[Federal Register Volume 62, Number 108 (Thursday, June 5, 1997)]
[Proposed Rules]
[Pages 30785-30796]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 97-14735]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 301
[REG-252487-96]
RIN 1545-AU90
Inbound Grantor Trusts With Foreign Grantors
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
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SUMMARY: This document contains proposed regulations implementing
section 672(f) of the Internal Revenue Code, as amended by the Small
Business Job Protection Act of 1996, which relates to the application
of the grantor trust rules to certain trusts established by foreign
persons. The proposed regulations affect primarily United States
persons who are beneficiaries of trusts established by foreign persons.
This document also provides notice of a public hearing on these
proposed regulations.
DATES: Written comments must be received by August 4, 1997. Requests to
speak (with outlines of oral comments) to be discussed at the public
hearing scheduled for August 27, 1997, at 10 a.m. must be submitted by
August 6, 1997.
ADDRESSES: Send submissions to: CC:DOM:CORP:R (REG-252487-96), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
[[Page 30786]]
Washington, DC 20044. Submissions may be hand delivered between the
hours of 8 a.m. and 5 p.m. to: CC:DOM:CORP:R (REG-252487-96), Courier's
Desk, Internal Revenue Service, 1111 Constitution Avenue, NW.,
Washington, DC. Alternatively, taxpayers may submit comments
electronically via the Internet by selecting the ``Tax Regs'' option on
the IRS Home Page, or by submitting comments directly to the IRS
Internet site at http://www.irs.ustreas.gov/prod/tax__regs/
comments.html.
The public hearing will be held in room 3313, Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC.
FOR FURTHER INFORMATION CONTACT: Concerning Sec. 1.671-2(e), James
Quinn (202) 622-3060; concerning the remainder of these regulations, M.
Grace Fleeman (202) 622-3850; concerning submissions and the hearing,
Michael Slaughter (202) 622-7190 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
Section 1904 of the Small Business Job Protection Act of 1996 (the
Act), Public Law 104-188, 110 Stat. 1755 (August 20, 1996), amended
section 672(f) and certain other sections of the Internal Revenue Code
(Code). The amendments affect the application of sections 671 through
679 of the Code (the grantor trust rules) to certain trusts created by
foreign persons.
1. Prior Law
Under prior law, a grantor of a trust generally was treated as the
owner of any portion of the trust over which he retained any of the
powers or interests described in sections 673 through 677 without
regard to whether he was a domestic or foreign person. A special rule
contained in prior section 672(f) generally provided that, if a U.S.
beneficiary of a trust created by a foreign person transferred property
to the foreign person by gift, the U.S. beneficiary was treated as the
grantor of the trust to the extent of the transfer.
Under the prior rules, if a foreign person created a trust with one
or more U.S. beneficiaries that was treated as a grantor trust with the
foreign person as the grantor, a distribution of income from the trust
to a U.S. beneficiary was treated as a gift and was not subject to U.S.
income tax in the hands of the beneficiary. See Rev. Rul. 69-70 (1969-1
C.B. 182). If the income of the trust was not taxable to the foreign
grantor under section 871 and also not taxable to either the grantor or
the trust by either the grantor's country of residence or another
foreign country, the income of the trust was, thus, not subject to tax
by any jurisdiction.
A special rule contained in section 665(c) provided generally that
intermediaries or nominees interposed between certain foreign trusts
and their U.S. beneficiaries could be disregarded. However, that rule
applied only to trusts created by U.S. persons.
2. Overview of Changes
The changes made by section 1904 of the Act are designed to ensure
that U.S. persons who benefit from offshore trusts created by foreign
persons (inbound trusts) pay an appropriate amount of U.S. tax.
Generally, the grantor trust rules now cause a person to be treated as
the owner of a trust only to the extent such application results,
directly or indirectly, in an amount being currently taken into account
in computing the income of a U.S. citizen or resident or a domestic
corporation. Exceptions are provided for certain revocable trusts, for
trusts from which the only amounts distributable during the lifetime of
the grantor are to the grantor or the grantor's spouse, and for certain
compensatory trusts. There also are grandfather rules for certain
trusts that were in existence on September 19, 1995.
As a result of the changes, many inbound trusts that were grantor
trusts under prior law are now nongrantor trusts. Distributions of
trust income to the U.S. beneficiaries of such trusts are now taxable
to U.S. beneficiaries and may be subject to an interest charge on
accumulation distributions.
Section 1904 of the Act also includes some special rules. Section
643(h), which replaces former section 665(c), treats any amount paid to
a U.S. person that is derived directly or indirectly from a foreign
trust of which the payor is not the grantor as if the amount is paid by
the foreign trust directly to the U.S. person. Section 672(f)(4) allows
the IRS to recharacterize a purported gift or bequest from a
partnership or foreign corporation when necessary to prevent the
avoidance of the purpose of section 672(f). Section 672(f)(5), which is
an expansion of prior section 672(f), generally provides that if a U.S.
beneficiary of a trust created by a foreign person transfers property
to the foreign person, the U.S. beneficiary is treated as the grantor
of the trust to the extent of the transfer.
Explanation of Provisions
1. Section 1.643(h)-1: Distributions by Certain Foreign Trusts Through
Intermediaries
The proposed regulations describe the circumstances under which an
amount of property that is derived, directly or indirectly, by a U.S.
person from a foreign trust through an intermediary will be deemed to
have been paid directly by the foreign trust to the U.S. person. This
rule does not apply if the intermediary is the grantor of the portion
of the trust from which the amount is distributed. The amount will be
deemed to have been paid directly by the foreign trust if any one of
the following conditions is satisfied: (1) The intermediary is related
(as defined in the regulations) to either the U.S. person or the
foreign trust and the intermediary transfers to the U.S. person either
property that the intermediary received from the trust or proceeds from
the property that the intermediary received from the trust; (2) the
intermediary would not have transferred the property to the U.S. person
(or would not have transferred the property on substantially the same
terms) but for the fact the intermediary received property from the
foreign trust; or (3) the intermediary received the property from the
foreign trust pursuant to a plan one of the principal purposes of which
was the avoidance of U.S. tax.
The proposed regulations describe the effect of disregarding the
intermediary. If the intermediary is an agent of either the foreign
trust or the U.S. person under generally applicable agency principles
(under the standards set forth in Commissioner v. Bollinger, 485 U.S.
340 (1988)), the amount is treated as paid by the foreign trust to the
U.S. person in the year it would be so treated under the general
principles. Thus, if the intermediary is an agent of the foreign trust,
the amount is treated as paid to the U.S. person in the year it is paid
by the intermediary to the U.S. person. If, however, the intermediary
is an agent of the U.S. person, the amount is treated as paid to the
U.S. person in the year it is paid by the foreign trust to the
intermediary.
If the intermediary is not an agent of either the foreign trust or
the U.S. person under generally applicable agency principles, the
intermediary generally will be treated as an agent of the foreign
trust, and the amount will be treated as paid by the foreign trust to
the U.S. person in the year the amount is paid by the intermediary to
the U.S. person. However, the district director may determine, based on
all the relevant facts and circumstances, that the
[[Page 30787]]
intermediary should be treated as the agent of the U.S. person.
The regulations provide a de minimis rule for distributions that do
not exceed in the aggregate $10,000.
2. Section 1.671-2(e): Definition of Grantor
The proposed regulations provide a definition of grantor that
applies for purposes of the grantor trust rules generally. A grantor is
any individual, corporation, or other person to the extent such person
(i) creates a trust or (ii) directly or indirectly makes a gratuitous
transfer to a trust. For purposes of the proposed regulations, a
gratuitous transfer is any transfer other than a transfer for fair
market value, or a corporate or partnership distribution. Treasury and
the IRS request comments regarding the appropriate scope of gratuitous
transfers.
A grantor includes a person who acquires an interest in a trust in
a nongratuitous transfer from a person who is a grantor of the trust. A
grantor also includes an investor who acquires an interest in a fixed
investment trust from a person who had acquired his interest through a
direct investment in the trust. Treasury and the IRS request comments
on the appropriate scope of these rules as they affect fixed investment
trusts.
If a person creates or funds any portion of a trust primarily as an
accommodation for another person, the other person will be treated as a
grantor with respect to such portion of the trust. See, e.g., Stern v.
Commissioner, 77 T.C. 614 (1981), rev'd on other grounds, 747 F.2d 555
(9th Cir. 1984).
These regulations are not intended to change the result of existing
law with respect to trusts used for business purposes. See
Sec. 301.7701-4(e) (environmental remediation trusts); Rev. Rul. 87-
127, 1987-2 C.B. 156 (pre-need funeral trusts); Rev. Proc. 92-64, 1992-
2 C.B. 422 (rabbi trusts). Treasury and the IRS request comments on the
application of these new rules to trusts used for business purposes.
A grantor of a trust may or may not be treated as an owner of the
trust under sections 671 through 677 and 679. A person other than a
grantor of a trust may be treated as an owner of the trust under
section 678.
