Par. 2. Section 1.671-1 is amended by adding paragraphs (g) and (h) to read as follows:
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(g) Domestic nonexempt employees' trust--(1) General rule. An employer is not treated as an owner of any portion of a nonexempt employees' trust described in section 402(b) that is part of a deferred compensation plan, and that is not a foreign trust within the meaning of section 7701(a)(31), regardless of whether the employer has a power or interest described in sections 673 through 677 over any portion of the trust. See section 402(b)(3) and Sec. 1.402(b)-1(b)(6) for rules relating to treatment of a beneficiary of a nonexempt employees' trust as the owner of a portion of the trust.
(2) Example. The following example illustrates the rules of paragraph (g)(1) of this section:
Example. Employer X provides nonqualified deferred compensation through Plan A to certain of its management employees. Employer X has created Trust T to fund the benefits under Plan A. Assets of Trust T may not be used for any purpose other than to satisfy benefits provided under Plan A until all plan liabilities have been satisfied. Trust T is classified as a trust under Sec. 301.7701-4 of this chapter, and is not a foreign trust within the meaning of section 7701(a)(31). Under Sec. 1.83-3(e), contributions to Trust T are considered transfers of property to participants within the meaning of section 83. On these facts, Trust T is a nonexempt employees' trust described in section 402(b). Because Trust T is a nonexempt employees' trust described in section 402(b) that is part of a deferred compensation plan, and that is not a foreign trust within the meaning of section 7701(a)(31), Employer X is not treated as an owner of any portion of Trust T.
(h) Foreign employees' trust--(1) General rules. Except as provided under section 679 or as provided under this paragraph (h)(1), an employer is not treated as an owner of any portion of a foreign employees' trust (as defined in paragraph (h)(2) of this section), regardless of whether the employer has a power or interest described in sections
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673 through 677 over any portion of the trust.
(i) Plan of CFC employer. If a controlled foreign corporation (as defined in section 957) maintains a deferred compensation plan funded through a foreign employees' trust, then, with respect to the controlled foreign corporation, the provisions of subpart E apply to the portion of the trust that is the fractional interest described in paragraph (h)(3) of this section.
(ii) Plan of U.S. employer. If a United States person (as defined in section 7701(a)(30)) maintains a deferred compensation plan that is funded through a foreign employees' trust, then, with respect to the U.S. person, the provisions of subpart E apply to the portion of the trust that is the fractional interest described in paragraph (h)(3) of this section.
(iii) Plan of U.S.-related foreign partnership employer--(A) General rule. If a U.S.-related foreign partnership (as defined in paragraph (h)(1)(iii)(B) of this section) maintains a deferred compensation plan funded through a foreign employees' trust, then, with respect to the U.S.-related foreign partnership, the provisions of subpart E apply to the portion of the trust that is the fractional interest described in paragraph (h)(3) of this section.
(B) U.S.-related foreign partnership. For purposes of this paragraph (h), a U.S.-related foreign partnership is a foreign partnership in which a U.S. person or a controlled foreign corporation owns a partnership interest either directly or indirectly through one or more partnerships.
(iv) Application of Sec. 1.1297-4 to plan of foreign non-CFC employer. A foreign employer that is not a controlled foreign corporation may be treated as an owner of a portion of a foreign employees' trust as provided in Sec. 1.1297-4.
(v) Application to employer entity. The rules of paragraphs (h)(1)(i) through (h)(1)(iv) of this section apply to the employer whose employees benefit under the deferred compensation plan funded through a foreign employees' trust, or, in the case of a deferred compensation plan covering independent contractors, the recipient of services performed by those independent contractors, regardless of whether the plan is maintained through another entity. Thus, for example, where a deferred compensation plan benefitting employees of a controlled foreign corporation is funded through a foreign employees' trust, the controlled foreign corporation is considered to be the grantor of the foreign employees' trust for purposes of applying paragraph (h)(1)(i) of this section.
(2) Foreign employees' trust. A foreign employees' trust is a nonexempt employees' trust described in section 402(b) that is part of a deferred compensation plan, and that is a foreign trust within the meaning of section 7701(a)(31).
(3) Fractional interest for paragraph (h)(1)--(i) In general. The fractional interest for a foreign employees' trust used for purposes of paragraph (h)(1) of this section for a taxable year of the employer is an undivided fractional interest in the trust for which the fraction is equal to the relevant amount for the employer's taxable year divided by the fair market value of trust assets for the employer's taxable year.
