[Federal Register Volume 84, Number 242 (Tuesday, December 17, 2019)]
[Rules and Regulations]
[Pages 69022-69123]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2019-24848]
[[Page 69021]]
Vol. 84
Tuesday,
No. 242
December 17, 2019
Part II
Department of the Treasury
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Internal Revenue Service
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26 CFR Part 1
Foreign Tax Credit Guidance Related to the Tax Cuts and Jobs Act,
Overall Foreign Loss Recapture, and Foreign Tax Redeterminations; Final
Rule and Proposed Rule
Federal Register / Vol. 84 , No. 242 / Tuesday, December 17, 2019 /
Rules and Regulations
[[Page 69022]]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[TD 9882]
RIN 1545-BP19; 1545-BK55; 1545-AC09
Foreign Tax Credit Guidance Related to the Tax Cuts and Jobs Act,
Overall Foreign Loss Recapture, and Foreign Tax Redeterminations
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Final and temporary regulations, and removal of temporary
regulations.
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SUMMARY: This document contains final regulations that provide guidance
relating to the determination of the foreign tax credit under the
Internal Revenue Code. The guidance relates to changes made to the
applicable law by the Tax Cuts and Jobs Act, which was enacted on
December 22, 2017. This document finalizes the proposed regulations
published on December 7, 2018. This document also finalizes proposed
regulations on overall foreign losses that were published on June 25,
2012, and finalizes certain portions of proposed regulations published
on November 7, 2007, relating to a U.S. taxpayer's obligation to notify
the IRS of a foreign tax redetermination.
DATES:
Effective Date: These regulations are effective on December 17,
2019.
Applicability Dates: For dates of applicability, see Sec. Sec.
1.861-8(h), 1.861-9(k), 1.861-10(f), 1.861-11(h), 1.861-13(d), 1.861-
17(i), 1.901(j)-1(b), 1.904-1(e), 1.904-2(k), 1.904-3(h), 1.904-4(q),
1.904-5(o), 1.904-6(d), 1.904(b)-3(f), 1.904(f)-12(j)(6), 1.904(g)-
3(l), 1.905-3(d), 1.954-1(h), 1.960-7, 1.965-9(c), and 1.986(a)-1(f).
FOR FURTHER INFORMATION CONTACT: Concerning Sec. Sec. 1.861-8 through
1.861-13, 1.861-17, and 1.904(b)-3, Jeffrey P. Cowan, (202) 317-4924;
concerning Sec. Sec. 1.901(j)-1, 1.904-1 through 1.904-6, 1.904(f)-12,
1.904(g)-3, 1.905-3, 1.954-1, 1.986(a)-1, Jeffrey L. Parry, (202) 317-
4916, or Larry R. Pounders, (202) 317-5465; concerning Sec. 1.960-1
through 1.960-7, Suzanne M. Walsh, (202) 317-4908; concerning
Sec. Sec. 1.965-5 and 1.965-9, Karen J. Cate, (202) 317-4667 (not
toll-free numbers).
SUPPLEMENTARY INFORMATION:
Background
I. Proposed Regulations Implementing the TCJA
On December 7, 2018, the Department of the Treasury (the ``Treasury
Department'') and the IRS published proposed regulations (REG-105600-
18) relating to foreign tax credits in the Federal Register (83 FR
63200) (the ``2018 FTC proposed regulations''). The 2018 FTC proposed
regulations relate to changes made by the Tax Cuts and Jobs Act (Pub.
L. 115-97, 131 Stat. 2054, 2208 (2017)) (the ``TCJA'') and other
foreign tax credit issues. Terms used but not defined in this preamble
have the meaning provided in these regulations (the ``final
regulations'').
A public hearing on the proposed regulations was scheduled for
March 14, 2019, but it was not held because there were no requests to
speak. The Treasury Department and the IRS also received written
comments with respect to the 2018 FTC proposed regulations. Certain
portions of the proposed regulations relating to Sec. Sec. 1.78-1,
1.861-12(c)(2), and 1.965-7(e) were finalized as part of TD 9866,
published in the Federal Register (84 FR 29288) on June 21, 2019.
Comments received that do not pertain to the rules in the proposed
regulations or that are otherwise outside the scope of this rulemaking
are generally not addressed in this preamble but may be considered in
future guidance projects addressing the issues discussed in the
comments. All written comments received in response to the 2018 FTC
proposed regulations are available at www.regulations.gov or upon
request.
II. Proposed Regulations Relating to Overall Foreign Loss Recapture on
Property Dispositions
On June 25, 2012, the Federal Register published a notice of
proposed rulemaking at 77 FR 37837 (the ``2012 OFL proposed
regulations'') proposing rules for the coordination of the rules for
determining high-taxed income with capital gains adjustments and the
allocation and recapture of overall foreign losses and overall domestic
losses, as well as the coordination of the recapture of overall foreign
losses on certain dispositions of property and other rules concerning
overall foreign losses and overall domestic losses. One comment was
received concerning the 2012 OFL proposed regulations. A public hearing
was not requested and none was held.
III. Proposed and Temporary Regulations Under Sections 905(c) and
986(a)
On June 23, 1988, the Federal Register published a notice of
proposed rulemaking by cross-reference to temporary regulations (TD
8210) (the ``1988 temporary regulations'') at 53 FR 23659 and 53 FR
23611, respectively, relating to a taxpayer's obligation under section
905(c) to notify the IRS of a foreign tax redetermination or to make
adjustments to the pools of post-1986 undistributed earnings and
foreign income taxes of the taxpayer's foreign subsidiaries. The 1988
temporary regulations also provided guidance regarding the civil
penalty under section 6689 for failure to file the notice required
under section 905(c). In response to the written comments received on
the 1988 temporary regulations, on March 16, 1990, the Treasury
Department and the IRS issued Notice 90-26, 1990-1 C.B. 336, which
suspended the portion of the 1988 temporary regulations that provided
rules for accounting for foreign tax redeterminations that affect the
calculation of the indirect foreign tax credit under sections 902 and
960.
On May 15, 2006, the Treasury Department and the IRS issued Notice
2006-47, 2006-1 C.B. 892, which provides interim rules allowing a
taxpayer that otherwise would be required to use an average exchange
rate translation convention to elect to translate foreign income taxes
into U.S. dollars (dollars) using the exchange rates when the taxes
were paid, either for all foreign income taxes or only for those
foreign income taxes denominated in nonfunctional currency that are
attributable to qualified business units within the meaning of section
989(a) (QBUs) with dollar functional currencies.
On November 7, 2007, the Federal Register published new temporary
regulations (T.D. 9362) (the ``2007 temporary regulations'') at 72 FR
62771 and published a partial withdrawal of the notice of proposed
rulemaking relating to the 1988 temporary regulations and a new notice
of proposed rulemaking by cross-reference to the 2007 temporary
regulations at 72 FR 62805. Corrections to the temporary and proposed
regulations were published on December 19, 2007, in the Federal
Register (72 FR 71787 and 72 FR 71842, respectively). Comments were
received concerning the 2007 temporary regulations. A public hearing
was not requested and none was held. The 2007 temporary regulations
expired on November 5, 2010.
[[Page 69023]]
As part of the TCJA, section 905(c) was amended to reflect the
repeal of section 902, by eliminating the provisions allowing for
adjustments to pools of post-1986 undistributed earnings and foreign
income taxes. The TCJA made no changes to section 986(a) or 6689.
This Treasury decision adopts certain portions of the proposed
regulations under sections 905(c) and 986(a) that were published in
connection with the 2007 temporary regulations. References in this
preamble to the 2007 temporary regulations are understood to refer to
the corresponding provisions of the accompanying proposed regulations.
In particular, this Treasury decision finalizes (1) the currency
translation rules (which are moved from Sec. 1.905-3T(b) to Sec.
1.986(a)-1)), (2) the definition of foreign tax redetermination in
Sec. 1.905-3T(c), (3) the rules under Sec. 1.905-3T(d)(1) requiring a
redetermination of U.S. tax liability with respect to foreign income
taxes other than those that are deemed paid under section 960, and (4)
the rules in Sec. 1.905-3T(e) relating to foreign income taxes imposed
on foreign tax refunds. Portions of the 2007 temporary regulations
relating to prospective pooling adjustments are not included in the
final regulations in light of the TCJA's repeal of section 902 and
related amendments to section 905(c).
Section 1.905-3T(d)(2), which addresses redeterminations that
affect foreign taxes deemed paid under section 960, Sec. 1.905-4T,
which in general provides the procedural rules for how to notify the
IRS of a foreign tax redetermination, and Sec. 301.6689-1T, which
provides rules for the penalty for failure to notify the IRS of a
foreign tax redetermination, are not included in this Treasury
decision. Although the underlying substantive rule requiring
redeterminations of U.S. tax liability has not changed, in light of the
elimination of prospective pooling adjustments (which in many cases
obviated the need for U.S. tax redeterminations), the Treasury
Department and the IRS anticipate that there will be significantly more
instances in which taxpayers must redetermine their U.S. tax liability
with respect to a prior taxable year by reason of a foreign tax
redetermination with respect to a controlled foreign corporation
(``CFC''). As a result, the Treasury Department and the IRS have
determined that the rules under Sec. Sec. 1.905-3T(d)(2), 1.905-4T,
and 301.6689-1T should be reissued as a notice of proposed rulemaking
in order to allow taxpayers an additional opportunity to comment on
those rules. These regulations are available in a notice of proposed
rulemaking in the Proposed Rules section of this issue of the Federal
Register (the ``2019 FTC proposed regulations'').
IV. Technical Amendment to Regulations Issued Under Section 905
This Treasury Decision also makes a technical amendment to Sec.
1.905-2(a)(2). Regulations issued under Sec. 1.905-2 address the
forms, information, and evidence required to claim a foreign tax
credit. On December 31, 1964, the Federal Register published changes
(T.D. 6789) at 29 FR 19241 to the then existing regulations under Sec.
1.905-2, including a sentence at Sec. 1.905-2(a)(2) providing that if
a foreign receipt or return is in a foreign language, a certified
translation thereof must be furnished by the taxpayer. On January 27,
1998, the Federal Register published additional changes (T.D. 8759) at
63 FR 3812 to Sec. 1.905-2. However, the Federal Register
inadvertently deleted the sentence in Sec. 1.905-2(a)(2) requiring
certified translations of a foreign receipt or return in a foreign
language. This Treasury Decision restores the inadvertently deleted
sentence to Sec. 1.905-2(a)(2).
Summary of Comments and Explanation of Revisions
I. Overview
The final regulations retain the basic approach and structure of
the 2018 FTC proposed regulations, with certain revisions. Parts I
through III and V of this Summary of Comments and Explanation of
Revisions discuss those revisions as well as comments received in
response to the solicitation of comments in the 2018 FTC proposed
regulations. Part III.I of this Summary of Comments and Explanation of
Revisions discusses the revisions and comments received with respect to
the 2012 OFL proposed regulations. Part IV of this Summary of Comments
and Explanation of Revisions discusses the revisions with respect to
the 2007 temporary regulations relating to sections 905(c) and 986(a).
Finally, Part VI of this Summary of Comments and Explanation of
Revisions addresses the applicability dates for the final regulations.
II. Allocation and Apportionment of Deductions and the Calculation of
Taxable Income for Purposes of Section 904(a)
A. Allocation of Expenses to Section 951A Category
A taxpayer determines its foreign tax credit limitation under
section 904, in part, based on the taxpayer's taxable income from
sources without the United States. The 2018 FTC proposed regulations
provide that, in general, the regulations under sections 861 through
865 that provide rules for allocating and apportioning deductions to
determine the taxpayer's taxable income from sources without the United
States apply to income described in section 904(d)(1)(A) (the ``section
951A category'').
Some comments requested that regulations provide that no expenses
should be allocated to the section 951A category in order to ensure
that income of a United States shareholder (``U.S. shareholder'')
derived through a CFC would be effectively exempt from additional U.S.
tax if the foreign effective tax rate is greater than or equal to a
particular rate. These comments generally cite language in H.R. Rep.
115-466 (2017) (the ``Conference Report'') illustrating that no U.S.
``residual tax'' applies to foreign earnings subject to a foreign
effective tax rate of 13.125 percent or more. These comments suggest
that not requiring expenses to be allocated to the section 951A
category allows GILTI to function as a ``minimum tax.'' Alternatively,
some comments suggested that expense allocation be eliminated if the
taxpayer establishes that net CFC tested income is subject to a minimum
foreign effective tax rate of 13.125 percent, or that expense
allocation to the section 951A category be eliminated until section
864(f)(1) (providing an election to allocate interest expense on a
worldwide basis) becomes effective. One comment suggested a
fundamentally different approach to expense allocation that would allow
taxpayers to prorate the allocation of expenses to certain foreign
source income based on a ratio of the foreign tax rate with the U.S.
tax rate, and recalculate U.S. income tax liability after disallowing
the prorated expenses allocated to foreign source income. One comment
suggested that after the TCJA the United States no longer relies on the
general principle of a foreign tax credit to relieve double taxation,
and that allocation of any expenses to section 951A category income is
therefore inconsistent with U.S. treaty obligations to exempt the
income from U.S. tax. One comment agreed with the approach of the
proposed regulations requiring expense allocation to the section 951A
category, noting that the application of the expense allocation rules
is important to minimize the potential for base erosion.
As explained in Part I of the Explanation of Provisions section of
the 2018 FTC proposed regulations, the TCJA did not provide for any
changes to
[[Page 69024]]
how the generally applicable rules for computing taxable income within
each separate category should apply with respect to the new section
951A category, and other provisions added in the TCJA are inconsistent
with the notion that Congress intended effectively to exempt section
951A category income that was subject to a certain foreign effective
tax rate. Therefore, the Treasury Department and the IRS have
determined that the statute requires that expenses be allocated and
apportioned to the section 951A category. This approach is also
consistent with U.S. treaty obligations, which preserve the right of
the United States to limit allowable foreign tax credits ``in
accordance with the provisions and subject to the limitations of the
law of the United States (as it may be amended from time to time
without changing the general principles hereof) . . . '' See Article
23, Par. 2 of the 2016 U.S. Model Treaty.
This approach is confirmed by the Joint Committee on Taxation's
Explanation of the TJCA, which states that Congress intended that the
foreign tax credit limitation in the section 951A category, like any
other separate category, is calculated by taking into account expenses
allocable to income in that category. See Joint Comm. on Tax'n, General
Explanation of Public Law 115-97, at 381 n. 1753 (``As under the law
prior to enactment of the Act, U.S. shareholders are required to
allocate expenses to foreign-source income for foreign tax credit
limitation purposes based on principles applicable prior to the
enactment of the Act.''). The Joint Committee's explanation also
elaborates on the statement cited in the Conference Report that is
cited by the comments, and clarifies that the ability to fully utilize
foreign tax credits to eliminate U.S. tax liability at a foreign
effective tax rate of 13.125 percent is possible only if it is assumed,
``among other things, . . . that the domestic corporation has no
expenses.'' Id. at 381. The Explanation acknowledges that absent the
assumption of there being no expenses, ``the results . . . may
change.'' Id.
Accordingly, the final regulations do not alter the requirement
under the Code for deductions to be allocated and apportioned to the
section 951A category. However, the 2019 FTC proposed regulations
provide certain additional rules under Sec. Sec. 1.861-8 through
1.861-17, including rules that will have the effect of precluding the
allocation and apportionment of certain research and experimentation
expenses to the section 951A category. In addition, Part I.A.5 of the
Explanation of Provisions of the 2019 FTC proposed regulations states
that the Treasury Department and the IRS are studying whether further
guidance with respect to the allocation and apportionment of interest
expenses is necessary, and request comments on this topic.
B. General Rules Relating to the Allocation and Apportionment of
Expenses
1. Definitions of Exempt Income and Exempt Asset
The 2018 FTC proposed regulations make certain clarifying changes
to the definitions of exempt income and exempt asset in proposed Sec.
1.861-8(d)(2)(ii). Additionally, those regulations address the
treatment of the deduction under section 250(a)(1) (the ``section 250
deduction'') for purposes of the exempt income and assets rule. Under
proposed Sec. 1.861-8(d)(2)(ii)(C)(1), the portion of a domestic
corporation's income that is foreign derived intangible income
(``FDII'') or results from an inclusion under section 951A(a) (a
``GILTI inclusion''), and the corresponding amount treated as a
dividend under section 78 (``section 78 dividend''), is treated as
exempt income based on the amount of the section 250 deduction allowed
to the U.S. shareholder. Proposed Sec. 1.861-8(d)(2)(ii)(C)(2) treats
an equivalent portion of the domestic corporation's assets that give
rise to FDII, or the stock of the CFC that gives rise to the GILTI
inclusion, as an exempt asset.
One comment argued that the full allocation of expenses to the
section 951A is needed to prevent base erosion. The comment recommended
that the rules in proposed Sec. 1.861-8(d)(2)(ii)(C) that treat income
offset by the section 250 deduction as exempt income and the assets
that give rise to that income as exempt assets are inappropriate and
should be withdrawn. Another comment agreed with the approach of the
proposed regulations.
The Treasury Department and the IRS have determined that the
treatment of the section 250 deduction as giving rise to exempt income
is consistent with the legislative history, which states that Congress
``intends for the [section 250 deduction to] be treated as exempting
the deducted income from tax.'' See Senate Committee on Finance,
Explanation of the Bill, S. Prt. 115-20 at 376 n.1210 (November 22,
2017). The approach is also consistent with the treatment under section
864(e)(3) of certain deductions allowed under sections 243 and 245(a).
Accordingly, the final regulations adopt the rules from the 2018 FTC
proposed regulations regarding the treatment of the section 250
deduction for purposes of the exempt income and asset provisions. See
Sec. 1.861-8(d)(2)(ii)(C).
One comment requested that the final regulations clarify the
requirement to identify assets that produce gross income included in
FDII for purposes of determining the portion of a taxpayer's assets
that are treated as exempt by reason of having FDII. In particular, the
comment stated that it would be difficult to identify assets that
produce FDII, and that tangible assets should be treated differently
due to the exemption for qualified business asset investment (``QBAI'')
under section 250(b)(2)(B). As a result, the comment recommended that
FDII-related assets should not be treated as exempt assets.
Alternatively, the comment recommended a formulary approach, which
would take into account only basis of intangible assets that gave rise
to either deduction eligible income (as defined in section 250(b)(3))
or foreign derived deduction eligible income (``FDDEI'') (as defined in
section 250(b)(4)). Another comment suggested that the rule be modified
to refer to assets that produce FDDEI rather than FDII.
Following the issuance of the 2018 FTC proposed regulations, the
Treasury Department and the IRS issued rules under section 250
providing that the determination of FDDEI requires applying Sec. Sec.
1.861-8 through 1.861-14T and 1.861-17 to allocate and apportion
deductions between gross income derived from sales and services that
are FDDEI (``gross FDDEI'') versus gross income that is not gross
FDDEI. See proposed Sec. 1.250(b)-1. In light of these changes, the
Treasury Department and the IRS agree with the comment that proposed
Sec. 1.861-8(d)(2)(ii)(C)(2) should be revised to refer to assets that
produce gross FDDEI. As a result of this change, the final regulations
generally do not impose any additional requirements for identifying
assets that produce gross FDDEI beyond what is necessary in order to
determine the amount of the section 250 deduction. In addition, the
final regulations do not limit application of the exempt asset rule to
intangible assets because the effect of QBAI is already taken into
account in determining the amount of the section 250 deduction and
therefore reduces the fraction used in Sec. 1.861-8(d)(2)(ii)(C)(2) to
determine the portion of an asset that is exempt.
Under proposed Sec. 1.861-8(d)(2)(ii)(C)(1), the amount of income
treated as exempt as a result of the section 250 deduction is the
amount of gross income offset by the section 250
[[Page 69025]]
deduction. In order to conform the exempt asset rule with respect to
FDII to the exempt income rule, Sec. 1.861-8(d)(2)(ii)(C)(2) provides
that the portion of assets that produce gross FDDEI which is treated as
exempt is determined by dividing the portion of the section 250
deduction relating to FDII by the taxpayer's gross FDDEI, instead of
its FDII. This recognizes that gross FDDEI, and not FDII, reflects the
gross income which the section 250 deduction is effectively exempting.
The final regulations will have the effect of significantly reducing
the portion of assets that are exempt by reason of FDII and, therefore,
the revisions address the comments that the 2018 FTC proposed
regulations' approach overstated the portion of assets that are exempt
by reason of the section 250 deduction with respect to FDII.
The 2018 FTC proposed regulations also confirm that earnings and
profits excluded from income under section 959 (``previously taxed
earnings and profits'') do not result in any portion of the stock in a
CFC being treated as an exempt asset. Proposed Sec. 1.861-8(d)(2)(iv).
One comment suggested adding the word ``solely'' to proposed Sec.
1.861-8(d)(2)(iv) in order to clarify that stock that is not exempt by
reason of earnings and profits described in section 959(c)(1) or (c)(2)
can nonetheless be partially exempt under other rules. The adjustment
to stock value in respect of earnings and profits under section
864(e)(4) and Sec. 1.861-12(c)(2) precedes the application of the
exempt asset rules of section 864(e)(3) and Sec. 1.861-8(d)(2), and
the determination of whether stock is exempt is unrelated to whether
the value of the stock was adjusted by reference to previously taxed
earnings and profits. Proposed Sec. 1.861-8(d)(2)(iv) was merely
intended to clarify existing law in order to preclude taxpayers from
taking unreasonable positions inconsistent with section 864(e)(4), and
the rule is clear that it is limited to precluding arguments that stock
is exempt ``by reason of'' an adjustment under Sec. 1.861-12(c)(2) for
previously taxed earnings and profits. Therefore, the addition of the
word ``solely'' is unnecessary, and the comment is not adopted.
2. Application to Insurance Companies in Connection With Certain
Dividends and Tax-Exempt Interest
One comment to the 2018 FTC proposed regulations suggested that
insurance companies reduce exempt income and assets to reflect prorated
amounts of dividends and tax exempt interest. See sections 805(a)(4),
807, 812, and 832(b)(5)(B). This comment is addressed in Part I.A.4 of
the Explanation of Provisions of the 2019 FTC proposed regulations.
3. Allocation and Apportionment of the Section 250 Deduction
Proposed Sec. 1.861-8(e)(13) and (14) provide rules for allocating
and apportioning (i) the portion of the section 250 deduction for FDII
and (ii) the portion of the section 250 deduction for the GILTI
inclusion and the amount of the section 78 dividend attributable to
foreign taxes deemed paid with respect to the GILTI inclusion. In
particular, proposed Sec. 1.861-8(e)(13) provides that the portion of
the section 250 deduction for FDII is treated as definitely related and
allocable to the specific class of gross income that is included in the
taxpayer's FDDEI, and that the deduction is apportioned between the
statutory and residual grouping based on the FDDEI in each grouping.
A comment expressed concern that, to the extent that the portion of
the section 250 deduction for FDII is allocated to foreign source
income, it would reduce the ability to claim foreign tax credits. The
comment recommended not apportioning this portion of the deduction to
FDDEI. Under sections 861 and 862, a taxpayer must determine its
taxable income by deducting from gross income the deductions properly
apportioned or allocated thereto. Under Sec. 1.861-8, deductions are
generally allocated and apportioned based on a factual relationship
between the deductions and gross income. Because a portion of the
section 250 deduction for FDII is factually related to the taxpayer's
FDDEI, under the principles of Sec. 1.861-8 that portion of the
section 250 deduction is allocated to that income, regardless of
whether the FDDEI is U.S. or foreign source. Accordingly, this comment
is not adopted.
4. Allocation and Apportionment of State Income Taxes
The 2018 FTC proposed regulations did not make any changes to the
rules in Sec. 1.861-8(e)(6) for allocating and apportioning state
income taxes, which were finalized in 1991 (T.D. 8337). The final
regulations also make no changes to these rules but remove Examples 28
through 33 in Sec. 1.861-8(g), which apply the rules in Sec. 1.861-
8(e)(6) to fact patterns involving foreign subsidiaries, pending
further study by the Treasury Department and the IRS as to whether the
rules in Sec. 1.861-8(e)(6) should be revised. See Part II.B of the
Explanation of Provisions to the 2019 FTC proposed regulations
(requesting comments on Sec. 1.861-8(e)(6)).
C. Allocation and Apportionment of Interest Expense
1. Special Rule for Specified Partnership Loans
The 2018 FTC proposed regulations included rules addressing the
source and separate category of interest income and expense related to
loans to a partnership by a U.S. person (or a member of its affiliated
group) that owns an interest (directly or indirectly) in the
partnership. These loans are referred to as specified partnership
loans. Proposed Sec. 1.861-9(e)(8)(vi)(C). Under proposed Sec. 1.861-
9(e)(8)(ii), the lender in these transactions is generally required to
match the source and separate category of the interest income and
expense by assigning the interest income to the same statutory and
residual groupings from which the interest expense is deducted. The
portion of the loan that corresponds to the matched income and expense
is not taken into account for purposes of allocating and apportioning
the lender's remaining interest expense. Proposed Sec. 1.861-
9(e)(8)(i). The 2018 FTC proposed regulations also include anti-
avoidance rules to extend the application of these provisions to
certain back-to-back loans or loans made through CFCs. See proposed
Sec. 1.861-9(e)(8)(iii) and (iv).
One comment suggested modifying the language in proposed Sec.
1.861-9(e)(8)(ii) to clarify that the rules for specified partnership
loans apply solely to match existing income and expense related to the
loan, and therefore the rules do not create additional gross income.
The final regulations clarify the language of the 2018 FTC proposed
regulations consistent with the comment. See Sec. 1.861-9(e)(8)(ii).
The same comment requested clarification with respect to the anti-
avoidance rule in proposed Sec. 1.861-9(e)(8)(iii). Proposed Sec.
1.861-9(e)(8)(iii) provides that if instead of loaning directly to a
partnership, a partner instead enters into a back-to-back loan
structure through an unrelated person, then the series of loans will be
recharacterized as a direct loan to the partnership if there was a
principal purpose of avoiding the rules in proposed Sec. 1.861-
9(e)(8). A per se rule provides that a series of loans will be subject
to the recharacterization rule without regard to the principal purpose
test if the loan to the unrelated person would not have been made or
maintained on substantially the same terms irrespective of the loan of
funds
[[Page 69026]]
by the unrelated person to the partnership. The comment requested that
the per se rule be converted to an adverse factor in determining
whether a principal purpose of avoidance exists.
The Treasury Department and the IRS have determined that a loan to
an unrelated person that would not have been made or maintained on
substantially the same terms if the unrelated person did not loan the
funds to the partnership in which the original lender (or an affiliate
of the original lender) has a direct or indirect interest is
necessarily made with a principal purpose of avoiding the rules in
Sec. 1.861-9(e)(8). In addition, this rule is parallel to a similar
anti-avoidance rule in Sec. 1.861-11T(e)(3) that applies to loans
between members of an affiliated group. The Treasury Department and the
IRS have determined that a similar standard should apply in both cases.
Therefore, the comment is not adopted.
The comment also requested clarification with respect to the anti-
avoidance rule in proposed Sec. 1.861-9(e)(8)(iv), which provides that
certain loans to a partnership held by a CFC will be treated as held
directly by the U.S. shareholder of the CFC if the loan was made or
transferred with a principal purpose of avoiding the rules of proposed
Sec. 1.861-9(e)(8). The comment requested further guidance as to when
a CFC loan to a partnership is considered to have a principal purpose
of avoidance. The final regulations do not provide further guidance on
the determination of principal purpose, which is a highly factual and
case specific inquiry. The comment further requested clarification as
to the tax consequences that arise when the loan is deemed to be held
by the U.S. shareholder under the rule, and requested an example that
would illustrate the operation of these rules. The final regulations
clarify the operation of Sec. 1.861-9(e)(8)(i), which generally
requires that the U.S. person that owns a direct or indirect interest
in the partnership disregard a portion of the loan receivable for
purposes of allocating any other interest expense of the U.S. person.
Where this anti-avoidance rule applies, the loan receivable is held by
the CFC rather than its U.S. shareholder (which has the direct or
indirect interest in the partnership), and thus merely disregarding the
loan receivable would not affect the interest expense allocated by the
U.S. shareholder because the relevant asset to the U.S. shareholder is
the stock of the CFC that holds the loan receivable. Accordingly, the
final regulations provide that appropriate adjustments are made to the
value and characterization of the U.S. shareholder's stock in the CFC
to reflect the amount of the loan that is disregarded under Sec.
1.861-9(e)(8)(i). The final regulations also provide examples that
illustrate the application of Sec. 1.861-9(e)(8) in general. See Sec.
1.861-9(e)(8)(vii).
Several comments requested that the rules for specified partnership
loans be expanded to cover loans made by a partnership to a partner
(``upstream partnership loans'') so that the treatment of loans by
partners to partnerships and vice versa would be parallel for purposes
of determining the source and separate category of the associated
interest income and expense. The Treasury Department and the IRS agree
that providing similar rules for upstream partnership loans is
appropriate. Therefore, the 2019 FTC proposed regulations provide
similar rules for determining the source and separate category of
interest income and expense with respect to upstream partnership loans.
These rules are being proposed in order to provide taxpayers an
additional opportunity to comment on the rule. To better coordinate the
terminology between Sec. 1.861-9(e)(8) and the rules addressing
upstream partnership loans in the 2019 FTC proposed regulations, all
references in the final regulations to a specified partnership loan, or
SPL, are changed to downstream partnership loan, or DPL, respectively.
2. Treatment of Limited Partners Under Sec. 1.861-9(e)(4)
Proposed Sec. 1.861-9(e)(4)(i) requires that limited partners and
corporate general partners with less than 10 percent ownership in a
partnership directly allocate their distributive share of partnership
interest expense to their share of partnership gross income, which is
generally treated as passive category income under proposed Sec.
1.904-4(n)(1)(ii). One comment requested that the direct allocation
rule be revised such that individuals that are partners with less than
10 percent ownership in a limited liability company or limited
liability partnership be treated per se as limited partners.
Whether a partner is a general partner or limited partner is
determined under general partnership law principles and therefore
further guidance on this issue is outside the scope of the regulations.
Accordingly, the comment is not adopted. See also Part III.E of this
Summary of Comments and Explanation of Revisions for changes conforming
the treatment of corporate and individual general partners.
3. Direct Allocation of Interest Expense for Certain Financing
Companies
The general method to allocate and apportion interest expense, as
provided in Sec. 1.861-9T(a), is based on the principle that money is
fungible and interest expense is attributable to all activities and
property regardless of any specific purpose for incurring an obligation
on which interest is paid. See H.R. Rep. No. 99-426, at 374 (1986)
(``With limited exceptions, the committee believes that it is
appropriate for taxpayers to allocate and apportion interest expense on
the basis that money is fungible.''). The 2018 FTC proposed regulations
do not alter this approach. However, one comment requested that a
finance company that borrowed money to fund loans to customers should
be permitted to directly allocate the expense to the extent of interest
income from the financing activity. The comment does not identify any
reasons why debt of a financing company cannot be used to fund income
of the entire group (either directly through the proceeds or by freeing
up capital elsewhere in the group). To the extent the financing entity
is a ``financial corporation,'' the rules in Sec. 1.861-11T(d)(4)
allow for separate treatment of income of financial corporations versus
nonfinancial corporations. Therefore, the Treasury Department and the
IRS have determined that an exception to the general rule of
fungibility for finance companies is unwarranted.
4. Election To Use the Alternative Tax Book Value Method
One comment requested that the final regulations suspend
restrictions on changing any elections under either the foreign tax
credit or expense allocation rules, including any elections included in
these final regulations, whether from year-to-year or a retroactive
basis, for a three-year period beginning in 2018. The only election
identified by the comment letter is the election to use the alternative
tax book value method for apportioning interest expense.
Allowing annual or retroactive changes to the decision to use the
alternative tax book value method would create significant compliance
concerns for taxpayers and administrability concerns for the IRS
because each change in method will require adjusting asset bases and
depreciation schedules to reflect the new method. Therefore, the
comment is not adopted. However, the final regulations provide
additional time for taxpayers to change between the sales and gross
income methods for purposes of allocating and apportioning research
[[Page 69027]]
and experimental (``R&E'') expenditures. See Part II.D. of this Summary
of Comments and Explanation of Revisions.
5. Valuation of Assets for Purposes of Apportioning Interest Expense
In general, under the tax book value method or alternative tax book
value method of interest apportionment, a taxpayer must determine the
value of its assets based on an average of the tax book value of the
asset at the beginning and end of the year. See proposed Sec. 1.861-
9(g)(2)(i)(A). Before the TCJA, taxpayers could elect to use the fair
market value method, which required a determination of the fair market
value of the asset as of the last day of the year. However, the fair
market value method was repealed as part of the TJCA. See section
864(e)(2). In order to provide transitional relief with respect to the
TJCA's repeal of the fair market value method, proposed Sec. 1.861-
9(g)(2)(i)(A) provides that for the first taxable year beginning after
December 31, 2017, a taxpayer that had been using the fair market value
method may choose to determine asset values using an average of the end
of the first quarter and the year-end values of its assets, provided
that all the members of an affiliated group (as defined in Sec. 1.861-
11T(d)) make the same choice and no substantial distortion would
result.
One comment requested that for a given asset, taxpayers be
permitted to average the prior taxable year's end of year fair market
value with the current year-end value, which would be based on tax book
value. This approach, however, would be inconsistent with the repeal of
the fair market value method for interest apportionment as part of the
TCJA. Furthermore, because the fair market value and tax book value
methods rely on different methodologies, this approach could lead to a
substantial distortion. Therefore, the comment is not adopted.
Another comment requested either that taxpayers be permitted to
rely solely on the year-end tax book value of assets (and thus not
requiring averaging) or that taxpayers electing to use first quarter
values be permitted to do so without the earnings adjustment under
Sec. 1.861-12(c)(2)(i)(A) when the asset being valued is stock in a 10
percent owned corporation. The comment argues that this is necessary
because otherwise taxpayers would have to determine the amount of the
earnings adjustment at the end of the taxpayer's first quarter, which
would be burdensome to comply with. However, the regulations already
provide that taxpayers do not need to determine the earnings adjustment
described in Sec. 1.861-12(c)(2)(i)(A) as of the end of the first
quarter. Under proposed Sec. 1.861-9(g)(2)(ii)(B), with respect to
stock in a 10 percent owned corporation, the tax book value of the
stock at the end of the first quarter is determined before the
adjustment required by Sec. 1.861-12(c)(2)(i)(A), and a single
earnings and profits adjustment is made based on the earnings and
profits determined as of the end of the taxable year. This rule is
maintained in the final regulations.
6. Clarification of Application of the Asset Method Under Sec. 1.861-
9T(g)
Section 1.861-9T(g) provides rules for purposes of allocating and
apportioning interest expense of a CFC under the asset method, which
also apply to characterize the stock of a first-tier CFC under Sec.
1.861-12 for purposes of allocating and apportioning expenses of the
CFC's U.S. shareholders. Under the rules in Sec. 1.861-12, the
adjusted basis of the stock of the first-tier CFC is adjusted by the
earnings and profits of the CFC and other lower-tier foreign
corporations owned by the CFC.
One comment requested that the asset method under Sec. 1.861-9T(g)
be clarified to confirm that when applying Sec. 1.861-9 at the level
of a CFC, the rules in Sec. 1.861-12 apply for purposes of
characterizing stock owned directly and indirectly by the CFC, and that
such rules apply for all operative sections, not just section 904. The
Treasury Department and the IRS agree that in applying the asset method
at the level of a CFC (including for purposes of characterizing CFC
stock in applying section 904 as the operative section), the CFC must
apply the rules in Sec. 1.861-12(c) with respect to any lower-tier
CFCs. For example, a CFC applying the asset method must make basis
adjustments to reflect earnings and profits of lower-tier corporations
when valuing and characterizing the assets of the CFC. Otherwise, the
value of the lower-tier corporations would be under- or over-
represented in characterizing the assets of the CFC. Furthermore, any
lower-tier CFCs must also apply the same rules, starting with the
lowest-tier CFC and moving up.
Therefore, the final regulations provide in Sec. 1.861-9(g)(4)
that Sec. 1.861-12 applies to characterize lower-tier stock in the
hands of a CFC. Consistent with the 2018 FTC proposed regulations,
Sec. 1.861-12(a) clarifies that the rules of that section apply for
all operative sections and are not limited to section 904.
7. Treatment of Tested Income in Allocating and Apportioning Interest
Expense of a CFC Under the Modified Gross Income Method
Section 1.861-9T(j)(2) provides rules for purposes of allocating
and apportioning interest expense of a CFC under the modified gross
income method, which also apply to characterize the stock of a first-
tier CFC under Sec. 1.861-12 for purposes of allocating and
apportioning expenses of the CFC's U.S. shareholders. In general, Sec.
1.861-9T(j)(2) requires each CFC in a chain of ownership, beginning
with the lowest-tier CFC, to allocate and apportion its interest
expense and then tier up its income (net of interest expense) to the
next-highest CFC in the chain, which then allocates and apportions its
interest expense. Under proposed Sec. 1.861-9(j)(2)(ii), gross tested
income (net of interest expense) of a lower-tier corporation does not
tier up to a higher-tier corporation, which is consistent with how the
rules applied to subpart F income before the TCJA. One comment
recommended that the regulations be revised to allow upper-tier CFCs to
take into account gross tested income (net of interest expense) of
lower-tier CFCs, noting that this would be consistent with the group-
based approach of section 951A, would minimize differences between the
modified gross income method and the asset method in Sec. 1.861-9T(g),
and would eliminate distortions that could arise in the case of an
upper-tier holding company. The Treasury Department and the IRS agree
with the comment, and therefore Sec. 1.861-9(j)(2)(ii) eliminates the
rule that excludes gross tested income from tiering up to higher-tier
corporations for purposes of allocating and apportioning interest
expense of the CFC. Additionally, modifications were made to Sec.
1.861-13(c)(3) (Example 3) to reflect this change.
8. Characterization of Stock of Certain Foreign Corporations Under
Proposed Sec. Sec. 1.861-12(c)(3) and 1.861-13
Proposed Sec. 1.861-12(c)(3) provides rules for characterizing the
stock of a CFC for purposes of allocating and apportioning expenses
under an asset method. If the operative section is not section 904, the
stock of a CFC is characterized under either the asset method or the
modified gross income method. Proposed Sec. 1.861-12(c)(3)(i)(A).
Where section 904 is the operative section, proposed Sec. 1.861-13
applies to characterize the stock of the CFC as producing foreign
source income in the separate categories or as producing U.S. source
income. Proposed Sec. 1.861-
[[Page 69028]]
12(c)(3)(i)(B). Under proposed Sec. 1.861-13(a)(1), the stock of the
CFC is first characterized according to the described statutory
groupings under the asset method or the modified gross income method.
If the CFC owns stock in a noncontrolled 10-percent owned foreign
corporation, the assets or income of the foreign corporation is
assigned to a gross subpart F income grouping to the extent the income
of the foreign corporation, when distributed to the CFC, would be gross
subpart F income of the CFC. The stock of the CFC is then assigned to
the section 951A category, a treaty category, or other separate
category under subsequent steps. The stock of the CFC may be assigned,
in whole or in part, to the section 951A category if the CFC has gross
tested income, even if the CFC has a tested loss. See proposed Sec.
1.861-13(a)(2).
One comment requested that proposed Sec. 1.861-13 provide that
stock of a noncontrolled 10-percent owned foreign corporation owned by
a CFC is instead assigned to the groupings for specified foreign source
general category income or specified foreign source passive category
income (as described in proposed Sec. 1.861-13(a)(1)(i)(A)(9)). The
comment notes this would be appropriate because proposed Sec. 1.861-13
characterizes stock based on the income to which the stock gives rise,
and a distribution by a noncontrolled 10-percent owned foreign
corporation to a CFC should be eligible for the dividends received
deduction in section 245A (the ``section 245A deduction'') under Sec.
1.952-2.
As noted in Part III.B of the Explanation of Provisions to the
temporary regulations under section 245A, the Treasury Department and
the IRS intend to address issues related to the application of Sec.
1.952-2, taking into account various comments received in connection
with the TCJA (including in connection with regulations issued under
section 951A), in a future guidance project. See T.D. 9865; 84 FR
28405. This guidance will clarify that, in general, any provision that
is expressly limited in its application to domestic corporations does
not apply to CFCs by reason of Sec. 1.952-2. The Treasury Department
and the IRS continue to study whether, and to what extent, proposed
regulations should be issued that provide that dividends received by a
CFC are eligible for a section 245A deduction notwithstanding the fact
that the deduction is only available to domestic corporations. Given
that no proposed regulations have been issued, the Treasury Department
and the IRS have determined that it is appropriate to continue to
characterize the stock of a noncontrolled 10-percent owned foreign
corporation as giving rise to subpart F income, and accordingly, the
comment is not adopted. Any changes that may be necessary to Sec.
1.861-13 if proposed regulations under section 245A are issued
providing that dividends received by a CFC are eligible for a section
245A deduction will be considered as part of that guidance.
Another comment suggested that the gross income and assets of
tested loss CFCs should be exempt from the expense apportionment rules
due to the existence of special rules for tested loss CFCs in the
context of calculating GILTI, including the disallowance of any foreign
tax credits related to the tested loss under section 960(d)(3). Section
864(e)(2) requires that interest expense be apportioned on the basis of
the adjusted bases of assets. Whether or not a CFC is profitable does
not change the fact that a taxpayer's borrowings can fund the
operations of the CFC. In addition, a CFC may be highly valuable (and
have a large and positive amount of accumulated earnings and profits)
even if it happens to be in a loss position for a particular year.
Exempting the assets of tested loss CFCs would also result in
distortive incentives whereby a CFC with a small amount of tested
income would have an incentive to shift into a tested loss in order to
have the entire value of the CFC be excluded for purposes of interest
expense apportionment. Finally, the special treatment of tested losses
in the determination of the GILTI inclusion is already accounted for by
reducing the value of the stock of any CFC that is assigned to the
section 951A category based on the inclusion percentage. See Sec.
1.861-13(a)(2). Accordingly, this comment is not adopted.
Finally, the final regulations clarify in Sec. 1.861-13(a)(1)(i)
and (ii) that for purposes of characterizing the stock of a CFC in the
various statutory groupings, the U.S. shareholder of the CFC must use
the same method (either the asset method or modified gross income
method) that the CFC uses to apportion its interest expense. This is
consistent with the rule in existence before the 2018 FTC proposed
regulations, which is still reflected in Sec. 1.861-12(c)(3)(i)(A).
9. Assets Funded by Disallowed Interest
Under Sec. 1.861-12T(f)(1), to the extent that interest expense is
capitalized, deferred, or disallowed, the adjusted basis of an asset
connected to the interest expense is reduced to account for the
interest that was capitalized, deferred, or disallowed. One comment
suggested a revision to clarify, and narrow, the scope of this rule.
The Treasury Department and the IRS agree that this rule should be
clarified and have proposed changes in the 2019 FTC proposed
regulations.
D. Allocation and Apportionment of Research and Experimental
Expenditures
Proposed Sec. 1.861-17 provides a one-time exception to the five-
year binding election period by allowing taxpayers to switch between
the sales method and gross income method in the first taxable year
beginning after December 31, 2017. This exception is finalized without
change.
Comments requested revisions to the approach for allocating and
apportioning R&D expenditures under Sec. 1.861-17, which the 2018 FTC
proposed regulations do not otherwise modify. These comments are
discussed in the 2019 FTC proposed regulations, which propose changes
to the application of the sales method and allow taxpayers that are on
the sales method to rely on those changes for taxable years before the
proposed rulemaking is in effect. In order to give taxpayers an
additional opportunity after the 2019 FTC proposed regulations have
been issued to switch to the sales method, the final regulations
provide that taxpayers may change to the sales method up to their last
taxable year that begins before January 1, 2020, without the prior
consent of the Commissioner.
E. Section 904(b)(4)
Section 904(b)(4) makes certain adjustments to both the taxpayer's
foreign source taxable income and the taxpayer's entire taxable income
for purposes of computing the applicable foreign tax credit limitation,
based on the foreign-source portion (as defined in section 245A(c)) of
any dividend from a specified 10-percent owned foreign corporation (as
defined in section 245A(b)) and the deductions allocated and
apportioned to, in general, income with respect to stock of the foreign
corporation that will generally be eligible for a section 245A
deduction or the stock of the foreign corporation that gives rise to
that income. Proposed Sec. 1.904(b)-3(c)(1) and (2) provide rules for
determining what amount of the stock of the foreign corporation gives
rise to income that, if distributed, is generally eligible for a
section 245A deduction. The rules subdivide a portion of the value of
the stock into a section 245A subgroup and a non-section 245A subgroup
within each separate category.
[[Page 69029]]
One comment requested that the regulations clarify the treatment of
stock basis of a CFC that is associated with a hybrid instrument when
the stock would give rise to dividends for which a deduction is
disallowed under section 245A(e), and suggested that the amount of the
basis of that stock should be assigned to the non-section 245A
subgroup.