3. Section 1.672(f)-1: Foreign Persons Not Treated as Owners
The proposed regulations prescribe a two-step analysis for
implementing the general rule of section 672(f). First, the grantor
trust rules other than section 672(f) (the basic grantor trust rules)
are applied to determine the worldwide amount and the U.S. amount.
Then, the trust is treated as partially or wholly owned by a foreign
person based on an annual year-end comparison of the worldwide amount
and the U.S. amount.
The worldwide amount is defined as the net amount of income, gains,
deductions, and losses that would be taken into account for the current
year under the basic grantor trust rules in computing the worldwide
taxable income of any person, whether or not such person is a U.S.
taxpayer (as defined in the regulation). The worldwide amount is
determined in accordance with U.S. principles of income taxation, and
includes amounts that would be attributable to foreign persons, without
regard to whether such amounts are subject to U.S. income taxation.
The U.S. amount is defined as the net amount of income, gains,
deductions, and losses that would be taken into account for the current
year under the basic grantor trust rules (directly or through one or
more entities) in computing the taxable income of a U.S. taxpayer. The
U.S. amount includes amounts such as interest on state or local bonds
that are not includible in gross income.
A U.S. taxpayer is defined as any person who is a U.S. citizen, a
resident alien individual, a domestic corporation, a U.S. person who is
treated as the owner of a trust under section 679, or a domestic trust
to the extent such trust actually pays U.S. tax with respect to the
income, gains, deductions, and losses.
If the worldwide amount and the U.S. amount are the same, the basic
grantor trust rules continue to apply without the limitation of section
672(f). If the worldwide amount is greater than the U.S. amount,
section 672(f) prevents the basic grantor trust rules from treating a
person as the owner of that portion of the trust attributable to the
excess of the worldwide amount over the U.S. amount.
4. Section 1.672(f)-2: Trusts Created by Certain Foreign Corporations
Section 672(f)(3) provides in part that, except as otherwise
provided in regulations, a controlled foreign corporation (CFC) shall
be treated as a domestic corporation for purposes of section 672(f)(1).
Under the proposed regulations, a CFC that creates and funds a trust
will be treated as a domestic corporation to the extent that, if the
basic grantor trust rules were applied, income earned by the trust for
the taxable year would be subpart F income to the CFC that would be
currently taken into account in computing the gross income of a U.S.
citizen or resident or a domestic corporation. However, the CFC will
not be treated as a domestic corporation to the extent the income of
the trust would not be subpart F income or to the extent it would be
subpart F income but would not be taken into account in computing the
gross income of a U.S. citizen or resident or a domestic corporation
(e.g., the CFC had no overall earnings and profits).
The proposed regulations include similar rules for trusts created
by passive foreign investment companies (PFICs) or foreign personal
holding companies.
Section 672(f)(3) also provides that the general rule of section
672(f)(1) shall not apply for purposes of section 1296. The proposed
regulations implement this rule by providing that, for purposes of
determining whether a foreign corporation is a PFIC, the grantor trust
rules shall be applied as if section 672(f) had not come into effect.
Consequently, a foreign corporation cannot avoid PFIC status by
transferring passive assets to a trust that would be treated as a
nongrantor trust if section 672(f) were applied.
5. Section 1.672(f)-3: Exceptions to General Rule
A. Certain Revocable Trusts
The proposed regulations provide that the general rule of
Sec. 1.672(f)-1 does not apply to any portion of a trust if the power
to revest in the grantor title to such portion is exercisable solely by
the grantor without the approval or consent of any other person. If the
grantor can exercise the power only with the approval of a related or
subordinate party who is subservient to the grantor, such power will be
treated as exercisable solely by the grantor.
The exception will not apply unless the power to revest is
exercisable for a period or periods aggregating 183 days or more during
the taxable year of the trust. This rule is intended to provide a
bright line rule for the benefit of both taxpayers and IRS examiners
that addresses potentially abusive situations in which a power to
revest is so limited that it is not likely to be exercised. The 183
days need not be consecutive; thus, a power to revest that is
exercisable each year from January 1 through May 31 and again from
September 1 through December 31 would be eligible for the exception.
Consistent with the statute, the proposed regulations provide a
grandfather rule for a trust that was treated as owned by the grantor
under
[[Page 30788]]
section 676 on September 19, 1995. As long as such a trust would
continue to be so treated under the basic grantor trust rules, the
trust will be exempt from the general rule of section 672(f), except
with respect to any portion of the trust attributable to transfers to
the trust after September 19, 1995. Under the proposed regulations,
separate accounting is required for amounts transferred to the trust
after September 19, 1995, together with all income and gains thereof,
as well as losses and distributions therefrom.
B. Certain Other Trusts
The proposed regulations provide that the general rule does not
apply to any trust (or portion of a trust) if the only amounts
distributable (whether income or corpus) from such trust (or portion of
a trust) during the lifetime of the grantor are amounts distributable
to the grantor or the grantor's spouse. For this purpose, payments of
reasonable nongratuitous amounts, such as reasonable administrative
expenses, are not considered to be amounts distributable from the
trust.
The proposed regulations clarify that amounts distributable in
discharge of a legal obligation of the grantor or the grantor's spouse
will generally be treated as amounts distributable to the grantor or
the grantor's spouse. Thus, it is expected that a reinsurance trust
that would have been a grantor trust under prior law generally will
continue to be a grantor trust. (No inference is intended as to whether
a reinsurance trust constitutes a trust under regulation Sec. 301.7701-
4.) However, a legal obligation will not include an obligation to a
person who is related (as defined in the regulations) to the grantor or
the grantor's spouse, unless the obligation was entered into for
adequate and full consideration in money or money's worth. Trusts from
which distributions are taxable as compensation for services rendered
generally will be covered by the exception for compensatory trusts,
described below.
Amounts distributable to support a family member will be treated as
amounts distributable to the grantor or the grantor's spouse only if
certain requirements are satisfied. Although different jurisdictions
have different requirements for support obligations, administrative
simplicity is served by providing one uniform rule on this point. Under
the proposed regulations, the family member must be an individual who
would be treated as a dependent of the grantor or the grantor's spouse
under sections 152(a)(1) through (8), without regard to the requirement
that half of the individual's support be received from the grantor or
the grantor's spouse. In addition, the family member must be either
permanently and totally disabled (within the meaning of section
22(e)(3)) or, in the case of a son, daughter, stepson, or stepdaughter,
less than 24 years old.
Consistent with the statute, the proposed regulations provide a
grandfather rule for a trust that was treated as owned by the grantor
under section 677 (other than subsection (a)(3) thereof) on September
19, 1995. As long as such a trust would continue to be so treated under
the basic grantor trust rules, the trust will be exempt from the
general rule, except with respect to any portion of the trust
attributable to transfers to the trust after September 19, 1995. Under
the proposed regulations, separate accounting is required for amounts
transferred to the trust after September 19, 1995, together with all
income and gains thereof, as well as losses and distributions
therefrom.
C. Compensatory Trusts
The proposed regulations implement section 672(f)(2)(B), which
provides that, except as provided in regulations, the general rule
shall not apply to any portion of a trust from which distributions are
taxable as compensation for services rendered. Tracking the language of
the statute, the proposed regulations list categories of trusts that
constitute compensatory trusts, without regard to whether they could be
treated as grantor trusts under the basic grantor trust rules. This
list is intended to be an exclusive list. However, the proposed
regulations also provide that additional categories of compensatory
trusts may be designated later in guidance published in the Internal
Revenue Bulletin.
The following categories of trusts are classified as compensatory
trusts: (i) qualified trusts described in section 401(a), (ii) trusts
described in section 457(g), (iii) nonexempt employees' trusts
described in section 402(b), (iv) individual retirement account (IRA)
trusts that are either simplified employee pensions described in
section 408(k) or simple retirement accounts described in section
408(p), (v) IRA trusts to which the only contributions are rollover
contributions listed in section 408(a)(1), (vi) certain so-called rabbi
trusts (see Rev. Proc. 92-64 (1992-2 C.B. 422)), and (vii) trusts that
are welfare benefit funds described in section 419(e) (without regard
to whether they provide taxable benefits).
The IRS and Treasury contemplate that the nonexempt employees'
trusts listed in category (iii) above will be treated as grantor trusts
only to the extent provided in proposed regulations Sec. 1.671-1(g) and
Sec. 1.671-1(h), which were published in the Federal Register (61 FR
50778) on September 27, 1996.
IRAs that are excluded from the list of compensatory trusts because
they are funded by individuals, rather than employers, are expected to
be covered by one or both of the exceptions for revocable trusts or for
trusts from which the only amounts distributable during the lifetime of
the grantor are to the grantor or the grantor's spouse.
6. Section 1.672(f)-4: Recharacterization of Purported Gifts
The proposed regulations implement the purported gift rule of
section 672(f)(4), which was enacted as a backstop to section 672(f).
See Staff of the Joint Committee on Taxation, 104th Cong., 2nd Sess.,
General Explanation of the Tax Legislation Enacted in the 104th
Congress, at 271 (1996). The purported gift rule prevents taxpayers
from avoiding the general rule of section 672(f) by using a partnership
or a foreign corporation as a substitute for a trust.