(ii) Relevant amount--(A) In general. For purposes of applying paragraph (h)(3)(i) of this section, and except as provided in paragraph (h)(3)(iii) of this section, the relevant amount for the employer's taxable year is the amount, if any, by which the fair market value of trust assets, plus the fair market value of any assets available to pay plan liabilities that are held in the equivalent of a trust within the meaning of section 404A(b)(5)(A), exceed the plan's accrued liability. The following rules apply for this purpose:
(1) The plan's accrued liability is determined using a projected unit credit funding method that satisfies the requirements of Sec. 1.412(c)(3)-1, taking into account only liabilities relating to services performed through the measurement date for the employer or a predecessor employer.
(2) The plan's accrued liability is reduced (but not below zero) by any liabilities that are provided for under annuity contracts held to satisfy plan liabilities.
(3) Any amount held under an annuity contract that exceeds the amount that is needed to satisfy the liabilities provided for under the contract (e.g., the value of a participation right under a participating annuity contract) is added to the fair market value of any assets available to pay plan liabilities that are held in the equivalent of a trust.
(4) If the relevant amount as determined under this paragraph (h)(3)(ii), without regard to this paragraph (h)(3)(ii)(A)(4), is greater than the fair market value of trust assets, then the relevant amount is equal to the fair market value of trust assets.
(B) Permissible actuarial assumptions for accrued liability. For purposes of paragraph (h)(3)(ii)(A) of this section, a plan's accrued liability must be calculated using an interest rate and other actuarial assumptions that the Commissioner determines to be reasonable. It is appropriate in determining this interest rate to look to available information about rates implicit in current prices of annuity contracts, and to look to rates of return on high-quality fixed-income investments currently available and expected to be available during the period prior to maturity of the plan benefits. If the qualified business unit computes its income or earnings and profits in dollars pursuant to the dollar approximate separate transactions method under Sec. 1.985-3, the employer must use an exchange rate that can be demonstrated to clearly reflect income, based on all relevant facts and circumstances, including appropriate rates of inflation and commercial practices.
(iii) Exception for reasonable funding. The relevant amount does not include an amount that the taxpayer demonstrates to the Commissioner is attributable to amounts that were properly contributed to the trust pursuant to a reasonable funding method, applied using actuarial assumptions that the Commissioner determines to be reasonable, or any amount that the taxpayer demonstrates to the Commissioner is attributable to experience that is favorable relative to any actuarial assumptions used that the Commissioner determines to be reasonable. For this paragraph (h)(3)(iii) to apply to a controlled foreign corporation employer described in paragraph (h)(1)(i) of this section, the taxpayer must indicate on a statement attached to a timely filed Form 5471 that the taxpayer is relying on this rule. For purposes of this paragraph (h)(3)(iii), an amount is considered contributed pursuant to a reasonable funding method if the amount is contributed pursuant to a funding method permitted to be used under section 412 (e.g., the entry age normal funding method) that is consistently used to determine plan contributions. In addition, for purposes of this paragraph (h)(3)(iii), if there has been a change to that method from another funding method, an amount is considered contributed pursuant to a reasonable funding method only if the prior funding method is also a funding method described in the preceding sentence that was consistently used to determine plan contributions. For purposes of this paragraph (h)(3)(iii), a funding method is considered reasonable only if the method provides for any initial unfunded liability to be amortized over a period of at least 6 years, and for any net change in accrued liability resulting from a change in
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funding method to be amortized over a period of at least 6 years.
(iv) Reduction for transition amount. The relevant amount is reduced (but not below zero) by any transition amount described in paragraphs (h)(5), (h)(6), or (h)(7) of this section.
(v) Fair market value of assets. For purposes of paragraphs (h)(3) (i) and (ii) of this section, for a taxable year of the employer, the fair market value of trust assets, and the fair market value of other assets held in the equivalent of a trust within the meaning of section 404A(b)(5)(A), equals the fair market value of those assets, as of the measurement date for the employer's taxable year, adjusted to include contributions made after the measurement date and by the end of the employer's taxable year.
(vi) Annual valuation. For purposes of determining the relevant amount for a taxable year of the employer, the fair market value of plan assets, and the plan's accrued liability as described in paragraphs (h)(3) (ii) and (iii) of this section, and the normal cost as described in paragraph (h)(4) of this section, must be determined as of a consistently used annual measurement date within the employer's taxable year.
