T.D. 9087

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Internal Revenue Bulletin:

2003-41 October 14, 2003

T.D. 9087

Exclusions From Gross Income of Foreign Corporations

AGENCY:

Internal Revenue Service (IRS), Treasury.

ACTION:

Final regulations.

SUMMARY:

This document contains final regulations implementing sections 883(a) and (c) that relate to income derived by foreign corporations from the international operation of ships or aircraft. The final regulations reflect changes made by the Tax Reform Act of 1986 and subsequent legislative amendments. The final regulations provide, in general, that a foreign corporation organized in a qualified foreign country and engaged in the international operation of ships or aircraft shall exclude qualified income from gross income for purposes of U.S. federal income taxation, provided that the corporation can satisfy certain ownership and related documentation requirements. The final regulations explain when a foreign country is a qualified foreign country and what income is considered to be qualified income. The final regulations specify how a foreign corporation may satisfy the ownership and related documentation requirements. In addition, the final regulations describe the information that the foreign corporation must include on its U.S. income tax return in order to claim an exemption. All foreign corporations engaged in the international operation of ships or aircraft that claim an exemption from U.S. federal income tax based on section 883 are affected by these regulations.

DATES:

Effective Date: These regulations are effective August 26, 2003.

Applicability Date: These regulations are applicable to taxable years of the foreign corporation beginning 30 days or more after August 26, 2003.

FOR FURTHER INFORMATION CONTACT:

Patricia A. Bray or David L. Lundy at (202) 622-3880 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act (44 U.S.C. 3507) under control number 1545-1677. Responses to these collections of information are mandatory.

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by the Office of Management and Budget.

For corporations, the estimated annual burden per respondent varies from 30 minutes to eight hours, depending on the individual circumstances of the foreign corporation, with an estimated average of one hour. For shareholders, the estimated annual burden per respondent varies from zero minutes to eight hours, depending on the individual circumstances of the shareholder or intermediary, with an estimated average of 90 minutes.

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:T:T:SP, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law. Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.

Background

A notice of proposed rulemaking (REG-208280-86, 2000-1 C.B. 654 [65 FR 6065]) under sections 883(a) and (c) was published in the Federal Register on February 8, 2000 (the 2000 proposed regulations). Due to the substantial number of comments that were received on the 2000 proposed regulations, and the significant impact the regulations have on large segments of the shipping and air transport industries, the 2000 proposed regulations were withdrawn on August 2, 2002. A revised notice of proposed rulemaking (REG-136311-01, 2002-2 C.B. 485 [67 FR 50510]) was published in the Federal Register on August 2, 2002 (the proposed regulations), and provided an opportunity for additional comments. A public hearing on the proposed regulations was held on November 25, 2002. Numerous comments have been received. After consideration of all the comments, the proposed regulations are adopted as revised by this Treasury decision.

The preamble to the 2000 proposed regulations contains a detailed explanation of the provisions in the 2000 proposed regulations, and the preamble to the proposed regulations describes the comments received on the 2000 proposed regulations and the consequent changes reflected in the proposed regulations. The explanations contained in those preambles are not repeated herein. The comments submitted to the IRS on the proposed regulations and the consequent changes reflected in the final regulations are described herein.

Public Comments

Comments Relating to §1.883-1: Exclusion of Income From The International Operation of Ships or Aircraft

A. Substantiation and reporting requirements For a foreign corporation to be considered a qualified foreign corporation under §1.883-1(c)(3), the proposed regulations require that the corporation provide on its return a reasonable estimate of the amount of income in each category of qualified income for which an exemption is claimed to the extent such amounts are readily determinable. Commentators criticized this requirement on the ground that it could require the creation of a separate accounting system, and would necessitate the allocation of expenses to each of the specific categories of income. Commentators suggested that whether amounts are readily determinable should depend on whether records to ascertain such amounts are available in the ordinary course of business.

The IRS and Treasury believe that the suggested definition of readily determinable does not ensure that adequate records will be maintained. That term should be interpreted in accordance with §1.6012-2(g)(1)(i). However, the final regulations have been revised to clarify that a reasonable estimate of the gross amount of income in each category is required. Accordingly, there is no requirement that expenses be allocated to each category of income.

B. Operation of ships or aircraft Section 1.883-1(e) of the proposed regulations provides generally that a corporation is considered engaged in the operation of ships or aircraft only when it is an owner or lessee of an entire ship or aircraft used in the carriage of passengers or cargo for hire. Commentators said that a shipping company utilizing less than the entire space on several vessels also should be considered engaged in the operation of ships or aircraft. The final regulations do not adopt this suggestion. The IRS and Treasury believe that it is appropriate to consider a foreign corporation to be engaged in the operation of ships or aircraft for purposes of section 883 only when it is an owner or lessee of an entire ship or aircraft.

C. Pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture Section 1.883-1(e)(2) generally treats a foreign corporation as engaged in the operation of ships or aircraft with respect to its participation in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture. Commentators asked that these rules be made applicable to single-member disregarded entities in addition to arrangements with multiple owners. Commentators also asked for clarification concerning whether these rules apply to tiered partnerships, such as in the case of a foreign corporation that is a partner in a partnership, whose sole activity is to be a partner in another partnership that is engaged in international shipping.

The rules have been revised to cover single-member disregarded entities, and to clarify that they apply to tiered entities in the case of both joint venture entities and joint ventures that are not entities. An example was added to illustrate these revisions.

D. Cruises to nowhere Section 1.883-1(f)(1) excludes from the international operation of ships or aircraft the carriage of passengers or cargo on a voyage or flight that begins and ends in the United States, even if the voyage or flight contains a segment extending beyond the territorial limits of the United States, unless the passenger disembarks or the cargo is unloaded outside the United States. Commentators renewed their objection to this exclusion of such "cruises to nowhere.” The final regulations continue to exclude cruises to nowhere because such travel has beginning and ending points within the United States within the meaning of section 863(c)(1).

E. Determining whether income is derived from international operation of ships or aircraft Section 1.883-1(f)(2) of the proposed regulations provides that whether income is derived from international operation of ships or aircraft is determined on a passenger by passenger basis and on an item-of-cargo by item-of-cargo basis. Commentators suggested that with respect to the carriage of passengers by ship, the determination should be made on a voyage by voyage basis. Commentators said the voyage should be treated as international if it cannot be completed because of weather or similar factors.

The final regulations do not adopt the suggestion that income be determined on a voyage by voyage basis. The regulations have been revised, however, to exempt income from the sale of a ticket for international carriage of a passenger when the passenger does not begin or complete an international journey because of unanticipated circumstances. For example, if a passenger does not leave on an international flight because of a change in plans, or is unable to complete an international voyage because of illness, any income derived from the sale of the ticket nonetheless will qualify for exemption.

F. International carriage of cargo Under §1.883-1(e)(1), a foreign corporation is considered engaged in the operation of ships or aircraft only if the ship or aircraft is used in the carriage of passengers or cargo for hire. Commentators pointed out that the regulations do not define the term for hire. They expressed concern that requiring the carriage of cargo for hire might be interpreted to exclude income derived by a vessel owner or operator who charters a vessel to a lessee, if the lessee uses it to transport the lessee's own cargo or repositions the vessel without cargo on board for its next voyage. Commentators suggested that the term for hire be defined to include carriage of proprietary goods and an empty backhaul voyage, or that it be deleted from the regulations.

Section 1.883-1(f)(2)(iv) of the final regulations provides that if a foreign corporation time, voyage, or bareboat charters out a ship or aircraft, and the lowest-tier lessee uses the ship or aircraft to carry passengers or cargo on a fee basis, the ship or aircraft is considered used to carry passengers or cargo for hire, regardless of whether the ship or aircraft may be empty during a portion of the charter period due to a backhaul voyage or flight or for purposes of repositioning. If a foreign corporation time, voyage, or bareboat charters out a ship or aircraft, and the lowest-tier lessee uses the ship or aircraft for the carriage of proprietary goods, including an empty backhaul voyage or flight or repositioning related to such carriage of proprietary goods, the ship or aircraft similarly will be treated as used to carry cargo for hire.

G. Bareboat charter of ships or dry lease of aircraft used in international operation of ships or aircraft When a foreign corporation bareboat charters a ship or dry leases an aircraft to a lessee, §1.883-1(f)(2)(iii) of the proposed regulations requires the corporation to adopt a reasonable method for determining the amount of charter income attributable to the international operation of ships or aircraft by the lowest tier lessee. The regulations contain two ratios that may provide a reasonable method for determining the amount of qualifying charter income.

Commentators asked for clarification that business records or log books are a reasonable method for determining the amount of charter income when those records show that the vessel has been used exclusively in international transportation. Commentators also asserted that the ratios are unnecessary and suggested that they be deleted.

The IRS and Treasury believe that business records or log books showing that a ship or aircraft has been used exclusively on voyages or flights that begin or end in the United States (but not both) may be sufficient to establish that the foreign corporation's entire gross income is income from the international operation of ships or aircraft. However, if the ship or aircraft also has been used on voyages or flights that begin and end outside the United States, the foreign corporation must determine the amount of the charter income that is attributable to voyages or flights that begin or end in the United States (but not both) to determine the amount of income potentially within the scope of section 883. The final regulations have been revised generally to require such a foreign corporation to determine the amount of such income based on the total number of days of uninterrupted travel on voyages or flights between the United States and the farthest point or points where cargo or passengers are loaded en route to, or discharged en route from, the United States. However, the final regulations permit the foreign corporation to adopt an alternative method for determining the amount of the charter income that is attributable to the international operation of ships or aircraft if it can establish that the alternative method more accurately reflects the amount of such income.

H. Activities incidental to the international operation of ships or aircraft Section 1.883-1(g) of the proposed regulations provides that certain activities of an operator of a ship or aircraft are so closely related to the primary activity of the international operation of ships or aircraft that income from those incidental activities shall be considered income from the international operation of ships or aircraft, and thus eligible for exemption.

Intermodal Containers. Section 1.883-1(g)(1)(x) of the proposed regulations treats certain container rental activities in the United States as incidental to the international operation of ships or aircraft. The regulations limit incidental treatment to the rental of containers for use in the United States for a period not exceeding five days beyond the original delivery date to the consignee as stated on the bill of lading, and also impose other limitations on incidental treatment.

Commentators stated that ocean carriers provide containers to their customers as an integral part of international shipping, but do not “rent” containers or provide them for “temporary warehousing” of cargo. Commentators also noted that deliveries can be delayed beyond five days for many reasons that clearly do not involve warehousing, such as congestion at port facilities. Commentators said it would be difficult and unrealistic to allocate a portion of the shipping charges to the use of containers.