As a general rule, if a U.S. donee receives a purported gift or
bequest directly or indirectly from a partnership, the purported gift
or bequest must be included in the U.S. donee's income as ordinary
income. If a U.S. donee receives a purported gift or bequest directly
or indirectly from a foreign corporation, the purported gift or bequest
generally must be included in the U.S. donee's gross income as a
distribution from the foreign corporation. In the latter case, the U.S.
donee will not be treated as having basis in the foreign corporation,
and the U.S. donee will be treated as having a holding period in the
foreign corporation equal to the average holding period (using a
weighted average) of the actual interest holders.
However, the gift or bequest will not be recharacterized if the
donee can establish that a U.S. citizen or resident alien who directly
or indirectly holds an interest in the partnership or foreign
corporation treated the purported gift as a distribution from the
partnership or foreign corporation and a subsequent gift to the donee.
There also is an exception for charitable contributions to donees
described in section 170(c).
The proposed regulations provide rules for gratuitous transfers to
U.S. donees from trusts created by partnerships or foreign
corporations. As a result, a partnership or foreign corporation cannot
avoid the purported gift rule by creating a nongrantor trust that makes
an immediate nontaxable distribution of trust corpus to a U.S.
[[Page 30789]]
donee. Under the proposed regulations, if the partnership or foreign
corporation is not treated under the grantor trust rules as the owner
of the portion of the trust from which property is distributed to a
U.S. donee in a gratuitous transfer, the distribution will be
characterized as a distribution from the partnership or foreign
corporation if such characterization results in a higher U.S. tax
liability.
Notwithstanding any other provision, the proposed regulations
provide that the district director may recharacterize a transfer that
is subject to the rules of section 672(f)(4) to prevent the avoidance
of U.S. tax or clearly to reflect income. For example, the district
director may determine, based upon the facts and circumstances, that a
distribution from a partnership or foreign corporation is more properly
treated as a distribution from a trust.
The proposed regulations provide a de minimis rule for purported
gifts or bequests that do not exceed in the aggregate $10,000.
7. Section 1.672(f)-5: Special Rules
A. Transfers by Certain Beneficiaries to Foreign Settlor
The proposed regulations provide that if, but for section
672(f)(5), a foreign person would be treated as the owner of any
portion of a trust, any U.S. beneficiary of the trust will be treated
as the owner of a portion of the trust to the extent the U.S.
beneficiary directly or indirectly made transfers of property to such
foreign person in excess of transfers to the U.S. beneficiary from the
foreign person. (Such a transfer may also constitute an indirect
transfer from a U.S. person to a foreign trust for purposes of section
679.) The U.S. beneficiary need not have been a U.S. person at the time
of the transfer.
The proposed regulations do not specify a time period within which
a transfer must have been made to trigger this rule. However, they do
provide that the rule will not apply to the extent the U.S. beneficiary
can demonstrate that the transfer was wholly unrelated to any
transaction involving the trust. In addition, consistent with the
statute, the proposed regulations provide that a transfer of property
does not include either a nongratuitous transfer or a gift that would
be excluded from taxable gifts under section 2503(b).
B. Different Taxable Years
The proposed regulations provide that if a person has a different
taxable year from the taxable year of the trust, an amount is currently
taken into account in computing the income of such person for purposes
of the general rule if the amount is taken into account for the taxable
year of such person that includes the last day of the taxable year of
the trust.
C. Entity Characterization
The proposed regulations provide that entities generally will be
characterized under U.S. income tax principles. See regulations
Secs. 301.7701-1 through 301.7701-4. However, an entity having a single
owner could avoid the purported gift rule if it could elect to be
disregarded as a separate entity, because the purported gift or bequest
would then be received from the owner of the entity, rather than from
the entity itself. Therefore, the proposed regulations provide that,
for purposes of section 672(f)(4), a wholly owned business entity must
be treated as a corporation, separate from its single owner.
8. Section 301.7701-2(c)(2)(iii): Special Rule for Business Entities
That Make Purported Gifts
As explained above, an entity having a single owner could avoid the
purported gift rule if it elected to be disregarded as a separate
entity under the existing entity classification regulations. Therefore,
the proposed regulations add a new sentence to the existing regulations
to provide that, for purposes of section 672(f)(4), a wholly owned
business entity must be treated as a corporation, separate from its
owner.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in EO 12866. Therefore,
a regulatory assessment is not required. It also has been determined
that section 553(b) of the Administrative Procedure Act (5 U.S.C.
chapter 5) does not apply to these regulations, and, because the
regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Pursuant to section 7805(f) of the Code, these regulations will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on their impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (preferably a
signed original and eight (8) copies) that are submitted timely to the
IRS. All comments will be available for public inspection and copying.
A public hearing has been scheduled for August 27, 1997, at 10
a.m., in room 3313, Internal Revenue Building, 1111 Constitution
Avenue, NW., Washington DC. Because of access restrictions, visitors
will not be admitted beyond the Internal Revenue Building lobby more
than 15 minutes before the hearing starts.
The rules of 26 CFR 601.601(a)(3) apply to the hearing.
Persons that wish to present oral comments at the hearing must
submit written comments by August 4, 1997, and submit an outline of the
topics to be discussed and the time to be devoted to each topic
(preferably a signed original and eight (8) copies) by August 6, 1997.
A period of 10 minutes will be allotted to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal author of these regulations is M. Grace Fleeman of
the Office of Associate Chief Counsel (International). However, other
personnel from the IRS and Treasury Department participated in their
development.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Employment taxes, Estate taxes, Excise taxes, Gift taxes, ncome
taxes, Penalties, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1 and 301 are proposed to be 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 1.643(h)-1 also issued under 26 U.S.C. 643(a)(7).
Section 1.671-2(e) also issued under 26 U.S.C. 643(a)(7) and
672(f)(6).
Section 1.672(f)-1 also issued under 26 U.S.C. 643(a)(7) and
672(f)(6).
Section 1.672(f)-2 also issued under 26 U.S.C. 643(a)(7), 72(f)
(3) and (6).
Section 1.672(f)-3 also issued under 26 U.S.C. 643(a)(7), 72(f)
(2) and (6).
[[Page 30790]]
Section 1.672(f)-4 also issued under 26 U.S.C. 643(a)(7),
72(f)(4) and (6).
Section 1.672(f)-5 also issued under 26 U.S.C. 643(a)(7) and
672(f)(6). * * *
Par. 2. Section 1.643(h)-1 is added to read as follows:
Sec. 1.643(h)-1 Distributions by certain foreign trusts through
intermediaries.
(a) In general. For purposes of sections 641 through 683, any
amount of property that is derived, directly or indirectly, by a United
States person from a foreign trust through another person (an
intermediary) shall be deemed to have been paid directly by the foreign
trust to the United States person if any one of the following
conditions is satisfied--
(1) The intermediary is related (within the meaning of paragraph
(e) of this section) to either the United States person or the foreign
trust and the intermediary transfers to the United States person either
property that the intermediary received from the foreign trust or
proceeds from the property that the intermediary received from the
foreign trust;
(2) The intermediary would not have transferred the property to the
United States person (or would not have transferred the property to the
United States person on substantially the same terms) but for the fact
that the intermediary received property from the foreign trust; or
(3) The intermediary received the property from the foreign trust
pursuant to a plan one of the principal purposes of which was the
avoidance of U.S. tax.
(b) Exception for grantor as intermediary. Paragraph (a) of this
section shall not apply if the intermediary is the grantor of the
portion of the trust from which the amount is derived. For the
definition of grantor, see Sec. 1.671-2(e).
(c) Effect of disregarding intermediary. If an amount is treated as
paid directly by the foreign trust to a United States person pursuant
to this section, one of the following rules shall apply:
(1) Intermediary is agent under general principles. If the
intermediary is an agent of the foreign trust or the United States
person under generally applicable agency principles, the payment shall
be treated as paid by the foreign trust to the United States person in
the year it would be so treated under such principles. Thus, if the
intermediary is an agent of the foreign trust, the payment shall be
treated as paid to the United States person in the year the amount is
paid by the intermediary to the United States person. If, however, the
intermediary is an agent of the United States person, the payment shall
be treated as paid to the United States person in the year the amount
is paid by the foreign trust to the intermediary.
(2) Intermediary is not agent under general principles--(i) Agent
of foreign trust. Except as provided in paragraph (c)(2)(ii) of this
section, if the intermediary is not an agent of the foreign trust or
the United States person under generally applicable agency principles--
(A) The intermediary shall be treated as an agent of the foreign
trust; and
(B) The payment shall be treated as paid by the foreign trust to
the United States person in the year the amount is paid by the
intermediary to the United States person.
(ii) Agent of United States person. The district director may
determine, based on all the relevant facts and circumstances, that the
intermediary should be treated as the agent of the United States
person. If the intermediary is treated as the agent of the United
States person pursuant to this paragraph (c)(2)(ii), the payment shall
be treated as paid to the United States person in the year the
intermediary receives the payment from the foreign trust.
(d) De minimis exception. This section shall not apply if, during
the taxable year of the United States person, the aggregate amount that
is transferred to such person from all foreign trusts through one or
more intermediaries does not exceed $10,000.
