[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2002]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.864-8T]

[Page 311-316]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.864-8T  Treatment of related person factoring income (temporary).

    (a) Applicability--(1) General rule. This section applies for 
purposes of determining the treatment of income derived by a person from 
a trade or service receivable acquired from a related person. Except as 
provided in paragraph (d) of this section, if a person acquires 
(directly or indirectly) a trade or service receivable from a related 
person, any income (including any stated interest, discount or service 
fee) derived from the trade or service receivable shall be treated as if 
it were interest received on a loan to the obligor under the receivable. 
The characterization of income as interest pursuant to this section 
shall apply only for purposes of sections 551-558 (relating to foreign 
personal holding companies), sections 951-964 (relating to controlled 
foreign corporations), and section 904 (relating to the limitation on 
the foreign tax credit) of the Code and the regulations thereunder. The 
principles of sections 861 through 863 and the regulations thereunder 
shall be applied to determine the source of such interest income for 
purposes of section 904.
    (2) Override. With respect to income characterized as interest under 
this section, the special rules of section 864(d) and this section 
override any conflicting provisions of the Code and regulations relating 
to foreign personal holding companies, controlled foreign corporations, 
and the foreign tax credit limitation. Thus, for example, pursuant to 
section 864(d)(5) and paragraph (e) of this section, stated interest 
derived from a factored trade or service receivable is not eligible for 
the subpart F de minimis rule of section

[[Page 312]]

954(b)(3), the same country exception of section 954(c)(3)(A)(i), or the 
special rules for export financing interest of sections 904(d)(2) and 
954(c)(2)(B), even if in the absence of this section the treatment of 
such stated interest would be governed by those sections.
    (3) Limitation. Section 864(d) and this section apply only with 
respect to the tax treatment of income derived from a trade or service 
receivable acquired from a related person. Therefore, neither section 
864(d) nor this section affects the characterization of an expense or 
loss of either the seller of a receivable or the obligor under a 
receivable. Accordingly, the obligor under a trade or service receivable 
shall not be allowed to treat any part of the purchase price of property 
or services as interest (other than amounts treated as interest under 
provisions other than section 864(d)).
    (b) Definitions. The following definitions apply for purposes of 
this section and Sec. 1.956-3T.
    (1) Trade or service receivable. The term ``trade or service 
receivable'' means any account receivable or evidence of indebtedness, 
whether or not issued at a discount and whether or not bearing stated 
interest, arising out of the disposition by a related person of property 
described in section 1221(l) (hereinafter referred to as ``inventory 
property'') or the performance of services by a related person.
    (2) Related person. A ``related person'' is:
    (i) A person who is a related person within the meaning of section 
267(b) and the regulations thereunder;
    (ii) A United States shareholder (as defined in section 951(b)); or
    (iii) A person who is related (within the meaning of section 267(b) 
and the regulations thereunder) to a United States shareholder.
    (c) Acquisition of a trade or service receivable--(1) General rule. 
A trade or service receivable is considered to be acquired by a person 
at the time when that person is entitled to receive all or a portion of 
the income from the trade or service receivable. A person who acquires a 
trade or service receivable (hereinafter referred to as the ``factor'') 
is considered to have acquired a trade or service receivable regardless 
of whether:
    (i) The acquisition is characterized for federal income tax purposes 
as a sale, a pledge of collateral for a loan, an assignment, a capital 
contribution, or otherwise;
    (ii) The factor takes title to or obtains physical possession of the 
trade or service receivable;
    (iii) The related person assigns the trade or service receivable 
with or without recourse:
    (iv) The factor or some other person is obligated to collect the 
payments due under the trade or service receivable;
    (v) The factor is liable for all property, excise, sales, or similar 
taxes due upon collection of the receivable;
    (vi) The factor advances the entire face amount of the trade or 
service receivable transferred;
    (vii) All trade or service receivables assigned by the related 
person are assigned to one factor; and
    (viii) The obligor under the trade or service receivable is notified 
of the assignment.
    (2) Example. The following example illustrates the application of 
paragraphs (a), (b), and (c)(1) of this section.

