PLR 1103010: Security agreement does not prevent subsidiary from joining its parent’s consolidated group

Plain-English summary

A US parent’s affiliated group included a subsidiary indirectly owned by a foreign parent. A government department required the subsidiary to operate under a security agreement designed to insulate it from foreign ownership, control, or influence so it could maintain facility security clearances. The IRS ruled that the subsidiary’s ownership of another company’s stock under the agreement constituted beneficial and direct ownership for purposes of section 1504. It also ruled that the agreement did not prevent the other company from remaining in the affiliated group or filing a consolidated federal income tax return with the group.

Ruling snapshot

• Question: Does a security agreement designed to limit foreign control prevent a subsidiary from being treated as the direct owner of stock or prevent the lower-tier company from joining the affiliated group?
• Outcome: Approved
• Key authorities: IRC § 1504

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201103010 Third Party Communication: None
Release Date: 1/21/2011 Date of Communication: Not Applicable
Index Number: 1504.00-00, 1504.01-00
Person To Contact:
------------------------------------- ----------------------, ID No. -------------
--------------------------------- Telephone Number:
------------------------------------------------ ---------------------
------------------------------------ Refer Reply To:
CC:CORP:6
PLR-117432-10
Date:
October 15, 2010

LEGEND

Foreign Parent = -------------------------------------

US Parent = ---------------------------------
-----------------------

Subsidiary = ---------------------------------------------------

Subsidiary 1 = ------------------------------------------------------
-----------------------

Department = ------------------------------------------------------------------------------------
----------

Security = ------------------------------------------------------------------------------------
Agreement ------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
--------------------------------------------------------------
------------------------------

Business A = ------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
------------------------------------------------------------------------------------
------------
PLR-117432-10 2

State X = -------------

State Y = --------------------------

Country Z = -------------

Year A = -------

Year B = ----------------------------------------------------

Dear ------------:

This letter responds to your request for rulings, dated April 21, 2010, submitted by your
authorized representatives on behalf of US Parent. The information submitted for
consideration is summarized below.

The rulings contained in this letter are based upon information and representations
submitted by the taxpayer and accompanied by a penalty of perjury statement executed
by an appropriate party. While this office has not verified any of the material submitted
in support of the request for rulings, it is subject to verification on examination.

                                SUMMARY OF FACTS

US Parent, a State X corporation, is the common parent of an affiliated group of
corporations that join in filing a consolidated return (the “US Parent Group”). US Parent
is a wholly owned subsidiary of Foreign Parent, a publicly traded Country Z entity. US
Parent owns all of the issued and outstanding stock of Subsidiary (voting common
stock), a State X corporation. Subsidiary purchased all of the outstanding stock of
Subsidiary 1 (voting common stock), a State Y corporation, in Year A. US Parent and
its direct and indirect subsidiaries, including Subsidiary, filed consolidated returns prior
to the acquisition of Subsidiary 1. Subsidiary 1 was included in the US Parent Group’s
consolidated return for Year A as well as for Year B.

Subsidiary 1 is engaged in Business A. In order to perform certain contracts, Subsidiary
1 requires facility security clearance(s) granted by the Department. Because of the
indirect foreign ownership of stock in Subsidiary 1, the Department requires that
Subsidiary 1 be effectively insulated from foreign ownership, control, or influence in
order to maintain those clearances.

To create a security measure designed to insulate Subsidiary 1 from any foreign control
or influence that might arise from Foreign Parent’s indirect ownership of stock in
PLR-117432-10 3

Subsidiary 1, Foreign Parent, US Parent, Subsidiary, Subsidiary 1 and the Department
have entered into the Security Agreement. Pursuant to the Security Agreement,
Subsidiary appoints the board of directors (the “Board”) of Subsidiary 1 subject to
limited approval rights held by the Department. The Board must be composed of: (1) at
least two members without prior relationships with Subsidiary 1, or any entities
Subsidiary 1 either controls or is controlled by, except as otherwise allowed by the
Department (the “Outside Directors”); (2) at least one officer of Subsidiary 1 (the
“Officer/Director(s)”); and (3) at least one representative of Subsidiary (the “Inside
Director(s)”).

