LB&I International Practice Service
Concept Unit
IPS Level Number Title UIL Code Number
Shelf N/A Business Outbound – –
Volume 2 Deferral Planning Level 1 UIL 9412
Part 2.3 Foreign Personal Holding Company Income Level 2 UIL 9412.03
Chapter N/A N/A Level 3 UIL
Sub-Chapter N/A N/A
Unit Name Concepts of Foreign Personal Holding Company Income
Document Control Number (DCN) DPL/CU/P_2.3_13(2016)
Date of Last Update 02/29/2016
Note: This document is not an official pronouncement of law, and cannot be used, cited or relied upon as such. Further, this document may not contain a
comprehensive discussion of all pertinent issues or law or the IRS's interpretation of current law.
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DRAFT
General Overview
Concepts of Foreign Personal Holding Company Income (FPHCI)
A U.S. shareholder of a foreign corporation generally is not subject to tax on the income of the corporation until the shareholder
receives a distribution from the corporation. However, under subpart F, certain types of income earned by a controlled foreign
corporation (CFC) are currently included in the income of the CFC's U.S. shareholders even if the CFC does not distribute the income
to its shareholders in that year.
One such type of income is Foreign Personal Holding Company Income (FPHCI), which generally includes income of a CFC such as
dividends, interest, royalties, rents, annuities, and net gains on dispositions of property producing any of the foregoing types of
income* unless an exception or exclusion from FPHCI (discussed later in this unit) applies. When Congress enacted subpart F, it
recognized the need to maintain active American business operations abroad on equal competitive footing with other operating
businesses in the countries where the American-controlled businesses were operating. However, where a CFC has portfolio t ypes of
investments, or where the CFC is merely passively receiving investment income, there is no competitive justification to defer the tax
until the income is repatriated. As such, the provisions of subpart F require a U.S. shareholder to include its pro-rata share of the
CFC’s FPHCI in income currently.
*FPHCI also includes net gains from certain commodities transactions, net foreign currency gains, income equivalent to interest,
income from notional principal contracts, payments in lieu of dividends, and income from certain personal service contracts, all of
which are beyond the scope of this unit.
NOTE: FPHCI of a CFC results in a current income inclusion for the U.S. shareholder(s) under IRC 951 (“subpart F inclusion”). That
is, the CFC has FPHCI (a type of subpart F income), and as a result, the U.S. shareholder has a subpart F inclusion. However,
income of the U.S. shareholder(s) itself is not FPHCI, even if received from the CFC. For example, if a CFC received royalties, the
CFC may have FPHCI, and the U.S. shareholder(s) may have a subpart F inclusion, but if the U.S. shareholder(s) itself receives
royalties from the CFC, the U.S. shareholder(s) has royalty income, not FPHCI or a subpart F inclusion.
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DRAFT
!
General Overview (cont’d)
Concepts of FPHCI
Common Exceptions/Exclusions:
Same country exception – certain income received from a related CFC incorporated in the same country that uses a substantial part
of its assets in a trade or business in that country is not FPHCI. IRC 954(c)(3).
Look-thru rule – certain income received from a related CFC and allocable or attributable to income that is neither subpart F nor
effectively connected income (ECI) is not FPHCI. IRC 954(c)(6).
Active financing exception – qualified income derived by a CFC that is predominantly engaged in the active conduct of a banking,
financing, or similar business is not FPHCI. IRC 954(h).
Active leasing/licensing exception – certain rents/royalties received from unrelated parties by a CFC in the active conduct of a trade
of business are not FPHCI. IRC 954(c)(2), Treas. Reg. 1.954-2(b)(6), 1.954-2(c), and 1.954 -2(d).
Insurance income exclusion – certain investment income received from unrelated parties by a CFC in a qualified insurance business
is not FPHCI. IRC 954(i).
CAUTION: These exceptions/exclusions to FPHCI involve a variety of complex requirements and are summarized very
briefly here for information purposes only. Other exceptions may apply and are beyond the scope of this unit. For a more
comprehensive discussion, review the references cited above and related IPS Practice Units.