    Example. P, a domestic corporation, owns all of the outstanding 
stock of FS, a controlled foreign corporation. P manufactures and sells 
paper products to customers, including X, an unrelated domestic 
corporation. As part of a sales transaction, P takes back a trade 
receivable from X and sells the receivable to FS. Because FS has 
acquired a trade or service receivable from a related person, the income 
derived by FS from P's receivable is interest income described in 
paragraph (a)(1) of this section.

    (3) Indirect acquisitions--(i) Acquisition through unrelated person. 
A trade or service receivable will be considered to be acquired from a 
related person if it is acquired from an unrelated person who acquired 
(directly or indirectly) such receivable from a person who is a related 
person to the factor. The following example illustrates the application 
of this paragraph (c)(3)(i).

    Example. A, a United States citizen, owns all of the outstanding 
stock of FPHC, a foreign personal holding company. A performs 
engineering services within and without the United States for customers, 
including X, an

[[Page 313]]

unrelated corporation. A performs engineering services for X and takes 
back a service receivable. A sells the receivable to Y, an unrelated 
corporation engaged in the factoring business. Y resells the receivable 
to FPHC. Because FPHC has indirectly acquired a service receivable from 
a related person, the income derived by FPHC from A's receivable is 
interest income described in paragraph (a)(1) of this section.

    (ii) Acquisition by nominee or pass-through entity. A factor will be 
considered to have acquired a trade or service receivable held on its 
behalf by a nominee or by a partnership, simple trust, S corporation or 
other pass-through entity to the extent the factor owns (directly or 
indirectly) a beneficial interest in such partnership or other pass-
through entity. The rule of this paragraph (c)(3)(ii) does not limit the 
application of paragraph (c)(3)(iii) of this section regarding the 
characterization of trade or service receivables of unrelated persons 
acquired pursuant to certain swap or pooling arrangements. The following 
example illustrates the application of this paragraph (c)(3)(ii).

    Example. FS1, a controlled foreign corporation, acquires a 20 
percent limited partnership interest in PS, a partnership. PS purchases 
trade or service receivables resulting from the sale of inventory 
property by FS1's domestic parent, P. PS does not purchase receivables 
of any person who is related to any other partner in PS. FS1 is 
considered to have acquired a 20 percent interest in the receivables 
acquired by PS. Thus, FS1's distributive share of the income derived by 
PS from the receivables of P is considered to be interest income 
described in paragraph (a)(1) of this section.

    (iii) Swap or pooling arrangements. A trade or service receivable of 
a person unrelated to the factor will be considered to be a trade or 
service receivable acquired from a related person and subject to the 
rules of this section if it is acquired in accordance with an 
arrangement that involves two or more groups of related persons that are 
unrelated to each other and the effect of the arrangement is that one or 
more related persons in each group acquire (directly or indirectly) 
trade or service receivables of one or more unrelated persons who are 
also parties to the arrangement, in exchange for reciprocal purchases of 
the first group's receivables. The following example illustrates the 
application of this paragraph (c)(3)(iii).

    Example. Controlled foreign corporations A, B, C, and D are wholly-
owned subsidiaries of domestic corporations M, N, O, and P, 
respectively. M, N, O, and P are not related persons. According to a 
prearranged plan, A, B, C, and D each acquire trade or service 
receivables of M, N, O, and/or P, except that neither A, B, C nor D 
acquires receivables of its own parent corporation. Because the effect 
of this arrangement is that the unrelated groups acquire each other's 
trade or service receivables pursuant to the arrangement, income derived 
by A, B, C, and D from the receivables acquired from M, N, O, and P is 
interest income described in paragraph (a)(1) of this section.

    (iv) Financing arrangements. If a controlled foreign corporation (as 
defined in section 957(a)) participates (directly or indirectly) in a 
lending transaction that results in a loan to the purchaser of inventory 
property, services, or trade or service receivables of a related person 
(or a loan to a person who is related to the purchaser), and if the loan 
would not have been made or maintained on the same terms but for the 
corresponding purchase, then the controlled foreign corporation shall be 
considered to have indirectly acquired a trade or service receivable, 
and income derived by the controlled foreign corporation from such a 
loan shall be considered to be income described in paragraph (a)(1) of 
this section. For purposes of this paragraph (c)(3)(iv), it is 
immaterial that the sums lent are not, in fact, the sums used to finance 
the purchase of a related person's inventory property, services, or 
trade or service receivables. The amount of income derived by the 
controlled foreign corporation to be taken into account shall be the 
total amount of income derived from a lending transaction described in 
this paragraph (c)(3)(iv), if the amount lent is less than or equal to 
the purchase price of the inventory property, services, or trade or 
service receivables. If the amount lent is greater than the purchase 
price of the inventory property, services or receivables, the amount to 
be taken into account shall be the proportion of the interest charge 
(including original issue discount) that the purchase price bears to the 
total amount lent pursuant to the lending transaction. The following

