Extraterritorial Income Exclusion Does Not Apply to Reduce a CFCs' Subpart F Income

In Chief Counsel Advice 201240019, IRS has determined that former IRC Sec. 114's extraterritorial income (ETI) exclusion doesn't apply for purposes of determining the amount of subpart F income that a taxpayer/CFC shareholder was required to include under Code Sec. 951(a)(1)(A)(i). The applicability of the ETI provisions turned on certain provisions within subchapter N which were expressly not taken into account in determining a CFC's subpart F income.

The taxpayer was a domestic corporation and a U.S. shareholder under Code Sec. 951(b) with respect to four subsidiaries, each of which is a CFC under Code Sec. 957(a). The four CFCs were the only partners in a foreign entity that is treated as a partnership for U.S. tax purposes.

The taxpayer manufactures personal property in the U.S. and sells it to the foreign partnership, which resells the property to unrelated customers outside the U.S. Each partner's distributive share of the foreign partnership's income derived from the sales is treated as subpart F income earned by the partner under Code Sec. 952 and Code Sec. 954, and generally results in a subpart F income inclusion to Taxpayer.

IRC Sec. 114, which excludes ETI from income, is located in subchapter B, which isn't excluded under Reg. § 1.952-2(c)(1). Under Code Sec. 114, if a taxpayer has gross income attributable to FTGR, then the taxpayer excludes the portion of such income that constitutes QFTI—which in turn requires application of Code Sec. 941 through Code Sec. 943 as a threshold inquiry to see whether Code Sec. 114 even applies.

However, Code Sec. 941 through Code Sec. 943 are located in subchapter N, which doesn't apply for purposes of calculating a CFC's subpart F income. Accordingly, the CCA states, an ETI exclusion cannot be calculated and claimed in connection with determining a CFC's subpart F income, and thus isn't taken into account in determining a U.S. shareholder's subpart F income inclusion.

The ETI exclusion may be computed only with respect to sales income subject to U.S. taxation in the hands of the person that earned it. Subpart F income, on the other hand, is taken into income by the U.S. shareholders of a CFC, not the CFC itself. Therefore, the ETI exclusion can't apply to a CFC for purposes of computing subpart F income since a CFC is not subject to U.S. taxation on its subpart F income.

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