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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 301

\[TD 9093\]

RIN 1545-AX39

Special Rules for Certain Foreign Business Entities

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

SUMMARY: This document contains final regulations providing rules
regarding the application of the general entity classification rules to
certain foreign business entities, in particular providing a rule that
terminates the grandfathered status of certain foreign business entities
upon a 50 percent change of ownership and a special rule that clarifies
and further modifies the rules relating to whether the classification of
certain foreign eligible entities is relevant for Federal tax purposes.

EFFECTIVE DATES: These regulations are effective as of October 22, 2003.

FOR FURTHER INFORMATION CONTACT: Ronald M. Gootzeit, (202) 622-3860 (not
a toll-free number).

SUPPLEMENTARY INFORMATION:

**Background**

On December 18, 1996, Treasury and IRS published in the **Federal
Register** (61 FR 66584) final regulations relating to the
classification of business entities under section 7701 (check-the-box
regulations). On November 29, 1999, Treasury and the IRS published in
the **Federal Register** (64 FR 66591) a notice of proposed rulemaking
(REG-110385-99) proposing to amend §§301.7701-2 and 301.7701-3 of the
current check-the-box regulations (proposed regulations). A public
hearing on the proposed regulations was held on January 31, 2000. In
addition, written comments were received. Most of the written and oral
comments related to proposed §301.7701-3(h), which provided a rule that
would have operated to change the classification of a foreign
disregarded entity if a so-called "extraordinary transaction" occurred
one day before or within one year after the election to treat the entity
as disregarded. On June 26, 2003, Treasury and the IRS issued Notice
2003-46 (2003-28 IRB 53) announcing the intention to withdraw this
extraordinary transaction rule of proposed §301.7701-3(h) and to
finalize the remaining provisions of the proposed regulations.

With the publication of a notice of withdrawal elsewhere in this issue
of the **Federal Register**, proposed §301.7701-3(h) is withdrawn. This
Treasury decision adopts without substantive change the remaining
provisions of the proposed regulations. The final regulations thus adopt
the following provisions from the proposed regulations: (1) the rule
that terminates the grandfathered status of certain foreign business
entities when there has been a 50 percent change of ownership of such
entity; (2) the provision clarifying that a foreign eligible entity with
respect to which an entity classification election is made and which is
not otherwise relevant for Federal tax purposes is deemed so relevant
only on the effective date specified on a Form 8832, "Entity
Classification Election"; and (3) the modifications to the
classification rules for certain foreign eligible entities that have
never been relevant or are no longer relevant for Federal tax purposes.

**Explanation of Provisions**

A. [Grandfathered Foreign Per Se Entities]{.underline}

The check-the-box regulations allow certain foreign business entities
that were in existence and treated as partnerships prior to the date the
check-the-box regulations were proposed (PS-43-95, 61 FR 21989) and that
would otherwise be classified as per se corporations under
\'301.7701-2(b)(8)(i) to remain classified as partnerships if the
conditions enumerated in \'301.7701‑2(d)(1) are satisfied. These rules
also provide that the occurrence of certain events results in a
termination of this grandfathered status. See §301.7701-2(d)(3)(i). The
final regulations adopt the rule in the proposed regulations at
§301.7701-2(d)(3)(i) that provides an additional event resulting in the
termination of an entity's grandfathered status. Under this rule, an
entity's grandfathered status is terminated on the date when one or more
persons who were not owners of the entity as of November 29, 1999, own
in the aggregate a 50 percent or greater interest in the entity.
Consistent with the proposed regulations, the final regulations provide
that this rule will apply as of the date the final regulations are
published in the federal register; therefore, if persons that were not
owners of a grandfathered entity on November 29, 1999, obtain a greater
than 50 percent ownership interest between November 29, 1999, and
October 22, 2003, the grandfathered entity will cease to have that
status on October 22, 2003.

Several commentators requested clarification as to whether this rule
takes into account changes in direct ownership only or also changes in
indirect ownership, and they suggested that the rule should take into
account only changes in direct ownership. Treasury and the IRS believe
that for purposes of grandfathered foreign per se entities a rule that
took only direct changes of ownership into account could be easily
circumvented in inappropriate cases. Therefore, this rule has not been
modified in these final regulations. Some commentators requested that
the rule be limited to significant changes in ownership within a
specified period of time. For example, one commentator suggested that
the rule be limited to situations where persons obtained a 50 percent or
greater ownership interest within a 12-month period. The final
regulations do not adopt this suggestion because Treasury and the IRS
believe that an entity should retain grandfathered status only if there
have been no significant changes in the ownership of that entity.

