Affirmative Use of U.S. Partnerships in Inbound Tax Planning

by Bilzin Sumberg

A “U.S. shareholder” of a controlled foreign corporation (CFC) is required to include in its gross income its pro rata share of a CFC’s “subpart F” income, regardless of whether such income is distributed.  In general, a CFC is a foreign corporation that is more than 50 percent owned (directly, indirectly or constructively) by “U.S. shareholders.”  Subpart F income includes most forms of passive income (e.g., interest, dividends, royalties, capital gains, etc.), as well as income from related party sales and service transactions that have little, if any, connection with the CFC’s country of incorporation.

Under Sections 951(b), 957(c) and 7701(a)(4) of the Internal Revenue Code (the “Code”), a U.S. partnership (including a U.S. LLC taxed as a partnership) is treated as a “U.S. shareholder” for subpart F purposes, even if all of its partners are foreign persons that are not subject to U.S. federal income tax.  The IRS has never challenged this position.  In fact, the IRS has indicated on more than one occasion that no consideration has ever been given to requiring a foreign person to include in its income any portion of the subpart F income passing through a U.S. partnership. See 1995 FSA Lexis 496 (March 17, 1995) and 1995 FSA Lexis 131 (March 17, 1995).

Therefore, the receipt of passive income (e.g., interest) by a foreign corporation that is more than 50 percent owned by a U.S. partnership, will give rise to subpart F income that is includible in the gross income of a U.S. shareholder of a CFC (i.e., the U.S. partnership), even though no U.S. person actually will be subject to U.S. federal income tax on that income.  While the IRS has challenged the affirmative use of U.S. partnerships in the outbound context when the foreign partners themselves are CFCs with U.S. shareholders that are subject to U.S. federal income tax (see IRS Notices 2010-41 and 2009-7), the IRS has never challenged the use of a U.S. partnership for the sole purpose of creating a CFC in the inbound context.

Planning Opportunities

This disparity in treatment may lead to a number of interesting tax planning opportunities when structuring inbound investments into the United States.

Section 163(j) Interest Stripping Rules

For example, if a U.S. corporation’s debt-to-equity ratio exceeds 1.5 to 1, Section 163(j) limits a U.S. corporation’s interest deductions to 50 percent of its taxable income where, (i) the interest is paid to a related foreign person and (ii) no (or reduced) U.S. withholding tax is imposed on such payment.  Under Proposed Regulation Section 1.163(j)-4, however, a payment of interest that is exempt from U.S. withholding tax (for example, either under the portfolio interest exception or pursuant to an income tax treaty) is deemed to be subject to tax, and therefore not subject to Section 163(j), to the extent the interest results in an inclusion in the gross income of a U.S. shareholder of a CFC for subpart F purposes.

As noted above, a U.S. partnership is treated as a U.S. shareholder under the subpart F rules, even if all of its partners are foreign persons.  Therefore, interest paid by a U.S. corporation to a foreign corporation that is owned by a U.S. partnership that has exclusively foreign partners, all of which are exempt from U.S. federal income tax, will not be subject to Section 163(j).

This opportunity may be useful in hedge fund or private equity fund structures that have a foreign feeder and use a U.S. corporation as a blocker corporation.  Instead of the foreign investors investing through an entity taxed as a foreign partnership, the foreign investors could invest in an entity taxed as a U.S. partnership and potentially avoid the limitations imposed by Section 163(j).

Section 267(a)(3) Accruals to Related Foreign Persons

Section 267(a)(3) prevents a U.S. corporation from currently deducting an amount accrued to a related foreign person until the amount actually is paid.  An exception is provided, however, that allows a corporation to deduct the amount accrued in a taxable year prior to the year of payment where the amount accrued is includible in the gross income of a U.S. person who owns stock in a CFC.

Therefore, similar to the opportunity mentioned above, a U.S. corporation potentially can deduct an amount accrued to a related foreign person in a taxable year prior to payment, where the related foreign person is a CFC solely because it is owned by a U.S. partnership that has exclusively foreign partners that are not subject to U.S. federal income tax.

Converting Foreign Source ECI into Subpart F Income

While foreign corporations are generally not subject to U.S. federal income tax, they are subject to tax like a U.S. corporation on any income effectively connected to a U.S. trade or business (otherwise known as ECI).  Although this rule typically applies only to U.S.-source ECI, there are certain categories of foreign-source income that can be treated as ECI under Section 864(c)(4)(B).

If, however, the foreign corporation is a CFC and the foreign-source ECI also gives rise to subpart F income (which it likely would), the subpart F rules will trump the ECI rules,  regardless of whether any amount is taxable in the hands of a U.S. person.  Regulation Section 1.864-5(d)(2), example 1.  Accordingly, it may be possible for a foreign corporation that is owned by foreign persons and that is subject to U.S. federal income tax on foreign-source ECI to interpose a U.S. partnership in between the corporation and its foreign shareholders to take advantage of the CFC trumping rule, without actually triggering any U.S. federal income tax.

Avoiding Taxable Dividend  

Under Section 332(d), a liquidating distribution to a foreign corporation of an “applicable holding company” is treated as a dividend (rather than non-taxable income) that generally will be subject to a 30 percent U.S. withholding tax.  In general, an applicable holding company is a domestic corporation that (i) has been in existence for less than 5 years and (ii) substantially all of its assets consist of stock in other members of an affiliated group.  An exception exists, however, if the foreign corporation is a CFC.  In this situation, the liquidating distribution generally will be exempt from U.S. withholding tax.  Therefore, it may be possible to convert taxable dividend income into a non-taxable distribution by interposing a U.S. partnership in between the foreign corporation and its shareholders to cause such foreign corporation to be characterized as a CFC.