[[Page 314]]

examples illustrate the application of this paragraph (c)(3)(iv).

    Example 1. P, a domestic corporation, owns all of the outstanding 
stock of FS1, a controlled foreign corporation engaged in the financing 
business in Country X. P manufactures and sells toys, including sales to 
C, an unrelated corporation. Prior to P's sale of toys to C for $2,000, 
D, a wholly-owned Country X subsidiary of C, borrows $3,000 from FS1. 
The loan from FS1 to D would not have been made or maintained on the 
same terms but for C's purchase of toys from P. Two-thirds of the income 
derived by FS1 from the loan to D is interest income described in 
paragraph (a)(1) of this section.
    Example 2. P, a domestic corporation, owns all of the outstanding 
stock of FS1, a controlled foreign corporation organized under the laws 
of Country X. FS1 has accumulated cash reserves. P has uncollected trade 
and service receivables of foreign obligors. FS1 makes a $1,000 loan to 
U, a foreign corporation that is unrelated to P or FS1. U purchases P's 
trade and service receivables for $2,000. The loan would not have been 
made or maintained on the same terms but for U's purchase of P's 
receivables. The income derived by U from the receivables is not 
interest income within the meaning of paragraph (a) of this section. 
However, the interest paid by U to FS1 is interest income described in 
paragraph (a)(1) of this section.
    Example 3. The facts are the same as in Example (2), except that U 
is a wholly-owned Country Y subsidiary of FS1. Because U is related to P 
within the meaning of paragraph (b)(2) of this section, under paragraph 
(c)(1) of this section, income derived by U from P's receivables is 
interest income described in paragraph (a)(1) of this section. In 
addition, the income derived by FS1 from the loan to U is interest 
income described in paragraph (a)(1) of this section.

    (d) Same country exception--(1) Income from trade or service 
receivables. Income derived from a trade or service receivable acquired 
from a related person shall not be treated as interest income described 
in paragraph (a)(1) of this section if:
    (i) The person acquiring the trade or service receivable and the 
related person are created or organized under the laws of the same 
foreign country;
    (ii) The related person has a substantial part of its assets used in 
its trade or business located in such foreign country; and
    (iii) The related person would not have derived foreign base company 
income, as defined in section 954(a) and the regulations thereunder, or 
income effectively connected with a United States trade or business from 
such receivable if the related person had collected the receivable.

For purposes of paragraph (d)(1)(ii) of this section, the standards 
contained in Sec. 1.954-2(e) shall apply in determining the location of 
a substantial part of the assets of a related person. For purposes of 
paragraph (d)(1)(iii) of this section, a determination of whether the 
related person would have derived foreign base company income shall be 
made without regard to the de minimis test described in section 
954(b)(3)(A). The following examples illustrate the application of this 
paragraph (d)(1).

    Example 1. FS1, a controlled foreign corporation incorporated under 
the laws of Country X, owns all of the outstanding stock of FS2, which 
is also incorporated under the laws of Country X. FS1 has a substantial 
part of its assets used in its business in Country X. FS1 manufactures 
and sells toys for use in Country Y. The toys sold are considered to be 
manufactured in Country X under Sec. 1.954-3(a)(2). FS1 is not 
considered to have a branch or similar establishment in Country Y that 
is treated as a separate corporation under section 954(d)(2) and 
Sec. 1.954-3(b). Thus, gross income derived by FS1 from the toy sales is 
not foreign base company sales income. FS1 takes back receivables 
without stated interest from its customers. FS1 assigns those 
receivables to FS2. The income derived by FS2 from the receivables of 
FS1 is not interest income described in paragraph (a)(1) of this 
section, because it satisfies the same country exception under paragraph 
(d)(1) of this section.
    Example 2. The facts are the same as in Example 1, except that the 
toys sold by FS1 are purchased from FS1's U.S. parent and are sold for 
use outside of Country X. Thus, any income derived by FS1 from the sale 
of the toys would be foreign base company sales income. Therefore, 
income derived by FS2 from the receivables of FS1 is interest income 
described in paragraph (a)(1) of this section. FS2 is considered to 
derive interest income from the receivable even if, solely by reason of 
the de minimis rule of section 954(b)(3)(A), FS1 would not have derived 
foreign base company income if FS1 had collected the receivable.

