b)(2)(ii)(e), and (b)(4) Example 3, (b)(4) Example 8, and (b)(4) Example 9 of this section shall apply to taxable years of controlled foreign corporations beginning after June 30, 2009, and for taxable years of United States shareholders in which or with which such taxable years of the controlled foreign corporations end.
- (d) **Application of regulations to earlier taxable years.** A taxpayer may choose to apply these regulations retroactively with respect to its open taxable years that began prior to July 1, 2009. The taxpayer may so choose if and only if the taxpayer and all members of the taxpayer's affiliated group (within the meaning of [section 1504(a)](/cfr/26/1504.md?p=a)) apply these regulations, in their entirety, to the earliest taxable year of each controlled foreign corporation that ends with or within an open taxable year of the taxpayer and to all subsequent taxable years.

# §1.954-4. Foreign base company services income.

- (a) **Items included.** Except as provided in [paragraph (d)](#d) of this section, foreign base company services income means income of a controlled foreign corporation, whether in the form of compensation, commissions, fees, or otherwise, derived in connection with the performance of technical, managerial, engineering, architectural, scientific, skilled, industrial, commercial, or like services which—
  - (1) Are performed for, or on behalf of a related person, as defined in [paragraph (e)(1)](/cfr/26/1.954-1.md?p=e-1) of § 1.954-1, and
  - (2) Are performed outside the country under the laws of which the controlled foreign corporation is created or organized.
- (b) **Services performed for, or on behalf of, a related person—**
  - (1) **Specific cases.** For purposes of [paragraph (a)(1)](#a-1) of this section, “services which are performed for, or on behalf of, a related person” include (but are not limited to) services performed by a controlled foreign corporation in a case where—
    - (i) The controlled foreign corporation is paid or reimbursed by, is released from an obligation to, or otherwise receives substantial financial benefit from, a related person for performing such services;
    - (ii) The controlled foreign corporation performs services (whether or not with respect to property sold by a related person) which a related person is, or has been, obligated to perform;
    - (iii) The controlled foreign corporation performs services with respect to property sold by a related person and the performance of such services constitutes a condition or a material term of such sale; or
    - (iv) Substantial assistance contributing to the performance of such services has been furnished by a related person or persons.
  - (2) **Special rules—**
    - (i) **Guaranty of performance.** [Subparagraph (1)(ii)](#b-1-ii) of this paragraph shall not apply with respect to services performed by a controlled foreign corporation pursuant to a contract the performance of which is guaranteed by a related person, if (a) the related person's sole obligation with respect to the contract is to guarantee performance of such services, (b) the controlled foreign corporation is fully obligated to perform the services under the contract, and (c) the related person (or any other person related to the controlled foreign corporation) does not in fact (1) pay for performance of, or perform, any of such services the performance of which is so guaranteed or (2) pay for performance of, or perform, any significant services related to such services. If the related person (or any other person related to the controlled foreign corporation) does in fact pay for performance of, or perform, any of such services or any significant services related to such services, [subparagraph (1)(ii)](#b-1-ii) of this paragraph shall apply with respect to the services performed by the controlled foreign corporation pursuant to the contract the performance of which is guaranteed by the related person, even though such payment or performance is not considered to be substantial assistance for purposes of [subparagraph (1)(iv)](#b-1-iv) of this paragraph. For purposes of this subdivision, a related person shall be considered to guarantee performance of the services by the controlled foreign corporation whether it guarantees performance of such services by a separate contract of guaranty or enters into a service contract solely for purposes of guaranteeing performance of such services and immediately thereafter assigns the entire contract to the controlled foreign corporation for execution.
    - (ii) **Application of substantial assistance test.** For purposes of [subparagraph (1)(iv)](#b-1-iv) of this paragraph—

      (a) Assistance furnished by a related person or persons to the controlled foreign corporation 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.

      (b) Assistance furnished by a related person or persons to a controlled foreign corporation in the form of direction, supervision, services, or know-how shall not be considered substantial unless either (1) the assistance so furnished provides the controlled foreign corporation with skills which are a principal element in producing the income from the performance of such services by such corporation or (2) the cost to the controlled foreign corporation of the assistance so furnished equals 50 percent or more of the total cost to the controlled foreign corporation of performing the services performed by such corporation. The term “cost”, as used in this subdivision (b), shall be determined after taking into account adjustments, if any, made under [section 482](/cfr/26/482.md).

      (c) Financial assistance (other than contributions to capital), equipment, material, or supplies furnished by a related person to a controlled foreign corporation shall be considered assistance only in that amount by which the consideration actually paid by the controlled foreign corporation for the purchase or use of such item is less than the arm's length charge for such purchase or use. The total of such amounts so considered to be assistance in the case of financial assistance, equipment, material, and supplies furnished by all related persons shall be compared with the profits derived by the controlled foreign corporation from the performance of the services to determine whether the financial assistance, equipment, material, and supplies furnished by a related person or persons are by themselves substantial assistance contributing to the performance of such services. For purposes of this subdivision (c), determinations shall be made after taking into account adjustments, if any, made under [section 482](/cfr/26/482.md) and the term “consideration actually paid” shall include any amount which is deemed paid by the controlled foreign corporation pursuant to such an adjustment.

