Notice 2007-9 provides guidance under recently enacted Section 954(c)(6), which excludes from subpart F income certain items of income received by a controlled foreign corporation (“CFC”) from related CFCs to the extent the items are not considered attributable or allocable to subpart F income or income that is effectively connected with a trade or business in the United States (“ECI”).


U.S. shareholders of a CFC on the last day of the CFC’s taxable year must take into income their pro rata share of the “subpart F income” recognized by the CFC during the taxable year. Among other things, subpart F income includes foreign personal holding company income (“FPHCI”) which includes passive income such as dividends, interest, royalties, rent and annuities. However, FPHCI does not include dividends and interest from a related corporation incorporated in the same country as the CFC and engaged in a business in that county. The exception applies to dividends only if they are attributable to earnings and profits accumulated when the recipient was related to the CFC. Rents and royalties from same country related corporations are excluded from FPHCI to the extent they relate to property used in the same foreign country. The same country exception does not apply to deductible items to the extent the item reduces the payer’s subpart F income (including by the creation of an earnings and profits deficit under Section 952(c)).

Section 954(c)(6) provides that FPHCI does not include dividends, interest, rent and royalties received from a related CFC (whether or not incorporated in the same country), but only to the extent the dividend is attributable or the interest, rent and royalties are allocable to income of the payer CFC that is neither subpart F income nor ECI. In effect, Section 954(c)(6) is an extension of the same country FPHCI exclusion. It is not elective and it applies to taxable years of foreign corporations beginning after December 31, 2005, and before January 1, 2009, and to taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end. Notice 2007-9 generally applies as of the effective date of Section 954(c)(6) except that two of its four anti-abuse rules are effective for taxable years of a foreign corporation beginning after December 31, 2006.


Notice 2007-9 defines dividends for purposes of Section 954(c)(6) under the general definition of dividends in Section 316. The term also includes amounts received in redemption of stock that are treated as a dividend under Section 301(c)(1) (including a redemption that is deemed to occur pursuant to Section 304 related party stock transactions), gain realized by a CFC on the sale of stock in a lower tier foreign corporation that is treated as a dividend under Section 964(e) and boot received in a tax-free transaction that is classified as a dividend under Section 356. However, dividends do not include income recognized by a CFC under the Section 367(b) regulations on account of a transaction involving another CFC that results in recognition of the all earnings and profits amount. Finally, in a change from the same country exception, the Section 954(c)(6) exclusion may apply to dividends attributable to earnings and profits realized in periods when the recipient was not related to the CFC.


Notice 2007-9 provides that interest, rents or royalties received by a CFC from a partnership are treated as received from a related CFC and eligible for the Section 954(c)(6) exclusion to the extent the partnership has related CFC partners that would be treated as the payer of the item of income under Regulation Section 1.954-2(b). If dividends, interest, rent or royalties are received by a partnership with one or more CFC partners, the CFC partners are treated as receiving or accruing such amounts for purposes of the Section 954(c)(6) exclusion to the extent provided under applicable regulations under subchapter K and subpart F.

Allocation and Attribution Rules

Section 954(c)(6) provides that items of income or deduction are attributable or properly allocable to subpart F income or ECI under “rules similar to” the foreign tax credit limitation basket allocation rules of Section 904(d)(3)(C), which are largely based on the deduction sourcing rules in the Section 861 regulations. Notice 2007-9 follows the statute with little elaboration. The notice provides that interest, rent and royalties are not eligible for Section 954(c)(6) to the extent they create an earnings and profit deficit under Section 952(c) that may reduce subpart F income of the payer CFC (or a related CFC under the chain deficit rule) or a net operating loss that could offset ECI in future years.

Anti-Abuse Rules

Notice 2007-9 provides four discrete examples of transactions that “abuse the general purposes of Section 954(c)(6).” A transaction is generally considered abusive if it reduces the U.S. income tax base by having the net effect of creating a deduction or a loss for a person that is subject to U.S. tax while the CFC recipient of the payment is able to avoid a corresponding increase in subpart F income through the Section 954(c)(6) exclusion.

The first example involves the sale by a U.S. parent company (“USP”) of receivables from its wholly-owned CFC1 (derived from the sale of inventory by USP to CFC1) to USP’s wholly-owned CFC2. The sale is at a discount and it generates a loss. Absent the anti-abuse rule, USP will realize a loss on the sale of receivables and CFC2 will exclude interest paid by CFC1 on the receivables under Section 954(c)(6) (generally speaking factoring income qualifies as interest). The notice provides that CFC2 must recognize subpart F income in respect of the interest from CFC1. The second example illustrates that Section 954(c)(6) will not apply to payments that are designed to reduce the applicable earnings of the payer CFC to avoid an income inclusion under Section 956 where the payer CFC holds U.S. property. In the example a second tier CFC paid a dividend to a first tier CFC in order to eliminate its applicable earnings under Section 956. The third example illustrates that Section 954(c)(6) will not apply to dividends, interest, rent or royalties if the payer CFC is a CFC only because it has issued options or similar instruments for the principal purpose of qualifying for the Section 954(c)(6) exclusion. The fourth example illustrates that Section 954(c)(6) will not apply to payments made through structures involving conduit entities where the principal purpose is to qualify the payments for the Section 954(c)(6) exclusion. In the example, CFC1 is a Country Y corporation and CFC2 is a Country Z corporation and both companies are 100 percent owned by USP. FC, also a Country Z corporation, is not a CFC but it is related to CFC2 for purposes of the subpart F income same country exclusion. FC wishes to rent property owned by CFC1, but instead of entering into a lease directly with CFC1 (which would produce subpart F income for CFC1), CFC1 leases the property to CFC2 which in turn sub-leases the property to FC. Without an anti-abuse rule, rent received by CFC2 from FC will not be subpart F income under the same country exclusion and rent received by CFC1 from CFC2 will not be subpart F income under Section 954(c)(6). However, the notice provides that Section 954(c)(6) will not apply to the rent received by CFC1 because the principal purpose of inserting CFC2 into the transaction as a conduit was to qualify the rent for the Section 954(c)(6) exclusion. The third and fourth examples are effective for taxable years beginning after 2006.

Planning Considerations

While Notice 2007-9 clarifies some issues under Section 954(c)(6) in a taxpayer friendly manner, the notice leaves loose ends in some important areas. For example, additional guidance will likely be needed on the attribution or allocation of dividends and items of income between subpart F income or ECI and other types of income. Guidance may also be necessary on earnings and profits deficits and net operating losses. It is also likely that more guidance will be forthcoming on abusive transactions. Finally, in light of the sunset of Section 954(c)(6) after 2009 and the planning opportunities available with the check-the-box election to avoid dividends between CFCs, it will be interesting to see whether the impact of Section 954(c)(6) is more academic than practical.