Question 132: European Parent Corp. owns 83.33% of EuroCorpA, which in turn owns 100% of EuroCorpB, which in turn owns 100% of USACorp1. On the other side of this "family tree," European Parent Corp. also owns 100% of EuroCorpY, which in turn owns 98% of EuroCorpZ, which in turn owns 100% of USACorp2. USACorp1 and USACorp2 are the only US subsidiaries. They do not conduct business together or have common customers. In fact, they do not even communicate with one another! USACorp1 sponsors a 401(k) plan; USACorp2 does not. Must USACorp2's employees be covered (or at least tested) in USACorp1's plan as part of a controlled group?
Answer: Yes, but that's not all.

The Code defines a parent-subsidiary controlled group as

One or more chains of corporations connected through stock ownership with a common parent corporation if--

(A) [at least 80 percent of the] stock . . . of each of the corporations, except the common parent corporation, is owned . . . by one or more of the other corporations; and

(B) the common parent corporation owns . . . [at least 80 percent of the] stock of at least one of the other corporations, excluding . . . stock owned directly by such other corporations.
That is exactly what you have here. All the Euro corporations and the USA corporations you mention are in a single parent-subsidiary controlled group. Note that the definition does not talk about domestic or foreign corporations. All corporations included in the group are counted.

IRC 1563(b)(2)(C) excludes foreign corporations from treatment as component members of a controlled group. Hence, for income tax purposes, the group would consist solely of USACorp1 and USACorp2.

However, IRC 414(b) does not incorporate the component member rules into pension law. The regulations are quite clear on this point. That means for pension purposes you must test employees of all the European and USA corporations as a single employer. Fortunately, as you do so, you can exclude nonresident aliens without U.S.-source income. See Q&A 103.

More discussion of the issues concern foreign parents is in Chapter 9 of my book, Who's the Employer?.

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