Rev. Rul. 87-90

1987-2 C.B. 216, 1987-37 I.R.B. 18.

PASSIVE FOREIGN INVESTMENT COMPANY; MANUFACTURING TRADE OR BUSINESS

Published: August 31, 1987

SECTION 1296. -- PASSIVE FOREIGN INVESTMENT COMPANY

  Passive foreign investment company; manufacturing trade or business. A controlled foreign corporation actively engaged in a manufacturing trade or business is a passive foreign investment company when 50 percent or more of the assets it owns directly or indirectly through certain lower-tier corporations produce passive income or are held for production of passive income.

ISSUE

  Is a controlled foreign corporation actively engaged in a manufacturing trade or business a passive foreign investment company under the facts described below?

FACTS

  P, a domestic corporation, owns all of the stock of FS1, a controlled foreign corporation (CFC) within the meaning of section 957 of the Internal Revenue Code. FS1 is organized under the laws of foreign country F and maintains a calendar year annual accounting period for financial and tax purposes. During the period 1978 through 1987 FS1 operated a branch in foreign country G that manufactures and sells product M to unrelated distributors located throughout Europe. FSl's assets, other than stock in FS2, described below, are as follows: (1) property with an average value of 1,000x dollars during 1987 which is located in the country G branch and used to conduct its manufacturing activities; and (2) property producing passive income as defined in section 1296(b) of the Code that during 1987 had an average value of 100x dollars. It is assumed that the sales income derived by the branch is not foreign base company sales income because the branch is engaged in manufacturing within country G. See section 1.959-3(a)(4) of the Income Tax Regulations.

  FS1 owns all the stock of FS2, a CFC organized under the laws of foreign country H. Throughout the period 1978 to 1987, FS1 contributed most of its manufacturing profits to FS2 for investment by FS2. During 1987, FS2 owned assets that had an average value of 1.000x dollars and produced only passive income within the meaning of section 1296(b) of the Code. None of FS2's assets is an ownership interest in a subsidiary corporation the value of which equals or exceeds 25 percent of the total value of all outstanding stock in the subsidiary corporation. All of FS2's income is subpart F income within the meaning of section 952.

LAW AND ANALYSIS

  Any United States person who is a shareholder of a passive foreign investment company is potentially taxable under section 1291 of the Code on receipt of a distribution paid by the passive foreign investment company or upon disposition of the stock in the passive foreign investment company. Section 1291 imposes tax which includes an interest charge based on the value of tax deferral on income realized from a passive foreign investment company. Section 1293, however, provides that each United States person who is a shareholder of a passive foreign investment company that makes the election under section 1295 to be a qualified electing fund is taxed currently on his pro rata share of the income of the passive foreign investment company. If a passive foreign investment company that has made the election under section 1295 also is a controlled foreign corporation within the meaning of section 957, section 951(f) provides that an amount that otherwise would be included in the gross income of a United States shareholder (as defined in section 951(b) under both section 951(a)(1)(A)(1) and section 1293 will only be included in income under section 951(a)(1)(A). Section 1291(d)(1) provides that the section 1291 tax shall not apply to distributions from a qualified electing fund, or to dispositions of stock in a passive foreign investment company that has been a qualified electing fund for each of its taxable years beginning after 1986 that include any portion of the taxpayer's holding period.

  Section 1296(a) defines a passive foreign investment company as any foreign corporation if either 75 percent or more of its gross income for the taxable year is passive income as defined in section 1296(b), or 50 percent or more of the average value of its assets during the tax year produce passive income or are held for the production of passive income. Section 1296(c) provides that, for purposes of determining whether a foreign corporation is a passive foreign investment company, a foreign corporation will be treated as owning its proportionate share of the assets and receiving its proportionate share of the income of any subsidiary in which it owns at least 25 percent of the stock (determined by value).

  Under section 1296(c), for purposes of determining whether FS1 is a passive foreign investment company, FS1 is treated as owning all of the assets of FS2. Accordingly, FS1 is treated as owning 1,100x dollars in assets that produce passive income (1,000x dollars from FS2 and 100x dollars from FS1), and 1,000x dollars in assets used in manufacturing product M. FS1 is a passive foreign investment company because at least 50 percent of the average value of its assets during 1987 produce passive income. FS2 also is a passive foreign investment company because all of its assets produce passive income.

  If in 1987 FS1 and FS2 elect under section 1295 of the Code to be qualified electing funds, P will be taxable under section 951(a)(1)(A) with respect to FS1's subpart F income, if any, and all of FS2's income, and under section 1293 with respect to FS1's nonsubpart F income.

HOLDING

  A controlled foreign corporation that engages in manufacturing is a passive foreign investment company when 50 percent or more of the assets it owns directly or indirectly through certain lower-tier corporations produce passive income or are held for the production of passive income.

Rev. Rul. 87-90, 1987-2 C.B. 216, 1987-37 I.R.B. 18