Notice 2007-13: Loosening the Rules Surrounding Substantial Assistance

By Joe Ben Combs, CPA, and Frank Landreneau, CPA, PKF Texas, Houston, TX

Editor: Kevin F. Reilly, J.D., CPA

The global marketplace has undergone a dramatic transformation since the regulations governing foreign base company services income were issued in 1968. As this change continues, the IRS must give serious consideration to the relevance of existing statutes that originated when American commerce was far more domesticated than it is today.

Fortunately, Treasury is taking note of the need for reform. Notice 2007-13 was released in January 2007 in response to a growing segment of businesses with foreign subsidiaries that use certain domestically centralized support functions. The notice will provide welcome relief to those U.S. corporations that have been forced either to pay tax on foreign base company services income or to employ a suboptimal corporate structure to avoid the tax.

In general, under Sec. 367(b), the earnings of a controlled foreign corporation (CFC) are not taxed in the United States until they are repatriated to its U.S. parent company. As a result, before the enactment of subpart F (Secs. 951–965), a corporation could generate earnings through a CFC incorporated in a low-tax jurisdiction and avoid (or at least defer) U.S. taxation on those earnings. Subpart F was enacted in response, making certain types of income generated by CFCs subject to taxation in the United States in the tax year the income is earned, regardless of whether the income is repatriated. This item focuses on one such type of income: foreign base company services income (FBCSI).

Sec. 954(e)(i) defines FBCSI as in-come of a CFC generated from the performance of services that (1) are performed for, or on behalf of, a related person and (2) are performed outside the country in which the CFC is organized. Services are deemed to be performed for, or on behalf of, a related person if that person provides substantial assistance contributing to the performance of such services. The determination of substantial assistance is the primary focus of Notice 2007-13.

The notice announces several amendments that will be made to Regs. Sec. 1.954-4(b)(2). Under current law, taxpayers may use either a subjective test or an objective cost test to determine whether substantial assistance is provided in connection with services performed. The subjective test, which provides that assistance is substantial if it is a “principal element” of the services performed, will be eliminated under the updated regulations, and the objective test will be revised drastically to limit the level of assistance that is considered substantial.

Under the objective test, current regulations specify that income from services performed by a CFC outside its country of incorporation is considered FBCSI if the cost of services provided by a related person is at least 50% of the CFC’s total cost of performing the services. The new regulations will increase this amount to 80%, allowing U.S. parent corporations more freedom to centralize support functions and provide assistance to CFCs without incurring immediate inclusion of foreign earnings in the U.S. tax base. In addition, the 80% includes only services provided by related U.S.persons; services provided by related CFCs no longer contribute toward substantial assistance. While other minor changes are introduced by the notice, those mentioned here are the most important.

Planning Strategies

As in any case in which tax rules change in favor of the taxpayer, one of the primary considerations going forward is whether strategies used under the old regulations are still sound. Previous tax planning on substantial assistance dealt largely with how services were provided to CFCs. In order to avoid generating FBCSI, certain support functions had to be decentralized, and often duplicated, to reduce the percentage of services provided by related parties. For example, to avoid providing substantial assistance, a multinational corporation engaged in construction might have previously decided to train personnel to supervise operations in the country of incorporation of one of its foreign subsidiaries, rather than centralize all supervisory services in the U.S. parent, even though centralization may have increased operational efficiency and reduced overall costs. The new regulations will allow a substantially greater portion of services to be provided by the U.S. parent, enabling the corporation to use the optimal operational structure without fear of generating subpart F income.

Perhaps the greatest opportunity for new planning stems from the exclusion of services provided by related CFCs from the definition of substantial assistance. Foreign subsidiaries will now be able to receive an unlimited amount of assistance from related foreign corporations in the performance of the services without generating subpart F income. Practically speaking, a multinational corporation can centralize support functions in whatever foreign jurisdiction is most advantageous, providing services above the 80% threshold, if necessary, without violating substantial assistance rules. This provides additional options for multinationals to locate regional service centers based on where the talent pool is located.

Caution: This exclusion does not apply to services performed indirectly by a U.S. corporation seeking to provide substantial assistance to a CFC through a related foreign corporation.


Notice 2007-13 itself is rather brief and defers to the final regulations a number of interpretive issues that remain unaddressed. Even so, it is a welcome change and serves as an encouraging signal that Treasury will continue to respond to the changing needs of a growing number of internationally focused businesses. Taxpayers may rely on the notice until the regulations are issued (when issued, they will apply to tax years of CFCs beginning on or after January 1, 2007).

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