(e) Related parties. For purposes of this section, an intermediary
shall be treated as related to a United States person or foreign trust
if the intermediary and the United States person or foreign trust are
related within the meaning of section 643(i)(2)(B), with the following
modifications:
(1) For purposes of applying section 267 (other than section
267(f)) and section 707(b)(1), ``at least 10 percent'' shall be
substituted for ``more than 50 percent'' each place it appears;
(2) The principles of section 267(b)(10), substituting ``at least
10 percent'' for ``more than 50 percent,'' shall apply to determine
whether two corporations are related; and
(3) The principles applicable to trusts shall apply to determine
whether an estate is related to another person.
(f) Examples. The following examples illustrate the rules of this
section. In each example, FT is an irrevocable foreign trust that is
not treated as owned by any other person. The examples follow:
Example 1. Related intermediary. I, a nonresident alien who is
not the grantor of FT, receives a distribution of stock from FT in
the year 2001. In the year 2002, I sells the stock to an unrelated
party for its fair market value of 100X and gives the 100X to his
daughter, B, who is a U.S. resident. I is not an agent of either FT
or B under generally applicable agency principles. Under paragraphs
(a)(1) and (c)(2)(i) of this section, FT is deemed to have
distributed 100X directly to B in the year 2002.
Example 2. ``But for'' condition. I, a foreign bank that is
unrelated to any of the parties in these transactions, received a
deposit of 500X from FT in the year 2001. In the year 2002, I
transfers 400X to B, a United States person, in a transfer that it
would not have made but for the fact that I had received 500X from
FT. I is not an agent of either FT or B under generally applicable
agency principles. Under paragraphs (a)(2) and (c)(2)(i) of this
section, FT is deemed to have distributed 400X directly to B in the
year 2002.
Example 3. Tax avoidance purpose. FT was created in 1980 by A, a
nonresident alien. In the year 2001, FT's trustee, T, determines
that 1000X of accumulated income should be distributed to A's U.S.
granddaughter, B. Pursuant to a plan with a principal purpose of
avoiding the interest charge that would be imposed by section 668, T
causes FT to distribute 1000X to I, an unrelated foreign person. I
subsequently transfers 1000X to B in the year 2001. Under paragraph
(a)(3) of this section, B is deemed to have received an accumulation
distribution from FT in the year 2001.
Example 4. Amount not derived from foreign trust. W and her
husband, H, are both nonresident aliens. W's son, S, is a U.S.
resident. W receives annual income of 5000X from her own
investments. Several years ago, H created and funded FT using his
separate property. At the beginning of the year 2001, W receives a
distribution of 100X from FT. There is no plan with a principal
purpose of avoiding U.S. tax. At the end of the year 2001, W gives
100X of her investment income to S. None of the conditions in
paragraph (a) of this section is satisfied. The transfer to S is
treated as a nontaxable gift from W and not as an amount derived
directly or indirectly from FT.
(g) Effective date. The rules of this section are applicable for
transfers made by foreign trusts on or after August 20, 1996.
Par. 3. In Sec. 1.671-2, paragraph (e) is revised to read as
follows:
Sec. 1.671-2 Applicable principles.
* * * * *
(e)(1) For purposes of subchapter J of the Internal Revenue Code, a
grantor includes any person to the extent such person either creates a
trust, or directly or indirectly makes a gratuitous transfer (within
the meaning of paragraph (e)(4)(i) of this section) of property to a
trust.
(2) A grantor includes a person who acquires an interest in a trust
from a grantor of the trust if either--
[[Page 30791]]
(i) The transfer is nongratuitous (within the meaning of paragraph
(e)(4)(ii) of this section); or
(ii) The transfer is of an interest in a fixed investment trust.
(3) If one person creates or funds a trust (or portion of a trust)
primarily as an accommodation for another person, the other person
shall be treated as a grantor of the trust (or portion of the trust).
(4)(i) A gratuitous transfer is any transfer other than a transfer
for fair market value, or a corporate or partnership distribution. A
transfer of property to a trust may be considered a gratuitous transfer
without regard to whether the transfer is a gift for gift tax purposes
(see chapter 12 of subtitle B of the Internal Revenue Code).
(A) For purposes of this paragraph (e), a transfer for fair market
value includes only transfers in consideration for property received
from the trust, services rendered by the trust, or the right to use
property of the trust. A transfer is for fair market value only to the
extent that the value of the property received, services rendered, or
the right to use property is equal to at least the fair market value of
the property transferred. For example, rents, royalties, and
compensation paid to a trust are transfers for fair market value only
if the payments reflect an arm's length price for the use of the
property of, or services rendered by, the trust. For purposes of this
determination, if a person contributes property to a trust (or to
another entity that subsequently transfers the property (or proceeds
therefrom) to a trust) in exchange for any type of interest in the
trust (or other entity), such interest in the trust (or other entity)
shall be disregarded in determining whether fair market value has been
received. In addition, a person shall not be treated as making a
transfer for fair market value merely because the transferor recognizes
gain on the transaction. For example, if a taxpayer elects to treat a
transfer of appreciated property to a foreign trust as a deemed sale
under section 1057, such a transfer will not be treated as a transfer
for fair market value because the transferor did not receive actual
fair market value consideration pursuant to the deemed sale.
(B) For purposes of this paragraph (e), a transfer to a trust is a
corporate distribution, and therefore not a gratuitous transfer, only
if it is a distribution described in section 301, 302, 305, 355 or 356.
Similarly, for purposes of this paragraph (e), a transfer to a trust is
a partnership distribution, and therefore not a gratuitous transfer,
only if it is described in section 731. A distribution from one trust
to another trust that is a beneficiary of the first trust is a
gratuitous transfer.
(C) Notwithstanding any other provision of this paragraph (e), the
district director may determine, based upon the facts and
circumstances, that a direct or indirect transfer to a trust is more
properly characterized as a gratuitous transfer if the transfer was
structured with a principal purpose of avoiding U.S. tax. See, e.g.,
sections 643(a)(7) and 679(d).
(ii) For purposes of this paragraph (e), any transfer other than a
gratuitous transfer is a nongratuitous transfer.
(5) The following examples illustrate the rules of this paragraph
(e):
Example 1. A creates and funds a trust, T, for the benefit of
her children. Under paragraph (e)(1) of the section, A is a grantor
of T.
Example 2. A makes an investment in a fixed investment trust, T,
that is classified as a trust under Sec. 301.7701-4(c)(1) of this
chapter. B subsequently acquires A's entire interest in T for fair
market value. Under paragraph (e)(2) of this section, B is a grantor
of T with respect to such interest.
Example 3. A, an attorney, creates a trust, T, for the benefit
of his client, B, and B's children. The trust instrument names A as
the grantor. A funds T with a nominal contribution out of his own
funds. A views the contribution as an investment in the generation
of fees for future legal services. Under paragraph (e)(3) of this
section, B is a grantor of T.
Example 4. A, a U.S. citizen, creates and funds a trust, T, for
the benefit of B. B holds an unrestricted power to withdraw any
amount contributed to the trust for a period of 60 days after the
contribution is made. B is treated as an owner of T under section
678 as a result of the withdrawal power. However, B is not a grantor
of T under paragraph (e)(1) of this section as a result of the
withdrawal power, because B neither created T nor made a gratuitous
transfer to T.
Example 5. A contributes cash to a trust, T, through a broker,
in exchange for units in T. The value of the units in T is
disregarded in determining whether A has received fair market value
under paragraph (e)(4)(i)(A) of this section. Therefore, A has made
a gratuitous transfer to T, and, under paragraph (e)(1) of this
section, A is a grantor of T.
Example 6. A borrows cash from T, an unrelated trust. Arm's-
length interest payments by A to T will not be treated as gratuitous
transfers under paragraph (e)(4)(i)(A) of this section. Therefore,
under paragraph (e)(1) of this section, A is not a grantor of T with
respect to the interest payments.
Example 7. A creates and funds a domestic trust, DT. After A's
death, DT distributes cash to a foreign trust, FT, that is a
beneficiary of DT. Under paragraph (e)(4)(i)(B) of this section, the
trust distribution by DT is a gratuitous transfer. Therefore, under
paragraph (e)(1) of this section, DT is a grantor of FT with respect
to such transfer.
Example 8. A creates and funds a trust, T. T owns stock of C, a
publicly traded company, that pays a dividend to its shareholders,
including T. The dividend paid by C is a nongratuitous transfer
under paragraph (e)(4)(i)(B) of this section. Therefore, C is not a
grantor under paragraph (e)(1) of this section with respect to the
dividend.
Example 9. A, a nonresident alien, creates a trust, T, for the
benefit of her spouse, B, who is a U.S. citizen. T is not treated as
owned by any other person. A sells property worth $1,000,000 to T in
exchange for $100,000 in cash. Under paragraph (e)(4)(i)(A) of this
section, the $900,000 excess is a gratuitous transfer by A.
Therefore, A is a grantor of T under paragraph (e)(1) of this
section with respect to such transfer.