      (d) Even though assistance furnished by a related person or persons to a controlled foreign corporation in the form of direction, supervision, services, or know-how is not considered to be substantial under (b) of this subdivision and assistance furnished by a related person or persons in the form of financial assistance (other than contributions to capital), equipment, material, or supplies is not considered to be substantial under (c) of this subdivision, such assistance may nevertheless constitute substantial assistance when taken together or in combination with other assistance furnished by a related person or persons which in itself is not considered to be substantial.

      (e) Assistance furnished by a related person or persons to a controlled foreign corporation in the form of direction, supervision, services, or know-how shall not be taken into account under (b) or (d) of this subdivision unless the assistance so furnished assists the controlled foreign corporation directly in the performance of the services performed by such corporation.

    - (iii) **Special rule applicable to distributive share of partnership income.** A controlled foreign corporation's distributive share of a partnership's services income will be deemed to be derived from services performed for or on behalf of a related person, within the meaning of [section 954(e)(1)(A)](/cfr/26/954.md?p=e-1-A), if the partnership is a related person with respect to the controlled foreign corporation, under [section 954(d)(3)](/cfr/26/954.md?p=d-3), and, in connection with the services performed by the partnership, the controlled foreign corporation, or a person that is a related person with respect to the controlled foreign corporation, provided assistance that would have constituted substantial assistance contributing to the performance of such services, under [paragraph (b)(2)(ii)](#b-2-ii) of this section, if furnished to the controlled foreign corporation by a related person. This [paragraph (b)(2)(iii)](#b-2-iii) applies to taxable years of a controlled foreign corporation beginning on or after July 23, 2002.
  - (3) **Illustrations.** The application of this paragraph may be illustrated by the following examples:
- (c) **Place where services are performed.** The place where services will be considered to have been performed for purposes of [paragraph (a)(2)](#a-2) of this section will depend on the facts and circumstances of each case. As a general rule, services will be considered performed where the persons performing services for the controlled foreign corporation which derives income in connection with the performance of technical, managerial, architectural, engineering, scientific, skilled, industrial, commercial, or like services are physically located when they perform their duties in the execution of the service activity resulting in such income. Therefore, in many cases, total gross income of a controlled foreign corporation derived in connection with each service contract or arrangement performed for or on behalf of a related person must be apportioned, between income which is not foreign base company services income and that which is foreign base company services income, on a basis of employee-time spent within the foreign country under the laws of which the controlled foreign corporation is created or organized and employee-time spent without the foreign country under the laws of which such corporation is created or organized. In allocating time spent within and without the foreign country under the laws of which the controlled foreign corporation is created or organized, relative weight must also be given to the value of the various functions performed by persons in fulfillment of the service contract or arrangement. For example, clerical work will ordinarily be assigned little value, while services performed by technical, highly skilled, and managerial personnel will be assigned greater values in relation to the type of function performed by each individual.
- (d) **Items excluded.** Foreign base company services income does not include—
  - (1) **Income derived in connection with the performance of services by a controlled foreign corporation if—**
    - (i) The services directly relate to the sale or exchange of personal property by the controlled foreign corporation,
    - (ii) The property sold or exchanged was manufactured, produced, grown, or extracted by such controlled foreign corporation, and
    - (iii) The services were performed before the sale or exchange of such property by the controlled foreign corporation;
  - (2) Income derived in connection with the performance of services by a controlled foreign corporation if the services directly relate to an offer or effort to sell or exchange personal property which was, or would have been, manufactured, produced, grown, or extracted by such controlled foreign corporation whether or not a sale or exchange of such property was in fact consummated; or
  - (3) For taxable years beginning after December 31, 1975, foreign base company shipping income (as determined under [§ 1.954-6](/cfr/26/1.954-6.md)).

# §1.954-5. Increase in qualified investments in less developed countries; taxable years of controlled foreign corporations beginning before January 1, 1976.


For rules applicable to taxable years of controlled foreign corporations beginning before January 1, 1976, see [section 954(b)(1)](/cfr/26/954.md?p=b-1) (as in effect before the enactment of the Tax Reduction Act of 1975) and 26 CFR 1.954-5 (Revised as of April 1, 1975).


