Foreign Base Company Income
Therefore the first type of Foreign Base Company Income, Foreign Base Company Sales Income has as its function to be utilized as a sale or trade conduit offshore corporation in an international corporate structure. Certainly the intra activity sequences have many facets and planning opportunities. Those will be discussed subsequently in a more specific discussion of offshore companies that come within the characterization as a Foreign Base Company Sales Income.
Foreign Base Company Service Income
A second category of Foreign Base Company Income whose activities are subject to Subpart F Income treatment is Foreign Base Company Service Income. This type of Subpart F Income is income derived by a foreign corporation in connection with the performance of technical, managerial, scientific, skilled, industrial, commercial or similar type services. In practicality corporate structures tend to find their utility most beneficial as an administrative or service oriented company in a favorable tax preferred Financial Center.
The service industry provides numerous opportunities to enable a corporate taxpayer to make use of corporate structural planning. The administrative or service company is, for illustrative purposes, established in a Financial Center Offshore as part of a larger corporate structure.
The services provided to other divisions offer opportunity to expropriate high taxed income of an operational situs to the Financial Haven. The mechanics are basically an expense debit for he services being provided to an operational foreign situs and income reflected by the offshore administrative company.
Foreign Base Company Service Income is comprised of two distinguishing elements. The services are performed for or on behalf of a related person and performed outside the country in which the foreign corporation is incorporated.
For purpose of the first element, a related person is an individual, corporation, partnership, trust, or estate which controls or is controlled by the foreign corporation or a person who is a corporation, partnership, trust or estate which is controlled by the same person or persons that control the foreign corporation. The statute is designed to pick up as Subpart F Income, transactions in which a taxpayer receives a substantial financial benefit from a related party.
There are several basic transactional sequences that the statute is meant to police. To some degree each of these transactional arrangement embodies principles of tying arrangements. It is an effort to discourage income being shifted among related parties by the trade off of some remuneration.
Foreign Base Personal Holding Company Income
The third type of Foreign Base Company Income used to illustrate Subpart F Income characterization is Foreign Base Personal Holding Company Income. This type of Subpart F Income is directed to the taxation of offshore passive income.
It is similar conceptually to taxation of domestic personal holding companies. Offshore Personal Holding Companies are used to achieve varying objectives. Utilized in corporate planning structures, the Foreign Based Personal Holding Company can reduce withholding taxation of foreign subsidiaries, mix foreign tax credit to accomplish the most beneficiary use, and provide tax treaty advantages.
Foreign Personal Holding Company Income generally consists of dividends, interest, rents, royalties, certain commodity and future transactions, and foreign currency gains. Two items of Foreign Personal Holding Company Income particularly noteworthy are rental and royalty income of a controlled foreign corporation.
Rent and royalty derived from a related person or in the actual conduct of a trade or business are not necessarily subject to Subpart F Income treatment. They are accorded certain safe harbor provisions that are significant in financial planning of corporate structures.
As an illustration, rents and royalties are not construed as Foreign Personal Holding Company Income when the payor is a corporation that is a related person and the rents and royalties are used for the privilege of using the property. In order to avail oneself of the safe harbor, the privilege of use for which the rent or royalty is paid must occur within the country whose laws incorporated the recipient of payments.
On the other hand rents or royalties derived from the active conduct of a trade or business and which are received from a person other than a related person are not Foreign Personal Holding Company Income. It is a factual question making the determination of whether income is deemed to be from the active conduct of a trade or business.
One other such illustration of the rental income safe harbor is in connection with the performance of marketing functions. Property leased as a result of the performance of marketing functions by a lessor, controlled foreign corporation, shall be considered to be derived in the active conduct of a trade or business. The marketing function must be performed by activity of the controlled foreign corporations’ own officers or staff or employees.
These functions must be performed in a foreign country where it maintains and operates an organization regularly engaged in the business of marketing and servicing leased property. The marketing function must be substantial in relation to the amount of rents derived from the leasing of property.
Lastly of primary importance in activities of Foreign Personal Holding Companies is income derived from commodity transactions. The term commodity embraces tangible personal property that is a type actively traded or alternatively to which contractual interests are actively traded. Commodity transactions include spot contracts or forward contracts with respect to a particular commodity.
It consists of leveraged contracts in a commodity purchased from leveraged transaction merchants, the purchase or sale of an option, other right to acquire or transfer a commodity, and a futures contract in a commodity of an index of commodities. These illustrate the numerous types of commodity transactions that give rise to Foreign Personal Holding Company Income.
In summary, a foreign corporation is not considered engaged in a commodities business if its business is primarily financial. Generally the business of a controlled foreign corporation is financial if it primarily engages in commodities transactions for investment, speculation, or providing products or serves to a customer for investment or speculation.