The IRS Chief Counsel determined that interest paid by a foreign disregarded entity of a U.S. domestic corporation to a foreign corporation was U.S. source income under Code Sec. 861(a)(1) and, therefore, subject to withholding under Code Sec. 1442. The foreign corporation payee was a controlled foreign corporation and the U.S. domestic corporation was a U.S. shareholder of that controlled foreign corporation. Since the foreign disregarded entity payor, which was wholly owned by the U.S. domestic corporation, elected to be treated for federal tax purposes as disregarded as an entity separate from its owner, the activities of a business entity that has made the election to be treated for federal tax purposes as a disregarded entity are treated in the same manner as a branch or division of its sole owner. Thus, interest paid by the foreign disregarded entity to the foreign corporation payee was considered to have been paid by the U.S. domestic corporation.
Pursuant to Treas. Reg. § 301.7701-2(a), the activities of a business entity that has made the election to be treated for federal tax purposes as a disregarded entity are treated in the same manner as a branch or division of its sole owner. (Certain provisions of the Treasury regulations provide that an entity that has made this election will be treated as an entity separate from its owner for limited purposes; sourcing of interest payments is not one of the limited purposes.)
Accordingly, interest paid by the foreign disregarded entity to the foreign corporation payee is considered to have been paid by the U.S. domestic corporation. With exceptions not relevant here (relating to interest paid on certain deposits with banks and savings institutions) interest paid by a domestic corporation is U.S. source income under section 861(a)(1) and so is subject to withholding under section 1442.
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