Under proposed Sec. 1.861-13(a)(5), stock is assigned to a section
245A subgroup without regard to whether a dividend paid (either in the
current or future year) with respect to the stock may actually qualify
for a section 245A deduction (for example, the deduction could be
disallowed due to section 245A(e) or section 246(c)). The Treasury
Department and the IRS considered a rule that would assign a portion of
stock to a section 245A subgroup only if the earnings and profits
reflected in the stock's value were allowed (or would be allowed in the
future) a section 245A deduction. However, taxpayers generally could
not know in a current year whether a distribution of the current
earnings and profits would be allowed a section 245A deduction in a
future year, and a rule requiring taxpayers to recalculate their
section 245A subgroups through amended returns would create compliance
burdens for taxpayers and administrative burdens for the IRS.
Therefore, the final regulations retain the rules in the 2018 FTC
proposed regulations, which determine the amount of stock in a section
245A subgroup without regard to whether a section 245A deduction is or
would be allowed with respect to dividends paid with respect to the
stock.
The comment also suggested that stock associated with hybrid
instruments owned directly by a U.S. shareholder should be assigned to
the non-section 245A subgroup due to a concern that the value of stock
assigned to a section 245A subgroup would be excluded for purposes of
valuing the stock under the beginning- and end-of-year averaging rule
in Sec. 1.861-9(g)(2). However, neither Sec. 1.861-13(a)(5) nor Sec.
1.904(b)-3 provides that stock assigned to the section 245A subgroup is
excluded. Instead, deductions allocated and apportioned to stock
assigned to the section 245A subgroup are added back to the numerator
and denominator determined under section 904(a). Therefore, contrary to
the comment, the assignment of stock to the section 245A subgroup (as
opposed to the non-section 245A subgroup) does not impact the
calculation of the total value of stock under the beginning- and end-
of-year averaging rule in Sec. 1.861-9(g)(2). Thus, the comment is not
adopted.
Another comment recommended that proposed Sec. 1.904(b)-3 be
amended to provide that the treatment of deductions allocated and
apportioned to the section 245A subgroup not be added back to entire
taxable income for purposes of applying section 904(a) to section 951A
category income. The comment is not adopted. Section 904(b)(4) is clear
that deductions described in that provision are disregarded for
purposes of ``entire taxable income,'' which means that the computation
under section 904(a) (which describes a fraction, the denominator of
which is ``entire taxable income'') with respect to all separate
categories, including the section 951A category, are affected by
deductions allocated and apportioned to the section 245A subgroup.
However, the amount of income in the section 951A category (the
numerator of the section 904(a) fraction when section 904(a) applies to
that category) is not affected by deductions allocated and apportioned
to the section 245A subgroups of other separate categories.
III. Foreign Tax Credit Limitation Under Section 904
A. Transition Rules Accounting for New Separate Categories
1. Carryovers and Carrybacks of Unused Foreign Taxes Under Section
904(c)
The 2018 FTC proposed regulations provide transition rules for
assigning carryforwards of unused foreign taxes paid or accrued, or
deemed paid or accrued, in pre-2018 taxable years to post-2017 separate
categories, which include new categories for section 951A category
income and foreign branch category income. Proposed Sec. 1.904-
2(j)(1)(ii) provides that if unused foreign taxes paid or accrued or
deemed paid with respect to a separate category of income are carried
forward to a taxable year beginning after December 31, 2017, those
taxes are allocated to the same post-2017 separate category as the pre-
2018 separate category from which the unused foreign taxes are carried.
Proposed Sec. 1.904-2(j)(1)(iii) provides an exception that permits
taxpayers to assign unused foreign taxes in the pre-2018 separate
category for general category income to the post-2017 separate category
for foreign branch category income to the extent they would have been
assigned to that separate category if the taxes had been paid or
accrued in a post-2017 taxable year. Any remaining unused taxes are
assigned to the post-2017 separate category for general category
income.
Several comments requested a simplified rule for assigning a
portion of the pre-2018 unused foreign taxes to the post-2017 separate
category for foreign branch category income. One comment recommended a
simplified rule under which unused foreign taxes are assigned to the
foreign branch category in the same proportions as foreign taxes paid
or accrued by the taxpayer's foreign branches in the relevant pre-2018
year bear to all foreign taxes paid or accrued by the taxpayer in that
year. Another comment recommended a simplified rule that assigns the
pre-2018 unused foreign taxes to the post-2017 separate categories by
reference to a single year. Another comment recommended either allowing
taxpayers to allocate pre-2018 unused foreign taxes freely between the
post-2017 separate categories for general category income and foreign
branch category income, or in the alternative, using any reasonable
method. Finally, one comment recommended that if the reconstruction
option is maintained in the final regulations that it be simplified by
not requiring taxpayers to reconstruct disregarded payments between a
branch and its owner.
After considering the comments, the Treasury Department and the IRS
agree that a simplified safe harbor option with respect to the
reconstruction option should be provided. Section 1.904-2(j)(1)(iii)(B)
provides a safe harbor that allocates unused foreign taxes from a
particular pre-2017 taxable year to the post-2018 separate category for
foreign branch category income based on a ratio equal to the amount of
foreign income taxes that were paid or accrued by the taxpayer's
foreign branches divided by the amount of all foreign income taxes
assigned to the general category that were paid or accrued, or deemed
paid by the taxpayer with respect to the taxable year. The Treasury
Department and the IRS adopt this recommendation because it combines
administrative convenience, a low potential for manipulation, and a
reasonable approximation of a full reconstruction. Furthermore, in
light of the addition of a safe harbor option, no changes are made to
the requirements for reconstruction if the safe harbor option is not
chosen. Taxpayers that do not choose the safe harbor must determine the
unused foreign taxes with respect to foreign branch category income as
if that separate category (and thus, all the rules in Sec. 1.904-4(f))
had applied in the year the taxes were paid or accrued.
Another comment requested that when applying the reconstruction
option, the final regulations provide that for purposes of determining
whether excess credits relate to direct or indirect
[[Page 69030]]
foreign taxes, taxpayers may treat indirect credits as having been used
first. However, under the reconstruction option, taxpayers must
allocate unused foreign taxes by applying the rules for foreign branch
category income to the origin year and determining the amount of taxes
that would have been unused foreign taxes and would have been allocated
to foreign branch category income had the foreign branch category
applied for that year. Because deemed paid taxes can never relate to
the foreign branch category, no deemed paid taxes will be treated as
giving rise to unused foreign taxes that would have been allocated to
foreign branch category income. Therefore, the Treasury Department and
the IRS have determined that no special rules are needed. See Sec.
1.904-2(j)(1)(iii).
Another comment requested that taxpayers be allowed to apply the
general category exception in proposed Sec. 1.904-2(j)(1)(iii) to
post-2017 tax years on a year-by-year basis, rather than to all post-
2017 tax years. The Treasury Department and the IRS have determined
that the use of different methods in different years could result in
inconsistent allocations of the same foreign tax credit carryovers and
create significant complexity for taxpayers and the IRS. Accordingly
the comment is not adopted.
2. Separate Limitation Losses, Overall Foreign Losses, Overall Domestic
Losses, and Net Operating Loss Carryforwards
Proposed Sec. 1.904(f)-12(j) generally provides that any separate
limitation loss (``SLL'') or overall foreign loss (``OFL'') accounts in
a pre-2018 separate category remain in the same post-2017 separate
category. However, to the extent there are any unused foreign taxes
with respect to the pre-2018 separate category for general category
income that are allocated between the post-2017 separate categories for
general category income and foreign branch category income, then any
SLL or OFL account in the pre-2018 separate category for general
category income is allocated to those post-2017 separate categories in
the same proportion that the unused foreign taxes were allocated.
Similar rules were provided in the 2018 FTC proposed regulations with
respect to the recapture of SLLs or overall domestic losses (each an
``ODL'') that reduced income in a separate category in a pre-2018
taxable year, as well as for foreign losses that are part of a net
operating loss that is incurred in a pre-2018 taxable year and carried
forward to post-2017 taxable years.
One comment suggested that it was not clear that the allocation of
losses should follow the allocation of unused foreign taxes, and that
it was inflexible not to allow an allocation of losses with respect to
the pre-2018 separate category for general category income between the
post-2017 separate categories for general category income and branch
category income when there were no unused foreign taxes with respect to
that category to be allocated. The comment suggested that a true
reconstruction of the losses would be too complex, but requested that
the Treasury Department and the IRS consider some other unspecified
approach that was independent from the allocation of unused foreign
taxes.
Another comment on the same issue requested that the Treasury
Department and the IRS allow taxpayers to elect to reconstruct the
losses. In other words, this approach would allow taxpayers to allocate
a portion of loss accounts with respect to the pre-2018 separate
category for general category income to the post-2017 separate category
for foreign branch category income to the extent they were attributable
to losses that either related to, or offset, pre-2018 general category
income that would have been foreign branch category income if
recognized in a post-2017 taxable year, regardless of the taxpayer's
treatment of unused foreign taxes.
The Treasury Department and the IRS agree that additional options
should be added under the transition rules for loss accounts that
relate to the pre-2018 separate category for general category income.
Accordingly, Sec. 1.904(f)-12(j)(2) provides that a SLL or OFL account
incurred in the pre-2018 separate category for general category income
by default remains in the general category, but that the taxpayer may
choose to reconstruct how much of the loss account would have been in
the foreign branch category had that category been in effect before
2018. As an alternative to reconstruction, a safe harbor provides that
the taxpayer may instead recapture the pre-2018 loss account by
recharacterizing the first available income in the post-2017 separate
category for either general category income or foreign branch category
income. To the extent the income in both separate categories available
for recapture exceeds the balance in the loss account, the loss account
is recaptured proportionately from each separate category. An ordering
rule provides that the balance in a pre-2018 loss account is recaptured
before any post-2017 additions to the account. This safe harbor follows
similar transition rules provided in Sec. 1.904(f)-12(a) for pre-1987
loss accounts.
Similarly, Sec. 1.904(f)-12(j)(3) provides that an SLL or OFL that
reduced pre-2018 general category income is by default recaptured in
post-2018 years as general category income, but that a taxpayer may
choose to reconstruct how much of the balance in the loss account would
have offset foreign branch category income had that separate category
applied in the year the loss was incurred, and recapture that amount in
post-2017 taxable years as income in the foreign branch category. As an
alternative to reconstruction, the final regulations retain the rule in
proposed Sec. 1.904(f)-12(j)(3)(ii) as a safe harbor, which provides
that the taxpayer may instead recapture the balance in the loss account
in subsequent taxable years ratably as income in the taxpayer's post-
2017 separate categories for general category and foreign branch
category income based on the proportion in which any unused foreign
taxes in the pre-2018 separate category for general category income are
allocated under the transition rules in Sec. 1.904-2(j)(1)(iii)(A) or
(B).
Section 1.904(f)-12(j)(4) provides that foreign losses that are
part of general category net operating losses incurred in pre-2018
taxable years which are carried forward to post-2017 taxable years are
by default treated as general category net operating losses, but that
the taxpayer may choose to reconstruct how much of that loss would have
been attributable to the foreign branch category had that separate
category applied in the year the net operating loss arose. As an
alternative to reconstruction, a safe harbor provides that the taxpayer
may instead choose to treat the net operating loss carryforward as
attributable to the general category and foreign branch category to the
extent of any general category income and foreign branch category
income, respectively, that is available in the year to be offset by the
net operating loss carryforward (the carryforward year). To the extent
the net operating loss carryforward offsets any other income in the
carryforward year, it is treated as attributable to the general
category. If the sum of taxpayer's general category income and foreign
branch category income in the carryforward year exceeds the amount of
the net operating loss carryforward, then the amount of each type of
separate category income that is offset by the net operating loss
carryforward, and therefore the separate category treatment of the net
operating loss carryforward, is determined on a proportionate basis. An
ordering rule provides that a pre-2018 general
[[Page 69031]]
category net operating loss is applied before any post-2017 general
category net operating loss.
Finally, Sec. 1.904(f)-12(j)(5) sets forth a coordination rule
that provides that for purposes of applying the transition rules for
unused foreign taxes or any of the rules for loss accounts, the choice
whether to default to the general category or to reconstruct must be
made consistently in all cases. However, if the taxpayer chooses to
reconstruct, the choice to apply a safe harbor may be made
independently under each set of transition rules.
B. Foreign Branch Category Income
1. Policy Considerations
Comments recommended that the final regulations, or preamble to the
final regulations, include a discussion of the tax policy
considerations relevant to proposed Sec. 1.904-4(f). In general,
proposed Sec. 1.904-4(f) defines the term foreign branch category
income, which affects both the limitation on foreign tax credits under
section 904 and the deduction for FDII under section 250(a)(1)(A).
Under section 904(d)(2)(J), foreign branch income is defined as the
business profits attributable to one or more QBUs in one or more
foreign countries, with the amount of business profits attributable to
a QBU determined under rules established by the Secretary. Accordingly,
the 2018 FTC proposed regulations provide guidance regarding the
attribution of profits to a foreign branch.
The legislative history to the TCJA does not discuss the
attribution of business profits to a QBU. In drafting the 2018 FTC
proposed regulations, the Treasury Department and the IRS balanced
various policy objectives, including: Attributing gross income to a
foreign branch in a manner that is commensurate with its business
activities; administrability for taxpayers and the IRS; conformity with
local country tax law; and giving effect to the policies of sections
250(b)(3)(A)(i)(VI) and 904(d)(1)(B), which limit, respectively, the
deduction under section 250 and the allowance of a credit under section
901 by reference to the amount of business profits attributable to a
QBU.
The Treasury Department and the IRS have determined that the 2018
FTC proposed regulations' approach to attributing gross income to a
foreign branch strikes the appropriate balance among those goals. In
general, the 2018 FTC proposed regulations attribute gross income by
reference to the books and records maintained with respect to a foreign
branch, subject to certain adjustments (including adjustments to
reflect Federal income tax principles). Proposed Sec. 1.904-
4(f)(2)(i). Reliance on a foreign branch's books and records promotes
administrability for both taxpayers and the IRS. In addition, gross
income reflected on the books and records of a foreign branch generally
reflects payments for economic activity of that foreign branch, such
that the proposed regulations' approach is broadly consistent with the
policy of attributing gross income based on the relative economic
activity of a foreign branch. Furthermore, the rule will promote
conformity between the income attributed to a foreign branch under
Sec. 1.904-4(f) and the income subject to tax in the foreign
jurisdiction.
To further those policies, the 2018 FTC proposed regulations also
give effect to payments made in connection with certain transactions
that are disregarded for Federal income tax purposes (such payments,
``disregarded payments''). Proposed Sec. 1.904-4(f)(2)(vi). These
payments are generally reflected on the books and records of a foreign
branch, represent compensation for economic activity performed by or
for a foreign branch, and are frequently given effect for foreign
income tax purposes. Accordingly, giving effect to those transactions
generally aligns with the policies furthered by the general rule for
attributing gross income to a foreign branch. For additional discussion
regarding the policies and rules relating to disregarded payments, see
Part III.B.2 of this Summary of Comments and Explanation of Revisions.
2. Disregarded Payments
i. In General
Several comments were received regarding proposed Sec. 1.904-
4(f)(2)(vi), under which gross income attributable to a foreign branch
that is not passive category income must be adjusted to reflect
disregarded payments between a foreign branch and its foreign branch
owner, and between foreign branches (the ``disregarded payment rule'').
Some comments expressed support for the rule, while others indicated
that they believed that proposed Sec. 1.904-4(f) would be more
administrable without the disregarded payment rule. As described in
Part III.B.1 of this Summary of Comments and Explanation of Revisions,
the Treasury Department and the IRS have determined that the
disregarded payment rule furthers the various policies related to the
attribution of gross income to a foreign branch. The disregarded
payment rules are designed to utilize information that is already
available to taxpayers, making the rule more administrable. Taking
disregarded payments into account will also give effect to the economic
activity of a foreign branch (or a foreign branch owner) while reducing
mismatches between the amount of gross income attributable to a foreign
branch and the foreign tax base. Accordingly, the final regulations
retain the disregarded payment rule, subject to the modifications
described in this Part III.B.2 of the Summary of Comments and
Explanation of Revisions.
ii. Source and Character of Income Allocated in Connection With
Disregarded Payments
Comments recommended that the character and source of gross income
that is reattributed under the disregarded payment rule be determined
by reference to the disregarded transaction giving rise to the
reattribution. For example, if a foreign branch owner earned $50 of
U.S. source royalty income, and made a $50 disregarded payment to its
foreign branch for services performed that if regarded would be
allocable to the royalty income under the 2018 FTC proposed
regulations, the proposed regulations would attribute $50 of U.S.
source royalty income to the foreign branch. Because attributing U.S.
source royalty income to the foreign branch would not increase the
taxpayer's limitation under section 904(d)(2)(B) (the foreign branch
category), the comments recommended that the source and character of
the reattributed gross income be determined by reference to the
disregarded payment, such that the $50 of U.S. source royalty income
would be converted to foreign source services income, potentially
increasing the creditability of taxes attributable to the foreign
branch (including taxes imposed by reason of the disregarded
transaction).
The Treasury Department and the IRS have determined that it would
be inappropriate to issue rules under section 904 converting the source
and character, as opposed to the separate category, of a taxpayer's
gross income. Generally, section 904(d) and the regulations under Sec.
1.904-4(f) provide rules regarding the separate application of section
904 with respect to certain categories of regarded gross income of a
taxpayer. The Treasury Department and the IRS have determined that
section 904 does not provide for the redetermination of the character
or source of a taxpayer's gross income. Converting U.S. source income
to foreign source income would also be inconsistent with the purpose of
section
[[Page 69032]]
904, which is to ensure that the foreign taxes may not be used as a
credit against U.S. tax on U.S. source income. Finally, rules allowing
taxpayers to increase foreign source income through transactions with
foreign branches would be prone to significant manipulation.
Accordingly, the final regulations do not include special rules for
determining the source and character of gross income that is
reattributed under the disregarded payment rule. Similarly, the final
regulations clarify that Sec. 1.904-4(f) does not affect the analysis
of whether an amount of gross income can be resourced under an
applicable bilateral tax treaty. Such analysis is based solely on the
treaty text and related authorities.
iii. Netting of Disregarded Payments
Comments recommended that disregarded payments be netted before
determining the amount of gross income attributable to a foreign branch
and its owner. For example, under a netting rule, if a foreign branch
made a $100 disregarded payment to its foreign branch owner, and the
foreign branch owner made an $85 disregarded payment to the foreign
branch during the same year, no more than $15 of the gross income
reflected on the books and records of the foreign branch would be
attributed to the foreign branch owner, regardless of the factual
relationship between the two payments. Similarly, if a foreign branch
owner made a $50 disregarded payment to one branch, and received a $50
disregarded payment from a second branch, none of the gross income
reflected on the books and records of the second foreign branch would
be attributed to its owner and none of the gross income earned by the
foreign branch owner would be attributed to the first foreign branch.
The Treasury Department and the IRS have determined that
disregarded payments should not be netted before making adjustments
under the disregarded payment rule. As described in Part III.B.2.ii of
this Summary of Comments and Explanation of Revisions, the disregarded
payment rule affects only the separate category of gross income, and
not the source or character of a taxpayer's gross income. Accordingly,
when a disregarded payment is made between a foreign branch owner and a
foreign branch, the payment must be allocated to gross income of the
payor to determine the source and character of the amount that is
reattributed. When there is an increase to the amount of gross income
attributable to a foreign branch, for example, there must be a
corresponding decrease to income of the foreign branch owner with the
same source and character. Moreover, the disregarded payment rule only
affects the assignment of gross income in the foreign branch category
and the general category, or a specified separate category that is
associated with the foreign branch or general categories. Passive
income, for example, is always excluded from the foreign branch
category. Thus, to the extent that a disregarded payment from a foreign
branch owner to a foreign branch would be allocable to passive income
of the foreign branch owner, there can be no adjustment as a result of
that payment to the taxpayer's gross income in the passive category,
even though the amount of passive category income that is attributable
to the foreign branch (and the foreign branch owner) may change.
Netting disregarded payments would distort these rules by
preventing the disregarded payment rule from accurately identifying the
source and character of gross income that is attributable to the
foreign branch and its owner, respectively. For example, if a foreign
branch earned $100 of foreign source royalty income that was initially
attributable to the foreign branch, and made a $90 disregarded payment
to its foreign branch owner that if regarded would be allocable to that
foreign source royalty income, only $10 of that foreign source royalty
income should be treated as foreign branch category income. Under a
netting rule, however, a $90 disregarded payment by the foreign branch
owner to that foreign branch (or another foreign branch of the foreign
branch owner) that would be allocable to U.S. source passive category
income of the foreign branch owner would offset the payment, such that
U.S. source passive category income that could not increase foreign
branch category income itself would effectively increase foreign branch
category income, by increasing the non-passive foreign source royalty
income attributable to a foreign branch. Accordingly, to prevent this
and similarly arbitrary outcomes under the disregarded payment rule,
the final regulations do not include a rule netting disregarded
payments between a foreign branch owner and its foreign branches.
A comment further recommended that disregarded payments between
foreign branches should be disregarded, and stated that taking those
transactions into account added administrative complexity to the 2018
FTC proposed regulations without changing the categorization of any
item of gross income as foreign branch category income. The Treasury
Department and the IRS have determined that this comment is incorrect,
and the final regulations retain the 2018 FTC proposed regulations'
rules regarding transactions between foreign branches. The items of
gross income attributable to a particular foreign branch vary based on
the nature of the disregarded transaction, which could include multiple
back-to-back disregarded payments between foreign branches and the
foreign branch owner; further, the amount, character, and source of
gross income allocable to a particular foreign branch may vary, and
knowing which gross income items are attributable to a particular
foreign branch is necessary to determine the amount, character, and
source of gross income that is attributed to a foreign branch or the
foreign branch owner as the result of a particular disregarded payment.
The final regulations clarify this point, including through
clarifications to the ordering rule in Sec. 1.904-4(f)(2)(vi)(F), and
a new example illustrating the effects of transactions between foreign
branches. See Sec. 1.904-4(f)(4)(xi) (Example 11). However, the final
regulations also clarify that in the case where there is no disregarded
payment between the foreign branch and foreign branch owner,
disregarded payments between foreign branches have no effect. See Sec.
1.904-4(f)(2)(vi)(A).
iv. Interest and Other Financial Transactions
Under the proposed regulations, the disregarded payment rules do
not apply to disregarded payments of interest or interest equivalents
(``disregarded interest payments''). See proposed Sec. 1.904-
4(f)(2)(vi)(C)(1). The preamble to the 2018 FTC proposed regulations
stated that, like remittances from a foreign branch or contributions to
a foreign branch, disregarded interest payments reflect a shift of, or
return on, capital. Several comments disagreed with that statement,
arguing that disregarded interest payments reflect business profits
with respect to the payee, particularly with respect to the financial
services industry. Comments also indicated that distinguishing among
different types of disregarded payments based on their character
presented administrative challenges. Finally, a comment noted that
failing to reattribute gross income on the basis of disregarded
interest payments resulted in incongruities between the gross income
attributed to a foreign branch for section 904 purposes and the gross
income subject to tax under foreign law.
The final regulations adopt the 2018 FTC proposed regulations'
approach to disregarded interest payments. The Treasury Department and
the IRS have
[[Page 69033]]
determined that a general rule reattributing gross income by reference
to disregarded interest payments would be inappropriate. As one comment
noted, reattributing gross income by reference to disregarded interest
payments, but not by reference to remittances and contributions, would
allow taxpayers to ``strip'' the foreign branch category, potentially
resulting in manipulation of the limitations in sections
250(b)(3)(A)(i)(VI) and 904(d)(1)(B). Similarly, a taxpayer seeking to
increase foreign branch category income could instead borrow money from
the foreign branch and shift income from the general category through
disregarded interest payments made to the foreign branch. However, as
described in Part III.B.4.iii of this Summary of Comments and
Explanation of Revisions, the Treasury Department and the IRS are
considering future guidance providing special rules for certain
financial institutions, including rules that would provide for
adjustments to the attribution of gross income by reference to
disregarded interest payments.
v. Disregarded Transfers of Intangible Property
Proposed Sec. 1.904-4(f)(2)(vi)(D) (the ``intangible property
rule'') requires the use of section 367(d) principles to impute
payments, over time, for certain transfers of intangible property in a
disregarded transaction. Comments requested that the intangible
property rule be withdrawn, either in whole or in part (for example, by
limiting the application of the rule to transfers from a foreign branch
owner to a foreign branch). The comments argued that (i) there is no
compelling policy rationale for the intangible property rule; (ii) the
intangible property rule undermines a legislative objective of the
TCJA, which was to achieve neutrality as to whether to locate
intellectual property in a domestic corporation or its foreign
subsidiary; (iii) the anti-abuse rule in Sec. 1.904-4(f)(2)(v) is
sufficient to prevent abusive tax-avoidance through disregarded
remittances or contributions; (iv) the absence of a similar rule for
tangible property or money evidences the lack of a need for a special
rule for certain intangible property; (v) the intangible property rule
would result in mismatches between the gross income attributable to a
foreign branch and the gross income of the foreign branch for foreign
tax purposes; and (vi) the rule would present administrative and
compliance challenges. Certain comments acknowledged that the
intangible property rule may be theoretically accurate, but argued that
the compliance burdens that the rule posed outweighed its benefits.
The Treasury Department and the IRS have determined that retaining
the intangible property rule is appropriate, and that it should apply
to any disregarded transfer between a foreign branch owner and a
foreign branch, as well as to transfers between foreign branches. While
the intangible property rule may increase compliance burdens and
increase the disparity between the gross income attributable to a
foreign branch and the gross income taxable by a foreign country, the
Treasury Department and the IRS have determined that those concerns are
outweighed by the benefits derived from the rule. In general, Sec.
1.904-4(f)(2)(vi)(A) adjusts the attribution of gross income when
disregarded payments are made between a foreign branch and a foreign
branch owner, or between foreign branches. Disregarded remittances or
contributions, however, do not result in the reattribution of gross
income. Section 1.904-4(f)(2)(vi)(C)(2) and (3). Accordingly, when a
disregarded transaction with a foreign branch may be structured as
either a remittance or contribution, on the one hand, or as a sale,
exchange, or license, on the other hand, the amount of gross income
attributed to a foreign branch could be manipulated. This concern is
heightened when the property in question is highly mobile and highly
valuable, as is generally true of intangible property (and less
frequently true of tangible property). In light of the higher risk of
manipulation for transfers of intangible property, the Treasury
Department and the IRS have determined that the anti-abuse rule in
Sec. 1.904-4(f)(2)(v) does not sufficiently protect against
manipulation, necessitating the more specific and mechanical intangible
property rule.
The Treasury Department and the IRS have, however, modified the
intangible property rule in response to comments. First, comments
recommended that the intangible property rule be limited to disregarded
transfers occurring after the enactment of the TCJA, after the date on
which the proposed regulations were issued, or after the date on which
the final regulations become effective. In response to these comments,
the final regulations provide that the intangible property rule does
not apply to transfers that occurred before December 7, 2018 (the date
on which the proposed regulations were published). Section 1.904-
4(f)(2)(vi)(D)(2). The Treasury Department and the IRS have determined
that limiting the application of the intangible property rule to
transfers occurring on or after the date on which the rule was proposed
strikes the appropriate balance between providing taxpayers with
sufficient notice regarding the intangible property rule, on the one
hand, and preventing manipulation of the amount of gross income
attributable to a foreign branch, on the other hand.
Second, several comments indicated that the intangible property
rule inappropriately captures transient ownership of intangible
property that was neither developed nor exploited by the foreign branch
(or foreign branch owner) before a transfer. For example, several
comments suggested that the intangible property rule would apply to
certain repatriations of intangible property from a foreign subsidiary
that elected to be treated as a disregarded entity (within the meaning
of Sec. 1.904-4(f)(3)(iv)), and immediately thereafter distributed
intangible property to its U.S. owner. The Treasury Department and the
IRS have determined that the potential distortions that the intangible
property rule addresses generally are not implicated in the situation
described in the comments. Accordingly, the final regulations adopt the
recommendation. Specifically, the final regulations provide that the
intangible property rule does not apply to transfers by a foreign
branch or foreign branch owner that owns the intangible property
transitorily, subject to certain limitations. See Sec. 1.904-
4(f)(2)(vi)(D)(3)(i) through (iii). For this purpose, whether or not a
foreign branch owner that is a transferor of intangible property is
treated as satisfying the transitory ownership requirements is
determined by reference to both the foreign branch owner transferor and
any predecessor to the foreign branch owner. See Sec. 1.904-
4(f)(2)(vi)(D)(3)(iv).
Finally, comments requested additional guidance and examples
illustrating the application of section 367(d) principles in the
context of a remittance of intangible property from a foreign branch to
the foreign branch owner. In response to the comments, the final
regulations specify that if a foreign branch remits property described
in section 367(d)(4) to its foreign branch owner, the foreign branch is
treated as having sold the transferred property to the foreign branch
owner in exchange for annual payments contingent on the productivity or
use of the property, the amount of which are determined under the
principles of section 367(d) and the regulations under that section.
The final regulations also include an example illustrating the
application of the intangible property rule to a remittance
[[Page 69034]]
of intangible property from a foreign branch to a foreign branch owner.
See Sec. 1.904-4(f)(4)(xii) (Example 12). The final regulations do not
address comments regarding the operation of section 367(d), which are
outside of the scope of the final regulations.
vi. Special Rule for Certain Disregarded Payments
A comment recommended that the final regulations clarify that
disregarded payments that would be capitalized into amortizable or
depreciable basis may produce adjustments under Sec. 1.904-4(f)(2)(vi)
in the year or years that the amortization or depreciation deductions
would be allowed if those payments had been regarded. The final
regulations adopt this recommendation. See Sec. Sec. 1.904-
4(f)(2)(vi)(B)(1) (specifically including disregarded cost recovery
deductions, such as depreciation and amortization, in the disregarded
payment allocation rules) and 1.904-4(f)(2)(vi)(B)(3) (clarifying the
timing of those reattributions).
The final regulations also provide additional guidance regarding
certain disregarded payments that would, if regarded, not be
deductible, including guidance regarding disregarded sales of property
that reattribute gross income when basis would be recovered other than
through depreciation, amortization, or other disregarded cost recovery
deductions. Under these rules, for example, a foreign branch owner's
sale of property with a zero basis to its foreign branch for $100,
followed by a sale by the foreign branch of that property to a third
party for $110, would generally result in $110 of income that is
reflected on the books and records of a foreign branch. The final
regulations clarify that, in this example, $100 of gross income must be
attributed to the foreign branch owner. Specifically, the foreign
branch would be treated as having an adjusted disregarded basis in the
property of $100, resulting in $10 of gain from the sale of the
property being attributed to the foreign branch, and $100 of adjusted
disregarded gain being attributed to its foreign branch owner. See
Sec. 1.904-4(f)(2)(vi)(B)(2) (concerning disregarded sales of
property). Attributions of income under this rule are adjusted to the
extent that the basis would otherwise have been recovered by the
transferee (for example, through a disregarded cost recovery
deduction). See Sec. 1.904-4(f)(3)(i) (defining adjusted disregarded
basis).
vii. Certain Disregarded Transactions
The 2018 FTC proposed regulations provide for certain adjustments
to the amount of gross income that would otherwise be attributed to a
foreign branch under proposed Sec. 1.904-4(f)(2)(i). For example,
gross income attributable to a foreign branch generally does not
include gain attributable to a sale of stock by the foreign branch. See
proposed Sec. 1.904-4(f)(2)(iii). The final regulations clarify that
consistent adjustments must be made when attributing income under the
disregarded payment rule. See Sec. 1.904-4(f)(2)(vi)(C)(4). Thus, for
example, a disregarded payment from a foreign branch owner to its
foreign branch with respect to a disregarded sale of stock from the
foreign branch to the foreign branch owner would not result in
adjustments to the attribution of gross income between the foreign
branch owner and the foreign branch.
3. Foreign Branch Definition
i. Trade or Business Requirement
The proposed regulations define a foreign branch by reference to
the definition of a QBU in Sec. 1.989(a)-1(b)(2)(ii) and (b)(3), which
require that the branch maintain a separate set of books and records
with respect to its activities and conduct of a trade or business
outside of the United States (among other things). For this purpose,
the trade or business standard described in Sec. 1.989(a)-1(c)
applies, subject to certain modifications. See proposed Sec. 1.904-
4(f)(3)(iii). The proposed regulations provide that activities
conducted outside the United States that constitute a permanent
establishment under the terms of an income tax treaty between the
United States and the country in which the activities are carried out
are presumed to constitute a trade or business conducted outside the
United States for purposes of determining whether the activities meet
the trade or business standard of the foreign branch definition.
A comment indicated that it is not clear when activities that
constitute a permanent establishment should ever be treated as failing
to satisfy this requirement. The Treasury Department and the IRS have
determined that, consistent with the policy of promoting conformity
between the gross income attributable to a foreign branch and the gross
income subject to tax in a foreign jurisdiction, no exception to this
rule is warranted. Accordingly, the final regulations provide that
activities conducted outside the United States that constitute a
permanent establishment under the terms of an income tax treaty between
the United States and the country in which the activities are carried
out constitute a trade or business conducted outside the United States
for purposes of determining whether the activities meet the trade or
business standard of the foreign branch definition, and do not adopt
the presumption rule in the proposed regulations. Sec. 1.904-
4(f)(3)(vii)(B).
ii. Separate Set of Books and Records
The proposed regulations include a special rule treating a
partnership as maintaining a separate set of books and records with
respect to the activities of a foreign trade or business, whether or
not a separate set of books and records was actually maintained. See
proposed Sec. 1.904-4(f)(3)(iii)(C)(2). Thus, for example, a foreign
branch exists when a partnership records on a single set of books
income from a trade or business conducted outside the United States and
also income earned from unrelated investment activity. The proposed
regulations deem the partnership to maintain a separate set of books
and records with respect to the trade or business conducted outside the
United States, and the taxpayer must determine, as the context
requires, the items that would be reflected on such books and records.
Id.
A comment recommended that the final regulations provide additional
guidance regarding the attribution of income items to any deemed set of
books and records. In particular, the comment recommended that the
principles of sections 864(c)(2), (c)(4), and (c)(5) should apply in
constructing any deemed books and records in a manner analogous to the
approach taken under the dual consolidated loss regulations with
respect to genuine branches (although the comment recommended that the
rule apply whether the QBU was a genuine branch or was held in a
disregarded entity). See Sec. 1.1503(d)-5(c)(2)(i). The Treasury
Department and the IRS agree that, when a foreign branch does not have
a separate set of books and records, the regulations should include a
standard to construct hypothetical books and records. Accordingly, the
final regulations adopt the recommendation. See Sec. 1.904-
4(f)(3)(vii)(C)(2).
4. Other Comments and Revisions
i. Attribution of Gain or Loss on Disposition of a Foreign Branch
To the extent that gross income (as adjusted to conform to Federal
income tax principles) is reflected on the books and records of a
foreign branch, the 2018 FTC proposed regulations generally treat the
income as attributable to a foreign branch. Thus,
[[Page 69035]]
for example, gain from the sale of an asset held by a foreign branch
that is reflected on the books and records of the foreign branch is
generally attributable to the foreign branch under proposed Sec.
1.904-4(f)(2)(i). Similarly, gain from the sale of all of the assets of
a foreign branch would, to the extent reflected on the books and
records of the foreign branch, generally be attributable to the foreign
branch. By contrast, when a foreign branch owner sells its interests in
a disregarded entity through which it operates a foreign branch, and
the gain or loss is not reflected on the books and records of a foreign
branch, the income would not generally be attributable to the foreign
branch under proposed Sec. 1.904-4(f)(2)(i). Furthermore, the
regulations provide a special rule providing that gross income from the
disposition of an interest in a partnership or other pass-through
entity, or an interest in a disregarded entity, generally is not
included in the foreign branch category. See proposed Sec. 1.904-
4(f)(2)(iv)(A).
Comments recommended that gain or loss from the disposition of a
foreign branch be treated as attributable to a foreign branch whether
or not the gain or loss is reflected on the books and records of a
foreign branch, including the disposition of a foreign branch held
through a disregarded entity. The Treasury Department and the IRS have
determined that the rules for attributing gain from the sale of an
interest in a foreign branch in the proposed regulations are
appropriate. In general, the proposed regulations' treatment of the
disposition of a foreign branch promotes conformity with local country
taxation. Gain on the sale of assets properly reflected on the books of
a foreign branch will generally be included in the taxable income of
the foreign branch in its local country, and will generally reflect
income associated with the trade or business activities of the foreign
branch. In contrast, a foreign branch owner's sale of an entity that
includes a foreign branch will not be reflected on the books of the
foreign branch being sold, and will generally not give rise to local
country tax on the transferred entity. Furthermore, proposed Sec.
1.904-4(f)(2)(i), which relies on the books and records of a foreign
branch, sets forth a rule that is administrable for taxpayers and the
IRS.
In the case of a sale by a foreign branch of another entity that
includes a foreign branch, the sale generally reflects gain that is not
associated with the selling branch's trade or business activities,
except when there is a sufficiently close business connection between
the selling branch and the entity being sold. As described in Part
III.B.4.ii of this Summary of Comments and Explanation of Revisions,
the proposed and final regulations include an exception that allows
gain or loss on the sale of another entity to be included in foreign
branch category income when that connection exists.
The exception to this rule in proposed Sec. 1.904-4(f)(2)(iv)(A)
(excluding the disposition of certain interests reflected on the books
and records of a foreign branch), appropriately prevents gain from the
sale of interests unrelated to the trade or business conducted by a
foreign branch from being treated as the ``business profits'' of the
foreign branch. Accordingly, the final regulations adopt the rules set
forth in the proposed regulations, subject to the modifications
described in Part III.B.4.ii of this Summary of Comments and
Explanation of Revisions.
ii. Ordinary Course of Business Exception
The proposed regulations provide that the disposition of an
interest in a partnership or other pass-through entity is treated as
occurring in the ordinary course of the foreign branch's active trade
or business to the extent that the foreign branch ``engages in the same
or a related trade or business as the partnership or other pass-through
entity (other than through a less than 10 percent interest)'' (the
``same or related trade or business rule''). Proposed Sec. 1.904-
4(f)(2)(iv)(B). A comment suggested that the reference to a ``10
percent interest'' in the same or related trade or business rule is
unclear. To address the comment, the final regulations clarify that the
same or related trade or business rule applies only when the foreign
branch owns 10 percent or more of the interests in the partnership or
other pass-through entity, and the foreign branch directly engages in
the same, or a related, trade or business as that partnership or other
pass-through entity.
iii. Comments Outside the Scope of the Final Regulation; Future
Guidance
Several comments to proposed Sec. 1.904-4(f) were received that
are outside the scope of this rulemaking, including: Comments related
to the allocation of expenses to foreign branch category income;
comments relating to the trade or business and books and records
standards of Sec. 1.989(a)-1(c) and (d); comments relating to the
interaction of Sec. 1.1502-13 with Sec. 1.904-4(f); comments relating
to the operation of section 367(d); and comments relating to the
application of the step transaction doctrine. These comments are not
addressed in this Summary of Comments and Explanation of Revisions, but
may be considered in future guidance projects addressing the issues
discussed in the comments.
In particular, the Treasury Department and the IRS intend to issue
future guidance coordinating the allocation and apportionment of
expenses with the determination of foreign branch category income. In
particular, the Treasury Department and the IRS are considering
proposing rules applicable to regulated financial institutions
regarding the allocation of interest expense to foreign branch category
income. Under one approach, interest expense on demand deposits of a
foreign banking branch would be directly allocated to foreign branch
category income that is denominated in the same currency. Interest
expense with respect to U.S. dollar-denominated demand deposits could
similarly be directly allocated to interest income earned on U.S.
dollar-denominated assets. Assets and liabilities would then be
adjusted and residual interest expense would be allocated fungibly
under the generally-applicable rules. This approach would take account
of the fact that regulated financial institutions typically invest
foreign currency-denominated deposits in interest-bearing assets
denominated in the same currency, in part because interest rates vary
across different currencies and this practice is more likely to yield a
predictable return.
Under another approach, interest expense would be allocated to the
foreign branch category using an approach similar to the rules
applicable to foreign corporations that are engaged in the conduct of a
trade or business within the United States. Generally, those rules
provide for the allocation of interest expense by reference to the
liabilities reflected on the books and records of a branch, and make
adjustments to the amount of interest expense allocable to a branch by
reference to the leverage ratio of the taxpayer as a whole. See
generally Sec. 1.882-5. Under this approach to allocating interest
expense to foreign branch category income, it is anticipated that the
amount of interest expense allocated to the foreign branch category
would take into account both regarded and disregarded transactions
reflected on the books and records of the foreign branch. Furthermore,
in connection with this approach, disregarded interest payments would
be subject to the general disregarded payment rule, resulting in
adjustments to the attribution of gross income by reason of disregarded
interest payments.
[[Page 69036]]
The Treasury Department and the IRS also recognize that the
existing expense allocation rules, including with respect to R&E
expenditures, depreciation, or losses, when applied to allocate and
apportion expenses to gross income that has been reattributed under the
disregarded payment rule in Sec. 1.904-4(f)(2)(vi), may lead to
results that are inconsistent with the policy goal of identifying
income attributable to the foreign branch that is commensurate with its
business activities. The Treasury Department and the IRS are studying
whether additional rules for allocating and apportioning expenses to
foreign branch category income or limiting the amount of the
adjustments to the attribution of gross income as a result of certain
disregarded payments are appropriate.
The Treasury Department and the IRS welcome comments on issues
relating to allocation and apportionment of expenses to the foreign
branch category. Comments on this topic should be submitted as part of
the notice and comment process for the 2019 FTC proposed regulations.
See Part I.A.5 of the Explanation of Provisions to the 2019 FTC
proposed regulations.
C. Section 951A and Passive Category Income
Proposed Sec. 1.904-4(g) generally provides that section 951A
category income means amounts included in the gross income of a United
States person (``U.S. person'') under section 951A(a), but does not
include passive category income. See also section 904(d)(1)(A).
Additionally, proposed Sec. 1.904-4(c)(1) provides that passive income
that is considered to be high-taxed income under section
904(d)(2)(B)(iii)(II) (``the section 904 high-tax kickout'') is treated
as general category income, foreign branch category income, section
951A category income, or income in a specified separate category,
depending on the application of the general rules in Sec. 1.904-4. One
comment suggested that the regulations should provide that income
included under section 951A is never assigned to the passive category.
The comment also suggested that passive category income that qualifies
for the section 904 high-tax kickout should never be assigned to the
section 951A category. The comment assumed that all passive category
income earned by a CFC was necessarily foreign personal holding company
income and therefore could never be included under section 951A.
The Treasury Department and the IRS note that although it is
generally unlikely that passive category income would be included under
section 951A, nothing in section 904 eliminates this possibility. To
the contrary, the parenthetical in section 904(d)(1)(A) contemplates
that all or part of a GILTI inclusion could be passive category income
by expressly excluding passive category income from the section 951A
category. Further, to the extent that income included under section
951A is excluded from passive category income under the section 904
high-tax kickout, it is appropriate under the rules of section 904(d)
and Sec. 1.904-4 that the income be reclassified as section 951A
category income rather than income in another separate category. The
section 904 high-tax kickout does not specify the category to which
high-taxed income is assigned; it merely specifies that the high-taxed
income is not passive category income. Therefore, the comment is not
adopted.
Additionally, under section 904(c) as amended by the TCJA, unused
foreign taxes with respect to section 951A category income may not be
carried back or carried forward. Proposed Sec. 1.904-2(a) incorporated
this statutory change into the regulations. One comment recommended
that unused foreign taxes with respect to section 951A category income
should be eligible to be carried back or carried forward. However,
because the statutory language of section 904(c) is clear, the comment
is not adopted.
D. Items Resourced Under Treaties
The 2018 FTC proposed regulations include rules regarding section
904(d)(6), which applies when a taxpayer elects the benefits of a
treaty obligation to resource an item of income. Proposed Sec. 1.904-
4(k)(2) adopts a grouping methodology for purposes of section 904(d)(6)
whereby the relevant portions of sections 904, 907, and 960 apply
separately to the aggregate amount of items of income that are in a
single separate category and resourced under a particular treaty rather
than separately to each item resourced under the treaty. The proposed
regulations also provide that Sec. 1.904-6 applies to allocate foreign
income taxes to a separate category determined under section 904(d)(6).
The preamble to the 2018 FTC proposed regulations requested comments on
whether special rules should apply to limit the taxes allocated to a
separate category determined under section 904(d)(6) to taxes imposed
by the foreign jurisdiction that was a party to the relevant treaty, or
whether taxes imposed by a third-party jurisdiction should continue to
be allocated to the separate category determined under section
904(d)(6).
One comment addressed the issue of foreign taxes imposed by third-
party jurisdictions, noting that any rule that allocated such taxes
away from the income on which it was imposed under Sec. 1.904-6 would
be a departure from the framework of the foreign tax credit regime,
which generally aims to attribute foreign taxes to the income to which
they relate. The Treasury Department and the IRS agree with the
comment, and therefore the final regulations reaffirm that taxes
imposed by a third-party jurisdiction should continue to be allocated
to the separate category determined under section 904(d)(6) or 865(h).
See Sec. 1.904-4(k)(1)(iii) and (k)(2).
