Qualified Business Units -- Final Regulations Under Section 989

 [4830-01]

 ACTION: Final Regulations.

 SUMMARY: This document contains final Income Tax Regulations relating to the definition of a qualified business unit under section 989 of the Internal Revenue Code of 1986. This section was added to the Code by Section 1261 of the Tax Reform Act of 1986. These final regulations define the term "Qualified Business Unit" and affect taxpayers who must make income tax determinations for their QBUs for taxable years beginning after December 31, 1986.

 EFFECTIVE DATE: These regulations are effective for taxable years beginning after December 31, 1986.

 FOR FURTHER INFORMATION CONTACT: Carl Cooper of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224, (Attention: CC:CORP:T:R (INTL-983-86)) and (202-566-6795, not a toll-free call).

SUPPLEMENTARY INFORMATION:

BACKGROUND

On June 8, 1988, the Federal Register published proposed amendments (53 FR 20612) to the Income Tax Regulations (26 CFR Part 1) under section 989 of the Internal Revenue Code of 1986. These amendments added regulations under section 989 of the Internal Revenue Code of 1986 defining the term "Qualified Business Unit" (QBU). This section was added to the Code by section 1261 of the Tax Reform Act of 1986 (P.L. 99-514, 100 Stat. 2085, 2090). No written comments responding to this notice were received. No public hearing was requested or held.

EXPLANATION OF PROVISIONS

 Section 1.989(a)-1(a) provides that the effective date of these regulations is generally for taxable years beginning after December 31, 1986.

 Section 1.989(h)-1(b) expands the definition of QBU to include partnerships, trusts, and estates. In addition, a branch of a partnership, trust, or an estate may qualify as a QBU. Because a partnership, trust, or estate is treated as a QBU of each of the partners or beneficiaries, section 987 (relating to branch transactions) may apply to remittances from a partnership, trust, or estate to partners or beneficiaries. A QBU also includes activities that produce income or loss effectively connected with a United States trade or business.

 Section 1.989(a)-1(c) provides that a trade or business for purposes of section 989(a) is generally any specific unified group of activities that constitute (or could constitute) an independent economic enterprise carried on for profit, the expenses related to which are deductible under section 162 or 212 (rather than only section 162). Thus, all activities engaged in for profit are eligible for QBU status.

 Section 1.989(a)-1(d) provides that books and records include those used to determine effectively connected income or loss.

SPECIAL ANALYSES

 It has been determined that these rules are not major rules as defined in Executive Order 12291. Therefore, a Regulatory Impact Analysis is not required. It has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. Chapter 5) and the Regulatory Flexibility Act (5 U.S.C. Chapter 6) do not apply to these regulations, and, therefore, a final Regulatory Flexibility Analysis is not required.

DRAFTING INFORMATION

 The principal author of these regulations is Carl Cooper of the Office of Associate Chief Counsel (International), within the Office of Chief Counsel, Internal Revenue Service. Other personnel from the Internal Revenue Service and Treasury Department participated in developing the regulations.

LIST OF SUBJECTS IN 26 CFR PART 1

Income taxes, aliens. exports. DISC, Foreign Investments in U.S., Foreign tax credit, FSC. Sources of income, U.S. investments abroad.

Treasury Decision 8279

ADOPTION OF AMENDMENTS TO THE REGULATIONS

Accordingly, 26 CFR Part 1 is amended as follows:

INCOME TAX REGULATIONS (26 CFR Part 1)

Paragraph 1. The authority for part 1 continues to read in part:

Authority: 26 U.S.C. 7805. * * *

Par. 2. Sections 1.989(a)-0T and 1.989(a)-1T are removed and new section 1.989(a)-1 is added to read as follows:

SECTION 1.989(A)-1 DEFINITION OF A QUALIFIED BUSINESS UNIT.

(a) APPLICABILITY -- (1) IN GENERAL. This section provides rules relating to the definition of the term "qualified business units" (QBU) within the meaning of section 989.

(2) EFFECTIVE DATE. These rules shall apply to taxable years beginning after December 31, 1986. However, any person may apply on a consistent basis section 1.989(a)-1T(c) of the Temporary Income Tax Regulations in lieu of section 1.989(a)-1(c) to all taxable years beginning after December 31, 1986, and on or before February 5, 1990. For the text of the temporary regulation, see 53 FR 20612 (June 8, 1988).

