The United States

Northwestern Journal of International Law & Business, Dec 1997

This article is a detailed study of the taxation by the United States of foreign base company services income. Foreign base company services in- come is defined generally as the income derived by a controlled foreign corporation from the performance of services for a related person.2 Con- trolled foreign corporations, in turn, generally are the foreign subsidiaries of U.S. parent corporations.3 A controlled foreign corporation's foreign base company services income is taxed to its U.S. parent corporation, subject to various exclusions and qualifications. This article defines the class of sus- pect relationships between the controlled foreign corporation and its related persons and delineates the category of relevant services. The article's con- tributions to the literature on controlled foreign corporations include: the proper coordination of the guaranty-plus rule with the substantial assistance rule;4 a critique of the avoidance of tax through the use of branches and, more generally, of the requirement that a related person figure in a tax ha- ven arrangement before the United States imposes tax;5 a clear analysis of the complex relationship among related-person factoring, foreign personal holding company income, and foreign base company services income;6 and

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The United States

United States' Response to Tax Havens The U nited States' Response to Tax Havens: The Foreign Base Company Ser vices Income of Controlled Foreign Corporations Eric T. Laity 0 1 0 This Article is brought to you for free and open access by Northwestern University School of Law Scholarly Commons. It has been accepted for inclusion in Northwestern Journal of International Law & Business by an authorized administrator of Northwestern University School of Law Scholarly Commons 1 Part of the International Law Commons , Taxation-Transnational Commons, and the Tax Law Follow this and additional works at: http://scholarlycommons.law.northwestern.edu/njilb Recommended Citation - Commons The United States' Response to Tax Havens: The Foreign Base Company Services Income of Controlled Foreign Corporations Eric T. Laity* 18:1 (1997) INTRODUCTION United States multinational corporations save substantial amounts of income tax through the use of foreign base companies organized in tax havens. The United States has responded to the erosion of its tax base through the use of foreign base companies by enacting the Subpart F rules of the Internal Revenue Code (or "Code").' Under those rules, the United States taxes its multinational corporations on much of the income derived by their foreign subsidiaries through base company operations in tax havens. Subpart F is only a limited response; significant amounts of income continue to escape U.S. taxation. This article is a detailed study of the taxation by the United States of foreign base company services income. Foreign base company services income is defined generally as the income derived by a controlled foreign corporation from the performance of services for a related person.2 Controlled foreign corporations, in turn, generally are the foreign subsidiaries of U.S. parent corporations.3 A controlled foreign corporation's foreign base company services income is taxed to its U.S. parent corporation, subject to various exclusions and qualifications. This article defines the class of suspect relationships between the controlled foreign corporation and its related persons and delineates the category of relevant services. The article's contributions to the literature on controlled foreign corporations include: the proper coordination of the guaranty-plus rule with the substantial assistance rule;4 a critique of the avoidance of tax through the use of branches and, more generally, of the requirement that a related person figure in a tax haven arrangement before the United States imposes tax;5 a clear analysis of the complex relationship among related-person factoring, foreign personal holding company income, and foreign base company services income;6 and ' Subpart F in the parlance of international tax lawyers comprises sections 951-964 of the Internal Revenue Code. Section 954(e) defines foreign base company services income, the subject matter of this article. There is very little legislative history for section 954(e). The provision originated in the Senate as an amendment to what was to become the Revenue Act of 1962, Pub. L. No. 87-834, § 12, 76 Stat. 960, 1006 (1962). S. REP. No. 1881, 87th Cong., 2d Sess. (1962), reprintedin 1962-3 C.B. 703, 785. The Senate Report states only that the purpose of the provision is "to deny tax deferral where a service subsidiary is separated from manufacturing or similar activities of a related corporation and organized in another country primarily to obtain a lower rate of tax for the service income." Id. at 790. Code section 954(e) is broader in scope, of course, and reaches a service subsidiary that is separated from a U.S. parent corporation that engages only in services. Examples include corporations engag2eId. Rin.Ce.n§gi9n5ee4r(ien)g(1,)c(oAn)st(r1u9c9t4io).n, or oil field services. All citations in this article to Code section 954 are to that sec3tion as it appears in the current United States Code, which is dated 1994. The statutory definition of a controlled foreign corporation includes more within its sco4pe and can be found in section 957(a) of the Internal Revenue Code. See Parts II.B.2 and II.B.4.d infra ofthis article. 5See Part II.C infra of this article. 6See Part III.A.l.a infraof this article. a critique of the exclusion of services performed within a controlled foreign corporation's country of incorporation.7 The article recommends a number of changes in the Code's definition of foreign base company services income and the supporting administrative law. THE TYPES OF RELATIONSHIPS A controlled foreign corporation derives foreign base company services income by rendering services for the benefit of a related person through any of several relationships. This section first touches upon the relevant definition of a related person, then describes the principal relationships that give rise to foreign base company services income, and concludes by evaluating the requirement that a related person participate in the c (...truncated)


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Eric T. Laity. The United States, Northwestern Journal of International Law & Business, 1997, Volume 18, Issue 1,