For these reasons, the reference to container rental as an incidental activity has been modified. The “five day” rule has been eliminated and replaced with a more flexible rule under which the provision of containers or other related equipment by the foreign corporation in connection with the international carriage of cargo for use by its customers, including short-term use within the United States immediately preceding or following the international carriage of cargo, is considered an incidental activity. The regulations presume that a container is used in connection with the international carriage of cargo if it is used for a period of five days or less immediately preceding or following the international carriage of cargo. Beyond this five-day period, whether a container is being used in connection with the international carriage of cargo, or for some other purpose such as warehousing of cargo, will depend on the facts and circumstances. The regulations make clear that the use of containers for any such other purpose will be considered to give rise to income that is not incidental to the international operation of ships or aircraft.

Hotel Accommodations. Arranging for one night in a hotel within the United States before or after a cruise is considered incidental to the international operation of ships under §1.883-1(g)(1)(vii) of the proposed regulations. Commentators suggested that the exception also should apply to one-night hotel accommodations arranged by airlines. Commentators said that airlines occasionally provide such accommodations to passengers on tour packages for the same reasons that cruise companies provide accommodations. The final regulations do not adopt this suggestion. The IRS and Treasury believe that different rules are appropriate in light of operational differences between the airline and cruise industries.

Inland Transportation of Cargo. Section 1.883-1(g)(1)(v) treats the inland transportation of cargo by a related or unrelated corporation as incidental. Commentators suggested that inland transportation of cargo by the foreign corporation itself (after the cargo has passed through Customs) also should be treated as incidental. The final regulations do not adopt this suggestion. The IRS and Treasury are concerned that an exemption would permit foreign corporations engaged in international transportation to compete unfairly with other corporations engaged in the inland transportation of cargo.

Under the proposed regulations, inland transportation by another corporation must be documented by a through bill of lading, airway bill, or similar document. Commentators asked whether the term similar document can include any document showing an inland leg to international transportation, such as a seaway bill or cargo receipt. The IRS and Treasury believe that similar document may be construed broadly to include any appropriate document.

Commentators stated that some unincorporated entities provide inland transportation, and asked that such entities be included in the regulations. Accordingly, the final regulations have been revised to permit any unrelated person (whether incorporated or not) to provide inland transportation of cargo. The final regulations also provide that the rules of section 267(b) shall apply for purposes of determining whether persons are related.

Inland Transportation of Passengers. Section 1.883-1(g)(1)(vi) treats the sale or issuance by a foreign corporation of interline or code-sharing tickets for the inland transportation of passengers by air as an incidental activity. Commentators suggested that the inland segment of an international journey also should be treated as incidental when provided by the foreign airline itself through the sale or issuance of an intraline ticket. The final regulations extend incidental treatment to the sale or issuance of intraline tickets. The final regulations also impose a maximum 12-hour scheduled interval between the international and inland segments of any flight involving intraline tickets.

Shore Excursions. Land tour packages are excluded from incidental activities under §1.883-1(g)(2)(i). Commentators contend that single-day shore excursions are not the same as land tour packages and should qualify as an incidental activity. The final regulations do not adopt this suggestion because the two activities are similar in nature.

Short-term Use. Ships normally engaged in international cruises may occasionally be used for other purposes, such as cruises to nowhere. Commentators asked that such short-term use be treated as an incidental activity. The final regulations do not adopt this suggestion because domestic use of a vessel does not qualify as the international operation of ships or aircraft.

Airline Tickets. Section 1.883-1(g)(1) treats as incidental the sale of tickets by an airline for international transportation on another airline, and the sale of tickets by a ship operator on behalf of another ship operator. Section 1.883-1(g)(2)(iii), however, excludes from incidental income the sale of airline tickets by a cruise company. Commentators objected to this exclusion. This exclusion is retained in the final regulations. Cruise companies that sell airline tickets are acting in a capacity comparable to travel agents, and would have an unfair competitive advantage if their income from this activity were exempt.

Ground Services and Other Services. The proposed regulations, in §1.883-1(g)(3), reserve on the treatment of ground services, maintenance and catering, as well as other services not mentioned as included among incidental activities. In the absence of a clear international norm or standard regarding the appropriate treatment of such services, the IRS and Treasury solicited comments on an appropriate rule. Commentators generally suggested that activities be treated as incidental unless they rise to the level of a separate, nonshipping business. The final regulations continue to reserve on this issue, pending further consideration by the IRS and Treasury.

I. Determining equivalent exemptions for each category of income Section 1.883-1(h)(2) of the proposed regulations provides that if an exemption is unavailable in a foreign country for one of the eight enumerated categories of income, the foreign country is not considered to grant an equivalent exemption with respect to that category of income. Paragraph (h)(2)(vi) of this section treats incidental income, other than incidental bareboat charter or dry lease income and incidental container-related income, as one category of income.

Commentators suggested that an equivalent exemption be determined on an item-of-income basis rather than by category of income. Commentators objected to the requirement that a foreign country exempt all items of income within a category of income to be treated as granting an equivalent exemption. The examples provided by commentators indicated that this concern arose primarily in the context of the residual category of incidental income described in paragraph (h)(2)(vi).

The final regulations retain the requirement that a foreign country exempt all items of income within a category of income, but provide an exception for incidental income described in paragraph (h)(2)(vi). The final regulations permit an exemption of any type of incidental income that qualifies under paragraph (g)(1) if a foreign country grants an equivalent exemption with respect to that type of income. For example, if a foreign country grants an equivalent exemption for the sale of airline tickets on behalf of another corporation engaged in international operation of aircraft, as provided in paragraph (g)(1)(iii), but does not provide an equivalent exemption for the inland transportation of cargo, as provided in paragraph (g)(1)(v), the foreign country is nonetheless considered to grant an equivalent exemption for the sale of airline tickets.

Commentators also pointed out that some income items may be described in more than one category of income, and asked which category would apply for purposes of determining whether the foreign country provides an equivalent exemption. The IRS and Treasury believe that the taxpayer can select any applicable category of income that provides an exemption.

J. Special rules with respect to income tax conventions Section 1.883-1(h)(3)(i) of the proposed regulations provides that if a taxpayer is eligible to exempt income under both an applicable income tax convention and section 883, the taxpayer may claim an exemption under both the applicable income tax convention and section 883 with respect to such category of income. Such an election must be made with respect to all income of the foreign corporation from the international operation of ships or aircraft, and cannot be made separately with respect to different categories of income.

Commentators requested clarification concerning the election to claim an exemption under both the applicable income tax convention and section 883 when the benefits under the two exemptions are not co-extensive with respect to any category of income.

The final regulations have been clarified to provide that if a corporation chooses to claim an exemption under an income tax convention, it may simultaneously claim an exemption under section 883 with respect to any category of income listed in paragraphs (h)(2)(i) through (v), (vii), and (viii) of §1.883-1 and to any type of income described in paragraph (h)(2)(vi) of §1.883-1, but only to the extent that such income also is exempt under the income tax convention.

K. Participation in certain joint ventures Under §1.883-1(h)(3)(i), a corporation organized in a foreign country that provides an exemption only through an income tax convention is not permitted to claim an exemption under section 883, with one exception. Paragraph (h)(3)(ii) permits such corporation to claim an exemption under section 883 if the foreign corporation participates in a joint venture described in paragraph (e)(2) that is not treated as fiscally transparent with respect to the category of income derived from the joint venture under the income tax laws of the jurisdiction where the foreign corporation is organized, and treaty benefits would be available but for this reason.

Commentators suggested that the exception in §1.883-1(h)(3)(ii) should apply to single-owner disregarded entities in addition to transparent joint ventures. This suggestion was not adopted. The IRS and Treasury believe that the policy justification for relief in the joint venture context is not present in the context of a wholly owned entity.

L. Independent interpretation of income tax conventions Section 1.883-1(h)(3)(iii) of the proposed regulations clarifies that definitions provided in these regulations do not give meaning or provide guidance regarding similar terms in U.S. income tax conventions or the scope of any treaty exemption. Commentators stated that definitions in the regulations and income tax conventions should have the same scope and be interpreted in the same way. The IRS and Treasury continue to believe that terms used in the proposed regulations should not be used to interpret terms and concepts in U.S. income tax conventions except to the extent that a treaty that entered into force after August 26, 2003, or its legislative history explicitly refers to section 883 and guidance thereunder for its meaning.

Comments Relating to §1.883-2: Treatment of Publicly-traded Corporations

A. Closely-held classes of stock not treated as meeting trading requirements Section 1.883-2(d)(3)(i) of the proposed regulations disqualifies a class of stock from being relied on to satisfy the publicly traded test if, at any time during the taxable year, one or more 5-percent shareholders of that class of stock (determined without regard to the attribution rules in §1.883-4) owns, in the aggregate, 50 percent or more of the total vote and value of that class of stock (closely-held rule).

Commentators pointed out that a company could lose its exemption if a nonqualified shareholder held a sufficiently large block of stock for one day. Commentators suggested requiring a longer period of ownership by nonqualified shareholders before disqualifying a class of stock from being relied on to satisfy the publicly traded test.

This suggestion has been adopted. The final regulations provide that a class of stock will be disqualified if one or more 5-percent shareholders of that class of stock owns, in the aggregate, 50 percent or more of the total vote and value of that class of stock for more than half the number of days during the corporation's taxable year. In this way, the closely-held rule matches the exception provided in §1.883-2(d)(3)(ii) which permits a foreign corporation to establish that qualified shareholders own sufficient shares in the closely-held block of stock to preclude nonqualified shareholders from owning 50 percent or more of the total value of the class of stock for more than half the number of days during the taxable year.

To demonstrate that a class of stock is not closely-held for purposes of §1.883-2(d)(3)(i), a foreign corporation whose stock is traded on an established securities market in the United States may rely on current Schedule 13G filings with the Securities and Exchange Commission to identify its 5-percent shareholders in each class of stock relied upon to meet the regularly traded test, without having to make any independent investigation to determine the identity of the 5-percent shareholders. §1.883-4(d)(3)(viii). Commentators suggested that a foreign corporation also be permitted to rely on current Schedule 13D filings with the Securities and Exchange Commission to identify 5-percent shareholders for purposes of meeting the exception contained in §1.883-2(d)(3)(ii). The final regulations adopt this suggestion.

Under §1.883-2(d)(3)(iii)(B) of the proposed regulations, an investment company registered under the Investment Company Act of 1940 will not be treated as a 5-percent shareholder if no person owns both 5 percent or more of the value of the outstanding interests in the investment company and 5 percent or more of the value of the shares of the class of stock of the foreign corporation. Commentators suggested that this exception be extended to foreign mutual funds, other investment companies not registered under the Investment Company Act of 1940, and financial institutions with customer or nominee accounts. Commentators also pointed out that it would be difficult for a shipping company to determine the identity of 5-percent owners of a mutual fund because most mutual fund shares are held in street name.