Can the IRS Challenge These Structures?

If the IRS were to challenge the use of U.S. partnerships in these situations, it would seem that the most likely scenario would be an attack under the partnership anti-abuse rules.  It is interesting to note, however, that in Notice 2010-41 decided against the use of these provisions, but instead selectively chose to treat the U.S. partnership as a foreign partnership to prevent the purported abuse.  This may be because the partnership anti-abuse rules themselves contain an example that approves the interposition of a U.S. partnership in between the shareholders and a foreign corporation for the sole purpose of converting the foreign corporation into a CFC, which would allow the shareholders to take advantage of more favorable foreign tax credit provisions.  Regulation Section 1.701-2(f), example 3.

Other possible avenues of attack include the use of judicial doctrines, such as substance over form, sham transaction and economic substance.  However, those arguments typically are much more difficult to sustain.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

© Bilzin Sumberg | Attorney Advertising

Written by:

Bilzin Sumberg

Bilzin Sumberg on:

Readers' Choice 2017
Reporters on Deadline

"My best business intelligence, in one easy email…"

Your first step to building a free, personalized, morning email brief covering pertinent authors and topics on JD Supra:
Sign up using*

Already signed up? Log in here

*By using the service, you signify your acceptance of JD Supra's Privacy Policy.
Custom Email Digest
Privacy Policy (Updated: October 8, 2015):

JD Supra provides users with access to its legal industry publishing services (the "Service") through its website (the "Website") as well as through other sources. Our policies with regard to data collection and use of personal information of users of the Service, regardless of the manner in which users access the Service, and visitors to the Website are set forth in this statement ("Policy"). By using the Service, you signify your acceptance of this Policy.

Information Collection and Use by JD Supra

JD Supra collects users' names, companies, titles, e-mail address and industry. JD Supra also tracks the pages that users visit, logs IP addresses and aggregates non-personally identifiable user data and browser type. This data is gathered using cookies and other technologies.

The information and data collected is used to authenticate users and to send notifications relating to the Service, including email alerts to which users have subscribed; to manage the Service and Website, to improve the Service and to customize the user's experience. This information is also provided to the authors of the content to give them insight into their readership and help them to improve their content, so that it is most useful for our users.

JD Supra does not sell, rent or otherwise provide your details to third parties, other than to the authors of the content on JD Supra.

If you prefer not to enable cookies, you may change your browser settings to disable cookies; however, please note that rejecting cookies while visiting the Website may result in certain parts of the Website not operating correctly or as efficiently as if cookies were allowed.

Email Choice/Opt-out

Users who opt in to receive emails may choose to no longer receive e-mail updates and newsletters by selecting the "opt-out of future email" option in the email they receive from JD Supra or in their JD Supra account management screen.


JD Supra takes reasonable precautions to insure that user information is kept private. We restrict access to user information to those individuals who reasonably need access to perform their job functions, such as our third party email service, customer service personnel and technical staff. However, please note that no method of transmitting or storing data is completely secure and we cannot guarantee the security of user information. Unauthorized entry or use, hardware or software failure, and other factors may compromise the security of user information at any time.

If you have reason to believe that your interaction with us is no longer secure, you must immediately notify us of the problem by contacting us at In the unlikely event that we believe that the security of your user information in our possession or control may have been compromised, we may seek to notify you of that development and, if so, will endeavor to do so as promptly as practicable under the circumstances.

Sharing and Disclosure of Information JD Supra Collects

Except as otherwise described in this privacy statement, JD Supra will not disclose personal information to any third party unless we believe that disclosure is necessary to: (1) comply with applicable laws; (2) respond to governmental inquiries or requests; (3) comply with valid legal process; (4) protect the rights, privacy, safety or property of JD Supra, users of the Service, Website visitors or the public; (5) permit us to pursue available remedies or limit the damages that we may sustain; and (6) enforce our Terms & Conditions of Use.

In the event there is a change in the corporate structure of JD Supra such as, but not limited to, merger, consolidation, sale, liquidation or transfer of substantial assets, JD Supra may, in its sole discretion, transfer, sell or assign information collected on and through the Service to one or more affiliated or unaffiliated third parties.

Links to Other Websites

This Website and the Service may contain links to other websites. The operator of such other websites may collect information about you, including through cookies or other technologies. If you are using the Service through the Website and link to another site, you will leave the Website and this Policy will not apply to your use of and activity on those other sites. We encourage you to read the legal notices posted on those sites, including their privacy policies. We shall have no responsibility or liability for your visitation to, and the data collection and use practices of, such other sites. This Policy applies solely to the information collected in connection with your use of this Website and does not apply to any practices conducted offline or in connection with any other websites.

Changes in Our Privacy Policy

We reserve the right to change this Policy at any time. Please refer to the date at the top of this page to determine when this Policy was last revised. Any changes to our privacy policy will become effective upon posting of the revised policy on the Website. By continuing to use the Service or Website following such changes, you will be deemed to have agreed to such changes. If you do not agree with the terms of this Policy, as it may be amended from time to time, in whole or part, please do not continue using the Service or the Website.

Contacting JD Supra

If you have any questions about this privacy statement, the practices of this site, your dealings with this Web site, or if you would like to change any of the information you have provided to us, please contact us at:

- hide
*With LinkedIn, you don't need to create a separate login to manage your free JD Supra account, and we can make suggestions based on your needs and interests. We will not post anything on LinkedIn in your name. Or, sign up using your email address.