Rent allocated to foreign corporation subject to gross income tax.

In Central de Gas de Chihuahua, S.A. v. Commissioner, the Tax Court ruled that rent allocated to a foreign corporation under a tax code section 482 adjustment was subject to a 30% gross income tax imposed by section 881.

Central de Gas de Chihuahua, S.A., a Mexican corporation, loaned a fleet of tractors and trailers rent-free to a sister Mexican corporation. The fleet was used to transport liquefied petroleum gas from sites in the United States to Mexico. The Internal Revenue Service allocated rents to Central de Gas under section 482, which grants it authority to allocate items of income and expense among related parties to reflect income properly.

The IRS asserted that the rents allocated to Central de Gas were subject to tax under section 881(a), which in part imposes a 30% tax on fixed or determinable annual or periodic (FDAP) income (such as rents, interest or dividends) received by foreign corporations from sources within the United States. Central de Gas did not dispute the IRS's allocation of rents under section 482 but contended the term received as used in section 881(a) applied only to actual payments from sources within the United States.

Absent any direct precedent under section 881, both parties argued that code section 1442, which requires withholding of tax from amounts paid to foreign corporations subject to U.S. tax, parallels section 881 as the method for collecting tax imposed under that section. Central de Gas cited cases in which section 1442 was found not to apply when no actual payment was made. The IRS, in turn, cited a number of court rulings to the contrary.

The Tax Court reasoned that section 881 imposes a tax liability, while section 1442 provides one method for collecting that tax and chose not to compare the provisions in deciding the case at hand. Rather, it said section 482's effectiveness in allocating income and expense items when foreign corporations are involved would be undermined significantly if section 881 required actual payment.

It therefore held the word received in section 881 included the fair rental value of the equipment, even though the amount actually was not received by Central de Gas.

Observation: Based on the holding in this case, foreign corporations that depend on the withholding mechanism of tax code section 1442 to satisfy their FDAP income tax liability in the United States should be aware that the lack of a withholding requirement may not necessarily denote the absence of a tax liability .

--Marianne Burge, CPA, international tax partner, Kenneth Kral, CPA, international tax partner, and Jack Serota, Esq., international tax manager, at Price Waterhouse, New York City.