Unexpected Discrimination Issues Facing Multinational Employers Operating Multiple Businesses in the U.S. -- Are You Your Brother's Keeper?

August 31, 2007

It is not unusual for a foreign-based multinational entity to own several businesses in the United States that are largely unrelated other than by their common ownership.  Often the U.S. based management of such a business has no detailed knowledge of or relationship with its “brother” or “sister” business in the U.S.  Nevertheless, the U.S. operations of a foreign-based entity that maintains a tax-qualified retirement plan (including a “401(k) plan”) are subject to the same non-discrimination requirements that apply to any such qualified plan, which includes taking into account the employees of members of its entire “controlled group” (even if connected only through common foreign ownership).

Controlled Group Treated as Single Employer for Discrimination Testing

One such requirement is the minimum coverage requirement, which dictates that a plan not cover a higher percentage of its highly compensated employees than of its non-highly compensated employees.  Satisfying this test can be a particular problem for foreign-based employers because testing is performed by treating all commonly owned employers as a single employer.  This can create problems for a foreign corporation that owns various business operations in the U.S. that are operated independently with each business maintaining its own qualified retirement plans with no consideration of the plans maintained by other U.S. businesses of its parent.  Sometimes a U.S. entity may not even be aware of the types of plans maintained by other U.S. entities owned by a common parent.  Indeed, since the existence of common ownership is determined for this purpose based on complicated “controlled group” regulations promulgated under Sections 414(b) and (c) of the Internal Revenue Code, it may not even be clear whether two U.S. entities constitute a “controlled group” required to be treated as a single employer for qualified plan purposes.  This could disqualify the plans of any member of the “controlled group”.

Non-Resident Aliens Excluded

Fortunately, non-resident alien employees with no income earned from U.S. sources may be excluded in the discrimination testing.  Thus, the coverage ratios for highly compensated and non-highly compensated employees can ignore those not working in the U.S.  Determination of whether an alien is a U.S. resident is made under the general rules used for tax purposes under the Internal Revenue Code, which strictly limit the number of days that an employee may work in the U.S. without being considered a resident.  Determining whether an employee as U.S. source income depends primarily on where the employee’s services to receive such income are performed.

Separate Line of Business Testing

The most important exception to the required aggregation of all commonly owned U.S. businesses of a foreign organization is the rule that permits separate testing for a “separate line of business” (or “SLOB”).  Under the Internal Revenue Code, a number of qualification requirements (including the coverage requirements prohibiting discrimination in favor of highly compensated employees) may be satisfied on a “separate line of business” basis.

The rules for determining whether two business constitute a “separate line of business” are fairly complex and require the compilation of a significant amount of data from the commonly owned businesses.  If these businesses are operated independently, it may be difficult to obtain this data and to coordinate the process of proving that the business can be tested separately under the SLOB rules.

Determination whether a business may be treated as a “separate line of business” involves several steps, which include (i) identifying the different lines of business, (ii) demonstrating that these lines of business are “separate”, (iii) demonstrating that these “separate lines of business” are “qualified” based on the number of employees in each line, notification of the IRS and passing an “administrative scrutiny” test and (iv) allocating employees among the lines of business.

●  Line of business:  The rules as to what constitutes a “line of business” are fairly flexible but there are detailed rules which generally require that a line of business must have customers other than the employer.

●  Separate:  In order to be “separate”, a “line of business” must (i) be organized and operated separately, (ii) constitute a distinct profit center, (iii) have a separate employee workforce (based on a 90% numerical test measuring overlap), and (iv) have separate management (based on an 80% numerical test applied to top-paid employees).

●  Qualified:  To be “qualified”, a “separate line of business” must (i) have at least 50 employees, (ii) notify the IRS that it treats itself as operating a “separate line of business” and (iii) pass an “administrative scrutiny” test by satisfying a safe harbor based on highly compensated employee percentage ratios, satisfying a safe harbor based on businesses in different industries, satisfying a safe harbor for a “separate line of business” acquired through a merger or acquisition, satisfying a safe harbor for “separate lines of business” that provide certain minimum or maximum benefits or obtaining an individual determination from the IRS taking into account the purposes of the nondiscrimination rules.

●  Allocation of employees:  Employees are allocated to the various qualified “separate lines of business’ in accordance with rules based on the percentage of their services to each line of business.

For most of these tests, nonresident aliens with no U.S. source income are excluded.

Rules for Counting Service Outside the U.S.

Although nonresident aliens are excluded for most of these tests, service of employees working for members of a controlled group outside the U.S. is counted for satisfying eligibility and vesting (but not benefit accrual) under U.S. qualified plans.

Other Application of ERISA

Many of the other rules of ERISA, including the liability for funding terminating underfunded plans are applied on a “controlled group” basis, which can result in unexpected liabilities on foreign entities with U.S. operations maintaining retirement plans.


These “separate line of business” rules are very detailed and complex and their application involves detailed calculations and requires significant data collection from separate sources.  Foreign-based business entities operating more than one business in the U.S. and the U.S. operations themselves should seek expert advice to be sure that their qualified savings and retirement plans not only satisfy the applicable qualification rules separately, but that they also satisfy such rules taking into account any other U.S. operations of a common foreign owner.