(vii) Special rule for plan funded through multiple trusts. In cases in which a plan is funded through more than one foreign employees' trust, the fractional interest determined under paragraph (h)(3)(i) of this section in each trust is determined by treating all of the trusts as if their assets were held in a single trust for which the fraction is determined in accordance with the rules of this paragraph (h)(3).
(4) De minimis exception. If the relevant amount is not greater than the plan's normal cost for the plan year ending with or within the employer's taxable year, computed using a funding method and actuarial assumptions as described in paragraph (h)(3)(ii) of this section or as described in paragraph (h)(3)(iii) of this section if the requirements of that paragraph are met, that are used to determine plan contributions, then the relevant amount is considered to be zero for purposes of applying paragraph (h)(3)(i) of this section.
(5) General rule for transition amount--(i) General rule. If paragraphs (h)(6) and (h)(7) of this section do not apply to the employer, the transition amount for purposes of paragraph (h)(3)(iv) of this section is equal to the preexisting amount multiplied by the applicable percentage for the year in which the employer's taxable year begins.
(ii) Preexisting amount. The preexisting amount is equal to the relevant amount of the trust, determined without regard to paragraphs (h)(3)(iv) and (h)(4) of this section, computed as of the measurement date that immediately precedes September 27, 1996 disregarding contributions to the trust made after the measurement date.
(iii) Applicable percentage. The applicable percentage is equal to 100 percent for the employer's first taxable year ending after this document is published as a final regulation in the Federal Register and prior taxable years of the employer, and is reduced (but not below zero) by 10 percentage points for each subsequent taxable year of the employer.
(6) Transition amount for new CFCs--(i) General rule. In the case of a new controlled foreign corporation employer, the transition amount for purposes of paragraph (h)(3)(iv) is equal to the pre-change amount multiplied by the applicable percentage for the year in which the new controlled foreign corporation employer's taxable year begins.
(ii) Pre-change amount. The pre-change amount for purposes of paragraph (h)(6)(i) is equal to the relevant amount of the trust, determined without regard to paragraphs (h)(3)(iv) and (h)(4) of this section and disregarding contributions to the trust made after the measurement date, for the new controlled foreign corporation employer's last taxable year ending before the corporation becomes a new controlled foreign corporation employer.
(iii) Applicable percentage--(A) General rule. Except as provided in paragraph (h)(6)(iii)(B) of this section, the applicable percentage is equal to 100 percent for a new controlled foreign corporation employer's first taxable year ending after the corporation becomes a controlled foreign corporation. The applicable percentage is reduced (but not below zero) by 10 percentage points for each subsequent taxable year of the new controlled foreign corporation.
(B) Interim rule. For any taxable year of a new controlled foreign corporation employer that ends on or before the date this document is published as a final regulation in the Federal Register, the applicable percentage is equal to 100 percent. The applicable percentage is reduced by 10 percentage points for each subsequent taxable year of the new controlled foreign corporation employer that ends after the date this document is published as a final regulation in the Federal Register.
(iv) New CFC employer. For purposes of paragraph (h)(6) of this section, a new controlled foreign corporation employer is a corporation that first becomes a controlled foreign corporation within the meaning of section 957 after September 27, 1996. A new controlled foreign corporation employer includes a corporation that was a controlled foreign corporation prior to, but not on, September 27, 1996 and that first becomes a controlled foreign corporation again after September 27, 1996.
(v) Anti-stuffing rule. Notwithstanding paragraph (h)(6)(iii) of this section, if, prior to becoming a controlled foreign corporation, a corporation contributes amounts to a foreign employees' trust with a principal purpose of obtaining tax benefits by increasing the pre- change amount, the applicable percentage with respect to those amounts is 0 percent for all taxable years of the new controlled foreign corporation employer.
(7) Transition amount for new U.S.-related foreign partnerships-- (i) General rule. In the case of a new U.S.-related foreign partnership employer, the transition amount for purposes of paragraph (h)(3)(iv) of this section is equal to the pre-change amount multiplied by the applicable percentage for the year in which the new U.S.-related foreign partnership employer's taxable year begins.
(ii) Pre-change amount. The pre-change amount for purposes of paragraph (h)(7)(i) of this section is equal to the relevant amount of the trust, determined without regard to paragraphs (h)(3)(iv) and (h)(4) of this section and disregarding contributions to the trust made after the measurement date, for the entity's last taxable year ending before the entity becomes a new U.S.-related foreign partnership employer.