The final regulations eliminate the provision that treats an investment company registered under the Investment Company Act of 1940 as a 5-percent shareholder if a person owns both 5 percent or more of the value of the outstanding interests in the investment company and 5 percent or more of the value of the shares of the class of stock of the foreign corporation. Instead, the final regulations provide that such an investment company shall not be treated as a 5-percent shareholder for purposes of these regulations. The final regulations do not expand the mutual fund exception to include other types of investment vehicles or financial institutions.

Comments relating to §1.883-3: Treatment of Controlled Foreign Corporations

Income inclusion test Section 883(c)(2) provides that the stock ownership test of section 883(c)(1) shall not apply to controlled foreign corporations (CFCs). Under the proposed regulations, a CFC is considered to satisfy the CFC exception of section 883(c)(1) if it meets the requirements of §1.883-3. One such requirement is the income inclusion test of §1.883-3(b). This test requires that more than 50 percent of the subpart F income derived by the CFC from the international operation of ships or aircraft be includible in the gross income of one or more U.S. citizens, individual residents of the United States, or domestic corporations.

Commentators restated their objection to the income inclusion test. They argued that the test is too restrictive because it could deny qualified foreign corporation status to CFCs legitimately owned and controlled by U.S. shareholders.

The IRS and Treasury continue to believe that the income inclusion rule contained in the proposed regulations is supported by the legislative history to section 883(c). The Conference report accompanying the legislation that added the CFC exception provides with respect to the exception that “corporations are not considered residents of countries that exempt U.S. persons unless 50 percent or more of the ultimate individual owners are U.S. shareholders of controlled foreign corporations”. H.R. Conf. Rep. No. 99-841, 99^th Cong., 2d Sess. 598 (1986), reprinted in 1986-3 C.B. vol. 4, at 598 (1986). The intent of the CFC exception, therefore, is for the general ownership requirement of section 883(c)(1) to apply unless the foreign corporation is a CFC and 50 percent or more of the subpart F income of that corporation derived from the international operation of ships or aircraft is includible by U.S. citizens, individual residents, or domestic corporations.

Commentators stated that if the income inclusion test is retained, the regulations should provide that income derived by U.S. tax-exempt organizations holding shares in CFCs should be counted toward satisfying the income inclusion test even though the income is not taxed.

The final regulations do not adopt this suggestion. A U.S. tax-exempt organization is not in substance different from a U.S. person that is not required to include in its gross income the subpart F income of a CFC.

Comments Relating to §1.883-4: Qualified Shareholder Stock Ownership Test

A. Qualified shareholders A foreign corporation satisfies the stock ownership test of §1.883-1(c)(2) if more than 50 percent of the value of its outstanding shares is owned, or treated as owned through attribution, for at least half of the number of days in the foreign corporation's taxable year by one or more qualified shareholders. Section 1.883-4(b)(1)(i)(A) of the proposed regulations treats an individual resident in a qualified foreign country as a qualified shareholder, but excludes individuals described in §1.883-4(b)(1)(i)(E) and (F). Commentators stated that the exclusion of pension fund beneficiaries described in paragraph (b)(1)(i)(E) could be interpreted to prevent the qualification of an individual under paragraph (b)(1)(i)(A). For example, if an individual held stock directly in a shipping company and also was the beneficiary of a pension fund holding stock in the same company, commentators believe that the individual might not qualify under paragraph (b)(1)(i)(A) with respect to the individual's direct ownership. The final regulations clarify that an individual can be a qualified shareholder under paragraph (b)(1)(i)(A) and also be a qualified shareholder under paragraph (b)(1)(i)(E) with respect to a category of income for which a foreign corporation is seeking an exemption.

Under §1.883-4(b)(1)(i)(D) of the proposed regulations, a not-for-profit organization described in §1.883-4(b)(4) is treated as a qualified shareholder. Section 1.883-4(b)(4)(iii)(A) requires a not-for-profit organization to expend more than 50 percent of its annual support on behalf of individuals described in §1.883-4(b)(1)(i)(A).

Commentators suggested that the category of recipients eligible for support be expanded to include other not-for-profit organizations. This suggestion has been adopted in part. The final regulations provide that a not-for-profit organization may be a qualified shareholder if it expends more than 50 percent of its annual support on behalf of U.S. organizations that have received determination letters under section 501(c)(3) and on behalf of individuals described in §1.883-4(b)(1)(i)(A).

Commentators asked that the list of qualified shareholders in §1.883-4(b)(1)(i) be expanded to include international organizations as defined in section 7701(a)(18), and pension funds established for employees of such organizations. The final regulations do not adopt this suggestion. Under section 883(c)(1) and §1.883-4(a), a foreign corporation satisfies the stock ownership test if more than 50 percent of the value of its outstanding shares is owned by qualified shareholders who are residents of qualified foreign countries. The remaining shares of the foreign corporation can be owned by nonqualified shareholders, including international organizations.

Section 1.883-4(b)(1)(ii) of the proposed regulations provides that a shareholder is a qualified shareholder only if the shareholder does not own its interest in the foreign corporation through bearer shares, either directly or by applying the attribution rules of §1.883-4(c). Commentators renewed their objection to this rule. The final regulations retain this provision due to the difficulty of reliably demonstrating the true ownership of bearer shares.

B. Substantiation of stock ownership Section 1.883-4(b)(1)(iii) of the proposed regulations provides that a shareholder is a qualified shareholder only if the shareholder provides to the foreign corporation the documentation required in §1.883-4(d), and the foreign corporation meets the reporting requirements of §1.883-4(e) with respect to such shareholder. Commentators argued that the required reporting requirements are burdensome, and suggested that taxpayers have the option of submitting a sworn statement with their return stating that qualified individuals own the corporation and that supporting documentation has been deposited with a qualified tax practitioner in the United States. The final regulations do not adopt this suggestion. The IRS and Treasury continue to believe that this information is necessary for proper administration of section 883 and that the provision of this information with the foreign corporation's tax return is not unduly burdensome.

Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866. Therefore, a regulatory assessment is not required. It is hereby certified that the collection of information in these regulations will not have a significant economic impact on a substantial number of U.S. small entities. This certification is based upon the fact that these regulations apply to foreign corporations and impose only a limited collection of information burden on shareholders of such corporations, which in some cases may include U.S. small entities. Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.

* * * * *

Adoption of Amendments to the Regulations

Accordingly, 26 CFR parts 1 and 602 are amended as follows:

PART 1—INCOME TAXES

Paragraph 1. The authority citation for part 1 is amended by adding entries in numerical order to read as follows:

Authority: 26 U.S.C. 7805 * * *

Section 1.883-1 is also issued under 26 U.S.C. 883.

Section 1.883-2 is also issued under 26 U.S.C. 883.

Section 1.883-3 is also issued under 26 U.S.C. 883.

Section 1.883-4 is also issued under 26 U.S.C. 883.

Section 1.883-5 is also issued under 26 U.S.C. 883. * * *

Par. 2. Section 1.883-0 is added to read as follows:

§1.883-0 Outline of major topics. This section lists the major paragraphs contained in §§1.883-1 through 1.883-5.

§1.883-1 Exclusion of income from the international operation of ships or aircraft. (a) General rule.

(b) Qualified income.

(c) Qualified foreign corporation.

(1) General rule.

(2) Stock ownership test.

(3) Substantiation and reporting requirements.

(i) General rule.

(ii) Further documentation.

(4) Commissioner's discretion to cure defects in documentation.

(d) Qualified foreign country.

(e) Operation of ships or aircraft.

(1) General rule.

(2) Pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture.

(3) Activities not considered operation of ships or aircraft.

(4) Examples.

(5) Definitions.

(i) Bareboat charter.

(ii) Code-sharing arrangement.

(iii) Dry lease.

(iv) Entity.

(v) Fiscally transparent entity under the income tax laws of the United States.

(vi) Full charter.

(vii) Nonvessel operating common carrier.

(viii) Space or slot charter.

(ix) Time charter.

(x) Voyage charter.

(xi) Wet lease.

(f) International operation of ships or aircraft.

(1) General rule.

(2) Determining whether income is derived from international operation of ships or aircraft.

(i) International carriage of passengers.

(A) General rule.

(B) Round trip travel on ships.

(ii) International carriage of cargo.

(iii) Bareboat charter of ships or dry lease of aircraft used in international operation of ships or aircraft.

(iv) Charter of ships or aircraft for hire.

(g) Activities incidental to the international operation of ships or aircraft.

(1) General rule.

(2) Activities not considered incidental to the international operation of ships or aircraft.

(3) Services.

(i) Ground services, maintenance, and catering.

(ii) Other services.

(4) Activities involved in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture.

(h) Equivalent exemption.

(1) General rule.

(2) Determining equivalent exemptions for each category of income.

(3) Special rules with respect to income tax conventions.

(i) General rule.

(ii) Participation in certain joint ventures.

(iii) Independent interpretation of income tax conventions.

(4) Exemptions not qualifying as equivalent exemptions.

(i) General rule.

(ii) Reduced tax rate or time limited exemption.

(iii) Inbound or outbound freight tax.

(iv) Exemptions for limited types of cargo.

(v) Territorial tax systems.

(vi) Countries that tax on a residence basis.

(vii) Exemptions within categories of income.

(i) Treatment of possessions.

(j) Expenses related to qualified income.

§1.883-2 Treatment of publicly-traded corporations. (a) General rule.

(b) Established securities market.

(1) General rule.

(2) Exchanges with multiple tiers.

(3) Computation of dollar value of stock traded.

(4) Over-the-counter market.

(5) Discretion to determine that an exchange does not qualify as an established securities market.

(c) Primarily traded.

(d) Regularly traded.

(1) General rule.

(2) Classes of stock traded on a domestic established securities market treated as meeting trading requirements.

(3) Closely-held classes of stock not treated as meeting trading requirements.

(i) General rule.

(ii) Exception.

(iii) Five-percent shareholders.

(A) Related persons.

(B) Investment companies.

(4) Anti-abuse rule.

(5) Example.

(e) Substantiation that a foreign corporation is publicly traded.

(1) General rule.

(2) Availability and retention of documents for inspection.

(f) Reporting requirements.

§1.883-3 Treatment of controlled foreign corporations. (a) General rule.

(b) Income inclusion test.

(1) General rule.

(2) Examples.

(c) Substantiation of CFC stock ownership.

(1) General rule.

(2) Documentation from certain United States shareholders.

(i) General rule.

(ii) Availability and retention of documents for inspection.

(d) Reporting requirements.

§1.883-4 Qualified shareholder stock ownership test. (a) General rule.

(b) Qualified shareholder.

(1) General rule.

(2) Residence of individual shareholders.

(i) General rule.

(ii) Tax home.

(3) Certain income tax convention restrictions applied to shareholders.

(4) Not-for-profit organizations.

(5) Pension funds.

(i) Pension fund defined.

(ii) Government pension funds.

(iii) Nongovernment pension funds.

(iv) Beneficiary of a pension fund.

(c) Rules for determining constructive ownership.

(1) General rules for attribution.

(2) Partnerships.

