Reg-146537-06

68119

Proposed Rules

Federal Register
Vol. 76, No. 213
Thursday, November 3, 2011

This section of the FEDERAL REGISTER
contains notices to the public of the proposed
issuance of rules and regulations. The
purpose of these notices is to give interested
persons an opportunity to participate in the
rule making prior to the adoption of the final
rules.

DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1 and 602
[REG–146537–06]
RIN 1545–BG08

Income of Foreign Governments and
International Organizations
Internal Revenue Service (IRS),
Treasury.
ACTION: Notice of proposed rulemaking.
AGENCY:

This document contains
proposed Income Tax Regulations that
provide guidance relating to the taxation
of the income of foreign governments
from investments in the United States
under section 892 of the Internal
Revenue Code of 1986 (Code). The
regulations will affect foreign
governments that derive income from
sources within the United States.
DATES: Written or electronic comments
and requests for a public hearing must
be received by February 1, 2012.
ADDRESSES: Send submissions to:
CC:PA:LPD:PR (REG–146537–06), Room
5205, Internal Revenue Service, PO Box
7604, Ben Franklin Station, Washington,
DC 20044. Submissions may be handdelivered Monday through Friday
between the hours of 8 a.m. and 4 p.m.
to CC:PA:LPD:PR (REG–146537–06),
Courier’s Desk, Internal Revenue
Service, 1111 Constitution Avenue NW.,
Washington, DC, or sent electronically,
via the Federal eRulemaking Portal at
http://www.regulations.gov (IRS REG–
146537–06).
FOR FURTHER INFORMATION CONTACT:
Concerning the proposed regulations,
David A. Juster, (202) 622–3850 (not a
toll-free number); concerning
submission of comments, contact
Richard A. Hurst at Richard.A.Hurst@
irscounsel.treas.gov.
SUPPLEMENTARY INFORMATION:

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SUMMARY:

Paperwork Reduction Act
The collections of information
contained in this notice of proposed

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rulemaking have been submitted to the
Office of Management and Budget
(OMB) for review and approval under
OMB approval number 1545–1053 in
accordance with the Paperwork
Reduction Act of 1995 (44 U.S.C.
3507(d)). Comments on the collections
of information should be sent to the
Office of Management and Budget, Attn:
Desk Officer for the Department of the
Treasury, Office of Information and
Regulatory Affairs, Washington, DC
20503, with copies to the Internal
Revenue Service, Attn: IRS Reports
Clearance Officer, SE:CAR:MP:T:T:SP,
Washington, DC 20224. Comments on
the collection of information should be
received by January 3, 2012. Comments
are specifically requested concerning:
Whether the proposed collection of
information is necessary for the proper
performance of the functions of the
Internal Revenue Service, including
whether the information will have
practical utility;
The accuracy of the estimated burden
associated with the proposed collection
of information;
How the quality, utility, and clarity of
the information to be collected may be
enhanced;
How the burden of complying with
the proposed collections of information
may be minimized, including through
the application of automated collection
techniques or other forms of information
technology; and
Estimates of capital or start-up costs
and costs of operation, maintenance,
and purchase of services to provide
information.
The collection of information in this
proposed regulation is in §§ 1.892–
5(a)(2)(ii)(B) and 1.892–5(a)(2)(iv). This
information is required to determine if
taxpayers qualify for exemption from
tax under section 892. The collection of
information is voluntary to obtain a
benefit. The likely respondents are
foreign governments.
Estimated total annual reporting
burden: 975 hours.
Estimated average annual burden
hours per respondent: 5 hours.
Estimated number of respondents:
195.
Estimated annual frequency of
responses: 1.
An agency may not conduct or
sponsor, and a person is not required to
respond to, a collection of information
unless it displays a valid control