# §1.954-6. Foreign base company shipping income.

- (a) **Scope—**
  - (1) **In general.** This section prescribes rules for determining foreign base company shipping income under the provisions of [section 954(f)](/cfr/26/954.md?p=f), as amended by the Tax Reduction Act of 1975.
  - (2) **Effective date.**
    - (i) The rules prescribed in this section apply to taxable years of foreign corporations beginning after December 31, 1975, and to taxable years of United States shareholders (as defined in [section 951 (b)](/cfr/26/951.md?p=b)) within which or with which such taxable years of such foreign corporations end.
    - (ii) Except as described in [paragraph (b)(1)(viii)](#b-1-viii) of this section, foreign base company shipping income does not include amounts earned by a foreign corporation in a taxable year of such corporation beginning before January 1, 1976. See example 1 of [paragraph (g)(2)](#g-2) of this section for an illustration of the effect of this subparagraph on partnership income. See example 3 of [paragraph (f)(4)(ii)](#f-4-ii) of this section for an illustration of the effect of this subparagraph on certain dividend income. See [paragraph (f)(5)(iii)](#f-5-iii) of this section for the effect of this subparagraph on certain interest and gains.
- (b) **Definitions—**
  - (1) **Foreign base company shipping income.** The term “foreign base company shipping income” means—
    - (i) Gross income derived from, or in connection with, the use (or hiring or leasing for use) of any aircraft or vessel in foreign commerce (see [paragraph (c)](#c) of this section),
    - (ii) Gross income derived from, or in connection with, the performance of services directly related to the use of any aircraft or vessel in foreign commerce (see [paragraph (d)](#d) of this section),
    - (iii) Gross income incidental to income described in subdivisions (i) and (ii) of this subparagraph, as provided in [paragraph (e)](#e) of this section,
    - (iv) Gross income derived from the sale, exchange, or other disposition of any aircraft or vessel used or held for use (by the seller or by a person related to the seller) in foreign commerce,
    - (v) In the case of a controlled foreign corporation, dividends, interest, and gains described in [paragraph (f)](#f) of this section,
    - (vi) Income described in [paragraph (g)](#g) of this section (relating to partnerships, trusts, etc.),
    - (vii) Exchange gain, to the extent allocable to foreign base company shipping income (see [§ 1.952-2(c)(2)(v)(b)](/cfr/26/1.952-2.md?p=c-2-v-b), and
    - (viii) In the case of a controlled foreign corporation and at its option, dividends, interest, and gains attributable to income derived from aircraft and vessels (as defined in [26 CFR 1.954-1(b)(2)](/cfr/26/1.954-1.md?p=b-2) (Revised as of April 1, 1975)) by a less developed country shipping company (described in [§ 1.955-5(b)](/cfr/26/1.955-5.md?p=b)) in taxable years beginning after December 31, 1962, and before January 1, 1976. The portion of a dividend, interest, or gain attributable to such income shall be determined by the same method as that for determining the portion of a dividend, interest, or gain attributable to foreign base company shipping income under paragraphs [(f)(4)](#f-4), [(5)](#f-5), and [(6)](#f-6) of this section, but without regard to paragraphs [(f)(6)(ii)](#f-6-ii) and (iv)(B).
  - (2) **Foreign base company shipping operations.** For purposes of [sections 951 through 964](/cfr/26/951..964.md), the term “foreign base company shipping operations” means the trade or business from which gross income described in subparagraph [(1)(i)](#b-1-i) and [(ii)](#b-1-ii) of this paragraph is derived.
  - (3) **Foreign commerce.** For purposes of [sections 951 through 964](/cfr/26/951..964.md)—
    - (i) An aircraft or vessel is used in foreign commerce to the extent it is used in transportation of property or passengers—
      - (A) Between a port (or airport) in the United States or possession of the United States and a port (or airport) in a foreign country, or
      - (B) Between a port (or airport) in a foreign country and another in the same country or between a port (or airport) in a foreign country and one in another foreign country.
    - (ii) The term vessel includes all water craft and other artificial contrivances of whatever description and at whatever stage of construction, whether on the stocks or launched, which are used or are capable of being used or are intended to be used as a means of transportation on water. This definition does not apply for purposes of [section 956(b)(2)(G)](/cfr/26/956.md?p=b-2-G) and [§ 1.956-2(b)(1)(ix)](/cfr/26/1.956-2.md?p=b-1-ix).
    - (iii) The term port means any place (whether on or off shore) where aircraft or vessels are accustomed to load or unload goods or to take on or let off passengers.
    - (iv) Any vessel (such as a lighter or beacon lightship) which serves other vessels used in foreign commerce (within the meaning of subdivision (i) of this subparagraph) shall, to the extent so used, also be considered to be used in foreign commerce.
    - (v) **For the meaning of the term “foreign country”, see section 638(2).**
  - (4) **Use in foreign commerce.** For purposes of [sections 951 through 964](/cfr/26/951..964.md), the use of an aircraft or vessel in foreign commerce includes the hiring or leasing (or subleasing) of an aircraft or vessel to another for use in foreign commerce. Thus, for example, an aircraft or vessel is “used in foreign commerce” within the meaning of [section 955(b)(1)(A)](/cfr/26/955.md?p=b-1-A) if such aircraft or vessel is chartered (whether pursuant to a bareboat charter, time charter, or otherwise) to another for use in foreign commerce.
  - (5) **Related person.** With respect to a controlled foreign corporation, the term “related person” means a related person as defined in [§ 1.954-1(e)(1)](/cfr/26/1.954-1.md?p=e-1), and the term “unrelated person” means an unrelated person as defined in [§ 1.954-1(e)(2)](/cfr/26/1.954-1.md?p=e-2).