(b) DEFINITION OF A QUALIFIED BUSINESS UNIT -- (1) IN GENERAL. A QBU is any separate and clearly identified unit of a trade or business of a taxpayer provided that separate books and records are maintained.

(2) APPLICATION OF THE QBU DEFINITION --

(i) PERSONS. A corporation is a QBU. An individual is not a QBU. A partnership, trust, or estate is a QBU of a partner or beneficiary.

(ii) ACTIVITIES. Activities of a corporation, partnership, trust, estate, or individual qualify as a QBU if --

(A) The activities constitute a trade or business; and

(B) A separate set of books and records is maintained with respect to the activities.

(3) SPECIAL RULE. Any activity (wherever conducted and regardless of its frequency) that produces income or loss that is, or is treated as, effectively connected with the conduct of a trade or business within the United States shall be treated as a separate QBU, provided the books and records requirement of paragraph (d)(2) of this section is satisfied.

(c) TRADE OR BUSINESS -- The determination as to whether activities constitute a trade or business is ultimately dependent upon an examination of all the facts and circumstances. Generally, a trade or business for purposes of section 989(a) is a specific unified group of activities that constitutes (or could constitute) an independent economic enterprise carried on for profit, the expenses related to which are deductible under section 162 or 212 (other than that part of section 212 dealing with expenses incurred in connection with taxes). To constitute a trade or business, a group of activities must ordinarily include every operation which forms a part of, or a step in, a process by which an enterprise may earn income or profit. Such group of activities must ordinarily include the collection of income and the payment of expenses. It is not necessary that the activities carried out by a QBU constitute a different trade or business from those carried out by other QBUs of the taxpayer. A vertical, functional, or geographic division of the same trade or business may be a trade or business for this purpose provided that the activities otherwise qualify as a trade or business under this paragraph (c). However, activities that are merely ancillary to a trade or business will not constitute a trade or business under this paragraph (c). Activities of an individual as an employee are not considered by themselves to constitute a trade or business under this paragraph (c).

(d) SEPARATE BOOKS AND RECORDS -- (1) GENERAL RULE. Except as provided in paragraph (d)(2) of this section, a separate set of books and records shall include books of original entry and ledger accounts, both general and subsidiary, or similar records. For example, in the case of a taxpayer using the cash receipts and disbursements method of accounting, the books of original entry include a cash receipts and disbursements journal where each receipt and each disbursement is recorded. Similarly, in the case of a taxpayer using an accrual method of accounting, the books of original entry include a journal to record sales (accounts receivable) and a journal to record expenses incurred (accounts payable). In general, a journal represents a chronological account of all transactions entered into by an entity for an accounting period. A ledger account, on the other hand, chronicles the impact during an accounting period of the specific transactions recorded in the journal for that period upon the various items shown on the entity's balance sheet (i.e., assets, liabilities, and capital accounts) and income statement (i.e., revenues and expenses).

(2) SPECIAL RULE. For purposes of paragraph (b)(3) of this section, books and records include books and records used to determine income or loss that is, or is treated as, effectively connected with the conduct of a trade or business within the United States.

(e) EXAMPLES. The provisions of this section may be illustrated by the following examples:

EXAMPLE (1). Corporation X is a domestic corporation. Corporation X manufactures widgets in the U.S. for export. Corporation X sells widgets in the United Kingdom through a branch office in London. The London office has its own employees and solicits and processes orders. Corporation X maintains in the U.S. a separate set of books and records for all transactions conducted by the London office. Corporation X is a QBU under paragraph (b)(2)(i) of this section because of its corporate status. The London branch office is a QBU under paragraph (b)(2)(ii) of this section because (1) the sale of widgets is a trade or business as defined in paragraph (c) of this section; and (2) a complete and separate set of books and records (as described in paragraph (d) of this section) is maintained with respect to its sales operations.