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number assigned by the Office of
Management and Budget.
Books or records relating to a
collection of information must be
retained as long as their contents may
become material in the administration
of any internal revenue law. Generally,
tax returns and tax return information
are confidential, as required by 26
U.S.C. 6103.
Background
This document contains proposed
amendments to 26 CFR part 1 and to 26
CFR part 602. On June 27, 1988,
temporary regulations under section 892
(TD 8211, 53 FR 24060) (1988 temporary
regulations) with a cross-reference
notice of proposed rulemaking (53 FR
24100) were published in the Federal
Register to provide guidance concerning
the taxation of income of foreign
governments and international
organizations from investments in the
United States. The proposed regulations
contained herein supplement the crossreferenced notice of proposed
rulemaking to provide additional
guidance for determining when a
foreign government’s investment
income is exempt from U.S. taxation.
Explanation of Provisions
The Treasury Department and the IRS
have recently received numerous
written comments on the 1988
temporary regulations. The proposed
regulations are issued in response to
those comments.
Treatment of Controlled Entities
Section 892 exempts from U.S.
income taxation certain qualified
investment income derived by a foreign
government. Section 1.892–2T defines
the term foreign government to mean
only the integral parts or controlled
entities of a foreign sovereign. The
exemption from U.S. income tax under
section 892 does not apply to income
(1) Derived from the conduct of any
commercial activity, (2) received by a
controlled commercial entity or
received (directly or indirectly) from a
controlled commercial entity, or (3)
derived from the disposition of any
interest in a controlled commercial
entity. Section 892(a)(2)(B) defines a
controlled commercial entity as an
entity owned by the foreign government
that meets certain ownership or control
thresholds and that is engaged in
commercial activities anywhere in the

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world. Accordingly, an integral part of
a foreign sovereign that derives income
from both qualified investments and
from the conduct of commercial activity
is eligible to claim the section 892
exemption with respect to the income
from qualified investments, but not with
respect to the income derived from the
conduct of commercial activity. In
contrast, if a controlled entity (as
defined in § 1.892–2T(a)(3)) engages in
commercial activities anywhere in the
world, it is treated as a controlled
commercial entity, and none of its
income (including income from
otherwise qualified investments)
qualifies for exemption from tax under
section 892. In addition, none of the
income derived from the controlled
entity (e.g., dividends), including the
portion attributable to qualified
investments of the controlled entity,
will be eligible for the section 892
exemption. Several comments raised
concerns that this so-called ‘‘all or
nothing’’ rule represents an unnecessary
administrative and operational burden
for foreign governments and a trap for
unwary foreign governments that
inadvertently conduct a small level of
commercial activity. These comments
have requested that the Treasury
Department and the IRS revise § 1.892–
5T(a) to provide for a de minimis
exception under which an entity would
not be treated as a controlled
commercial entity as a result of certain
inadvertent commercial activity.
In response to these comments, the
proposed regulations at § 1.892–5(a)(2)
provide that an entity will not be
considered to engage in commercial
activities if it conducts only inadvertent
commercial activity. Commercial
activity will be treated as inadvertent
commercial activity only if: (1) The
failure to avoid conducting the
commercial activity is reasonable; (2)
the commercial activity is promptly
cured; and (3) certain record
maintenance requirements are met.
However, none of the income derived
from such inadvertent commercial
activity will qualify for exemption from
tax under section 892.
In determining whether an entity’s
failure to avoid conducting a particular
commercial activity is reasonable, due
regard will be given to the number of
commercial activities conducted during
the taxable year, as well as the amount
of income earned from, and assets used
in, the conduct of the commercial
activity in relationship to the entity’s
total income and assets. However, a
failure to avoid conducting commercial
activity will not be considered
reasonable unless adequate written
policies and operational procedures are

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in place to monitor the entity’s
worldwide activities. The proposed
regulations include a safe harbor at
§ 1.892–5(a)(2)(ii)(C) under which,
provided that there are adequate written
policies and operational procedures in
place to monitor the entity’s worldwide
activities, the controlled entity’s failure
to avoid the conduct of commercial
activity during a taxable year will be
considered reasonable if: (1) The value
of the assets used in, or held for use in,
the activity does not exceed five percent
of the total value of the assets reflected
on the entity’s balance sheet for the
taxable year as prepared for financial
accounting purposes; and (2) the income
earned by the entity from the
commercial activity does not exceed
five percent of the entity’s gross income
as reflected on its income statement for
the taxable year as prepared for
financial accounting purposes.
Comments also requested further
guidance on the duration of a
determination that an entity is a
controlled commercial entity. In
response to these comments, the
proposed regulations at § 1.892–5(a)(3)
provide that the determination of
whether an entity is a controlled
commercial entity within the meaning
of section 892(a)(2)(B) will be made on
an annual basis. Accordingly, an entity
will not be considered a controlled
commercial entity for a taxable year
solely because the entity engaged in
commercial activities in a prior taxable
year.
Definition of Commercial Activity
Section 1.892–4T of the 1988
temporary regulations provides rules for
determining whether income is derived
from the conduct of a commercial
activity, and specifically identifies
certain activities that are not
commercial, including certain
investments, trading activities, cultural
events, non-profit activities, and
governmental functions. Several
comments have expressed uncertainty
about the applicable U.S. standard for
determining when an activity will be
considered a commercial activity, a nonprofit activity, or governmental function
for purposes of section 892 and § 1.892–
4T.
Section 1.892–4(d) of the proposed
regulations restates the general rule
adopted in the 1988 temporary
regulations that, subject to certain
enumerated exceptions, all activities
ordinarily conducted for the current or
future production of income or gain are
commercial activities. Section 1.892–
4(d) of the proposed regulations further
provides that only the nature of an
activity, not the purpose or motivation