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DRAFT
Relevant Key Factors
Concepts of FPHCI
Key Factors
As discussed in the General Overview, FPHCI includes dividends, interest, royalties, rents, and a variety of other income items, and
the rules for FPHCI provide for several different exceptions, which are covered in more detail in separate IPS Practice Units. In order
to determine whether to apply the FPHCI rules and corresponding exceptions, generally the following key factors must be addressed
with respect to the CFC:
1. The character of the income (i.e., dividends, interest, royalties, rents, etc.).
2. The relationship, if any, between the recipient of the income and the payor of the income (IRC 954(d)(3)).
These factors can be determined by performing a functional analysis and reviewing relevant contracts.
CONSULTATION: Note that transactions between related parties may implicate not only IRC 954 but also IRC 482
because FPHCI and transfer pricing are not mutually exclusive. The examiner should consult with the Transfer Pricing
Practice or Income Shifting IPN regarding any potential transfer pricing issues.
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DRAFT
Detailed Explanation of the Concept
Concepts of FPHCI
FPHCI includes dividends, interest, royalties, rents, annuities, net gains from certain property transactions, net gains from certain
commodities transactions, net foreign currency gains, interest equivalents, income from notional principal contracts, payments in lieu
of dividends, and income from certain personal service contracts.
Analysis Resources
1. The character of the income (i.e., dividends, interest, royalties, rents, etc.).
Before considering whether the FPHCI rules apply to a given fact pattern, the examiner must
determine the proper character of the income derived by the CFC. The examiner should
review relevant contracts/transaction agreements, as well as the activities and conduct of the
parties to the transaction. Income will be characterized based on the substance of the
transaction(s) without regard to the designation given to the income by the parties involved.
For example, a review of the facts and circumstances surrounding a purported rental
agreement may reveal that the substance of the arrangement is, in fact, a sales transaction.
In this case, the FPHCI rules would not apply, but the examiner should consider whether the
Foreign Base Company Sales Income (FBCSI) rules may apply.
CONSULTATION: If the character of the income derived in the transaction(s) is
uncertain, the examiner should consult with the FTC Mgt. IPN or relevant IPG for
assistance and, if necessary, with counsel (e.g. reviewing contracts/agreements).
Treas. Reg. 1.954-1(e)(1).
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DRAFT
Detailed Explanation of the Concept (cont’d)
Concepts of FPHCI
The FPHCI rules provide for several exceptions, many of which are contingent upon whether or not the payor of the income i s a
related person with respect to the recipient of such income.
Analysis Resources
2. The relationship, if any, between the recipient of the income and the payor of the income.
It is important to determine the relationship, if any, between the CFC deriving the income and
the party that is paying the income as there are certain exceptions from FPHCI for items of
income that a CFC receives from a related payor and other exceptions for items of income a
CFC receives from unrelated payors.
A related person is an individual who controls the CFC or a corporation, partnership, trust or
estate that controls or is controlled by the CFC (or the same person(s) that control the CFC).
Control means direct or indirect ownership of: (1) in the case of corporations, stock having
more than 50% of the total voting power of all classes of stock entitled to vote or of the total
value of stock of the corporation; and (2) in the case of a partnership, trust, or estate, more
than 50% (by value) of the capital or profits in the partnership or more than 50% (by value) of
the beneficial interest in the trust or estate. For example, a CFC and its USP are related
parties.
IRC 954(d)(3)
Treas. Reg. 1.954-1(f).
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DRAFT
Examples of the Concept
Concepts of FPHCI
Examples
CFC 1, incorporated under the laws of foreign Country A, is a
wholly-owned subsidiary of domestic corporation USP.
CFC1 manufactures widgets which it sells to unrelated parties.
It is not a bank or financing business, and it deposits its excess
cash into an unrelated bank in Country B. It receives interest
in excess of $1 million on its deposits. The interest income
makes up 40% of CFC1’s income for the taxable year.
The interest income received from the bank is FPHCI. CFC1
is not eligible for the active financing exception as it is not
actively engaged in the conduct of a banking, financing, or
similar business. IRC 954(c)(1)(A).