B. [Relevance of Classification]{.underline}

The check-the-box regulations provide that if the classification of a
foreign eligible entity that was previously relevant for Federal tax
purposes ceases to be relevant for 60 consecutive months and then
subsequently becomes relevant again, the entity=s classification at the
start of the subsequent period of relevance will be determined under the
default classification rules (60-month rule).

These final regulations adopt the two rules in the proposed regulations
that relate to the application of the 60-month rule. First, these final
regulations adopt the rule providing that the classification of a
foreign eligible entity that files an entity classification election is
deemed to be relevant for Federal tax purposes on the effective date of
the election for purposes of the 60‑month rule. Second, these final
regulations adopt the rule providing that the classification of a
foreign eligible entity whose classification has never been relevant for
Federal tax purposes will initially be determined pursuant to the
default classification provisions of \'301.7701‑3(b)(2) at the time the
classification of the entity first becomes relevant.

Commentators generally agreed with and supported the approach taken in
the proposed regulations with respect to the relevance issues, and
several commentators requested that these provisions be retroactive when
finalized. These final regulations do not adopt the suggestion that
these provisions be applied retroactively because Treasury and the IRS
believe that it is not in the interest of sound tax administration.

One commentator requested that the provisions be revised to clarify that
it is the Federal tax classification of the foreign eligible entity, and
not the entity itself, that is deemed to be relevant. Treasury and the
IRS have adopted this clarifying change in these final regulations.

One commentator requested that the regulations clarify why the
classification of a foreign eligible entity, not otherwise relevant,
that files Form 8832, "Entity Classification Election", is deemed
relevant only on the date the entity classification election is
effective. The commentator neither suggested what the period of deemed
relevance should be if not limited to one day nor suggested a principle
for when the deemed relevance should terminate such that the 60-month
rule would be triggered. In the interest of certainty and
administrability of the application of the 60-month rule, Treasury and
the IRS have retained the limitation of deemed relevance to the day on
which the entity's classification is effective.

One commentator requested further guidance on when and under what
circumstances the classification of a foreign eligible entity that was
previously relevant ceases to be relevant under the 60-month rule.
Treasury and the IRS believe §301.7701-3(d)(1) and (3) provide
sufficient guidance on when an entity's classification becomes relevant
and, accordingly, when an entity's classification ceases to be relevant.

One commentator suggested that the regulations be revised to provide
that an election by a non-relevant foreign entity to continue its
current classification may be filed at any time within the 60-month
period starting on the day after the date of the most recent election
for that entity, and that such election will start a new 60-month
period. Section 301.7701-3(c) provides that an eligible entity may elect
to be classified other than as provided under the default classification
rules of §301.7701-3(b), or to change its election. Allowing an eligible
entity whose classification is not relevant to renew its election for
purposes of the 60-month rule would frustrate the policies underlying
that rule. Accordingly, the suggestion was not adopted.

One commentator requested clarification and examples regarding the
determination of the classification of a foreign eligible entity whose
classification was never relevant or whose classification has not been
relevant for 60 months and therefore has lapsed under the 60-month rule.
In either case (assuming in the latter case that no election is made
following the lapse of the classification), the entity\'s classification
initially will be determined under the default classification rules of
§301.7701-3(b)(2) when the classification of the entity becomes
relevant. Under the general rules of §301.7701-3(c), an eligible entity
may elect at such time to be classified other than as provided under the
default classification rules, and may elect at some later time to change
its classification. Treasury and the IRS do not believe at this time
that further guidance or examples are needed to illustrate these general
rules.

**Special Analyses**

It has been determined that this notice of proposed rulemaking is not a
significant regulatory action as defined in Executive Order 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 final regulations, and because
these regulations do not impose a collection of information on small
entities, the Regulatory Flexibility Act (5 U.S.C. chapter 6) does not
apply. Therefore, a Regulatory Flexibility Analysis is not required.

**Drafting Information**

The principal authors of these regulations are Aaron A. Farmer and
Ronald M. Gootzeit, Office of Associate Chief Counsel (International).
However, other personnel from Treasury and the IRS participated in their
development.