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for conducting the activity, is
determinative of whether the activity is
a commercial activity. This standard
also applies for purposes of determining
whether an activity is characterized as
a non-profit activity or governmental
function under § 1.892–4T(c)(3) and
(c)(4). In addition, § 1.892–4(d) of the
proposed regulations clarifies the rule in
the 1988 temporary regulations by
providing that an activity may be
considered a commercial activity even if
the activity does not constitute a trade
or business for purposes of section 162
or does not constitute (or would not
constitute if undertaken in the United
States) the conduct of a trade or
business in the United States for
purposes of section 864(b).
Section 1.892–4T(c) lists certain
activities that will not be considered
commercial activities. One such activity
is investments in financial instruments,
as defined in § 1.892–3T(a)(4), which, if
held in the execution of governmental
financial or monetary policy, are not
commercial activities for purposes of
section 892. Several comments have
requested that the condition that
financial instruments be ‘‘held in the
execution of governmental financial or
monetary policy’’ be eliminated to more
closely conform the treatment of
investments in financial instruments,
including derivatives, with investments
in physical stocks and securities, which
under the 1988 temporary regulations
generally are not commercial activities
regardless of whether they are held in
the execution of governmental financial
or monetary policy. Section 1.892–
4(e)(1)(i) of the proposed regulations
modifies the rules in § 1.892–4T(c)(1)(i)
by providing that investments in
financial instruments will not be treated
as commercial activities for purposes of
section 892, irrespective of whether
such financial instruments are held in
the execution of governmental financial
or monetary policy. In addition,
§ 1.892–4(e)(1)(ii) of the proposed
regulations expands the existing
exception in § 1.892–4T(c)(1)(ii) from
commercial activity for trading of
stocks, securities, and commodities to
include financial instruments, without
regard to whether such financial
instruments are held in the execution of
governmental financial or monetary
policy. These revisions address only the
definition of commercial activity for
purposes of determining whether a
government will be considered to derive
income from the conduct of a
commercial activity, or whether an
entity will be considered to be engaged
in commercial activities. They do not
address whether income from activities

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that are not commercial activities will
be exempt from tax under section 892.
Pursuant to § 1.892–3T(a), only income
derived from investments in financial
instruments held in the execution of
governmental financial or monetary
policy will qualify for exemption from
tax under section 892.
Comments have requested
clarification as to whether an entity that
disposes of a United States real property
interest (USRPI) as defined in section
897(c) will be deemed to be engaged in
commercial activities solely by reason of
this disposition. Section 897(a)(1)
requires that a nonresident alien or
foreign corporation take into account
gain or loss from the disposition of a
USRPI as if the taxpayer were engaged
in a trade or business within the United
States during the taxable year and as if
such gain or loss were effectively
connected with that trade or business.
The Treasury Department and the IRS
believe that an entity that only holds
passive investments and is not
otherwise engaged in commercial
activities should not be deemed to be
engaged in commercial activities solely
by reason of the operation of section
897(a)(1). Accordingly, § 1.892–
4(e)(1)(iv) of the proposed regulations
provides that a disposition, including a
deemed disposition under section
897(h)(1), of a USRPI, by itself, does not
constitute the conduct of a commercial
activity. However, as provided in
§ 1.892–3T(a), the income derived from
the disposition of the USRPI described
in section 897(c)(1)(A)(i) shall in no
event qualify for the exemption from tax
under section 892.
After the 1988 temporary regulations
were published, section 892(a)(2)(A)
was amended by the Technical and
Miscellaneous Revenue Act of 1988
(TAMRA), Public Law No. 100–647, 102
Stat. 3342 to provide that income
derived from the disposition of any
interest in a controlled commercial
entity does not qualify for the
exemption under section 892. The
proposed regulations revised § 1.892–
5(a) to reflect the amendment of section
892 by TAMRA.
Treatment of Partnerships
Section 1.892–5T(d)(3) provides a
general rule that commercial activities
of a partnership are attributable to its
general and limited partners
(‘‘partnership attribution rule’’) and
provides a limited exception to this rule
for partners of publicly traded
partnerships (PTPs). Several comments
have requested that the Treasury
Department and the IRS modify the
partnership attribution rule to provide
that the activities of a partnership will