Another comment recommended that the final regulations apply the
approach under section 904(d)(6) to income resourced under section
865(h). The comment indicated that there was no compelling reason why
similar grouping rules should not also be extended to income subject to
section 865(h). The Treasury Department and the IRS agree that
consistent application of the similar rules in sections 865(h) and
904(d)(6) that assign items of income resourced under a treaty to a
separate category is appropriate. Accordingly, the final regulations
provide that, with respect to gains described in section 865(h)(2)(A),
the provisions of section 904(a), (b), (c), (d), (f), and (g), and
sections 907 and 960 are applied separately with respect to each treaty
under which the taxpayer has claimed benefits and, within each treaty,
to each separate category of income. See Sec. 1.904-4(k)(2).
Therefore, if a taxpayer recognizes gain described in section
865(h)(2)(A) from multiple sales and other U.S. source income that is
resourced and subject to section 904(d)(6), the gains and other income
are all passive category income, and the gains and other income are
resourced under the same treaty, then the aggregate amount of the
resourced gains are included in a single section 865(h) separate
category for passive category income resourced under a tax treaty, and
the other passive income is included in a single section 904(d)(6)
separate category for passive category income resourced under a tax
treaty. In addition, the high-taxed income rules of section 904(d)
(including the grouping rules in Sec. 1.904-4(c)) apply separately to
the items of income included in each separate category for passive
category income resourced under a particular tax treaty.
E. Distributive Shares of Partnership Income
Under former Sec. 1.904-5(h) (as in effect before the final
regulations) and
[[Page 69037]]
proposed Sec. 1.904-4(n), a partner's distributive share of
partnership income is characterized as passive income to the extent
that the distributive share is a share of income earned or accrued by
the partnership in the passive category. However, this rule does not
apply to any limited partner or corporate general partner that owns
less than 10 percent of the value in a partnership. Instead, that
partner's entire distributive share of partnership income is assigned
to the passive category. The preamble to the proposed regulations
requested comments on whether this rule should be modified. One comment
stated that, if a general partner is a CFC, its distributive share
should be characterized on a look-through basis by referencing the
income earned or accrued by the partnership, regardless of whether the
CFC owns 10 percent of the value in a partnership, and that
consideration should be given to making this rule elective. The comment
also suggested considering a look-through approach for all corporate
general partners that own less than 10 percent of the partnership.
The Treasury Department and the IRS agree that in the case of
corporate general partners in a partnership, the corporation's
distributive share of income of the partnership should be characterized
based on the income of the partnership regardless of the corporate
partner's ownership threshold. The rule in former Sec. 1.904-5(h)
assigning income of a less than 10-percent partner to the passive
category reflected the concern that partners would have difficulty
obtaining information from the partnership in order to determine the
partnership's income. However, the comment states that corporate
general partners are generally able to obtain information to determine
their distributive shares of the partnership's income. In addition,
with respect to CFCs, section 951A requires the CFC to determine
whether each item of partnership income is tested income, subpart F
income, or excluded from tested income under section
951A(c)(2)(A)(i)(I) through (V) regardless of the CFC's ownership
percentage in the partnership. Furthermore, with respect to
individuals, the prior final regulations at Sec. 1.904-5(h)(1) already
provided that general partners with less than 10 percent ownership in
the partnership apply a look-through approach. Therefore, there is
minimal administrative benefit to assigning all of a less-than-10-
percent corporate general partner's income to the passive category
rather than following the general rule that assigns the distributive
share based on the income of the partnership. Therefore, Sec. 1.904-
4(n)(1)(ii) provides that all general partners apply the general rule
even if the partner owns less than 10 percent of the partnership. The
same change is made to the expense allocation rules under Sec. 1.861-
9(e)(4), which provides rules for assigning partnership interest
expense in the case of a less-than-10-percent limited partner or
corporate general partner.
F. Look-Through Rules
1. Section 951A Category
The proposed regulations generally provide that the look-through
rules under section 904(d)(3) provide look-through treatment solely
with respect to payments allocable to the passive category. See
proposed Sec. 1.904-5. Other payments described in section 904(d)(3)
are assigned to a separate category other than the passive category
based on the general rules in Sec. 1.904-4. Proposed Sec. 1.904-
5(b)(1). Accordingly, dividends, interest, rents, or royalties paid
from a CFC to a U.S. shareholder are not assigned to the section 951A
category, because only amounts included in the gross income of a U.S.
shareholder under section 951A (and the related gross-up amount for
foreign taxes deemed paid) are assigned to the section 951A category.
Comments requested that Sec. 1.904-4 be revised to provide that
the look-through rules under section 904(d)(3) apply to characterize
interest, rents, and royalties paid by a CFC to a U.S. shareholder as
income in the section 951A category. However, section 904(d)(3)
provides that look-through payments not allocable to passive category
income are not treated as passive category income, but does not assign
the income to a particular category. Section 904(d)(1) generally
defines the separate categories, and section 904(d)(1)(A) is clear that
only amounts includible in gross income under section 951A are assigned
to the section 951A category. Accordingly, under the clear terms of the
statute, look-through payments cannot give rise to section 951A
category income and must be assigned to other separate categories, such
as the foreign branch category (if described in section 904(d)(1)(B)),
a separate category for income described in section 901(j) or income
resourced under a tax treaty, or the general category. Therefore, the
comment is not adopted.
2. Treatment of Interest Deductions That Are Disallowed
Proposed Sec. 1.861-9(c)(5) provides that if a taxpayer's
deduction for business interest expense is disallowed under section
163(j) in a given year but permitted in a future taxable year, that the
deduction for the business interest expense is apportioned under the
rules of Sec. 1.861-9 as though it were incurred in the year in which
the expense is deductible. This is consistent with the existing general
rule in Sec. 1.861-9T(c) that in order for interest expense to be
allocated and apportioned, the expense must be currently deductible.
See also Sec. 1.861-9T(c)(3) (applying the same rule to interest
deductions deferred under section 163(d)).
One comment requested guidance on how to apply the look-through
rules, which require allocating and apportioning interest expense under
Sec. 1.861-9 in order to match the interest with gross income of the
payor, when the interest expense is not allowed as a deduction at the
CFC level. The comment noted that the disallowance at the CFC level
does not defer a recipient income inclusion that must be assigned to a
separate category.
In response to the comment, the final regulations provide in Sec.
1.904-5(c)(2)(i) that the allocation and apportionment rule described
in Sec. 1.904-5(c)(2)(ii) is applied in the year the interest income
is taken into account even if the interest expense is not actually
deductible by the CFC in that year.
G. Allocation and Apportionment of Foreign Taxes
Proposed Sec. 1.904-6(a) provides rules for the allocation and
apportionment of taxes to the separate categories of income. Consistent
with section 904(d)(2)(H)(i), proposed Sec. 1.904-6(a)(1)(iv) provides
that foreign taxes imposed with respect to base differences are
assigned to the separate category in section 904(d)(1)(B), which is the
foreign branch category. Comments stated that Congress had
inadvertently failed to revise the cross-reference in section
904(d)(2)(H)(i) and that the regulations should assign taxes associated
with base differences to the general category, or should provide a rule
assigning the taxes to the general category or the foreign branch
category depending on the types of income that the taxpayer earns.
Because the statute is clear that taxes associated with base
differences are assigned solely to the foreign branch category, the
final regulations confirm that such taxes are assigned to the category
specified in section 904(d)(2)(H)(i).
Several comments to the 2018 FTC proposed regulations requested
additional guidance clarifying the allocation and apportionment of
foreign income taxes under Sec. 1.904-6. These
[[Page 69038]]
rules apply not only for purposes of assigning taxes to separate
categories, but also apply under Sec. 1.960-1(d) for purposes of
associating foreign income taxes with income groups and PTEP groups in
determining the amount of deemed paid credits under section 960. In
particular, the comments requested additional rules clarifying the
meaning of base and timing differences as well as new examples, and
rules on assigning taxes incurred with respect to disregarded payments,
and clarification on how those rules interact with the foreign branch
category rules.
The Treasury Department and the IRS have determined that proposed
Sec. 1.904-6(a)(1)(iv) generally reflects the appropriate principles
regarding what constitutes a base or timing difference, but agree that
additional guidance regarding how those principles apply in specific
fact patterns is warranted. In order to provide final rules for
taxpayers to apply, while also providing an additional opportunity for
taxpayers to comment on the new additional guidance, the final
regulations finalize the rules in the 2018 FTC proposed regulations in
Sec. 1.904-6(a)(1)(iv). New rules relating to the allocation and
apportionment of foreign income taxes are contained in the 2019 FTC
proposed regulations.
H. Separate Limitation Loss and Overall Foreign Loss Rules Under
Section 904(f)
Other than a provision coordinating the application of the
adjustments in proposed Sec. 1.904(b)-3 with the ordering rules for
allocation and recapture of losses, including SLLs and OFLs, see
proposed Sec. 1.904(b)-3(d), the 2018 FTC proposed regulations did not
make any changes to the rules governing SLLs and OFLs. However, a
number of comments requested changes to the application of those rules
with respect to the section 951A category.
One comment recommended that income in the section 951A category be
excluded for purposes of the OFL recapture rule in Sec. 1.904(f)-
2(c)(1), which generally provides that the OFL recapture amount in a
separate category is the lesser of the maximum recapture amount in that
category (the lesser of the OFL account balance or income in that
category) or 50 percent of total foreign source income. The comment
suggested that for most taxpayers, GILTI inclusions will significantly
exceed foreign source income in other separate categories and as a
result the foreign source income in those other separate categories
will always be fully subject to the recapture rule, up to the amount of
the OFL account balance in that category. Comments also recommended
that the final regulations provide that the separate limitation loss
rules under section 904(f)(5) do not apply with respect to the section
951A category, that the ODL rules in section 904(g) do not apply to
reduce income in the section 951A category, and that foreign tax
credits assigned to the section 951A category that are not allowed by
reason of a separate limitation loss or ODL ``hover'' until the loss is
recaptured, at which time the ``hovering'' foreign tax credits would be
allowed.
The current OFL recapture rule reflects the intended application of
section 904(f)(1) as expressed in legislative history from 1986. In
addition, section 904(f)(5) and (g) are clear that foreign source
losses must be allocated to foreign source income in other separate
categories before reducing U.S. source income and that ODLs reduce
foreign source income in each separate category and must be recaptured
out of income in those categories. The TCJA did not modify the
operation of section 904(f) or (g) with respect to the section 951A
category, nor is there any indication in the TCJA or legislative
history that Congress intended the rules under section 904(f) and (g)
to apply differently to section 951A category income as compared to
other separate categories. In addition, no authority is provided in
section 904 to allow taxes assigned to the section 951A category that
accrue in one year to be deferred and claimed as a credit in a future
year. Such a rule would be inconsistent with sections 901 and 905(a),
which allow a foreign tax credit only when the foreign tax is paid or
accrued (or deemed paid), and section 904(c) which, as amended by the
TCJA, explicitly provides that foreign income taxes assigned to the
section 951A category that are not credited in the current year cannot
be carried to different taxable years. Accordingly, the comments are
not adopted.
I. Overall Foreign Loss Recapture on Property Dispositions
The 2012 OFL proposed regulations revise the ordering rules under
Sec. 1.904(g)-3 that generally provide for the coordination of section
904(f) and (g) to include specific references for taking into account
OFL recapture on property dispositions under section 904(f)(3). In the
case of dispositions in which gain is recognized irrespective of
section 904(f)(3), the proposed regulations provide that the OFL
recapture is included in Step Five along with other general OFL
recapture. In the case of dispositions in which gain would not
otherwise be recognized on a disposition, the 2012 OFL proposed
regulations add a new Step Eight to those ordering rules to address the
recognition of the additional income under section 904(f)(3) and the
corresponding recapture of the applicable OFL account. New Step Eight
also provides that if the additional recognition of gain increases the
allowable amount of the net operating loss deduction, then the
recapture of the OFL account occurs first before the additional net
operating loss carryover is taken into account to offset all or a
portion of that gain.
Step Eight did not address the case where additional recognition of
gain reduces the amount of a current year net operating loss. The final
regulations revise the new Step Eight to provide that the allocation
rules for additional net operating loss carryovers apply similarly to
reductions in current year net operating losses, because both cases
involve loss offsetting the additional recognized gain.
One comment was received with respect to the 2012 OFL proposed
regulations, which recommended addressing dispositions that result in
additional income recognition under branch loss recapture and dual
consolidated loss recapture rules. The 2019 FTC proposed regulations
provide a new Step Nine addressing branch loss recapture and dual
consolidated loss recapture amounts. The new Step Nine is being
proposed in order to provide taxpayers an additional opportunity to
comment on the rule.
IV. Translation of Foreign Income Taxes and Foreign Tax
Redeterminations
A. Currency Translation Rules
1. Relevant Taxable Year and Definition of the Term ``Two Years''
The 2007 temporary regulations provide currency translation rules
to reflect the statutory changes made to sections 905(c) and 986(a) by
the Taxpayer Relief Act of 1997 (Pub. L. 105-34, 111 Stat. 788 (1997))
and to section 986(a) by the American Jobs Creation Act of 2004 (Pub.
L. 108-357, 118 Stat. 1418 (2004)). Consistent with section
986(a)(1)(A), Sec. 1.905-3T(b)(1)(i) of the 2007 temporary regulations
generally provides that accrued foreign income taxes are translated
into dollars at the average exchange rate for the taxable year to which
such taxes relate. The 2007 temporary regulations also provide,
consistent with section 986(a), several exceptions to this rule,
including that, under section 986(a)(1)(B), the exchange rate on the
date the taxes are paid is used to translate accrued foreign income
taxes
[[Page 69039]]
that are paid before, or more than two years after the close of, the
taxable year to which the taxes relate. Section 905(c)(1)(B) also
provides that, if accrued taxes are not paid before the date two years
after the close of the taxable year to which such taxes relate, the
taxpayer must notify the IRS and redetermine its U.S. tax liability for
the year or years in which it claimed a credit for such taxes.
Consistent with sections 905(c)(1)(B) and 986(a)(1)(A), Sec.
1.905-3T(b)(1)(ii) and (c) of the 2007 temporary regulations use the
term ``two years,'' raising the issue of whether the term refers to two
taxable years or two calendar years (that is, 24 months). The Treasury
Department and the IRS have determined that a short taxable year, such
as could result from a restructuring or other event, should not reduce
the period within which a taxpayer can pay an accrued tax without
triggering a foreign tax redetermination and thereby requiring the tax
to be translated into dollars at the exchange rate on the date of
payment. Accordingly, the final regulations at Sec. Sec. 1.986(a)-
1(a)(2)(i) and (c) and 1.905-3(a) use the term ``24 months'' instead of
the term ``two years.'' See also Sec. 1.905-3(b)(1)(ii)(E) (Example
5).
The relevant taxable year of a partner or beneficiary that is
legally liable for foreign income tax on a distributive share of income
is the partner's or beneficiary's taxable year. On the other hand, in
the case of a partnership that has legal liability under foreign law
for foreign income tax and that uses a different U.S. taxable year than
its partners who take their distributive shares of the partnership's
tax into account under section 901(b)(5) and Sec. 1.702-1(a)(6), the
rules under Sec. 1.905-3T(b)(1)(i) of the 2007 temporary regulations
does not specify whether the taxable year of the partnership or of the
partner is the relevant ``taxable year to which such taxes relate'' for
purposes of determining the applicable exchange rate, including whether
the tax is denominated in inflationary currency, as well as whether the
tax is paid within two years. A similar issue may arise with respect to
a beneficiary of a trust who takes into account a distributive share of
foreign income taxes paid by the trust.
The Treasury Department and the IRS have determined that the
relevant taxable year is that of the person, including a partnership or
trust, that has legal liability for the tax within the meaning of Sec.
1.901-2(f) (the ``section 901 taxpayer''). Measuring the period with
reference to the taxable year of a partnership or trust that is the
section 901 taxpayer is simpler and more administrable than a rule that
would vary the applicable translation convention and determine whether
a foreign tax has been redetermined by reference to the taxable year of
each partner or beneficiary. It will also generally conform the average
exchange rate translation convention used to translate the taxes with
the translation rate used to translate the income out of which the tax
is paid by using the same taxable year to determine the average rate
for both purposes. See section 989(b)(4). Accordingly, the final
regulations at Sec. 1.986(a)-1(a)(1) and (2) clarify that the relevant
taxable year to which the tax relates is that of the person that is
considered to pay the tax under Sec. 1.901-2(f).
2. Definition of Inflationary Currency
Under section 986(a)(1)(C) and section 986(a)(2), a foreign tax
liability denominated in an inflationary currency (as determined under
regulations) is translated into dollars at the exchange rate on the
date of payment of the foreign tax. Section 1.905-3T(b)(1)(ii)(C) of
the 2007 temporary regulations defines an inflationary currency as the
currency of a country in which there is cumulative inflation of at
least 30 percent during the 36-month base period immediately preceding
the last day of the taxable year. The 2007 temporary regulations do not
address which year or years are relevant to determining whether a
currency in which a foreign tax liability is denominated is
inflationary.
The purpose of the payment date translation rule for tax
denominated in inflationary currency is to more accurately reflect the
dollar cost of satisfying a foreign tax liability when the currency
experiences significant inflation between the time the tax accrues and
the date the tax is paid, including when the average exchange rate
would otherwise apply because the tax is paid within 24 months of the
close of the taxable year to which the tax relates. To avoid
overstating the dollar cost of the foreign tax liability, the Treasury
Department and the IRS have determined that it is appropriate to
translate a foreign tax liability into dollars at the spot rate (as
defined in Sec. 1.988-1(d)) on the date of payment of the foreign
taxes if the taxes are denominated in a currency that is inflationary
in the accrual year or in any subsequent taxable year up to and
including the taxable year of the section 901 taxpayer in which the tax
is paid. See Sec. 1.986(a)-1(a)(2)(iii).
The final regulations also reflect editorial changes to the
definition of an inflationary currency that adopt the principles of
Sec. 1.985-1(b)(2)(ii)(D) as modified by cross-reference instead of
restating the method described in that paragraph. No substantive change
to the computation was intended as a result of this rephrasing of the
rule.
3. Year-End Translation Rate
Section 1.905-3T(b)(1)(ii)(C) and (D) of the 2007 temporary
regulations and Sec. 1.986(a)-1(a)(2)(iii) and (a)(2)(iv)(A) of the
final regulations provide that, in the case of accrued taxes, the
liability for which is denominated in an inflationary currency, or in
the case of a taxpayer that elects to translate accrued taxes into
dollars using the spot rate as of the date of payment, any accrued but
unpaid taxes are translated into dollars at the spot rate on the last
day of the U.S. taxable year to which such taxes relate. If the
currency is not inflationary in the accrual year, but is inflationary
when paid, under the general rule of Sec. 1.986(a)-1(a)(1) of the
final regulations, the tax will be provisionally translated into
dollars at the average rate for the year of accrual. In each of these
cases, when the taxes are subsequently paid they are translated into
dollars at the spot rate on the date of payment. If this amount differs
from the provisional year-end rate or average rate initially used to
assign a dollar value to the credit, the later payment of the tax will
constitute a foreign tax redetermination requiring an adjustment to
reflect the difference between the accrued amount and the actual dollar
cost of paying the tax. See Sec. 1.905-3T(c) of the 2007 temporary
regulations and Sec. 1.905-3(a) of the final regulations for the
definition of a foreign tax redetermination. The final regulations at
Sec. 1.986(a)-1(a)(2)(iii) and (iv) include a cross reference to Sec.
1.905-3 to clarify that there generally will be a foreign tax
redetermination when the accrued tax is subsequently paid, which may
result in a U.S. tax redetermination.
The 2007 temporary regulations effectively require that two returns
be filed in the case of accrued taxes subject to Sec. 1.905-
3T(b)(1)(ii)(C) (inflationary currency) or (D) (spot rate election)
that accrue in one taxable year and are paid in the next taxable year
before the return for the accrual year has been filed: First, the
original return on which the accrued but unpaid taxes are translated at
the provisional year-end rate, and, second, an amended return, filed
after such taxes are paid, on which such taxes are translated at the
rate on the date of payment. To minimize compliance burdens for
taxpayers, the final regulations at Sec. 1.986(a)-1(a)(2)(iii) and
(iv) provide that taxpayers may translate
[[Page 69040]]
accrued but unpaid taxes (including foreign taxes deemed paid under
section 960) into dollars using the spot rate on the date of payment,
in lieu of the provisional year-end rate, on the original return for
the year for which the credit is claimed if such taxes are paid before
the due date (with extensions) of such original return and such return
is timely filed.
4. Election To Translate Accrued Taxes Using the Rate on the Date of
Payment
Section 1.905-3T(b)(1)(ii)(D) of the 2007 temporary regulations
provides that, pursuant to section 986(a)(1)(D), a taxpayer that
otherwise would be required to translate foreign taxes using the
average exchange rate may elect to translate all foreign income taxes
denominated in nonfunctional currency using the exchange rate as of the
date of payment (spot rate election). Although using the spot rate on
the date of payment most accurately reflects the dollar cost of paying
the foreign income tax, the 2007 temporary regulations reflect the view
that taxpayers should not be permitted to use hindsight to select the
more favorable of the spot rate or average exchange rate conventions to
translate nonfunctional currency taxes on a QBU-by-QBU basis. Rather,
in addition to a spot rate election for all of a taxpayer's
nonfunctional currency foreign income taxes, the 2007 temporary
regulations also permit an election to use the spot rate to translate
less than all of a taxpayer's nonfunctional currency foreign income
taxes, but only in situations that would reduce compliance burdens or
avoid a mismatch between the exchange rates used to translate
creditable foreign taxes and the same nonfunctional currency amount of
income used to pay the tax. As noted in the preamble to the 2007
temporary regulations, such a mismatch may occur in the case of a QBU
that has a dollar functional currency (dollar QBU) if the average
exchange rate is used to translate nonfunctional currency tax that is
paid out of nonfunctional currency income earned by the dollar QBU,
because in that case income from transactions involving foreign
currency are accounted for using the spot rate on a transaction-by-
transaction basis. Accordingly, Sec. 1.905-3T(b)(1)(ii)(D) of the 2007
temporary regulations provides that a taxpayer may make a spot rate
election for all foreign income taxes denominated in nonfunctional
currency, or for only those foreign income taxes that are denominated
in nonfunctional currency and are attributable to dollar QBUs.
Section 1.905-3T(b)(1)(ii)(D) of the 2007 temporary regulations
refers only to a ``taxpayer'' and not also to a section 902 corporation
(a qualified group member described in section 909(d)(5) before its
repeal in the TCJA), raising a question whether a foreign corporation
with a U.S. shareholder eligible to compute deemed paid taxes should be
considered a separate ``taxpayer'' that is eligible to make the spot
rate election. To address this issue, the final regulations at Sec.
1.986(a)-1(a)(2)(iv)(A) and (B) provide that the taxpayer for purposes
of making the spot rate election under section 986(a)(1)(D) is any
individual or corporation, and revise the references to section 902
corporations to reflect the repeal of sections 902 and 909(d)(5).
Accordingly, a foreign corporation that is a specified 10-percent owned
foreign corporation may elect separately from any of its U.S.
shareholders to translate either all of the foreign corporation's
foreign income taxes denominated in nonfunctional currency, or only
those nonfunctional currency taxes of the foreign corporation's dollar
QBUs, using the spot rate on the date of payment. Section 1.986(a)-
1(a)(2)(iv)(B) of the final regulations also clarifies that a spot rate
election by a U.S. shareholder does not further require that the
shareholder's foreign subsidiaries make a spot rate election.
Section 986(a)(1)(D)(i) provides that a spot rate election is
available only for foreign taxes denominated in a taxpayer's
nonfunctional currency. The final regulations clarify at Sec.
1.986(a)-1(a)(2)(iv)(A) that whether a tax that is attributable to a
QBU of a taxpayer is denominated in nonfunctional currency is
determined by reference to the functional currency of the taxpayer
(which includes a specified 10-percent owned foreign corporation), and
not that of the QBU. Accordingly, taxes denominated in a QBU's
functional currency that is a nonfunctional currency of the taxpayer
are considered nonfunctional currency taxes for purposes of these
rules.
The final regulations at Sec. 1.986(a)-1(a)(2)(iv)(B) also confirm
that, in the case of a taxpayer (including a specified 10-percent owned
foreign corporation) that makes the spot rate election only with
respect to nonfunctional currency taxes that are attributable to dollar
QBUs, the election must be made for all of the taxpayer's dollar QBUs
and cannot be made separately for each dollar QBU. Finally, the final
regulations clarify that foreign tax is attributable to a dollar QBU
for purposes of these rules if it is properly recorded on the books and
records of the QBU in accordance with the regulations under sections
985 through 989. This rule will help ensure matching of the exchange
rate used to determine the dollar amount of the credit with the
exchange rate used to determine the dollar amount of income that is
used to pay the tax.
The 2007 temporary regulations do not permit the spot rate election
to be used to translate taxes that are denominated in a nonfunctional
currency of the taxpayer and attributable to QBUs with non-dollar
functional currencies (non-dollar QBUs), other than as part of an
election to translate all foreign taxes at the spot rate on the date of
payment. As noted, one of the rationales for providing an election for
taxpayers to translate less than all of their nonfunctional currency
taxes using the rate on the date of payment is to allow taxpayers to
avoid a mismatch due to the use of different translation conventions in
determining the translated dollar amount of foreign tax credit and the
translated dollar amount of the foreign income used to pay the tax.
However, there is generally no mismatch between the translation
rate for taxes on income earned through non-dollar QBUs and the income
used to pay the taxes. Under sections 986(a)(1)(A), 987(2), and
989(b)(4), such taxes and income generally are translated into dollars
at the average exchange rate, minimizing administrative and compliance
burdens. Although Sec. 1.987-3T(c)(2)(v), issued in 2016, requires
section 987 income or loss equal to the creditable tax amount to be
translated at the same exchange rate that is used to translate the
creditable taxes for purposes of section 901, the Treasury Department
and the IRS intend to amend the regulations under section 987,
deferring the applicability date of Sec. 1.987-3T(c)(2)(v) (along with
other portions of the regulations under section 987). See Notice 2018-
57. Because in the absence of applicable final regulations the spot
rate election to translate taxes paid by non-dollar QBUs would
generally create a mismatch between the translated dollar amount of the
foreign tax credit and the translated dollar amount of the foreign
income used to pay the tax, and would increase, rather than reduce,
administrative burdens for the IRS and compliance burdens for
taxpayers, the Treasury Department and the IRS have determined that it
is inappropriate to allow selective use of the spot rate election for
nonfunctional currency taxes attributable to non-dollar QBUs.
Accordingly, the final regulations provide that the spot rate election
may not be made for foreign income taxes attributable to non-dollar
QBUs, except
[[Page 69041]]
as part of an election to translate all taxes denominated in
nonfunctional currency at the spot rate on the date of payment.
5. Section 988 Gain or Loss When There Is a Change in Functional
Currency
The 2007 temporary regulations do not address how to determine
section 988 gain or loss when there has been a change in functional
currency between the time a tax is paid or accrued and when it is
refunded. If a QBU receives a refund of nonfunctional currency tax that
is denominated in a currency that was the functional currency of the
QBU when the tax was claimed as a credit or added to PTEP group taxes,
Sec. 1.986(a)-1(e)(2) of the final regulations provides that the QBU
uses the exchange rate used under Sec. 1.985-5(c) when the QBU's
functional currency changed to determine its basis in the refunded
nonfunctional currency. If a QBU receives a refund of functional
currency tax that was denominated in a nonfunctional currency when the
tax was claimed as a credit or added to PTEP group taxes, Sec.
1.986(a)-1(e)(3) of the final regulations provides that the QBU
recognizes the section 988 gain or loss that would have been recognized
under Sec. 1.985-5(b) if the refund had been received immediately
before the QBU's functional currency changed. The final regulations
also add a cross-reference to these rules at Sec. 1.988-
2(a)(2)(iii)(C).
B. Accounting for Foreign Tax Redeterminations
1. Definition of a Foreign Tax Redetermination
Section 1.905-3T(c) of the 2007 temporary regulations defines a
``foreign tax redetermination'' as a change in the foreign tax
liability that may affect a taxpayer's foreign tax credit, including
accrued taxes that when paid differ from the amounts added to post-1986
foreign income taxes or claimed as credits by the taxpayer (such as
corrections to overaccruals and additional payments); accrued taxes
that are not paid before the date two years after the close of the
taxable year to which such taxes relate; refunds of tax paid; and for
accrued taxes translated into dollars when paid, a difference between
the dollar value of the accrued tax and the dollar value of the tax
paid attributable to fluctuations in the foreign currency's value.
Section 1.905-3(a) of the final regulations reflects several
clarifying changes to what constitutes a foreign tax redetermination.
First, a foreign tax redetermination includes certain situations
covered by section 905(c) that do not involve a change in the foreign
tax liability, such as the failure to pay accrued taxes within two
years and the subsequent payment of any such accrued but unpaid taxes.
Second, a foreign tax redetermination includes adjustments such as a
correction to an accrual that determined the tax due with reasonable
accuracy, but is revised after additional consideration to reflect the
correct final tax liability. Third, the regulations clarify that a
foreign tax redetermination occurs if any tax that is claimed as a
credit or added to PTEP group taxes is subsequently refunded,
regardless of whether the tax was properly treated as paid within the
meaning of Sec. 1.901-2(e) (which includes, among other requirements,
that the tax was owed and not refundable) when claimed as a credit or
added to PTEP group taxes. New examples at Sec. 1.905-3(b)(1)(ii) of
the final regulations illustrate these rules, including an example
demonstrating that a foreign tax redetermination includes the accrual
and payment of contested taxes following the resolution of a dispute
with a foreign government.
Section 1.905-3T(c) of the 2007 temporary regulations, implementing
section 905(c)(1)(B), states that a foreign tax redetermination
includes ``accrued taxes that are not paid before the date two years
after the close of the taxable year to which such taxes relate.''
(Emphasis added.) In contrast, the currency translation rule at Sec.
1.905-3T(b)(1)(ii)(A) of the 2007 temporary regulations, implementing
sections 986(a)(1)(B)(i) and 986(a)(2)(A), provides that, ``[a]ny
foreign income taxes denominated in foreign currency that are paid more
than two years after the close of the U.S. taxable year to which they
relate shall be translated into dollars using the exchange rate as of
the date of payment of the foreign taxes.'' (Emphasis added.)
If a calendar year taxpayer accrues foreign taxes at the close of
calendar Year 1, ``the date two years after the close of the taxable
year to which such taxes relate'' literally refers to December 31 of
Year 3, rather than January 1 of Year 4. Thus, if the taxpayer has not
paid the taxes before December 31 of Year 3, that is, on or before
December 30, a foreign tax redetermination would occur on December 31
of Year 3 even if the tax was paid on December 31 of Year 3, and such
payment would constitute a second foreign tax redetermination. Both
foreign tax redeterminations generally would require translating the
foreign taxes at the same average exchange rate, resulting in
offsetting foreign tax redeterminations.
To better coordinate the application of the foreign tax
redetermination and currency translation rules and to ease compliance
burdens, the definition of a foreign tax redetermination has been
revised to include ``accrued taxes that are not paid on or before the
date 24 months after the close of the taxable year to which such taxes
relate.'' (Emphasis added.)
The Treasury Department and the IRS also have determined that the
foreign tax redetermination resulting from accrued taxes that remain
unpaid after two years should be considered to occur on the date that
is 24 months after the close of the taxable year to which the taxes
relate. Accordingly, Sec. 1.905-3(a) of the final regulations provides
that if accrued taxes are not paid on or before the date that is 24
months after the close of the taxable year to which they relate, the
resulting foreign tax redetermination will be accounted for as if the
unpaid portion of the taxes were refunded on such date.
Finally, the final regulations clarify that taxes that first accrue
after the date 24 months after the close of the taxable year to which
such taxes relate may not be claimed as a credit or added to PTEP group
taxes until they are paid. The final regulations also include a cross-
reference to the rules of section 905(b) and the all-events test under
Sec. 1.461-4(g)(6)(iii)(B), which require the taxpayer to establish
the amount of tax that was properly accrued.
2. Adjustments to Foreign Taxes Claimed as a Direct Credit
Section 1.905-3T(d)(1) of the 2007 temporary regulations provides
that, in the case of a foreign tax redetermination with respect to
taxes paid or accrued by a U.S. taxpayer, a redetermination of U.S. tax
liability is required ``for the taxable year for which the foreign tax
was claimed as a credit.'' The final regulations clarify how the rules
apply when a U.S. taxpayer's foreign taxes exceed the applicable
limitation under section 904(d) and the taxpayer carries its unused
foreign taxes back or forward to another year under section 904(c).
Section 1.905-3(b)(1)(i) of the final regulations provides that, if a
foreign tax redetermination occurs with respect to foreign tax claimed
as a direct credit, then a redetermination of U.S. tax liability is
required for the taxable year in which the credit was claimed and any
year to which unused foreign taxes from such year were carried under
section 904(c).
Section 1.905-3T(d)(1) of the 2007 temporary regulations provides
that a
[[Page 69042]]
redetermination of U.S. tax liability is not required if the difference
between the dollar value of the accrued tax and the tax paid is
attributable to fluctuations in the value of the foreign currency and
the amount of the foreign tax redetermination with respect to each
foreign country is less than the lesser of $10,000 or two percent of
the dollar amount of the foreign tax initially accrued with respect to
that foreign country. The application of this rule was unclear in the
case of foreign tax redeterminations occurring with respect to multiple
foreign countries. The final regulations at Sec. 1.905-3(b)(1)(i)
clarify that the exception to a redetermination of U.S. tax liability
applies only if the $10,000 or two percent threshold is satisfied with
respect to each and every foreign country with respect to which a
foreign tax redetermination occurs.
3. Foreign Tax Imposed on Refund
Section 1.905-3T(e) of the 1988 temporary regulations provided that
tax imposed on a refund of foreign tax is considered to reduce the
amount of the refund, and no other credit or deduction is allowed with
respect to such tax imposed on such refund. This provision was carried
over at Sec. 1.905-3T(e) of the 2007 temporary regulations without
change. Section 1.905-3(c) of the final regulations modifies this rule
to clarify that it applies in the case of any section 901 taxpayer,
which includes a specified 10-percent owned foreign corporation.
V. Deemed Paid Taxes Under Section 960
A. Scope of Current Year Taxes
Proposed Sec. 1.960-2 deems a corporate U.S. shareholder of a CFC
to pay certain of the CFC's current year foreign income taxes that are
attributable to the CFC's income that the domestic corporation includes
under sections 951(a)(1)(A) and 951A(a). Current year taxes are the
foreign income taxes that a CFC pays or accrues in its current taxable
year, which the rule defines as the U.S. taxable year of a CFC that
either is an inclusion year or during which the CFC receives or makes a
distribution that is described in sections 959(a) or (b). Proposed
Sec. 1.960-1(b)(3), (4). Proposed Sec. 1.960-1(b)(4) preserves
current law with respect to the timing of the accrual of foreign income
taxes. Under current law, taxes accrue when all the events have
occurred that establish the fact of the liability and the amount of the
liability can be determined with reasonable accuracy. Therefore, in the
case of taxes that are withheld from a payment, the withholding taxes
accrue when the payment from which the tax is withheld is made. In the
case of taxes that are imposed on net income that a taxpayer recognizes
under foreign law with respect to a taxable period, the net income
taxes accrue on the last day of the foreign taxable period. See Sec.
1.446-1(c)(1)(ii) (a liability is incurred and taken into account for
Federal income tax purposes in the taxable year in which all the events
have occurred that establish the fact of the liability, the amount of
the liability can be determined with reasonable accuracy, and economic
performance has occurred with respect to the liability); Sec. 1.461-
4(g)(6)(iii)(B) (economic performance with respect to foreign income
tax liability occurs when the requirements of the all events test other
than economic performance are met). Therefore, under the 2018 FTC
proposed regulations, if there is a difference between the U.S. and
foreign taxable years, the foreign tax may accrue, for U.S. tax
purposes, in a U.S. taxable year that does not include all the income
to which the tax relates. The proposed regulations further provide that
if current year taxes are imposed on an item of income that U.S. law
recognizes in a different taxable year--in other words, if a difference
in the foreign and U.S. taxable bases results from a timing
difference--the taxes relate to the income group in a section 904
category of the CFC to which they would be assigned if the income item
was recognized under U.S. law in the current year. Proposed Sec. Sec.
1.960-1(c)(3)(ii)(B) and 1.904-6(a)(1)(iv).
Comments requested changes to the definition of ``current year
taxes'' that address timing differences that arise when a CFC has
different U.S. and foreign taxable years. Specifically, the comments
suggested a number of approaches to match the foreign income taxes that
the CFC pays or accrues with respect to a foreign taxable year with the
income that it recognizes in a U.S. taxable year. For example, comments
requested that the definition take into account foreign income taxes
that relate to income recognized during the current taxable year but
that are paid or accrued by a CFC with respect to a foreign taxable
year that closes after the current taxable year. Comments suggested
that a portion of the foreign income taxes could be allocated between
U.S. taxable years on the basis of a ratable allocation of the foreign
taxable income on which the taxes are imposed to the portion of a
foreign taxable year of the CFC that corresponds to the two U.S.
taxable years. The foreign income taxes that are allocated to the
current taxable year under the proration would then be treated as
current year taxes for purposes of computing deemed paid taxes under
section 960(a) and section 960(d), even though a portion of the taxes
do not accrue under section 461 and the all events test until after the
close of the current taxable year. Comments also suggested modifying
the current accrual rule for foreign income taxes to treat any foreign
income taxes paid or accrued by a CFC that are allocated to a current
taxable year under the proration as accruing in that year. In addition,
comments suggested a ``closing of the books'' method for determining
the foreign tax that is treated as either a current year tax or as
accruing during the next U.S. taxable year, or other approaches such as
a ``with-and-without'' calculation to determine taxes attributable to
extraordinary transactions.
Differences in the timing of the accrual of foreign income taxes
and the inclusion of income by a U.S. shareholder on which the taxes
are imposed due to a CFC's differing U.S. and foreign taxable years
will generally resolve over time because although the U.S. and foreign
taxable years start and close on different dates, both taxable periods
encompass profits earned over the same length of time. A comment noted
that this mismatch might not resolve if there are differences in the
type or amount of income that a CFC earns from year to year. Unless the
CFC earns all of its income ratably every year for both U.S. and
foreign tax purposes, however, any method for allocating foreign tax to
a different U.S. taxable year may not mitigate or may even exacerbate
an ongoing mismatch of the income recognized in the current U.S.
taxable year with the foreign income tax that accrues after the close
of that year. Moreover, as one comment acknowledged, a rule that relies
on estimates of foreign income taxes that have not accrued because they
are attributable to a foreign taxable year that closes after the U.S.
taxable year would require the ongoing correction of inaccurate
estimates through redeterminations under section 905(c) and the filing
of amended returns.
A comment noted that Sec. 1.901-2(f)(4) requires the allocation of
certain foreign taxes to a U.S. taxable year and treats those taxes as
accruing in that year. This rule, however, only applies to mismatches
that occur with respect to a single foreign taxable year due to the
transfer of a disregarded entity or a partnership interest. Section
1.901-2(f)(4) addresses these narrow fact patterns by treating the
foreign taxes that accrue in one U.S. taxable year but
[[Page 69043]]
that are imposed on foreign taxable income that is likely to be
recognized for Federal income tax purposes in a different, short U.S.
taxable year of a partnership due to a partnership termination, or in a
different U.S. taxable year of an owner of a disregarded entity due to
a transfer of a disregarded entity, as having accrued in that short
U.S. taxable year or ownership period. In certain cases, the rule may
require the filing of an amended return to reflect the allocation of a
portion of foreign taxes that accrue under the all events test in one
U.S. taxable year to a different U.S. taxable year. This rule is
appropriate to resolve a one-time mismatch in the foreign and U.S.
taxable years in connection with an ownership change and is not an
appropriate mechanism to address ongoing mismatches in U.S. and foreign
taxable years that will generally resolve over time. In light of the
fact that providing an election to choose among a variety of allocation
and accrual methods in respect of foreign income tax would create
compliance burdens for taxpayers and administrative burdens for the IRS
and may produce results that are no more and possibly less accurate
than the current accrual rule, the final regulations do not adopt the
comments requesting that taxpayers be allowed to treat foreign taxes as
accruing in a taxable year other than the year in which the taxes
actually accrue under current law.
One comment requested that the fourth sentence in Sec. 1.960-
1(b)(4), which provides that net basis foreign income taxes accrue on
the last day of the foreign taxable year, be removed or qualified,
because the comment asserted that the statement did not reflect current
law regarding the accrual of these taxes. However, the comment did not
identify any fact patterns in which net basis foreign income taxes
could accrue before the last day of the foreign taxable year. By
definition, net basis foreign income taxes can only be determined with
reasonable accuracy after the foreign taxable year has closed and all
income and deductions have been accrued for foreign tax purposes.
Therefore, the fourth sentence in Sec. 1.960-1(b)(4) reflects current
law regarding when these taxes accrue and the comment is not adopted.
B. Other Changes Relating to Current Year Taxes Imposed on Timing
Difference Items
1. Assignment of Current Year Taxes to Income Groups
One comment suggested that mismatches between the U.S. and foreign
taxable years could be addressed by characterizing current year tax,
and therefore allocating and apportioning it to an income group, based
upon the earnings recognized under Federal income tax law for the
current taxable year, regardless of whether that income was included in
the foreign tax base upon which the current year tax was imposed.
However, this change would nullify the Sec. 1.904-6(a) rules as a
mechanism for attributing a current year tax to a statutory grouping of
income, namely, income items included under section 951A or 951(a) and
distributions of previously taxed earnings and profits, and potentially
associate current year taxes with income for section 960 purposes other
than the income to which the tax would relate for purposes of section
904. Congress intended, however, that similar principles would apply to
treat current year taxes as properly attributable to a statutory
grouping of income for purposes of determining deemed paid taxes under
section 960 as those that apply for purposes of assigning foreign
income tax to a section 904 category. See Conference Report, at 628
(``It is anticipated that the Secretary would provide regulations with
rules for allocating taxes similar to rules in place for purposes of
determining the allocation of taxes to specific foreign tax credit
baskets.''). In addition, this rule would be inconsistent with the
statutory requirement that taxes be ``properly attributable'' to the
income that was included, because no factual connection would exist
between the taxes and the income to which the taxes would be assigned.
Therefore, the comment is not adopted.
2. Current Year Taxes Assigned to Groups With No Current Year Income
Comments also requested changes that would address a broader range
of timing differences, such as a difference in the timing of income
recognition with respect to a particular transaction or difference in
the timing of cost recovery, in addition to taxable year mismatches.
Consistent with section 960(a) and (d), the 2018 FTC proposed
regulations deem a corporate U.S. shareholder of a CFC to pay foreign
income taxes of the CFC, which are allocated and apportioned to an
income group under the principles of Sec. 1.904-6, only if there is an
inclusion under either section 951(a)(1)(A) or section 951A that is
attributable to net income in the income group. See proposed Sec.
1.960-2(b) and (c). A current year tax that is allocated and
apportioned to an income group cannot therefore be deemed paid if there
is no net income in a particular group due to a timing difference or a
reduction of the net income under section 952(c) to reflect the
earnings and profits limitation or a chain deficit. The comments
requested various changes that would have the effect of preserving a
current year tax that, applying the principles of Sec. 1.904-6, would
otherwise be allocated to an income group with no net income and not
deemed paid under section 960.
Several comments addressed the ineligibility of a current year tax
to be deemed paid because it is associated under the principles of
Sec. 1.904-6 with an income group that has no current year income or
to which no inclusion is otherwise attributable. Comments requested
that, in that circumstance, the current year tax be treated as properly
attributable to previously taxed earnings and profits and deemed paid
under section 960(b) upon a subsequent distribution of the previously
taxed earnings and profits. A similar comment suggested that a current
year tax that is assigned to an income group to which no inclusion is
attributable nonetheless be treated as deemed paid under section 960
for the current taxable year as long as the income that was included in
the foreign tax base either was previously recognized or will be
recognized in the future under Federal income tax rules.
Section 960 requires an inclusion of subpart F income under section
951(a)(1) or of tested income under section 951A in order for foreign
income taxes that are associated with that income to be deemed paid.
See Conference Report at 628 (``Tax imposed on income that is not
included in subpart F income, is not considered attributable to subpart
F income.''). In the absence of an inclusion, only a distribution of
previously taxed earnings and profits may cause a current year tax to
be associated with previously taxed earnings and profits instead of
current year earnings, and treated as deemed paid by the distribution
recipient.
Congress intended for Sec. 1.904-6 principles to apply to
associate current year tax with those inclusions or distributions so
that the taxes that are deemed paid with respect to an inclusion or
distribution are also associated, for purposes of applying the
limitation under section 904(d), with the separate category to which
the inclusion or previously taxed earnings and profits is assigned.