(i) General rule.

(ii) Partners resident in the same country.

(iii) Examples.

(3) Trusts and estates.

(i) Beneficiaries.

(ii) Grantor trusts.

(4) Corporations that issue stock.

(5) Taxable nonstock corporations.

(6) Mutual insurance companies and similar entities.

(7) Computation of beneficial interests in nongovernment pension funds.

(d) Substantiation of stock ownership.

(1) General rule.

(2) Application of general rule.

(i) Ownership statements.

(ii) Three-year period of validity.

(3) Special rules.

(i) Substantiating residence of certain shareholders.

(ii) Special rule for registered shareholders owning less than one percent of widely-held corporations.

(iii) Special rule for beneficiaries of pension funds.

(A) Government pension fund.

(B) Nongovernment pension fund.

(iv) Special rule for stock owned by publicly-traded corporations.

(v) Special rule for not-for-profit organizations.

(vi) Special rule for a foreign airline covered by an air services agreement.

(vii) Special rule for taxable nonstock corporations.

(viii) Special rule for closely-held corporations traded in the United States.

(4) Ownership statements from shareholders.

(i) Ownership statements from individuals.

(ii) Ownership statements from foreign governments.

(iii) Ownership statements from publicly-traded corporate shareholders.

(iv) Ownership statements from not-for-profit organizations.

(v) Ownership statements from intermediaries.

(A) General rule.

(B) Ownership statements from widely-held intermediaries with registered shareholders owning less than one percent of such widely-held intermediary.

(C) Ownership statements from pension funds.

(1) Ownership statements from government pension funds.

(2) Ownership statements from nongovernment pension funds.

(3) Time for making determinations.

(D) Ownership statements from taxable nonstock corporations.

(5) Availability and retention of documents for inspection.

(e) Reporting requirements.

§1.883-5 Effective dates. (a) General rule.

(b) Election for retroactive application.

(c) Transitional information reporting rule.

Par. 3. §1.883-1 is revised to read as follows:

§1.883-1 Exclusion of income from the international operation of ships or aircraft. (a) General rule. Qualified income derived by a qualified foreign corporation from its international operation of ships or aircraft is excluded from gross income and exempt from United States federal income tax. Paragraph (b) of this section defines the term qualified income. Paragraph (c) of this section defines the term qualified foreign corporation. Paragraph (f) of this section defines the term international operation of ships or aircraft.

(b) Qualified income. Qualified income is income derived from the international operation of ships or aircraft that—

(1) Is properly includible in any of the income categories described in paragraph (h)(2) of this section; and

(2) Is the subject of an equivalent exemption, as defined in paragraph (h) of this section, granted by the qualified foreign country, as defined in paragraph (d) of this section, in which the foreign corporation seeking qualified foreign corporation status is organized.

(c) Qualified foreign corporation—(1) General rule. A qualified foreign corporation is a corporation that is organized in a qualified foreign country and considered engaged in the international operation of ships or aircraft. The term corporation is defined in section 7701(a)(3) and the regulations thereunder. Paragraph (d) of this section defines the term qualified foreign country. Paragraph (e) of this section defines the term operation of ships or aircraft, and paragraph (f) of this section defines the term international operation of ships or aircraft. To be a qualified foreign corporation, the corporation must satisfy the stock ownership test of paragraph (c)(2) of this section and satisfy the substantiation and reporting requirements described in paragraph (c)(3) of this section. A corporation may be a qualified foreign corporation with respect to one category of qualified income but not with respect to another such category. See paragraph (h)(2) of this section for a discussion of the categories of qualified income.

(2) Stock ownership test. To be a qualified foreign corporation, a foreign corporation must satisfy the publicly-traded test of §1.883-2(a), the CFC stock ownership test of §1.883-3(a), or the qualified shareholder stock ownership test of §1.883-4(a).

(3) Substantiation and reporting requirements—(i) General rule. To be a qualified foreign corporation, a foreign corporation must include the following information in its Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” in the manner prescribed by such form and its accompanying instructions—

(A) The corporation's name and address (including mailing code);

(B) The corporation's U.S. taxpayer identification number;

(C) The foreign country in which the corporation is organized;

(D) The applicable authority for an equivalent exemption, for example, citation of a statute in the country where the corporation is organized, a diplomatic note between the United States and such country, (for further guidance, see Rev. Rul. 2001-48, 2001-2 C.B. 324 (see §601.601(d)(2) of this chapter)), or, in the case of a corporation described in paragraph (h)(3)(ii) of this section, an income tax convention between the United States and such country;

(E) The category or categories of qualified income for which an exemption is being claimed;

(F) A reasonable estimate of the gross amount of income in each category of qualified income for which the exemption is claimed, to the extent such amounts are readily determinable;

(G) Any other information required under §1.883-2(f), 1.883-3(d), or 1.883-4(e), as applicable; and

(H) Any other relevant information specified by the Form 1120-F and its accompanying instructions.

(ii) Further documentation. If the Commissioner requests in writing that the foreign corporation document or substantiate representations made under paragraph (c)(3)(i) of this section, or under §1.883-2(f), 1.883-3(d) or 1.883-4(e), the foreign corporation must provide the documentation or substantiation within 60 days following the written request. If the foreign corporation does not provide the documentation and substantiation requested within the 60-day period, but demonstrates that the failure was due to reasonable cause and not willful neglect, the Commissioner may grant the foreign corporation a 30-day extension to provide the documentation or substantiation. Whether a failure to obtain the documentation or substantiation in a timely manner was due to reasonable cause and not willful neglect shall be determined by the Commissioner after considering all the facts and circumstances.

(4) Commissioner's discretion to cure defects in documentation. The Commissioner retains the discretion to cure any defects in the documentation where the Commissioner is satisfied that the foreign corporation would otherwise be a qualified foreign corporation.

(d) Qualified foreign country. A qualified foreign country is a foreign country that grants to corporations organized in the United States an equivalent exemption, as described in paragraph (h) of this section, for the category of qualified income, as described in paragraph (h)(2) of this section, derived by the foreign corporation seeking qualified foreign corporation status. A foreign country may be a qualified foreign country with respect to one category of qualified income but not with respect to another such category.

(e) Operation of ships or aircraft—(1) General rule. Except as provided in paragraph (e)(2) of this section, a foreign corporation is considered engaged in the operation of ships or aircraft only during the time it is an owner or lessee of one or more entire ships or aircraft and uses such ships or aircraft in one or more of the following activities—

(i) Carriage of passengers or cargo for hire;

(ii) In the case of a ship, the leasing out of the ship under a time or voyage charter (full charter), space or slot charter, or bareboat charter, as those terms are defined in paragraph (e)(5) of this section, provided the ship is used to carry passengers or cargo for hire; and

(iii) In the case of aircraft, the leasing out of the aircraft under a wet lease (full charter), space, slot, or block-seat charter, or dry lease, as those terms are defined in paragraph (e)(5) of this section, provided the aircraft is used to carry passengers or cargo for hire.

(2) Pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture. A foreign corporation is considered engaged in the operation of ships or aircraft within the meaning of paragraph (e)(1) of this section with respect to its participation in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture if it directly, or indirectly through one or more fiscally transparent entities under the income tax laws of the United States, as defined in paragraph (e)(5)(v) of this section—

(i) Owns an interest in a partnership, disregarded entity, or other fiscally transparent entity under the income tax laws of the United States that itself would be considered engaged in the operation of ships or aircraft under paragraph (e)(1) of this section if it were a foreign corporation; or

(ii) Participates in a pool, strategic alliance, joint operating agreement, code-sharing arrangement, or other joint venture that is not an entity, as defined in paragraph (e)(5)(iv) of this section, involving one or more activities described in paragraphs (e)(1)(i) through (iii) of this section, but only if—

(A) In the case of a direct interest, the foreign corporation is otherwise engaged in the operation of ships or aircraft under paragraph (e)(1) of this section; or

(B) In the case of an indirect interest, either the foreign corporation is otherwise engaged, or one of the fiscally transparent entities would be considered engaged if it were a foreign corporation, in the operation of ships or aircraft under paragraph (e)(1) of this section.

(3) Activities not considered operation of ships or aircraft. Activities that do not constitute operation of ships or aircraft include, but are not limited to—

(i) The activities of a nonvessel operating common carrier, as defined in paragraph (e)(5)(vii) of this section;

(ii) Ship or aircraft management;

(iii) Obtaining crews for ships or aircraft operated by another party;

(iv) Acting as a ship's agent;

(v) Ship or aircraft brokering;

(vi) Freight forwarding;

(vii) The activities of travel agents and tour operators;

(viii) Rental by a container leasing company of containers and related equipment; and

(ix) The activities of a concessionaire.

(4) Examples. The rules of paragraphs (e)(1) through (3) of this section are illustrated by the following examples:

Example 1. Three tiers of charters—(i) Facts. A, B, and C are foreign corporations. A purchases a ship. A and B enter into a bareboat charter of the ship for a term of 20 years, and B, in turn, enters into a time charter of the ship with C for a term of 5 years. Under the time charter, B is responsible for the complete operation of the ship, including providing the crew and maintenance. C uses the ship during the term of the time charter to carry its customers' freight between U.S. and foreign ports. C owns no ships.

(ii) Analysis. Because A is the owner of the entire ship and leases out the ship under a bareboat charter to B, and because the sublessor, C, uses the ship to carry cargo for hire, A is considered engaged in the operation of a ship under paragraph (e)(1) of this section during the term of the time charter. B leases in the entire ship from A and leases out the ship under a time charter to C, who uses the ship to carry cargo for hire. Therefore, B is considered engaged in the operation of a ship under paragraph (e)(1) of this section during the term of the time charter. C time charters the entire ship from B and uses the ship to carry its customers' freight during the term of the charter. Therefore, C is also engaged in the operation of a ship under paragraph (e)(1) of this section during the term of the time charter.

Example 2. Partnership with contributed shipping assets—(i) Facts. X, Y, and Z, each a foreign corporation, enter into a partnership, P. P is a fiscally transparent entity under the income tax laws of the United States, as defined in paragraph (e)(5)(v) of this section. Under the terms of the partnership agreement, each partner contributes all of the ships in its fleet to P in exchange for interests in the partnership and shares in the P profits from the international carriage of cargo. The partners share in the overall management of P, but each partner, acting in its capacity as partner, continues to crew and manage all ships previously in its fleet.

(ii) Analysis. P owns the ships contributed by the partners and uses these ships to carry cargo for hire. Therefore, if P were a foreign corporation, it would be considered engaged in the operation of ships within the meaning of paragraph (e)(1) of this section. Accordingly, because P is a fiscally transparent entity under the income tax laws of the United States, as defined in paragraph (e)(5)(v) of this section, X, Y, and Z are each considered engaged in the operation of ships through P, within the meaning of paragraph (e)(2)(i) of this section, with respect to their distributive share of income from P's international carriage of cargo.

