An effective operational offshore company often used is the leasing company. Leasing has been utilized in the acquisition of assets and there is a split benefit gained through a leasing company. Tax benefits accrue in the way of substantial depreciation deductions reducing taxable income to one party, while the other party may also be entitled to amortization benefits. This is a cross-border effect of the virtues of depreciation. (1)

The leasing company in the United States context is governed by the Foreign Base Company Income category of Foreign Personal Holding Company Income. (See TaxConnections/TaxBlogoshere/September 20, 2013/Foreign Corporations and Subpart F Income-Part III). Foreign Personal Holding Company Income consisting of rental income normally is characterized as of leasing activities. (2) Foreign Personal Holding Company Income, however, does not include income received in the active conduct of a trade or business and from a person other than a related person. Whether rents are received in the conduct of a trade or business is a case-by-case determination. (3)

There are several safe harbors that specifically outline circumstances in which activity will be deemed a trade or business where rent is received by a controlled foreign corporation from leasing. (4) An illustration of the leasing company function safe harbor in offshore planning can be demonstrated with this example. A domestic parent corporation manufactures hotel and resort supplies that it distributes to its newly formed hotel and resorts in Jamaica and Monaco, as well as in other locations. It desires to establish its own corporate entity in an Offshore Financial Center to provide for booking and reservations services. Additionally, a core segment of its operations are to fulfill international orders for shipping merchandise to its foreign customers. This accounts for 90 percent of all orders.

The United States domestic parent establishes a foreign controlled corporation in Curacao Netherlands Antilles. The Netherlands Antilles leasing company acquires a 20-story office building in Curacao Netherlands Antilles. It occupies 3 floors for the purpose of its booking, reservations, international orders, and shipping operations. The Netherlands Antilles leasing company leases the remaining floors of the office building to unrelated third parties. It acts as the leasing manager for the leasing of the other part of the building. In doing so, it employs a substantial staff to perform other management and maintenance functions.

The rents derived from the lease agreements by the Netherlands Antilles leasing company are deemed to be received in the active conduct of a trade or business and therefore not subject to Subpart F Income treatment. (5) Rents received in the active conduct of a trade or business by a lessor, controlled foreign corporation may be excluded as Foreign Personal Holding Company Income with respect to real property. To qualify for this exclusion, the lessor, through its own officers or staff of employees, must regularly perform active and substantial management as well as operational functions while the property is leased. (6)

In considering the ramifications of source of income principles, rental income received from property located in the United States is sourced within the United States. By inference, income from real property not located within the United States is deemed to be income without the United States. The place of geographical situs is the basis for the determination of sourcing rental income. (7) In structuring a Foreign Personal Holding Company as a leasing company, additional analysis of transfer pricing concepts and ownership percentage is appropriate.

Footnotes

***************************

1. See generally, Adrian Ogley, The Principles of International Tax, A Multinational Perspective, International Leasing, P. 103, InterFisc Publishing, 1993, London, United Kingdom.

2. IRC Section 954 (c) (1) (A) (1986).

3. Treas. Reg. Section 1.954 – 2 (b) (6) of the IRC of 1986 and as thereafter amended.

4. Treas. Reg. Section 1.954 – 2 (c) of the IRC of 1986 and as thereafter amended. (c) Excluded rents — (1) Active conduct of a trade or business. Rents will be considered for purposes of paragraph (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 has manufactured or produced, or has acquired and added substantial value to, but only if the lessor 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 if the lessor, through its own officers or staff of employees located in a foreign country, maintains and operates an organization in such country 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.

5. Id. at note 4.

6. Treas. Reg. Section 1.954 – 2 (c) (2) (1) (ii) of the IRC of 1986 and as thereafter amended. Section 1.954 – 2(a) “… 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) of this section…” Section (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 … 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) or (d) of this section are satisfied…” “… (c) Excluded returns – (1) Active conduct of a trade or business. Rents will be considered for purpose 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-…” “…(ii) Real property with respect to which lessor, through its own officers or staff of employees, regularly performs active and substantial management and operational functions while the property is lease;…” “… (iv) Property that is leased as a result of the performance of marketing functions by such lessor is the lessor, through its own officers or staff of employees located in a foreign country, maintains and operates an organization in such country that is regularly engaged in the business of marketing, or or marketing and servicing, the leased property and that is substantial in relation to the amount of rents derived from the leasing of such property…”.

7. Treas. Reg. Section 1.861 – 5 of the IRC of 1986 and as thereafter amended. See also Treas. Reg. Section 1.862-1. Income specifically from sources without the United States. (a) Gross income. (1) The following items of gross income shall be treated as income from sources without the United States: “… (iv) Rentals or royalties from property located without the United States or from any interest in such property, including rentals or royalties for the use of, or for the privilege of using, without the United States, patents, copyrights, secret processes and formulas, goodwill, trademarks, trade brands, franchises, and other like property;…”.

In accordance with Circular 230 Disclosure