**List of Subjects in 26 CFR Part 301**

Employment taxes, Estate taxes, Excise taxes, Gift taxes, Income taxes,
Penalties, Reporting and recordkeeping requirements.

**Adoption of Amendments to the Regulations**

Accordingly, 26 CFR part 301 is proposed to be amended as follows:

PART 301\--PROCEDURE AND ADMINISTRATION

Par. 1. The authority citation for part 301 continues to read in part as
follows:

> Authority: 26 U.S.C. 7805 \* \* \*
>
> Par. 2. Section 301.7701-2 is amended by:
>
> 1\. Removing the language \"or\" at the end of paragraph (d)(3)(i)(B).
>
> 2\. Removing the period at the end of paragraph (d)(3)(i)(C) and
> adding \"; or\"
>
> in its place.
>
> 3\. Adding paragraph (d)(3)(i)(D).
>
> 4\. Adding a sentence at the end of paragraph (e).
>
> The additions read as follows:
>
> [§301.7701-2 Business entities; definitions]{.underline}.
>
> \* \* \* \* \*
>
> \(d\) \* \* \*
>
> \(3\) \* \* \*
>
> \(i\) \* \* \*
>
> \(D\) The date any person or persons, who were not owners of the
> entity as of
>
> November 29, 1999, own in the aggregate a 50 percent or greater
> interest in the
>
> entity.
>
> \* \* \* \* \*
>
> \(e\) [Effective date]{.underline}. \* \* \* However, paragraph
> (d)(3)(i)(D) of this section
>
> applies on or after October 22, 2003.
>
> Par. 3. Section 301.7701-3 is amended as follows:
>
> 1\. The text of paragraph (d)(1) following the paragraph heading is
> redesignated as paragraph (d)(1)(i), and a paragraph heading is added
> for paragraph (d)(1)(i).
>
> 2\. Paragraph (d)(1)(ii) is added.\
> 3. Paragraph (d)(2) is revised.\
> 4. Paragraphs (d)(3) and (d)(4) are added.
>
> The revision and additions read as follows:
>
> [§301.7701-3 Classification of certain business entities]{.underline}.
>
> \* \* \* \* \*
>
> \(d\) [Special rules for foreign eligible entities]{.underline}\--(1)
> [Definition of relevance]{.underline}
>
> \--(i) [General rule]{.underline}. \* \* \*
>
> \(ii\) [Deemed relevance]{.underline}\--(A) [General
> rule]{.underline}. For purposes of this section, except as provided in
> paragraph (d)(1)(ii)(B) of this section, the classification for
> Federal tax purposes of a foreign eligible entity that files Form
> 8832, "Entity Classification Election", shall be deemed to be relevant
> only on the date the entity classification election is effective.
>
> \(B\) [Exception]{.underline}. If the classification of a foreign
> eligible entity is relevant within the meaning of paragraph (d)(1)(i)
> of this section, then the rule in paragraph (d)(1)(ii)(A) of this
> section shall not apply.

\(2\) [Entities the classification of which has never been
relevant]{.underline}. If the classification of a foreign eligible
entity has never been relevant (as defined in paragraph (d)(1) of this
section), then the entity\'s classification will initially be determined
pursuant to the provisions of paragraph (b)(2) of this section when the
classification of the entity first becomes relevant (as defined in
paragraph (d)(1)(i) of this section).

\(3\) [Special rule when classification is no longer
relevant]{.underline}. If the classification of a foreign eligible
entity is not relevant (as defined in paragraph (d)(1) of this section)
for 60 consecutive months, then the entity\'s classification will
initially be determined pursuant to the provisions of paragraph (b)(2)
of this section when the classification of the foreign eligible entity
becomes relevant (as defined in paragraph (d)(1)(i) of this section).
The date that the classification of a foreign entity is not relevant is
the date an event occurs that causes the classification to no longer be
relevant, or, if no event occurs in a taxable year that causes the
classification to be relevant, then the date is the first day of that
taxable year.

> \(4\) [Effective date]{.underline}. Paragraphs (d)(1)(ii), (d)(2), and
> (d)(3) of this section
>
> apply on or after October 22, 2003.

\* \* \* \* \*

Deputy Commissioner for Services and Enforcement.

Robert E. Wenzel

Approved: October 8, 2003

Assistant Secretary of the Treasury.

Pamela F. Olson