(6) The rules of this paragraph (e) are applicable as of August 20,
1996.
Par. 4. Sections 1.672(f)-1, 1.672(f)-2, 1.672(f)-3, 1.672(f)-4,
and 1.672(f)-5 are added to read as follows:
Sec. 1.672(f)-1 Foreign persons not treated as owners.
(a) General rule. Section 672(f)(1) provides that sections 671
through 679 (the grantor trust rules) shall cause a person to be
treated as the owner of any portion of a trust only to the extent such
application results in an amount (if any) being currently taken into
account (directly or through one or more entities) in computing the
income of a citizen or resident of the United States or a domestic
corporation. Section 672(f)(1) may apply only to a trust that would be
treated as owned, in whole or in part, by a foreign person under the
grantor trust rules without regard to section 672(f). For rules
describing the application of this section, see paragraph (b) of this
section. For definitions regarding the rules of this section, see
paragraph (c) of this section. For examples illustrating the
application of this section, see paragraph (d) of this section. For the
effective date of the rules of this section, see paragraph (e) of this
section.
(b) Application of general rule--(1) Initial determination. To
determine whether a trust is treated as owned by a foreign person, the
taxpayer should first apply the grantor trust rules without regard to
section 672(f) (the basic grantor trust rules) to determine the
worldwide amount (as defined in paragraph (c)(1) of this section) and
the U.S. amount (as defined in paragraph (c)(2) of this section).
(2) Result. The trust is treated as owned by a foreign person based
on an annual comparison at the end of the trust's taxable year of the
worldwide amount and the U.S. amount. If there is a worldwide amount
and such amount is greater than the U.S. amount, under
[[Page 30792]]
section 672(f) the foreign person shall not be treated as the owner of
the portion of the trust attributable to the excess of the worldwide
amount over the U.S. amount. Otherwise, the basic grantor trust rules
shall apply without the limitation of section 672(f). For examples, see
paragraph (d) of this section.
(c) Definitions--(1) Worldwide amount. The worldwide amount is the
net amount of income, gains, deductions, and losses that would be taken
into account for the current year under the basic grantor trust rules
in computing the worldwide taxable income of any person, whether or not
such person is a U.S. taxpayer (as defined in paragraph (c)(3) of this
section). The worldwide amount is computed in accordance with U.S.
principles of income taxation and includes amounts that would be
attributable to foreign persons, without regard to whether such amounts
are subject to U.S. income tax.
(2) U.S. amount. The U.S. amount is the net amount of income,
gains, deductions, and losses that would be taken into account for the
current year under the basic grantor trust rules (directly or through
one or more entities) in computing the taxable income of a U.S.
taxpayer (as defined in paragraph (c)(3) of this section). The U.S.
amount includes amounts that would be attributable to the U.S. taxpayer
even if the amount would not be includible in gross income (e.g., tax-
exempt interest described in section 103(a)).
(3) U.S. taxpayer. A U.S. taxpayer is any person who is a U.S.
citizen, a resident alien individual, a domestic corporation, a U.S.
person who is treated as the owner of a trust under section 679, or a
domestic trust to the extent such trust actually pays U.S. tax with
respect to its income, gains, deductions, and losses.
(d) Examples. The following examples illustrate the rules of this
section:
Example 1. U.S. amount equals worldwide amount. A, a citizen of
the United States, creates and funds an irrevocable foreign trust,
FT, for the benefit of his U.S. son, B. Under the basic grantor
trust rules (see section 679), A would be treated as the owner of
FT. For the taxable year ending December 31, 1999, FT has ordinary
income of 100X, long-term capital gain of 200X, deductions of 20X,
and short-term capital losses of 15X. Under paragraph (c)(1) of this
section, the worldwide amount is 265X (100X+200X-20X-15X). Under
paragraph (c)(2) of this section, the U.S. amount also is 265X.
Consequently, under paragraph (b)(2) of this section, because the
worldwide amount is equal to the U.S. amount, the basic grantor
trust rules apply without the limitation of section 672(f) to treat
A as the owner of FT.
Example 2. No U.S. amount. A, a nonresident alien, funds an
irrevocable domestic trust, DT, for the benefit of his U.S. son, B.A
has a reversionary interest within the meaning of section 673. If
the basic grantor trust rules were applied, A would be treated as
the owner of DT, and any distributions to B would be considered
nontaxable gifts from A to B. Under paragraph (c)(2) of this
section, there is no U.S. amount, because no amount is taken into
account for the current year under the basic grantor trust rules in
computing the taxable income of a U.S. taxpayer. Under paragraph
(c)(1) of this section, the worldwide amount is equal to DT's net
income. Under paragraph (b)(2) of this section, A is not treated as
the owner of any portion of DT. Consequently, DT is a separate
taxable entity, and distributions from DT to B must be taken into
account in computing B's income.
Example 3. U.S. amount less than worldwide amount. FP is a
foreign partnership for U.S. income tax purposes. FP has two
partners: C, a nonresident alien, and D, a U.S. citizen. The
partnership agreement provides that all income, gains, losses,
deductions, and credits are allocated 50 percent to each partner. FP
contributed cash to an irrevocable foreign trust, FT, primarily for
the benefit of E, D's U.S. brother. FP can control the beneficial
enjoyment of the trust assets within the meaning of section 674. If
the basic grantor trust rules were applied, FT would be treated as
the owner of FP. Because D's 50 percent distributive share of FP's
income would be currently taken into account in computing the income
of a U.S. citizen, the U.S. amount computed under paragraph (c)(2)
of this section is equal to one half of the worldwide amount
computed under paragraph (c)(1) of this section. Therefore, under
paragraph (b)(2) of this section, FP is not treated as the owner of
the portion of FT attributable to C's interest in FP. Such portion
of FT will be treated as a separate taxable entity, and
distributions by FT to E with respect to that portion of the trust
will be considered distributions to E under section 662 and may be
subject to the section 668 interest charge on accumulation
distributions. (In addition, distributions from FP to E may be
subject to recharacterization as purported gifts under
Sec. 1.672(f)-4.)
Example 4. No worldwide amount. USC is a U.S. corporation with a
wholly owned foreign subsidiary, FC. USC funds an irrevocable
foreign trust, FT, that cannot benefit any U.S. person. USC retains
no power or interest that would cause it to be treated as the owner
of FT under the basic grantor trust rules. However, FC is given a
power of appointment such that FC would be treated as the owner of
FT under section 678. FT acquires a note issued by FC. FT has no
items of income, deduction, losses, or credit other than income from
the note. Under U.S. income tax principles, if the basic grantor
trust rules were applied, FC would be treated as the owner of FT.
Thus, FC would be treated as both the debtor and the creditor with
respect to the note, and the note would be disregarded. Under
paragraph (c)(1) of this section, there is no worldwide amount.
Under paragraph (c)(2) of this section, there is no U.S. amount.
Consequently, under paragraph (b)(2) of this section, the basic
grantor trust rules apply without the limitation of section 672(f)
to treat FC as the owner of FT.
Example 5. Deemed contribution on effective date. Assume the
same facts as in Example 2. DT was created in 1990. On August 20,
1996, DT held accumulated income. Prior to August 20, 1996, A was
treated as the owner of DT. A is deemed to have contributed the
assets that were held in DT on August 20, 1996 to a new trust on
that date.
(e) Effective date. The rules of this section are applicable as of
August 20, 1996.
Sec. 1.672(f)-2 Trusts created by certain foreign corporations.
(a) Controlled foreign corporations. A controlled foreign
corporation (as defined in section 957) that creates and funds a trust
shall be treated as a domestic corporation for purposes of
Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if the grantor
trust rules without regard to section 672(f) (the basic grantor trust
rules) were applied, income earned by the trust for the taxable year
would be currently taken into account pursuant to section 951 in
computing the gross income of a citizen or resident of the United
States or a domestic corporation.
(b) Passive foreign investment companies--(1) In general. A passive
foreign investment company (as defined in section 1296) that creates
and funds a trust shall be treated as a domestic corporation for
purposes of Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if
the basic grantor trust rules were applied, income earned by the trust
for the taxable year would be currently taken into account pursuant to
section 1293 in computing the gross income of a citizen or resident of
the United States or a domestic corporation.
(2) Application of section 1296. For purposes of determining
whether a foreign corporation is a passive foreign investment company
as defined in section 1296, the grantor trust rules shall be applied as
if section 672(f) had not come into effect.
(c) Foreign personal holding companies. A foreign personal holding
company (as defined in section 552) that creates and funds a trust
shall be treated as a domestic corporation for purposes of
Secs. 1.672(f)-1 through 1.672(f)-5 to the extent that, if the basic
grantor trust rules were applied, income earned by the trust for the
taxable year would be currently taken into account pursuant to section
551 in computing the gross
[[Page 30793]]
income of a citizen or resident of the United States or a domestic
corporation.
(d) Examples. The following examples illustrate the rules of this
section. In each example, FT is an irrevocable foreign trust, and CFC
is a controlled foreign corporation. The examples follow:
Example 1. Controlled foreign corporation without ultimate U.S.
ownership. Two nonresident aliens, A and B, create a domestic
partnership, DP. DP's only asset is all the stock of CFC. CFC
creates and funds FT to benefit A's U.S. daughter, C. CFC retains an
administrative power over the trust as described in section 675.