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not be attributed to a foreign
government partner if that government:
(i) Holds a minority interest, as a limited
partner, in the partnership; and (ii) has
no greater rights to participate in the
management and conduct of the
partnership’s business than would a
minority shareholder in a corporation
conducting the same activities as the
partnership. The comments assert that
the partnership attribution rule causes
many controlled entities of foreign
sovereigns to forego making investments
in foreign partnerships or other foreign
entities that do not invest in the United
States out of concern that such
investments might cause those
controlled entities to be treated as
controlled commercial entities.
In response to these comments,
§ 1.892–5(d)(5)(iii) of the proposed
regulations modifies the existing
exception to the partnership attribution
rule for PTP interests by providing a
more general exception for limited
partnership interests. Under this revised
exception, an entity that is not
otherwise engaged in commercial
activities will not be treated as engaged
in commercial activities solely because
it holds an interest as a limited partner
in a limited partnership, including a
publicly traded partnership that
qualifies as a limited partnership.
For this purpose, an interest as a
limited partner in a limited partnership
is defined as an interest in an entity
classified as a partnership for federal tax
purposes if the holder of the interest
does not have rights to participate in the
management and conduct of the
partnership’s business at any time
during the partnership’s taxable year
under the law of the jurisdiction in
which the partnership is organized or
under the governing agreement. This
definition of an interest as a limited
partner in a limited partnership applies
solely for purposes of this exception,
and no inference is intended that the
same definition would apply for any
other provision of the Code making or
requiring a distinction between a
general partner and a limited partner.
Although the commercial activity of a
limited partnership will not cause a
controlled entity of a foreign sovereign
limited partner meeting the
requirements of the exception for
limited partnerships to be engaged in
commercial activities, the controlled
entity partner’s distributive share of
partnership income attributable to such
commercial activity will be considered
to be derived from the conduct of
commercial activity, and therefore will
not be exempt from taxation under
section 892. Additionally, in the case of
a partnership that is a controlled

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commercial entity, no part of the foreign
government partner’s distributive share
of partnership income will qualify for
exemption from tax under section 892.
Comments also assert that disparity in
tax treatment exists under the temporary
regulations regarding foreign
government trading activity described in
§ 1.892–4T(c)(1)(ii) because trading for a
foreign government’s own account does
not constitute a commercial activity but
no similar rule applies in the case of
trading done by a partnership of which
a foreign government is a partner. The
comments note that this disparity is not
generally present in determining
whether an activity is a trade or
business within the United States under
section 864(b). See § 1.864–2(c)(2)(i) and
(d)(2)(i). In response to these comments,
§ 1.892–5(d)(5)(ii) of the proposed
regulations provides that an entity that
is not otherwise engaged in commercial
activities will not be considered to be
engaged in commercial activities solely
because it is a member of a partnership
that effects transactions in stocks,
bonds, other securities, commodities, or
financial instruments for the
partnership’s own account. However,
this exception does not apply in the
case of a partnership that is a dealer in
stocks, bonds, other securities,
commodities, or financial instruments.
For this purpose, whether a partnership
is a dealer is determined under the
principles of § 1.864–2(c)(2)(iv)(a).
Proposed Effective/Applicability Date
These regulations are proposed to
apply on the date of publication of the
Treasury decision adopting these rules
as final regulations in the Federal
Register. For rules applicable to periods
prior to the publication date, see the
corresponding provisions in §§ 1.892–
4T and 1.892–5T in the 1988 temporary
regulations and in § 1.892–5(a) as issued
under TD 9012 (August 1, 2002).
Reliance on Proposed Regulations
Taxpayers may rely on the proposed
regulations until final regulations are
issued.
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
has also 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
proposed regulations do not impose a
collection of information on small
entities, the Regulatory Flexibility Act
(5 U.S.C. chapter 6) does not apply.

