The Internal Revenue Service (the “IRS”) has released an internal memorandum (the “Memorandum”), from the Office of Chief Counsel to the Director of Field Operations in Manhattan (Financial Services), which concludes that a foreign corporation is engaged in a lending business in the United States because its agent, a separate and possibly unrelated corporation, originates loans in the United States. Although a Chief Counsel memorandum does not constitute authority on which a taxpayer may rely, it does provide insight into the views of the IRS. The Memorandum does not provide a detailed analysis of the activities that constitute a lending business, but instead focuses on the attribution of a separate party’s office to a foreign corporation. It notes, however, that the lending activities at issue were “considerable, continuous and regular.”
In the situation at issue in the Memorandum, a foreign corporation (“Foreign Co”) that has no office or employees in the United States enters into a contract with a United States corporation (“Origination Co”) under which Origination Co, in exchange for arm’s-length fees, provides services in the United States in connection with loans to U.S. borrowers that are funded by Foreign Co. Origination Co performs all activities necessary to originate the loans, but is not authorized to conclude contracts on behalf of Foreign Co. Employees of Foreign Co give final approval for the loans, and sign the loan documents on behalf of Foreign Co, outside of the United States. Foreign Co is organized in a country that does not have an income tax treaty with the United States. The Memorandum does not disclose whether Foreign Co and Origination Co are related parties.
The Memorandum concludes that Origination Co is acting as the agent of Foreign Co and that, regardless of whether Origination Co is an independent or a dependent agent, its lending activities are attributable to Foreign Co, with the result that Foreign Co is engaged in a trade or business in the United States. According to the Memorandum, the interest that Foreign Co derives from the loans is “effectively connected” with a U.S. trade or business under the special rules that determine the portion of interest income that is effectively connected with a banking, financing or similar business conducted through an office in the United States.
Under those rules, if a foreign corporation derives U.S. source interest in the active conduct of a banking, financing or similar business in the United States, the interest will be treated as effectively connected income only if the securities giving rise to the interest are attributable to the U.S. office through which the business is carried on. The Memorandum states that the U.S. office in question need not be maintained by the foreign corporation. Specifically, it concludes that rules limiting the circumstances under which the office of an agent can be attributed to its principal, which are applicable for purposes of determining whether foreign source income constitutes effectively connected income, do not apply to the determination whether U.S. source income is effectively connected with a banking, financing or similar business conducted in the United States.
The Memorandum ends with the statement that the IRS understands that non-U.S. persons may be using other strategies to engage in lending activities that give rise to effectively connected income. It encourages the IRS field agents to develop cases addressing these issues.