Thus, if the basic grantor trust rules were applied, CFC would be
treated as the owner of FT, and distributions from FT to C would not
be taxed as distributions under section 662. However, under
paragraph (a) of this section, CFC is not treated as a domestic
corporation for purposes of Sec. 1.672(f)-1. Although CFC is a
controlled foreign corporation (because CFC is owned by DP, a
domestic person), no income earned by CFC will be included in the
income of a U.S. taxpayer. Consequently, there is no U.S. amount
under Sec. 1.672(f)-1(c)(2). Under Sec. 1.672(f)-1(b)(2), the basic
grantor trust rules do not apply to treat CFC as the owner of FT.
Transfers from FT to C are considered to be distributions to C under
section 662 and may be subject to the section 668 interest charge on
accumulation distributions. (In addition, distributions to C from
DP, CFC, or FT may be subject to recharacterization as purported
gifts under Sec. 1.672(f)-4.)
Example 2. Trust income is all subpart F income. CFC is wholly
owned by USC, a domestic corporation. CFC creates and funds FT for
the benefit of USC. CFC can control the beneficial enjoyment of the
trust assets within the meaning of section 674. All of FT's income
is of the type that is subpart F income (as defined in section 952).
FT does not distribute any income. Without regard to income earned
by FT, CFC has a significant amount of earnings and profits. If the
basic grantor trust rules were applied, CFC would be treated as the
owner of FT, and all items of income of FT would be currently taken
into account in computing the income of USC, a domestic corporation.
Consequently, under paragraph (a) of this section, CFC is treated as
a domestic corporation for purposes of Sec. 1.672(f)-1. Under
Sec. 1.672(f)-1(b)(2), the basic grantor trust rules apply without
the limitation of section 672(f) to treat CFC as the owner of FT.
Distributions from FT to USC are treated as distributions from CFC
to USC.
Example 3. Portion of trust income is subpart F income. Assume
the same facts as in Example 2, except that FT also owns all of the
stock of S, a corporation that is incorporated in the same country
as CFC and that uses a substantial part of its assets in a trade or
business in such country. Thus, dividends from S are not subpart F
income. In the taxable year ending December 31, 1999, FT's only
income is subpart F income of 200X and dividends from S of 50X. FT
has no deductions or losses for 199X. Under paragraph (a) of this
section, CFC is treated as a domestic corporation for purposes of
computing the U.S. amount under Sec. 1.672(f)-1(c)(2) only to the
extent FT's income is of the type that is subpart F income.
Consequently, the U.S. amount is 200X. Under Sec. 1.672(f)-1(c)(1),
the worldwide amount is 250X. Under Sec. 1.672(f)-1(b)(2), CFC is
not treated as the owner of the portion of FT attributable to the
excess of the worldwide amount over the U.S. amount. Such portion of
FT will be treated as a separate taxable entity. Distributions to
USP with respect to such portion of FT will be included in USP's
income under section 662 and may be subject to the section 668
interest charge on accumulation distributions.
Example 4. Reduction in portion of trust treated as nongrantor
trust. Assume the same facts as in Example 3. For each of the years
2001 through 2010, FT receives dividend income of 2X from S, none of
which is distributed. In the year 2011, at a time when FT's basis in
the stock of S is 80X, S sells its business and invests the proceeds
in assets that generate subpart F income. CFC will now be treated as
the owner of the portion of FT that had previously been treated as a
separate taxable entity. FT will be deemed to have distributed 80X
(the stock of S) to CFC. CFC will be required to include 20X of
undistributed net income (2X a year for 10 years) in its income.
(d) Effective date. The rules of this section are applicable as of
August 20, 1996.
Sec. 1.672(f)-3 Exceptions to general rule.
(a) Certain revocable trusts--(1) In general. The general rule of
Sec. 1.672(f)-1(a) shall not apply to any portion of a trust if the
power to revest absolutely in the grantor title to such portion is
exercisable solely by the grantor without the approval or consent of
any other person. If the grantor can exercise such power only with the
approval of a related or subordinate party who is subservient to the
grantor, such power will be treated as exercisable solely by the
grantor. The grantor will be treated as having a power to revest only
if the grantor has such power for a period or periods aggregating 183
days or more during the taxable year of the trust. See section
643(a)(7). For the definition of grantor, see Sec. 1.671-2(e). For the
definition of related or subordinate party, see Sec. 1.672(c)-1. For
purposes of this paragraph (a), a related or subordinate party is
subservient to the grantor unless the presumption in the last sentence
of Sec. 1.672(c)-1 is rebutted by a preponderance of the evidence.
(2) Grandfather rule--(i) In general. The general rule of
Sec. 1.672(f)-1 shall not apply to a trust that was treated as owned by
the grantor under section 676 on September 19, 1995, as long as the
trust would continue to be so treated under the basic grantor trust
rules. However, such a trust will be subject to the general rule of
Sec. 1.672(f)-1 with respect to any portion of the trust attributable
to transfers to the trust after September 19, 1995.
(ii) Separate accounting for transfers after September 19, 1995. In
the case of a revocable trust that contains both amounts held in the
trust on September 19, 1995, and amounts that were transferred to the
trust after September 19, 1995, paragraph (a)(2)(i) of this section
shall apply only if the amounts that were held in the trust on
September 19, 1995, together with all income, gains, and losses derived
therefrom (less all post-September 19, 1995, distributions therefrom)
are separately accounted for from the amounts that were transferred to
the trust after September 19, 1995, together with all income, gains,
and losses derived therefrom (less all distributions therefrom). If
there is no separate accounting, the general rule of Sec. 1.672(f)-1
shall apply to the trust. If there is separate accounting, the general
rule of Sec. 1.672(f)-1 shall not apply to the portion of the trust
that is attributable to amounts that were held in the trust on
September 19, 1995.
(3) Examples. The following examples illustrate the rules of this
paragraph (a):
Example 1. Owner is grantor. After September 19, 1995, FP1, a
foreign person, creates and funds a revocable trust, T, for the
benefit of FP1's children, who are U.S. residents. The trustee is a
foreign bank, FB, that is owned and controlled by FP1 and FP2, who
is FP1's brother. The power to revoke T and revest absolutely in FP1
title to the trust property is exercisable by FP1, but only with the
approval or consent of FB. There are no facts that would suggest
that FB is not subservient to FP1. Therefore, under paragraph (a)(1)
of this section, T is not subject to the general rule of
Sec. 1.672(f)-1. FP1 is treated as the owner of T.
Example 2. Owner not grantor. Assume the same facts as in
Example 1, except that FP1 dies. After FP1's death, FP2 has the
power to withdraw the assets of T, but only with the approval of FB.
There are no facts that would suggest that FB is not subservient to
FP2. However, under paragraph (a)(1) of this section, T is now
subject to the general rule of Sec. 1.672(f)-1, because FP2 is not a
grantor of T. FP2 is not treated as the owner of T.
Example 3. Trustee not related or subordinate party. Assume the
same facts as in Example 1, except that neither FP1 nor any member
of his family has any substantial ownership interest or other
connection with FB. FP1 can remove and replace FB at any time for
any reason. Although FP1 can replace FB if FB refuses to approve or
consent to FP1's decision to revest the trust property in himself,
FB is not a related or subordinate party. Therefore, under paragraph
(a)(1) of this section, T is subject to the general rule of
Sec. 1.672(f)-1. FP1 will not be treated as the owner of T.
Example 4. Unrelated trustee will consent to revocation. FP, a
foreign person, creates
[[Page 30794]]
and funds an irrevocable trust, T. The trustee is a foreign bank,
FB, that is not a related or subordinate party within the meaning of
Sec. 1.672(c)-1. FB has the discretion to distribute trust income or
corpus to any person, including FP. Even if FB would in fact
distribute all the trust property to FP if requested to do so by FP,
under paragraph (a)(1) of this section, T is subject to the general
rule of Sec. 1.672(f)-1, because FP does not have the power to
revoke T. FP will not be treated as the owner of T.
Example 5. Husband treated as holding power held by wife. H and
his wife, W, both nonresident aliens, create and fund a trust, T,
using community property. The power to revoke T and revest
absolutely in H and W title to the trust property is exercisable
either by W acting alone or by H with the consent of W. W has
advised H that she will not consent to any decision by H to revoke
T. Although W is a related or subordinate party to H within the
meaning of Sec. 1.672(c)-1, the presumption that W is subservient to
H is rebutted by a preponderance of the evidence. However, pursuant
to section 672(e), H is treated as holding the power to revest that
is held by W. Therefore, under paragraph (a)(1) of this section, T
is not subject to the general rule of Sec. 1.672(f)-1. H and W are
treated as the owners of T.