Congress also repealed section 902, which tracked multi-year amounts of
a CFC's foreign income taxes and associated those amounts with multi-
year amounts of its earnings and profits, in favor of a system that
associates, within a single, current
[[Page 69044]]
taxable year, the foreign income taxes that a CFC pays or accrues with
the income it recognizes in that year. See H.R. Rep. No. 115-409, at
383 (``[O]ffering deemed paid foreign tax credits on a current year
basis solely under section 960 reflects what the Committee believes to
be a simpler and more appropriate application of the foreign tax credit
regime in a 100 percent participation exemption system); Conference
Report at 628 (``The provision eliminates the need for computing and
tracking cumulative tax pools.''). In a current year system that relies
on Sec. 1.904-6 principles to associate taxes paid or accrued by a CFC
with respect to a taxable year with its income for that taxable year,
taxes that accrue in a taxable year but relate to income other than the
income that is included by a U.S. shareholder in that year are not
deemed paid. Section 1.960-1(d)(3)(ii)(B) carries out the legislative
intent by assigning taxes under the timing difference rule to current
items of income of the same type as the items included in the foreign
tax base, even if the tax was factually associated with specific items
of income that were recognized for U.S. tax purposes in a different
taxable year.
Associating the tax with previously taxed earnings and profits
rather than current year items of income would be inconsistent with
Congress's intent to eliminate pooling and calculate deemed paid
foreign tax credits on a current year basis rather than on a multi-year
basis; the change requested by the comments, in other words, would
circumvent Congress's intent that, in the absence of a distribution of
previously taxed earnings and profits, the only event that causes a
foreign income tax to be deemed paid by a domestic corporation is an
inclusion of the income to which the foreign income tax that is paid or
accrued by a CFC relates. Conference report at 628. Therefore, the
comments are not adopted.
Comments also requested the allowance of carryovers or carrybacks
at the CFC level if a current year tax is not deemed paid because it is
imposed on a timing difference item to which no inclusion is
attributable or if the inclusion amount is reduced to reflect the
shareholder's qualified deficit. The requested changes to allow
carryovers of foreign income taxes at the CFC level are inappropriate
in light of the transition, discussed in this Part V.B, from a system
based on multi-year pools of foreign income taxes to a current-year
system. Moreover, Congress also expressly disallowed carryovers of
section 951A category foreign income taxes paid, accrued, or deemed
paid by a domestic corporation. See section 904(c). The allowance of
carryovers by a CFC of current year taxes that are not deemed paid by a
U.S. shareholder with respect to an inclusion would undermine
Congress's intent to deem a U.S. shareholder to pay foreign income
taxes with respect to inclusions only on a current year basis and to
allow carryovers only of certain foreign income taxes. Therefore, the
comments are not adopted.
One comment specifically referenced the rule in proposed Sec.
1.960-2(c)(5) that provides for no deemed paid taxes under section
960(d) and proposed Sec. 1.960-2(c)(1) when the taxpayer has no
inclusion under section 951A(a) in arguing for a proportionate
carryover of taxes not deemed paid in the current year. The comment
noted that if there was no inclusion under section 951A(a) because the
taxpayer had no net CFC tested income (as defined in Sec. 1.951A-
1(c)(2)) or had deemed tangible income return (as defined in Sec.
1.951A-1(c)(3)) in excess of its net CFC tested income, the earnings
associated with that income may not be eligible for the deduction under
section 245A and therefore could be subject to double taxation.
In general, earnings and profits related to income that is not
included under section 951(a) or section 951A(a) (including income that
is not included because of the taxpayer's deemed tangible income return
or a lack of net CFC tested income) are eligible for the dividends
received deduction under section 245A when those earnings are
distributed to a domestic corporation, if the holding period and other
requirements under section 245A are met. Thus, excluding the taxes
associated with those earnings from being deemed paid under proposed
Sec. 1.960-2(c)(5) does not result in double taxation as asserted by
the comment. See also section 245A(d). Accordingly, no changes were
made to proposed Sec. 1.960-2(c)(5).
3. Current Year Taxes Attributable to Inclusion Reduced by Qualified
Deficit
A comment requested an adjustment to the computation of deemed paid
taxes if a domestic corporation's subpart F inclusion that is
attributable to net income in a subpart F income group is reduced by
the amount of the domestic corporation's share of a qualified deficit.
The requested adjustment would cause all taxes in the subpart F income
group to be deemed paid in the year the qualified deficit is used.
Under the requested adjustment, the amount of the current year taxes
allocated and apportioned to the group that would be deemed paid by the
domestic corporation would be disproportionate to the portion of the
subpart F income in the group that is included in income by the
domestic corporation. Under section 952(c)(1)(B), a qualified deficit
reduces the amount of subpart F income of a CFC that a U.S. shareholder
includes in its gross income under section 951(a)(1)(A) but does not
reduce the subpart F income of the CFC. In contrast, section
952(c)(1)(A) reduces the subpart F income of the CFC at the CFC level.
In addition, whereas the current year E&P limitation in section
952(c)(1)(A) can give rise to recapture in a future taxable year of the
reduced subpart F income amount, no such recapture occurs with respect
to qualified deficits. Therefore, the final regulations retain the rule
in Sec. 1.960-2(b)(3)(ii) that reduces the amount of foreign income
taxes deemed paid to the extent the U.S. shareholder reduces its
subpart F inclusion by reason of a qualified deficit. Otherwise,
taxpayers could be allowed a deemed paid credit in excess of the amount
of foreign income taxes the CFC paid with respect to the income that
was included.
4. Assignment of Current Year Taxes to Section 904 Categories and
Income Groups Determined Under Federal Income Tax Law
Comments requested clarification on the application of the timing
difference rule in the case of foreign income taxes incurred by a CFC
after the enactment of section 951A but imposed on income included in
the foreign tax base that may correspond to income recognized under
Federal income tax law in a pre-enactment taxable year (including, for
example, income of a CFC that was included in a U.S. shareholder's
income under section 965). In particular, comments noted that the
description in proposed Sec. 1.960-1(d)(3)(ii)(B)(2) of the timing
difference rule as applied to certain taxes with respect to previously
taxed earnings and profits suggested that the taxes would relate to the
category that existed in the inclusion year, rather than (if different)
the category to which the previously taxed earnings and profits would
have been assigned in the year in which the taxes are paid or accrued.
The comments recommended the rules confirm that taxes incurred by a CFC
after the enactment of section 951A can be assigned to a tested income
group even if such taxes were imposed on income that accrued for U.S.
tax purposes before section 951A was enacted.
Under Sec. 1.904-6(a)(1)(iv), a tax imposed on an amount that is
not included in U.S. taxable income in the
[[Page 69045]]
current year is allocated and apportioned to the appropriate separate
category or categories to which the tax would be allocated and
apportioned if the income were recognized under Federal income tax
principles in the year in which the tax was imposed. Therefore, in the
context of proposed Sec. 1.960-1(d)(3)(ii), which applies the
principles of Sec. 1.904-6, a tax imposed in a post-TCJA year with
respect to pre-TCJA income is assigned to a tested income group if the
pre-TCJA income, if recognized in the year the tax was imposed, would
be tested income. Therefore, no further change to the regulations is
necessary to achieve the result requested by the comments. However, the
sentence in proposed Sec. 1.960-1(d)(3)(ii)(B)(2) is revised to
eliminate any inference that the timing difference rule assigns the tax
on the basis of the separate categories that existed in the inclusion
year.
One comment asked for clarifications regarding how current year
taxes are allocated and apportioned under proposed Sec. 1.960-
1(d)(3)(ii) when the foreign corporation's U.S. and foreign taxable
years do not match. In addition to the change to proposed Sec. 1.960-
1(d)(3)(ii)(B)(2) described in the previous paragraph, as requested by
the comment certain changes were also made to proposed Sec. 1.960-
1(d)(3)(ii) to clarify the allocation and apportionment process that
applies to associate a current year tax with a particular income group
or PTEP group that is treated as an income group. These changes clarify
that in order to allocate and apportion a current year tax to the
section 904 categories and income groups within those categories, all
of the foreign taxable income for the period with respect to which the
tax is imposed under foreign law is characterized under Federal income
tax law and assigned to the categories or groups as though that foreign
taxable income were recognized under Federal income tax law in the year
in which the tax is paid or accrued. See Sec. 1.960(d)(3)(ii)(A) and
(C). Additionally, as discussed in Part III.G of this Summary of
Comments and Explanation of Revisions, further guidance relating to the
allocation and apportionment of foreign income taxes is contained in
the 2019 FTC proposed regulations.
C. Application of Section 960 to Inclusions Under Section 1293
Proposed Sec. 1.960-1(a)(1) sets out the general scope of the
rules providing for the determination of the foreign income taxes
deemed paid by a domestic corporation under section 960. Comments
requested that proposed Sec. 1.960-1(a)(1) be modified to clarify that
the regulations under section 960 do not preclude a credit under
section 1293(f). The final regulations in Sec. 1.960-1(a)(1) clarify
that the regulations apply for purposes of any provision that treats a
taxpayer as a domestic corporation that is deemed to pay foreign income
taxes or treats a foreign corporation as a CFC for purposes of section
960, including for example, section 962(a)(2) or 1293(f).
D. Assigning Gross Income to Section 904 Categories and Income Groups
1. Separate Categories to Which Income May Be Assigned
With respect to a CFC, proposed Sec. 1.960-1(d) provides rules for
assigning gross income, and allocating and apportioning deductions and
current year taxes, to section 904 categories and income groups for
purposes of determining what taxes are properly attributable to, and
therefore deemed paid with respect to, a subpart F inclusion, GILTI
inclusion, or a distribution of previously taxed earnings and profits.
Under proposed Sec. 1.960-1(d)(2)(i), gross income is first assigned
to a section 904 category. The rule also specifies that, other than
gross income relating to a section 959(b) distribution, gross income of
a CFC cannot be assigned to the section 951A category or foreign branch
category.
One comment recommended changes to this language, in general, to
specify that gross income relating to a section 959(b) distribution can
be assigned to the section 951A category, but that gross income of a
CFC can never be assigned to the foreign branch category. The Treasury
Department and the IRS agree that the language could be clarified, and
accordingly, the final regulations modify Sec. 1.960-1(d)(2)(i) to
omit any references to the foreign branch category. However, the
Treasury Department and the IRS are studying whether in certain cases a
CFC may have gross income that is assigned to the foreign branch
category and therefore the final regulations do not preclude that
possibility.
2. Scope of Subpart F Income Groups
After assignment of income to section 904 categories, proposed
Sec. 1.960-1(d)(2)(ii)(A) provides that the income is further assigned
to income groups within the section 904 categories. Under proposed
Sec. 1.960-1(d)(2)(ii)(B), gross subpart F income is assigned to
income groups based on the items of income determined under Sec.
1.954-1(c)(1)(iii).
Comments requested that all subpart F income in a separate category
be treated as a single item for purposes of determining what taxes are
properly attributable to a subpart F inclusion. However, because the
grouping rules in the 2018 FTC proposed regulations are necessary to
properly coordinate the calculation of foreign taxes deemed paid under
section 960(a) with the application of the subpart F high-tax exception
and the section 904 high-tax kickout, the final regulations do not
adopt these comments.
Section 960(a) requires a determination of the foreign income taxes
that are attributable to ``any item of income . . . with respect to [a]
controlled foreign corporation'' that is included in gross income of a
domestic corporation under section 951(a)(1). However, under the
subpart F high-tax exception, a taxpayer may exclude from a CFC's
foreign base company income an ``item of income'' that is high-taxed.
High-taxed income is excluded from foreign base company income, and
therefore is not included in the U.S. shareholder's income under
section 951(a)(1). The regulations under section 954(b)(4) identify
items of gross foreign base company income within each section 904
category and allocate and apportion expenses (including foreign tax
expense) among these items in order to compute the net items of foreign
base company income and determine the foreign effective tax rate with
respect to each item. The grouping rules in the section 954(b)(4)
regulations further coordinate the application of the subpart F high-
tax exception with the section 904 high-tax kickout by adopting the
passive category grouping rules used in the section 904 regulations.
See Sec. 1.954-1(c)(1)(iii) and sections 904(d)(2)(B)(ii)(II) and
904(d)(2)(F), excluding from passive income any income with respect to
which the foreign income taxes paid, accrued, and deemed paid exceed
the highest U.S. tax rate.
By adopting the same grouping rules used to determine eligibility
for the subpart F high-tax exception and the application of the section
904 high-tax kickout, the subpart F income groups of proposed Sec.
1.960-1(d)(2)(ii)(B) ensure that the same amount of foreign tax is
treated as attributable to a particular item of a CFC's foreign base
company income for purposes of all three Code sections. This helps
minimize the circumstances in which passive subpart F income could fail
to qualify for the subpart F high-tax exception, but when included
under section 951(a) by the U.S. shareholder with foreign taxes deemed
paid trigger the similar (but not identical) section 904 high-tax
kickout. Additionally, given that section 960(a)
[[Page 69046]]
specifically refers to the foreign income taxes properly attributable
to the ``item of income,'' which has historically been determined in
this manner in applying the subpart F high-tax exception and the
section 904 high-tax kickout, the Treasury Department and the IRS have
determined that retaining the separate subpart F income groups as
provided in the 2018 FTC proposed regulations is appropriate.
Accordingly, the comments are not adopted.
E. Deemed Paid Credits for Inclusions Under Section 951(a)(1)(B)
Proposed Sec. 1.960-2(b)(1) provides that no foreign income taxes
are deemed paid under section 960(a) with respect to an inclusion under
section 951(a)(1)(B), which is based on the amount determined under
section 956 (a ``section 956 inclusion''). The preamble to the proposed
regulations explains that a section 956 inclusion is not an inclusion
of an ``item of income'' of the CFC but instead is an inclusion equal
to an amount that is determined under the formula in section 956(a) and
therefore section 960(a), which as amended by the TCJA computes deemed
paid taxes by reference to foreign taxes attributable to an ``item of
income,'' does not allow for a deemed paid credit. Comments noted that
section 960(a) references section 951(a)(1), not merely subpart F
inclusions under section 951(a)(1)(A), and argued that a section 956
inclusion is an item of income in respect of the U.S. shareholder and
requested that the regulation be modified to allow for a deemed paid
credit in connection with a section 956 inclusion. Additionally,
comments argued that not allowing credits in respect of section 956
inclusions was inconsistent with the legislative history of the TCJA.
However, one comment stated that the rule in proposed Sec. 1.960-
2(b)(1) represented sensible policy because, under a pre-TCJA regime
that deferred U.S. taxation of a CFC's earnings until those earnings
were repatriated through a dividend distribution, section 956 served
the purpose of treating effective repatriations of CFC earnings in the
form of investments in certain U.S. property in a manner similar to
repatriations in the form of dividends. The TCJA allowed a dividend
received deduction for dividends from subsidiary foreign corporations,
and no foreign taxes are deemed paid under the TCJA with respect to
dividends (including dividends that are not eligible for a deduction
under section 245A).
The Treasury Department and the IRS disagree that the ``item of
income'' reference in section 960(a) refers to the U.S. shareholder's
inclusion under section 951(a)(1), rather than the item of income of
the CFC that is included in the U.S. shareholder's income. If that were
the case, then no foreign taxes of the CFC would be properly
attributable to such item of income, since the foreign taxes are
imposed on the items of income earned by the CFC and not on the U.S.
shareholder's subpart F inclusion. Therefore, the items to which
foreign tax can be properly attributed must refer to the CFC's income
items in order for section 960(a) to allow for a deemed paid credit for
foreign taxes paid or accrued by the CFC. Because a section 956
inclusion is not traceable to an item of income of the CFC, section
960(a) does not permit a deemed paid credit for section 956 inclusions.
See also Whitlock v. Comm'r, 494 F.2d 1297 (10th Cir. 1974) (earnings
that give rise to a section 956 inclusion are ``not an `income' type
item of the corporation'').
In addition, section 960(a) does not define what it means for taxes
to be ``properly attributable'' to items of income. The legislative
history provides that rules similar to Sec. 1.904-6(a) should apply in
attributing foreign income taxes to ``item[s] of subpart F income.''
H.R. Rep. No. 115-409, at 383. Section 1.960-1(d)(3)(ii) accordingly
applies the principles of Sec. 1.904-6(a) to allocate a CFC's current
year taxes to the CFC's income items that comprise its subpart F income
and other income earned in the current taxable year. Those principles
require attributing foreign income taxes, which are paid or accrued by
the CFC, to items of income of the CFC, not to an item of income of the
U.S. shareholder, since an inclusion under section 951(a) with respect
to the U.S. shareholder is not ``included in the [foreign] base upon
which the [CFC's foreign income] tax is imposed.'' Section 1.904-
6(a)(1). Furthermore, an inclusion under section 951(a) with respect to
the U.S. shareholder is not an ``item of subpart F income,'' and
subpart F income excludes earnings relating to section 956. See section
952(a) (defining ``subpart F income'').
The Treasury Department and the IRS have also determined that
attributing any foreign income taxes to a section 956 inclusion would
be inconsistent with the intent of Congress to eliminate the need for
multi-year tracking of income and taxes and move to a foreign tax
credit system based solely on current year taxes and income. H.R. Rep.
No. 115-409, at 383 (``[O]ffering deemed paid foreign tax credits on a
current year basis solely under section 960 reflects what the Committee
believes to be a simpler and more appropriate application of the
foreign tax credit regime in a 100 percent participation exemption
system.''). Congress intended for the repeal of section 902 and the
amendment of section 960 to ``eliminate[ ] the need for computing and
tracking cumulative tax pools.'' Id. Allowing a deemed paid credit for
inclusions under section 956, as requested by comments, would require
the promulgation of complex rules for tracking annual layers of taxes
that were associated with earnings that were not included under section
951(a)(1) or 951A, special ordering rules for determining which layer
of taxes were deemed paid with respect to a section 956 inclusion
relating to earnings from a prior year, and would also potentially
require multifaceted rules to trace movements in layers as a result of
distributions of earnings and profits or reorganizations of entities.
Therefore, consistent with the proposed regulations, the final
regulations provide that no foreign income taxes are deemed paid under
section 960(a) with respect to a section 956 inclusion.
F. PTEP Groups in Annual PTEP Accounts
Under proposed Sec. 1.960-3(c)(1), a CFC must establish a
separate, annual account (``annual PTEP account'') for its earnings and
profits for its current taxable year to which subpart F or GILTI
inclusions of U.S. shareholders are attributable. The previously taxed
earnings and profits in each annual account are then assigned to one of
ten possible groups of previously taxed earnings described in proposed
Sec. 1.960-3(c)(2) (each, a ``PTEP group''). After the proposed
regulations were issued, the Treasury Department and the IRS released
Notice 2019-01, 2019-2 I.R.B. 275, which announced the intention to
issue regulations relating to foreign corporations with previously
taxed earnings and profits. Notice 2019-01 affirmed the requirement to
maintain annual PTEP accounts, but expanded the number of PTEP groups
to 16, which included the original ten PTEP groups in the 2018 FTC
proposed regulations as well as six additional groups. Notice 2019-01
provided that these rules would be coordinated with proposed Sec. Sec.
1.960-1 and 1.960-3. Both the preamble to the 2018 FTC proposed
regulations and Notice 2019-01 requested comments on possible ways to
simplify the PTEP groups. While no comments made specific suggestions
on how to combine or consolidate PTEP groups, one comment noted that
the rules were complex and questioned whether tracking all the PTEP
groups was necessary.
[[Page 69047]]
After evaluating the various limitations on the creditability of
certain foreign income taxes and the application of the foreign
currency rules under section 986(c) with respect to PTEP groups, the
Treasury Department and the IRS have determined that it is possible to
consolidate certain of the PTEP groups that were listed in Notice 2019-
01. Accordingly, the final regulations update the list of the PTEP
groups in Sec. 1.960-3 to include ten PTEP groups. This list
consolidates the PTEP groups that were included in the 2018 FTC
proposed regulations with the PTEP groups that were included in Notice
2019-01. The updated list permits taxpayers to track fewer PTEP groups
than those provided for in Notice 2019-01, while still permitting the
application of the relevant foreign tax credit and foreign currency
provisions. However, the Treasury Department and the IRS intend to
issue more comprehensive regulations addressing the maintenance of
annual PTEP accounts and the PTEP groups in a separate notice of
proposed rulemaking under section 959. It is anticipated that, as part
of that guidance, further changes may be made to Sec. 1.960-3 in order
to coordinate both sets of regulations.
G. Transition Rule for Foreign Income Taxes Deemed Paid With Respect to
PTEP Groups
Proposed Sec. 1.960-3(d)(3) provides rules for how to determine
whether foreign income taxes that were paid or accrued by a CFC in a
taxable year that began before January 1, 2018, with respect to PTEP
groups that were established for an inclusion year beginning before
January 1, 2018, are treated as PTEP group taxes for purposes of
applying Sec. 1.960-3. The rule requires that the foreign income taxes
meet three conditions, including a condition that the taxes were paid
or accrued in a taxable year of the CFC that began before January 1,
2018.
One comment noted that this condition could be read to provide that
taxes imposed after 2017 on a distribution from a PTEP group from an
inclusion year before 2018 are not treated as PTEP group taxes. The
comment recommended eliminating this condition. The Treasury Department
and the IRS agree with the comment that the condition inappropriately
limited the foreign income taxes that could qualify as PTEP group taxes
under the rule. Accordingly, the final regulations eliminate the
requirement in proposed Sec. 1.960-3(d)(3)(i). See Sec. 1.960-
3(d)(3).
H. Application of Section 960(c) to Inclusions Under Section 951A
If certain conditions are met, section 960(c)(1) and Sec. 1.960-4
allow a taxpayer to increase its section 904 limitation in the year of
receipt of previously taxed earnings and profits. Because a
distribution of previously taxed earnings and profits is excluded from
gross income under section 959(a), the distribution will not increase
the taxpayer's section 904 limitation except to the extent of any
foreign currency gain recognized under section 986(c). The lack of
sufficient section 904 limitation could prevent the taxpayer from
claiming a credit for foreign income tax, such as a withholding tax,
imposed by reason of the distribution. Section 960(c)(1) and Sec.
1.960-4 permit foreign tax on the distribution to be credited to the
extent the taxpayer had excess limitation in the year of inclusion of
the income under section 951A or section 951(a).
However, in order to limit the increase to the limitation
attributable to the inclusion, the increase in the section 904
limitation is reduced by the amount which would have been the section
904 limitation in the inclusion year if the amounts had not been
included in gross income under section 951(a) or 951A(a). See Sec.
1.960-4(c) and proposed Sec. 1.960-4(a)(1). The increase in the
section 904 limitation also excludes any excess limitation in the year
of the inclusion that was used to claim a credit for foreign taxes in
addition to those paid, accrued, or deemed paid with respect to the
inclusions under section 951(a) or section 951A. See Sec. 1.960-4(d)
and proposed Sec. 1.960-4(a)(1).
A comment recommended that Sec. 1.960-4(c) and (d) not apply to
GILTI inclusions because GILTI inclusions are segregated in a separate
category that cannot include any other income. However, the
parenthetical in section 904(d)(1)(A) contemplates that all or part of
a GILTI inclusion could be passive category income by expressly
excluding passive category income from the section 951A category.
Therefore, the comment is not adopted.
I. Application of Section 965(g) to Section 960(b)
Section 965(g) provides that no credit is allowed under section 901
for the applicable percentage of any taxes paid or accrued (or treated
as paid or accrued) with respect to any amount for which a deduction is
allowed under section 965(c). On August 9, 2018, the Treasury
Department and the IRS published proposed regulations (REG-104226-18)
in the Federal Register (83 FR 39514) (the ``section 965 proposed
regulations''), which included a provision to disallow credits under
section 901 for the applicable percentage of any foreign income taxes
attributable to a distribution of section 965(a) previously taxed
earnings and profits or section 965(b) previously taxed earnings and
profits. The section 965 proposed regulations included a rule for
foreign taxes deemed paid under section 960(a)(3) and reserved a rule
for foreign taxes deemed paid under section 960(b) in proposed Sec.
1.965-5(c)(1)(iii). Subsequently, in December 2018, the 2018 FTC
proposed regulations provided the rule in Sec. 1.965-5(c)(1)(iii) to
disallow credits for the applicable percentage of foreign income taxes
deemed paid under section 960(b) with respect to distributions to the
domestic corporation of section 965(a) previously taxed earnings and
profits or section 965(b) previously taxed earnings and profits, and
provided a coordination rule with proposed Sec. 1.960-3, which
provides rules for section 960(b). On February 5, 2019, the Federal
Register published final regulations under section 965 (T.D. 9846) at
84 FR 1838, and these regulations confirmed, under Sec. 1.965-
5(c)(1)(i), that no credit was allowed for the applicable percentage of
foreign income taxes deemed paid under section 960(b) with respect to
distributions of section 965(a) previously taxed earnings and profits
or section 965(b) previously taxed earnings and profits. The final
regulations in this Treasury decision finalize the rule in Sec. 1.965-
5(c)(1)(iii) limiting the application of section 965(g) to
distributions to domestic corporations in order to avoid multiple
disallowances, and coordinating the application of Sec. 1.965-
5(c)(1)(i) with Sec. 1.960-3.
In addition, the 2018 FTC proposed regulations provide a rule
similar to the rule that applies to taxes deemed paid under section
960(a)(3) (as in effect on December 21, 2017) that is in Sec. 1.965-
5(c)(1)(ii) in the section 965 proposed regulations. In particular,
foreign income taxes that would have been deemed paid under section
960(a)(1) (as in effect on December 21, 2017) with respect to the
portion of a section 965(a) earnings amount that was reduced under
Sec. 1.965-1(b)(2) or Sec. 1.965-8(b) are not eligible to be deemed
paid under section 960(b) and Sec. 1.960-3(b)(1) or any other section
of the Code. See proposed Sec. 1.965-5(c)(1)(iii).
A comment asserted that these taxes should be considered to meet
the requirements of section 960(b) as they are income taxes ``properly
attributable'' to section 965(b) previously taxed
[[Page 69048]]
earnings and profits. The comment states that although such earnings
are not included in income under section 951(a), they are effectively
taxed upon distribution through the reduction of basis under section
961(b).
The Treasury Department and the IRS disagree with the comment for
several reasons. First, any distribution of PTEP that reduces basis
does not necessarily result in U.S. tax; rather, such distribution is
excluded from income under section 959(a) to the extent there is
sufficient basis. The reasoning suggested by the comment would require
that when a U.S. shareholder has a section 951(a) inclusion that is not
reduced under section 965(b)(4), a deemed paid credit would be allowed
twice, once at the time of the section 951(a) inclusion and then again
when a distribution of PTEP is made that results in a reduction of
basis under section 961(b), which is plainly contrary to the text of
section 960 and the purpose of the foreign tax credit.
Second, the comment argues that section 965(b)(4)(A) provides that
section 965(a) earnings amounts offset by an aggregate foreign E&P
deficit are treated as income previously included under section 951(a)
``solely'' for purposes of applying section 959, so that such earnings
are not treated as previously included under section 951(a) for
purposes of applying section 960. However, the application of section
959 is a precondition to the application of section 960(b); section
960(b) cannot result in deemed paid taxes other than with respect to a
distribution that is excluded from income under section 959, and in
order to be so treated the section 965(b) previously taxed earnings and
profits are necessarily treated as previously included under section
951(a) for purposes of section 959. See also Part VI.B of the Summary
of Comments and Explanation of Revisions to the final regulations under
section 965 (T.D. 9846, published in the Federal Register (84 FR 1838)
on February 5, 2019) (rejecting similar argument in the context of
prior law under section 960(a)(3)).
Third, section 960(b) allows a credit for foreign income taxes paid
by CFCs upon a subsequent distribution of the section 965(b) previously
taxed earnings and profits through a chain of CFCs to the domestic
corporate shareholder, but does not allow a credit for foreign income
taxes that were previously deemed paid (or treated as deemed paid)
under section 960(a) when the amounts were included (or treated as
included) in income under section 951(a). As explained in Part VI.B of
the Summary of Comments and Explanation of Revisions to the final
regulations under section 965 (T.D. 9846, published in the Federal
Register (84 FR 1838) on February 5, 2019), foreign income taxes
attributable to a section 965(a) earnings amount that were offset by an
aggregate foreign E&P deficit were treated as deemed paid under section
960(a) when those earnings were treated as included in income under
section 951(a) for purposes of section 959. Therefore, such taxes are
not available to be deemed paid again under section 960(b) upon a
distribution of the section 965(b) previously taxed earnings and
profits.
Finally, section 960(b) provides that only taxes that are
``properly attributable to'' a distribution of PTEP are treated as
deemed paid. The comment does not explain why foreign income taxes that
were paid or accrued in taxable years before the TCJA would be
``properly attributable'' to a distribution of PTEP in a later taxable
year. The legislative history to the TCJA indicates that rules similar
to Sec. 1.904-6(a) should apply to determine the meaning of ``properly
attributable.'' H.R. Rep. No. 115-409, at 383. Under Sec. 1.904-6(a)
as in effect at the time of the TCJA, foreign income taxes paid or
accrued in a current year are allocated and apportioned to current year
income in a separate category (taking into account timing differences
under former Sec. 1.904-6(a)(1)(iv)), and not to income in a different
taxable year. Section 1.960-1(d)(3)(ii) implements this legislative
intent by providing that only current year taxes imposed solely by
reason of a distribution of PTEP are allocated and apportioned to PTEP
groups. Because section 960(b) applies only to distributions of PTEP
arising in taxable years covered by the TCJA, foreign income taxes paid
or accrued in taxable years before the TCJA can never be ``properly
attributable'' to a distribution of PTEP that is described in section
960(b).
Therefore, the final regulations provide that no credit is allowed
under section 960(b) or any other provision of the Code for taxes
attributable to section 965(a) earnings amounts offset by an aggregate
foreign E&P deficit that would have been deemed paid under former
section 960(a)(1) had the amounts actually been included in income
under section 951(a).
J. Treatment of Section 78 Dividend
1. Taxes Deemed Paid Under Section 960(b)
Under section 78, as amended by the TCJA, an amount equal to the
taxes deemed paid by a domestic corporation under section 960(a), (b),
and (d) are treated as a dividend received from the foreign
corporation. Section 960(b) addresses taxes deemed paid on
distributions of previously taxed earnings and profits. Before the
TCJA, section 78 did not reference former section 960(a)(3), which at
the time addressed taxes deemed paid on distributions of previously
taxed earnings and profits. This is consistent with the purpose of the
section 78 dividend, which is to ensure that a U.S. shareholder cannot
effectively both deduct and credit the foreign taxes paid by a foreign
subsidiary that are deemed paid by the U.S. shareholder. See Elizabeth
A. Owens & Gerald T. Ball, The Indirect Credit Sec. 2.2B1a n.54
(1975); Stanley Surrey, ``Current Issues in the Taxation of Corporate
Foreign Investment,'' 56 Columbia Law Rev. 815, 828 (June 1956)
(describing the ``mathematical quirk'' that necessitated enactment of
section 78). However, there is no deduction taken into account by the
U.S. shareholder for U.S. tax purposes with respect to taxes deemed
paid under either former section 960(a)(3) or section 960(b) that would
need to be reversed by section 78.
One comment requested that the final regulations make clear that,
notwithstanding the amendment of section 78, deemed paid taxes are not
treated as a section 78 dividend to the extent that the taxes are
related to previously taxed earnings and profits. The comment states
that providing a section 78 dividend on these taxes is inappropriate
given the purpose of section 78, and that no changes to the statutory
language of section 78 should be needed to achieve this result based on
the final regulations in effect before the enactment of the TCJA.
Finally, the comment also requested changes to the example in proposed
Sec. 1.960-1(f) to show the computation of deemed paid taxes of a U.S.
shareholder under section 960(b)(1) and the application of section 78
to the deemed paid taxes.
Because section 78 clearly states that taxes deemed paid under
section 960(b) give rise to a section 78 dividend, the final
regulations do not adopt the comment. Additionally, because an example
of the application of section 960(b)(1) is already provided in Sec.
1.960-3(e)(2), no changes were made to the example in proposed Sec.
1.960-1(f) in the final regulations.
2. Inclusion in Foreign Oil Related Income
One comment requested clarification that a section 78 dividend
associated with an inclusion under section 951A can be included in
foreign oil related income under section 907(c)(3)(B). The
[[Page 69049]]
TCJA amended section 907(c)(3)(B) to delete references to section 902
and to refer to taxes deemed paid under section 960, instead of section
960(a). The comment requested amendments to Sec. 1.907(c)-2(d)(5).
The Treasury Department and the IRS agree that section 78 dividends
with respect to inclusions under section 951A can be included in
foreign oil related income, and that section 907(c)(3)(B), as amended
by the TCJA, clearly provides for this result notwithstanding the
existence of outdated regulations. However, the final regulations do
not contain revisions to the regulations under section 907, which is
beyond the scope of the final regulations. The regulations under
section 907 have not been revised since 1991 and substantial revisions
are required to conform to statutory changes made since 1991. The
Treasury Department and the IRS expect to revise the regulations under
section 907 in a future guidance project. Comments are requested on
what additional issues should be addressed as part of revising those
regulations.
VI. Applicability Dates
In general, the 2018 FTC proposed regulations provide that the
portions of the regulations that relate to statutory amendments made by
the TCJA apply to taxable years beginning after December 31, 2017. See
section 7805(b)(2). In the case of Sec. Sec. 1.78-1, 1.861-12(c)(2),
and 1.965-7(e), these regulations were finalized as part of TD 9866,
published in the Federal Register (84 FR 29288) on June 21, 2019.
Other portions of the proposed regulations that do not relate to
the TCJA apply to taxable years ending on or after December 4, 2018.
See section 7805(b)(1)(B). Certain portions of the proposed regulations
contain rules that relate to the TCJA as well as rules that do not
relate to the TCJA. Those regulations generally apply to taxable years
that satisfy both of the following two conditions: (1) The taxable year
begins after December 31, 2017, and (2) the taxable year ends on or
after December 4, 2018. See section 7805(b)(1)(B).
In general, no changes were made to the proposed applicability
dates in the 2018 FTC proposed regulations in the final regulations.
For Sec. Sec. 1.904(b)-3 and 1.960-1 through 1.960-6, the
applicability dates were revised to apply the regulations to taxable
years that both begin after December 31, 2017, and end on or after
December 4, 2018, consistent with section 7805(b)(1)(B).
Section 1.904(g)-3, which finalizes the 2012 OFL proposed
regulations, is applicable to taxable years ending on or after December
16, 2019.
Section 1.905-3, which finalizes proposed Sec. 1.905-3 (other than
proposed Sec. 1.905-3(a)) is applicable to foreign tax
redeterminations occurring in taxable years ending on or after December
16, 2019. See proposed Sec. 1.905-3(b)(2) and Sec. 1.905-5, contained
in the 2019 FTC proposed regulations, for rules that apply to foreign
tax redeterminations of foreign corporations.
Section 1.986(a)-1, which finalizes proposed Sec. 1.905-3(a),
applies to taxable years ending on or after December 16, 2019, and to
taxable years of foreign corporations which end with or within a
taxable year of a U.S. shareholder ending on or after December 16,
2019.
Special Analyses
I. Regulatory Planning and Review
Executive Orders 13563 and 12866 direct agencies to assess costs
and benefits of available regulatory alternatives and, if regulation is
necessary, to select regulatory approaches that maximize net benefits
(including potential economic, environmental, public health and safety
effects, distributive impacts, and equity). Executive Order 13563
emphasizes the importance of quantifying both costs and benefits,
reducing costs, harmonizing rules, and promoting flexibility. For
purposes of Executive Order 13771, this rule is regulatory.
The final regulations have been designated by the Office of
Information and Regulatory Affairs (OIRA) as subject to review under
Executive Order 12866 pursuant to the Memorandum of Agreement (MOA,
April 11, 2018) between the Treasury Department and the Office of
Management and Budget regarding review of tax regulations. The Office
of Information and Regulatory Affairs has designated these regulations
as economically significant under section 1(c) of the MOA. Accordingly,
the OMB has reviewed these regulations.
A. Background and Need for the Final Regulations
Before the Tax Cuts and Jobs Act (TCJA), the United States taxed
its citizens, residents, and domestic corporations on their worldwide
income. However, to the extent that a foreign jurisdiction and the
United States taxed the same income, this framework could have resulted
in double taxation. The U.S. foreign tax credit (FTC) regime alleviated
potential double taxation by allowing a non-refundable credit for
foreign income taxes paid or accrued that could be applied to reduce
the U.S. tax on foreign source income. Although the TCJA eliminated the
U.S. tax on some foreign source income, the United States continues to
provide foreign tax credits for foreign source income subject to U.S.
tax. The changes made by TCJA to international taxation necessitate
certain changes in this FTC regime.
In plain language, the FTC calculation is applied separately to
different categories of income (a ``separate category''), a long-
standing framework that is unchanged by TCJA.\1\ This framework entails
the taxpayer allocating income, expenses, and foreign income taxes paid
or accrued to each separate category. Taxpayers who pay foreign taxes
on income in one separate category cannot claim a credit against U.S.
tax owed on income (more precisely, gross income minus deductions) in a
different category. For example, suppose a domestic corporate taxpayer
has $100 of active foreign source income in the ``general category''
and $100 of passive foreign source income, such as interest income, in
the ``passive category.'' It also has $50 of foreign taxes associated
with the ``general category'' income and $0 of foreign taxes associated
with the ``passive category'' income. The allowable FTC is determined
separately for the two categories. Therefore, none of the $50 of
``general category'' FTCs can be used to offset U.S. tax on the
``passive category'' income. This taxpayer has a pre-FTC U.S. tax
liability of $42 (21 percent of $200) but can claim a FTC for only $21
(21 percent of $100) of this liability, which is with respect to active
foreign source income in the general category. The $21 represents what
is referred to as the taxpayer's foreign tax credit limitation with
respect to the general category. The taxpayer may carry the remaining
$29 of foreign taxes ($50 minus $21) back to the prior taxable year and
then forward for up to 10 years (until used), and is allowed a credit
against U.S. tax on general category foreign source income in the
carryover year, subject to certain restrictions.
---------------------------------------------------------------------------
\1\ Prior to the enactment of the TCJA, these categories were
primarily the passive and general categories. The TCJA added new
separate categories for global intangible low-taxed income (the
section 951A category) and foreign branch category income.
---------------------------------------------------------------------------
Expenses borne by U.S. parents and domestic affiliates that support
foreign operations also generally follow this long-standing framework.
Deductions that reduce foreign source taxable income in a particular
category thereby reduce the allowable FTCs for that
[[Page 69050]]
category. The rules for expense allocation need updating in light of
the changes made by TCJA.
The TCJA added new separate categories for global intangible low-
taxed income (the section 951A category) and foreign branch income. The
addition of these new categories and other changes \2\ necessitate
practical guidance for implementation. The final regulations also
update outdated portions of the existing regulations to help conform
the existing regulations to the post-TCJA world. Finally, the final
regulations address comments received on the 2018 FTC proposed
regulations.
---------------------------------------------------------------------------
\2\ TCJA repealed the fair market value method of asset
valuation used to apportion interest expense to separate categories
and amended Code sections that address deemed paid credits for
subpart F income, global intangible low-taxed income (GILTI), and
distributions of previously taxed earnings and profits. Further,
because repatriated dividends are no longer taxable, the TCJA also
repealed section 902 (which allowed a domestic corporation to claim
FTCs with respect to dividends paid from a foreign corporation) and
made other conforming changes.
---------------------------------------------------------------------------
B. Overview of the Final Regulations
The final regulations specify the methodologies and approaches
necessary to conform the existing regulations to the changes specified
in the TCJA. The final regulations provide guidance for taxpayers to
determine the amount of their foreign tax credits and how to compute
their foreign tax credit limitation.
Most notably, the final regulations help interpret the statute by
providing details regarding how income is assigned and expenses are
apportioned to the new separate categories created by the TCJA. In
particular, the final regulations specify that, for purposes of
applying the expense allocation and apportionment rules, the portion of
gross income related to FDII or a GILTI inclusion which is offset by
the section 250 deduction is treated as exempt income, and the stock
giving rise to GILTI that is offset by the section 250 deduction is
treated as a partially exempt asset. Such treatment implies that fewer
expenses will be allocated to the section 951A category as a result of
this rule, leading to higher computed foreign source taxable income, a
larger foreign tax credit limitation, and a larger foreign tax credit
offset with respect to GILTI income. Because in the absence of these
regulations, these expenses would generally be allocated to the section
951A category (which makes it more difficult to utilize FTCs related to
GILTI), this rule will in general reduce the tax burden of U.S.
multinational corporations with GILTI income and allocable expenses.
The final regulations also address how FTC carryovers are allocated
across the new separate categories. The formation of two new separate
categories requires a determination regarding how the balance of FTC
carryovers in existence upon enactment of TCJA are to be allocated
across new and existing separate categories.
The final regulations also address certain potentially abusive
borrowing arrangements, such as when a U.S. person lends money to a
foreign partnership in order to artificially increase foreign source
income (and therefore the FTC limitation) without affecting U.S.
taxable income. In addition, they clarify the regulatory environment by
updating inoperative language in Sec. Sec. 1.904-1 through 1.904-3,
parts of the regulations that have not previously been updated to
reflect changes to section 904 made in 1978.
The final regulations also ease transitional administrative burdens
associated with the implementation of the TCJA; for example, they allow
an exception to the 5 year waiting period for the election of the gross
income or sales method for R&E expense allocation, and provide added
flexibility for when the average bases of assets is measured by
taxpayers who are required to switch to the tax book method of
valuation. The final regulations further clarify the Sec. 1.904-6
rules concerning how allocation of taxes across separate categories
should be calculated in the presence of base and timing differences and
also fill technical gaps in how to implement the statute in practice,
for example, by providing a clear rule for how to characterize the
value of stock in each separate category in the context of the new
separate categories.
C. Economic Analysis
1. Baseline
The Treasury Department and the IRS have assessed the benefits and
costs of the final regulations relative to a no-action baseline
reflecting anticipated Federal income tax-related behavior in the
absence of these regulations.
2. Summary of Economic Effects
The final regulations provide certainty and clarity to taxpayers
regarding the allocation of income, expenses, and FTC carryovers to the
separate income categories. In the absence of the enhanced specificity
provided by these regulations, similarly situated taxpayers might
interpret the foreign tax credit provisions of the tax code
differently, potentially resulting in inefficient patterns of economic
activity. For example, because separate categories for GILTI and
foreign branch income did not previously exist, one taxpayer might
undertake a particular business activity, based on that taxpayer's
interpretations of how that activity's income, expenses, and carryover
foreign tax credits will be allocated across these categories, that
another taxpayer, making a different interpretation of the tax
treatment of these allocations, might forego. If this difference in
interpretations confers a competitive advantage on the less profitable
enterprise, U.S. economic performance may suffer. The guidance provided
in these regulations helps to ensure that taxpayers face more uniform
incentives when making economic decisions. In general, economic
performance is enhanced when businesses face more uniform signals about
tax treatment.
Because the TCJA is new, the Treasury Department and the IRS do not
know with reasonable precision the tax interpretations that taxpayers
might make in the absence of this guidance. To the extent that
taxpayers would generally have interpreted the foreign tax credit rules
as being less favorable to the taxpayer than the final regulations
provide, these final regulations may result in additional international
activity by these taxpayers relative to the no-action baseline. This
additional activity may include both activities that are beneficial to
the U.S. economy (perhaps because they represent enhanced international
opportunities for businesses with U.S. owners) and activities that are
not beneficial (perhaps because they are accompanied by reduced
activity in the United States) The Treasury Department and the IRS
recognize that additional U.S. economic activity abroad may be a
complement or substitute to activity within the United States and that
to the extent these regulations change this activity (relative to the
no-action baseline or alternative regulatory approaches), a mix of
results may occur.
The Treasury Department and the IRS have not undertaken
quantitative estimates of the economic effects of the final
regulations. The Treasury Department and the IRS do not have readily
available data or models to estimate with reasonable precision (i) the
tax stances that taxpayers would likely take in the absence of these
final regulations or under alternative regulatory approaches; (ii) the
difference in economic decisions that taxpayers might make between the
final regulations and the no-action baseline or alternative regulatory
approaches; or (iii) how this difference in business activities will
affect U.S. economic
[[Page 69051]]
activity. In the absence of such quantitative estimates, the Treasury
Department and the IRS have undertaken a qualitative analysis of the
economic effects of the final regulations relative to the no-action
baseline and relative to alternative regulatory approaches. This
analysis is presented in Parts I.C.3 and I.C.4. of this Special
Analyses.
3. Economic Effects of Important Provisions Revised From the 2018 FTC
Proposed Regulations
i. Transition Rules Relating to Foreign Tax Credit Carryovers
a. Background
Under the Code, to the extent a taxpayer pays or accrues creditable
foreign taxes in excess of its foreign tax credit limitation in a given
year, the taxpayer can carry those excess credits back one year or
forward ten years (FTC carryover). Because a taxpayer's FTC limitation
is determined on a separate category basis, FTC carryovers are
maintained on a separate category basis as well. When there are changes
in the number of separate categories, transition rules are generally
needed to deal with how to classify the existing FTC carryovers so that
they can be allocated to the new separate categories. The TCJA expanded
the existing separate categories by subdividing the general category
into three categories: General, foreign branch, and section 951A. The
TCJA did not, however, provide transition rules for the existing stock
of FTC carryovers.