    (2) Income from financing arrangements. Income derived by a 
controlled foreign corporation from a loan to a person that purchases 
inventory property or services of a person that is related to the 
controlled foreign corporation, or from other loans described in

[[Page 315]]

paragraph (c)(3)(iv) of this section, shall not be treated as interest 
income described in paragraph (a)(1) of this section if:
    (i) The person providing the financing and the related person are 
created or organized under the laws of the same foreign country;
    (ii) The related person has a substantial part of its assets used in 
its trade or business located in such foreign country; and
    (iii) The related person would not have derived foreign base company 
income or income effectively connected with a United States trade or 
business:
    (A) From the sale of inventory property or services to the borrower 
or from financing the borrower's purchase of inventory property or 
services, in the case of a loan to the purchaser of inventory property 
or services of a related person; or
    (B) From collecting amounts due under the receivable or from 
financing the purchase of the receivable, in the case of a loan to the 
purchaser of a trade or service receivable of a related person.

For purposes of paragraph (d)(2)(ii) of this section, the standards 
contained in Sec. 1.954-2(e) shall apply in determining the location of 
a substantial part of the assets of a related person. For purposes of 
paragraph (d)(2)(iii) of this section, a determination of whether the 
related person would have derived foreign base company income shall be 
made without regard to the de minimis test described in section 
954(b)(3)(A). The following examples illustrate the application of this 
paragraph (d)(2).

    Example 1. FS1, a controlled foreign corporation incorporated under 
the laws of Country X, owns all of the outstanding stock of FS2, which 
is also incorporated under the laws of Country X. FS1, which has a 
substantial part of its assets used in its business located in Country 
X, manufactures and sells toys for use in Country Y. The toys sold are 
considered to be manufactured in Country X under Sec. 1.954-3(a)(2). FS1 
is not considered to have a branch or similar establishment in Country Y 
that is treated as a separate corporation under section 954(d)(2) and 
Sec. 1.954-3(b). Thus, the gross income derived by FS1 from the toy 
sales is not foreign base company sales income. FS2 makes a loan to FS3, 
a wholly-owned subsidiary of FS1 which is also incorporated under the 
laws of Country X, in connection with FS3's purchase of toys from FS1. 
FS3 does not earn any subpart F gross income. Thus, FS1 would not have 
derived foreign personal holding company interest income if FS1 had made 
the loan to FS3, because the interest would be covered by the same 
country exception of section 954(c)(3). Therefore, the income derived by 
FS2 from its loan to FS3 is not treated as interest income described in 
paragraph (a)(1) of this section, because it satisfies the same country 
exception under paragraph (d)(2) of this section. Such income is also 
not treated as foreign personal holding company income described in 
section 954(c)(1)(A) because the same country exception of section 
954(c)(3) also applies to the interest actually derived by FS2 from its 
loan to FS3.
    Example 2. FS1, a controlled foreign corporation incorporated under 
the laws of Country X, owns all of the outstanding stock of FS2, which 
is also incorporated under the laws of Country X. FS1 purchases toys 
from its U.S. parent and resells them for use outside of Country X. As 
part of a sales transaction, FS1 takes back trade receivables. FS2 makes 
a loan to U, an unrelated corporation, to finance U's purchase of FS1's 
trade receivables. Because FS1 would have derived foreign base company 
income if FS1 had collected the receivables or made the loan itself, the 
same country exception of paragraph (d)(2) of this section does not 
apply. Accordingly, under paragraph (c)(3)(iv) of this section, the 
income derived by FS2 from its loan to U is treated as interest income 
described in paragraph (a)(1) of this section.