- (c) **Aircraft or vessel income—**
  - (1) **In general.** The term “income derived from, or in connection with, the use (or hiring or leasing for use) of any aircraft or vessel in foreign commerce” as used in [paragraph (b)(1)(i)](#b-1-i) of this section means—
    - (i) Income derived from transporting passengers or property by aircraft or vessel in foreign commerce and
    - (ii) **Income derived from hiring or leasing an aircraft or vessel to another for use in foreign commerce.**
  - (2) **Illustrations.** The application of this paragraph may be illustrated by the following examples:
- (d) **Services directly related—**
  - (1) **In general.** The term “income derived from, or in connection with, the performance of services directly related to the use of an aircraft or vessel in foreign commerce”, as used in [paragraph (b)(1)(ii)](#b-1-ii) of this section, means—
    - (i) Income derived from, or in connection with, the performance of services described in subparagraph [(2)](#d-2) or [(3)](#d-3) of this paragraph, and
    - (ii) **Income treated as foreign base company shipping income under subparagraph (4) of this paragraph.**
  - (2) **Intragroup services.** The services described in this subparagraph are services performed for a person who is the owner, lessor, lessee or operator of an aircraft or vessel used in foreign commerce, by such person or by a person related to such person, and which fall into one or more of the following categories:
    - (i) Terminal services, such as dockage, wharfage, storage, lights, water, refrigeration, and similar services;
    - (ii) Stevedoring and other cargo handling services;
    - (iii) Container related services (including the rental of containers and related equipment) performed either in connection with the local drayage or inland haulage of cargo or in the course of transportation in foreign commerce;
    - (iv) Services performed by tugs, lighters, barges, scows, launches, floating cranes, and other similar equipment;
    - (v) Maintenance and repairs;
    - (vi) Training of pilots and crews;
    - (vii) Licensing of patents, know-how, and similar intangible property developed and used in the course of foreign base company shipping operations;
    - (viii) Services performed by a booking, operating, or managing agent; and
    - (ix) **Any service performed in the course of the actual transportation of passengers or property.**
  - (3) **Services for passenger, consignor, or consignee.** The services described in this subparagraph are services provided by the operator (or person related to the operator) of an aircraft or vessel in foreign commerce for the passenger, consignor, or consignee, such as—
    - (i) Services described in one or more of the categories set out in subparagraphs [(2)(i) through (iv)](#d-2-i..d-2-iv) and [(ix)](#d-2-ix) of this paragraph,
    - (ii) The rental of staterooms, berths, or living accommodations and the furnishing of meals,
    - (iii) Barber shop and other services to passengers aboard vessels,
    - (iv) Excess baggage, and
    - (v) **Demurrage, dispatch, and dead freight.**
  - (4) **The 70-percent test.** At the option of the foreign corporation all the gross income for a taxable year derived by a foreign corporation from any facility used in connection with the performance of services described in one or more of the categories set out in [subparagraph (2)(i) through (ix)](#d-2-i..d-2-ix) of this paragraph is foreign base company shipping income if more than 70 percent of such gross income for either—
    - (i) Such taxable year, or
    - (ii) Such taxable year and the two preceding taxable years,
  - (5) **Rules for applying subparagraph (4).**
    - (i) Solely for purposes of applying [subparagraphs (4)](#d-4) of this paragraph, foreign base company shipping income and gross income shall be deemed to include an arm's length charge (see [paragraph (h)(5)](#h-5) of this section) for services performed by the foreign corporation for itself.
    - (ii) In determining whether services performed by a foreign corporation are performed at a single facility or at two or more different facilities, all of the facts and circumstances involved will be taken into account. Ordinarily, all services performed by a foreign corporation within a single port area will be considered performed at a single facility.
    - (iii) The application of this subparagraph and [subparagraph (4)](#d-4) of this paragraph may be illustrated by the following example in which it is assumed that the foreign corporation has chosen to apply the 70-percent test of [subparagraph (4)](#d-4):
  - (6) **Arm's length charge.** For purposes of this section, the arm's length charge for services performed by a foreign corporation for itself shall be determined by applying the principles of [section 482](/cfr/26/482.md) and the regulations thereunder as if the party for whom the services are performed and the party by whom the services are performed were not the same person, but were controlled taxpayers within the meaning of [§ 1.482-1(a)(4)](/cfr/26/1.482-1.md?p=a-4).
  - (7) **Illustrations.** The application of this paragraph may be illustrated by the following examples:
- (e) **Incidental income—**
  - (1) **In general.** Foreign base company shipping income includes all incidental income derived by a foreign corporation in the course of its active conduct of foreign base company shipping operations.
  - (2) **Examples.** Examples of incidental income derived in the course of the active conduct of foreign base company shipping operations include—
    - (i) Gain from the sale, exchange or other disposition of assets which are related shipping assets within the meaning of [§ 1.955A-2(b)](/cfr/26/1.955A-2.md?p=b),
    - (ii) Income derived from temporary investments described in § [1.955A-2(b)(2)(i)](/cfr/26/1.955A-2.md?p=b-2-i) and [(iii)](/cfr/26/1.955A-2.md?p=b-2-iii),