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Federal Register / Vol. 76, No. 213 / Thursday, November 3, 2011 / Proposed Rules

Pursuant to section 7805(f) of the Code,
this notice of proposed rulemaking has
been submitted to the Chief Counsel for
Advocacy of the Small Business
Administration for comment on its
impact on small business.
Comments and Requests for Public
Hearing
Before the proposed regulations are
adopted as final regulations,
consideration will be given to any
written (a signed original and eight (8)
copies) or electronic comments, that are
submitted timely to the IRS. The
Treasury Department and the IRS
request comments on the clarity of the
proposed regulations and how they can
be made easier to understand. All
comments will be available for public
inspection and copying. A public
hearing will be scheduled if requested
in writing by any person that timely
submits written comments. If a public
hearing is scheduled, notice of the date,
time, and place for the public hearing
will be published in the Federal
Register.
Drafting Information
The principal author of these
regulations is David A. Juster of the
Office of Associate Chief Counsel
(International), within the Office of
Chief Counsel, IRS. Other personnel
from the Treasury Department and the
IRS participated in developing the
regulations.
List of Subjects
26 CFR Part 1
Income taxes, Reporting and
recordkeeping requirements.
26 CFR Part 602
Reporting and recordkeeping
requirements.
Proposed Amendments to the
Regulations
Accordingly, 26 CFR parts 1 and 602
are proposed to be amended as follows:
PART 1—INCOME TAX REGULATIONS

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Paragraph 1. The authority citation
for parts 1 and 601 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Section 1.892–4 also issued under 26
U.S.C. 892(c). * * *

Par. 2. Section 1.892–4 is added to
read as follows:
§ 1.892–4

Commercial activities.

(a) through (c) [Reserved]. For further
guidance, see § 1.892–4T(a) through (c).
(d) In general. Except as provided in
paragraph (e) of this section, all

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activities (whether conducted within or
outside the United States) which are
ordinarily conducted for the current or
future production of income or gain are
commercial activities. Only the nature
of the activity, not the purpose or
motivation for conducting the activity,
is determinative of whether the activity
is commercial in character. An activity
may be considered a commercial
activity even if such activity does not
constitute a trade or business for
purposes of section 162 or does not
constitute (or would not constitute if
undertaken in the United States) the
conduct of a trade or business in the
United States for purposes of section
864(b).
(e) Activities that are not
commercial—(1) Investments—(i) In
general. Subject to the provisions of
paragraphs (e)(1)(ii) and (iii) of this
section, the following are not
commercial activities: investments in
stocks, bonds, and other securities (as
defined in § 1.892–3T(a)(3)); loans;
investments in financial instruments (as
defined in § 1.892–3T(a)(4)); the holding
of net leases on real property; the
holding of real property which is not
producing income (other than on its sale
or from an investment in net leases on
real property); and the holding of bank
deposits in banks. Transferring
securities under a loan agreement which
meets the requirements of section 1058
is an investment for purposes of this
paragraph (e)(1)(i). An activity will not
cease to be an investment solely because
of the volume of transactions of that
activity or because of other unrelated
activities.
(ii) Trading. Effecting transactions in
stocks, bonds, other securities (as
defined in § 1.892–3T(a)(3)),
commodities, or financial instruments
(as defined in § 1.892–3T(a)(4)) for a
foreign government’s own account does
not constitute a commercial activity
regardless of whether such activity
constitutes a trade or business for
purposes of section 162 or constitutes
(or would constitute if undertaken
within the United States) the conduct of
a trade or business in the United States
for purposes of section 864(b). Such
transactions are not commercial
activities regardless of whether they are
effected by the foreign government
through its employees or through a
broker, commission agent, custodian, or
other independent agent and regardless
of whether or not any such employee or
agent has discretionary authority to
make decisions in effecting the
transactions. Such transactions
undertaken as a dealer (as determined
under the principles of § 1.864–
2(c)(2)(iv)(a)), however, constitute

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commercial activity. For purposes of
this paragraph (e)(1)(ii), the term
commodities means commodities of a
kind customarily dealt in on an
organized commodity exchange but only
if the transaction is of a kind
customarily consummated at such
place.
(iii) Banking, financing, etc.
Investments (including loans) made by
a banking, financing, or similar business
constitute commercial activities, even if
the income derived from such
investments is not considered to be
income effectively connected with the
active conduct of a banking, financing,
or similar business in the U.S. by reason
of the application of § 1.864–4(c)(5).
(iv) Disposition of a U.S. real property
interest. A disposition (including a
deemed disposition under section
897(h)(1)) of a U.S. real property interest
(as defined in section 897(c)), by itself,
does not constitute the conduct of a
commercial activity. As described in
§ 1.892–3T(a), however, gain derived
from a disposition of a U.S. real
property interest defined in section
897(c)(1)(A)(i) will not qualify for
exemption from tax under section 892.
(2) through (5) [Reserved]. For further
guidance, see § 1.892–4T(c)(2) through
(c)(5).
(f) Effective/applicability date. This
section applies on the date the
regulations are published as final
regulations in the Federal Register. See
§ 1.892–4T for the rules that apply
before the date the regulations are
published as final regulations in the
Federal Register.
Par. 3. Section 1.892–5 is revised to
read as follows:
§ 1.892–5

Controlled commercial entity.