    (e) Special rules--(1) Foreign personal holding companies and 
controlled foreign corporations. For purposes of sections 551-558 
(relating to foreign personal holding companies), the exclusion provided 
by section 552(c) for interest described in section 954(c)(3)(A) shall 
not apply to income described in paragraph (a)(1) of this section. For 
purposes of the sections 951-964 (relating to controlled foreign 
corporations), income described in paragraph (a)(1) of this section 
shall be included in a United States shareholder's pro rata share of a 
controlled foreign corporation's subpart F income without regard to the 
de minimis rule under section 954(b)(3)(A). However, income described in 
paragraph (a)(1) of this section shall be included in the computation of 
a controlled foreign corporation's foreign base company income for 
purposes of applying the de minimis rule under section 954(b)(3)(A) and 
the more than 70 percent of gross income test under section 
954(b)(3)(B). In addition, income

[[Page 316]]

described in paragraph (a)(1) of this section shall be considered to be 
subpart F income without regard to the exclusions from foreign base 
company income provided by section 954(c)(2)(B) (relating to export 
financing interest derived in the conduct of a banking business) and 
section 954(c)(3)(A)(i) (relating to certain interest income received 
from related persons).
    (2) Foreign tax credit. Income described in paragraph (a)(1) of this 
section shall be considered to be interest income for purposes of the 
section 904 foreign tax credit limitation and is not eligible for the 
exceptions for export financing interest provided in section 904(d)(2) 
(A)(iii)(II), (B)(ii), and (C)(iii). In addition, such income will be 
subject to the look-through rule for subpart F income set forth in 
section 904(d)(3) without regard to the de minimis exception provided in 
section 904(d)(3)(E).
    (3) Possessions corporations--(i) Limitation on credit. Income 
described in paragraph (a)(1) of this section shall not be treated as 
income described in section 936(a)(1) (A) or (B) unless the income is 
considered under the principles of Sec. 1.863-6 to be derived from 
sources within the possessions. Thus, the credit provided by section 936 
is not available for income described in paragraph (a)(1) of this 
section unless the obligor under the receivable is a resident of a 
possession. In the case of a loan described in section 864(d)(6), the 
credit provided by section 936 is not available for income described in 
paragraph (a)(1) of this section unless the purchaser of the inventory 
property or services is a resident of a possession.
    (ii) Eligibility determination. Notwithstanding the limitation on 
the availability of the section 936 credit for income described in 
paragraph (a)(1) of this section, if income treated as interest income 
under paragraph (a)(1) of this section is derived from sources within a 
possession (determined without regard to this section), such income 
shall be eligible for inclusion in a corporation's gross income for 
purposes of section 936(a)(2)(A). If such income is derived from the 
active conduct of a trade or business within a possession (determined 
without regard to this section), such income shall be eligible for 
inclusion in a corporation's gross income for purposes of section 
936(a)(2)(B). (These rules apply for purposes of determining whether a 
corporation is eligible to elect the credit provided under section 
936(a).)
    (iii) Example. The following example illustrates the application of 
paragraph (e)(3) of this section.

    Example. Corporation X is operating in a possession as a possessions 
corporation. In 1985, X earned $50,000 from the active conduct of a 
business in the possession, including $5,000 from trade or service 
receivables acquired from a related party. Obligors under the 
receivables acquired by X are not residents of the possession. 
Corporation X also earned $20,000 from activities other than its active 
conduct of business in the possession. The $5,000 derived by X from the 
receivables is not eligible for the section 936 credit. However, the 
$5,000 may be used by X to meet the percentage tests under section 
936(a)(2) to the extent that such income is considered to be derived 
from sources within the possession (for purposes of section 
936(a)(2)(A)) or is considered to be derived from the active conduct of 
a trade or business in the possession (for purposes of section 
936(a)(2)(B)), in either case determined without regard to the 
characterization of such income under this section.

    (f) Effective date. The provisions of this section shall apply with 
respect to accounts receivable and evidences of indebtedness transferred 
after March 1, 1984 and are effective June 14, 1988.

[T.D. 8209, 53 FR 22166, June 14, 1988]