SECTION 2. BACKGROUND

Section 951(a)(1) provides that if a foreign corporation is a CFC for an uninterrupted period of 30 days or more during any taxable year, every person who is a United States shareholder of such corporation and who owns stock in such corporation on the last day, in such year, on which such corporation is a CFC shall include in its gross income, for its taxable year in which or with which such taxable year of the corporation ends, its pro rata share of the corporation’s subpart F income for such year.

Section 957(a) defines a CFC as any foreign corporation if more than 50 percent of the total combined voting power of all classes of stock of such corporation entitled to vote, or more than 50 percent of the total value of the stock of such corporation, is owned (within the meaning of section 958(a)), or is considered as owned by applying the rules of ownership of section 958(b), by United States shareholders on any day during the taxable year of such corporation. Section 951(b) defines a United States shareholder as a United States person who owns (within the meaning of section 958(a)), or is considered as owning by applying the rules of ownership of section 958(b), 10 percent or more of the total combined voting power of all classes of stock entitled to vote of such foreign corporation.

Section 952(a)(2) provides that subpart F income includes foreign base company income (FBCI). Subject to certain exceptions, section 954(a)(1) provides that FBCI includes foreign personal holding company income (FPHCI) for the taxable

year. Section 954(c)(1)(A) provides that FPHCI includes dividends, interest, royalties, rents, and annuities. Section 954(c) also provides special rules and exceptions to the definition of FPHCI ( e.g., sections 954(c)(2) and (3)). Section 103(b) of the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) (P.L. 109–222), enacted on May 17, 2006, added section 954(c)(6) to the Code. Section 426(a) of Division A of the Tax Relief and Health Care Act of 2006 (P.L. 109–432), enacted on December 20, 2006, made technical corrections to section 954(c)(6).

Section 954(c)(6)(A) provides that for purposes of section 954(c), dividends, interest, rents, and royalties received or accrued from a CFC which is a related person shall not be treated as FPHCI to the extent attributable or properly allocable (determined under rules similar to the rules of subparagraphs (C) and (D) of section 904(d)(3)) to income of the related person which is neither subpart F income nor ECI (section 954(c)(6) exception). For this purpose, interest includes factoring income which is treated as income equivalent to interest for purposes of section 954(c)(1)(E). Section 954(c)(6)(A) also provides that the Secretary shall prescribe such regulations as may be necessary or appropriate to carry out the provision, including regulations to prevent the abuse of the purposes of the provision.

Section 954(c)(6)(B) provides that subparagraph (A) applies to taxable years of foreign corporations beginning after December 31, 2005, and before January 1, 2009, and to taxable years of United States shareholders with or within which such taxable years of the foreign corporations end.

For purposes of section 954(c)(6), a related person has the meaning provided in section 954(d)(3) and Treas. Reg. § 1.954–1(f). The CFCs must be related persons only at the time the particular dividend, interest, rent, or royalty in question is received or accrued. The section 954(c)(6) exception is not elective, and so applies to all covered transactions.