(a) In general—(1) General rule and
definition of term ‘‘controlled
commercial entity’’. Under section
892(a)(2)(A)(ii) and (a)(2)(A)(iii), the
exemption generally applicable to a
foreign government (as defined in
§ 1.892–2T) for income described in
§ 1.892–3T does not apply to income
received by a controlled commercial
entity or received (directly or indirectly)
from a controlled commercial entity, or
to income derived from the disposition
of any interest in a controlled
commercial entity. For purposes of
section 892 and the regulations
thereunder, the term entity means and
includes a corporation, a partnership, a
trust (including a pension trust
described in § 1.892–2T(c)), and an
estate, and the term controlled
commercial entity means any entity
(including a controlled entity as defined
in § 1.892–2T(a)(3)) engaged in
commercial activities (as defined in

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Federal Register / Vol. 76, No. 213 / Thursday, November 3, 2011 / Proposed Rules
§§ 1.892–4 and 1.892–4T) (whether
conducted within or outside the United
States) if the government—
(i) Holds (directly or indirectly) any
interest in such entity which (by value
or voting power) is 50 percent or more
of the total of such interests in such
entity, or
(ii) Holds (directly or indirectly) any
other interest in such entity which
provides the foreign government with
effective practical control of such entity.
(2) Inadvertent commercial activity—
(i) General rule. For purposes of
determining whether an entity is a
controlled commercial entity for
purposes of section 892(a)(2)(B) and
paragraph (a)(1) of this section, an entity
that conducts only inadvertent
commercial activity will not be
considered to be engaged in commercial
activities. However, any income derived
from such inadvertent commercial
activity will not qualify for exemption
from tax under section 892. Commercial
activity of an entity will be treated as
inadvertent commercial activity only if:
(A) Failure to avoid conducting the
commercial activity is reasonable as
described in paragraph (a)(2)(ii) of this
section;
(B) The commercial activity is
promptly cured as described in
paragraph (a)(2)(iii) of this section; and
(C) The record maintenance
requirements described in paragraph
(a)(2)(iv) of this section are met.
(ii) Reasonable failure to avoid
commercial activity—(A) In general.
Subject to paragraphs (a)(2)(ii)(B) and
(C) of this section, whether an entity’s
failure to prevent its worldwide
activities from resulting in commercial
activity is reasonable will be determined
in light of all the facts and
circumstances. Due regard will be given
to the number of commercial activities
conducted during the taxable year and
in prior taxable years, as well as the
amount of income earned from, and
assets used in, the conduct of the
commercial activities in relationship to
the entity’s total income and assets,
respectively. For purposes of this
paragraph (a)(2)(ii)(A) and paragraph
(a)(2)(ii)(C) of this section, where a
commercial activity conducted by a
partnership is attributed under
paragraph (d)(5)(i) of this section to an
entity owning an interest in the
partnership—
(1) Assets used in the conduct of the
commercial activity by the partnership
are treated as assets used in the conduct
of commercial activity by the entity in
proportion to the entity’s interest in the
partnership; and
(2) The entity’s distributive share of
the partnership’s income from the

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conduct of the commercial activity shall
be treated as income earned by the
entity from the conduct of commercial
activities.
(B) Continuing due diligence
requirement. A failure to avoid
commercial activity will not be
considered reasonable unless there is
continuing due diligence to prevent the
entity from engaging in commercial
activities within or outside the United
States as evidenced by having adequate
written policies and operational
procedures in place to monitor the
entity’s worldwide activities. A failure
to avoid commercial activity will not be
considered reasonable if the
management-level employees of the
entity have not undertaken reasonable
efforts to establish, follow, and enforce
such written policies and operational
procedures.
(C) Safe Harbor. Provided that
adequate written policies and
operational procedures are in place to
monitor the entity’s worldwide
activities as required in paragraph
(a)(2)(ii)(B) of this section, the entity’s
failure to avoid commercial activity
during the taxable year will be
considered reasonable if:
(1) The value of the assets used in, or
held for use in, all commercial activity
does not exceed five percent of the total
value of the assets reflected on the
entity’s balance sheet for the taxable
year as prepared for financial
accounting purposes, and
(2) The income earned by the entity
from commercial activity does not
exceed five percent of the entity’s gross
income as reflected on its income
statement for the taxable year as
prepared for financial accounting
purposes.
(iii) Cure requirement. A timely cure
shall be considered to have been made
if the entity discontinues the conduct of
the commercial activity within 120 days
of discovering the commercial activity.
For example, if an entity that holds an
interest as a general partner in a
partnership discovers that the
partnership is conducting commercial
activity, the entity will satisfy the cure
requirement if, within 120 days of
discovering the commercial activity, the
entity discontinues the conduct of the
activity by divesting itself of its interest
in the partnership (including by
transferring its interest in the
partnership to a related entity), or the
partnership discontinues its conduct of
commercial activity.
(iv) Record maintenance. Adequate
records of each discovered commercial
activity and the remedial action taken to
cure that activity must be maintained.
The records shall be retained so long as