    - (iii) Interest on accounts receivable and evidences of indebtedness described in [§ 1.955A-2(b)(2)(ii)](/cfr/26/1.955A-2.md?p=b-2-ii),
    - (iv) Income derived from granting concessions to others aboard aircraft or vessels used in foreign commerce,
    - (v) Income derived from stock and currency futures described in § [1.955A-2(b)(2)(vii)](/cfr/26/1.955A-2.md?p=b-2-vii) and [(viii)](/cfr/26/1.955A-2.md?p=b-2-viii),
    - (vi) Income derived by the lessor of an aircraft or vessel used in foreign commerce from additional rentals for the use of related equipment (such as a complement of containers), and
    - (vii) Interest derived by the seller from a purchase money mortgage loan in respect of the sale of an aircraft or vessel described in [§ 1.955A-2(a)(1)(i)](/cfr/26/1.955A-2.md?p=a-1-i).
- (f) **Certain dividends, interest, and gain—**
  - (1) **In general.**
    - (i) The foreign base company shipping income of a controlled foreign corporation (referred to in subdivision (ii)(A) of this [paragraph (f)(1)](#f-1) as “first corporation”) includes—
      - (A) Dividends and interest received from foreign corporations listed in subdivision (ii) of this [paragraph (f)(1)](#f-1), and
      - (B) Gain recognized from the sale, exchange, or other disposition of stock or obligations of foreign corporations listed in subdivision (ii) of this [paragraph (f)(1)](#f-1),
    - (ii) **The foreign corporations referred to in subdivision (i) of this paragraph (f)(1) are—**
      - (A) Foreign corporations with respect to which the first corporation (see subdivision (i) of this [paragraph (f)(1)](#f-1)) would be deemed under [section 902(b)](/cfr/26/902.md?p=b) to pay taxes,
      - (B) Controlled foreign corporations which are related persons (within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3)), and
      - (C) Less developed country shipping companies described in [§ 1.955-5(b)](/cfr/26/1.955-5.md?p=b).
  - (2) **Corporation deemed to pay taxes.**
    - (i) For purposes of this paragraph, a controlled foreign corporation would be deemed under [section 902(b)](/cfr/26/902.md?p=b) to pay taxes in respect of any other foreign corporation if such controlled foreign corporation would be deemed, for purposes of applying [section 902(a)](/cfr/26/902.md?p=a) to any United States shareholder of such controlled foreign corporation, to pay taxes in respect of dividends which were received from such other foreign corporation (whether or not such other foreign corporation actually pays any taxes or dividends). Solely for purposes of this subdivision, each United States shareholder (within the meaning of [section 951(b)](/cfr/26/951.md?p=b)) shall be deemed to be a domestic corporation.
    - (ii) The application of subdivision (i) of this subparagraph may be illustrated by the following examples:
  - (3) **Obligation defined.** For purposes of this section, the term “obligation” means any bond, note, debenture, certificate, or other evidence of indebtedness, and a debt recorded in the books of account of both the creditor and the debtor. In the absence of legal, governmental, or business reasons to the contrary, the indebtedness must bear interest or be issued at a discount.
  - (4) **Dividends.**
    - (i) For purposes of this paragraph and [§ 1.954-1(b)(2)](/cfr/26/1.954-1.md?p=b-2), the portion of a dividend which is attributable to foreign base company shipping income is that amount which bears the same ratio to the total dividend received as the earnings and profits out of which such dividend is paid that are attributable to foreign base company shipping income bears to the total earnings and profits out of which such dividend is paid. For purposes of this subdivision, the source of the earnings and profits out of which a distribution is made shall be determined under [section 316(a)](/cfr/26/316.md?p=a), except that the source of the earnings and profits out of which a distribution is made by a controlled foreign corporation with respect to stock owned (within the meaning of [section 958(a)](/cfr/26/958.md?p=a)) by a United States shareholder of such controlled foreign corporation shall be determined under [§ 1.959-3](/cfr/26/1.959-3.md).
    - (ii) The application of this subparagraph may be illustrated by the following examples:
  - (5) **Interest and gain.**
    - (i) Except as provided in subdivisions (ii) and (iii) of this subparagraph, the portion of any interest paid by a foreign corporation, or gain recognized from the sale, exchange, or other disposition of stock or obligations of a foreign corporation, which is attributable to the foreign base company shipping income of such foreign corporation is that amount which bears the same ratio to such interest or gain as the foreign base company shipping income of such corporation for the period described in [subparagraph (6)](#f-6) of this paragraph bears to its gross income for such period.
    - (ii) Interest which is paid by a controlled foreign corporation is attributable to such corporation's foreign base company shipping income to the same extent that such interest is allocable (under the principles of [§ 1.954-1(c)](/cfr/26/1.954-1.md?p=c)) to its foreign base company shipping income.
    - (iii) If interest is paid by a foreign corporation, or if stock obligations of a foreign corporation are sold, exchanged, or otherwise disposed of, during a taxable year of such foreign corporation beginning before January 1, 1976, then no portion of such interest or gain is attributable to foreign base company shipping income.
    - (iv) Solely for purposes of subdivision (i) of this subparagraph, if a controlled foreign corporation (the “first corporation”) owns more than 10 percent of the stock of another controlled foreign corporation (the “second corporation”), then
      - (A) The gross income of the first corporation for any taxable year shall be—