To deal with the transition issue, the 2018 FTC proposed
regulations provided a default rule that kept FTC carryovers in the
general category going forward. However, taxpayers could elect to
reconstruct their FTC carryover with respect to the foreign branch (but
not the section 951A) category. To do so, a taxpayer would need to
determine what portion of its FTC carryover would be in the foreign
branch category if the foreign branch category had existed in the year
the carryover arose. No amount of the carryover was required to be
allocated to the section 951A category because of the difficulty
associated with the reconstruction and because under the TCJA
carryovers are not allowed for the foreign tax credits in the section
951A category. The provision in the 2018 FTC proposed regulations not
to require taxpayers that elected reconstruction to allocate FTC
carryovers to the section 951A category is generally favorable to the
affected taxpayers because otherwise taxpayers would have had carryover
credits allocated to the section 951A category and those taxpayers
would not have been allowed to utilize those credits.
b. Options Considered for the Final Regulations
The Treasury Department and the IRS considered several options to
deal with FTC carryovers in response to taxpayer comments.\3\ The first
option was to adopt the rule from the 2018 FTC proposed regulations
without modification. A second set of options was to adopt simplified
rules to assist taxpayers with allocating the FTC carryovers to the
different separate categories. The Treasury Department and the IRS
considered three variants of simplified rules: (a) Allow taxpayers to
assign FTCs to the foreign branch category proportionately according to
the ratio of foreign taxes paid or accrued by the taxpayer's branches
to total foreign taxes paid or accrued by the taxpayer (in that year);
(b) allow taxpayers to assign FTCs based on any reasonable method; or
(c) allow taxpayers to assign FTCs by reconstructing FTC carryforwards
but do not require taxpayers to apply the disregarded payment rule in
Sec. 1.904-4(f)(2)(vi).
---------------------------------------------------------------------------
\3\ The 2018 FTC proposed regulations requested comments on
whether a simplified safe harbor approach was appropriate and
several comments requested such a rule.
---------------------------------------------------------------------------
The final regulations adopt the first simplified rule, (a). Thus,
taxpayers may keep FTC carryovers in the general category, allocate
them to the foreign branch category in the same manner as they would
have been allocated had the foreign branch category always existed, or
allocate them to the foreign branch category proportionately. This
simplified rule reduces complexity for some taxpayers and is not
expected to result in a substantially different allocation of FTCs to
the branch basket than full reconstruction. The final rule therefore
minimizes the potential for the manipulation of allocations of income,
expenses, and foreign taxes to the categories while minimizing taxpayer
compliance and IRS administrative costs.
c. Number of Affected Taxpayers
This provision potentially affects any taxpayer with a general
category FTC arising in a taxable year beginning before January 1,
2018, that is carried to a taxable year beginning on or after January
1, 2018. The Treasury Department and the IRS estimate that there are
between 2 and 2.25 million individual and business taxpayers that would
be affected by the transition rules related to FTC carryovers. This
estimate is based on currently available counts of taxpayers with FTC
carryovers reported on Form 1118 schedule B line 5 and Form 1116 part
III line 10 for tax years 2015-2017.
ii. Transfers of IP for Purposes of the Foreign Branch Category
a. Background
The TCJA added a new separate category related to foreign branch
income. The statute did not, however, provide specific guidance on what
constitutes foreign branch income other than that it is business
profits attributable to one or more qualified business units of the
taxpayer in one or more foreign countries. To provide greater
specificity over the definition of foreign branch income, the 2018 FTC
proposed regulations generally determined the foreign branch income
based on the U.S.-tax adjusted books and records of the foreign branch.
However, certain adjustments were made to those books and records based
on certain disregarded transactions that may have occurred between the
foreign branch owner and the foreign branch. These adjustments were
intended to get to a more accurate representation of the gross income
attributable to the branch.
The issue of disregarded payments is particularly salient in the
context of disregarded transfers of intellectual property (IP). The
2018 FTC proposed regulations included a rule that disregarded
transfers of IP between a foreign branch and its owner would result in
a deemed payment that reallocates income between the foreign branch
category and the general category. This rule has the effect of
preventing artificial manipulation of the foreign branch category
through changes in ownership of IP between a foreign branch and its
owner. This rule applied regardless of when the transfer of IP occurred
and regardless of how long the IP remained in the foreign branch.
Comments requested that the rule be withdrawn and cited, among other
concerns, its administrative and compliance burdens. Other comments
requested that the Treasury Department limit the applicability of the
rule to a later date and also limit its applicability where ownership
of the IP by the foreign branch is transitory.
b. Options Considered for the Final Regulations
The Treasury Department and the IRS considered three options with
respect to the treatment of disregarded transfers of IP for purposes of
determining foreign branch income. The first option was to withdraw the
rule in its entirety and to provide no specific guidance for
[[Page 69052]]
disregarded transfers of IP. The second option was to adopt the rule
unchanged from the 2018 FTC proposed regulations. The third option was
to adopt the rule with certain modifications that would alleviate some
of the compliance and administrative burdens. These modifications
include applying the rule to transfers that occurred after the date of
publication of the 2018 FTC proposed regulations and providing
exceptions for transfers involving transitory ownership by the foreign
branch.
The final regulations adopt the third option. They retain the
structure of the 2018 FTC proposed regulations but limit its
applicability to transactions that occurred after the date of
publication of the 2018 FTC proposed regulations, and included an
exception for transitory ownership. The Treasury Department and the IRS
recognize that this rule may result in higher compliance costs relative
to the no-action baseline but project that this negative consequence is
outweighed by concerns that taxpayers could otherwise structure highly
valuable and mobile IP transfers to avoid the purpose of the rules.
This avoidance would be difficult for the IRS to address absent the
rule. In order to minimize the increase in compliance costs relative to
withdrawing the rule (and simultaneously to reduce compliance costs
relative to retaining the proposed regulations without change), the
rule is limited to IP transfers that occurred after the publication of
the 2018 FTC proposed regulations, when taxpayers were aware of the
rule and how foreign branch category income would be determined.
Furthermore, the Treasury Department and the IRS determined that cases
where the foreign branch only owned the IP for brief periods of time
were unlikely to pose the risk identified and thus should be excepted.
c. Number of Affected Taxpayers
This provision affects any taxpayer that transfers IP to or from a
foreign branch on or after December 7, 2018. Because transfers of IP
are not specifically identified on any tax forms, the Treasury
Department and the IRS estimated the number of taxpayers who report
nonzero gross income and allocable deductions with respect to a foreign
branch as an upper bound on the group of taxpayers potentially affected
by this rule. The Treasury Department and the IRS have determined that
there were 1,500 unique taxpayers that meet these conditions in
currently available data from taxable years 2015-2017. The number of
these taxpayers that transfer IP is likely much smaller than this count
because most taxpayers do not transfer IP in any given tax year.
iii. Treatment of GILTI for Purposes of the Interest Allocation Rules
a. Background
The Code provides rules for how the interest expense of a CFC is to
be allocated for purposes of claiming the foreign tax credit. Under the
Code, a CFC must allocate and apportion its interest expense among
groups of income for purposes of determining its tested income, subpart
F income, or other types of net foreign source income. At the same
time, a U.S. taxpayer must characterize (in terms of separate
categories) the value of its CFCs for purposes of allocating and
apportioning its own interest expense. Existing rules allow a CFC to
allocate its interest using one of two methods (the asset method or the
modified gross income (MGI) method) and the U.S. taxpayer characterizes
the stock of its CFC (for purposes of allocating its own interest)
using the same method that the CFC used to allocate its interest. The
MGI method treats subpart F income differently than other types of
gross income with respect to interest allocations for tiered CFC
ownership structures; in particular, subpart F income of lower tier
CFCs is not accounted for by upper tier CFCs (that is, it does not
``tier up'') for purposes of interest expense allocation, whereas all
other types of a CFC's income do tier up.
The 2018 FTC proposed regulations do not take into account gross
tested income from a lower-tier CFC with respect to an upper-tier CFC
for purposes of allocating the upper tier CFC's interest expense. A
comment requested that gross tested income tier up to the upper-tier
CFC under the MGI method in order to minimize differences between the
results obtained under the asset method and the MGI method.
b. Options Considered for the Final Regulations
The Treasury Department and the IRS considered two options with
respect to the treatment of interest expense allocation. The first
option was to adopt the rule from the 2018 FTC proposed regulations.
The second option was to adopt a rule that requires gross tested income
to tier up for purposes of applying the MGI method.
The final regulations require tested income to tier up to the
upper-tier CFC for purposes of allocating interest expense when
applying the MGI method. This is an appropriate solution for several
reasons. First, the section 951A rules do not have special rules for
passive income similar to those present in the subpart F regime; the
Treasury Department and the IRS have further determined that the
existing rule accounts for the special rules that apply to subpart F
income. Hence, an exception to the general tiering up rule is not
needed for tested income. Second, the solution minimizes differences in
the results obtained by taxpayers that elect the asset method rather
than the MGI method, thus minimizing arbitrary differences in the tax
treatment of similarly situated taxpayers. Finally, the solution is
consistent with how the rules in section 951A apply for purposes of
determining the CFC's tested income.
c. Number of Affected Taxpayers
The Treasury Department and the IRS determined that the group of
taxpayers affected by the regulation consists of any taxpayer with at
least one second-tier CFC that earns gross tested income. The Treasury
Department and the IRS estimate that there are between 11,000 and
14,000 taxpayers that fit that profile based on tax filings for tax
years 2015-2017.
4. Economic Effects of Provisions Not Substantially Revised From the
2018 FTC Proposed Regulations
i. Matching Interest Income Allocation to Interest Expense Allocation
for Partnerships
The existing rules for the foreign tax credit generally specify how
taxpayer income, expenses, and FTC carryovers are to be allocated to
the separate categories. There remain, however, many allocation rules
that would benefit from additional clarity. Regarding interest income
and expenses in the case of partnership loan structures, the 2018 FTC
proposed regulations specified that the taxpayer's interest income
allocation is to be matched to its interest expense allocation, rather
than specifying that the interest expense allocation be matched to the
taxpayer's interest income allocation.
This rule reduces opportunities for taxpayers to increase their
gross foreign source income based solely on a related party loan to a
partnership. Such potentially abusive borrowing arrangements occur, for
example, when a U.S. person lends money to a foreign partnership in
order to artificially increase foreign source income (and therefore the
FTC limitation) without affecting U.S. taxable income. This increase in
the FTC limitation is accomplished, for example, by lending to a
controlled partnership, which has no effect on U.S. taxable income
[[Page 69053]]
because the interest income received from the partnership is offset by
the lender's share of the interest expense incurred by the partnership.
However, the transaction can increase foreign source income and
allowable foreign tax credits, because the existing interest expense
allocation rules do not generally allocate interest income and interest
expenses similarly.
To prevent such artificial inflation of foreign tax credits, the
final regulations specify that interest income attributable to
borrowing through a partnership will be allocated across separate
foreign tax credit categories in the same manner as the associated
interest expense. Accordingly, the proposed matching rule achieves a
more neutral foreign tax credit limitation result and better minimizes
the impact of related party loans on a taxpayer's foreign tax credit
limitation.
The final regulations are the same as the 2018 FTC proposed
regulations in this regard except for minor technical modifications.
ii. Treatment of Income Associated With the Section 250 Deduction as
Exempt Income and Treatment of Expenses Allocated to Section 951A
Category as Exempt Expenses
The statute does not specify how income associated with the section
250 deduction is to be treated for purposes of claiming the FTC. To
address this issue, the proposed regulations specified that the income
associated with the section 250 deduction is treated as income that is
partially exempt from income tax (based on the amount of the section
250 deduction allowed) for purposes of the foreign tax credit. As a
result, the taxpayer's expenses are to be allocated and apportioned
without taking into account this income.
The partially exempt treatment provided for section 250 income
means that fewer expenses are allocated to the section 951A category
than would have been if that income were not partially exempt (since
the total gross income in the section 951A category would have been
higher). The regulations therefore potentially increase the
competitiveness of U.S. corporations relative to the no-action
baseline, as described in Part I.3.B of this Special Analyses.
The 2018 FTC proposed regulations requested comment on the
estimated impact of the reduced expense allocation to the section 951A
category relative to specifying that no expenses may be allocated
against this income. Most comments did not address this issue. One
comment expressed the view that the increased incentive to over-
allocate expenses to the United States (relative to the no-action
baseline) might not be small, because expense allocation responds to
effective tax rates rather than statutory rates, and post-TCJA
effective tax rates might not have fallen as much as statutory rates.
Estimates of post-TCJA marginal effective tax rates suggest that
effective tax rates have fallen meaningfully, consistent with a reduced
incentive to over-allocate interest expense to the United States.\4\
---------------------------------------------------------------------------
\4\ DeBacker, Jason, and Roy Kasher, ``Effective Tax Rates on
Business Investment Under the Tax Cuts and Jobs Act'', May 2018.
---------------------------------------------------------------------------
The final regulations are the same as the 2018 FTC proposed
regulations in this regard except for minor technical modifications.
iii. Clarifications to the Look-Through Rules
Before the TCJA, dividends, interest, rents and royalties (``look-
through payments'') paid to a United States shareholder by its CFC were
generally allocated to the general category to the extent that they
were not treated as passive category income. Because TCJA split the
general category income into three categories, it created a question of
how to assign look-through payments. To address this issue, the 2018
FTC proposed regulations specified that these look-through payments be
assigned to the general category or foreign branch category. They may
not be assigned to the section 951A category. This treatment is
consistent with the fact that payments of dividends, interest, rents,
and royalties made directly to a United States shareholder are not
included in the new section 951A category. By contrast, certain
interest, rents, and royalties earned by a foreign branch can meet the
definition of foreign branch category income, and the general category
is a residual category that encompasses all income that is not
specifically assigned to any other category.
The Treasury Department and the IRS considered as an alternative
not issuing guidance for the treatment of look-through payments but
concluded that affected taxpayers and the overall U.S. economy would
benefit from the issuance of final regulations on this issue.
The final regulations are the same as the 2018 FTC proposed
regulations in this regard except for minor technical modifications.
II. Paperwork Reduction Act
The rules relating to foreign tax credits that were modified by the
Act are reflected in several revised and new schedules added to
existing forms discussed in this Part II of the Special Analyses. For
purposes of the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d))
(``PRA''), the reporting burden associated with the revised and new
schedules will be reflected in the PRA submission associated with the
forms described in this Part II. Additionally, a revised collection of
information is added with respect to section 986 in Sec. 1.986(a)-
1(a)(2)(iv).
The collection of information in Sec. 1.986(a)-1(a)(2)(iv) is an
election to translate foreign income taxes denominated in nonfunctional
currency using the spot rate as of the date of payment (rather than the
average exchange rate for the year). This election may be made by an
individual or corporation and may be made on behalf of a foreign
corporation by a U.S. shareholder. A pass-through entity cannot make
this election. This election can be made for all foreign income taxes
denominated in nonfunctional currency, or it can be made only with
respect to all foreign income taxes denominated in nonfunctional
currency that are recorded on the separate books and records of a
dollar functional currency QBU of the taxpayer. This election, if made
with respect to dollar functional currency QBUs, will match the
exchange rate used to determine the dollar amount of the foreign tax
credit with the exchange rate used to determine the dollar amount of
income that is used to pay the tax. The election is made once and
applies to all future years. The election is made by attaching a
statement to a timely filed U.S. income tax return for the first year
to which the election applies. For purposes of the PRA, the reporting
burden associated with Sec. 1.986(a)-1(a)(2)(iv) will be reflected in
the PRA submission associated with the Form 1040 series and Form 1120
series.
Form 1118, Foreign Tax Credit--Corporations, has been revised to
add new Schedule C (Tax Deemed Paid With Respect to Section 951(a)(1)
Inclusions by Domestic Corporation Filing Return (Section 960(a)),
Schedule D (Tax Deemed Paid With Respect to Section 951A Income by
Domestic Corporation Filing the Return (Section 960(d)), and Schedule E
(Tax Deemed Paid With Respect to Previously Taxed Income by Domestic
Corporation Filing the Return (Section 960(b)). In addition, the
existing schedules of Form 1118 have been modified to account for the
two new separate categories of income under section 904(d); the repeal
of section 902 indirect credits for foreign taxes deemed paid with
respect to dividends from foreign corporations; modified indirect
[[Page 69054]]
credits under section 960 for inclusions under sections 951(a)(1) and
951A; the modified section 78 gross up with respect to inclusions under
sections 951(a)(1) and 951A; the revised sourcing rule for certain
income from the sale of inventory under section 863(b); the repeal of
the fair market value method for apportioning interest expense under
864(e); new adjustments for purposes of section 904 with respect to
expenses allocable to certain stock or dividends for which a dividends
received deduction is allowed under section 245A; the election to
increase pre-2018 section 904(g) Overall Domestic Loss (ODL) recapture;
and limited foreign tax credits with respect to inclusions under
section 965. For purposes of the PRA, the reporting burden associated
with these changes is reflected in the PRA submission associated with
Form 1118 (OMB control number 1545-0123, which represents a total
estimated burden time, including all other related forms and schedules,
of 3.157 billion hours and total estimated monetized costs of $58.148
billion).
Form 5471, Information Return of U.S. Persons With Respect to
Certain Foreign Corporations, has also been revised to add Schedule E-1
(Taxes Paid, Accrued, or Deemed Paid on Accumulated Earnings and
Profits (E&P) of Foreign Corporation) and Schedule P (Previously Taxed
Earnings and Profits of U.S. Shareholder of Certain Foreign
Corporations) and to amend Schedule E (Income, War Profits, and Excess
Profits Taxes Paid or Accrued) and Schedule J (Accumulated Earnings &
Profits (E&P) of Controlled Foreign Corporations). These changes to the
Form 5471 reflect the two new separate categories of income under
section 904(d); the repeal of section 902 indirect credits for foreign
taxes deemed paid with respect to dividends from foreign corporations;
modified indirect credits under section 960 for inclusions under
sections 951(a)(1) and 951A; and limited foreign tax credits with
respect to inclusions under section 965. For purposes of the PRA, the
reporting burden associated with these changes is reflected in the PRA
submission associated with Schedules E, E-1, J, and P of Form 5471 (OMB
control number 1545-0123).
Schedule B (Specifically Attributable Taxes and Income (Section
999(c)(2)) of the Form 5713, International Boycott Report, has also
been revised to reflect the repeal of section 902. Schedule C (Tax
Effect of the International Boycott Provisions) of the Form 5713 has
been revised to account for the new section 904(d) categories of
income. For purposes of the PRA, the reporting burden associated with
these changes is reflected in the PRA submission associated with
Schedules B and C of Form 5713 (OMB control number 1545-0216, which
represents a total estimated burden time, including all other related
forms and schedules, of 143,498 hours).
Schedules K and K-1 of the following forms have been revised to
account for the new section 904(d) categories of income: Form 1065,
U.S. Return of Partnership Income, Form 1120-S, U.S. Income Tax Return
for an S Corporation, and Form 8865, Return of U.S. Persons With
Respect to Certain Foreign Partnerships. Form 1116, Foreign Tax Credit
(Individual, Estate, or Trust), has also been revised to account for
the new section 904(d) categories of income. For purposes of the PRA,
the reporting burden associated with these changes is reflected in the
PRA submission associated with Forms 1065 and 1120S (OMB control number
1545-0123); Form 8865 (OMB control number 1545-1668, which represents a
total estimated burden time, including all other related forms and
schedules, of 289,354 hours), and Form 1116 (OMB control numbers 1545-
0121, which represents a total estimated burden time, including all
other related forms and schedules, of 25,066,693 hours; and 1545-0074,
which represents a total estimated burden time, including all other
related forms and schedules, of 1.784 billion hours and total estimated
monetized costs of $31.764 billion).
The IRS estimates the number of affected filers for the
aforementioned forms to be the following:
------------------------------------------------------------------------
Number of
Form respondents *
(estimated)
------------------------------------------------------------------------
Form 1116............................................... 8,000,000
Form 1118............................................... 15,000
Form 1040............................................... 150,000,000
Form 1065............................................... 4,000,000
Form 1065 Schedule K-1.................................. 24,750,000
Form 1120............................................... 1,700,000
Form 1120-S............................................. 4,750,000
Form 1120-S Schedule K-1................................ 7,500,000
Form 5471............................................... 28,000
Form 5471 Schedule E.................................... 10,000
Form 5471 Schedule J.................................... 25,500
Form 5713 Schedule B.................................... <1,000
Form 5713 Schedule C.................................... <1,000
Form 8865............................................... 14,500
------------------------------------------------------------------------
Data tabulated from 2015 and 2016 Business Return Transaction File and E-
file data.
* Except for K-1 filings, which count the total number of K-1s received;
same issuer K-1s are aggregated at the recipient level.
The estimates for the number of impacted filers with respect to the
collections of information described in this part II of the Special
Analysis section are based on filers of U.S. income tax returns that
file a Form 1040 or Form 1120 because only filers of these forms would
be subject to the collection of information requirement. The IRS
estimates the number of impacted filers to be the following:
Tax Forms Impacted
------------------------------------------------------------------------
Number of Forms to which the
Collection of information respondents information may be
(estimated) attached
------------------------------------------------------------------------
Sec. 1.986(a)-1(a)(2)(iv)........ 1,625-3,250 Form 1040 series and
Form 1120 series.
------------------------------------------------------------------------
Data tabulated from 2015 and 2016 Business and Individual Return
Transaction File and E-file data.
The current status of the PRA submissions related to foreign tax
credits is provided in the following table. The burden estimates
provided in the above narrative are aggregate amounts that relate to
the entire package of forms associated with the OMB control numbers
1545-0123 (which represents a total estimated burden time for all forms
and schedules for corporations of 3.157 billion hours and total
estimated monetized costs of $58.148 billion ($2017)), 1545-0074 (which
represents a total estimated burden time, including all other related
forms and schedules for individuals, of 1.784 billion hours and total
estimated monetized costs of $31.764 billion ($2017)), 1545-0216 (which
represents a total estimated burden time, including all other related
forms and schedules, of 143,498 hours), 1545-1668 (which represents a
total estimated burden time, including all other related forms and
schedules of 289,354 hours), and 1545-0121 (which represents a total
estimated burden time, including all other related forms and schedules
of 25,066,693 hours). The overall burden estimates provided for the OMB
control numbers below are aggregate amounts that relate to the entire
package of forms associated with the applicable OMB control number and
will in the future include, but not isolate, the estimated burden of
only the foreign tax credit-related forms that are included in the
tables in this Part II. These numbers are therefore unrelated to the
future calculations needed to assess the burden imposed by the
regulations. These burdens have been reported for other regulations
related to the taxation of cross-border income and the Treasury
Department and the IRS urge readers to recognize that these numbers are
duplicates and to guard against overcounting the burden that
international tax provisions imposed prior to the TCJA. No burden
estimates specific to the forms affected by the regulations are
currently available. The Treasury Department and the IRS have not
estimated the burden, including that
[[Page 69055]]
of any new information collections, related to the requirements under
the regulations. The Treasury Department and the IRS estimate PRA
burdens on a taxpayer-type basis rather than a provision-specific
basis. Those estimates would capture both changes made by the Act and
those that arise out of discretionary authority exercised in the final
regulations.
The Treasury Department and the IRS request comments on all aspects
of information collection burdens related to these final regulations,
including estimates for how much time it would take to comply with the
paperwork burdens described above for each relevant form and ways for
the IRS to minimize the paperwork burden. Proposed revisions (if any)
to these forms that reflect the information collections contained in
these final regulations will be made available for public comment at
https://apps.irs.gov/app/picklist/list/draftTaxForms.html and will not
be finalized until after these forms have been approved by OMB under
the PRA.
----------------------------------------------------------------------------------------------------------------
Form Type of filer OMB No.(s) Status
----------------------------------------------------------------------------------------------------------------
Form 1116............................. All other Filers (mainly 1545-0121 Published in the Federal
trusts and estates) Register on 3/23/17. Public
(Legacy system). comment period closed 5/22/
18. Approved by OMB through
10/30/2020.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201704-1545-023 023.
-------------------------------------------------------------------------
Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/8/18. Public
Comment period closes on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
-------------------------------------------------------------------------
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission (all forms)
scheduled in 3-2019. 60 Day
Federal Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
Form 1118, 1065, 1065 Schedule K-1, Business (NEW Model)..... 1545-0123 Published in the Federal
1120-S. Register on 10/8/18. Public
Comment period closes on 12/
10/18.
rrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrrr
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
----------------------------------------------------------------------------------------------------------------
Form 5471 (including Schedules E, J).. Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/8/18. Public
Comment period closes on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
-------------------------------------------------------------------------
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms in
3-2019. 60 Day Federal
Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
Form 5713 Schedules B, C.............. All other Filers (mainly 1545-0216 Published in the Federal
trusts and estates) Register on 3/28/18. Public
(Legacy system). Comment period closed 5/29/
18. Renewal submitted on 10/
11/18 for review to OIRA.
New 2018 Forms not included
in renewal to OIRA due to
timing of submission.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/29/2018-23515/agency-information-collection-activities-submission-for-omb-review-comment-request-multiple-internal.
-------------------------------------------------------------------------
Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/11/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
-------------------------------------------------------------------------
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms in
3-2019. 60 Day Federal
Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
Form 8865............................. All other Filers (mainly 1545-1668 Published in the Federal
trusts and estates) Register on 10/1/18. Public
(Legacy system). Comment period closed on 11/
30/18. ICR in process by
Treasury as of 10/17/18.
-------------------------------------------------------------------------
[[Page 69056]]
Link: https://www.federalregister.gov/documents/2018/10/01/2018-21288/proposed-collection-comment-request-for-regulation-project.
-------------------------------------------------------------------------
Business (NEW Model)..... 1545-0123 Published in the Federal
Register on 10/8/18. Public
Comment period closed on 12/
10/18.
-------------------------------------------------------------------------
Link: https://www.federalregister.gov/documents/2018/10/09/2018-21846/proposed-collection-comment-request-for-forms-1065-1065-b-1066-1120-1120-c-1120-f-1120-h-1120-nd.
-------------------------------------------------------------------------
Individual (NEW Model)... 1545-0074 Limited Scope submission
(1040 only) on 10/11/18 at
OIRA for review. Full ICR
submission for all forms in
3-2019. 60 Day Federal
Register notice not
published yet for full
collection.
-------------------------------------------------------------------------
Link: https://www.reginfo.gov/public/do/PRAViewICR?ref_nbr=201808-1545-031 031.
----------------------------------------------------------------------------------------------------------------
In 2018, the IRS released and invited comments on drafts of the
above forms in order to give members of the public advance notice and
an opportunity to submit comments. The IRS received no comments on the
portions of the forms that relate to foreign tax credits during the
comment period. Consequently, the IRS made the forms available in late
2018 for use by the public. The IRS is contemplating making additional
changes to the forms in order to implement final regulations.
III. Regulatory Flexibility Act
It is hereby certified that this final regulation will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act
(RFA) (5 U.S.C. chapter 6).
These final regulations provide guidance needed to comply with
statutory changes and affect individuals and corporations claiming
foreign tax credits. The domestic small business entities that are
subject to the foreign tax credit rules in the Code and these final
regulations are generally those domestic small business entities that
are at least 10 percent corporate shareholders of foreign corporations,
and so are eligible to claim dividends-received deductions or compute
foreign taxes deemed paid under section 960 with respect to inclusions
under subpart F and section 951A from CFCs. Other provisions of the
TCJA, such as the new separate foreign tax credit limitation category
for foreign branch income and the repeal of the option to allocate and
apportion interest expense on the basis of the fair market value
(rather than tax basis) of a taxpayer's assets, might also affect
domestic small business entities that operate in foreign jurisdictions.
Based on 2017 Statistics of Income data, the Treasury Department and
the IRS computed the fraction of taxpayers owning a CFC by gross
receipts size class. The smaller size classes have a relatively small
fraction of taxpayers that own CFCs, which suggests that many domestic
small business entities will be unaffected by these regulations.
Many of the important aspects of these final regulations, including
all of the rules in Sec. Sec. 1.861-8(d)(2)(C), 1.861-10, 1.861-12,
1.861-13, 1.901(j)-1, 1.904-5, 1.904(b)-3, 1.954-1, 1.960-1 through
1.960-3, and 1.965-5(c)(1)(iii) apply only to U.S. persons that operate
a foreign business in corporate form, and, in most cases, only if the
foreign corporation is a CFC. Because it takes significant resources
and investment for a business to operate outside of the United States
in corporate form, and in particular to own a CFC, the owners of such
businesses will infrequently be domestic small business entities, as
indicated by the Table.
Fraction of U.S. Corporate Taxpayers Reporting CFC Ownership, by Gross
Receipts Size Class
------------------------------------------------------------------------
Percentage
Gross receipts size class with a CFC
------------------------------------------------------------------------
<1 mil.................................................. 0.40
1-5 mil................................................. 0.80
5-10 mil................................................ 2.70
10-20 mil............................................... 4.50
20-30 mil............................................... 9.30
30-50 mil............................................... 12.00
50-100 mil.............................................. 19.70
100-150 mil............................................. 26.80
150-200 mil............................................. 32.50
200-250 mil............................................. 37.40
250-500 mil............................................. 43.70
>=500 mil............................................... 63.50
------------------------------------------------------------------------
* Data based on 2017 Statistics of Income sample for all 1120 returns
except 1120-S (return type = 2) (1120-L, 1120-RIC, 1120-F, 1120-REIT,
1120-PC,1120, 1120-L Consolidated 1504c return (controlling industries
524142 and 524143),1120-PC Consolidated 1504C return (controlling
industries 524156, 524159), and 1120 Section 594/1504c consolidated
return (controlling industries not 524142, 524143, 524156, 524159),
1120 Non-consolidated return).
The Treasury Department and the IRS project that the final
regulations are unlikely to affect a substantial number of domestic
small business entities but data are unavailable to estimate with
certainty and certify in accordance with RFA that the number of small
entities affected will not be substantial.
The Treasury Department and the IRS have determined that these
final regulations will not have a significant economic impact on
domestic small business entities. Based on published information from
2013, foreign tax credits as a percentage of three different tax-
related measures of annual receipts (see Table for variables) by
corporations are substantially less than the 3 to 5 percent threshold
for significant economic impact. The amount of foreign tax credits in
2013 is an upper bound on the change in foreign tax credits resulting
from the final regulations.
--------------------------------------------------------------------------------------------------------------------------------------------------------
$500,000 $1,000,000 $5,000,000 $10,000,000 $50,000,000 $100,000,000
Size (by business receipts) Under under under under under under under $250,000,000
$500,000 (%) $1,000,000 $5,000,000 $10,000,000 $50,000,000 $100,000,000 $250,000,000 or more
(%) (%) (%) (%) (%) (%) (%)
--------------------------------------------------------------------------------------------------------------------------------------------------------
FTC/Total Receipts...................... 0.03 0.00 0.00 0.01 0.01 0.03 0.09 0.56
[[Page 69057]]
FTC/(Total Receipts-Total Deductions)... 0.48 0.03 0.04 0.26 0.22 0.51 1.20 9.00
FTC/Business Receipts................... 0.05 0.00 0.00 0.01 0.01 0.04 0.10 0.64
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: Statistics of Income (2013) Form 1120 available at https://www.irs.gov/statistics.
The collection of information in Sec. 1.986(a)-1(a)(2)(iv) of the
final regulations (relating to the election to translate creditable
foreign taxes at the spot rate on the date of payment instead of the
average exchange rate for the year) may affect some small business
entities with significant foreign operations. The data to assess the
number of small entities potentially affected by Sec. 1.986(a)-
1(a)(2)(iv) are not readily available. However, businesses with
significant foreign operations are generally not small businesses, as
indicated by the data above. Further, as demonstrated in the table in
this Part III of the Special Analyses, foreign tax credits generally do
not have a significant economic impact on small business entities.
Therefore, the Treasury Department and the IRS have determined that a
substantial number of domestic small business entities will not be
subject to Sec. 1.986(a)-1(a)(2)(iv). Consequently, the Treasury
Department and the IRS have determined, and hereby certify, that Sec.
1.986(a)-1(a)(2)(iv) will not have a significant economic impact on a
substantial number of small entities.
Pursuant to section 7805(f), the proposed regulations preceding
these final regulations (REG-105600-18) were submitted to the Chief
Counsel for Advocacy of the Small Business Administration for comment
on its impact on small businesses and no comments were received.
IV. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
state, local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. In 2019, that threshold is approximately $154 million. This
rule does not include any Federal mandate that may result in
expenditures by state, local, or tribal governments, or by the private
sector in excess of that threshold.
V. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on state and local
governments, and is not required by statute, or preempts state law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. This rule does not have federalism
implications and does not impose substantial direct compliance costs on
state and local governments or preempt state law within the meaning of
the Executive order.
VI. Congressional Review Act
The Administrator of the Office of Information and Regulatory
Affairs of the OMB has determined that this Treasury decision is a
major rule for purposes of the Congressional Review Act (5 U.S.C. 801
et seq.) (``CRA''). Under section 801(3) of the CRA, a major rule takes
effect 60 days after the rule is published in the Federal Register.
Notwithstanding this requirement, section 808(2) of the CRA allows
agencies to dispense with the requirements of section 801 of the CRA
when the agency for good cause finds that such procedure would be
impracticable, unnecessary, or contrary to the public interest and that
the rule shall take effect at such time as the agency promulgating the
rule determines.
Pursuant to section 808(2) of the CRA, the Treasury Department and
the IRS find, for good cause, that a 60-day delay in the effective date
is unnecessary and contrary to the public interest. In general, the
statutory provisions to which these rules relate were enacted on
December 22, 2017, and apply to taxable years of foreign corporations
beginning after 2017 and to the taxable years of U.S. persons in which
or with which such taxable years of foreign corporations end. In many
cases, these taxable years have already ended. This means that the
statutory provisions are currently effective, and taxpayers may be
subject to Federal income tax liability for their 2018 taxable year
reflecting these provisions. In certain cases, taxpayers may be
required to file returns reflecting this Federal income liability
during the 60-day period that begins after this rule is published in
the Federal Register.
These final regulations provide crucial guidance for taxpayers on
how to apply the relevant statutory rules, compute their tax liability
and accurately file their U.S. income tax returns. These final
regulations resolve statutory ambiguity, prevent abuse, and grant
taxpayer relief that would not be available based solely on the
statute. As taxpayers must already comply with the statute, a 60-day
delay in the effective date of the final regulations is unnecessary and
contrary to the public interest. A delay would place certain taxpayers
in the unusual position of having to determine whether to file U.S.
income tax returns during the pre-effective date period based on final
regulations that are not yet effective. If taxpayers chose not to
follow the final regulations and did not amend their returns after the
regulations became effective, it would place significant strain on the
IRS to ensure that taxpayers correctly calculated their tax
liabilities. For example, these final regulations provide significant
guidance on foreign branch category income, a provision added by the
TCJA along with a broad grant of regulatory authority to provide
additional guidance. Therefore, the rules in this Treasury decision are
effective on the date of publication in the Federal Register and apply
in certain cases to taxable years of foreign corporations and U.S.
persons beginning before such date.
The foregoing good cause statement only applies to the 60-day
delayed effective date provision of section 801(3) of the CRA and is
permitted under section 808(2) of the CRA. The Treasury Department and
the IRS hereby comply with all aspects of the CRA and the
Administrative Procedure Act (5 U.S.C. 551 et seq.).
Drafting Information
The principal authors of these regulations are Karen J. Cate,
Jeffrey P. Cowan, Jeffrey L. Parry, Larry R. Pounders, and Suzanne M.
Walsh of the Office of Associate Chief Counsel
[[Page 69058]]
(International). However, other personnel from the Treasury Department
and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Adoption of Amendments to the Regulations
Accordingly, 26 CFR part 1 is amended as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 is amended by:
0
1. Revising the entries for Sec. Sec. 1.861-8, 1.861-9 and 1.861-9T,
1.861-10(e), and 1.861-11.
0
2. Adding entries for Sec. Sec. 1.861-13, 1.861-17, 1.901(j)-1, 1.904-
1, 1.904-2, and 1.904-3 in numerical order.
0
3. Revising entries for Sec. Sec. 1.904-4, 1.904-5, and 1.904-6.
0
4. Adding entries for Sec. Sec. 1.904(g)-3 and 1.905-3 in numerical
order.
0
5. Revising the entry for Sec. 1.960-1.
0
6. Adding entries for Sec. Sec. 1.960-2, 1.960-3, 1.960-4, and
1.986(a)-1 in numerical order.
The revisions and additions read in part as follows:
Authority: 26 U.S.C. 7805.
* * * * *
Section 1.861-8 also issued under 26 U.S.C. 250(c), 26 U.S.C.
864(e)(7), and 26 U.S.C. 882(c).
Sections 1.861-9 and 1.861-9T also issued under 26 U.S.C.
863(a), 26 U.S.C. 864(e)(7), 26 U.S.C. 865(i), and 26 U.S.C.
7701(f).
Section 1.861-10(e) also issued under 26 U.S.C. 863(a), 26
U.S.C. 864(e)(7), 26 U.S.C. 865(i), and 26 U.S.C. 7701(f).
Section 1.861-11 also issued under 26 U.S.C. 863(a), 26 U.S.C.
864(e)(7), 26 U.S.C. 865(i), and 26 U.S.C. 7701(f).
* * * * *
Section 1.861-13 also issued under 26 U.S.C. 864(e)(7).
* * * * *
Section 1.861-17 also issued under 26 U.S.C. 864(e)(7).
* * * * *
Section 1.901(j)-1 also issued under 26 U.S.C. 901(j)(4).
* * * * *
Section 1.904-1 also issued under 26 U.S.C. 904(d)(7).
Section 1.904-2 also issued under 26 U.S.C. 904(d)(7).
Section 1.904-3 also issued under 26 U.S.C. 904(d)(7).
Section 1.904-4 also issued under 26 U.S.C. 250(c), 26 U.S.C.
865(j), 26. U.S.C. 904(d)(2)(J)(i), 26 U.S.C. 904(d)(6)(C), 26
U.S.C. 904(d)(7), and 26 U.S.C. 951A(f)(1)(B).
Section 1.904-5 also issued under 26 U.S.C. 904(d)(7) and 26
U.S.C. 951A(f)(1)(B).
Section 1.904-6 also issued under 26 U.S.C. 904(d)(7).
* * * * *
Section 1.904(g)-3 also issued under 26 U.S.C. 904(g)(4).
* * * * *
Section 1.905-3 also issued under 26 U.S.C. 989(c)(4).
* * * * *
Section 1.960-1 also issued under 26 U.S.C. 960(f).
Section 1.960-2 also issued under 26 U.S.C. 960(f).
Section 1.960-3 also issued under 26 U.S.C. 960(f).
Section 1.960-4 also issued under 26 U.S.C. 951A(f)(1)(B) and 26
U.S.C. 960(f).
* * * * *
Section 1.986(a)-1 also issued under 26 U.S.C. 986(a)(1)(C) and
26 U.S.C. 986(a)(1)(D)(ii).
* * * * *
0
Par. 2. Section 1.861-8 is amended by:
0
1. In paragraph (a)(1), removing the last sentence.
0
2. In paragraph (a)(4), removing the fourth through sixth sentences.
0
3. Removing paragraph (a)(5).
0
4. Revising paragraph (c)(2).
0
5. Adding paragraph (c)(4).
0
6. Revising paragraph (d)(2).
0
7. In paragraph (e)(1), adding two sentences after the sixth sentence.
0
8. In paragraph (e)(6)(i), adding a new first sentence and revising the
new second sentence.
0
9. Removing paragraph (e)(6)(iii).
0
10. Removing and reserving paragraph (e)(10).
0
11. Removing paragraph (e)(12)(iv).
0
12. Adding paragraphs (e)(13) through (15).
0
13. Removing and reserving paragraph (f)(1)(i).
0
14. Adding paragraph (f)(1)(ii).
0
15. Revising paragraphs (f)(4)(ii) and (g).
0
16. Adding paragraph (h).
The revisions and additions read as follows:
Sec. 1.861-8 Computation of taxable income from sources within the
United States and from other sources and activities.
* * * * *
(c) * * *
(2) Apportionment based on assets. Certain taxpayers are required
by paragraph (e)(2) of this section and Sec. 1.861-9T to apportion
interest expense on the basis of assets. A taxpayer may apportion other
deductions based on the comparative value of assets that generate
income within each grouping, provided that this method reflects the
factual relationship between the deduction and the groupings of income
and is applied in accordance with the rules of Sec. 1.861-9T(g). In
general, such apportionments must be made either on the basis of the
tax book value of those assets or, except in the case of interest
expense, on the basis of their fair market value. See Sec. 1.861-9(h).
Taxpayers using the fair market value method for their last taxable
year beginning before January 1, 2018, must change to the tax book
value method (or the alternative tax book value method) for purposes of
apportioning interest expense for their first taxable year beginning
after December 31, 2017. The Commissioner's approval is not required
for this change. In the case of any corporate taxpayer that both uses
tax book value or alternative tax book value, and owns directly or
indirectly (within the meaning of Sec. 1.861-12T(c)(2)(ii)(B)) 10
percent or more of the total combined voting power of all classes of
stock entitled to vote in any other corporation (domestic or foreign)
that is not a member of the affiliated group (as defined in section
864(e)(5)), the taxpayer must adjust its basis in that stock in the
manner described in Sec. 1.861-12(c)(2). For the definition of related
persons formerly contained in Sec. 1.861-8T(c)(2), see paragraph
(c)(4) of this section.
* * * * *
(4) Cross-referenced definition of related persons. The term
related persons means two or more persons in a relationship described
in section 267(b). In determining whether two or more corporations are
members of the same controlled group under section 267(b)(3), a person
is considered to own stock owned directly by such person, stock owned
by with the application of section 1563(e)(1), and stock owned by
application of section 267(c). In determining whether a corporation is
related to a partnership under section 267(b)(10), a person is
considered to own the partnership interest owned directly by such
person and the partnership interest owned with the application of
section 267(e)(3).
(d) * * *
(2) Allocation and apportionment to exempt, excluded, or eliminated
income--(i) In general. For further guidance, see Sec. 1.861-
8T(d)(2)(i).
(ii) Exempt income and exempt asset defined--(A) In general. For
purposes of this section, the term exempt income means any gross income
to the extent that it is exempt, excluded, or eliminated for Federal
income tax purposes. The term exempt asset means any asset to the
extent income from the asset is (or is treated as under paragraph
(d)(2)(ii)(B) or (C) of this section)
[[Page 69059]]
exempt, excluded, or eliminated for Federal income tax purposes.
(B) Certain stock and dividends. For further guidance, see Sec.
1.861-8T(d)(2)(ii)(B).
(C) Foreign-derived intangible income and inclusions under section
951A(a)--(1) Exempt income. The term ``exempt income'' includes an
amount of a domestic corporation's gross income included in gross
foreign-derived deduction eligible income (or gross FDDEI), and also
includes an amount of a domestic corporation's gross income from an
inclusion under section 951A(a) and the gross up under section 78
attributable to such an inclusion, in each case equal to the amount of
the deduction allowed under section 250(a) for such gross income
(taking into account the reduction under section 250(a)(2)(B), if any).
Therefore, for purposes of apportioning deductions using a gross income
method, gross income does not include gross income included in gross
FDDEI, an inclusion under section 951A(a), or the gross up under
section 78 attributable to an inclusion under section 951A(a), in an
amount equal to the amount of the deduction allowed under section
250(a)(1)(A), (B)(i), or (B)(ii), respectively (taking into account the
reduction under section 250(a)(2)(B), if any). The term gross foreign-
derived deduction eligible income, or gross FDDEI, means the portion of
the domestic corporation's gross income (determined without regard to
the amounts described in section 250(b)(3)(A)(i)(I) through (VI)) that
is derived from sales and services described in section 250(b)(4)(A)
and (B).
(2) Exempt assets--(i) Assets that produce foreign-derived
intangible income. The term ``exempt asset'' includes the portion of a
domestic corporation's assets that produce gross FDDEI equal to the
amount of such assets multiplied by the fraction that equals the amount
of the domestic corporation's deduction allowed under section
250(a)(1)(A) (taking into account the reduction under section
250(a)(2)(B)(i), if any) divided by its gross FDDEI. No portion of the
value of stock in a foreign corporation is treated as an exempt asset
by reason of this paragraph (d)(2)(ii)(C)(2)(i), including by reason of
a transfer of intangible property to a foreign corporation subject to
section 367(d) that gives rise to gross FDDEI.
(ii) Controlled foreign corporation stock that gives rise to
inclusions under section 951A(a). The term ``exempt asset'' includes a
portion of the value of a United States shareholder's stock in a
controlled foreign corporation if the United States shareholder is a
domestic corporation that is eligible for a deduction under section
250(a) with respect to income described in section 250(a)(1)(B)(i) and
all or a portion of the domestic corporation's stock in the controlled
foreign corporation is characterized as GILTI inclusion stock. The
portion of foreign corporation stock that is treated as an exempt asset
for a taxable year equals the portion of the value of such foreign
corporation stock (determined in accordance with Sec. Sec. 1.861-9(g),
1.861-12, and 1.861-13) that is characterized as GILTI inclusion stock
multiplied by a fraction that equals the amount of the domestic
corporation's deduction allowed under section 250(a)(1)(B)(i) (taking
into account the reduction under section 250(a)(2)(B)(ii), if any)
divided by its GILTI inclusion amount (as defined in Sec. 1.951A-
1(c)(1) or, in the case of a member of a consolidated group, Sec.