Example 3. Joint venture with chartered in ships—(i) Facts. Foreign corporation A owns a number of foreign subsidiaries involved in various aspects of the shipping business, including S1, S2, S3, and S4. S4 is a foreign corporation that provides cruises but does not own any ships. S1, S2, and S3 are foreign corporations that own cruise ships. S1, S2, S3, and S4 form joint venture JV, in which they are all interest holders, to conduct cruises. JV is a fiscally transparent entity under the income tax laws of the United States, as defined in paragraph (e)(5)(v) of this section. Under the terms of the joint venture, S1, S2, and S3 each enter into time charter agreements with JV, pursuant to which S1, S2, and S3 retain control of the navigation and management of the individual ships, and JV will use the ships to carry passengers for hire. The overall management of the cruise line will be provided by S4.

(ii) Analysis. S1, S2, and S3 each owns ships and time charters those ships to JV, which uses the ships to carry passengers for hire. Accordingly, S1, S2, and S3 are each considered engaged in the operation of ships under paragraph (e)(1) of this section. JV leases in entire ships by means of the time charters, and JV uses those ships to carry passengers on cruises. Thus, JV would be engaged in the operation of ships within the meaning of paragraph (e)(1) of this section if it were a foreign corporation. Therefore, although S4 does not directly own or lease in a ship, S4 also is engaged in the operation of ships, within the meaning of paragraph (e)(2)(i) of this section, with respect to its participation in JV.

Example 4. Tiered partnerships—(i) Facts. Foreign corporations A, B, and C enter into a partnership, P1. P1 is one of several shareholders of Poolco, a foreign limited liability company that makes an election pursuant to §301.7701-3 of this chapter to be treated as a partnership for U.S. tax purposes. P1 acquires several ships and time charters them out to Poolco. Poolco slot or voyage charters such ships out to third parties for use in the carriage of cargo for hire. P1 and Poolco are fiscally transparent entities under the income tax laws of the United States, as defined in paragraph (e)(5)(v) of this section.

(ii) Analysis. A, B, and C are considered engaged in the operation of ships under paragraph (e)(2)(i) of this section with respect to their direct interest in P1 and with respect to their indirect interest in Poolco because both P1 and Poolco are fiscally transparent entities under the income tax laws of the United States and would be considered engaged in the operation of ships under paragraph (e)(1) of this section if they were foreign corporations. The result would be the same if Poolco were a single-member disregarded entity owned solely by P1.

(5) Definitions—(i) Bareboat charter. A bareboat charter is a contract for the use of a ship or aircraft whereby the lessee is in complete possession, control, and command of the ship or aircraft. For example, in a bareboat charter, the lessee is responsible for the navigation and management of the ship or aircraft, the crew, supplies, repairs and maintenance, fees, insurance, charges, commissions and other expenses connected with the use of the ship or aircraft. The lessor of the ship bears none of the expense or responsibility of operation of the ship or aircraft.

(ii) Code-sharing arrangement. A code-sharing arrangement is an arrangement in which one air carrier puts its identification code on the flight of another carrier. This arrangement allows the first carrier to hold itself out as providing service in markets where it does not otherwise operate or where it operates infrequently. Code-sharing arrangements can range from a very limited agreement between two carriers involving only one market to agreements involving multiple markets and alliances between or among international carriers which also include joint marketing, baggage handling, one-stop check-in service, sharing of frequent flyer awards, and other services. For rules involving the sale of code-sharing tickets, see paragraph (g)(1)(vi) of this section.

(iii) Dry lease. A dry lease is the bareboat charter of an aircraft.

(iv) Entity. For purposes of this paragraph (e), an entity is any person that is treated by the United States as other than an individual for U.S. federal income tax purposes. The term includes disregarded entities.

(v) Fiscally transparent entity under the income tax laws of the United States. For purposes of this paragraph (e), an entity is fiscally transparent under the income tax laws of the United States if the entity would be considered fiscally transparent under the income tax laws of the United States under the principles of §1.894-1(d)(3).

(vi) Full charter. Full charter (or full rental) means a time charter or a voyage charter of a ship or a wet lease of an aircraft but during which the full crew and management are provided by the lessor.

(vii) Nonvessel operating common carrier. A nonvessel operating common carrier is an entity that does not exercise control over any part of a vessel, but holds itself out to the public as providing transportation for hire, issues bills of lading, assumes responsibility or is liable by law as a common carrier for safe transportation of shipments, and arranges in its own name with other common carriers, including those engaged in the operation of ships, for the performance of such transportation.

(viii) Space or slot charter. A space or slot charter is a contract for use of a certain amount of space (but less than all of the space) on a ship or aircraft, and may be on a time or voyage basis. When used in connection with passenger aircraft this sort of charter may be referred to as the sale of block seats.

(ix) Time charter. A time charter is a contract for the use of a ship or aircraft for a specific period of time, during which the lessor of the ship or aircraft retains control of the navigation and management of the ship or aircraft (i.e., the lessor continues to be responsible for the crew, supplies, repairs and maintenance, fees and insurance, charges, commissions and other expenses connected with the use of the ship or aircraft).

(x) Voyage charter. A voyage charter is a contract similar to a time charter except that the ship or aircraft is chartered for a specific voyage or flight rather than for a specific period of time.

(xi) Wet lease. A wet lease is the time or voyage charter of an aircraft.

(f) International operation of ships or aircraft—(1) General rule. The term international operation of ships or aircraft means the operation of ships or aircraft, as defined in paragraph (e) of this section, with respect to the carriage of passengers or cargo on voyages or flights that begin or end in the United States, as determined under paragraph (f)(2) of this section. The term does not include the carriage of passengers or cargo on a voyage or flight that begins and ends in the United States, even if the voyage or flight contains a segment extending beyond the territorial limits of the United States, unless the passenger disembarks or the cargo is unloaded outside the United States. Operation of ships or aircraft beyond the territorial limits of the United States does not constitute in itself international operation of ships or aircraft.

(2) Determining whether income is derived from international operation of ships or aircraft. Whether income is derived from international operation of ships or aircraft is determined on a passenger by passenger basis (as provided in paragraph (f)(2)(i) of this section) and on an item-of-cargo by item-of-cargo basis (as provided in paragraph (f)(2)(ii) of this section). In the case of the bareboat charter of a ship or the dry lease of an aircraft, whether the charter income for a particular period is derived from international operation of ships or aircraft is determined by reference to how the ship or aircraft is used by the lowest-tier lessee in the chain of lessees (as provided in paragraph (f)(2)(iii) of this section).

(i) International carriage of passengers—(A) General rule. Except in the case of a round trip described in paragraph (f)(2)(i)(B) of this section, income derived from the carriage of a passenger will be income from international operation of ships or aircraft if the passenger is carried between a beginning point in the United States and an ending point outside the United States, or vice versa. Carriage of a passenger will be treated as ending at the passenger's final destination even if, en route to the passenger's final destination, a stop is made at an intermediate point for refueling, maintenance, or other business reasons, provided the passenger does not change ships or aircraft at the intermediate point. Similarly, carriage of a passenger will be treated as beginning at the passenger's point of origin even if, en route to the passenger's final destination, a stop is made at an intermediate point, provided the passenger does not change ships or aircraft at the intermediate point. Carriage of a passenger will be treated as beginning or ending at a U.S. or foreign intermediate point if the passenger changes ships or aircraft at that intermediate point. Income derived from the sale of a ticket for international carriage of a passenger will be treated as income derived from international operation of ships or aircraft even if the passenger does not begin or complete an international journey because of unanticipated circumstances.

(B) Round trip travel on ships. In the case of income from the carriage of a passenger on a ship that begins its voyage in the United States, calls on one or more foreign intermediate ports, and returns to the same or another U.S. port, such income from carriage of a passenger on the entire voyage will be treated as income derived from international operation of ships or aircraft under paragraph (f)(2)(i)(A) of this section. This result obtains even if such carriage includes one or more intermediate stops at a U.S. port or ports and even if the passenger does not disembark at the foreign intermediate point.

(ii) International carriage of cargo. Income from the carriage of cargo will be income derived from international operation of ships or aircraft if the cargo is carried between a beginning point in the United States and an ending point outside the United States, or vice versa. Carriage of cargo will be treated as ending at the final destination of the cargo even if, en route to that final destination, a stop is made at a U.S. intermediate point, provided the cargo is transported to its ultimate destination on the same ship or aircraft. If the cargo is transferred to another ship or aircraft, the carriage of the cargo may nevertheless be treated as ending at its final destination, if the same taxpayer transports the cargo to and from the U.S. intermediate point and the cargo does not pass through customs at the U.S. intermediate point. Similarly, carriage of cargo will be treated as beginning at the cargo's point of origin, even if en route to its final destination a stop is made at a U.S. intermediate point, provided the cargo is transported to its ultimate destination on the same ship or aircraft. If the cargo is transferred to another ship or aircraft at the U.S. intermediate point, the carriage of the cargo may nevertheless be treated as beginning at the point of origin, if the same taxpayer transports the cargo to and from the U.S. intermediate point and the cargo does not pass through customs at the U.S. intermediate point. Repackaging, recontainerization, or any other activity involving the unloading of the cargo at the U.S. intermediate point does not change these results, provided the same taxpayer transports the cargo to and from the U.S. intermediate point and the cargo does not pass through customs at the U.S. intermediate point. A lighter vessel that carries cargo to, or picks up cargo from, a vessel located beyond the territorial limits of the United States and correspondingly loads or unloads that cargo at a U.S. port, carries cargo between a point in the United States and a point outside the United States. However, a lighter vessel that carries cargo to, or picks up cargo from, a vessel located within the territorial limits of the United States, and correspondingly loads or unloads that cargo at a U.S. port, is not engaged in international operation of ships or aircraft. Income from the carriage of military cargo on a voyage that begins in the United States, stops at a foreign intermediate port or a military prepositioning location, and returns to the same or another U.S. port without unloading its cargo at the foreign intermediate point, will nevertheless be treated as derived from international operation of ships or aircraft.

(iii) Bareboat charter of ships or dry lease of aircraft used in international operation of ships or aircraft. If a qualified foreign corporation bareboat charters a ship or dry leases an aircraft to a lessee, and the lowest tier lessee in the chain of ownership uses such ship or aircraft for the international carriage of passengers or cargo for hire, as described in paragraphs (f)(2)(i) and (ii) of this section, then the amount of charter income attributable to the period the ship or aircraft is used by the lowest tier lessee is income from international operation of ships or aircraft. The foreign corporation generally must determine the amount of the charter income that is attributable to such international operation of ships or aircraft by multiplying the amount of charter income by a fraction, the numerator of which is the total number of days of uninterrupted travel on voyages or flights of such ship or aircraft between the United States and the farthest point or points where cargo or passengers are loaded en route to, or discharged en route from, the United States during the smaller of the taxable year or the particular charter period, and the denominator of which is the total number of days in the smaller of the taxable year or the particular charter period. For this purpose, the number of days during which the ship or aircraft is not generating transportation income, within the meaning of section 863(c)(2), are not included in the numerator or denominator of the fraction. However, the foreign corporation may adopt an alternative method for determining the amount of the charter income that is attributable to the international operation of ships or aircraft if it can establish that the alternative method more accurately reflects the amount of such income.