Example 6. U.S. grantor of trust revocable by foreign person. A,
a nonresident alien, creates a revocable foreign trust, FT, and
funds FT with $5,000 cash. The only possible beneficiary of FT is a
foreign person. B, a U.S. citizen, contributes $1,000,000 of
appreciated property to FT. B retains no powers that would cause B
to be treated as an owner of any portion of FT under the grantor
trust rules. Although A has the power to revest absolutely in itself
title to the appreciated property, A is not a grantor of FT with
respect to the appreciated property. See Sec. 1.671-2(e). Therefore,
under paragraph (a)(1) of this section, the portion of FT that is
attributable to the appreciated property is subject to the general
rule of Sec. 1.672(f)-1. A is not treated as the owner of such
portion.
(b) Certain other trusts--(1) In general. The general rule of
Sec. 1.672(f)-1(a) shall not apply to any trust (or portion of a trust)
during the lifetime of the grantor if the only amounts distributable
(whether income or corpus) from such trust (or portion of a trust)
during the lifetime of the grantor are amounts distributable to the
grantor or the spouse of the grantor. This paragraph (b) shall not
apply to that portion of a trust from which, at any time after October
20, 1996, any amounts are distributable to any person other than the
grantor or the spouse of the grantor. For purposes of this paragraph
(b), payments of nongratuitous amounts (within the meaning of
Sec. 1.671-2(e)(4)(ii)) will not be considered amounts distributable.
For the definition of grantor, see Sec. 1.671-2(e).
(2) Amounts distributable in discharge of legal obligation--(i) In
general. Subject to the provisions of paragraph (b)(2)(ii) of this
section, amounts that are distributable from a portion of a trust in
discharge of a legal obligation of the grantor or the spouse of the
grantor shall be treated as amounts distributable to the grantor or the
spouse of the grantor for purposes of paragraph (b)(1) of this section.
For this purpose, an obligation is considered a legal obligation if it
is enforceable under the local law of the jurisdiction in which the
grantor (or the spouse of the grantor) resides.
(ii) Legal obligation to related person. For purposes of paragraph
(b)(2)(i) of this section, the term legal obligation does not include
an obligation to a related person except to the extent the obligation
was contracted bona fide and for adequate and full consideration in
money or money's worth (see Sec. 20.2043-1 of this chapter). For this
purpose, a related person is a person described in Sec. 1.643(h)-1(e).
(3) Amounts distributable in discharge of support obligation.
Amounts that are distributable from a portion of a trust in discharge
of the grantor's or the grantor's spouse's obligation to support a
family member shall be treated as amounts distributable to the grantor
or the spouse of the grantor only if the family member is an individual
who would be treated as a dependent of the grantor or the grantor's
spouse under sections 152(a) (1) through (8), without regard to the
requirement that half of the individual's support be received from the
grantor or the grantor's spouse, and the family member is either--
(i) Permanently and totally disabled (within the meaning of section
22(e)(3)); or
(ii) In the case of a son, daughter, stepson, or stepdaughter, less
than 24 years old.
(4) Grandfather rule--(i) In general. The general rule of
Sec. 1.672(f)-1 shall not apply to a trust that was treated as owned by
the grantor under section 677 (other than section 677(a)(3)) on
September 19, 1995, as long as the trust would continue to be so
treated under the basic grantor trust rules. However, such a trust will
be subject to the general rule of Sec. 1.672(f)-1 with respect to any
portion of the trust attributable to transfers to the trust after
September 19, 1995.
(ii) Separate accounting for transfers after September 19, 1995. In
the case of a trust that contains both amounts held in the trust on
September 19, 1995, and amounts that were transferred to the trust
after September 19, 1995, paragraph (b)(4)(i) of this section shall
apply only if the amounts that were held in the trust on September 19,
1995, together with all income, gains, and losses derived therefrom
(less all post-September 19, 1995, distributions therefrom) are
separately accounted for from the amounts that were transferred to the
trust after September 19, 1995, together with all income, gains, and
losses derived therefrom (less all distributions therefrom). If there
is no separate accounting, the general rule of Sec. 1.672(f)-1 shall
apply to the trust. If there is separate accounting, the general rule
of Sec. 1.672(f)-1 shall not apply to the portion of the trust that is
attributable to amounts that were held in the trust on September 19,
1995.
(5) Examples. The following examples illustrate the rules of this
paragraph (b):
Example 1. Amounts distributable only to grantor or grantor's
spouse. H and his wife, W, are both nonresident aliens. H and W have
a child, C, who is a U.S. resident. H creates and funds an
irrevocable trust, FT, using only his separate property. The only
amounts distributable (whether income or corpus) from FT as long as
either H or W are alive are amounts distributable to H or W. Upon
the death of both H and W, C may receive distributions from FT.
Under paragraph (b)(1) of this section, FT is not subject to the
general rule of Sec. 1.672(f)-1 during H's lifetime. H is treated as
the owner of FT.
Example 2. Amounts temporarily distributable to person other
than grantor or grantor's spouse. Assume the same facts as in
Example 1, except that C is a 30-year old law student at the time FT
is created, FT is created after October 20, 1996, and the trust
instrument provides that as long as C is in law school amounts may
be distributed from FT to pay C's expenses. Thereafter, the only
amounts distributable from FT as long as either H or W are alive
will be amounts distributable to H or W. C's expenses are not
treated as legal obligations of H or W under paragraph (b)(2)(ii) of
this section or as support obligations under paragraph (b)(3) of
this section. Therefore, under paragraph (b)(1) of this section, FT
is subject to the general rule of Sec. 1.672(f)-1(a). H is not
treated as the owner of FT. After C graduates from law school, the
general rule of Sec. 1.672(f)-1 still will be applicable, and H
still will not be treated as the owner of FT.
Example 3. Grantor predeceases spouse. Assume the same facts as
in Example 1. H predeceases W. Under paragraph (b)(1) of this
section, FT will become subject to the general rule of
Sec. 1.672(f)-1 upon H's death, because W is not a grantor.
Accordingly, FT will be treated as a separate taxable entity upon
H's death.
Example 4. Effect of divorce. H creates and funds a trust, FT,
from which the only amounts distributable are amounts distributable
to himself and A. At the time FT is created, A is H's wife. However,
the trust document refers to A only by her name. H and A divorce.
Under paragraph (b)(1) of this section, FT will be subject to the
general rule of Sec. 1.672(f)-1 after the divorce, because amounts
will still be distributable to A, and
[[Page 30795]]
A will no longer be the spouse of the grantor. After the divorce, FT
will be treated as a separate taxable entity.
Example 5. Fixed investment trust. FC, a foreign corporation,
invests in a domestic fixed investment trust, DT, that is classified
as a trust under Sec. 301.7701-4(c)(1) of this chapter. The only
amounts that are distributable from the portion of DT that is owned
by FC are amounts distributable to FC. Under paragraph (b)(1) of
this section, such portion of DT is exempt from the general rule of
Sec. 1.672(f)-1. FC is treated as the owner of its portion of DT.
Example 6. Reinsurance trust. A domestic insurance company, I,
reinsures a portion of its business with a foreign insurance
company, FI. FI creates and funds an irrevocable domestic trust, DT,
in the United States as security for its obligations under the
reinsurance agreement. The trust funds are held by a U.S. bank and
may be used only to pay claims arising out of the reinsurance
policies. On the termination of DT, any assets remaining will revert
to FI. The only amounts that are distributable from DT are
distributable in discharge of FI's legal obligation. Therefore,
under paragraph (b)(1) of this section, DT is exempt from the
general rule of Sec. 1.672(f)-1. FI is treated as the owner of DT.
Example 7. Asset securitization trust. A foreign corporation,
FC, borrows money from a bank, B, to finance the purchase of an
airplane. FC creates a foreign trust, FT, to hold the airplane as
security for the loan from B. The only amounts that are
distributable from FT are amounts distributable to B in the event
that FC defaults on its loan from B. Thus, the only amounts
distributable from FT are in discharge of FC's legal obligation to
B. When FC repays the loan, the trust assets will revert to FC.
Under paragraph (b)(1) of this section, FT is exempt from the
general rule of Sec. 1.672(f)-1. FC is treated as the owner of FT.
(c) Compensatory trusts--(1) In general. Except as provided in
paragraph (c)(4) of this section, Sec. 1.672(f)-1 does not apply to any
portion of a trust distributions from which are taxable as compensation
for services rendered. A trust described in this paragraph (c)(1) is
referred to in this section as a compensatory trust.
(2) Trusts classified as compensatory trusts. The following types
of trusts are the only types of trusts that shall be classified as
compensatory trusts within the meaning of paragraph (c)(1) of this
section--
(i) A qualified trust described in section 401(a) (but see
Sec. 1.641(a)-0(a));
(ii) A trust described in section 457(g);
(iii) A nonexempt employees' trust described in section 402(b) (see
Sec. 1.671-1(g) and (h));
(iv) A trust that is an individual retirement account described in
section 408(k) or 408(p);
(v) A trust that is an individual retirement account the only
contributions to which are rollover contributions listed in section
408(a)(1);
(vi) A trust that would be a nonexempt employees' trust described
in section 402(b) but for the fact that the trust's assets are not set
aside from the claims of creditors of the actual or deemed transferor
within the meaning of Sec. 1.83-3(e); and
(vii) A trust that is a welfare benefit fund described in section
419(e).