1.1502-51(b)) for such taxable year. The portion of controlled foreign
corporation stock treated as an exempt asset under this paragraph
(d)(2)(ii)(C)(2)(ii) is treated as attributable to the relevant
categories of GILTI inclusion stock described in each of paragraphs
(d)(2)(ii)(C)(3)(i) through (v) of this section based on the relative
value of the portion of the stock in each such category.
(3) GILTI inclusion stock. For purposes of paragraph
(d)(2)(ii)(C)(2)(ii) of this section, the term GILTI inclusion stock
means the aggregate of the portions of the value of controlled foreign
corporation stock that are--
(i) Assigned to the section 951A category under Sec. 1.861-
13(a)(2);
(ii) Assigned to a particular treaty category under Sec. 1.861-
13(a)(3)(i) (relating to resourced gross tested income stock);
(iii) Assigned under Sec. 1.861-13(a)(1) to the gross tested
income statutory grouping within the foreign source passive category
less the amount described in Sec. 1.861-13(a)(5)(iii)(A);
(iv) Assigned under Sec. 1.861-13(a)(1) to the gross tested income
statutory grouping within the U.S. source general category less the
amount described in Sec. 1.861-13(a)(5)(iv)(A); and
(v) Assigned under Sec. 1.861-13(a)(1) to the gross tested income
statutory grouping within the U.S. source passive category less the
amount described in Sec. 1.861-13(a)(5)(iv)(B).
(4) Non-applicability to section 250(b). Paragraphs
(d)(2)(ii)(C)(1) through (3) of this section do not apply when
apportioning deductions for purposes of determining deduction eligible
income or foreign-derived deduction eligible income under the operative
section of section 250(b).
(5) Example. The following example illustrates the application
of the rules in this paragraph (d)(2)(ii)(C).
(i) Facts. USP, a domestic corporation, directly owns all of the
stock of CFC1 and CFC2, both of which are controlled foreign
corporations. The tax book value of CFC1 and CFC2's stock is
$10,000x and $9,000x, respectively. Pursuant to Sec. 1.861-13(a),
$6,100x of the stock of CFC1 is assigned to the section 951A
category under Sec. 1.861-13(a)(2) (``section 951A category
stock'') and the remaining $3,900x of the stock of CFC1 is assigned
to the general category (``general category stock''). Additionally,
$4,880x of the stock of CFC2 is section 951A category stock and the
remaining $4,120x of the stock of CFC2 is general category stock.
Under section 951A and the section 951A regulations (as defined in
Sec. 1.951A-1(a)(1)), USP's GILTI inclusion amount is $610x. The
portion of USP's deduction under section 250 described in section
250(a)(1)(B)(i) is $305x. No portion of USP's deduction is reduced
by reason of section 250(a)(2)(B)(ii).
(ii) Analysis. For purposes of apportioning deductions where
section 904 is the operative section, under paragraph
(d)(2)(ii)(C)(1) of this section, $305x of USP's gross income
attributable to its GILTI inclusion amount is exempt income. Under
paragraph (d)(2)(ii)(C)(3) of this section, the GILTI inclusion
stock of CFC1 is the $6,100x of stock that is section 951A category
stock and the GILTI inclusion stock of CFC2 is the $4,880x of stock
that is section 951A category stock. Under paragraph
(d)(2)(ii)(C)(2) of this section, the portion of the value of the
stock of CFC1 and CFC2 that is treated as an exempt asset equals the
portion of the value of the stock of CFC1 and CFC2 that is GILTI
inclusion stock multiplied by 50% ($305x/$610x). Accordingly, the
exempt portion of the stock of CFC1 is $3,050x (50% x $6,100x) and
the exempt portion of CFC2's stock is $2,440x (50% x $4,880x).
Therefore, the stock of CFC1 taken into account for purposes of
apportioning deductions is $3,050x of non-exempt section 951A
category stock and $3,900x of general category stock. The stock of
CFC2 taken into account for purposes of apportioning deductions is
$2,440x of non-exempt section 951A category stock and $4,120x of
general category stock.
(iii) Income that is not considered tax exempt. For further
guidance, see Sec. 1.861-8T(d)(2)(iii).
(A) For further guidance, see Sec. 1.861-8T(d)(2)(iii)(A) and (B).
(B) [Reserved]
(C) Dividends for which a deduction is allowed under section 245A;
(D) Foreign earned income as defined in section 911 (however, the
rules of Sec. 1.911-6 do not require the allocation and apportionment
of certain deductions, including home mortgage interest, to foreign
earned income for purposes of determining the deductions disallowed
under section 911(d)(6)); and
[[Page 69060]]
(E) Inclusions for which a deduction is allowed under section
965(c). See Sec. 1.965-6(c).
(iv) Value of stock attributable to previously taxed earnings and
profits. No portion of the value of stock in a controlled foreign
corporation is treated as an exempt asset by reason of the controlled
foreign corporation having previously taxed earnings and profits. For
example, no portion of the value of stock in a controlled foreign
corporation is treated as an exempt asset by reason of the adjustment
under Sec. 1.861-12(c)(2) in respect of previously taxed earnings and
profits described in section 959(c)(1) or (c)(2) (including earnings
and profits described in section 959(c)(2) by reason of section
951A(f)(1) and Sec. 1.951A-6(b)(1)). See also Sec. 1.965-6(c).
(e) * * * (1) * * * Paragraphs (e)(13) and (14) of this section
contain rules with respect to the allocation and apportionment of the
deduction allowed under section 250(a). Paragraph (e)(15) of this
section contains rules with respect to the allocation and apportionment
of a taxpayer's distributive share of a partnership's deductions. * * *
* * * * *
(6) * * * (i) * * * The deduction for foreign income, war profits
and excess profits taxes allowed by section 164 (including with respect
to a controlled foreign corporation)) is allocated and apportioned
among the applicable statutory and residual groupings under the
principles of Sec. 1.904-6(a)(1)(i), (ii), and (iv). The deduction for
state and local taxes (state income taxes) allowed by section 164 is
considered definitely related and allocable to the gross income with
respect to which such state income taxes are imposed. * * *
* * * * *
(13) Foreign-derived intangible income. The portion of the
deduction that is allowed for foreign-derived intangible income under
section 250(a)(1)(A) (taking into account the reduction under section
250(a)(2)(B)(i), if any) is considered definitely related and allocable
to the class of gross income included in the taxpayer's foreign-derived
deduction eligible income (as defined in section 250(b)(4)). If
necessary, the portion of the deduction is apportioned within the class
ratably between the statutory grouping (or among the statutory
groupings) of gross income and the residual grouping of gross income
based on the relative amounts of foreign-derived deduction eligible
income in each grouping.
(14) Global intangible low-taxed income and related section 78
gross up. The portion of the deduction (taking into account the
reduction under section 250(a)(2)(B)(ii), if any) that is allowed for
the global intangible low-taxed income amount described in section
250(a)(1)(B)(i), and that is allowed for the section 78 gross up under
section 250(a)(1)(B)(ii), is considered definitely related and
allocable to the class of gross income included under section 951A(a)
and section 78, respectively. If necessary (for example, because a
portion of the inclusion under section 951A(a) is passive category
income or U.S. source income), the portion of the deduction is
apportioned within the class ratably between the statutory grouping (or
among the statutory groupings) of gross income and the residual
grouping of gross income based on the relative amounts of gross income
in each grouping.
(15) Distributive share of partnership deductions. In general, if
deductions are incurred by a partnership in which the taxpayer is a
partner, the taxpayer's deductions that are allocated and apportioned
include the taxpayer's distributive share of the partnership's
deductions. See Sec. Sec. 1.861-9(e), 1.861-17(f), and 1.904-
4(n)(1)(ii) for special rules for apportioning a partner's distributive
share of deductions of a partnership.
(f) * * *
(1) * * *
(ii) Separate foreign tax credit limitations. Section 904(d)(1) and
other sections described in Sec. 1.904-4(m) require that a separate
foreign tax credit limitation be determined with respect to each
separate category of income specified in those sections. Accordingly,
the foreign source income within each separate category described in
Sec. 1.904-5(a)(4)(v) constitutes a separate statutory grouping of
income. U.S. source income is treated as income in the residual
grouping for purposes of determining the limitation on the foreign tax
credit.
* * * * *
(4) * * *
(ii) Example--(A) Facts. USP, a domestic corporation, purchases
and sells consumer items in the United States and foreign markets.
Its sales in foreign markets are made to related foreign
subsidiaries. USP reported $1,500,000x as sales during the taxable
year of which $1,000,000x was domestic sales and $500,000x was
foreign sales. USP took a deduction for expenses incurred by its
marketing department during the taxable year in the amount of
$150,000x. These expenses were determined to be allocable to both
domestic and foreign sales and are apportionable between such sales.
On audit of USP's return for the taxable year, the IRS adjusted,
under section 482, USP's sales to related foreign subsidiaries by
increasing the sales price by a total of $100,000x, thereby
increasing USP's foreign sales and total sales by the same amount.
Before the audit, USP allocated and apportioned the marketing
department deduction as follows:
Table 1 to Paragraph (f)(4)(ii)(A)
------------------------------------------------------------------------
------------------------------------------------------------------------
To gross income from domestic sales: $150,000x x $100,000x
($1,000,000x/$1,500,000x).................................
To gross income from foreign sales: $150,000x x ($500,000x/ 50,000x
$1,500,000x)..............................................
------------
Total.................................................. 150,000x
------------------------------------------------------------------------
(B) Analysis. As a result of the section 482 adjustment, the
apportionment of the deduction for the marketing department expenses
is redetermined as follows:
Table 2 to Paragraph (f)(4)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
To gross income from domestic sales: $150,000x x $93,750x
($1,000,000x/$1,600,000x).................................
To gross income from foreign sales:
$150,000x x ($600,000x/$1,600,000x).................... 56,250x
------------
Total.................................................. 150,000x
------------------------------------------------------------------------
[[Page 69061]]
* * * * *
(g) Examples. The following examples illustrate the principles of
the rules in this section. In each example, unless otherwise specified,
section 904 is the operative section. In addition, in each example,
where a method of allocation or apportionment is illustrated as an
acceptable method, it is assumed that such method is used by the
taxpayers on a consistent basis from year to year. Further, it is
assumed that each party named in each example operates on a calendar
year accounting basis and, where the party is a U.S. taxpayer, files
returns on a calendar year basis.
(1) through (18) [Reserved]
(19) Example 19: Supportive expense--(i) Facts--(A) USP, a
domestic corporation, purchases and sells products both in the
United States and in foreign countries. USP has no foreign
subsidiary and no international department. During the taxable year,
USP incurs the following expenses with respect to its worldwide
activities:
Table 3 to Paragraph (g)(19)(i)(A)
------------------------------------------------------------------------
------------------------------------------------------------------------
Personnel department expenses.............................. $50,000x
Training department expenses............................... 35,000x
General and administrative expenses........................ 55,000x
President's salary......................................... 40,000x
Sales manager's salary..................................... 20,000x
------------
Total.................................................. 200,000x
------------------------------------------------------------------------
(B) USP has domestic gross receipts from sales of $750,000x and
foreign gross receipts from sales of $500,000x and has gross income
from such sales in the same ratio, namely $300,000x from domestic
sources and $200,000x from foreign sources that is general category
income.
(ii) Analysis--(A) Allocation. The above expenses are definitely
related and allocable to all of USP's gross income derived from both
domestic and foreign markets.
(B) Apportionment. For purposes of applying the foreign tax
credit limitation, the statutory grouping is gross income from
sources outside the United States in general category income and the
residual grouping is gross income from sources within the United
States. USP's deductions for its worldwide sales activities must be
apportioned between these groupings. USP does not have a separate
international division which performs essentially all of the
functions required to manage and oversee its foreign activities. The
president and sales manager do not maintain time records. The
division of their time between domestic and foreign activities
varies from day to day and cannot be estimated on an annual basis
with any reasonable degree of accuracy. Similarly, there are no
facts which would justify a method of apportionment of their
salaries or of one of the other listed deductions based on more
specific factors than gross receipts or gross income. An acceptable
method of apportionment would be on the basis of gross receipts. The
apportionment of the $200,000x deduction is as follows:
Table 4 to Paragraph (g)(19)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
Apportionment of the $200,000x expense to the statutory $80,000x
grouping of gross income: $200,000x x [$500,000x/
($500,000x + $750,000x)]
Apportionment of the $200,000x expense to the residual 120,000x
grouping of gross income: $200,000x x [$750,000x/
($500,000x + $750,000x)]..................................
------------
Total apportioned supportive expense................... 200,000x
------------------------------------------------------------------------
(20) Example 20: Supportive expense--(i) Facts. Assume the same
facts as in paragraph (g)(19)(i) of this section (the facts in
Example 19), except that USP's president devotes only 5% of his time
to the foreign operations and 95% of his time to the domestic
operations and that USP's sales manager devotes approximately 10% of
her time to foreign sales and 90% of her time to domestic sales.
(ii) Analysis--(A) Allocation. The expenses incurred by USP with
respect to its worldwide activities are definitely related, and
therefore allocable to USP's gross income from both its foreign and
domestic markets.
(B) Apportionment. On the basis of the additional facts it is
not acceptable to apportion the salaries of the president and the
sales manager on the basis of gross receipts. It is acceptable to
apportion such salaries between the statutory grouping (gross income
from sources without the United States) and residual grouping (gross
income from sources within the United States) on the basis of time
devoted to each sales activity. Remaining expenses may still be
apportioned on the basis of gross receipts. The apportionment is as
follows:
Table 5 to Paragraph (g)(20)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
Apportionment of the $200,000x expense to the statutory
grouping of gross income:
President's salary: $40,000x x 5%...................... $2,000x
Sales manager's salary: $20,000x x 10%................. 2,000x
Remaining expenses: $140,000x x [$500,000x/($500,000x + 56,000x
$750,000x)]...........................................
------------
Subtotal: Apportionment of expense to statutory 60,000x
grouping..........................................
Apportionment of the $200,000x expense to the residual
grouping of gross income:
President's salary: $40,000x x 95%..................... 38,000x
Sales manager's salary: $20,000x x 90%................. 18,000x
Remaining expenses: $140,000x x [$750,000x/($500,000x + 84,000x
$750,000x)]...........................................
------------
Subtotal: Apportionment of expense to residual 140,000x
grouping..........................................
------------
Total: Apportioned supportive expense.......... 200,000x
------------------------------------------------------------------------
[[Page 69062]]
(21) Example 21: Supportive expense--(i) Facts. FC, a foreign
corporation doing business in the United States, is a manufacturer
of metal stamping machines. FC has no U.S. subsidiaries and no
separate division to manage and oversee its business in the United
States. FC manufactures and sells these machines in the United
States and in foreign countries A and B and has a separate
manufacturing facility in each country. Sales of these machines are
FC's only source of income. In Year 1, FC incurs general and
administrative expenses related to both its U.S. and foreign
operations of $100,000x. It has machine sales of $500,000x,
$1,000,000x, and $1,000,000x on which it earns gross income of
$200,000x, $400,000x, and $400,000x in the United States, Country A,
and Country B, respectively. The income from the manufacture and
sale of the machines in countries A and B is not effectively
connected with FC's business in the United States.
(ii) Analysis--(A) Allocation. The $100,000x of general and
administrative expense is definitely related to the income to which
it gives rise, namely a part of the gross income from sales of
machines in the United States, in Country A, and in Country B. The
expenses are allocable to this class of income, even though FC's
gross income from sources outside the United States is excluded
income since it is not effectively connected with a U.S. trade or
business.
(B) Apportionment. Since FC is a foreign corporation, the
statutory grouping is gross income effectively connected with FC's
trade of business in the United States, namely gross income from
sources within the United States, and the residual grouping is gross
income not effectively connected with a trade or business in the
United States, namely gross income from countries A and B. Since
there are no facts that would require a method of apportionment
other than on the basis of sales or gross income, the amount may be
apportioned between the two groupings on the basis of amounts of
gross income as follows:
Table 6 to Paragraph (g)(21)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
Apportionment of general and administrative expense to the $20,000x
statutory grouping, gross income from sources within the
United States: $100,000x x [$200,000x/($200,000x +
$400,000x + $400,000x)]...................................
Apportionment of general and administrative expense to the 80,000x
residual grouping, gross income from sources without the
United States: $100,000x x [($400,000x + $400,000x)/
($200,000x + $400,000x + $400,000x)]......................
------------
Total apportioned general and administrative expense... 100,000x
------------------------------------------------------------------------
(22) through (24) [Reserved]
(25) Example 25: Income taxes--(i) Facts. USP, a domestic
corporation, is a manufacturer and distributor of electronic
equipment with operations in states A, B, and C. USP also has a
foreign branch, as defined in section 904(d)(1)(B) and Sec. 1.904-
4(f), in Country Y which manufactures and distributes the same type
of electronic equipment. In Year 1, USP has taxable income from
these activities, as described under the Code (without taking into
account the deduction for state income taxes), of $1,000,000x, of
which $200,000x is foreign source foreign branch category income and
$800,000x is domestic source income. States A, B, and C each
determine USP's income subject to tax within their state by making
adjustments to USP's taxable income as determined under the Code,
and then apportioning the adjusted taxable income on the basis of
the relative amounts of USP's payroll, property, and sales within
each state as compared to USP's worldwide payroll, property, and
sales. The adjustments made by states A, B, and C all involve adding
and subtracting enumerated items from taxable income as determined
under the Code. However, in making these adjustments to taxable
income, none of the states specifically exempts foreign source
income as determined under the Code. On this basis, it is determined
that USP has taxable income of $550,000x, $200,000x, and $200,000x
in states A, B, and C, respectively. The corporate tax rates in
states A, B, and C are 10%, 5%, and 2%, respectively, and USP has
total state income tax liabilities of $69,000x ($55,000x + $10,000x
+ $4,000x), which it deducts as an expense for Federal income tax
purposes.
(ii) Analysis--(A) Allocation. USP's deduction of $69,000x for
state income taxes is definitely related and thus allocable to the
gross income with respect to which the taxes are imposed. Since the
statutes of states A, B, and C do not specifically exempt foreign
source income (as determined under the Code) from taxation and
since, in the aggregate, states A, B, and C tax $950,000x of USP's
income while only $800,000x is domestic source income under the
Code, it is presumed that state income taxes are imposed on
$150,000x of foreign source income. The deduction for state income
taxes is therefore related and allocable to both USP's foreign
source and domestic source income.
(B) Apportionment. For purposes of computing the foreign tax
credit limitation, USP's income is comprised of one statutory
grouping, foreign source foreign branch category gross income, and
one residual grouping, gross income from sources within the United
States. The state income tax deduction of $69,000x must be
apportioned between these two groupings. Corporation USP calculates
the apportionment on the basis of the relative amounts of foreign
source foreign branch category taxable income and U.S. source
taxable income subject to state taxation. In this case, state income
taxes are presumed to be imposed on $800,000x of domestic source
income and $150,000x of foreign source general category income.
Table 7 to Paragraph (g)(25)(ii)(B)
------------------------------------------------------------------------
------------------------------------------------------------------------
State income tax deduction apportioned to foreign source $10,895x
foreign branch category income (statutory grouping):
$69,000x x ($150,000x/$950,000x)..........................
State income tax deduction apportioned to income from 58,105x
sources within the United States (residual grouping):
$69,000x x ($800,000x/$950,000x)..........................
------------
Total apportioned state income tax deduction........... 69,000x
------------------------------------------------------------------------
(26) Example 26: Income taxes--(i) Facts. Assume the same facts
as in paragraph (g)(25)(i) of this section (the facts in Example
25), except that the language of state A's statute and the statute's
operation exempt from taxation all foreign source income, as
determined under the Code, so that foreign source income is not
included in adjusted taxable income subject to apportionment in
state A (and factors relating to USP's Country Y branch are not
taken into account in computing the state A apportionment fraction).
(ii) Analysis--(A) Allocation. USP's deduction of $69,000x for
state income taxes is definitely related and thus allocable to the
gross income with respect to which the taxes are imposed. Since
state A exempts all foreign source income by statute, state A is
presumed to impose tax on $550,000x of USP's $800,000x of domestic
source income. USP's state A tax of $55,000x is allocable,
therefore, solely to domestic source income. Since the statutes of
states B and C do not specifically exclude all foreign source income
as determined under the Code, and since states B and C impose tax on
$400,000x ($200,000x + $200,000x) of USP's income of which only
$250,000x ($800,000x-$550,000x) is presumed to be
[[Page 69063]]
domestic source, the deduction for the $14,000x of income taxes
imposed by states B and C is related and allocable to both foreign
source and domestic source income.
(B) Apportionment--(1) For purposes of computing the foreign tax
credit limitation, USP's income is comprised of one statutory
grouping, foreign source foreign branch category gross income, and
one residual grouping, gross income from sources within the United
States. The deduction of $14,000x for income taxes of states B and C
must be apportioned between these two groupings.
(2) Corporation USP calculates the apportionment on the basis of
the relative amounts of foreign source foreign branch category
income and U.S. source income subject to state taxation.
Table 8 to Paragraph (g)(26)(ii)(B)(2)
------------------------------------------------------------------------
------------------------------------------------------------------------
States B and C income tax deduction apportioned to foreign $5,250x
source foreign branch category income (statutory
grouping): $14,000x x ($150,000x/$400,000x)...............
States B and C income tax deduction apportioned to income 8,750x
from sources within the United States (residual grouping):
$14,000x x ($250,000x/$400,000x)..........................
------------
Total apportioned state income tax deduction........... 14,000x
------------------------------------------------------------------------
(3) Of USP's total income taxes of $69,000x, the amount
allocated and apportioned to foreign source foreign branch category
income equals $5,250x. The total amount of state income taxes
allocated and apportioned to U.S. source income equals $63,750x
($55,000x + $8,750x).
(27) Example 27: Income tax--(i) Facts. Assume the same facts as
in paragraph (g)(25)(i) of this section (the facts in Example 25),
except that state A, in which USP has significant income-producing
activities, does not impose a corporate income tax or other state
tax computed on the basis of income derived from business activities
conducted in state A. USP therefore has a total state income tax
liability in Year 1 of $14,000x ($10,000x paid to state B plus
$4,000x paid to state C), all of which is subject to allocation and
apportionment under paragraph (b) of this section.
(ii) Analysis--(A) Allocation--(1) USP's deduction of $14,000x
for state income taxes is definitely related and allocable to the
gross income with respect to which the taxes are imposed. However,
in these facts, an adjustment is necessary before the aggregate
state taxable incomes can be compared with U.S. source income on the
Federal income tax return in the manner described in paragraphs
(g)(25)(ii) and (g)(26)(ii) of this section (the analysis in
Examples 25 and 26). Unlike the facts in paragraphs (g)(25)(i) and
(g)(26)(i) of this section (the facts in Examples 25 and 26), state
A imposes no income tax and does not define taxable income
attributable to activities in state A. The total amount of USP's
income subject to state taxation is, therefore, $400,000x ($200,000x
in state B and $200,000x in state C). This total presumptively does
not include any income attributable to activities performed in state
A and therefore cannot properly be compared to total U.S. source
taxable income reported by USP for Federal income tax purposes,
which does include income attributable to state A activities.
(2)(i) Accordingly, before applying the method used in
paragraphs (g)(25)(ii) and (g)(26)(ii) of this section (the analysis
in Examples 25 and 26) to the facts of the example in this paragraph
(g)(27), it is necessary first to estimate the amount of taxable
income that state A could reasonably attribute to USP's activities
in state A, and then to reduce federal taxable income by that
amount.
(ii) Any reasonable method may be used to attribute taxable
income to USP's activities in state A. For example, the rules of the
Uniform Division of Income for Tax Purposes Act (``UDITPA'')
attribute income to a state on the basis of the average of three
ratios that are based upon the taxpayer's facts--property within the
state over total property, payroll within the state over total
payroll, and sales within the state over total sales--and, with
adjustments, provide a reasonable method for this purpose. When
applying the rules of UDITPA to estimate U.S. source income derived
from state A activities, the taxpayer's UDITPA factors must be
adjusted to eliminate both taxable income and factors attributable
to a foreign branch. Therefore, in the example in this paragraph
(g)(27) all taxable income as well as UDITPA apportionment factors
(property, payroll, and sales) attributable to USP's Country Y
branch must be eliminated.
(3)(i) Since it is presumed that, if state A had had an income
tax, state A would not attempt to tax the income derived by USP's
Country Y branch, any reasonable estimate of the income that would
be taxed by state A must exclude any foreign source income.
(ii) When using the rules of UDITPA to estimate the income that
would have been taxable by state A in these facts, foreign source
income is excluded by starting with federally defined taxable income
(before deduction for state income taxes) and subtracting any income
derived by USP's Country Y branch. The hypothetical state A taxable
income is then determined by multiplying the resulting difference by
the average of USP's state A property, payroll, and sales ratios,
determined using the principles of UDITPA (after adjustment by
eliminating the Country Y branch factors). The resulting product is
presumed to be exclusively U.S. source income, and the allocation
and apportionment method described in paragraph (g)(26) of this
section (Example 26) must then be applied.
(iii) If, for example, state A taxable income were determined to
equal $550,000x, then $550,000x of U.S. source income for Federal
income tax purposes would be presumed to constitute state A taxable
income. Under paragraph (g)(26) of this section (Example 26), the
remaining $250,000x ($800,000x-$550,000x) of U.S. source income for
Federal income tax purposes would be presumed to be subject to tax
in states B and C. Since states B and C impose tax on $400,000x, the
application of Example 25 would result in a presumption that
$150,000x is foreign source income and $250,000x is domestic source
income. The deduction for the $14,000x of income taxes of states B
and C would therefore be related and allocable to both foreign
source and domestic source income and would be subject to
apportionment.
(B) Apportionment. The deduction of $14,000x for income taxes of
states B and C is apportioned in the same manner as in paragraph
(g)(26) of this section (Example 26). As a result, $5,250x of the
$14,000x of state B and state C income taxes is apportioned to
foreign source foreign branch category income ($14,000x x $150,000x/
$400,000x), and $8,750x ($14,000x x $250,000x/$400,000x) of the
$14,000x of state B and state C income taxes is apportioned to U.S.
source income.
(h) Applicability date. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 3. Section 1.861-8T is amended by:
0
1. Revising paragraphs (c)(2) and (d)(2)(ii)(A).
0
2. Redesignating paragraphs (d)(2)(ii)(B)(1) and (2) as paragraphs
(d)(2)(ii)(B)(1)(i) and (ii).
0
3. Designating paragraph (d)(2)(ii)(B) introductory text as paragraph
(d)(2)(ii)(B)(1) introductory text.
0
4. Designating the undesignated paragraph following newly redesignated
paragraph (d)(2)(ii)(B)(1)(ii) as paragraph (d)(2)(ii)(B)(2).
0
5. Adding paragraph (d)(2)(ii)(C).
0
6. Adding the word ``and'' at the end of paragraph (d)(2)(iii)(B).
0
7. Revising paragraph (d)(2)(iii)(C).
0
8. Removing and reserving paragraph (d)(2)(iii)(D) and adding reserved
paragraph (d)(2)(iii)(E).
0
9. Revising paragraph (d)(2)(iv).
0
10. Removing paragraphs (e)(3) through (f)(1)(i), (f)(1)(ii), and
(f)(1)(iii) through (g).
0
11. Adding paragraph (e)(3), reserved paragraphs (e)(4) through (15),
paragraph (f), and reserved paragraph (g).
[[Page 69064]]
The revisions and additions read as follows:
Sec. 1.861-8T Computation of taxable income from sources within the
United States and from other sources and activities (temporary).
* * * * *
(c) * * *
(2) Apportionment based on assets. For further guidance, see Sec.
1.861-8(c)(2).
* * * * *
(d) * * *
(2) * * *
(ii) * * *
(A) In general. For further guidance, see Sec. 1.861-
8(d)(2)(ii)(A).
* * * * *
(C) Foreign-derived intangible income and inclusions under section
951A(a). For further guidance, see Sec. 1.861-8(d)(2)(ii)(C).
(iii) * * *
(C) For further guidance, see Sec. 1.861-8(d)(2)(iii)(C) through
(E).
(D) and (E) [Reserved]
(iv) Value of stock attributable to previously taxed earnings and
profits. For further guidance, see Sec. 1.861-8(d)(2)(iv).
(e) * * *
(3) Research and experimental expenditures. For further guidance,
see Sec. 1.861-8(e)(3) through (15).
(4) through (15) [Reserved]
(f) Miscellaneous matters. For further guidance, see Sec. 1.861-
8(f) through (g).
(g) [Reserved]
* * * * *
0
Par. 4. Section 1.861-9 is amended by:
0
1. Revising the section heading.
0
2. Removing paragraphs (a) through (e)(1).
0
3. Adding paragraph (a), reserved paragraph (b), and paragraphs (c),
(d), and (e)(1).
0
4. Removing the last sentence in paragraphs (e)(2) and (3).
0
5. Removing paragraphs (e)(4) through (f)(3)(i).
0
6. Adding paragraphs (e)(4) through (10), (f) heading, (f)(1) and (2),
(f)(3) heading, and (f)(3)(i).
0
7. Revising the heading of paragraph (f)(4).
0
8. Removing the language ``noncontrolled section 902 corporation''
wherever it appears in paragraphs (f)(4)(i) and (ii) and adding the
language ``noncontrolled 10-percent owned foreign corporation'' in its
place.
0
9. Removing the last sentence of paragraph (f)(4)(ii).
0
10. Revising paragraph (f)(4)(iii).
0
11. Removing paragraphs (f)(5) through (h)(3).
0
12. Adding paragraphs (f)(5), (g), (h) introductory text, and (h)(1)
and reserved paragraphs (h)(2) and (3).
0
13. Revising paragraph (h)(5).
0
14. In paragraph (i)(2)(i):
0
i. Revising the first and second sentences.
0
ii. Removing the language ``paragraph (i)(2)'' from the third and
fourth sentences and adding the language ``paragraph (i)(2)(i)'' in its
place.
0
15. Revising paragraphs (j) and (k).
The revisions and additions read as follows:
Sec. 1.861-9 Allocation and apportionment of interest expense and
rules for asset-based apportionment.
(a) In general. For further guidance, see Sec. 1.861-9T(a) through
(b).
(b) [Reserved]
(c) Allowable deductions. For further guidance, see Sec. 1.861-
9T(c) introductory text.
(1) Disallowed deductions. For further guidance, see Sec. 1.861-
9T(c)(1) through (4).
(2) through (4) [Reserved]
(5) Section 163(j). If a taxpayer is subject to section 163(j), the
taxpayer's deduction for business interest expense is limited to the
sum of the taxpayer's business interest income, 30 percent of the
taxpayer's adjusted taxable income for the taxable year, and the
taxpayer's floor plan financing interest expense. In the taxable year
that any deduction is permitted for business interest expense with
respect to a disallowed business interest carryforward, that business
interest expense is apportioned for purposes of this section under
rules set forth in paragraph (d), (e), or (f) of this section (as
applicable) as though it were incurred in the taxable year in which the
expense is deducted.
(d) Apportionment rules for individuals, estates, and certain
trusts. For further guidance, see Sec. 1.861-9T(d).
(e) Partnerships--(1) In general--aggregate rule. For further
guidance, see Sec. 1.861-9T(e)(1).
* * * * *
(4) Entity rule for less than 10 percent limited partners--(i)
Partnership interest expense. A limited partner (whether individual or
corporate), whose ownership, together with ownership by persons that
bear a relationship to the partner described in section 267(b) or
section 707, of the capital and profits interests of the partnership is
less than 10 percent directly allocates its distributive share of
partnership interest expense to its distributive share of partnership
gross income. Under Sec. 1.904-4(n)(1)(ii), such a partner's
distributive share of foreign source income of the partnership is
treated as passive income (subject to the high-taxed income exception
of section 904(d)(2)(B)(iii)(II)), except in the case of income from a
partnership interest held in the ordinary course of the partner's
active trade or business, as defined in Sec. 1.904-4(n)(1)(ii)(B). A
partner's distributive share of partnership interest expense (other
than partnership interest expense that is directly allocated to
identified property under Sec. 1.861-10T) is apportioned in accordance
with the partner's relative distributive share of gross foreign source
income in each separate category and of gross domestic source income
from the partnership. To the extent that partnership interest expense
is directly allocated under Sec. 1.861-10T, a comparable portion of
the income to which such interest expense is allocated is disregarded
in determining the partner's relative distributive share of gross
foreign source income in each separate category and domestic source
income. The partner's distributive share of the interest expense of the
partnership that is directly allocable under Sec. 1.861-10T is
allocated according to the treatment, after application of Sec. 1.904-
4(n)(1), of the partner's distributive share of the income to which the
expense is allocated.
(ii) Other interest expense of the partner. For further guidance,
see Sec. 1.861-9T(e)(4)(ii).
(5) Tiered partnerships. For further guidance, see Sec. 1.861-
9T(e)(5) through (7).
(6) and (7) [Reserved]
(8) Special rule for downstream partnership loans--(i) In general.
For purposes of apportioning interest expense that is not directly
allocable under paragraph (e)(4) of this section or Sec. 1.861-10T,
the disregarded portion of a downstream partnership loan is not
considered an asset of a downstream partnership loan lender (DPL
lender). The disregarded portion of a downstream partnership loan is
the portion of the value of the loan (as determined under paragraph
(h)(4)(i) of this section) that bears the same proportion to the total
value of the loan as the matching income amount that is included by the
DPL lender for a taxable year with respect to the loan bears to the
total amount of downstream partnership loan interest income (DPL
interest income) that is included directly or indirectly in gross
income by the DPL lender with respect to the loan during that taxable
year.
(ii) Treatment of interest expense and interest income attributable
to a downstream partnership loan. If a DPL lender (or any other person
in the same
[[Page 69065]]
affiliated group as the DPL lender) takes into account a distributive
share of downstream partnership loan interest expense (DPL interest
expense), the DPL lender must assign an amount of DPL interest income
corresponding to the matching income amount for the taxable year that
is attributable to the same loan to the same statutory and residual
groupings as the statutory and residual groupings of gross income from
which the DPL interest expense is deducted (or would be deducted,
without regard to any limitations on the deductibility of interest,
such as section 163(j)) by the DPL lender (or any other person in the
same affiliated group as the DPL lender).
(iii) Anti-avoidance rule for third party back-to-back loans. If,
with a principal purpose of avoiding the rules in this paragraph
(e)(8), a person makes a loan to a person that is not related (within
the meaning of section 267(b) or 707) to the lender, the unrelated
person makes a loan to a partnership, and the first loan would
constitute a downstream partnership loan if made directly to the
partnership, then the rules of this paragraph (e)(8) apply as if the
first loan was made directly to the partnership and the interest
expense paid by the partnership is treated as made with respect to the
first loan. Such a series of loans will be subject to this
recharacterization rule without regard to whether there was a principal
purpose of avoiding the rules in this paragraph (e)(8) if the loan to
the unrelated person would not have been made or maintained on
substantially the same terms but for the loan of funds by the unrelated
person to the partnership. The principles of this paragraph (e)(8)(iii)
also apply to similar transactions that involve more than two loans and
regardless of the order in which the loans are made.
(iv) Anti-avoidance rule for loans held by CFCs. A loan receivable
held by a controlled foreign corporation with respect to a loan to a
partnership in which a United States shareholder (as defined in Sec.
1.904-5(a)(4)(vi)) of the controlled foreign corporation owns an
interest, directly or indirectly through one or more other partnerships
or other pass-through entities (as defined in Sec. 1.904-5(a)(4)(iv)),
is recharacterized as a loan receivable held directly by the United
States shareholder with respect to the loan to such partnership for
purposes of this paragraph (e)(8) if the loan was made or transferred
with a principal purpose of avoiding the rules in this paragraph
(e)(8). An appropriate amount of income derived by the United States
shareholder (or any other person in the same affiliated group as the
United States shareholder) from the controlled foreign corporation is
treated as DPL interest income. Appropriate adjustments must be made to
the value and characterization of the stock of the controlled foreign
corporation under Sec. Sec. 1.861-9 and 1.861-12 in order to reflect
the portion of the downstream partnership loan held by the controlled
foreign corporation that is disregarded under paragraph (e)(8)(i) of
this section.
(v) Interest equivalents. The principles of this paragraph (e)(8)
apply in the case of a partner, or any person in the same affiliated
group as the partner, that takes into account a distributive share of
an expense or loss (to the extent deductible) that is allocated and
apportioned in the same manner as interest expense under Sec. Sec.
1.861-9(b) and 1.861-9T(b) and has a matching income amount (treating
such interest equivalent as interest income or expense for purposes of
paragraph (e)(8)(vi)(B) of this section) with respect to the
transaction that gives rise to that expense or loss.
(vi) Definitions. For purposes of this paragraph (e)(8), the
following definitions apply.
(A) Affiliated group. The term affiliated group has the meaning
provided in Sec. 1.861-11(d)(1).
(B) Matching income amount. The term matching income amount means
the lesser of the total amount of the DPL interest income included
directly or indirectly in gross income by the DPL lender for the
taxable year with respect to a downstream partnership loan or the total
amount of the distributive shares of the DPL interest expense of the
DPL lender (or any other person in the same affiliated group as the DPL
lender) with respect to the loan.
(C) Downstream partnership loan. The term downstream partnership
loan means a loan to a partnership for which the loan receivable is
held, directly or indirectly through one or more other partnerships or
other pass-through entities, either by a person that owns an interest,
directly or indirectly through one or more other partnerships or other
pass-through entities, in the partnership, or by any person in the same
affiliated group as that person.
(D) Downstream partnership loan interest expense (DPL interest
expense). The term downstream partnership loan interest expense, or DPL
interest expense, means an item of interest expense paid or accrued
with respect to a downstream partnership loan, without regard to
whether the expense was currently deductible (for example, by reason of
section 163(j)).
(E) Downstream partnership loan interest income (DPL interest
income). The term downstream partnership loan interest income, or DPL
interest income, means an item of gross interest income received or
accrued with respect to a downstream partnership loan.
(F) Downstream partnership loan lender (DPL lender). The term
downstream partnership loan lender, or DPL lender, means the person
that holds the receivable with respect to a downstream partnership
loan. If a partnership holds the receivable, then any partner in the
partnership (other than a partner described in paragraph (e)(4)(i) of
this section) is also considered a DPL lender.
(vii) Examples. The following examples illustrate the application
of the rules in this paragraph (e)(8).
(A) Example 1--(1) Facts. US1, a domestic corporation, directly
owns 60% of PRS, a foreign partnership that is not engaged in a U.S.
trade or business. The remaining 40% of PRS is directly owned by
US2, a domestic corporation that is unrelated to US1. US1, US2, and
PRS all use the calendar year as their taxable year. In Year 1, US1
loans $1,000x to PRS. For Year 1, US1 has $100x of interest income
with respect to the loan and PRS has $100x of interest expense with
respect to the loan. US1's distributive share of the interest
expense is $60x. Under paragraph (e)(2) of this section, $45x of
US1's distributive share of the interest expense is apportioned to
U.S. source income and $15x is apportioned to foreign source foreign
branch category income. Under paragraph (h)(4)(i) of this section,
the total value of the loan between US1 and PRS is $1,000x.
(2) Analysis. The loan by US1 to PRS is a downstream partnership
loan and US1 is a DPL lender. Under paragraph (e)(8)(vi)(B) of this
section, the matching income amount is $60x, the lesser of the DPL
interest income included by US1 with respect to the loan for the
taxable year ($100x) and US1's distributive share of the DPL
interest expense ($60x). Under paragraph (e)(8)(ii) of this section,
US1 assigns $45x of the DPL interest income to U.S. source income
and $15x of the DPL interest income to foreign source foreign branch
category income. The source and separate category of the remaining
$40x of US1's DPL interest income is determined under the generally
applicable rules. Under paragraph (e)(8)(i) of this section, the
disregarded portion of the downstream partnership loan is $600x
($1,000x x $60x/$100x).
(B) Example 2--(1) Facts. The facts are the same as in paragraph
(e)(8)(vii)(A)(1) of this section (the facts in Example 1), except
that US1 and US2 are part of the same affiliated group, US2's
distributive share of the interest expense is $40x, and under
paragraph (e)(2) of this section, $30x of US2's distributive share
of the interest expense is apportioned to U.S. source income and
$10x is apportioned to foreign source foreign branch category
income.
(2) Analysis. The loan by US1 to PRS is a downstream partnership
loan and US1 is a DPL lender. Under paragraph (e)(8)(vi)(B) of this
section, the matching income amount is $100x, the lesser of the DPL
interest income
[[Page 69066]]
included by US1 with respect to the loan for the taxable year
($100x) and the total amount of US1 and US2's distributive shares of
the DPL interest expense ($100x). Under paragraph (e)(8)(ii) of this
section, US1 assigns $75x of the DPL interest income to U.S. source
income and $25x of the DPL interest income to foreign source foreign
branch category income. Under paragraph (e)(8)(i) of this section,
the disregarded portion of the downstream partnership loan is
$1,000x ($1,000x x $100x/$100x).
(C) Example 3--(1) Facts. US1, a domestic corporation, owns 80%
of PRS, a foreign partnership that is not engaged in a U.S. trade or
business. The remaining 20% of PRS is owned by US2, a domestic
corporation that is unrelated to US1. US1, US2, and PRS all use the
calendar year as their taxable year. In Year 1, US1 loans $3,000x to
Bank and Bank loans $3,000x to PRS. US1 makes the loan to Bank with
a principal purpose of avoiding the rules in this paragraph (e)(8).
For Year 1, US1 has $150x of interest income with respect to the
loan to Bank and PRS has $175x of interest expense with respect to
the loan from Bank. US1's distributive share of the interest expense
is $140x. Under paragraph (e)(2) of this section, $126x of US1's
distributive share of the interest expense is apportioned to U.S.
source income and $14x is apportioned to foreign source foreign
branch category income. Under paragraph (h)(4)(i) of this section,
the total value of the loan between US1 and PRS is $3,000x.
(2) Analysis. Under paragraph (e)(8)(iii) of this section,
because the loan from US1 to Bank is made with a principal purpose
of avoiding the rules of this paragraph (e)(8), the rules of this
paragraph (e)(8) apply as if the loan by US1 to Bank was made
directly to PRS. Accordingly, the loan by US1 to Bank is a
downstream partnership loan and US1 is a DPL lender. Under paragraph
(e)(8)(vi)(B) of this section, the matching income amount is $140x,
the lesser of the DPL interest income included by US1 with respect
to the loan for the taxable year ($150x) and US1's distributive
share of the DPL interest expense ($140x). Under paragraph
(e)(8)(ii) of this section, US1 assigns $126x of the DPL interest
income to U.S. source income and $14x of the DPL interest income to
foreign source foreign branch category income. The source and
separate category of the remaining $10x of US1's DPL interest income
is determined under the generally applicable rules. Under paragraph
(e)(8)(i) of this section, the disregarded portion of the downstream
partnership loan is $2,800x ($3,000x x $140x/$150x).
(D) Example 4--(1) Facts. US1, a domestic corporation, directly
owns all of the outstanding stock of CFC, a controlled foreign
corporation, and 90% of PRS, a foreign partnership that is not
engaged in a U.S. trade or business. The remaining 10% of PRS is
owned by US2, a domestic corporation that is unrelated to US1 and
CFC. US1, US2, and PRS all use the calendar year as their taxable
year. In Year 1, US1 loans $900x to CFC and CFC loans $900x to PRS.
CFC makes the loan with a principal purpose of avoiding the rules in
this paragraph (e)(8). For Year 1, CFC has $90x of interest income
and $90x of interest expense with respect to the loan to PRS, and
US1 has $90x of interest income with respect to the loan to CFC. PRS
has $90x of interest expense with respect to the loan, and US1's
distributive share of the interest expense is $81x. Under paragraph
(e)(2) of this section, $54x of US1's distributive share of the
interest expense is apportioned to U.S. source income and $27x is
apportioned to foreign source foreign branch category income. Under
paragraph (h)(4)(i) of this section, the total value of the loan
between CFC and PRS is $900x.
(2) Analysis. Under paragraph (e)(8)(iv) of this section,
because the loan from CFC to PRS is made with a principal purpose of
avoiding the rules of this paragraph (e)(8), the loan from CFC to
PRS is recharacterized as a loan receivable held directly by US1,
and an appropriate amount of income derived by US1, in this case,
the $90x of interest income from the loan to CFC, is treated as DPL
interest income. Accordingly, the loan from CFC to PRS is a
downstream partnership loan and US1 is a DPL lender. Under paragraph
(e)(8)(vi)(B) of this section, the matching income amount is $81x,
the lesser of the DPL interest income included by US1 ($90x) and
US1's distributive share of the DPL interest expense ($81x). Under
paragraph (e)(8)(ii) of this section, US1 assigns $54x of the DPL
interest income to U.S. source income and $27x of the DPL interest
income to foreign source foreign branch category income. The source
and separate category of the remaining $9x of US1's interest income
is determined under the generally applicable rules. Under paragraph
(e)(8)(i) of this section, the disregarded portion of the downstream
partnership loan is $810x ($900x x $81x/$90x). Appropriate
adjustments are made to the value and characterization of the stock
of CFC under Sec. Sec. 1.861-9 and 1.861-12 in order to reflect the
$810x disregarded portion of the downstream partnership loan.