EXAMPLE (2). A domestic corporation incorporates a wholly-owned subsidiary in Switzerland. The domestic corporation is a manufacturer that markets its product abroad primarily through the Swiss subsidiary. To facilitate sales of the parent's product in Europe, the Swiss subsidiary has branch offices in France and West Germany that are responsible for all marketing operations in those countries. Each branch has its own employees, solicits and processes orders, and maintains a separate set of books and records. The domestic corporation and the Swiss subsidiary are both QBUs under paragraph (b)(2)(i) of this section because of their corporate status. The French and West German branches are QBUs of the Swiss subsidiary. They satisfy paragraph (b)(2)(ii) because each constitutes a trade or business (as defined in paragraph (c) of this section) and because separate sets of books and record (as described in paragraph (d) of this section) of their respective operations is maintained. Each branch is considered to have a trade or business although each is a geographical division of the same trade or business.

EXAMPLE (3). W is a domestic corporation that manufactures product X in the United States for sale worldwide. All of W's sales functions are conducted exclusively in the United States. W employs individual Q to work in France. Q's sole function is to act as a courier to deliver sales documents to customers in France. With respect to Q's activities in France, a separate set of books and records as described in paragraph (d) is maintained. Under paragraph (c) of this section, Q's activities in France do not constitute a QBU since they are merely ancillary to W's manufacturing and selling business. Q is not considered to have a QBU because an individual's activities as an employee are not considered to constitute a trade or business of the individual under paragraph (c).

EXAMPLE (4). The facts are the same as in example (3) except that the courier function is the sole activity of a wholly-owned French subsidiary of W. Under paragraph (b)(2)(i) of this section, the French subsidiary is considered to be a QBU.

EXAMPLE (5). A corporation incorporated in the Netherlands is a subsidiary of a domestic corporation and a holding company for the stock of one or more subsidiaries incorporated in other countries. The Dutch corporation's activities are limited to paying its directors and its administrative expenses, receiving capital contributions from its United States parent corporation, contributing capital to its subsidiaries, receiving dividend distributions from its subsidiaries, and distributing dividends to its domestic parent corporation. Under paragraph (b)(2)(i) of this section, the Netherlands corporation is considered to be a QBU.

EXAMPLE (6). Taxpayer A, an individual resident of the United States, is engaged in a trade or business wholly unrelated to any type of investment activity. A also maintains a portfolio of foreign currency-denominated investments through a foreign broker. The broker is responsible for all activities necessary to the management of A's investments and maintains books and records as described in paragraph (d) of this section, with respect to all investment activities of A. A's investment activities qualify as a QBU under paragraph (b)(2)(ii) of this section to the extent the activities engaged in by A generate expenses that are deductible under section 212 (other than that part of section 212 dealing with expenses incurred in connection with taxes).

EXAMPLE (7). Taxpayer A, an individual resident of the United States, is the sole shareholder of foreign corporation (FC) whose activities are limited to trading in stocks and securities. FC is a QBU under paragraph (b)(2)(i) of this section.

EXAMPLE (8). Taxpayer A, an individual resident of the United States, markets and sells in Spain and in the United States various products produced by other United States manufacturers. A has an office and employs a salesman to manage A's activities in Spain, maintains a separate set of books and records with respect to his activities in Spain, and is engaged in a trade or business as defined in paragraph (c) of this section. Therefore, under paragraph (b)(2)(ii) of this section, the activities of A in Spain are considered to be a QBU.

EXAMPLE (9). Foreign corporation FX is incorporated in Mexico and is wholly owned by a domestic corporation. The domestic corporation elects to treat FX as a domestic corporation under section 1504(d). FX operates entirely in Mexico and maintains a separate set of books and records with respect to its activities in Mexico. FX is a QBU under paragraph (b)(2)(i) of this section. The activities of FX in Mexico also constitute a QBU under paragraph (b)(2)(ii) of this section.

EXAMPLE (10). F, a foreign corporation, computes a gain of $100 from the disposition of a United States real property interest (as defined in section 897(c)). The gain is taken into account as if F were engaged in a trade or business in the United States and as if such gain were effectively connected with such trade or business. F is a QBU under paragraph (b)(2)(i) of this section because of its corporate status. F's disposition activity constitutes a separate QBU under paragraph (b)(3) of this section.