Rev. Rul. 84-20

1984-1 C.B. 180, 1984-6 I.R.B. 7.

                       Internal Revenue Service
                                 Revenue Ruling

      PUERTO RICAN GOVERNMENT BONDS;  INTEREST EXCLUDED FROM GROSS INCOME;
                      CORPORATION ORGANIZED IN PUERTO RICO

                          Published: February 6, 1984

SECTION 957. - -CONTROLLED FOREIGN CORPORATIONS; UNITED STATES PERSON, 26 CFR 1.957-3: Corporations organized in United States possessions

(Also Section 103; 1.103-1.)

  Puerto Rican government bonds;  interest excluded from gross income;  corporation organized in Puerto Rico.  The term "gross income" as used in section 957(c) of the Code does not include interest received by a corporation organized under the laws of the Commonwealth of Puerto Rico from investments in bonds issued by the Commonwealth, that is excluded from gross income under section 103(a)(1) of the Code.

ISSUE

  Whether interest received by a corporation organized under the laws of the Commonwealth of Puerto Rico from investments in bonds issued by the Commonwealth of Puerto Rico, which is excluded from gross income under section 103(a)(1) of the Internal Revenue Code, is also excluded from gross income for purposes of computing the gross income tests described in sections 957(c)(1) and 957(c)(2).

FACTS

  FX is a corporation organized under the laws of the Commonwealth of Puerto Rico.  All of the outstanding stock of FX is held by A, a United States citizen.  FX is engaged in the manufacture of goods in the Commonwealth of Puerto Rico.  In addition, FX receives interest from investments in bonds issued by the Commonwealth of Puerto Rico which satisfy the conditions of section 103 of the Code and the interest on which is excluded from gross income under section 103(a)(1).

LAW AND ANALYSIS

  Section 957(a) of the Code provides that for purposes of subpart F, Part III, Subchapter N, chapter 1 of the Code, the term "controlled foreign corporation" means any foreign corporation of which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned (within the meaning of section 958(a)), or is considered as owned by applying the rules of ownership of section 958(b), by United States shareholders on any day during the taxable year of such foreign corporation.

  Section 957(c) of the Code provides that for purposes of this subpart F of the Code, the term "controlled foreign corporation" does not include any corporation created or organized in the Commonwealth of Puerto Rico or a possession of the United States or under the laws of the Commonwealth of Puerto Rico or a possession of the United States if--

    (1) 80 percent or more of the gross income of such corporation for the 3- year period immediately preceding the close of the taxable year (or for such part of such period immediately preceding the close of such taxable year as may be applicable) was derived from sources within the Commonwealth of Puerto Rico or a possession of the United States;  and

    (2) 50 percent or more of the gross income of such corporation for such period, or for such part thereof, was derived from the active conduct within the Commonwealth of Puerto Rico or a possession of the United States of any trades or businesses constituting the manufacture or processing of goods, wares, merchandise, or other tangible personal property;  the processing of agricultural or horticultural products or commodities (including but not limited to livestock, poultry, or fur-bearing animals);  the catching or taking of any kind of fish or the mining or extraction of natural resources, or any manufacturing or processing of any products or commodities obtained from such activities;  or the ownership or operation of hotels.

  Section 103(a)(1) of the Code provides that gross income does not include interest on the obligations of a possession of the United States.

  Section 7701(c) of the Code provides that, when not otherwise distinctly expressed or manifestly incompatible with the intent thereof, references in the Code to possessions of the United States shall be treated as also referring to the Commonwealth of Puerto Rico.

  Since section 103(a)(1) of the Code excludes from gross income interest received on obligations of possessions of the United States and the Commonwealth of Puerto Rico is considered a possession for purposes of this exclusion, the term "gross income" as used in section 957(c) does not include interest received on obligations of the Commonwealth of Puerto Rico.  See Rev. Rul. 57-435,

1957-2 C.B. 462, which provides that for purposes of the gross income percentage tests in former section 921, dealing with whether a corporation qualifies as a Western Hemisphere Trade Corporation, gross income does not include section 103(a)(1) interest on the obligations of a possession.

HOLDING

  The interest received by FX from the bonds issued by the Commonwealth of Puerto Rico, which is excluded from gross income under section 103(a)(1) of the Code, is also excluded from gross income for purposes of computing the gross income tests described in sections 957(c)(1) and 957(c)(2).

Rev. Rul. 84-20, 1984-1 C.B. 180, 1984-6 I.R.B. 7.