Question 32: I have a foreign parent with three wholly-owned subsidiaries in the U.S. (one foreign and two domestic) and a fairly large number of foreign subsidiaries outside of the U.S. Two of the subsidiaries in the U.S. have their own wholly-owned domestic subsidiaries. I am trying to figure out whether I need to include all of the foreign subsidiaries in the controlled group or just those somehow connected to the U.S. Further, how do I do non-discrimination testing? Do I need to include all employees of any corporation in the world that is owned by the parent? If I do, this will be a nightmare!

Answer: Nightmare in the IRC!

For ordinary income tax purposes, foreign corporations are not component members of controlled groups. (See IRC 1563(b)(2).) However, the component member rules do not apply to controlled groups for qualified plan purposes (See IRC 410(b).) That means that for qualified plan purposes, the status of a corporation as domestic or foreign is irrelevant in determining if that corporation is part of a controlled group or the consequences of that membership.

In the situtation you describe, for purposes of a plan set up by one of the U.S. subsidiaries, it must treat as its employees all employees who work for:
It
Its parent
Any other subsidiary of its parent, domestic or foreign.
Does that mean that all these people have to be included in the plan? No. IRC 410(b)(3)(C) allows you to exclude from your plan: "employees who are nonresident aliens and who receive no earned income (within the meaning of section 911(d)(2)) from the employer which constitutes income from sources within the United States (within the meaning of section 861(a) (3))."

I mentioned this as a side note at a recent conference. From the questions I got both on tape and afterwards you would have thought I was announcing something folks had never heard before. So, let me take a bit of time to discuss this provision.

A nonresident alien must meet both of the following tests:

He or she must not be a U.S. citizen
He or she must not be a resident of the U.S. Residency is defined in IRC 7701(b)(1) as follows:

(A) Resident alien. An alien individual shall be treated as a resident of the United States with respect to any calendar year if (and only if) such individual meets the requirements of clause (i), (ii) , or (iii) :
(i) Lawfully admitted for permanent residence. Such individual is a lawful permanent resident of the United States at any time during such calendar year.

(ii) Substantial presence test. Such individual meets the substantial presence test of paragraph (3).

(iii) First year election. Such individual makes the election provided in paragraph (4).
(B) Nonresident alien. An individual is a nonresident alien if such individual is neither a citizen of the United States nor a resident of the United States (within the meaning of subparagraph (A)).

Point (i) is significant. If you have a green card, it is my understanding that point (i) is satisfied and hence you are a resident.

Being a nonresident alien isn't enough, however, to permit exclusion. The worker must also have no U.S.-source earned income from the employer. Alternatively, the worker must come under the following rule from Treas. Regs. section 1.410(b)-6(c)(1):

Special treaty rule. In addition, an employee who is a nonresident alien (within the meaning of section 7701(b)(1)(B)) and who does receive earned income (within the meaning of section 911(d)(2)) from the employer that constitutes income from sources within the United States (within the meaning of section 861(a)(3)) is permitted to be excluded, if all of the employee's earned income from the employer from sources within the United States is exempt from United States income tax under an applicable income tax convention. This paragraph (c)(2) applies only if all employees described in the preceding sentence are so excluded.
Of course, that's going to vary on a treaty by treaty basis. What's more important is the more general case of excluding nonresident aliens with no U.S.-source income from the employer. What is U.S.-source income? 861(a)(3) tells us that US Source income includes:
Compensation for labor or personal services performed in the United States; except that compensation for labor or services performed in the United States shall not be deemed to be income from sources within the United States if?

(A) the labor or services are performed by a nonresident alien individual temporarily present in the United States for a period or periods not exceeding a total of 90 days during the taxable year,

(B) such compensation does not exceed $3,000 in the aggregate, and

(C) the compensation is for labor or services performed as an employee of or under a contract with?

(i) a nonresident alien, foreign partnership, or foreign corporation, not engaged in trade or business within the United States, or

(ii) an individual who is a citizen or resident of the United States, a domestic partnership, or a domestic corporation, if such labor or services are performed for an office or place of business maintained in a foreign country or in a possession of the United States by such individual, partnership, or corporation.
So, let's return to the situation at hand. Suppose a manager on the payroll of the parent comes to the states to oversee the sub. I had a lot of folks ask if it made a difference whether the parent or the sub paid manager. First, I would note that if he has a green card, it doesn't matter because he isn't an alien. But, I would also that that 861 doesn't care whether the payments are in yen or dollars, or where the check is written. It matters where the work is done. If the work is done in the U.S., it is U.S.-source income unless:
The worker is here less than 90 days,
The US income is less than $3000 (which effectively makes the limit a lot less than 90 days, especially if you are dealing with an executive),
The foreign parent isn't doing business itself in the US.

Of course, any U.S. citizens working for the parent cannot be excluded under this provision, regardless of where they are working.

The exclusion is not automatic. Your plan document needs to contain the language.

Important notice:

Answers are provided as general guidance on the subjects covered in the question and are not provided as legal advice to the questioner or to readers. Any legal issues should be reviewed by your legal counsel to apply the law to the particular facts of this and similar situations.

The law in this area changes frequently. Answers are believed to be correct as of the posting dates shown. The completeness or accuracy of a particular answer may be affected by changes in the law (statutes, regulations, rulings, court decisions, etc.) that occur after the date on which a particular Q&A is posted.