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DRAFT
USP
CFC2
Country C
Rent
Unrelated
Foreign Corp
Country D
Examples of the Concept
Examples
Concepts of FPHCI
CFC 2, incorporated under the laws of foreign Country C, is a
wholly-owned subsidiary of domestic corporation USP.
CFC2 purchases a building that it holds for investment. It
receives rental income from an unrelated Country D foreign
corporation.
The rental income earned by CFC2 is FPHCI because the
income does not qualify for the active leasing exception when
CFC2 holds the building for investment purposes.
Treas. Reg. 1.954-2(b)(6).
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DRAFT
Examples of the Concept
Concepts of FPHCI
Examples
CFC3 is incorporated under the laws of foreign Country E.
CFC4 is also incorporated under the laws of foreign Country E,
where it uses a substantial part of its assets in a trade or
business. CFC3 owns (and has always owned) 100% of
CFC4’s stock, so the CFCs are related persons. IRC
954(d)(3).
CFC4 paid a dividend to CFC3. The dividend did not reduce
any potential subpart F income or Effectively Connected
Income (ECI) of CFC4.
The same country exception (IRC 954(c)(3)) applies to the
dividend (and the look-thru rule under IRC 954(c)(6), if in
effect, would also apply), so CFC3’s dividend income is not
FPHCI.
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DRAFT
Examples of the Concept
Concepts of FPHCI
Examples
CFC5, through its own staff of employees, owns and operates
a research facility in Country G. CFC5’s employees are
regularly engaged in Country G in technical activities that
result in the issuance of patents which CFC5 licenses.
CFC5 received royalties from an unrelated customer for the
privilege of using patented rights that CFC5 developed as a
result of its employees’ research activity.
Since the royalties were derived in the active conduct of a
trade or business under IRC 954(c)(2)(A), CFC5’s royalty
income qualifies for the active licensing exception and is not
FPHCI.
Treas. Reg. 1.954-2(d)(3) Ex. 1.
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DRAFT
Training and Additional Resources
Concepts of FPHCI
Type of Resource Description(s) and/or Instructions for Accessing References
CENTRA sessions Training - FY 2011 CPE "Live" Recordings
CLE Centra – Subpart F 20130930
2010 Centra – Subpart F update
Discussion of FPHCI is
included in the resources at
left.
IRC Section 954(c)(6) Look-Thru Rules February 2014
(LRQ368149)
White Papers / Guidance Westlaw subscription Bittker & Lokken 69.4
TMFEDPORT No. 6220-1
st
,
CFCs - Foreign Personal
Holding Company Income
FAA20132702F
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DRAFT
Glossary of Terms and Acronyms
Term/Acronym Definition
CFC Controlled Foreign Corporation
ECI Effectively Connected Income
FBCSI Foreign Base Company Sales Income
FBCSvcI Foreign Base Company Services Income
FPHCI Foreign Personal Holding Company Income
IPG Issue Practice Group
IPN International Practice Network
QBU Qualified Business Unit
QBFI Qualified Banking or Financing Income
USP United States Parent
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DRAFT
Index of Related Issues
Issue Associated UIL(s) References
Sales or leases of tangible
property/goods
9411.05, 9422.07 Various units available
Subpart F Overview 9412, 9433.01 Subpart F Overview, DPL/CU/V_2_01(2013);
Overview of Subpart F Income for U.S. Individual
Shareholders, FEN/9433.01_09(2013)
Active financing exception
to FPHCI
9412.03 Interest Income Derived by CFC or QBU
Engaged in Banking, Financing, or Similar
Business, DPL/9412.03_02(2013)
Look-thru rule and same
country exception to FPHCI
9412.03 Receipt of Dividends or Interest from a Related
CFC, DPL/9412.03_04(2015)
Foreign Base Company
Income
9412.05 Computing Foreign Base Company Income,
DPL/9412.05_05(2013)
Functional Analysis 9412.06 Conducting Functional Analysis for Foreign Base
Company Income (FBCI),
DPL/9412.06_12(2015)
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