Rev. Rul. 87-15

1987-1 C.B. 248, 1987-6 I.R.B. 15

SUBPART F INCOME; SHIPPING

Published: February 9, 1987

Section 952.-Subpart F Income Defined, 26 CFR 1.952-1: Subpart F income defined.

(Also Section 883, 1.883-1.)

  Subpart F income; shipping. A controlled foreign corporation's U.S. source shipping income is not excluded from subpart F income if it is not included in gross income under section 883 of the Code.

ISSUE

  Whether, under the circumstances described below, a controlled foreign corporation's United States source shipping income is excluded from subpart F income pursuant to section 952(b) of the Internal Revenue Code.

FACTS

  P, a domestic corporation, owns all of the outstanding stock of FS, a country X corporation. FS is a controlled foreign corporation (CFC) within the meaning of section 957(a) of the Code.

  FS, a calendar year taxpayer, owns and operates a ship in international traffic. The United States does not have an income tax treaty with country X. FS has transportation income all of which is received as a result of shipping cargo on a regularly scheduled basis between a United States port and a port in country X. FS has offices in the United States, country X and other countries, from which it conducts its shipping business. A portion of FS's income earned after December 31, 1986, is effectively connected with a United States trade or business within the meaning of sections 864 and 887(b)(3) of the Code. Such income, however, is exempt from United States tax under the reciprocal shipping exemption of section 883(a)(1) of the Code.

LAW AND ANALYSIS

  Effective for taxable years beginning after December 31, 1986, section 883(a)(1) provides that gross income derived by a corporation organized in a foreign country which grants an equivalent exemption to United States citizens and corporations shall not be included in gross income of such foreign corporation as determined under section 882 and shall be exempt from United States income taxation. Section 883(c)(1), which limits the availability of the exemption in certain situations, does not apply to any foreign corporation which is a CFC.

  Section 952(a) of the Code defines the term subpart F income. Under section 952(a)(2), subpart F income includes 'foreign base company income,' as determined under section 954. Under section 954(a)(4), foreign base company income includes 'foreign base company shipping income' as defined in section 954(f). All of FS's income comes within the definition of foreign base company shipping income under section 954(f) because all of its income is derived from or in connection with the use of a vessel in foreign commerce.

  The shipping exemption provided in section 883(a) of the Code is for purposes of determining the gross income of foreign corporations subject to direct taxation under section 882 and does not preclude inclusion of FS's shipping income as subpart F income. For purposes of determining subpart F gross income, section 1.952-2(c)(1) of the regulations provides that, except where otherwise distinctly expressed, the provisions of subchapters F, G, H, L, M, N, S, and T of Chapter 1 of the Code shall not apply in the determination of gross income. Section 883 is included in subchapter N of the Code and, therefore, the shipping exemption does not apply for purposes of calculating subpart F income.

  In Rev. Rul. 72-527, 1972-2 C.B. 456, a CFC realized interest income excludable from gross income under section 103(a) of the Code. The revenue ruling holds that such interest will not be included in subpart F income. The section 103(a) exemption for interest income is provided under subchapter B of Chapter 1 of the Code which, in contrast to subchapter N, is not a subchapter enumerated in section 1.952-2(c)(1).

  Section 952(b) of the Code excludes from subpart F income any item of income from sources within the United States which is effectively connected with the conduct by the CFC of a trade or business within the United States unless such item is exempt from taxation (or is subject to a reduced rate of tax) pursuant to a treaty obligation of the United States. Since FS's income is exempt from United States taxation under section 883(a)(1) rather than pursuant to a treaty, the language of the section 952(b) exception for income exempt by treaty does not apply.

  Section 952(b) of the Code was originally enacted as part of the Revenue Act of 1962, Pub. L. No. 87-834, 1962-3 C.B. 111, 153. Before its subsequent amendment by section 104(j) of Pub. L. No. 89-809, 1966-2 C.B. 656, 678, the statute read as follows:

  (b) Exclusion of United States Income-Subpart F income does not include any item includible in gross income under this chapter (other than this subpart) as income derived from sources within the United States of a foreign corporation engaged in trade or business in the United States.

  Under former section 952(b), FS's United States source income clearly would not be excluded from subpart F income, since this income is not includible in FS's gross income for United States income tax purposes. In modifying section 952(b) in 1966, Congress intended only to clarify that income exempt from tax (or subject to a reduced rate of tax) by treaty is not to be considered includible in gross income and thereby excluded from subpart F income under section 952(b) and to make section 952(b) consistent with the general elimination of the force of attraction principle in the Code. S. Rep. No. 1707, 89th Cong., 2d Sess. 9 (1966), 1966-2 C.B. 1059, states:

  In determining 'subpart F income,' there is excluded income of a foreign corporation from U.S. sources which already is taxed by the United States because the corporation is engaged in trade or business in the United States. Present law is interpreted in the income tax regulations as not excluding from 'subpart F' income, income exempt from U.S. tax, or subject to a reduced rate of tax, in accordance with a treaty. The bill modifies existing law to conform this provision with the effectively connected concept and to clarify the language of existing law with respect to income affected by treaties.

  The modification of section 952(b) was not intended to exclude from subpart F income gross income that would be subject to United States tax as effectively connected income but for a statutory exemption.

HOLDING

  The exception in section 952(b) of the Code does not apply to FS's United States source shipping income earned in taxable years beginning after December 31, 1986, that is exempt from gross income under section 883(a)(1). Accordingly, that income is not excluded from subpart F income pursuant to section 952(b).

  The holding in this revenue ruling also applies to income earned in taxable years beginning on or before December 31, 1986. Therefore, the exception in section 952(b) of the Code does not apply to any United States source shipping income that is exempt from United States income tax under section 883(a)(1) of the Internal Revenue Code of 1954.

Rev. Rul. 87-15, 1987-1 C.B. 248, 1987-6 I.R.B. 15