(iii) Applicable percentage--(A) General rule. Except as provided in paragraph (h)(7)(iii)(B) of this section, the applicable percentage is equal to 100 percent for a new U.S.-related foreign partnership employer's first taxable year ending after the entity becomes a new U.S.-related foreign partnership employer. The applicable percentage is reduced (but not below zero) by 10 percentage points for each subsequent taxable year of the new U.S.-related foreign partnership employer.
(B) Interim rule. For any taxable year of a new U.S.-related foreign partnership employer that ends on or before the date this document is published as a final regulation in the Federal Register, the applicable percentage is equal to 100 percent. The applicable percentage is reduced by 10 percentage points for each subsequent
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taxable year of the new U.S.-related foreign partnership employer that ends after the date this document is published as a final regulation in the Federal Register.
(iv) New U.S.-related foreign partnership employer. For purposes of paragraph (h)(7) of this section, a new U.S.-related foreign partnership employer is an entity that was a foreign corporation other than a controlled foreign corporation, or that was a foreign partnership other than a U.S.-related foreign partnership, and that changes from this status to a U.S.-related foreign partnership after September 27, 1996. A new U.S.-related foreign partnership employer includes a corporation that was a U.S.-related foreign partnership prior to, but not on, September 27, 1996 and that first becomes a U.S.- related foreign partnership again after September 27, 1996.
(v) Anti-stuffing rule. Notwithstanding paragraph (h)(7)(iii) of this section, if, prior to becoming a new U.S.- related foreign partnership employer, an entity contributes amounts to a foreign employees' trust with a principal purpose of obtaining tax benefits by increasing the pre-change amount, the applicable percentage with respect to those amounts is 0 percent for all taxable years of the new U.S.-related foreign partnership employer.
(8) Examples. The following examples illustrate the rules of paragraph (h) of this section. In each example, the employer has a power or interest described in sections 673 through 677 over the foreign employees' trust, and the monetary unit is the applicable functional currency (FC) determined in accordance with section 985(b) and the regulations thereunder.
Example 1. (i) Employer X is a controlled foreign corporation (as defined in section 957). Employer X maintains a defined benefit retirement plan for its employees. Employer X's taxable year is the calendar year. Trust T, a foreign employees' trust, is the sole funding vehicle for the plan. Both the plan year of the plan and the taxable year of Trust T are the calendar year.
(ii) As of December 31, 1997, Trust T's measurement date, the fair market value (as described in paragraph (h)(3)(iv) of this section) of Trust T's assets is FC 1,000,000, and the amount of the plan's accrued liability is FC 800,000, which includes a normal cost for 1997 of FC 50,000. The preexisting amount for Trust T is FC 40,000. Thus, the relevant amount for 1997 is FC 160,000 (which is greater than the plan's normal cost for the year). Employer X's shareholder does not indicate on a statement attached to a timely filed Form 5471 that any of the relevant amount qualifies for the exception described in paragraph (h)(3)(iii) of this section. Therefore, the fractional interest for Employer X's taxable year ending on December 31, 1997, is 16 percent. Employer X is treated as the owner for federal income tax purposes of an undivided 16 percent interest in each of Trust T's assets for the period from January 1, 1997 through December 31, 1997. Employer X must take into account a 16 percent pro rata share of each item of income, deduction or credit of Trust T during this period in computing its federal income tax liability.
Example 2. Assume the same facts as in Example 1, except that Employer X's shareholder indicates on a statement attached to a timely filed Form 5471 and can demonstrate to the satisfaction of the Commissioner that, in reliance on paragraph (h)(3)(iii) of this section, FC 100,000 of the fair market value of Trust T's assets is attributable to favorable experience relative to reasonable actuarial assumptions used. Accordingly, the relevant amount for 1997 is FC 60,000. Because the plan's normal cost for 1997 is less than FC 60,000, the de minimis exception of paragraph (h)(4) of this section does not apply. Therefore, the fractional interest for Employer X's taxable year ending on December 31, 1997, is 6 percent. Employer X is treated as the owner for federal income tax purposes of an undivided 6 percent interest in each of Trust T's assets for the period from January 1, 1997, through December 31, 1997. Employer X must take into account a 6 percent pro rata share of each item of income, deduction or credit of Trust T during this period in computing its federal income tax liability.
(9) Effective date. Paragraphs (g) and (h) of this section apply to taxable years of an employer ending after September 27, 1996.