        (1) Increased by its pro rata share of the gross income of the second corporation for the taxable year which ends with or within such taxable year of the first corporation, and

        (2) Decreased by the amount of any dividends received from the second corporation; and

      - (B) The foreign base company shipping income of the first corporation for any taxable year shall be—

        (1) Increased by its pro rata share of the foreign base company shipping income of the second corporation for the taxable year which ends with or within such taxable year of the first corporation, and

        (2) Decreased by the amount of any dividends received from the second corporation which constitute foreign base company income.

    - (v) Solely for purposes of applying subdivision (i) of this subparagraph, the district director shall make such other adjustments to the gross income and the foreign base company shipping income of any foreign corporation as are necessary to properly determine the extent to which any interest or gain is attributable to foreign base company shipping income, including proper adjustments to reflect any transaction during the test period described in [subparagraph (6)](#f-6) of this paragraph to which section [332](/cfr/26/332.md), [351](/cfr/26/351.md), [354](/cfr/26/354.md), [355](/cfr/26/355.md), [356](/cfr/26/356.md), or [361](/cfr/26/361.md) applies.
  - (6) **Test period.**
    - (i) Except as provided in subdivisions (ii) and (iii) of this subparagraph the period described in this subparagraph with respect to any foreign corporation is the 3-year period ending with the close of such corporation's taxable year preceding the year during which interest was paid or stock or obligations were sold, exchanged, or otherwise disposed of, or such part of such period as such corporation was in existence.
    - (ii) The period described in this paragraph shall not include any part of a taxable year beginning before January 1, 1976.
    - (iii) If interest is paid by a foreign corporation, or if stock or obligations of a foreign corporation are sold, exchanged, or otherwise disposed of during its first taxable year, then the period described in this paragraph shall be such first taxable year.
    - (iv) For purposes of subdivision (iii) of this subparagraph, the first taxable year of a foreign corporation is the later of—
      - (A) The first taxable year of its existence, or
      - (B) **Its first taxable year beginning after December 31, 1975.**
- (g) **Income from partnerships, trusts, etc—**
  - (1) **In general.** The foreign base company shipping income of any foreign corporation includes—
    - (i) Its distributive share of the gross income of any partnership, and
    - (ii) Any amounts includible in its gross income under section [652(a)](/cfr/26/652.md?p=a), [662(a)](/cfr/26/662.md?p=a), [671](/cfr/26/671.md), or [691(a)](/cfr/26/691.md?p=a),
  - (2) **Illustrations.** The application of [subparagraph (1)](#g-1) of this paragraph may be illustrated by the following examples:
  - (3) **Other income.** Except as expressly provided in [subparagraph (1)](#g-1) of this paragraph, foreign base company shipping income does not include any amount includible in the gross income of a controlled foreign corporation under part I of subchapter J ([section 641](/cfr/26/641.md) and following, relating to estates, trusts, and beneficiaries), and gains from the sale or other disposition of any interest in an estate or trust.
- (h) **Additional rules—**
  - (1) **Gross income.** For purposes of this section and [§ 1.955A-2](/cfr/26/1.955A-2.md), the gross income of a foreign corporation (whether or not a controlled foreign corporation) shall be determined in accordance with the provisions of [section 952](/cfr/26/952.md) and [§ 1.952-2](/cfr/26/1.952-2.md). Thus, for example, [section 883](/cfr/26/883.md) (relating to exclusions from gross income of foreign corporations) is inapplicable under § [1.952-2 (a)(1)](/cfr/26/1.952-2.md?p=a-1) and [(c)(1)](/cfr/26/1.952-2.md?p=c-1). In addition, the gross income of a controlled foreign corporation shall be determined, with respect to a United States shareholder of such controlled foreign corporation, by excluding distributions received by such corporation which are excluded from gross income under [section 959(b)](/cfr/26/959.md?p=b) with respect to such shareholder.
  - (2) **Earnings and profits.** For purposes of this section, the earnings and profits of a foreign corporation (whether or not a controlled foreign corporation) shall be determined in accordance with the provisions of [section 964](/cfr/26/964.md) and the regulations thereunder.
  - (3) **No double counting.** No item of gross income shall be counted as foreign base company shipping income under more than one provision of this section. For example, If $200 of gross income derived from the use of a lighter is treated as foreign base company shipping income under both paragraphs [(b)(1)(i)](#b-1-i) and [(ii)](#b-1-ii) of this section, then such $200 is counted only once as foreign base company shipping income. A taxpayer may choose under which provision to include an item of income.
  - (4) **Losses.**
    - (i) Generally, if a controlled foreign corporation has losses which are properly allocable to foreign base company shipping income, the extent to which such losses are deductible from such income shall be determined by treating such foreign corporation as a domestic corporation and applying the principles of [section 63](/cfr/26/63.md). See §§ [1.954-1(c)](/cfr/26/1.954-1.md?p=c) and [1.952-2(b)](/cfr/26/1.952-2.md?p=b). Thus for example, losses from sales or exchanges of capital assets are allowable only to the extent of gains from such sales or exchanges.
    - (ii) If gain from the sale, exchange, or other disposition of any stock or obligation would be treated (to any extent) as foreign base company shipping income, then loss from such sale, exchange, or other disposition is properly allocable to foreign base company shipping income (to the same extent).
    - (iii) In determining the extent to which any loss on the disposition of a qualified investment in foreign base company shipping operations is deductible from foreign base company shipping income, it is immaterial that such loss is taken into account under [§ 1.955A-1(b)(1)(ii)](/cfr/26/1.955A-1.md?p=b-1-ii) as a reduction in the amount of the decrease in (withdrawal from) qualified investments in foreign base company shipping operations.
  - (5) **Hypothetical charges.** Under [paragraph (d)(5)(i)](#d-5-i) of this section and [§ 1.955A-2(a)(4)(ii)(A)](/cfr/26/1.955A-2.md?p=a-4-ii-A), gross income may be deemed to include hypothetical arm's length charges for services performed by a controlled foreign corporation for itself. Under [paragraph (d)(2)](#d-2) of this section, certain of these hypothetical charges may be treated as foreign based company shipping income. Such hypothetical charges are deemed to be income solely for purposes of applying the “extent of use” tests prescribed by [paragraph (d)(4)](#d-4) of this section and [§ 1.955A-2(a)(4)](/cfr/26/1.955A-2.md?p=a-4). Charges for services performed by a controlled foreign corporation for itself shall in no event be included in income for any other purposes.