The Outside Director(s) are required to: (1) be resident United States citizens; (2) have
or be eligible for the requisite security clearance; and (3) be approved by the
Department as satisfying the appropriate Department security requirements and the
applicable provisions of the Security Agreement. In addition, Outside Director(s) may
not be removed without notice to the Department. The Officer/Director(s) are required
to: (1) be resident United States citizens, and (2) have or be eligible for the requisite
personnel security clearance. The Inside Directors: (1) must not have personnel
security clearances; (2) are required to be formally excluded from access to classified
information; and (3) must be equal to or fewer in number than the sum of Outside
Directors and Officer/Director(s).

Subsidiary, as the sole stockholder of Subsidiary 1, may remove any member of
Subsidiary 1’s Board for any reason permitted by the provisions of applicable state law
or Subsidiary 1’s Certificate of Incorporation or Bylaws. However, the removal of an
Outside Director generally is not effective until prior notice is given, no objection is
raised by the Department, and a qualified successor has been nominated by Subsidiary
1 and approved by the Department. In the event of a vacancy on the Board, Subsidiary
has the right to fill the vacancy.

The Board retains all of their rights, powers and responsibilities conferred or imposed
under applicable statutes and regulations, and by Subsidiary’s charter and bylaws,
subject to certain terms and conditions set forth in the Security Agreement (described
below). With respect to actions by the Board, a majority of the members, including at
least one Outside Director and at least one Inside Director, is necessary to constitute a
quorum.

Pursuant to the Security Agreement, the Board is not permitted to take certain major
corporate actions without Subsidiary’s express written approval. These include: (1) the
sale, lease or other disposition of any of the property, assets or business of Subsidiary
1, or the purchase of any property or assets by Subsidiary 1 that is other than in the
ordinary course of business; (2) the merger, consolidation, reorganization, dissolution or
liquidation of Subsidiary 1; (3) the filing by Subsidiary 1 of any petition under the Federal
Bankruptcy Code or any applicable bankruptcy law or other acts of similar character;
PLR-117432-10 4

and (4) the initiation of action to terminate the Security Agreement (with certain
limitations).

During the period Subsidiary 1’s stock is subject to the Security Agreement, Subsidiary
retains all economic rights in the stock of Subsidiary 1. Nothing in the Security
Agreement limits, restricts, or otherwise diminishes the economic rights of Subsidiary
(or any successor shareholder) in the stock of Subsidiary 1.

Subsidiary and Subsidiary 1 have the right to petition the Department to terminate the
Security Agreement at any time and for any reason. The Department may refuse to
terminate the Security Agreement only when continuation is necessary in the interest of
the national security of the United States. The Security Agreement is subject to
termination by the Department at any time under the following circumstances: (1) in the
event of a sale of the business of Subsidiary 1 or the stock of Subsidiary 1 to a
company or person not under foreign ownership, control, or influence; (2) the Security
Agreement is no longer needed to maintain Subsidiary 1’s facility security clearance(s);
(3) the continuation of the facility security clearance(s) for Subsidiary 1 are no longer
necessary; or (4) there has been a breach of the Security Agreement that requires it to
be terminated or the Department otherwise determines that termination is in the national
interest. Unless renewed, the Security Agreement terminates automatically ten years
from the date of execution.

                                    RULINGS

Based solely on the information and representations set forth above and in your
submission, we rule as follows:

(1) During the period in which the Security Agreement is in place, Subsidiary’s
ownership of the stock of Subsidiary 1 constitutes beneficial and therefore, direct
ownership for purposes of section 1504(a).

(2) The Security Agreement does not prevent Subsidiary 1 from being a member of the
affiliated group (within the meaning of section 1504(a)) of which US Parent is the
common parent, or prevent Subsidiary 1 from filing a consolidated federal income tax
return with such affiliated group.

                         PROCEDURAL STATEMENTS

Except as expressly provided herein, no opinion is expressed or implied concerning the
tax consequences of any aspect of any transaction or item discussed or referenced in
this letter.
PLR-117432-10 5

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code
provides that it may not be used or cited as precedent.

A copy of this letter must be attached to any income tax return to which it is relevant.
Alternatively, taxpayers filing their returns electronically may satisfy this requirement by
attaching a statement to their return that provides the date and control number of the
letter ruling.

In accordance with the Power of Attorney on file with this office, a copy of this letter is
being sent to your authorized representative.

                                   Sincerely,



                                   Richard M. Heinecke
                                   Assistant to the Branch Chief, Branch 6
                                   Office of Associate Chief Counsel
                                   (Corporate)