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68123

the contents thereof may become
material in the administration of section
892.
(3) Annual determination of
controlled commercial entity status. If
an entity described in paragraph (a)(1)(i)
or (ii) of this section engages in
commercial activities at any time during
a taxable year, the entity will be
considered a controlled commercial
entity for the entire taxable year. An
entity not otherwise engaged in
commercial activities during a taxable
year will not be considered a controlled
commercial entity for a taxable year
even if the entity engaged in commercial
activities in a prior taxable year.
(b) through (d)(4) [Reserved]. For
further guidance, see § 1.892–5T(b)
through (d)(4).
(5) Partnerships—(i) General rule.
Except as provided in paragraph
(d)(5)(ii) or (d)(5)(iii) of this section, the
commercial activities of an entity
classified as a partnership for federal tax
purposes will be attributable to its
partners for purposes of section 892. For
example, if an entity described in
paragraph (a)(1)(i) or (ii) of this section
holds an interest as a general partner in
a partnership that is engaged in
commercial activities, the partnership’s
commercial activities will be attributed
to that entity for purposes of
determining if the entity is a controlled
commercial entity within the meaning
of section 892(a)(2)(B) and paragraph (a)
of this section.
(ii) Trading activity exception. An
entity not otherwise engaged in
commercial activities will not be
considered to be engaged in commercial
activities solely because the entity is a
member of a partnership (whether
domestic or foreign) that effects
transactions in stocks, bonds, other
securities (as defined in § 1.892–
3T(a)(3)), commodities (as defined in
§ 1.892–4(e)(1)(ii)), or financial
instruments (as defined in § 1.892–
3T(a)(4)) for the partnership’s own
account or solely because an employee
of such partnership, or a broker,
commission agent, custodian, or other
agent, pursuant to discretionary
authority granted by such partnership,
effects such transactions for the account
of the partnership. This exception shall
not apply to any member in the case of
a partnership that is a dealer in stocks,
bonds, other securities, commodities, or
financial instruments, as determined
under the principles of § 1.864–
2(c)(2)(iv)(a).
(iii) Limited partner exception—(A)
General rule. An entity that is not
otherwise engaged in commercial
activities (including, for example,
performing services for a partnership as

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Federal Register / Vol. 76, No. 213 / Thursday, November 3, 2011 / Proposed Rules

described in section 707(a) or section
707(c)) will not be deemed to be
engaged in commercial activities solely
because it holds an interest as a limited
partner in a limited partnership.
Nevertheless, pursuant to sections 875,
882, and 892(a)(2)(A)(i), a foreign
government member’s distributive share
of partnership income will not be
exempt from taxation under section 892
to the extent that the partnership
derived such income from the conduct
of a commercial activity. For example,
where a controlled entity described in
§ 1.892–2T(a)(3) that is not otherwise
engaged in commercial activities holds
an interest as a limited partner in a
limited partnership that is a dealer in
stocks, bonds, other securities,
commodities, or financial instruments
in the United States, although the
controlled entity partner will not be
deemed to be engaged in commercial
activities solely because of its interest in
the limited partnership, its distributive
share of partnership income derived
from the partnership’s activity as a
dealer will not be exempt from tax
under section 892 because it was
derived from the conduct of a
commercial activity.
(B) Interest as a limited partner in a
limited partnership. Solely for purposes
of paragraph (d)(5)(iii) of this section, an
interest in an entity classified as a
partnership for federal tax purposes
shall be treated as an interest as a
limited partner in a limited partnership
if the holder of such interest does not
have rights to participate in the
management and conduct of the
partnership’s business at any time
during the partnership’s taxable year
under the law of the jurisdiction in
which the partnership is organized or
under the governing agreement. Rights
to participate in the management and
conduct of a partnership’s business do
not include consent rights in the case of
extraordinary events such as admission
or expulsion of a general or limited
partner, amendment of the partnership
agreement, dissolution of the
partnership, disposition of all or
substantially all of the partnership’s
property outside of the ordinary course
of the partnership’s activities, merger, or
conversion.
(iv) Illustration. The following
example illustrates the application of
this paragraph (d)(5):
Example 1. K, a controlled entity of a
foreign sovereign, has investments in various
stocks and bonds of United States
corporations and in a 20% interest in Opco,
a limited liability company that is classified
as a partnership for federal tax purposes.
Under the governing agreement of Opco, K
has the authority to participate in the