# §1.954-7. Increase in qualified investments in foreign base company shipping operations.

- (a) **Determination of investments at close of taxable year—**
  - (1) **In general.** Under [section 954(g)](/cfr/26/954.md?p=g), the increase in qualified investments in foreign base company shipping operations, for purposes of [section 954(b)(2)](/cfr/26/954.md?p=b-2) and [paragraph (b)(1)](/cfr/26/1.954-1.md?p=b-1) of § 1.954-1, of any controlled foreign corporation for any taxable year is, except as provided in [paragraph (b)](#b) of this section, the amount by which—
    - (i) The controlled foreign corporation's qualified investments in foreign base company shipping operations at the close of the taxable year, exceed
    - (ii) Its qualified investments in foreign base company shipping operations at the close of the preceding taxable year.
  - (2) **Preceding taxable year.** For purposes of this section, a taxable year which begins before January 1, 1976, may be a preceding taxable year.
  - (3) **Cross-reference.** See [section 955 (b)](/cfr/26/955.md?p=b) and [§ 1.955A-2](/cfr/26/1.955A-2.md) for the definition of the term “qualified investments in foreign base company shipping operations”.
- (b) **Election to determine investments at close of following taxable year—**
  - (1) **General rule.** In lieu of determining an increase in qualified investments in foreign base company shipping operations for a taxable year in the manner provided in [paragraph (a)](#a) of this section, a United States shareholder of a controlled foreign corporation may make an election under [section 955(b)(3)](/cfr/26/955.md?p=b-3) to determine the increase for the corporation's taxable year by ascertaining the amount by which—
    - (i) Such corporation's qualified investments in foreign base company shipping operations at the close of the taxable year immediately following such taxable year, exceed
    - (ii) Its qualified investments in foreign base company shipping operations at the close of the taxable year immediately preceding such following taxable year.
  - (2) **Election with respect to first taxable year.** Notwithstanding [subparagraph (1)](#b-1) of this paragraph, if an election is made without consent by a United States shareholder under [§ 1.955A-4 (b)(1)](/cfr/26/1.955A-4.md?p=b-1) with respect to a controlled foreign corporation, the increase in such controlled foreign corporation's qualified investments in foreign base company shipping operations for the first taxable year to which such election applies shall be the amount by which—
    - (i) Such corporation's qualified investments in foreign base company shipping operations at the close of the taxable year immediately following such first taxable year, exceed
    - (ii) Its qualified investments in foreign base company shipping operations at the close of the taxable year immediately preceding such first taxable year.
  - (3) **Manner of making election.** For the manner of making an election under [section 955(b)(3)](/cfr/26/955.md?p=b-3), and for rules pertaining to the revocation of such an election, see [§ 1.955A-4](/cfr/26/1.955A-4.md).
  - (4) **Coordination with prior law.** If a United States shareholder makes an election without consent under [§ 1.955A-4(b)(1)](/cfr/26/1.955A-4.md?p=b-1) with respect to a controlled foreign corporation, then such corporation's increase in qualified investments in foreign base company shipping operations for the first taxable year to which such election applies shall be determined by disregarding any change which occurs during such taxable year in the amount of such corporation's investments in stock or obligations of a less developed country shipping company described in [§ 1.955-5 (b)](/cfr/26/1.955-5.md?p=b) if both of the following conditions exist:
    - (i) Such taxable year is the first taxable year of such corporation which begins after December 31, 1975, and
    - (ii) Such United States shareholder has elected to determine the change in such corporation's qualified investments in less developed countries for its last taxable year beginning before January 1, 1976, under [§ 1.954-5(b)](/cfr/26/1.954-5.md?p=b) or [§ 1.955-3](/cfr/26/1.955-3.md).
  - (5) **Illustrations.** The application of this paragraph may be illustrated by the following examples:
- (c) **Illustration.** The application of this section may be illustrated by the following example:

