Internal Revenue Service
Revenue Ruling

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 Rev. Rul. 69-27

1969-1 C.B. 191

Sec. 861
Sec. 862
Sec. 1441
Sec. 1442

IRS Headnote

Whether income from certain investments by an international finance subsidiary incorporated in the United States and wholly owned by a domestic corporation is treated as United States source income for purposes of section 861(a)(1)(B) of the Code.

Full Text

Rev. Rul. 69-27 /1/

Advice has been requested by an international finance subsidiary incorporated in the United States as to the treatment of income from certain types of investments for purposes of determining, under section 861(a)(1)(B) of the Internal Revenue Code of 1954, whether gross income derived by the corporation from sources within the United States is less than 20 percent of its gross income from all sources.

An international finance subsidiary incorporated in the United States is wholly owned by a domestic corporation. The subsidiary was organized to borrow funds abroad and lend the proceeds of such foreign borrowings to its foreign affiliates. Prior to investing the proceeds of these foreign borrowings in its foreign affiliates, the international finance subsidiary has invested a portion of these proceeds in certain short-term and medium-term debt obligations including deposits in foreign branches of domestic banks and in foreign banks and has derived less than 20 percent of its total gross income from sources within the United States.

The subsidiary now wishes to invest a portion of these proceeds in the United States so as to comply with the Foreign Direct Investment Regulations of the Office of Foreign Direct Investments of the Department of Commerce.

Section 861(a)(1)(B) of the Code provides, in pertinent part, that interest received from a domestic corporation shall not be treated as gross income from sources within the United States when it is shown to the satisfaction of the Secretary or his delegate that less than 20 percent of the gross income from all sources of such corporation has been derived from sources within the United States for the three-year period ending with the close of the taxable year of such corporation preceding the payment of such interest, or for such part of such period as may be applicable.

The problem is whether, as a result of making investments in the United States, the international finance subsidiary will continue to derive less than 20 percent of its total gross income from sources within the United States so that interest payments by the subsidiary to persons holding the subsidiary's debt obligations will not be treated under section 861(a)(1)(B) of the Code as gross income from sources within the United States, and, accordingly, will be exempt from the withholding tax under sections 1441 and 1442 of the Code on such interest payment to nonresident alien individuals, foreign partnerships, and foreign corporations. In this connection, specific advice has been requested whether the income received by the international finance subsidiary from the various types of investments described below would give rise to income from sources without the United States.

Type 1. Deposits in Banks Incorporated in a Possession of the United States or in Puerto Rico. Interest on deposits in a bank incorporated in a possession of the United States or in Puerto Rico (including interest paid on certificates of deposit issued by such bank), if less than 50 percent of the gross income from all sources of the bank for the three-year period ending with the close of its taxable year preceding the payment of such interest (or for such part of such period as the bank was in existence) was effectively connected with the conduct of a trade or business within the United States is considered to be from sources without the United States. However, interest paid or credited after December 31, 1972, by a domestic branch of a bank incorporated in a possession of the United States or in Puerto Rico, if such branch is engaged in the commercial banking business, will be treated as income from sources within the United States. See section 861(a)(1)(C) of the Code.

Type 2. Deposits in Branches of United States Banks Located in United States Possessions and Puerto Rico. Interest on deposits with a branch of a domestic corporation or a domestic partnership (including interest paid on certificates of deposit issued by such a branch), if such branch is located in a possession of the United States or in Puerto Rico and is engaged in the commercial banking business, is considered to be from sources without the United States. See section 861(a)(1)(F) of the Code.

Type 3. Debt Obligations of Certain Domestic Corporations. Interest on debt obligations of a domestic corporation, if less than 20 percent of the gross income from all sources of such corporation has been derived from sources within the United States for the three-year period ending with the close of the taxable year of such corporation preceding the payment of such interest, or for such part of such period as may be applicable, is considered to be from sources without the United States. See section 861(a)(1)(B) of the Code.

Type 4. Stock of Certain Domestic Corporations. Dividends on the stock of a domestic corporation, if such domestic corporation is entitled to the benefits of section 931 of the Code or if less than 20 percent of its gross income from all sources is derived from sources within the United States for the three-year period ending with the close of the taxable year of such corporation preceding the declaration of such dividends (or for such part of such period as the corporation has been in existence), are considered to be from sources without the United States. See section 861(a)(2)(A) of the Code. Since interest on certain governmental obligations, described in section 103 of the Code, is not included in gross income, it shall not be taken into account in determining whether the international finance subsidiary qualifies under the 80-20 test of section 861(a)(1)(B) of the Code.

/1/ Also released as Technical Information Release 1005, dated December 27, 1968.