(9) [Reserved]
(10) Characterizing certain partnership assets as foreign branch
category assets. For purposes of applying this paragraph (e) to section
904 as the operative section, a partner that is a United States person
that has a distributive share of partnership income that is treated as
foreign branch category income under Sec. 1.904-4(f)(1)(i)(B)
characterizes its pro rata share of the partnership assets that give
rise to such income as assets in the foreign branch category.
(f) Corporations--(1) Domestic corporations. For further guidance,
see Sec. 1.861-9T(f)(1).
(2) Section 987 QBUs of domestic corporations--(i) In general. In
the application of the asset method described in paragraph (g) of this
section, a domestic corporation--
(A) Takes into account the assets of any section 987 QBU (as
defined in Sec. 1.987-1(b)(2)), translated according to the rules set
forth in paragraph (g) of this section; and
(B) Combines with its own interest expense any deductible interest
expense incurred by a section 987 QBU, translated according to the
rules under section 987.
(ii) Coordination with section 987(3). For purposes of computing
foreign currency gain or loss under section 987(3) (including section
987 gain or loss recognized under Sec. 1.987-5), the rules of this
paragraph (f)(2) do not apply. See Sec. 1.987-4.
(iii) Example. The following example illustrates the application of
the rules in this paragraph (f)(2).
(A) Facts. X is a domestic corporation that operates B, a branch
doing business in a foreign country. B is a section 987 QBU (as
defined in Sec. 1.987-1(b)(2)) as well as a foreign branch (as
defined in Sec. 1.904-4(f)(3)(iii)). In 2020, without regard to B,
X has gross domestic source income of $1,000x and gross foreign
source general category income of $500x and incurs $200 of interest
expense. Using the tax book value method of apportionment, X,
without regard to B, determines the value of its assets that
generate domestic source income to be $6,000x and the value of its
assets that generate foreign source general category income to be
$1,000x. Applying the translation rules of section 987, X (through
B) earned $500 of gross foreign source foreign branch category
income and incurred $100x of interest expense. B incurred no other
expenses. For 2020, the average functional currency book value of
B's assets that generate foreign source foreign branch category
income translated at the year-end rate for 2020 is $3,000x.
(B) Analysis. The combined assets of X and B for 2020 (averaged
under Sec. 1.861-9T(g)(3)) consist 60% ($6,000x/$10,000x) of assets
generating domestic source income, 30% ($3,000x/$10,000x) of assets
generating foreign source foreign branch category income, and 10%
($1,000x/$10,000x) of assets generating foreign source general
category income. The combined interest expense of X and B is $300x.
Thus, $180x ($300x x 60%) of the combined interest expense is
apportioned to domestic source income, $90x ($300x x 30%) is
apportioned to foreign source foreign branch category income, and
$30x ($300x x 10%) is apportioned to foreign source general category
income, yielding net U.S. source income of $820 ($1,000x-$180x), net
foreign source foreign branch category income of $410 ($500x-$90x),
and net foreign source general category income of $470x ($500x-
$30x).
(3) Controlled foreign corporations--(i) In general. For purposes
of computing subpart F income and tested income and computing earnings
and profits for all Federal income tax purposes, the interest expense
of a controlled foreign corporation may be apportioned using either the
asset method described in paragraph (g) of this section or the modified
gross income method described in paragraph
[[Page 69067]]
(j) of this section, subject to the rules of paragraphs (f)(3)(ii) and
(iii) of this section.
* * * * *
(4) Noncontrolled 10-percent owned foreign corporations. * * *
(iii) Stock characterization. The stock of a noncontrolled 10-
percent owned foreign corporation is characterized under the rules in
Sec. 1.861-12(c)(4).
(5) Other relevant provisions. For further guidance, see Sec.
1.861-9T(f)(5).
(g) Asset method--(1) In general. (i) For further guidance, see
Sec. 1.861-9T(g)(1)(i).
(ii) A taxpayer may elect to determine the value of its assets on
the basis of either the tax book value or the fair market value of its
assets. However, for taxable years beginning after December 31, 2017,
the fair market value method is not allowed with respect to allocations
and apportionments of interest expense. See section 864(e)(2). For
rules concerning the application of an alternative method of valuing
assets for purposes of the tax book value method, see paragraph (i) of
this section. For rules concerning the application of the fair market
value method, see paragraph (h) of this section.
(iii) [Reserved]
(iv) For rules relating to earnings and profits adjustments by
taxpayers using the tax book value method for the stock in certain 10
percent owned corporations, see Sec. 1.861-12(c)(2).
(v) [Reserved]
(2) Asset values--(i) General rule--(A) Average of values. For
purposes of determining the value of assets under this section, an
average of values (book or market) within each statutory grouping and
the residual grouping is computed for the year on the basis of values
of assets at the beginning and end of the year. For the first taxable
year beginning after December 31, 2017 (post-2017 year), a taxpayer
that determined the value of its assets on the basis of the fair market
value method for purposes of apportioning interest expense in its prior
taxable year may choose to determine asset values under the tax book
value method (or the alternative tax book value method) by treating the
value of its assets as of the beginning of the post-2017 year as equal
to the value of its assets at the end of the first quarter of the post-
2017 year, provided that each member of the affiliated group (as
defined in Sec. 1.861-11T(d)) determines its asset values on the same
basis. Where a substantial distortion of asset values would result from
averaging beginning-of-year and end-of-year values, as might be the
case in the event of a major corporate acquisition or disposition, the
taxpayer must use a different method of asset valuation that more
clearly reflects the average value of assets weighted to reflect the
time such assets are held by the taxpayer during the taxable year.
(B) Tax book value method. Under the tax book value method, the
value of an asset is determined based on the adjusted basis of the
asset. For purposes of determining the value of stock in a 10 percent
owned corporation at the beginning and end of the year under the tax
book value method, the tax book value is determined without regard to
any adjustments under section 961(a) or 1293(d), see Sec. 1.861-
12(c)(2)(i)(B)(1), and before the adjustment required by Sec. 1.861-
12(c)(2)(i)(A) to the basis of stock in the 10 percent owned
corporation. The average of the tax book value of the stock at the
beginning and end of the year is then adjusted with respect to earnings
and profits as described in Sec. 1.861-12(c)(2)(i).
(ii) Special rule for qualified business units of domestic
corporations with functional currency other than the U.S. dollar--(A)
Tax book value method. For further guidance, see Sec. 1.861-
9T(g)(2)(ii)(A).
(1) Section 987 QBU. For further guidance, see Sec. 1.861-
9T(g)(2)(ii)(A)(1).
(2) U.S. dollar approximate separate transactions method. In the
case of a branch to which the U.S. dollar approximate separate
transactions method of accounting described in Sec. 1.985-3 applies,
the beginning-of-year dollar amount of the assets is determined by
reference to the end-of-year balance sheet of the branch for the
immediately preceding taxable year, adjusted for U.S. generally
accepted accounting principles and Federal income tax accounting
principles, and translated into U.S. dollars as provided in Sec.
1.985-3(c). The end-of-year dollar amount of the assets of the branch
is determined in the same manner by reference to the end-of-year
balance sheet for the current taxable year. The beginning-of-year and
end-of-year dollar tax book value of assets, as so determined, within
each grouping is then averaged as provided in paragraph (g)(2)(i) of
this section.
(B) Fair market value method. For further guidance, see Sec.
1.861-9T(g)(2)(ii)(B).
(iii) Adjustment for directly allocated interest. For further
guidance, see Sec. 1.861-9T(g)(2)(iii).
(iv) Assets in intercompany transactions. For further guidance, see
Sec. 1.861-9T(g)(2)(iv).
(3) Characterization of assets. For further guidance, see Sec.
1.861-9T(g)(3).
(4) Characterization of lower tier entities at the level of a CFC.
In the case of a controlled foreign corporation that is applying the
asset method, see for example Sec. 1.861-12T(c)(3)(ii) (requiring the
application of Sec. 1.861-9T(g) at the level of the controlled foreign
corporation) or paragraph (f)(3)(i) of this section, the controlled
foreign corporation (and any lower-tier controlled foreign
corporations) must characterize stock of a lower-tier 10 percent owned
corporation by applying Sec. 1.861-12 and treating the controlled
foreign corporation as the relevant taxpayer for such purposes. In the
case of a controlled foreign corporation that owns stock in one or more
lower-tier corporations, in applying the asset method, the first-tier
controlled foreign corporation must take into account the stock in the
lower-tier corporations. Therefore, the controlled foreign corporation
(and any lower-tier controlled foreign corporations) must make basis
adjustments in lower-tier 10 percent owned corporations under Sec.
1.861-12(c)(2) for purposes of valuing and characterizing the assets of
such controlled foreign corporation. For purposes of this paragraph
(g)(4), the stock of each such lower-tier corporation is characterized
by reference to the assets owned during the lower-tier corporation's
taxable year that ends during the first-tier controlled foreign
corporation's taxable year. The analysis of assets under this paragraph
(g)(4) and Sec. 1.861-12 of a controlled foreign corporation that is
in a chain of 10 percent owned corporations must begin at the lowest-
tier 10 percent owned corporation and proceed up the chain to the
first-tier controlled foreign corporation. See also Sec. 1.861-
12T(c)(3)(ii).
(h) Fair market value method. An affiliated group (as defined in
Sec. 1.861-11T(d)) or other taxpayer (the taxpayer) that elects to use
the fair market value method of apportionment values its assets
according to the methodology described in this paragraph (h). Effective
for taxable years beginning after December 31, 2017, the fair market
value method is not allowed for purposes of apportioning interest
expense. See section 864(e)(2). However, a taxpayer may continue to
apportion deductions other than interest expense that are properly
apportioned based on fair market value according to the methodology
described in this paragraph (h). See Sec. 1.861-8(c)(2).
(1) Determination of values. For further guidance, see Sec. 1.861-
9T(h)(1) through (3).
[[Page 69068]]
(2) and (3) [Reserved]
* * * * *
(5) Characterizing stock in related persons. Stock in a related
person held by the taxpayer or by another related person shall be
characterized on the basis of the fair market value of the taxpayer's
pro rata share of assets held by the related person attributed to each
statutory grouping and the residual grouping under the stock
characterization rules of Sec. 1.861-12T(c)(3)(ii), except that the
portion of the value of intangible assets of the taxpayer and related
persons that is apportioned to the related person under Sec. 1.861-
9T(h)(2) shall be characterized on the basis of the net income before
interest expense of the related person within each statutory grouping
or residual grouping (excluding income that is passive under Sec.
1.904-4(b)).
* * * * *
(i) * * *
(2) * * * (i) Except as provided in this paragraph (i)(2)(i), a
taxpayer may elect to use the alternative tax book value method. For
the taxpayer's first taxable year beginning after December 31, 2017,
the Commissioner's approval is not required to switch from the fair
market value method to the alternative tax book value method for
purposes of apportioning interest expense. * * *
* * * * *
(j) Modified gross income method. For further guidance, see Sec.
1.861-9T(j) introductory text.
(1) For further guidance, see Sec. 1.861-9T(j)(1).
(2) For further guidance, see Sec. 1.861-9T(j)(2) introductory
text.
(i) Step 1. For further guidance, see Sec. 1.861-9T(j)(2)(i).
(ii) Step 2. Moving to the next higher-tier controlled foreign
corporation, combine the gross income of such corporation within each
grouping with its pro rata share (as determined under principles
similar to section 951(a)(2)) of the gross income net of interest
expense of all lower-tier controlled foreign corporations held by such
higher-tier corporation within the same grouping adjusted as follows:
(A) Exclude from the gross income of the higher-tier corporation
any dividends or other payments received from the lower-tier
corporation other than interest income received from the lower-tier
corporation;
(B) Exclude from the gross income net of interest expense of any
lower-tier corporation any gross subpart F income, net of interest
expense apportioned to such income;
(C) Then apportion the interest expense of the higher-tier
controlled foreign corporation based on the adjusted combined gross
income amounts; and
(D) Repeat paragraphs (j)(2)(ii)(A) through (C) of this section for
each next higher-tier controlled foreign corporation in the chain.
(k) Applicability date. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 5. Section 1.861-9T is amended by:
0
1. Adding paragraph (c)(5).
0
2. Revising paragraph (e)(4)(i).
0
3. Adding paragraph (e)(8) and reserved paragraphs (e)(9) and (10).
0
4. Revising paragraph (f)(2) and removing the undesignated paragraph
and example paragraphs following paragraph (f)(2)(ii).
0
5. Removing and reserving paragraph (f)(3)(i).
0
6. Revising paragraphs (f)(4) and (g)(1)(ii).
0
7. Removing and reserving paragraphs (g)(1)(iii) through (v) and
(g)(2)(i).
0
8. Revising paragraph (g)(2)(ii)(A)(2).
0
9. Removing and reserving paragraph (g)(2)(v).
0
10. Revising paragraphs (h) introductory text and (j)(2)(ii).
0
11. Removing the undesignated paragraph following paragraph
(j)(2)(ii)(B).
The additions and revisions read as follows:
Sec. 1.861-9T Allocation and apportionment of interest expense
(temporary).
* * * * *
(c) * * *
(5) Section 163(j). For further guidance, see Sec. 1.861-9(c)(5).
* * * * *
(e) * * *
(4) * * *
(i) Partnership interest expense. For further guidance, see Sec.
1.861-9(e)(4)(i).
* * * * *
(8) Special rule for downstream partnership loans. For further
guidance, see Sec. 1.861-9(e)(8) through (10).
(9) and (10) [Reserved]
(f) * * *
(2) Section 987 QBUs of domestic corporations. For further
guidance, see Sec. 1.861-9(f)(2) through (f)(3)(i).
* * * * *
(4) Noncontrolled 10-percent owned foreign corporations. For
further guidance, see Sec. 1.861-9(f)(4).
* * * * *
(g) * * *
(1) * * *
(ii) For further guidance, see Sec. 1.861-9(g)(1)(ii) through
(g)(2)(i).
* * * * *
(2) * * *
(ii) * * *
(A) * * *
(2) U.S. dollar approximate separate transactions method. For
further guidance, see Sec. 1.861-9(g)(2)(ii)(A)(2).
* * * * *
(h) Fair market value method. For further guidance, see Sec.
1.861-9(h).
* * * * *
(j) * * *
(2) * * *
(ii) Step 2. For further guidance, see Sec. 1.861-9(j)(2)(ii).
* * * * *
0
Par. 6. Section 1.861-10 is amended by:
0
1. Revising paragraph (e)(8)(vi).
0
2. Removing and reserving paragraph (e)(10).
0
3. Adding paragraph (f).
The revisions and addition read as follows:
Sec. 1.861-10 Special allocations of interest expense.
* * * * *
(e) * * *
(8) * * *
(vi) Classification of hybrid stock. In determining the amount of
its related group indebtedness for any taxable year, a U.S. shareholder
must not treat stock in a related controlled foreign corporation as
related group indebtedness, regardless of whether the related
controlled foreign corporation claims a deduction for interest under
foreign law for distributions on such stock. For purposes of
determining the foreign base period ratio under paragraph (e)(2)(iv) of
this section for a taxable year that ends on or after December 4, 2018,
the rules of this paragraph (e)(8)(vi) apply to determine the related
group debt-to-asset ratio in each taxable year included in the foreign
base period, including in taxable years that end before December 4,
2018.
* * * * *
(f) Applicability date. This section applies to taxable years that
end on or after December 4, 2018.
0
Par. 7. Section 1.861-10T is amended by revising paragraph (e) to read
as follows:
Sec. 1.861-10T Special allocations of interest expense (temporary).
* * * * *
(e) Treatment of certain related group indebtedness. For further
guidance, see Sec. 1.861-10(e).
* * * * *
0
Par. 8. Section 1.861-11 is amended by:
0
1. Removing paragraphs (a) through (c).
[[Page 69069]]
0
2. Adding paragraphs (a), (b), and (c).
0
3. Removing the language ``, except that section 936 corporations are
also included within the affiliated group to the extent provided in
paragraph (d)(2) of this section'' from the first sentence of paragraph
(d)(1).
0
4. Removing and reserving paragraph (d)(2).
0
5. Adding paragraph (h).
The revisions and addition read as follows:
Sec. 1.861-11 Special rules for allocating and apportioning interest
expense of an affiliated group of corporations.
(a) In general. For further guidance, see Sec. 1.861-11T(a).
(b) Scope of application--(1) Application of section 864(e)(1) and
(5) (concerning the definition and treatment of affiliated groups).
Section 864(e)(1) and (5) and the portions of this section implementing
section 864(e)(1) and (5) apply to the computation of foreign source
taxable income for purposes of section 904 (relating to various
limitations on the foreign tax credit). Section 864(e)(1) and (5) and
the portions of this section implementing section 864(e)(1) and (5)
also apply in connection with section 907 to determine reductions in
the amount allowed as a foreign tax credit under section 901. Section
864(e)(1) and (5) and the portions of this section implementing section
864(e)(1) and (5) also apply to the computation of the combined taxable
income of the related supplier and a foreign sales corporation (FSC)
(under sections 921 through 927) as well as the combined taxable income
of the related supplier and a domestic international sales corporation
(DISC) (under sections 991 through 997).
(2) Nonapplication of section 864(e)(1) and (5) (concerning the
definition and treatment of affiliated groups). For further guidance,
see Sec. 1.861-11T(b)(2).
(c) General rule for affiliated corporations. For further guidance,
see Sec. 1.861-11T(c).
* * * * *
(h) Applicability dates. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 9. Section 1.861-11T is amended by revising paragraph (b)(1) to
read as follows:
Sec. 1.861-11T Special rules for allocating and apportioning
interest expense of an affiliated group of corporations (temporary).
* * * * *
(b) * * *
(1) Application of section 864(e)(1) and (5) (concerning the
definition and treatment of affiliated groups). For further guidance,
see Sec. 1.861-11(b)(1).
* * * * *
0
Par. 10. Section 1.861-12 is amended by:
0
1. Removing paragraphs (a) through (c)(1).
0
2. Adding paragraphs (a), (b), and (c)(1).
0
3. Revising paragraphs (c)(3) and (4).
0
4. Removing paragraph (c)(5) and paragraphs (d) through (j).
0
5. Adding paragraphs (d) and (e) and reserved paragraphs (f) through
(j).
The revisions read as follows:
Sec. 1.861-12 Characterization rules and adjustments for certain
assets.
(a) In general. The rules in this section apply to taxpayers
apportioning expenses under an asset method to income in the various
separate categories described in Sec. 1.904-5(a)(4)(v), and supplement
other rules provided in Sec. Sec. 1.861-9 through 1.861-11T. The
principles of the rules in this section also apply in apportioning
expenses among statutory and residual groupings for any other operative
section. See also Sec. 1.861-8(f)(2)(i) for a rule requiring
conformity of allocation methods and apportionment principles for all
operative sections. Paragraph (b) of this section describes the
treatment of inventories. Paragraph (c)(1) of this section concerns the
treatment of various stock assets. Paragraph (c)(2) of this section
describes a basis adjustment for stock in 10 percent owned
corporations. Paragraph (c)(3) of this section sets forth rules for
characterizing the stock in controlled foreign corporations. Paragraph
(c)(4) of this section describes the treatment of stock of
noncontrolled 10-percent owned foreign corporations. Paragraph (d)(1)
of this section concerns the treatment of notes. Paragraph (d)(2) of
this section concerns the treatment of notes of controlled foreign
corporations. Paragraph (e) of this section describes the treatment of
certain portfolio securities that constitute inventory or generate
income primarily in the form of gains. Paragraph (f) of this section
describes the treatment of assets that are funded by interest that is
capitalized, deferred, or disallowed. Paragraph (g) of this section
concerns the treatment of FSC stock and of assets of the related
supplier generating foreign trade income. Paragraph (h) of this section
concerns the treatment of DISC stock and of assets of the related
supplier generating qualified export receipts.
(b) Inventories. For further guidance, see Sec. 1.861-12T(b).
(c) Treatment of stock--(1) In general. For further guidance, see
Sec. 1.861-12T(c)(1).
* * * * *
(3) Characterization of stock of controlled foreign corporations--
(i) Operative sections--(A) Operative sections other than section 904.
For purposes of applying this section to an operative section other
than section 904, stock in a controlled foreign corporation (as defined
in section 957) is characterized as an asset in the relevant groupings
on the basis of the asset method described in paragraph (c)(3)(ii) of
this section, or the modified gross income method described in
paragraph (c)(3)(iii) of this section. Stock in a controlled foreign
corporation whose interest expense is apportioned on the basis of
assets is characterized in the hands of its United States shareholders
under the asset method described in paragraph (c)(3)(ii) of this
section. Stock in a controlled foreign corporation whose interest
expense is apportioned on the basis of modified gross income is
characterized in the hands of its United States shareholders under the
modified gross income method described in paragraph (c)(3)(iii) of this
section.
(B) Section 904 as operative section. For purposes of applying this
section to section 904 as the operative section, Sec. 1.861-13 applies
to characterize the stock of a controlled foreign corporation as an
asset producing foreign source income in the separate categories
described in Sec. 1.904-5(a)(4)(v), or as an asset producing U.S.
source income in the residual grouping, in the hands of the United
States shareholder, and to determine the portion of the stock that
gives rise to an inclusion under section 951A(a) that is treated as an
exempt asset under Sec. 1.861-8(d)(2)(ii)(C). Section 1.861-13 also
provides rules for subdividing the stock in the various separate
categories and the residual grouping into a section 245A subgroup and a
non-section 245A subgroup in order to determine the amount of the
adjustments required by section 904(b)(4) and Sec. 1.904(b)-3(c) with
respect to the section 245A subgroup, and provides rules for
determining the portion of the stock that gives rise to a dividend
eligible for a deduction under section 245(a)(5) that is treated as an
exempt asset under Sec. 1.861-8(d)(2)(ii)(B).
(ii) Asset method. For further guidance, see Sec. 1.861-
12T(c)(3)(ii).
(iii) Modified gross income method. Under the modified gross income
method, the taxpayer characterizes the tax book value of the stock of
the first-tier controlled foreign corporation based
[[Page 69070]]
on the gross income, net of interest expense, of the controlled foreign
corporation (as computed under Sec. 1.861-9T(j) to include certain
gross income, net of interest expense, of lower-tier controlled foreign
corporations) within each relevant category for the taxable year of the
controlled foreign corporation ending with or within the taxable year
of the taxpayer. For purposes of this paragraph (c)(3)(iii), however,
the gross income, net of interest expense, of the first-tier controlled
foreign corporation includes the total amount of gross subpart F
income, net of interest expense, of any lower-tier controlled foreign
corporation that was excluded under the rules of Sec. 1.861-
9(j)(2)(ii)(B).
(4) Characterization of stock of noncontrolled 10-percent owned
foreign corporations--(i) In general. Except in the case of a
nonqualifying shareholder described in paragraph (c)(4)(ii) of this
section, the principles of Sec. 1.861-12(c)(3), including the relevant
rules of Sec. 1.861-13 when section 904 is the operative section,
apply to characterize stock in a noncontrolled 10-percent owned foreign
corporation (as defined in section 904(d)(2)(E)). Accordingly, stock in
a noncontrolled 10-percent owned foreign corporation is characterized
as an asset in the various separate categories on the basis of either
the asset method described in Sec. 1.861-12T(c)(3)(ii) or the modified
gross income method described in Sec. 1.861-12(c)(3)(iii). Stock in a
noncontrolled 10-percent owned foreign corporation the interest expense
of which is apportioned on the basis of assets is characterized in the
hands of its shareholders under the asset method described in Sec.
1.861-12T(c)(3)(ii). Stock in a noncontrolled 10-percent owned foreign
corporation the interest expense of which is apportioned on the basis
of gross income is characterized in the hands of its shareholders under
the modified gross income method described in Sec. 1.861-
12(c)(3)(iii).
(ii) Nonqualifying shareholders. Stock in a noncontrolled 10-
percent owned foreign corporation is characterized as a passive
category asset in the hands of a shareholder that either is not a
domestic corporation or is not a United States shareholder with respect
to the noncontrolled 10-percent owned foreign corporation for the
taxable year. Stock in a noncontrolled 10-percent owned foreign
corporation is characterized as in the separate category described in
section 904(d)(4)(C)(ii) in the hands of any shareholder with respect
to whom look-through treatment is not substantiated. See also Sec.
1.904-5(c)(4)(iii)(B). In the case of a noncontrolled 10-percent owned
foreign corporation that is a passive foreign investment company with
respect to a shareholder, stock in the noncontrolled 10-percent owned
foreign corporation is characterized as a passive category asset in the
hands of the shareholder if such shareholder does not meet the
ownership requirements described in section 904(d)(2)(E)(i)(II).
(d) Treatment of notes--(1) General rule. For further guidance, see
Sec. 1.861-12T(d)(1).
(2) Characterization of related controlled foreign corporation
notes. The debt of a controlled foreign corporation is characterized in
the same manner as the interest income derived from that debt
obligation. See Sec. Sec. 1.904-4 and 1.904-5(c)(2) for rules treating
interest income as income in a separate category.
(e) Portfolio securities that constitute inventory or generate
primarily gains. For further guidance, see Sec. 1.861-12T(e) through
(i).
* * * * *
0
Par. 11. Section 1.861-12T is amended by:
0
1. Revising paragraph (a).
0
2. Removing paragraphs (c)(2)(vi).
0
3. Revising paragraph (c)(3)(i) and removing the undesignated paragraph
following paragraph (c)(3)(i)(B).
0
4. Revising paragraph (c)(3)(iii).
0
5. Removing paragraph (c)(5).
0
6. Revising paragraph (d)(2).
0
7. Removing and reserving paragraph (j).
The revisions read as follows:
Sec. 1.861-12T Characterization rules and adjustments for certain
assets (temporary).
(a) In general. For further guidance, see Sec. 1.861-12(a).
* * * * *
(c) * * *
(3) * * *
(i) Operative sections. For further guidance, see Sec. 1.861-
12(c)(3)(i).
* * * * *
(iii) Modified gross income method. For further guidance, see Sec.
1.861-12(c)(3)(iii).
* * * * *
(d) * * *
(2) Characterization of related controlled foreign corporation
notes. For further guidance, see Sec. 1.861-12(d)(2).
* * * * *
0
Par. 12. Sec. 1.861-13 is added to read as follows:
Sec. 1.861-13 Special rules for characterization of controlled
foreign corporation stock.
(a) Methodology. For purposes of allocating and apportioning
deductions for purposes of section 904 as the operative section, stock
in a controlled foreign corporation owned directly or indirectly
through a partnership or other pass-through entity by a United States
shareholder is characterized by the United States shareholder under the
rules described in this section. In general, paragraphs (a)(1) through
(5) of this section characterize the stock of the controlled foreign
corporation as an asset in the various statutory groupings and residual
grouping based on the type of income that the stock of the controlled
foreign corporation generates, has generated, or may reasonably be
expected to generate when the income is included by the United States
shareholder.
(1) Step 1: Characterize stock as generating income in statutory
groupings under the asset or modified gross income method--(i) Asset
method. A United States shareholder of a controlled foreign corporation
that apportions its interest expense on the basis of assets must
characterize stock of the controlled foreign corporation using the
asset method described in Sec. 1.861-12T(c)(3)(ii) to assign the
assets of the controlled foreign corporation to the statutory groupings
described in paragraphs (a)(1)(i)(A)(1) through (10) and (a)(1)(i)(B)
of this section. If the controlled foreign corporation owns stock in a
lower-tier noncontrolled 10-percent owned foreign corporation, the
assets of the lower-tier noncontrolled 10-percent owned foreign
corporation are assigned to a gross subpart F income grouping to the
extent such assets generate income that, if distributed to the
controlled foreign corporation, would be gross subpart F income of the
controlled foreign corporation. See also Sec. 1.861-12(c)(4).
(A) General and passive categories. Within each of the controlled
foreign corporation's general category and passive category, each of
the following subgroups within each category is a separate statutory
grouping--
(1) Foreign source gross tested income;
(2) For each applicable treaty, U.S. source gross tested income
that, when taken into account by a United States shareholder under
section 951A, is resourced in the hands of the United States
shareholder (resourced gross tested income);
(3) U.S. source gross tested income not described in paragraph
(a)(1)(i)(A)(2) of this section;
(4) Foreign source gross subpart F income;
(5) For each applicable treaty, U.S. source gross subpart F income
that, when included by a United States
[[Page 69071]]
shareholder under section 951(a)(1), is resourced in the hands of the
United States shareholder (resourced gross subpart F income);
(6) U.S. source gross subpart F income not described in paragraph
(a)(1)(i)(A)(5) of this section;
(7) Foreign source gross section 245(a)(5) income;
(8) U.S. source gross section 245(a)(5) income;
(9) Any other foreign source gross income (specified foreign source
general category gross income or specified foreign source passive
category gross income, as the case may be); and
(10) Any other U.S. source gross income (specified U.S. source
general category gross income or specified U.S. source passive category
gross income, as the case may be).
(B) Section 901(j) income. For each country described in section
901(j), all gross income from sources in that country.
(ii) Modified gross income method. A United States shareholder of a
controlled foreign corporation that apportions its interest expense on
the basis of modified gross income must characterize stock of the
controlled foreign corporation using the modified gross income method
under Sec. 1.861-12(c)(3)(iii) to assign the modified gross income of
the controlled foreign corporation to the statutory groupings described
in paragraphs (a)(1)(i)(A)(1) through (10) and (a)(1)(i)(B) of this
section. For purposes of this paragraph (a)(1)(ii), the rules described
in Sec. Sec. 1.861-12(c)(3)(iii) and 1.861-9T(j)(2) apply to combine
gross income in a statutory grouping that is earned by the controlled
foreign corporation with gross income of lower-tier controlled foreign
corporations that is in the same statutory grouping. For example,
foreign source general category gross tested income (net of interest
expense) earned by the controlled foreign corporation is combined with
its pro rata share of the foreign source general category gross tested
income (net of interest expense) of lower-tier controlled foreign
corporations. If the controlled foreign corporation owns stock in a
lower-tier noncontrolled 10-percent owned foreign corporation, gross
income of the lower-tier noncontrolled 10-percent owned foreign
corporation is assigned to a gross subpart F income grouping to the
extent that the income, if distributed to the upper-tier controlled
foreign corporation, would be gross subpart F income of the upper-tier
controlled foreign corporation. See also Sec. 1.861-12(c)(4).
(2) Step 2: Assign stock to the section 951A category. A controlled
foreign corporation is not treated as earning section 951A category
income. The portion of the value of the stock of the controlled foreign
corporation that is assigned to the section 951A category (as defined
in Sec. 1.904-4(g)) equals the value of the portion of the stock of
the controlled foreign corporation that is assigned to the foreign
source gross tested income statutory groupings within the general
category (general category gross tested income stock) multiplied by the
United States shareholder's inclusion percentage. Under Sec. 1.861-
8(d)(2)(ii)(C)(2)(ii), a portion of the value of stock assigned to the
section 951A category may be treated as an exempt asset. The portion of
the general category gross tested income stock that is not
characterized as a section 951A category asset remains a general
category asset and may result in expenses being disregarded under
section 904(b)(4). See paragraph (a)(5)(ii) of this section and Sec.
1.904(b)-3. No portion of the passive category gross tested income
stock or U.S. source gross tested income stock is assigned to the
section 951A category.
(3) Step 3: Assign stock to a treaty category--(i) Inclusions under
section 951A(a). The portion of the value of the stock of the
controlled foreign corporation that is assigned to a particular treaty
category due to an inclusion of U.S. source income under section
951A(a) that was resourced under a particular treaty equals the value
of the portion of the stock of the controlled foreign corporation that
is assigned to the resourced gross tested income statutory grouping
within each of the controlled foreign corporation's general or passive
categories (resourced gross tested income stock) multiplied by the
United States shareholder's inclusion percentage. Under Sec. 1.861-
8(d)(2)(ii)(C)(2)(ii), a portion of the value of stock assigned to a
particular treaty category by reason of this paragraph (a)(3)(i) may be
treated as an exempt asset. The portion of the resourced gross tested
income stock that is not characterized as a treaty category asset
remains a U.S. source general or passive category asset, as the case
may be, that is in the residual grouping and may result in expenses
being disregarded under section 904(b)(4) for purposes of determining
entire taxable income under section 904(a). See paragraph (a)(5)(iv) of
this section and Sec. 1.904(b)-3.
(ii) Inclusions under section 951(a)(1). The portion of the value
of the stock of the controlled foreign corporation that is assigned to
a particular treaty category due to an inclusion of U.S. source income
under section 951(a)(1) that was resourced under a treaty equals the
value of the portion of the stock of the controlled foreign corporation
that is assigned to the resourced gross subpart F income statutory
grouping within each of the controlled foreign corporation's general
category or passive category.
(4) Step 4: Aggregate stock within each separate category and
assign stock to the residual grouping. The portions of the value of
stock of the controlled foreign corporation assigned to foreign source
statutory groupings that were not specifically assigned to the section
951A category under paragraph (a)(2) of this section (Step 2) are
aggregated within the general category and the passive category to
characterize the stock as general category stock and passive category
stock, respectively. The portions of the value of stock of the
controlled foreign corporation assigned to U.S. source statutory
groupings that were not specifically assigned to a particular treaty
category under paragraph (a)(3) of this section (Step 3) are aggregated
to characterize the stock as U.S. source category stock, which is in
the residual grouping. Stock assigned to the separate category for
income described in section 901(j)(1) remains in that category.
(5) Step 5: Determine section 245A and non-section 245A subgroups
for each separate category and U.S. source category--(i) In general. In
the case of stock of a controlled foreign corporation that is held
directly or indirectly through a partnership or other pass-through
entity by a United States shareholder that is a domestic corporation,
stock of the controlled foreign corporation that is general category
stock, passive category stock, and U.S. source category stock is
subdivided between a section 245A subgroup and a non-section 245A
subgroup under paragraphs (a)(5)(ii) through (v) of this section for
purposes of applying section 904(b)(4) and Sec. 1.904(b)-3(c). Each
subgroup is treated as a statutory grouping under Sec. 1.861-8(a)(4)
for purposes of allocating and apportioning deductions under Sec. Sec.
1.861-8 through 1.861-14T and 1.861-17 in applying section 904 as the
operative section. Deductions apportioned to each section 245A subgroup
are disregarded under section 904(b)(4). See Sec. 1.904(b)-3.
Deductions apportioned to the statutory groupings for gross section
245(a)(5) income are not disregarded under section 904(b)(4); however,
a portion of the stock assigned to those groupings is treated as exempt
under Sec. 1.861-8T(d)(2)(ii)(B).
(ii) Section 245A subgroup of general category stock. The portion
of the
[[Page 69072]]
general category stock of the controlled foreign corporation that is
assigned to the section 245A subgroup of the general category equals
the value of the general category gross tested income stock of the
controlled foreign corporation that is not assigned to the section 951A
category under paragraph (a)(2) of this section (Step 2), plus the
value of the portion of the stock of the controlled foreign corporation
that is assigned to the specified foreign source general category gross
income statutory grouping.
(iii) Section 245A subgroup of passive category stock. The portion
of passive category stock of the controlled foreign corporation that is
assigned to the section 245A subcategory of the passive category equals
the sum of--
(A) The value of the portion of the stock of the controlled foreign
corporation that is assigned to the gross tested income statutory
grouping within foreign source passive category income multiplied by a
percentage equal to 100 percent minus the United States shareholder's
inclusion percentage for passive category gross tested income; and
(B) The value of the portion of the stock of the controlled foreign
corporation that was assigned to the specified foreign source passive
category gross income statutory grouping.
(iv) Section 245A subgroup of U.S. source category stock. The
portion of U.S. source category stock of the controlled foreign
corporation that is assigned to the section 245A subgroup of the U.S.
source category equals the sum of--
(A) The value of the portion of the stock of the controlled foreign
corporation that is assigned to the U.S. source general category gross
tested income statutory grouping multiplied by a percentage equal to
100 percent minus the United States shareholder's inclusion percentage
for the general category;
(B) The value of the portion of the stock of the controlled foreign
corporation that is assigned to the U.S. source passive category gross
tested income statutory grouping multiplied by a percentage equal to
100 percent minus the United States shareholder's inclusion percentage
for the passive category;
(C) The value of the resourced gross tested income stock of the
controlled foreign corporation that is not assigned to a particular
treaty category under paragraph (a)(3)(i) of this section (Step 3);
(D) The value of the portion of the stock of the controlled foreign
corporation that is assigned to the specified U.S. source general
category gross income statutory grouping; and
(E) The value of the portion of the stock of the controlled foreign
corporation that is assigned to the specified U.S. source passive
category gross income statutory grouping.
(v) Non-section 245A subgroup. The value of stock of a controlled
foreign corporation that is not assigned to the section 245A subgroup
within the general or passive category or the residual grouping is
assigned to the non-section 245A subgroup within such category or
grouping. The value of stock of a controlled foreign corporation that
is assigned to the section 951A category, the separate category for
income described in section 901(j)(1), or a particular treaty category
is always assigned to a non-section 245A subgroup.
(b) Definitions. This paragraph (b) provides definitions that apply
for purposes of this section.
(1) Gross section 245(a)(5) income. The term gross section
245(a)(5) income means all items of gross income described in section
245(a)(5)(A) and (B).
(2) Gross subpart F income. The term gross subpart F income means
all items of gross income that are taken into account by a controlled
foreign corporation in determining its subpart F income under section
952, except for items of gross income described in section 952(a)(5).
(3) Gross tested income. The term gross tested income has the
meaning provided in Sec. 1.951A-2(c)(1).
(4) Inclusion percentage. The term inclusion percentage has the
meaning provided in Sec. 1.960-2(c)(2).
(5) Separate category. The term separate category has the meaning
provided in Sec. 1.904-5(a)(4)(v).
(6) Treaty category. The term treaty category means a category of
income earned by a controlled foreign corporation for which section
904(a), (b), and (c) are applied separately as a result of income being
resourced under a treaty. See, for example, section 245(a)(10), 865(h),
or 904(h)(10). A United States shareholder may have multiple treaty
categories for amounts of income resourced by the United States
shareholder under a treaty. See Sec. 1.904-5(m)(7).
(7) U.S. source category. The term U.S. source category means the
aggregate of U.S. source income in each separate category listed in
section 904(d)(1).
(c) Examples. The following examples illustrate the application of
the rules in this section.
(1) Example 1: Asset method--(i) Facts--(A) USP, a domestic
corporation, directly owns all of the stock of a controlled foreign
corporation, CFC1. The tax book value of CFC1's stock is $20,000x.
USP uses the asset method described in Sec. 1.861-12T(c)(3)(ii) to
characterize the stock of CFC1. USP's inclusion percentage is 70%.
(B) CFC1 owns the following assets with the following values as
determined under Sec. Sec. 1.861-9(g)(2) and 1.861-9T(g)(3): Assets
that generate income described in the foreign source gross tested
income statutory grouping within the general category ($4,000x),
assets that generate income described in the foreign source gross
subpart F income statutory grouping within the general category
($1,000x), assets that generate specified foreign source general
category gross income ($3,000x), and assets that generate income
described in the foreign source gross subpart F income statutory
grouping within the passive category ($2,000x).
(C) CFC1 also owns all of the stock of CFC2, a controlled
foreign corporation. The tax book value of CFC1's stock in CFC2 is
$6,000x. CFC2 owns the following assets with the following values as
determined under Sec. Sec. 1.861-9(g)(2) and 1.861-9T(g)(3): Assets
that generate income described in the foreign source gross subpart F
income statutory grouping within the general category ($2,250x) and
assets that generate specified foreign source general category gross
income ($750x).
(ii) Analysis--(A) Step 1--(1) Characterization of CFC2 stock.
CFC2 has total assets of $3,000x, $2,250x of which are in the
foreign source gross subpart F income statutory grouping within the
general category and $750x of which are in the specified foreign
source general category gross income statutory grouping.
Accordingly, CFC2's stock is characterized as $4,500x ($2,250x/
$3,000x x $6,000x) in the foreign source gross subpart F income
statutory grouping within the general category and $1,500x ($750x/
$3,000x x $6,000x) in the specified foreign source general category
gross income statutory grouping.
(2) Characterization of CFC1 stock. CFC1 has total assets of
$16,000x, $4,000x of which are in the foreign source gross tested
income statutory grouping within the general category, $5,500x of
which are in the foreign source gross subpart F income statutory
grouping within the general category (including the portion of CFC2
stock assigned to that statutory grouping), $4,500x of which are in
the specified foreign source gross general category income statutory
grouping (including the portion of CFC2 stock assigned to that
statutory grouping), and $2,000x of which are in the foreign source
gross subpart F income statutory grouping within the passive
category. Accordingly, CFC1's stock is characterized as $5,000x
($4,000x/$16,000x x $20,000x) in the foreign source gross tested
income statutory grouping within the general category, $6,875x
($5,500x/$16,000x x $20,000x) in the foreign source gross subpart F
income statutory grouping within the general category, $5,625x
($4,500x/$16,000x x $20,000x) in the specified foreign source gross
general
[[Page 69073]]
category income statutory grouping, and $2,500x ($2,000x/$16,000x x
$20,000x) in the foreign source gross subpart F income statutory
grouping within the passive category.
(B) Step 2. The value of the portion of the stock of CFC1 that
is general category gross tested income stock is $5,000x. USP's
inclusion percentage is 70%. Accordingly, under paragraph (a)(2) of
this section, $3,500x of the stock of CFC1 is assigned to the
section 951A category and a portion thereof may be treated as an
exempt asset under Sec. 1.861-8(d)(2)(ii)(C)(2)(ii). The remainder,
$1,500x, remains a general category asset.
(C) Step 3. No portion of the stock of CFC1 is resourced gross
tested income stock or assigned to the resourced gross subpart F
income statutory grouping in any treaty category. Accordingly, no
portion of the stock of CFC1 is assigned to a treaty category under
paragraph (a)(3) of this section.
(D) Step 4--(1) General category stock. The total value of the
portion of the stock of CFC1 that is general category stock is
$14,000x, which is equal to $1,500x (the value of the portion of the
general category stock of CFC1 that was not assigned to the section
951A category in paragraph (c)(1)(ii)(B) of this section (Step 2))
plus $6,875x (the value of the portion of the stock of CFC1 assigned
to the foreign source gross subpart F income statutory grouping
within the general category) plus $5,625x (the value of the portion
of the stock of CFC1 assigned to the specified foreign source gross
income statutory grouping within the general category).
(2) Passive category stock. The total value of the portion of
the stock of CFC1 that is passive category stock is $2,500x.
(3) U.S source category stock. No value of the portion of the
stock of CFC1 is U.S. source category stock.
(E) Step 5--(1) General category stock. Under paragraph
(a)(5)(ii) of this section, the value of the portion of the stock of
CFC1 assigned to the section 245A subgroup of general category stock
is $7,125x, which is equal to $1,500x (the value of the portion of
the general category stock of CFC1 that was not assigned to the
section 951A category in paragraph (c)(1)(ii)(B) of this section
(Step 2)) plus $5,625x (the value of the portion of the stock of
CFC1 assigned to the specified foreign source general category gross
income statutory grouping). Under paragraph (a)(5)(v) of this
section, the remainder of the general category stock of CFC1,
$6,875x, is assigned to the non-section 245A subgroup of general
category stock.
(2) Passive category stock. No portion of the passive category
stock of CFC1 is in the foreign source gross tested income statutory
grouping or the specified foreign source passive category gross
income statutory grouping. Accordingly, under paragraph (a)(5)(iii)
of this section, no value of the portion of the stock of CFC1 is
assigned to the section 245A subgroup of passive category stock.
Under paragraph (a)(5)(v) of this section, the passive category
stock of CFC1, $2,500x is assigned to the non-section 245A subgroup
of passive category stock.
(3) Section 951A category stock. Under paragraph (a)(5)(v) of
this section, all of the section 951A category stock, $3,500x, is
assigned to the non-section 245A subgroup of section 951A category
stock.
(F) Summary. For purpose of the allocation and apportionment of
expenses, $14,000x of the stock of CFC1 is characterized as general
category stock, $7,125x of which is in the section 245A subgroup and
$6,875x of which is in the non-section 245A subgroup; $2,500x of the
stock of CFC1 is characterized as passive category stock, all of
which is in the non-section 245A subgroup; and $3,500x of the stock
of CFC1 is characterized as section 951A category stock, all of
which is in the non-section 245A subgroup.
(2) Example 2: Asset method with noncontrolled 10-percent owned
foreign corporation--(i) Facts. The facts are the same as in
paragraph (c)(1)(i) of this section (the facts in Example 1), except
that CFC1 does not own CFC2 and instead owns 20% of the stock of
FC2, a foreign corporation that is a noncontrolled 10-percent owned
foreign corporation. The tax book value of CFC1's stock in FC2 is
$6,000x. FC2 owns assets with the following values as determined
under Sec. Sec. 1.861-9(g)(2) and 1.861-9T(g)(3): Assets that
generate specified foreign source general category gross income
($3,000x). All of the assets of FC2 generate income that, if
distributed to CFC1 as a dividend, would be foreign source gross
subpart F income in the general category to CFC1.