(3) Other individual retirement accounts. For rules that apply to
individual retirement accounts (within the meaning of section 408(a))
that are not compensatory trusts within the meaning of paragraph (c)(1)
of this section, see paragraphs (a) and (b) of this section.
(4) Exceptions. The Commissioner may, in revenue rulings, notices,
or other guidance published in the Internal Revenue Bulletin (see
Sec. 601.601(d)(2)(ii)(b)), designate categories of compensatory trusts
to which the general rule of paragraph (c)(1) of this section does not
apply.
(d) Effective date. Except as provided in paragraph (b)(1) of this
section, the rules of this section are applicable as of August 20,
1996.
Sec. 1.672(f)-4 Recharacterization of purported gifts.
(a) In general--(1) Purported gifts from partnerships.
Except as provided in paragraphs (b) and (f) of this section, and
without regard to the existence of any trust, if a United States person
(U.S. donee) directly or indirectly receives a purported gift or
bequest (as defined in paragraph (d) of this section) from a
partnership, the purported gift or bequest must be included in the U.S.
donee's gross income as ordinary income.
(2) Purported gifts from foreign corporations. Except as provided
in paragraphs (b) and (f) of this section, and without regard to the
existence of any trust, if a U.S. donee directly or indirectly receives
a purported gift or bequest (as defined in paragraph (d) of this
section) from a foreign corporation, the purported gift or bequest must
be included in the U.S. donee's gross income as if it were a
distribution from the foreign corporation. For purposes of section
1012, the U.S. donee will not be treated as having basis in the foreign
corporation. However, for purposes of section 1223, the U.S. donee will
be treated as having a holding period in the foreign corporation on the
date of the deemed distribution equal to the weighted average of the
holding periods of the actual interest holders.
(b) Exceptions--(1) U.S. partner or shareholder treats transfer as
distribution and gift. Paragraph (a) of this section shall not apply if
the U.S. donee can establish that a U.S. citizen or resident alien who
directly or indirectly holds an interest in the partnership or foreign
corporation treated the purported gift as a distribution to the U.S.
partner or shareholder and a subsequent gift to the U.S. donee.
(2) Charitable contributions. Paragraph (a) of this section shall
not apply to U.S. donees that are described in section 170(c).
(c) Certain distributions from trusts created by partnerships or
foreign corporations. If a partnership or foreign corporation is
treated as the owner, under sections 671 through 679, of a portion of a
trust from which property is distributed to a U.S. donee in a
gratuitous transfer, the U.S. donee must treat the amount as a
distribution from the partnership or foreign corporation. If a
partnership or foreign corporation is not treated as the owner, under
sections 671 through 679, of the portion of a trust from which property
is distributed to a U.S. donee in a gratuitous transfer, the U.S. donee
shall be taxable in the manner provided in paragraph (a) of this
section only if the U.S. tax computed under that section exceeds the
U.S. tax that would be due if the U.S. donee treats the amount as a
distribution from the trust.
(d) Definition of purported gift or bequest. For purposes of this
section, a purported gift or bequest is any transfer by a partnership
or foreign corporation (other than a transfer for fair market value) to
a person who is not a partner in the partnership or shareholder of the
foreign corporation.
(e) Effect on U.S. partner or shareholder. This section applies
only to computations of the U.S. donee's gross income. This section
does not affect the U.S. tax treatment of a U.S. partner in the
partnership or a U.S. shareholder of the foreign corporation.
(f) Recharacterization by district director. Notwithstanding any
other provision in this section, if a U.S. donee receives a transfer
that is subject to the rules of this section, the district director may
recharacterize such transfer to prevent the avoidance of U.S. tax or
clearly to reflect income. For example, the district director may
determine, based upon the facts and circumstances, that a distribution
from a partnership or foreign corporation is more properly
characterized as a distribution from a trust.
(g) De minimis exception. This section shall not apply if, during
the taxable year of a U.S. donee, the aggregate amount of purported
gifts or bequests that is transferred to such U.S. donee
[[Page 30796]]
directly or indirectly from a partnership or foreign corporation does
not exceed $10,000. The aggregate amount must include gifts or bequests
from persons that the U.S. donee knows or has reason to know are
related to the partnership or foreign corporation (within the meaning
of section 643(i)).
(h) Examples. The following examples illustrate the rules of this
section:
Example 1. FC is a foreign corporation that is wholly owned by
A, a nonresident alien. FC distributes property directly to A's U.S.
daughter, B, purportedly as a gift. Under paragraph (a)(2) of this
section, B must treat the distribution as a dividend from FC.
(However, if B can establish that the distribution exceeded FC's
earnings and profits, B must treat such excess as an amount received
in excess of basis under section 301(c)(3).) If FC is a passive
foreign investment company, B must treat the amount as a
distribution under section 1291. B will be treated as having the
same holding period as A.
Example 2. FC is a foreign corporation that is wholly owned by
A, a nonresident alien. FC creates and funds a revocable foreign
trust, FT, from which a gratuitous transfer is made immediately to
A's U.S. daughter, B. Thus, the transfer is out of trust corpus. FC
is not treated as the owner of FT under sections 671 through 679.
Under paragraph (c) of this section, B must treat the transfer as a
dividend from FC, rather than a distribution from FT, if such
treatment results in a higher U.S. tax liability.
(i) Effective date. The rules of this section are applicable for
any transfer by a partnership or foreign corporation on or after August
20, 1996.
Sec. 1.672(f)-5 Special rules.
(a) Transfers by certain beneficiaries to foreign settlor--(1) In
general. If, but for section 672(f)(5), a foreign person would be
treated as the owner of any portion of a trust, any U.S. beneficiary of
such trust shall be treated as the owner of a portion of the trust to
the extent the U.S. beneficiary directly or indirectly made transfers
of property to such foreign person (without regard to whether the U.S.
beneficiary was a U.S. beneficiary at the time of any transfer) in
excess of transfers to the U.S. beneficiary from the foreign person.
The rule of this paragraph will not apply to the extent the U.S.
beneficiary can demonstrate to the satisfaction of the district
director that the transfer by the U.S. beneficiary to the foreign
person was wholly unrelated to any transaction involving the trust. For
purposes of this paragraph, a transfer of property does not include a
nongratuitous transfer. See Sec. 671-2(e)(4)(ii). In addition, a gift
shall not be taken into account to the extent such gift would not be
characterized as a taxable gift under section 2503(b). For a definition
of U.S. beneficiary, see section 679.
(2) Examples. The following examples illustrate the rules of this
section:
Example 1. A, a nonresident alien, contributes property to FC, a
foreign corporation that is wholly owned by A. FC creates a foreign
trust, FT, for the benefit of A and his children. FT is revocable by
FC without the approval or consent of any other person. FC funds FT
with the property received from A. A and his family move to the
United States. Under paragraph (a)(1) of this section, A is treated
as the owner of FT.
Example 2. B, a U.S. citizen, makes a gratuitous transfer of $1
million to his uncle, C, a nonresident alien. C creates a foreign
trust, FT, for the benefit of B and his children. FT is revocable by
C without the approval or consent of any other person. C funds FT
with the property received from B. Under paragraph (a)(1) of this
section, B is treated as the owner of FT. (B also would be treated
as the owner of FT as a result of section 679.)
(b) Different taxable years. If a person has a different taxable
year (as defined in section 7701(a)(23)) from the taxable year of the
trust, an amount is currently taken into account in computing the
income of such person for purposes of Sec. 1.672(f)-1 if the amount is
taken into account for the taxable year of such person that includes
the last day of the taxable year of the trust.
(c) Entity characterization. Entities generally shall be
characterized under U.S. income tax principles. See Secs. 301.7701-1
through 301.7701-4 of this chapter. However, for purposes of
Sec. 1.672(f)-4, a transferor that is a wholly owned business entity
shall be treated as a corporation, separate from its single owner. See
Sec. 301.7701-2(c)(2)(iii) of this chapter.
(d) Effective date. The rules of this section are generally
applicable as of August 20, 1996. However, the rules in paragraph (c)
of this section shall not be applicable until [date of publication as a
final regulation in the Federal Register].
PART 301--PROCEDURE AND ADMINISTRATION
Par. 5. The authority citation for part 301 is amended by adding an
entry in numerical order to read as follows:
Authority: 26 U.S.C. 7805 * * *
Section 301.7701-2(c)(2)(iii) also issued under 26 U.S.C.
643(a)(7), 672(f)(4) and (6).
Par. 6. Section 301.7701-2 is amended by adding paragraph
(c)(2)(iii) to read as follows:
Sec. 301.7701-2 Business entities; definitions.
* * * * *
(c) * * *
(2) * * *
(iii) Special rule for foreign business entities that make
purported gifts. For the purposes of applying the rules of section
672(f)(4), a wholly owned business entity shall be treated as a
corporation, separate from its single owner.
* * * * *
Michael P. Dolan,
Acting Commissioner of Internal Revenue.
[FR Doc. 97-14735 Filed 6-4-97; 8:45 am]
BILLING CODE 4830-01-U