(iv) Charter of ships or aircraft for hire. For purposes of this section, if a foreign corporation time, voyage, or bareboat charters out a ship or aircraft, and the lowest-tier lessee uses the ship or aircraft to carry passengers or cargo on a fee basis, the ship or aircraft is considered used to carry passengers or cargo for hire, regardless of whether the ship or aircraft may be empty during a portion of the charter period due to a backhaul voyage or flight or for purposes of repositioning. If a foreign corporation time, voyage, or bareboat charters out a ship or aircraft, and the lowest-tier lessee uses the ship or aircraft for the carriage of proprietary goods, including an empty backhaul voyage or flight or repositioning related to such carriage of proprietary goods, the ship or aircraft similarly will be treated as used to carry cargo for hire.

(g) Activities incidental to the international operation of ships or aircraft—(1) General rule. Certain activities of a foreign corporation engaged in the international operation of ships or aircraft are so closely related to the international operation of ships or aircraft that they are considered incidental to such operation, and income derived by the foreign corporation from its performance of these incidental activities is deemed to be income derived from the international operation of ships or aircraft. Examples of such activities include—

(i) Temporary investment of working capital funds to be used in the international operation of ships or aircraft by the foreign corporation;

(ii) Sale of tickets by the foreign corporation engaged in the international operation of ships for the international carriage of passengers by ship on behalf of another corporation engaged in the international operation of ships;

(iii) Sale of tickets by the foreign corporation engaged in the international operation of aircraft for the international carriage of passengers by air on behalf of another corporation engaged in the international operation of aircraft;

(iv) Contracting with concessionaires for performance of services onboard during the international operation of the foreign corporation's ships or aircraft;

(v) Providing (either by subcontracting or otherwise) for the carriage of cargo preceding or following the international carriage of cargo under a through bill of lading, airway bill or similar document through a related corporation or through an unrelated person (and the rules of section 267(b) shall apply for purposes of determining whether a corporation or other person is related to the foreign corporation);

(vi) To the extent not described in paragraph (g)(1)(iii) of this section, the sale or issuance by the foreign corporation engaged in the international operation of aircraft of intraline, interline, or code-sharing tickets for the carriage of persons by air between a U.S. gateway and another U.S. city preceding or following international carriage of passengers, provided that all such flight segments are provided pursuant to the passenger's original invoice, ticket or itinerary and in the case of intraline tickets are a part of uninterrupted international air transportation (within the meaning of section 4262(c)(3));

(vii) Arranging for port city hotel accommodations within the United States for a passenger for the one night before or after the international carriage of that passenger by the foreign corporation engaged in the international operation of ships;

(viii) Bareboat charter of ships or dry lease of aircraft normally used by the foreign corporation in international operation of ships or aircraft but currently not needed, if the ship or aircraft is used by the lessee for international carriage of cargo or passengers;

(ix) Arranging by means of a space or slot charter for the carriage of cargo listed on a bill of lading or airway bill or similar document issued by the foreign corporation on the ship or aircraft of another corporation engaged in the international operation of ships or aircraft; and

(x) The provision of containers or other related equipment by the foreign corporation in connection with the international carriage of cargo for use by its customers, including short-term use within the United States immediately preceding or following the international carriage of cargo (and for this purpose, a period of five days or less shall be presumed to be short-term).

(2) Activities not considered incidental to the international operation of ships or aircraft. Examples of activities that are not considered incidental to the international operation of ships or aircraft include—

(i) The sale of or arranging for train travel, bus transfers, single day shore excursions, or land tour packages;

(ii) Arranging for hotel accommodations within the United States other than as provided in paragraph (g)(1)(vii) of this section;

(iii) The sale of airline tickets or cruise tickets other than as provided in paragraph (g)(1)(ii), (iii), or (vi) of this section;

(iv) The sale or rental of real property;

(v) Treasury activities involving the investment of excess funds or funds awaiting repatriation, even if derived from the international operation of ships or aircraft;

(vi) The carriage of passengers or cargo on ships or aircraft on domestic legs of transportation not treated as either international operation of ships or aircraft under paragraph (f) of this section or as an activity that is incidental to such operation under paragraph (g)(1) of this section;

(vii) The carriage of cargo by bus, truck or rail by a foreign corporation between a U.S. inland point and a U.S. gateway port or airport preceding or following the international carriage of such cargo by the foreign corporation; and

(viii) The provision of containers or other related equipment by the foreign corporation within the United States other than as provided in paragraph (g)(1)(x) of this section, including warehousing.

(3) Services—(i) Ground services, maintenance and catering. [Reserved]

(ii) Other services. [Reserved]

(4) Activities involved in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture. Notwithstanding paragraph (g)(1) of this section, an activity is considered incidental to the international operation of ships or aircraft by a foreign corporation, and income derived by the foreign corporation with respect to such activity is deemed to be income derived from the international operation of ships or aircraft, if the activity is performed by or pursuant to a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture in which such foreign corporation participates directly, or indirectly through a fiscally transparent entity under the income tax laws of the United States, provided that—

(i) Such activity is incidental to the international operation of ships or aircraft by the pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture, and provided that it is described in paragraph (e)(2)(i) of this section; or

(ii) Such activity would be incidental to the international operation of ships or aircraft by the foreign corporation, or fiscally transparent entity if it performed such activity itself, and provided the foreign corporation is engaged or the fiscally transparent entity would be considered engaged if it were a foreign corporation in the operation of ships or aircraft under paragraph (e)(1) of this section.

(h) Equivalent exemption—(1) General rule. A foreign country grants an equivalent exemption when it exempts from taxation income from the international operation of ships or aircraft derived by corporations organized in the United States. Whether a foreign country provides an equivalent exemption must be determined separately with respect to each category of income, as provided in paragraph (h)(2) of this section. An equivalent exemption may be available for income derived from the international operation of ships even though income derived from the international operation of aircraft may not be exempt, and vice versa. For rules regarding foreign corporations organized in countries that provide exemptions only through an income tax convention, see paragraph (h)(3) of this section. An equivalent exemption may exist where the foreign country—

(i) Generally imposes no tax on income, including income from the international operation of ships or aircraft;

(ii) Specifically provides a domestic law tax exemption for income derived from the international operation of ships or aircraft, either by statute, decree, or otherwise; or

(iii) Exchanges diplomatic notes with the United States, or enters into an agreement with the United States, that provides for a reciprocal exemption for purposes of section 883.

(2) Determining equivalent exemptions for each category of income. Whether a foreign country grants an equivalent exemption must be determined separately with respect to income from the international operation of ships and income from the international operation of aircraft for each category of income listed in paragraphs (h)(2)(i) through (v), (vii), and (viii) of this section. If an exemption is unavailable in the foreign country for a particular category of income, the foreign country is not considered to grant an equivalent exemption with respect to that category of income. Income in that category is not considered to be the subject of an equivalent exemption and, thus, is not eligible for exemption from income tax in the United States, even though the foreign country may grant an equivalent exemption for other categories of income. With respect to paragraph (h)(2)(vi) of this section, a foreign country may be considered to grant an equivalent exemption for one or more types of income described in paragraph (g)(1) of this section. The following categories of income derived from the international operation of ships or aircraft may be exempt from United States income tax if an equivalent exemption is available—

(i) Income from the carriage of passengers and cargo;

(ii) Time or voyage (full) charter income of a ship or wet lease income of an aircraft;

(iii) Bareboat charter income of a ship or dry charter income of an aircraft;

(iv) Incidental bareboat charter income or incidental dry lease income;

(v) Incidental container-related income;

(vi) Income incidental to the international operation of ships or aircraft other than incidental income described in paragraphs (h)(2)(iv) and (v) of this section;

(vii) Capital gains derived by a qualified foreign corporation engaged in the international operation of ships or aircraft from the sale, exchange or other disposition of a ship, aircraft, container or related equipment or other moveable property used by that qualified foreign corporation in the international operation of ships or aircraft; and

(viii) Income from participation in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement, international operating agency, or other joint venture described in paragraph (e)(2) of this section.

(3) Special rules with respect to income tax conventions— (i) General rule. Except as provided in paragraph (h)(3)(ii) of this section, if a corporation is organized in a foreign country that provides an exemption only through an income tax convention with the United States, the foreign corporation is not organized in a foreign country that grants an equivalent exemption. Rather, the foreign corporation must satisfy the terms of that convention to receive a benefit under the convention, and the foreign corporation may not claim an exemption under section 883. If the corporation is organized in a foreign country that offers an exemption under an income tax convention and also by some other means, such as by diplomatic note or domestic statutory law, the foreign corporation may choose annually whether to claim an exemption under section 883 based upon the equivalent exemption provided by such other means or under the income tax convention. However, if a corporation chooses to claim an exemption under an income tax convention under the preceding sentence, it may simultaneously claim an exemption under section 883 with respect to any category of income listed in paragraphs (h)(2)(i) through (v), (vii), and (viii) of this section and to any type of income described in paragraph (h)(2)(vi) of this section, but only to the extent that such income also is exempt under the income tax convention. Any such choice will apply with respect to all qualified income of the corporation from the international operation of ships or aircraft and cannot be made separately with respect to different categories of such income. If a foreign corporation bases its claim for an exemption on section 883, the foreign corporation must satisfy all of the requirements of this section to qualify for an exemption from U.S. income tax. See §1.883-4(b)(3) for rules regarding satisfying the ownership test of paragraph (c)(2) of this section using shareholders resident in a foreign country that offers an exemption under an income tax convention.

(ii) Participation in certain joint ventures. Notwithstanding paragraph (h)(3)(i) of this section, if a corporation is organized in a foreign country that provides an exemption only through an income tax convention with the United States, the foreign corporation will be treated as organized in a foreign country that grants an equivalent exemption under section 883 with respect to a category of income derived through participation, directly or indirectly, in a pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture described in paragraph (e)(2) of this section, but only where treaty benefits would be available under the treaty but for the treatment of the pool, partnership, strategic alliance, joint operating agreement, code-sharing arrangement or other joint venture as not fiscally transparent with respect to that category of income under the income tax laws of the foreign country in which the foreign corporate interest holder is organized for purposes of §1.894-1(d)(3)(iii)(A).

(iii) Independent interpretation of income tax conventions. Nothing in this section and §§1.883-2 through 1.883-5 affects the rights or obligations under any income tax convention. The definitions provided in this section and §§1.883-2 through 1.883-5 shall neither give meaning to similar terms used in income tax conventions nor provide guidance regarding the scope of any exemption provided by such conventions, unless an income tax convention that entered into force after August 26, 2003, or its legislative history explicitly refers to section 883 and guidance thereunder for its meaning.

