AGGREGATE PARTNERSHIP THEORY IS APPLIED TO DETERMINE CFC'S OWNERSHIP OF U.S. PROPERTY.

Rev. Rul. 90-112

ISSUE

Does a controlled foreign corporation hold "United States property" within the meaning of section 956 of the Internal Revenue Code when it is a partner in a partnership that owns real property located in the United States?

FACTS

S, a wholly owned Country X subsidiary of P, a domestic corporation, is a controlled foreign corporation (CFC) as defined in section 957 of the Code. S reports its income on a calendar year basis. S is not engaged in any United States business activity and does not earn any income that is effectively connected with a United States trade or business. PRS, an entity classified as a partnership for United States federal tax purposes, is organized under the laws of Country X. S owns a 25 percent interest in the capital and profits of PRS, which it purchased in 1987. The remaining 75 per cent interest in PRS is owned by an unrelated Country X corporation. In 1988, PRS purchased undeveloped land in the United States. The land is not subject to any mortgages or other liabilities.

LAW AND ANALYSIS

Under section 956(a) of the Code, the amount of earnings of a CFC invested in United States property at the close of any taxable year is the aggregate amount of such property held, directly or indirectly, by the CFC at the close of the taxable year, to the extent that such amount would have constituted a dividend if it had been distributed. Under section 956(b)(1), "United States property" is defined as any tangible property located in the United States. "Tangible property" includes undeveloped land. See section 1.956- 2(a)(l)(i) of the Income Tax Regulations.

Section 956 of the Code and the regulations thereunder, do not specifically address the treatment of a CFC's investment in United States property through a partnership. Whether a CFC partner is treated as holding, on the last day of its taxable year, a portion of the United States property owned by the partnership depends upon whether the partnership is viewed as an "entity" separate from its partners or as an "aggregate" of its partners for purposes of section 956. There is no exclusive rule as to when a partnership will be treated as an entity or as as aggregate for purposes outside of subchapter K. The resolution depends upon which approach is more appropriate to the specific Code section involved. See, e.g., Rev. Rul. 89-72, 1989-1 C.B. 257, (a CFC's distributive share of income from a non-controlled partnership is treated as foreign base company sales income, if it would have been treated as such had it been realized directly by the CFC). See also Rev. Rul. 89-85, 1989-2 C.B. 218, and the authorities cited therein.

For purposes of section 956 of the Code, a CFC is considered to hold United States property if it holds the property directly or indirectly. See section 956(a)(1). This rule is a specific application of the general principle that section 956 is concerned with the substance of a transaction and not merely its form. See Rev. Rul. 89-73, 1989-1 C.B. 258. The House Report on the Revenue Act of 1962, which adopted section 956, stated that an objective of that section was "to prevent the repatriation of income to the United States in a manner which does not subject it to U.S. taxation." H.R. Rep. No. 1447, 87th Cong., 2d Sess. (1962), at 58, 1962-3 C.B. 405, 462. While taxpayers with excess foreign tax credits may desire to trigger a section 956 inclusion, it is still appropriate to construe section 956 in a manner consistent with this statement under these facts.

The purpose of section 956 of the Code would be frustrated if it were construed not to reach the United States property held by a CFC through a partnership. Thus, in the context of section 956, it is appropriate to apply the aggregate view of a partnership so that the United States property of the CFC includes United States property held by the CFC through a partnership. This result applies section 956 according to the substance of the arrangement, without regard to whether the form of the ownership is direct or indirect.

Therefore, for purposes of section 956 of the Code, S is considered to hold on the last day of its 1988 taxable year, a 25 percent interest in the undeveloped land that is owned by PRS on such date. The amount taken into account, for purposes of section 956, with respect to S's 25 percent interest in the undeveloped land will be 25 percent of PRS's adjusted basis in the land, limited by S's total basis in PRS. Section 1.956-1(e)(1) of the regulations. The result would be the same if PRS were a domestic partnership. See Tax Equity & Fiscal Responsibility Act of 1982 (TEFRA), section 404, 1982-2 C.B. 462, 596 and section 6031 and the regulations thereunder, for the return filing requirements for partnerships.

HOLDING

Real property located in the United States that is owned by a partnership in which a controlled foreign corporation is a partner constitutes United States property held by the CFC for purposes of section 956(b) of the Code.

DRAFTING INFORMATION

The principal author of this revenue ruling is Steven R. Marcuse of the Office of the Associate Chief Counsel (International). For further information about this ruling, call Phyllis Marcus at (202) 566-6645 (not a toll-free call).