# §1.954-8. Foreign base company oil related income.

- (a) **Foreign base company oil related income—**
  - (1) **In general.** Under [section 954(g)](/cfr/26/954.md?p=g), the foreign base company oil related income of a controlled foreign corporation (except as provided under [paragraph (b)](#b) of this section) consists of the items of foreign oil related income (“FORI”) described in section [907(c)(2)](/cfr/26/907.md?p=c-2) and [(3)](/cfr/26/907.md?p=c-3), other than such income derived from a source within a foreign country in connection with—
    - (i) Oil or gas which was extracted from an oil or gas well located in that foreign country (“extraction exception”), or
    - (ii) Oil, gas, or a primary product of oil or gas which is sold by the controlled foreign corporation or a related person for use or consumption within that country or is loaded in that country on a vessel or aircraft as fuel for the vessel or aircraft (“use or consumption exception”).
  - (2) **Source of income.** The source of foreign base company oil related income is determined generally under the principles of [§§ 1.861-1 to 1.863-5](/cfr/26/1.861-1..1.863-5.md). See [§ 1.863-6](/cfr/26/1.863-6.md). Thus, income from the performance of a service generally is sourced in the country where the service is performed. See [§ 1.861-4](/cfr/26/1.861-4.md). Underwriting income from insuring a foreign oil related activity is sourced at the location of the risk. See [section 861(a)(7)](/cfr/26/861.md?p=a-7) and [§ 1.953-2](/cfr/26/1.953-2.md).
  - (3) **Primary product.** The term “primary product” of oil or gas has the meaning given this term by § [1.907(c)-1(d)(5)](/cfr/26/1.907..1.md) and [(6)](/cfr/26/1.907.md?p=6).
  - (4) **Vessel.** For the definition of the term “vessel”, see [§ 1.954-6(b)(3)(ii)](/cfr/26/1.954-6.md?p=b-3-ii).
  - (5) **Foreign country.** For purposes of this section, the term “foreign country” has the same meaning as in [section 638](/cfr/26/638.md) (relating to continental shelf areas). Thus, for example, oil or gas extracted from a sea area will be deemed to be extracted in the country which has exclusive rights of exploitation of natural resources with respect to that area if the other conditions of [section 638](/cfr/26/638.md) are met.
  - (6) **Country of use or consumption.** For rules for determining the country of use or consumption, see [§ 1.954-3(a)(3)(ii)](/cfr/26/1.954-3.md?p=a-3-ii).
  - (7) **Insurance income.** For purposes of this section, income derived from or attributable to insurance of [section 907(c)(2)](/cfr/26/907.md?p=c-2) activities means taxable income as defined in [section 832(a)](/cfr/26/832.md?p=a) and as modified by the principles of [§ 1.953-4](/cfr/26/1.953-4.md) (other than as the section is applied to life insurance).
  - (8) **Fuel product.** For purposes of this section, the term “fuel product” means oil, gas or a primary product of oil or gas.
  - (9) **Effective date.** The provisions of [section 954(g)](/cfr/26/954.md?p=g) and this section are applicable to taxable years of foreign corporations beginning on or after January 1, 1983, and to taxable years of United States shareholders in which or with which those taxable years of foreign corporations end.
- (b) **Exemption for small oil producers—**
  - (1) **In general.** Foreign base company oil related income does not include any income of a foreign corporation which is not a large oil producer.
  - (2) **Large oil producer.** A corporation is a large oil producer (within the meaning of [section 954(g)(2)](/cfr/26/954.md?p=g-2)) if the average daily production (extraction) of foreign crude oil and natural gas by the related group which includes the corporation and related persons (within the meaning of [section 954(d)(3)](/cfr/26/954.md?p=d-3)) for the taxable year or immediately preceding taxable year is 1,000 or more barrels. The average daily production of foreign crude oil or natural gas for any taxable year (and the conversion of cubic feet of natural gas into barrels) is determined under rules similar to the rules of [section 613A](/cfr/26/613A.md), except that only crude oil or natural gas from a well located outside the United States is taken into account.
- (c) **Special rules for applying the extraction exception of paragraph (a)(1)(i) of this section—**
  - (1) **Refining income described in section 907(c)(2)(A).** With regard to a controlled foreign corporation's refining income from the processing of minerals extracted (by the taxpayer or by any other person) from oil or gas wells into their primary products, as described in [section 907(c)(2)(A)](/cfr/26/907.md?p=c-2-A), a pro rata method will be applied for purposes of determining the part of the refining income that qualifies for the extraction exception of [paragraph (a)(1)(i)](#a-1-i) of this section. The pro rata method will be based on the proportion that the barrels of the fuel product extracted in the country of processing bears to the total barrels of the fuel product processed in that country and will apply regardless of the country of sale of the primary product.
  - (2) **Marketing income described in section 907(c)(2)(C).** With regard to a controlled foreign corporation's marketing income from the distribution or sale of minerals extracted from oil or gas wells or of primary products, as described in [section 907(c)(2)(C)](/cfr/26/907.md?p=c-2-C), a pro rata method will be applied for purposes of determining the part of the marketing income that qualifies for the extraction exception of [paragraph (a)(1)(i)](#a-1-i) of this section. When applying the pro rata method to the sale of a fuel product other than a primary product, the pro rata method will be based on the proportion that the barrels of the fuel product extracted in the country of sale bears to the total barrels of the fuel product sold in that country. When applying the pro rata method to the sale of primary products, the method will be based on the proportion that the barrels of the fuel product extracted in the country of sale bears to the total barrels of the fuel product processed. For purposes of applying the pro rata method, data of the controlled foreign corporation's related group (as defined in [section 954(g)(2)(C)](/cfr/26/954.md?p=g-2-C)) will be taken into account. The pro rata method will not apply, however, if the mineral or primary product is purchased by the controlled foreign corporation from a person not within the controlled foreign corporation's related group. In that situation, the marketing income will be presumed to qualify for the extraction exception if the country of the source of the marketing income is a net exporter of crude oil or gas, whichever is relevant. If the country of the source of the marketing income is not a net exporter of crude oil or gas, whichever is relevant, the marketing income will be presumed not to qualify for the extraction exception. The controlled foreign corporation may, however, rebut this latter presumption by demonstrating on the basis of all the facts and circumstances that its marketing income does qualify for the extraction exception. If a primary product that is acquired from a person within the controlled foreign corporation's related group is commingled with like products acquired from persons not within that related group, the pro rata method based on the proportion that the barrels of the fuel product extracted in the country of sale bears to the total barrels of the fuel product processed will be applied to that portion of the total products sold that was purchased from persons within the related group, to the extent that that person did not sell product purchased from an unrelated person, and either the presumption or facts and circumstances will determine the characterization of the remainder.
  - (3) **Transportation income described in section 907(c)(2)(B).** With regard to a controlled foreign corporation's income from the transportation of minerals from oil and gas wells or of primary products, as described in [section 907(c)(2)(B)](/cfr/26/907.md?p=c-2-B), the rules set forth in [paragraph (c)(2)](#c-2) of this section will apply for purposes of determining the part of the transportation income that qualifies for the extraction exception of [paragraph (a)(1)(i)](#a-1-i) of this section.
  - (4) **Illustrations.** The following examples illustrate the application of this paragraph.