(4) Exemptions not qualifying as equivalent exemptions—(i) General rule. Certain types of exemptions provided to corporations organized in the United States by foreign countries do not satisfy the equivalent exemption requirements of this section. Paragraphs (h)(4)(ii) through (vii) of this section provide descriptions of some of the types of exemptions that do not qualify as equivalent exemptions for purposes of this section.

(ii) Reduced tax rate or time limited exemption. The exemption granted by the foreign country's law or income tax convention must be a complete exemption. The exemption may not constitute merely a reduction to a nonzero rate of tax levied against the income of corporations organized in the United States derived from the international operation of ships or aircraft or a temporary reduction to a zero rate of tax, such as in the case of a tax holiday.

(iii) Inbound or outbound freight tax. With respect to the carriage of cargo, the foreign country must provide an exemption from tax for income from transporting freight both inbound and outbound. For example, a foreign country that imposes tax only on outbound freight will not be treated as granting an equivalent exemption for income from transporting freight inbound into that country.

(iv) Exemptions for limited types of cargo. A foreign country must provide an exemption from tax for income from transporting all types of cargo. For example, if a foreign country were generally to impose tax on income from the international carriage of cargo but were to provide a statutory exemption for income from transporting agricultural products, the foreign country would not be considered to grant an equivalent exemption with respect to income from the international carriage of cargo, including agricultural products.

(v) Territorial tax systems. A foreign country with a territorial tax system will be treated as granting an equivalent exemption if it treats all income derived from the international operation of ships or aircraft derived by a U.S. corporation as entirely foreign source and therefore not subject to tax, including income derived from a voyage or flight that begins or ends in that foreign country.

(vi) Countries that tax on a residence basis. A foreign country that provides an equivalent exemption to corporations organized in the United States but also imposes a residence-based tax on certain corporations organized in the United States may nevertheless be considered to grant an equivalent exemption if the residence-based tax is imposed only on a corporation organized in the United States that maintains its center of management and control or other comparable attributes in that foreign country. If the residence-based tax is imposed on corporations organized in the United States and engaged in the international operation of ships or aircraft that are not managed and controlled in that foreign country, the foreign country shall not be treated as a qualified foreign country and shall not be considered to grant an equivalent exemption for purposes of this section.

(vii) Exemptions within categories of income. With respect to paragraphs (h)(2)(i) through (v), (vii), and (viii) of this section, a foreign country must provide an exemption from tax for all income in a category of income, as defined in paragraph (h)(2) of this section. For example, a country that exempts income from the bareboat charter of passenger aircraft but not the bareboat charter of cargo aircraft does not provide an equivalent exemption. However, an equivalent exemption may be available for income derived from the international operation of ships even though income derived from the international operation of aircraft may not be exempt, and vice versa. With respect to paragraph (h)(2)(vi) of this section, a foreign country may be considered to grant an equivalent exemption for one or more types of income described in paragraph (g)(1) of this section.

(i) Treatment of possessions. For purposes of this section, a possession of the United States will be treated as a foreign country. A possession of the United States will be considered to grant an equivalent exemption and will be treated as a qualified foreign country if it applies a mirror system of taxation. If a possession does not apply a mirror system of taxation, the possession may nevertheless be a qualified foreign country if, for example, it provides for an equivalent exemption through its internal law. A possession applies the mirror system of taxation if the U.S. Internal Revenue Code of 1986, as amended, applies in the possession with the name of the possession used instead of “United States” where appropriate.

(j) Expenses related to qualified income. If a qualified foreign corporation derives qualified income from the international operation of ships or aircraft as well as income that is not qualified income, and the nonqualified income is effectively connected with the conduct of a trade or business within the United States, the foreign corporation may not deduct from such nonqualified income any amount otherwise allowable as a deduction from qualified income, if that qualified income is excluded under this section. See section 265(a)(1).

Par. 4. Sections 1.883-2 through 1.883-5 are added to read as follows:

§1.883-2 Treatment of publicly-traded corporations. (a) General rule. A foreign corporation satisfies the stock ownership test of §1.883-1(c)(2) if it is considered a publicly-traded corporation and satisfies the substantiation and reporting requirements of paragraphs (e) and (f) of this section. To be considered a publicly-traded corporation, the stock of the foreign corporation must be primarily traded and regularly traded, as defined in paragraphs (c) and (d) of this section, respectively, on one or more established securities markets, as defined in paragraph (b) of this section, in either the United States or any qualified foreign country.

(b) Established securities market—(1) General rule. For purposes of this section, the term established securities market means, for any taxable year—

(i) A foreign securities exchange that is officially recognized, sanctioned, or supervised by a governmental authority of the qualified foreign country in which the market is located, and has an annual value of shares traded on the exchange exceeding $1 billion during each of the three calendar years immediately preceding the beginning of the taxable year;

(ii) A national securities exchange that is registered under section 6 of the Securities Act of 1934 (15 U.S.C. 78f);

(iii) A United States over-the-counter market, as defined in paragraph (b)(4) of this section;

(iv) Any exchange designated under a Limitation on Benefits article in a United States income tax convention; and

(v) Any other exchange that the Secretary may designate by regulation or otherwise.

(2) Exchanges with multiple tiers. If an exchange in a foreign country has more than one tier or market level on which stock may be separately listed or traded, each such tier shall be treated as a separate exchange.

(3) Computation of dollar value of stock traded. For purposes of paragraph (b)(1)(i) of this section, the value in U.S. dollars of shares traded during a calendar year shall be determined on the basis of the dollar value of such shares traded as reported by the International Federation of Stock Exchanges located in Paris, or, if not so reported, then by converting into U.S. dollars the aggregate value in local currency of the shares traded using an exchange rate equal to the average of the spot rates on the last day of each month of the calendar year.

(4) Over-the-counter market. An over-the-counter market is any market reflected by the existence of an interdealer quotation system. An interdealer quotation system is any system of general circulation to brokers and dealers that regularly disseminates quotations of stocks and securities by identified brokers or dealers, other than by quotation sheets that are prepared and distributed by a broker or dealer in the regular course of business and that contain only quotations of such broker or dealer.

(5) Discretion to determine that an exchange does not qualify as an established securities market. The Commissioner may determine that a securities exchange that otherwise meets the requirements of paragraph (b) of this section does not qualify as an established securities market, if—

(i) The exchange does not have adequate listing, financial disclosure, or trading requirements (or does not adequately enforce such requirements); or

(ii) There is not clear and convincing evidence that the exchange ensures the active trading of listed stocks.

(c) Primarily traded. For purposes of this section, stock of a corporation is primarily traded in a country on one or more established securities markets, as defined in paragraph (b) of this section, if, with respect to each class of stock described in paragraph (d)(1)(i) of this section (relating to classes of stock relied on to meet the regularly traded test)—

(1) The number of shares in each such class that are traded during the taxable year on all established securities markets in that country exceeds

(2) The number of shares in each such class that are traded during that year on established securities markets in any other single country.

(d) Regularly traded—(1) General rule. For purposes of this section, stock of a corporation is regularly traded on one or more established securities markets, as defined in paragraph (b) of this section, if—

(i) One or more classes of stock of the corporation that, in the aggregate, represent more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote and of the total value of the stock of such corporation are listed on such market or markets during the taxable year; and

(ii) With respect to each class relied on to meet the more than 50 percent requirement of paragraph (d)(1)(i) of this section—

(A) Trades in each such class are effected, other than in de minimis quantities, on such market or markets on at least 60 days during the taxable year (or 1/6 of the number of days in a short taxable year); and

(B) The aggregate number of shares in each such class that are traded on such market or markets during the taxable year are at least 10 percent of the average number of shares outstanding in that class during the taxable year (or, in the case of a short taxable year, a percentage that equals at least 10 percent of the average number of shares outstanding in that class during the taxable year multiplied by the number of days in the short taxable year, divided by 365).

(2) Classes of stock traded on a domestic established securities market treated as meeting trading requirements. A class of stock that is traded during the taxable year on an established securities market located in the United States shall be considered to meet the trading requirements of paragraph (d)(1)(ii) of this section if the stock is regularly quoted by dealers making a market in the stock. A dealer makes a market in a stock only if the dealer regularly and actively offers to, and in fact does, purchase the stock from, and sell the stock to, customers who are not related persons (as defined in section 954(d)(3)) with respect to the dealer in the ordinary course of a trade or business.

(3) Closely-held classes of stock not treated as meeting trading requirements—(i) General rule. Except as provided in paragraph (d)(3)(ii) of this section, a class of stock of a foreign corporation that otherwise meets the requirements of paragraph (d)(1) or (2) of this section shall not be treated as meeting such requirements for a taxable year if, for more than half the number of days during the taxable year, one or more persons who own at least 5 percent of the vote and value of the outstanding shares of the class of stock, as determined under paragraph (d)(3)(iii) of this section (each a 5-percent shareholder), own, in the aggregate, 50 percent or more of the vote and value of the outstanding shares of the class of stock. If one or more 5-percent shareholders own, in the aggregate, 50 percent or more of the vote and value of the outstanding shares of the class of stock, such shares held by the 5-percent shareholders will constitute a closely-held block of stock.

(ii) Exception. Paragraph (d)(3)(i) of this section shall not apply to a class of stock if the foreign corporation can establish that qualified shareholders, as defined in §1.883-4(b), applying the attribution rules of §1.883-4(c), own sufficient shares in the closely-held block of stock to preclude nonqualified shareholders in the closely-held block of stock from owning 50 percent or more of the total value of the class of stock of which the closely-held block is a part for more than half the number of days during the taxable year. Any shares that are owned, after application of the attribution rules in §1.883-4(c), by a qualified shareholder shall not also be treated as owned by a nonqualified shareholder in the chain of ownership for purposes of the preceding sentence. A foreign corporation must obtain the documentation described in §1.883-4(d) from the qualified shareholders relied upon to satisfy this exception. However, no person shall be treated for purposes of this paragraph (d)(3) as a qualified shareholder if such person holds an interest in the class of stock directly or indirectly through bearer shares.

(iii) Five-percent shareholders—(A) Related persons. Solely for purposes of determining whether a person is a 5-percent shareholder, persons related within the meaning of section 267(b) shall be treated as one person. In determining whether two or more corporations are members of the same controlled group under section 267(b)(3), a person is considered to own stock owned directly by such person, stock owned through the application of section 1563(e)(1), and stock owned through the application of section 267(c). In determining whether a corporation is related to a partnership under section 267(b)(10), a person is considered to own the partnership interest owned directly by such person and the partnership interest owned through the application of section 267(e)(3).

