2.  Subsidiary

Comment: One respondent stated that failure to define the term "subsidiary" will result in inconsistent application of the FAR rule. The respondent contended that this will cause problems for potential Government contractors as well as contracting officers.

The respondent first proposed that the legislative history suggests that Congress intended the prohibition to apply to "wholly-owned subsidiaries." The respondent stated that the impetus for expanding the prohibition to cover subsidiaries was to "plug a loophole" that became apparent when an award was made to a wholly-owned subsidiary of a foreign entity.

Alternatively, as the less preferred option, the respondent made a case for defining subsidiary in accordance with the tax code. The respondent cites both 6 U.S.C. 395 and 26 U.S.C. 7874, because they both require 80 percent ownership of stock in the foreign entity by former shareholders of the domestic corporation in order for the foreign entity to be designated as an inverted domestic corporation.

Response: The Councils concur that the rule should provide a definition of the term "subsidiary." In general terms, a subsidiary is an entity that is controlled by a separate entity, called the parent company. The most common way (but not the only way) that control of a subsidiary is achieved is through ownership of shares (or other form of ownership if not a corporation) in the subsidiary by the parent. Subsidiaries are separate distinct legal entities for the purposes of taxation and regulation.

The Councils do not agree with the respondent's request to have "subsidiary" defined as "wholly-owned subsidiary." This position is not supported in any of the research or current IRC. The respondent provided no citation to substantiate their request of defining subsidiary to mean wholly-owned subsidiary. Further, the words "wholly-owned," which denote a specific type of subsidiary, are not used in either of the two cited statutes. The fact that a particular instance involving a wholly-owned subsidiary occurred, does not mean that Congress intended to limit application to wholly-owned subsidiaries.

The Councils have defined "Subsidiary," as used in this rule, to mean an entity (or corporation) in which more than 50 percent is owned--

(1)  Directly by a parent company; or

(2)  Through another subsidiary of a parent company.

The definition revolves around the idea of management control and the financial interests of the parent company. Any single entity that controls greater than 50 percent of the stock (or assets of a non-public company) would essentially be able to control and benefit from the operations of the second entity. This option interprets the legislation's intent as wanting to prevent inverted domestic corporations from receiving the revenue benefit from Federal contracts. With a greater than 50 percent ownership within a subsidiary, the inverted domestic corporation would receive the majority of the benefit. This interpretation has grounding in the current IRC. Section (c)(1) of 26 U.S.C. 7874 states that expanded affiliated groups (a corporation or chain of corporations which are connected to a parent corporation through stock ownership) of foreign surrogates need only own 50 percent of the stock of the company instead of the normal 80 percent.

The mention of stock ownership as the measuring criteria was replaced in favor of a broader term of overall ownership in order to cover private companies.

In making the case for the 80 percent ownership interpretation, the respondent cited both 6 U.S.C. 395 and 26 U.S.C. 7874. Both sections of the United States Code are meant to provide the thresholds for determining whether a corporation is an inverted domestic corporation and not whether a corporation is a subsidiary. The Councils did not agree that it is correct to use the threshold for determining an inverted domestic corporation as the threshold for determining a subsidiary as they are two separate and different determinations. The IRC (26 U.S.C. 1563) does describe parent-subsidiary relationships using the 80 percent threshold, but only for filing consolidated returns.