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management and conduct of Opco’s business.
Opco has investments in various stocks and
bonds of United States corporations and also
owns and manages an office building in New
York. Because K has authority to participate
in the management and conduct of Opco’s
business, its interest in Opco is not a limited
partner interest. Therefore, K will be deemed
to be engaged in commercial activities
because of attribution of Opco’s commercial
activity, even if K does not actually make
management decisions with regard to Opco’s
commercial activity, the operation of the
office building. Accordingly, K is a
controlled commercial entity, and all of its
income, including its distributive share of
partnership income from its interest in Opco
and its income from the stocks and bonds it
owns directly, will not be exempt from tax
under section 892.
Example 2. The facts are the same as in
Example 1, except that Opco has hired a real
estate management firm to lease offices and
manage the office building. Notwithstanding
the fact that an independent contractor is
performing the activities, Opco will still be
deemed to be engaged in commercial
activities. Accordingly, K is a controlled
commercial entity, and all of its income,
including its distributive share of partnership
income from its interest in Opco and its
income from the stocks and bonds it owns
directly, will not be exempt from tax under
section 892.
Example 3. The facts are the same as in
Example 1, except that K is a member that
has no right to participate in the management
and conduct of Opco’s business. Assume
further that K is not otherwise engaged in
commercial activities. Under paragraph
(d)(5)(iii) of this section, Opco’s commercial
activities will not be attributed to K.
Accordingly, K will not be a controlled
commercial entity, and its income derived
from the stocks and bonds it owns directly
and the portion of its distributive share of
partnership income from its interest in Opco
that is derived from stocks and bonds will be
exempt from tax under section 892. The
portion of K’s distributive share of
partnership income from its interest in Opco
that is derived from the operation of the
office building will not be exempt from tax
under section 892 and § 1.892–3T(a)(1).

(e) Effective/applicability date. This
section applies on the date these
regulations are published as final
regulations in the Federal Register. See
§ 1.892–5(a) as issued under TD 9012
(August 1, 2002) for rules that apply on
or after January 14, 2002, and before the
date these regulations are published as
final regulations in the Federal Register.
See § 1.892–5T(a) for rules that apply
before January 14, 2002, and § 1.892–
5T(b) through (d) for rules that apply
before the date these regulations are
published as final regulations in the
Federal Register.

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PART 602—OMB CONTROL NUMBERS
UNDER THE PAPERWORK
REDUCTION ACT
Par. 4. The authority for part 602
continues to read as follows:
Authority: 26 U.S.C. 7805.

Par. 5. In § 602.101, paragraph (b) is
amended by adding an entry to the table
in numerical order to read as follows:
§ 602.101

*

OMB Control numbers.

*
*
(b) * * *

*

*

CFR part or section where
identified and described
*
*
*
1.892–5 .................................
*

*

*

Current OMB
Control No.
*

*
1545–1053

*

*

Steven T. Miller,
Deputy Commissioner for Services and
Enforcement.
[FR Doc. 2011–28531 Filed 11–2–11; 8:45 am]
BILLING CODE 4830–01–P

FEDERAL COMMUNICATIONS
COMMISSION
47 CFR Part 73
[MB Docket No. 09–115, RM–11543; DA 11–
1502]

Television Broadcasting Services;
Fond du Lac, WI
Federal Communications
Commission.
ACTION: Proposed rule.
AGENCY:

In this document, the
Commission denies a petition for
reconsideration of an August 12, 2009
Report and Order changing the allotted
channel for station WWAZ–TV, Fond
du Lac, Wisconsin, from channel 44 to
channel 5. The petitioner stated that the
staff, in granting the original channel
change, cited erroneous loss-of-service
figures. The petitioner further argues
that the primary technical justification
for creation of this loss area was not
raised until the reply comment stage,
and that the record further does not
support the technical justification. The
order finds that the staff requested a reengineered proposal that would result
in the replacement translators covering
the projected analog loss area. The
document finds that the re-engineered
translators sufficiently address any loss
of service, and further finds that the
public interest is served by substituting
channel 5 for channel 44 at Fond du Lac

SUMMARY:

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