## Facts

- A Mexican parent corporation guaranteed debt issued by its U.S. subsidiary to U.S. lenders as part of financing a U.S. acquisition strategy.
- The guaranty agreement required the U.S. subsidiary to pay the parent an annual fee equal to 1.5% of the outstanding principal balance of the guaranteed notes.
- The U.S. subsidiary paid three guaranty-fee installments totaling about $6.7 million to the foreign parent and withheld no U.S. tax.
- The IRS asserted a withholding tax deficiency on the ground that the fees were U.S.-source FDAP income subject to 30% tax under I.R.C. § 881(a).
- The parties agreed the payments were FDAP; the dispute was whether the income was from U.S. sources or foreign sources.

## Issues

1. Whether guaranty fees paid by a U.S. subsidiary to a foreign parent for guaranteeing the subsidiary’s debt are U.S.-source FDAP income subject to 30% withholding under I.R.C. § 881(a).
2. Whether such fees should be sourced by analogy to interest (source based on payor’s residence) or by analogy to compensation for services (source based on where services are performed).

## Decision

- The Tax Court held for the taxpayer that the guaranty fees were foreign-source income.
- The court characterized the guaranty fees as analogous to payments for services rather than interest.
- Applying the services sourcing rule, the court concluded the guaranty was provided from Mexico, making the fees foreign-source.
- Because the fees were foreign-source, the U.S. subsidiary had no obligation to withhold 30% under I.R.C. § 881(a).

## Legal Principles

- I.R.C. § 881(a) imposes a 30% tax (collected by withholding) on foreign corporations’ FDAP income from sources within the United States.
- When the Code and regulations do not provide a specific sourcing rule for a category of FDAP income, source is determined by analogy to the closest addressed category.
- Interest generally is sourced to the residence of the obligor/payor under Treasury regulations.
- Compensation for services is sourced to the place where the services are performed under Treas. Reg. § 1.861-4.
- Guaranty fees paid for a parent’s credit support of a subsidiary’s borrowing can be treated, for sourcing, as service-type income when the guaranty is most analogous to the performance of a service rather than the use of borrowed capital.

## Conclusion

The Tax Court determined that guaranty fees paid by a U.S. subsidiary to its foreign parent were foreign-source service income because the guaranty was provided from outside the United States; accordingly, the payments were not subject to the 30% withholding tax imposed on U.S.-source FDAP income under I.R.C. § 881(a).


Container Corp. v. Comm’r, 134 T.C. 22 (2010)