(B) Investment companies. For purposes of this paragraph (d)(3), an investment company registered under the Investment Company Act of 1940, as amended (54 Stat. 789), shall not be treated as a 5-percent shareholder.

(4) Anti-abuse rule. Trades between or among related persons described in section 267(b), as modified by paragraph (d)(3)(iii) of this section, and trades conducted in order to meet the requirements of paragraph (d)(1) of this section shall be disregarded. A class of stock shall not be treated as meeting the trading requirements of paragraph (d)(1) of this section if there is a pattern of trades conducted to meet the requirements of that paragraph. For example, trades between two persons that occur several times during the taxable year may be treated as an arrangement or a pattern of trades conducted to meet the trading requirements of paragraph (d)(1)(ii) of this section.

(5) Example. The closely-held test in paragraph (d)(3) of this section is illustrated by the following example:

Example. Closely-held exception—(i) Facts. X is a foreign corporation organized in a qualified foreign country and engaged in the international operation of ships. X has one class of stock, which is primarily traded on an established securities market in the qualified foreign country. The stock of X meets the regularly traded requirements of paragraph (d)(1)(ii) of this section without regard to paragraph (d)(3)(i) of this section. A, B, C and D are four members of the corporation's founding family who each own, during the entire taxable year, 25 percent of the stock of Hold Co, a company that issues registered shares. Hold Co, in turn, owns 60 percent of the stock of X during the entire taxable year. The remaining 40 percent of the stock of X is not owned by any 5-percent shareholder, as determined under paragraph (d)(3)(iii) of this section. A, B, and C are not residents of a qualified foreign country, but D is a resident of a qualified foreign country.

(ii) Analysis. Because Hold Co owns 60 percent of the stock of X for more than half the number of days during the taxable year, Hold Co is a 5-percent shareholder that owns 50 percent or more of the value of the stock of X. Thus, the shares owned by Hold Co constitute a closely-held block of stock. Under paragraph (d)(3)(i) of this section, the stock of X will not be regularly traded within the meaning of paragraph (d)(1) of this section unless X can establish, under paragraph (d)(3)(ii) of this section, that qualified shareholders within the closely-held block of stock own sufficient shares in the closely-held block of stock to preclude nonqualified shareholders in the closely-held block of stock from owning 50 percent or more of the value of the outstanding shares in the class of stock for more than half the number of days during the taxable year. A, B, and C are not qualified shareholders within the meaning of §1.883-4(b) because they are not residents of a qualified foreign country, but D is a resident of a qualified foreign country and therefore is a qualified shareholder. D owns 15 percent of the outstanding shares of X through Hold Co (25 percent x 60 percent = 15 percent) while A, B, and C in the aggregate own 45 percent of the outstanding shares of X through Hold Co. D, therefore, owns sufficient shares in the closely-held block of stock to preclude the nonqualified shareholders in the closely-held block of stock, A, B and C, from owning 50 percent or more of the value of the class of stock (60 percent - 15 percent = 45 percent) of which the closely-held block is a part. Provided that X obtains from D the documentation described in §1.883-4(d), X's sole class of stock meets the exception in paragraph (d)(3)(ii) of this section and will not be disqualified from the regularly traded test by virtue of paragraph (d)(3)(i) of this section.

(e) Substantiation that a foreign corporation is publicly traded—(1) General rule. A foreign corporation that relies on the publicly traded test of this section to meet the stock ownership test of §1.883-1(c)(2) must substantiate that the stock of the foreign corporation is primarily and regularly traded on one or more established securities markets, as that term is defined in paragraph (b) of this section. If one of the classes of stock on which the foreign corporation relies to meet this test is closely-held within the meaning of paragraph (d)(3)(i) of this section, the foreign corporation must obtain an ownership statement described in §1.883-4(d) from each qualified shareholder and intermediary that it relies upon to satisfy the exception to the closely-held test, but only to the extent such statement would be required if the foreign corporation were relying on the qualified shareholder stock ownership test of §1.883-4 with respect to those shares of stock. The foreign corporation must also maintain and provide to the Commissioner upon request a list of its shareholders of record and any other relevant information known to the foreign corporation supporting its entitlement to an exemption under this section.

(2) Availability and retention of documents for inspection. The documentation described in paragraph (e)(1) of this section must be retained by the corporation seeking qualified foreign corporation status until the expiration of the statute of limitations for the taxable year of the foreign corporation to which the documentation relates. Such documentation must be made available for inspection by the Commissioner at such time and such place as the Commissioner may request in writing.

(f) Reporting requirements. A foreign corporation relying on this section to satisfy the stock ownership test of §1.883-1(c)(2) must provide the following information in addition to the information required in §1.883-1(c)(3) to be included in its Form 1120-F, “U.S. Income Tax Return of a Foreign Corporation,” for the taxable year. The information must be current as of the end of the corporation's taxable year and must include the following—

(1) The name of the country in which the stock is primarily traded;

(2) The name of the established securities market or markets on which the stock is listed;

(3) A description of each class of stock relied upon to meet the requirements of paragraph (d) of this section, including the number of shares issued and outstanding as of the close of the taxable year;

(4) For each class of stock relied upon to meet the requirements of paragraph (d) of this section, if one or more 5-percent shareholders, as defined in paragraph (d)(3)(i) of this section, own in the aggregate 50 percent or more of the vote and value of the outstanding shares of that class of stock for more than half the number of days during the taxable year—

(i) The days during the taxable year of the corporation in which the stock was closely-held without regard to the exception in paragraph (d)(3)(ii) of this section and the percentage of the vote and value of the class of stock that is owned by 5-percent shareholders during such days;

(ii) For each qualified shareholder who owns or is treated as owning stock in the closely-held block upon whom the corporation intends to rely to satisfy the exception to the closely-held test of paragraph (d)(3)(ii) of this section—

(A) The name of each such shareholder;

(B) The percentage of the total value of the class of stock held by each such shareholder and the days during which the stock was held;

(C) The address of record of each such shareholder; and

(D) The country of residence of each such shareholder, determined under §1.883-4(b)(2) (residence of individual shareholders) or §1.883-4(d)(3) (special rules for residence of certain shareholders); and

(5) Any other relevant information specified by Form 1120-F and its accompanying instructions.

§1.883-3 Treatment of controlled foreign corporations. (a) General rule. A foreign corporation satisfies the stock ownership test of §1.883-1(c)(2) if it is a controlled foreign corporation (CFC), as defined in section 957(a), and satisfies the income inclusion test in paragraph (b) of this section and the substantiation and reporting requirements of paragraphs (c) and (d) of this section, respectively. A CFC that fails the income inclusion test of paragraph (b) of this section will not be a qualified foreign corporation unless it meets either the publicly traded test of §1.883-2(a) or the qualified shareholder stock ownership test of §1.883-4(a).

(b) Income inclusion test—(1) General rule. A CFC shall not be considered to satisfy the requirements of paragraph (a) of this section unless more than 50 percent of the CFC's adjusted net foreign base company income (as defined in §1.954-1(d) and as increased or decreased by section 952(c)) derived from the international operation of ships or aircraft is includible in the gross income of one or more United States citizens, individual residents of the United States or domestic corporations, pursuant to section 951(a)(1)(A) or another provision of the Internal Revenue Code, for the taxable years of such persons in which the taxable year of the CFC ends.

(2) Examples. The income inclusion test of paragraph (b)(1) of this section is illustrated in the following examples:

Example 1. Ship Co is a CFC organized in a qualified foreign country. All of Ship Co's income is foreign base company shipping income that is derived from the international operation of ships. All of its shares are owned by a domestic partnership that is a United States shareholder for purposes of section 951(b). All of the partners in the domestic partnership are citizens and residents of foreign countries. Ship Co fails the income inclusion test of paragraph (b)(1) of this section because no amount of Ship Co's subpart F income that is adjusted net foreign base company income derived from the international operation of ships is includible under any provision of the Internal Revenue Code in the gross income of one or more United States citizens, individual residents of the United States or domestic corporations. Therefore, Ship Co must satisfy the qualified shareholder stock ownership test of §1.883-4(a), in order to satisfy the stock ownership test of §1.883-1(c)(2) and to be considered a qualified foreign corporation.

Example 2. Ship Co is a CFC organized in a qualified foreign country. All of Ship Co's income is foreign base company shipping income that is derived from the international operation of ships. Corp A, a domestic corporation, owns 50 percent of the value of the stock of Ship Co. X, a domestic partnership, owns the remaining 50 percent of the value of the stock of Ship Co. A United States citizen is a partner owning a 10 percent income interest in X. Individual partners owning 90 percent of X are citizens and residents of foreign countries. There are no special allocations of partnership income. Ship Co satisfies the income inclusion test of paragraph (b)(1) of this section because 55 percent (50 percent + (10 percent x 50 percent)) of the subpart F income that is adjusted net foreign base company income derived from the international operation of ships would be includible in the gross income of U.S. citizens, individual residents of the United States or domestic corporations. If Ship Co satisfies the substantiation and reporting requirements of paragraphs (c) and (d) of this section, it will meet the stock ownership test of §1.883-1(c)(2).

(c) Substantiation of CFC stock ownership—(1) General rule. A foreign corporation that relies on this section to satisfy the stock ownership test of §1.883-1(c)(2) must substantiate all the facts necessary to satisfy the Commissioner that it qualifies under the income inclusion test of paragraph (b)(1) of this section. For purposes of the income inclusion test, if the CFC has one or more United States shareholders, as defined in section 951(b), that are domestic partnerships, estates, or trusts, the pro rata share of the subpart F income includible in the gross income of such shareholders will only be treated as includible in the income of any partner, beneficiary or other interest owner of such United States shareholder that is a United States citizen, resident of the United States or a domestic corporation if the CFC obtains the documentation described in paragraph (c)(2) of this section.

(2) Documentation from certain United States shareholders—(i) General rule. A CFC only meets the documentation requirements of paragraph (c)(1) of this section if the CFC obtains the following documentation with respect to each United States shareholder, as defined in section 951(b), that is a partnership, estate or trust, for the taxable year of the shareholder which ends with or within the taxable year of the CFC—

(A) A copy of the Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations,” filed with the controlling United States shareholder's return;

(B) A written statement, signed under penalties of perjury by a person authorized to sign the U.S. federal tax return of each such United States shareholder, providing the following information with respect to each United States citizen, individual resident of the United States or domestic corporation that is a partner, beneficiary or other interest owner of each such United States shareholder and upon whom the CFC intends to rely to satisfy the income inclusion test of paragraph (b)(1) of this section—

(1) The name, address from the CFC's corporate records (that is a specific street address and not a nonresidential address, such as a post office box or in care of a financial intermediary or stock transfer agent), and taxpayer identification number of the interest owner;

(2) The interest owner's proportionate interest in the United States shareholder that reflects that owner's share of subpart F income required to be included in income on such interest owner's U.S. federal income tax return;

(3) The percentage of the value of shares of the CFC owned by each such interes