Daily Tax Update - June 7, 2012: Treasury, IRS Issue Temporary and Final Regulations under Section 7874 Addressing Substantial Business Activities Test and Surrogate Foreign Corporation Rules

TREASURY, IRS ISSUE TEMPORARY AND FINAL REGULATIONS UNDER SECTION 7874 ADDRESSING SUBSTANTIAL BUSINESS ACTIVITIES TEST AND SURROGATE FOREIGN CORPORATION RULES:  Today, Treasury and the IRS issued temporary regulations (Treas. Reg. § 1.7874-3T, T.D. 9592) regarding when the expanded affiliated group of a foreign corporation is considered to have substantial business activities in its country of organization for purposes of applying section 7874.  Treasury and the IRS also issued final regulations (Treas. Reg. § 1.7874-2, T.D. 9591) under section 7874 addressing when a corporation is treated as a surrogate foreign corporation. 

  • Substantial Business Activities Test.  Prior temporary regulations issued in 2006 provided both a facts and circumstances test and a safe harbor, which was generally satisfied if at least ten percent of the employees, assets, and sales of the expanded affiliated group were in the relevant foreign country.  Temporary regulations issued in 2009 removed the safe harbor, leaving a facts and circumstances test.
    • The temporary regulations issued today replace the facts and circumstances test and provide that an expanded affiliated group will have substantial business activities in the relevant foreign country only if at least 25 percent of the group employees, group assets, and group income are located or derived in the relevant foreign country.  The regulations also provide rules for calculating employees, assets, and income.
    • The preamble to the temporary regulations states that the IRS and Treasury are considering to what extent partners of a partnership should be treated as if they were employees solely for purposes of the two tests based on group employees and specifically requests comments on these issues.
    • The temporary regulations apply to acquisitions completed on or after June 7, 2012.  Acquisitions completed after June 7 but described in an SEC filing before that date, or that were subject to a written agreement binding on June 7 and all times thereafter, may elect to apply the temporary regulations or the prior facts and circumstances test.
  • Surrogate Foreign Corporation.  The final regulations address, among other issues, the treatment of options in determining whether a foreign corporation is treated as a surrogate foreign corporation. 
    • The final regulations apply to acquisitions completed on or after June 7, 2012.
  • The regulations can be accessed via:
  • For additional information, contact Philip R. West - pwest@steptoe.com or Amanda Pedvin Varma - avarma@steptoe.com

FIFTH CIRCUIT HOLDS THAT UK WINDFALL TAX IS CREDITABLE, CREATING CIRCUIT SPLIT:  On June 5, the Fifth Circuit Court of Appeals in Entergy Corp. v. Commissioner 10-60988  held that the UK windfall profits tax is a creditable income tax under section 901.  The Fifth Circuit concluded that the actual effect of the foreign tax, including its history and practical operation, should be considered in evaluating its predominant character.  The Third Circuit held in December 2011 that the tax was not imposed on the basis of gross receipts and thus is not a creditable tax. 

OECD RELEASES DOCUMENTS ON TRANSFER PRICING:  The OECD has issued a discussion paper on draft guidance on revisions related to safe harbor and transfer pricing simplification.  Further description and analysis will appear in a later edition of the Daily Tax Update.

WHITE HOUSE REITERATES OPPOSITION TO EXTENDING BUSH TAX CUTS FOR WEALTHY:  White House Press Secretary Jay Carney said that President Obama does not support extending the Bush tax cuts for the wealthy.  Carney said, "President Obama has been clear about his position and it has not changed:  We should not extend and he will not extend the Bush-era tax cuts for the wealthiest 2 percent of the American people."  Earlier this week, former President Clinton suggested that he favored a temporary extension of the 2001 and 2003 cuts.  Clinton’s office issued a statement later clarifying the former President’s remarks.  The statement said, "On extending the Bush tax cuts, as President Clinton has said many times before, he supported extending all of the cuts in 2010 as part of the budget agreement, but does not believe the tax cuts for the wealthiest Americans should be extended again.  In the interview, he simply said that he doubted that a long-term agreement on spending cuts and revenues would be reached until after the election."

  • Congressional Republicans remain opposed to raising taxes.  Today, House Speaker John Boehner said, "One of the biggest challenges that small businesses are facing is that they have no idea what the tax rates are going to be next year.  As a matter of fact, they’re looking at a giant tax increase come January 1."
  • Today, House Minority Leader Nancy Pelosi said, "The Bush tax cuts for the high end [earners] just increase the deficit, do not create jobs and they should come to an end.  I urge the Speaker [Boehner] to pass the middle-income tax cuts [alone], freeing us from that stranglehold that the high-end tax cuts have had on our economy." 


Notice 2012-43 provides guidance as to the corporate bond weighted average interest rate and the permissible range of interest rates specified under § 412(b)(5)(B)(ii)(II) of the Internal Revenue Code as in effect for plan years beginning before 2008.  It also provides guidance on the corporate bond monthly yield curve (and the corresponding spot segment rates), and the 24-month average segment rates under § 430(h)(2).  In addition, this notice provides guidance as to the interest rate on 30-year Treasury securities under § 417(e)(3)(A)(ii)(II) as in effect for plan years beginning before 2008, the 30-year Treasury weighted average rate under § 431(c)(6)(E)(ii)(I), and the minimum present value segment rates under § 417(e)(3)(D) as in effect for plan years beginning after 2007.


1. [112th] H.R.5903 : To amend the Internal Revenue Code of 1986 to treat recipients of the Korea Defense Service Medal as war veterans for purposes of determining whether contributions to posts and organizations of war veterans are charitable contributions.
Sponsor: Rep Johnson, Sam [TX-3] (introduced 6/6/2012)      Cosponsors (None)
Committees: House Ways and Means
Latest Major Action: 6/6/2012 Referred to House committee. Status: Referred to the House Committee on Ways and Means.

2. [112th] H.RES.679 : Providing for consideration of the bill (H.R. 436) to amend the Internal Revenue Code of 1986 to repeal the excise tax on medical devices, and providing for consideration of the bill (H.R. 5882) making appropriations for the Legislative Branch for the fiscal year ending September 30, 2013, and for other purposes.
Sponsor: Rep Scott, Tim [SC-1] (introduced 6/6/2012)      Cosponsors (None)
Committees: House Rules
House Reports: 12à-518
Latest Major Action: 6/6/2012 Placed on the House Calendar, Calendar No. 136.

3. [112th] S.3267 : A bill to amend the Internal Revenue Code of 1986 to extend and modify the American Opportunity Tax Credit, and for other purposes.
Sponsor: Sen Schumer, Charles E. [NY] (introduced 6/6/2012)      Cosponsors (2)
Committees: Senate Finance
Latest Major Action: 6/6/2012 Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing, or recommending to another party any plan or arrangement addressed herein.

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