(ii) Analysis--(A) Step 1--(1) Characterization of FC2 stock.
All of the assets of FC2 generate income that, if distributed to
CFC1, would be foreign source gross subpart F income in the general
category to CFC1. Accordingly, under paragraph (a)(1)(i) of this
section, all of CFC1's stock in FC2 ($6,000x) is characterized as in
the foreign source gross subpart F income statutory grouping within
the general category.
(2) Characterization of CFC1 stock. CFC1 has total assets of
$16,000x, $4,000x of which are in the foreign source gross tested
income statutory grouping within the general category, $7,000x of
which are in the foreign source gross subpart F income statutory
grouping within the general category (including the FC2 stock
assigned to that statutory grouping), $3,000x of which are in the
specified foreign source general category gross income statutory
grouping, and $2,000x of which are in the foreign source gross
subpart F income statutory grouping within the passive category.
Accordingly, CFC1's stock is characterized as $5,000x ($4,000x/
$16,000x x $20,000x) in the foreign source gross tested income
statutory grouping within the general category, $8,750x ($7,000x/
$16,000x x $20,000x) in the foreign source gross subpart F income
statutory grouping within the general category, $3,750x ($3,000x/
$16,000x x $20,000x) in the specified foreign source general
category gross income statutory grouping, and $2,500x ($2,000x/
$16,000x x $20,000x) in the foreign source gross subpart F income
statutory grouping within the passive category.
(B) Step 2. The analysis is the same as in paragraph
(c)(1)(ii)(B) of this section (the analysis of Step 2 in Example 1).
(C) Step 3. The analysis is the same as in paragraph
(c)(1)(ii)(C) of this section (the analysis of Step 3 in Example 1).
(D) Step 4--(1) General category stock. The total value of the
portion of the stock of CFC1 that is general category stock is
$14,000x, which is equal to $1,500x (the value of the portion of the
general category stock of CFC1 that was not assigned to the section
951A category in paragraph (c)(2)(ii)(B) of this section (Step 2))
plus $3,750x (the value of the portion of the stock of CFC1 assigned
to the specified foreign source gross income statutory grouping
within the general category general category) plus $8,750x (the
value of the portion of the stock of CFC1 assigned to the foreign
source gross subpart F income statutory grouping within the general
category).
(2) Passive category stock. The analysis is the same as in
paragraph (c)(1)(ii)(D)(2) of this section (the analysis of Step 4
in Example 1).
(E) Step 5--(1) General category stock. Under paragraph
(a)(5)(ii) of this section, the value of the stock of CFC1 assigned
to the section 245A subgroup of general category stock is $5,250x,
which is equal to $1,500x (the value of the portion of the general
category stock of CFC1 that was not assigned to the section 951A
category in paragraph (c)(2)(ii)(B) of this section (Step 2)) plus
$3,750x (the value of the portion of the stock of CFC1 assigned to
the specified foreign source general category gross income statutory
grouping). Under paragraph (a)(5)(v) of this section, the remainder
of the general category stock of CFC1, $8,750x, is assigned to the
non-section 245A subgroup of general category stock.
(2) Passive category stock. The analysis is the same as in
paragraph (c)(1)(ii)(E)(2) of this section (the analysis of Step 5
in Example 1).
(3) Section 951A category stock. The analysis is the same as in
paragraph (c)(1)(ii)(E)(3) of this section (the analysis of Step 5
in Example 1).
(F) Summary. For purpose of the allocation and apportionment of
expenses, $14,000x of the stock of CFC1 is characterized as general
category stock, $5,250x of which is in the section 245A subgroup and
$8,750x of which is in the non-section 245A subgroup; $2,500x of the
stock of CFC1 is characterized as passive category stock, all of
which is in the non-section 245A subgroup; and $3,500x of the stock
of CFC1 is characterized as section 951A category stock, all of
which is in the non-section 245A subgroup.
(3) Example 3: Modified gross income method--(i) Facts--(A) USP,
a domestic corporation, directly owns all of the stock of a
controlled foreign corporation, CFC1. The tax book value of CFC1's
stock is $100,000x. CFC1 owns all of the stock of CFC2, a controlled
foreign corporation. USP uses the modified gross income method
described in Sec. 1.861-12(c)(3)(iii) to characterize the stock in
CFC1. USP's inclusion percentage is 100%.
(B) CFC1 earns $1,500x of foreign source gross tested income
within the general category and $500x of foreign source gross
subpart F income within the passive category. CFC1 incurs $1,000x of
interest expense.
(C) CFC2 earns $3,000x of foreign source gross tested income
within the general
[[Page 69074]]
category, $2,000x of foreign source gross subpart F income within
the general category, and $1,000x of specified foreign source
general category gross income. CFC2 incurs $3,000x of interest
expense.
(ii) Analysis--(A) Step 1--(1) Determination of CFC2 gross
income (net of interest expense). CFC2 has total gross income of
$6,000x. CFC2's $3,000x of interest expense is apportioned among the
statutory groupings of gross income based on the gross income of
CFC2 to determine the gross income (net of interest expense) of CFC2
in each statutory grouping. As a result, $1,500x ($3,000x/$6,000x x
$3,000x) of interest expense is apportioned to foreign source gross
tested income within the general category, $1,000x ($2,000x/$6,000x
x $3,000x) of interest expense is apportioned to foreign source
gross subpart F income within the general category, and $500x
($1,000x/$6,000x x $3,000x) of interest expense is apportioned to
specified foreign source general category gross income. Accordingly,
CFC2 has the following amounts of gross income (net of interest
expense): $1,500x ($3,000x - $1,500x) of foreign source gross tested
income within the general category, $1,000x ($2,000x - $1,000x) of
foreign source gross subpart F income within the general category,
and $500x ($1,000x - $500x) of specified foreign source general
category gross income.
(2) Determination of CFC1 gross income (net of interest
expense). Before including the gross income consisting of subpart F
income (net of interest expense) of CFC2, CFC1 has total gross
income of $4,000x, including $1500x of CFC2's foreign source gross
tested income within the general category and $500x of CFC2's
specified foreign source general category gross income which are
combined with CFC1's items of gross income under Sec. 1.861-
9(j)(2)(ii). CFC1's $1,000x of interest expense is apportioned among
the statutory groupings of gross income of CFC1 to determine the
gross income (net of interest expense) of CFC1 in each statutory
grouping. As a result, $750x ($3,000x/$4,000x x $1,000x) of interest
expense is apportioned to foreign source gross tested income within
the general category, $125x ($500x/$4,000 x $1,000x) to foreign
source gross subpart F income within the passive category, and $125x
($500x/$4,000x x $1,000x) to specified foreign source general
category gross income. Accordingly, CFC1 has the following amounts
of gross income (net of interest expense) before including the gross
income consisting of subpart F income (net of interest expense) of
CFC2: $2,250x ($3,000x - $750x) of foreign source gross tested
income within the general category, $375x ($500x - $125x) of foreign
source gross subpart F income within the passive category, and $375x
($500 - $125x) of specified foreign source general category gross
income. After including the gross income consisting of subpart F
income (net of interest expense) of CFC2, CFC1 has the following
amounts of gross income (net of interest expense): $2,250x of
foreign source gross tested income within the general category,
$1,000x of foreign source gross subpart F income within the general
category, $375x of specified foreign source general category gross
income, and $375x of foreign source gross subpart F income within
the passive category.
(3) Characterization of CFC1 stock. CFC1 is considered to have a
total of $4,000x of gross income (net of interest expense) for
purposes of characterizing the stock of CFC1. Accordingly, CFC1's
stock is characterized as $56,250x ($2,250x/$4,000x x $100,000x) in
the foreign source gross tested income statutory grouping within the
general category, $25,000x ($1,000x/$4,000x x $100,000x) in the
foreign source gross subpart F income statutory grouping within the
general category, $9,375x ($375x/$4,000x x $100,000x) in the
specified foreign source general category gross income statutory
grouping, and $9,375x ($375x/$4,000x x $100,000x) in the foreign
source gross subpart F income statutory grouping within the passive
category.
(B) Step 2. The value of the portion of the stock of CFC1 that
is general category gross tested income stock is $56,250x. USP's
inclusion percentage is 100%. Accordingly, under paragraph (a)(2) of
this section, all of the $56,250x of the stock of CFC1 is assigned
to the section 951A category and a portion thereof may be treated as
an exempt asset under Sec. 1.861-8(d)(2)(ii)(C)(2)(ii).
(C) Step 3. No portion of the stock of CFC1 is resourced gross
tested income or assigned to the resourced gross subpart F income
statutory group in any treaty category. Accordingly, no portion of
the stock of CFC1 is assigned to a treaty category under paragraph
(a)(3) of this section.
(D) Step 4--(1) General category stock. The total value of the
portion of the stock of CFC1 that is general category stock is
$34,375x, which is equal to $25,000x (the value of the portion of
the stock of CFC1 assigned to the subpart F income statutory
grouping within the general category income statutory grouping) plus
$9,375x (the value of the portion of the stock of CFC1 assigned to
the specified foreign source general category gross income statutory
grouping).
(2) Passive category stock. The total value of the portion of
the stock of CFC1 that is passive category stock is $9,375x.
(3) U.S. source category stock. No value of the portion of the
stock of CFC1 is U.S. source category stock.
(E) Step 5--(1) General category stock. All of the value of the
general category gross tested income stock of CFC1 was assigned to
the section 951A category in paragraph (c)(3)(ii)(B) of this section
(Step 2). Accordingly, under paragraph (a)(5)(ii) of this section,
the value of the stock of CFC1 assigned to the section 245A subgroup
of general category stock is $9,375x, which is equal to the value of
the portion assigned to the specified foreign source general
category gross income statutory grouping. Under paragraph (a)(5)(v)
of this section, the remainder of the general category stock of
CFC1, $25,000x, is assigned to the non-section 245A subgroup of
general category stock.
(2) Passive category stock. No portion of the passive category
stock of CFC1 is in the foreign source gross tested income statutory
grouping or the specified foreign source passive category gross
income statutory grouping. Accordingly, under paragraph (a)(5)(iii)
of this section, no value of the portion of the stock of CFC1 is
assigned to the section 245A subgroup. Under paragraph (a)(5)(v) of
this section, the passive category stock of CFC1, $9,375x, is
assigned to the non-section 245A subgroup of passive category stock.
(3) Section 951A category stock. Under paragraph (a)(5)(v) of
this section, all of the section 951A category stock, $56,250x, is
assigned to the non-section 245A subgroup of section 951A category
stock.
(F) Summary. For purposes of the allocation and apportionment of
expenses, $56,250x of the stock of CFC1 is characterized as section
951A category stock, all of which is in the non-section 245A
subgroup; $34,375x of the stock of CFC1 is characterized as general
category stock, $9,375x of which is in the section 245A subgroup and
$25,000x of which is in the non-section 245A subgroup; and $9,375x
of the stock of CFC1 is characterized as passive category stock, all
of which is in the non-section 245A subgroup.
(d) Applicability dates. This section applies for taxable years
that both begin after December 31, 2017, and end on or after December
4, 2018.
Sec. 1.861-14 [Amended]
0
Par. 13. Section 1.861-14 is amended by:
0
1. Removing the language ``, except that section 936 corporations (as
defined in Sec. 1.861-11(d)(2)(ii)) are also included within the
affiliated group to the extent provided in paragraph (d)(2) of this
section'' from the first sentence of paragraph (d)(1).
0
2. Removing and reserving paragraph (d)(2).
0
Par. 14. Section 1.861-17 is amended by:
0
1. Adding paragraph (e)(3).
0
2. Removing and reserving paragraph (g).
0
3. Adding paragraph (i).
The additions and revisions read as follows:
Sec. 1.861-17 Allocation and apportionment of research and
experimental expenditures.
* * * * *
(e) * * *
(3) Change of method for taxable years beginning after December 31,
2017, and before January 1, 2020. A taxpayer otherwise subject to the
binding election described in paragraph (e)(1) of this section may
change its method for each taxable year beginning after December 31,
2017, and before January 1, 2020, without the prior consent of the
Commissioner. The taxpayer's use of a new method constitutes a binding
election to use the new method for its return filed for its last year
that begins before January 1,
[[Page 69075]]
2020, and for four taxable years thereafter.
* * * * *
(i) Applicability date. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 15. Section 1.901(j)-1 is added to read as follows:
Sec. 1.901(j)-1 Denial of foreign tax credit with respect to certain
foreign countries.
(a) Sourcing rule for certain payments and inclusions. Any income
paid or accrued through one or more entities is treated as income from
sources within a country described in section 901(j)(2) if the income
was, without regard to such entities, from sources within that country.
(b) Applicability date. This section applies to taxable years that
end on or after December 4, 2018.
Sec. 1.904-0 [Removed]
0
Par. 16. Sec. 1.904-0 is removed.
0
Par. 17. Sec. 1.904-1 is revised to read as follows:
Sec. 1.904-1 Limitation on credit for foreign taxes.
(a) In general. For each separate category described in Sec.
1.904-5(a)(4)(v), the total credit for taxes paid or accrued (including
those deemed to have been paid or accrued other than by reason of
section 904(c)) does not exceed that proportion of the tax against
which such credit is taken which the taxpayer's taxable income from
foreign sources (but not in excess of the taxpayer's entire taxable
income) in such separate category bears to the taxpayer's entire
taxable income for the same taxable year.
(b) Special computation of taxable income. For purposes of
computing the limitation under paragraph (a) of this section, the
taxable income in the case of an individual, estate, or trust is
computed without any deduction for personal exemptions under section
151 or 642(b).
(c) Joint return. In the case of spouses making a joint return, the
applicable limitation prescribed by section 904(a) on the credit for
taxes paid or accrued to foreign countries and possessions of the
United States is applied with respect to the aggregate taxable income
in each separate category from sources without the United States, and
the aggregate taxable income from all sources, of the spouses.
(d) Consolidated group. For rules relating to the computation of
the foreign tax credit limitation for a consolidated group, see Sec.
1.1502-4.
(e) Applicability dates. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 18. Section 1.904-2 is amended by:
0
1. Revising paragraphs (a) through (d).
0
2. Removing the language ``904(d)'' and adding the language ``904(c)''
in its place in paragraph (e).
0
3. Removing and reserving paragraph (g).
0
4. Revising paragraphs (h) and (i).
0
5. Adding paragraphs (j) and (k).
The revisions and additions read as follows:
Sec. 1.904-2 Carryback and carryover of unused foreign tax.
(a) Credit for foreign tax carryback or carryover. A taxpayer who
chooses to claim a credit under section 901 for a taxable year is
allowed a credit under that section not only for taxes otherwise
allowable as a credit but also for taxes deemed paid or accrued in that
year as a result of a carryback or carryover of an unused foreign tax
under section 904(c). However, the taxes so deemed paid or accrued are
not allowed as a deduction under section 164(a). Foreign tax paid,
accrued, or deemed paid under section 960 with respect to section 951A
category income, including section 951A category income that is
reassigned to a separate category for income resourced under a treaty,
may not be carried back or carried forward or deemed paid or accrued
under section 904(c). See Sec. 1.904-6 for rules for allocating and
apportioning taxes to separate categories. For special rules regarding
these computations in case of taxes paid, accrued, or deemed paid with
respect to foreign oil and gas extraction income or foreign oil related
income, see section 907(f).
(b) Years to which foreign taxes are carried. If the taxpayer
chooses the benefits of section 901 for a taxable year, any unused
foreign tax paid or accrued in that year is carried first to the
immediately preceding taxable year and then, as applicable, to each of
the ten succeeding taxable years, in chronological order, but only to
the extent not absorbed as taxes deemed paid or accrued under
paragraphs (a) and (d) of this section in a prior taxable year.
(c) Definitions. This paragraph (c) provides definitions that apply
for purposes of this section.
(1) Unused foreign tax. The term unused foreign tax means, with
respect to each separate category for any taxable year, the excess of
the amount of creditable foreign tax paid or accrued, or deemed paid
under section 902 (as in effect on December 21, 2017) or section 960,
in such year, over the applicable foreign tax credit limitation under
section 904 for the separate category in such year. Unused foreign tax
does not include any amount for which a credit is disallowed, including
foreign income taxes for which a credit is disallowed or reduced when
the tax is paid, accrued, or deemed paid.
(2) Separate category. The term separate category has the same
meaning as provided in Sec. 1.904-5(a)(4)(v).
(3) Excess limitation--(i) In general. The term excess limitation
means, with respect to a separate category for any taxable year (the
excess limitation year) and an unused foreign tax carried from another
taxable year (the excess credit year), the amount (if any) by which the
limitation for that separate category with respect to that excess
limitation year exceeds the sum of--
(A) The creditable foreign tax actually paid or accrued or deemed
paid under section 902 (as in effect on December 21, 2017) or section
960 with respect to the separate category in the excess limitation
year; and
(B) The portion of any unused foreign tax for a taxable year
preceding the excess credit year that is absorbed as taxes deemed paid
or accrued in the excess limitation year under paragraphs (a) and (d)
of this section.
(ii) Deduction years. Excess limitation for a taxable year absorbs
unused foreign tax, regardless of whether the taxpayer chooses to claim
a credit under section 901 for the year. In such case, the amount of
the excess limitation, if any, for the year is determined in the same
manner as though the taxpayer had chosen to claim a credit under
section 901 for that year. For purposes of this determination, if the
taxpayer has an overall foreign loss account, the excess limitation in
a deduction year is determined based on the amount of the overall
foreign loss the taxpayer would have recaptured if the taxpayer had
chosen to claim a credit under section 901 for that year and had not
made an election under Sec. 1.904(f)-2(c)(2) to recapture more of the
overall foreign loss account than is required under Sec. 1.904(f)-
2(c)(1).
(d) Taxes deemed paid or accrued--(1) Amount deemed paid or
accrued. The amount of unused foreign tax with respect to a separate
category that is deemed paid or accrued in any taxable year to which
such unused foreign tax may be carried under paragraph (b) of this
section is equal to the smaller of--
(i) The portion of the unused foreign tax that may be carried to
the taxable year under paragraph (b) of this section; or
[[Page 69076]]
(ii) The amount, if any, of the excess limitation for such taxable
year with respect to the separate category of such unused foreign tax.
(2) Carryback or carryover tax deemed paid or accrued in the same
separate category. Any unused foreign tax, which is deemed to be paid
or accrued under section 904(c) in the year to which it is carried, is
deemed to be paid or accrued with respect to the same separate category
as the category to which it was assigned in the year in which it was
actually paid or accrued. However, see paragraphs (h) through (j) of
this section for transition rules in the case of certain carrybacks and
carryovers.
(3) No duplicate disallowance of creditable foreign tax. Foreign
income taxes for which a credit is partially disallowed, including when
the tax is paid, accrued, or deemed paid, are not reduced again by
reason of the unused foreign tax being deemed to be paid or accrued in
the year to which it is carried under section 904(c).
* * * * *
(h) Transition rules for carryovers of pre-2003 unused foreign tax
and carrybacks of post-2002 unused foreign tax paid or accrued with
respect to dividends from noncontrolled section 902 corporations. For
transition rules for carryovers of pre-2003 unused foreign tax, and
carrybacks of post-2002 unused foreign tax, paid or accrued with
respect to dividends from noncontrolled section 902 corporations, see
26 CFR 1.904-2(h) (revised as of April 1, 2018).
(i) Transition rules for carryovers of pre-2007 unused foreign tax
and carrybacks of post-2006 unused foreign tax. For transition rules
for carryovers of pre-2007 unused foreign tax, and carrybacks of post-
2006 unused foreign tax, see 26 CFR 1.904-2(i) (revised as of April 1,
2018).
(j) Transition rules for carryovers and carrybacks of pre-2018 and
post-2017 unused foreign tax--(1) Carryover of unused foreign tax--(i)
In general. For purposes of this paragraph (j), the terms post-2017
separate category, pre-2018 separate category, and specified separate
category have the meanings set forth in Sec. 1.904(f)-12(j)(1). The
rules of this paragraph (j)(1) apply to reallocate to the taxpayer's
post-2017 separate categories for foreign branch category income,
general category income, passive category income, and specified
separate categories of income, any unused foreign taxes (as defined in
paragraph (c)(1) of this section) that were paid or accrued or deemed
paid under sections 902 and 960 with respect to income in a pre-2018
separate category.
(ii) Allocation to the same separate category. Except as provided
in paragraph (j)(1)(iii) of this section, to the extent any unused
foreign taxes paid or accrued or deemed paid with respect to a separate
category of income are carried forward to a taxable year beginning
after December 31, 2017, such taxes are allocated to the same post-2017
separate category as the pre-2018 separate category from which the
unused foreign taxes are carried.
(iii) Exception for certain general category unused foreign taxes--
(A) In general. To the extent any unused foreign taxes with respect to
general category income are carried forward to a taxable year beginning
after December 31, 2017, a taxpayer may choose to allocate those taxes
to the taxpayer's post-2017 separate category for foreign branch
category income to the extent the unused foreign taxes would have been
allocated to the taxpayer's post-2017 separate category for foreign
branch category income, and would have been unused foreign taxes with
respect to foreign branch category income if that separate category had
applied in the year or years the unused foreign taxes arose. Any
remaining unused foreign taxes paid or accrued or deemed paid with
respect to general category income carried forward to a taxable year
beginning after December 31, 2017, are allocated to the taxpayer's
post-2017 separate category for general category income.
(B) Safe harbor. In lieu of applying paragraph (j)(1)(iii)(A) of
this section, the taxpayer may choose to allocate the unused foreign
taxes with respect to general category income in a taxable year
beginning before January 1, 2018, to the taxpayer's post-2017 separate
category for foreign branch category income based on a ratio equal to
the amount of foreign income taxes assigned to the general category
that were paid or accrued by the taxpayer's foreign branches (as
defined in Sec. 1.904-4(f)(3)(vii)) bears to all foreign income taxes
assigned to the general category that were paid or accrued, or deemed
paid by the taxpayer with respect to such taxable year. The amount of
taxes paid or accrued by a foreign branch in a taxable year beginning
before January1, 2018, means all foreign income taxes properly
reflected on the separate set of books and records (as defined in Sec.
1.989(a)-1(d)(1) and (2)) of the foreign branch as an expense (which
does not include any taxes deemed paid under section 902 or 960).
(C) Rules regarding the exception. A taxpayer applying the
exception described in this paragraph (j)(1)(iii) (the branch carryover
exception) must apply the exception to all of its unused foreign taxes
paid or accrued with respect to general category income that are
carried forward to all taxable years beginning after December 31, 2017.
A taxpayer may apply the branch carryover exception on a timely filed
original return (including extensions) or an amended return. A taxpayer
that applies the exception on an amended return must make appropriate
adjustments to eliminate any double benefit arising from application of
the exception to years that are not open for assessment.
(D) Coordination rule. See Sec. 1.904(f)-12(j)(5) for coordination
rule with respect to the exception described in paragraph (j)(1)(iii)
of this section and the exceptions described in Sec. 1.904(f)-12(j)(2)
through (4).
(2) Carryback of unused foreign tax--(i) In general. The rules of
this paragraph (j)(2) apply to any unused foreign taxes that were paid
or accrued, or deemed paid under section 960, with respect to income in
a post-2017 separate category.
(ii) Passive category income and specified separate categories of
income described in Sec. 1.904-4(m). Any unused foreign taxes paid or
accrued or deemed paid with respect to passive category income or a
specified separate category of income in a taxable year beginning after
December 31, 2017, that are carried back to a taxable year beginning
before January 1, 2018, are allocated to the same pre-2018 separate
category as the post-2017 separate category from which the unused
foreign taxes are carried.
(iii) General category income and foreign branch category income.
Any unused foreign taxes paid or accrued or deemed paid with respect to
general category income or foreign branch category income in a taxable
year beginning after December 31, 2017, that are carried back to a
taxable year beginning before January 1, 2018, are allocated to the
taxpayer's pre-2018 separate category for general category income.
(k) Applicability date. Paragraphs (a) through (i) of this section
apply to taxable years that both begin after December 31, 2017, and end
on or after December 4, 2018. Paragraph (j) of this section applies to
taxable years beginning after December 31, 2017. Paragraph (j)(2) of
this section also applies to the last taxable year beginning before
January 1, 2018.
0
Par. 19. Section 1.904-3 is amended by:
0
1. Revising the section heading.
0
2. Removing the language ``a husband and wife'' and adding the language
[[Page 69077]]
``spouses'' in its place in paragraphs (a), (b), (c), and (d).
0
3. Adding a sentence to the end of paragraph (a).
0
4. Removing the second and third sentences in paragraph (d).
0
5. Revising paragraphs (e) and (f)(1) through (3).
0
6. Removing the language ``904(d)'' and adding the language ``904(c)''
in its place in paragraphs (f)(5)(i) and (ii).
0
7. Removing paragraph (f)(6) and the undesignated paragraph following
paragraph (f)(6)(ii).
0
8. Removing and reserving paragraph (g).
0
9. Adding paragraph (h).
The additions and revisions read as follows:
Sec. 1.904-3 Carryback and carryover of unused foreign tax by
spouses making a joint return.
(a) * * * The rules in this section apply separately with respect
to each separate category as defined in Sec. 1.904-5(a)(4)(v).
* * * * *
(e) Amounts carried from or through a joint return year to or
through a separate return year--(1) In general. It is necessary to
allocate to each spouse the spouse's share of an unused foreign tax or
excess limitation for any taxable year for which the spouses filed a
joint return if--
(i) The spouses file separate returns for the current taxable year
and an unused foreign tax is carried thereto from a taxable year for
which they filed a joint return;
(ii) The spouses file separate returns for the current taxable year
and an unused foreign tax is carried to such taxable year from a year
for which they filed separate returns but is first carried through a
year for which they filed a joint return; or
(iii) The spouses file a joint return for the current taxable year
and an unused foreign tax is carried from a taxable year for which they
filed joint returns but is first carried through a year for which they
filed separate returns.
(2) Computation and adjustments. In the cases described in
paragraph (e)(1) of this section, the separate carryback or carryover
of each spouse to the current taxable year shall be computed in the
manner described in Sec. 1.904-2 but with the modifications set forth
in paragraph (f) of this section. Where applicable, appropriate
adjustments are made to take into account the fact that, for any
taxable year involved in the computation of the carryback or the
carryover, either spouse has combined foreign oil and gas income
described in section 907(b) with respect to which the limitation in
section 907(a) applies.
(f) * * * (1) Separate category limitation. The limitation in a
separate category of a particular spouse for a taxable year for which a
joint return is made shall be the portion of the limitation on the
joint return which bears the same ratio to such limitation as such
spouse's foreign source taxable income (with gross income and
deductions taken into account to the same extent as taken into account
on the joint return) in such separate category (but not in excess of
the joint foreign source taxable income) bears to the joint foreign
source taxable income in such separate category.
(2) Unused foreign tax. For purposes of this section, the term
unused foreign tax means, with respect to a particular spouse and
separate category for a taxable year for which a joint return is made,
the excess of the foreign tax paid or accrued by that spouse with
respect to that separate category over that spouse's separate category
limitation.
(3) Excess limitation. For purposes of this section, the term
excess limitation means, with respect to a particular spouse and
separate category for a taxable year for which a joint return is made,
the excess of that spouse's separate category limitation over the
foreign taxes paid or accrued by such spouse with respect to such
separate category for such taxable year.
* * * * *
(h) Applicability date. This section is applicable for taxable
years that both begin after December 31, 2017, and end on or after
December 4, 2018.
0
Par. 20. Section 1.904-4 is amended by:
0
1. Revising paragraph (a).
0
2. Removing the word ``or'' from the end of paragraph (b)(2)(i)(A).
0
3. Removing the period from the end of paragraph (b)(2)(i)(B) and
adding a semicolon in its place.
0
4. Adding paragraphs (b)(2)(i)(C) and (D).
0
5. Revising the first and second sentences and adding a sentence after
the second sentence of paragraph (b)(2)(ii).
0
6. Revising paragraph (b)(2)(iv).
0
7. In paragraph (c)(1):
0
i. Removing the language ``shall not be'' from the first sentence and
adding the language ``is not'' in its place.
0
ii. Revising the second, third, and fourth sentences and removing the
last two sentences.
0
8. Removing the language ``1.861-14T'' in the first sentence of
paragraph (c)(2)(i) and adding the language ``1.861-17'' in its place.
0
9. Adding paragraph (c)(2)(iii).
0
10. In paragraph (c)(3) introductory text:
0
i. Removing the language ``shall be'' in the first sentence and adding
the language ``are'' in its place.
0
ii. Revising the second, third, and fourth sentences, and adding a
sentence after the fourth sentence.
0
11. Revising paragraphs (c)(4) and (c)(5)(ii).
0
12. Removing the second and third sentences of paragraphs
(c)(5)(iii)(A) and (B).
0
13. Revising paragraph (c)(5)(iii)(C).
0
14. In paragraph (c)(6)(i):
0
i. Revising the first sentence.
0
ii. Removing the language ``deemed paid or accrued'' and adding the
language ``deemed paid'' in its place and removing the word ``taxable''
in the second sentence.
0
15. In paragraph (c)(6)(iii):
0
i. Revising the first, fourth, fifth, and sixth sentences.
0
ii. Removing the word ``taxable'' in the second and third sentences.
0
iii. Removing the language ``deemed paid or accrued'' and adding the
language ``deemed paid'' in its place and removing ``(A),'' ``(B),''
and ``(C)'' in the third sentence.
0
16. Revising paragraph (c)(6)(iv).
0
17. In paragraph (c)(7)(i):
0
i. Removing the language ``is reduced'' and adding the language ``would
be reduced'' in its place in the first sentence.
0
ii. Revising the second and sixth sentences.
0
18. In paragraph (c)(7)(iii):
0
i. Removing the language ``general category income'' and adding the
language ``income in another separate category'' in its place in the
third sentence.
0
ii. Removing the last sentence.
0
19. Revising paragraph (c)(8).
0
20. Adding paragraph (d).
0
21. Revising paragraph (e)(1).
0
22. Removing and reserving paragraph (e)(2)(i)(W).
0
23. Removing the seventh sentence of paragraph (e)(3)(i).
0
24. Removing the last sentence of paragraph (e)(3)(ii).
0
25. Removing and reserving paragraphs (e)(3)(iv) and (e)(4)(i)(B).
0
26. Removing paragraph (e)(5).
0
27. Adding paragraphs (f) and (g).
0
28. Revising paragraphs (h)(2), (4), and (5) and (k) through (n).
0
29. Adding paragraphs (o), (p), and (q).
The revisions and additions read as follows:
Sec. 1.904-4 Separate application of section 904 with respect to
certain categories of income.
(a) In general. A taxpayer is required to compute a separate
foreign tax credit
[[Page 69078]]
limitation for income received or accrued in a taxable year that is
described in section 904(d)(1)(A) (section 951A category income),
904(d)(1)(B) (foreign branch category income), 904(d)(1)(C) (passive
category income), 904(d)(1)(D) (general category income), or paragraph
(m) of this section (specified separate categories). For purposes of
this section, the definitions in Sec. 1.904-5(a)(4) apply.
(b) * * *
(2) * * *
(i) * * *
(C) Distributive shares of partnership income treated as passive
category income under paragraph (n)(1) of this section, and income from
the sale of a partnership interest treated as passive category income
under paragraph (n)(2) of this section; or
(D) Income treated as passive category income under the look-
through rules in Sec. 1.904-5.
(ii) Exceptions. Passive income does not include any export
financing interest (as defined in paragraph (h) of this section), any
high-taxed income (as defined in paragraph (c) of this section),
financial services income (as defined in paragraph (e)(1)(ii) of this
section), or any active rents and royalties (as defined in paragraph
(b)(2)(iii) of this section). In addition, passive income does not
include any income that would otherwise be passive but is excluded from
passive category income under Sec. 1.904-5(b)(1) or that is assigned
to a separate category other than passive category income under Sec.
1.904-5(c)(4)(iii). See also paragraph (k) of this section for rules
relating to income resourced under a tax treaty. * * *
* * * * *
(iv) Examples. The following examples illustrate the application of
this paragraph (b)(2).
(A) Example 1. For Year 1, USP, a domestic corporation, has a
net foreign currency gain that would not constitute foreign personal
holding company income if USP were a controlled foreign corporation
because the gain is directly related to the business needs of USP.
See section 954(c)(1)(D). Under paragraph (b)(2)(i)(A) of this
section, the foreign currency gain is, therefore, not passive
category income to USP because it is not income of a kind that would
be foreign personal holding company income.
(B) Example 2. Controlled foreign corporation, CFC, is a wholly-
owned subsidiary of USP, a domestic corporation. CFC is regularly
engaged in the restaurant franchise business. USP licenses
trademarks, tradenames, certain know-how, related services, and
certain restaurant designs for which CFC pays USP an arm's length
royalty. USP is regularly engaged in the development and licensing
of such property. Some of the franchisees are unrelated to CFC and
USP. Other franchisees are related to CFC or USP and use the
licensed property outside of CFC's country of incorporation. CFC
does not satisfy, but USP does satisfy, the active trade or business
requirements of section 954(c)(2)(A). The royalty income earned by
CFC from both its related and unrelated franchisees is foreign
personal holding company income because CFC does not satisfy the
active trade or business requirements of section 954(c)(2)(A) and,
in addition, the royalty income from the related franchisees does
not qualify for the same country exception of section 954(c)(3) or
the look-through exception in section 954(c)(6). However, all of the
royalty income earned by CFC is general category income to CFC under
Sec. 1.904-4(b)(2)(iii) because USP, a member of CFC's affiliated
group, satisfies the active trade or business test (which is applied
without regard to whether the royalties are paid by a related
person). USP's inclusion under section 951(a)(1)(A) of CFC's royalty
income is general category income to USP under Sec. 1.904-5(c)(5)
and paragraph (d) of this section. The royalties received by USP are
general category income to USP under Sec. 1.904-5(b)(1) and
paragraph (d) of this section.
* * * * *
(c) * * * (1) * * * Income is considered to be high-taxed income
if, after allocating expenses, losses, and other deductions of the
United States person to that income under paragraph (c)(2) of this
section, the sum of the foreign income taxes paid or accrued, and
deemed paid under section 960, by the United States person with respect
to such income (reduced by any portion of such taxes for which a credit
is not allowed) exceeds the highest rate of tax specified in section 1
or 11, whichever applies (and with reference to section 15 if
applicable), multiplied by the amount of such income (including the
amount treated as a dividend under section 78). If, after application
of this paragraph (c), income that would otherwise be passive income is
determined to be high-taxed income, the income is treated as general
category income, foreign branch category income, section 951A category
income, or income in a specified separate category, as determined under
the rules of this section, and any taxes imposed on that income are
considered related to the same separate category of income under Sec.
1.904-6. If, after application of this paragraph (c), passive income is
zero or less than zero, any taxes imposed on the passive income are
considered related to the same separate category of income to which the
passive income (if not reduced to zero or less than zero) would have
been assigned had the income been treated as high-taxed income (general
category, foreign branch category, section 951A category, or a
specified separate category). * * *
(2) * * *
(iii) Coordination with section 904(b), (f) and (g). The
determination of whether foreign source passive income is high-taxed is
made before taking into account any adjustments under section 904(b) or
any allocation or recapture of a separate limitation loss, overall
foreign loss, or overall domestic loss under section 904(f) and (g).
(3) * * * Paragraph (c)(4) of this section provides additional
rules for inclusions under section 951(a)(1) or 951A(a) that are
passive income, dividends from a controlled foreign corporation or
noncontrolled 10-percent owned foreign corporation that are passive
income, and income that is received or accrued by a United States
person through a foreign QBU that is passive income. For purposes of
this paragraph (c), a foreign QBU is a qualified business unit (as
defined in section 989(a)), other than a controlled foreign corporation
or noncontrolled 10-percent owned foreign corporation, that has its
principal place of business outside the United States. The rules in
this paragraph (c)(3) apply whether the income is received from a
controlled foreign corporation of which the United States person is a
United States shareholder, from a noncontrolled 10-percent owned
foreign corporation of which the United States person is a United
States shareholder that is a domestic corporation, or from any other
person. In applying the rules in this paragraph (c)(3), passive income
is not treated as subject to a withholding tax or other foreign tax
when a credit is disallowed in full for such foreign tax, for example,
under section 901(k). * * *
* * * * *
(4) Dividends and inclusions from controlled foreign corporations,
dividends from noncontrolled 10-percent owned foreign corporations, and
income attributable to foreign QBUs. Except as provided in paragraph
(c)(5) of this section, the rules of this paragraph (c)(4) apply to all
dividends and all amounts included in gross income of a United States
shareholder under section 951(a)(1) or 951A(a) with respect to the
foreign corporation that (after application of the look-through rules
of section 904(d)(3) and Sec. 1.904-5) are attributable to passive
income received or accrued by a controlled foreign corporation, all
dividends from a noncontrolled 10-percent owned foreign corporation
that are received or accrued by a United States shareholder that (after
application of the look-through rules of section 904(d)(4) and Sec.
1.904-5) are treated as passive income,
[[Page 69079]]
and all amounts of passive income received or accrued by a United
States person through a foreign QBU. The grouping rules of paragraphs
(c)(3)(i) through (iv) of this section apply separately to dividends,
to inclusions under section 951(a)(1) and to inclusions under section
951A(a) with respect to each controlled foreign corporation of which
the taxpayer is a United States shareholder, and to dividends with
respect to each noncontrolled 10-percent owned foreign corporation of
which the taxpayer is a United States shareholder that is a domestic
corporation. The grouping rules of paragraphs (c)(3)(i) through (iv) of
this section also apply separately to income attributable to each
foreign QBU of a controlled foreign corporation, noncontrolled 10-
percent owned foreign corporation, any other look-through entity as
defined in Sec. 1.904-5(i), or any United States person.
(5) * * *
(ii) Treatment of partnership income. A partner's distributive
share of income from a foreign or domestic partnership that is treated
as passive income under paragraph (n)(1)(ii) of this section (generally
providing that a less than 10 percent partner's distributive share of
partnership income is passive income) is treated as a single item of
income and is not grouped with other amounts. A distributive share of
income from a partnership that is treated as passive income under
paragraph (n)(1)(i) of this section is grouped according to the rules
in paragraph (c)(3) of this section, except that the portion, if any,
of the distributive share of income attributable to income earned by a
domestic partnership through a foreign QBU is separately grouped under
the rules of paragraph (c)(4) of this section.
* * * * *
(iii) * * *
(C) Example. The following example illustrates the application of
this paragraph (c)(5)(iii).
(1) Facts. USP, a domestic corporation, owns all of the stock of
CFC, a controlled foreign corporation organized and operating in
Country X that uses the ``u'' as its functional currency. In Year 1,
when the highest rate of U.S. tax in section 11 is 21%, CFC earns
100u of passive category foreign personal holding company income
subject to no foreign tax. When included in USP's income under
section 951(a), the applicable exchange rate is 1u=$1x. Therefore,
USP's section 951(a) inclusion is $100x and no foreign taxes are
deemed paid by USP with respect to the inclusion. At the end of Year
1, CFC has previously taxed earnings and profits of 100u and USP's
basis in those earnings is $100x. In Year 2, CFC has no earnings and
profits and distributes 100u to USP. The value of the earnings when
distributed is $150x. Assume that under section 986(c), USP must
recognize $50x of passive category income attributable to the
appreciation of the previously taxed earnings and profits. Country X
does not recognize any gain or loss on the distribution, but imposes
a 10u withholding tax on USP with respect to the distribution.
(2) Analysis. Because the section 986(c) gain is not subject to
any foreign withholding tax or other foreign tax, under paragraph
(c)(3)(iii) of this section the section 986(c) gain is grouped with
other items of USP's income that are subject to no withholding tax
or other foreign tax. Under paragraph (c)(6)(iii) of this section,
the 10u withholding tax is related to passive category income. See
section 960(c) and Sec. 1.960-4 for rules relating to the increase
in limitation in the year of distribution of previously taxed
earnings and profits.
\* * * * *
(6) * * * (i) * * * The determination of whether an amount included
in gross income under section 951(a)(1) or 951A(a) is high-taxed income
is made in the taxable year the income is included in the gross income
of the United States shareholder under section 951(a) or 951A(a) (for
purposes of this paragraph (c), the year of inclusion). * * *
* * * * *
(iii) * * * If an item of income is considered high-taxed income in
the year of inclusion and paragraph (c)(6)(i) of this section applies,
then any increase in foreign income taxes imposed with respect to that
item are considered to be related to the same separate category to
which the income was assigned in the taxable year of inclusion. * * *
The taxpayer shall treat any taxes paid or accrued, or deemed paid, on
the distribution in excess of this amount as taxes related to the same
category of income to which such inclusion would have been assigned had
the income been treated as high-taxed income in the year of inclusion
(general category income, section 951A category income, or income in a
specified separate category). If these additional taxes are not
creditable in the year of distribution, the carryover rules of section
904(c) apply (see section 904(c) and Sec. 1.904-2(a) for rules
disallowing carryovers in the section 951A category). For purposes of
this paragraph (c)(6), the foreign tax on an inclusion under section
951(a)(1) or 951A(a) is considered increased on distribution of the
earnings and profits associated with that inclusion if the total of
taxes paid and deemed paid on the inclusion and the distribution
(taking into account any reductions in tax and any withholding taxes)
exceeds the total taxes deemed paid in the year of inclusion. * * *
(iv) Increase in taxes paid by successors. If passive earnings and
profits previously included in income of a United States shareholder
are distributed to a person that was not a United States shareholder of
the distributing corporation in the year the earnings were included,
any increase in foreign taxes paid or accrued, or deemed paid, on that
distribution is treated as taxes related to general category income (or
income in a specified separate category, if applicable) in the case of
earnings and profits previously included under section 951(a)(1), and
is treated as taxes related to section 951A category income (or income
in a specified separate category, if applicable) in the case of
earnings and profits previously included under section 951A(a),
regardless of whether the previously-taxed income was considered high-
taxed income under section 904(d)(2)(F) in the year of inclusion.
(7) * * * (i) * * * If the inclusion is considered to be high-taxed
income, then the taxpayer treats the inclusion as general category
income, section 951A category income, or income in a specified separate
category as provided in paragraph (c)(1) of this section. * * * For
purposes of this paragraph (c)(7)(i), the foreign tax on an inclusion
under section 951(a)(1) or 951A(a) is considered reduced on
distribution of the earnings and profits associated with the inclusion
if the total taxes paid and deemed paid on the inclusion and the
distribution (taking into account any reductions in tax and any
withholding taxes) is less than the total taxes deemed paid in the year
of inclusion. * * *
* * * * *
(8) Examples. The following examples illustrate the application of
this paragraph (c). All of the examples assume that the highest tax
rate under section 11 is 21%, unless otherwise noted.
(i) Example 1. CFC, a controlled foreign corporation, is a
wholly-owned subsidiary of domestic corporation USP. CFC is a single
qualified business unit (QBU) operating in foreign Country X. In
Year 1, CFC earns $130x of gross royalty income that is passive
income from Country X sources, and incurs $30x of expenses that do
not include any payments to USP. CFC's $100x of pre-tax passive
income from the royalty is subject to $30x of foreign tax, and is
included under section 951(a)(1) in USP's gross income for the
taxable year. USP allocates $50x of expenses to the $100x
(consisting of the $70x section 951(a)(1) inclusion and $30x section
78 amount), resulting in net passive income of $50x. USP does not
elect to exclude from subpart F under section 954(b)(4) the $70x of
CFC's net passive income. After application of the high-tax kick-out
rules of paragraph (c) of this section, the $50x of USP's net
passive income is treated as general category income,
[[Page 69080]]
and the $30x of taxes deemed paid are treated as taxes imposed on
general category income, because the foreign taxes paid and deemed
paid on the income exceed the highest U.S. tax rate multiplied by
the $50x of net passive income ($30x > $10.5x (21% x $50x)).
(ii) Example 2. CFC, a controlled foreign corporation, is a
wholly-owned subsidiary of domestic corporation USP. CFC is
incorporated and operating in Country Y and has a branch in Country
Z. CFC has two QBUs (QBU Y and QBU Z). In Year 1, CFC earns $65x of
gross royalty income that is passive income in Country Y through QBU
Y and $65x of gross royalty income that is passive income in Country
Z through QBU Z. CFC allocates $15x of expenses to the gross royalty
income earned by each QBU, resulting in pre-tax passive income of
$50x in each QBU. Country Y imposes $5x of foreign tax on the
royalty income earned in Y, and Country Z imposes $10x of tax on
royalty income earned in Z. All of CFC's income constitutes foreign
personal holding company income that is passive income and is
included under section 951(a)(1) in USP's gross income for the
taxable year. USP allocates $50x of expenses pro rata to the $100x
section 951(a)(1) inclusion attributable to the QBUs (consisting of
the $45x section 951(a)(1) inclusion derived through QBU Y, the $5x
section 78 amount attributable to QBU Y, the $40x section 951(a)(1)
inclusion derived through QBU Z, and the $10x section 78 amount
attributable to QBU Z), resulting in net passive income of $50x.
Pursuant to paragraph (c)(4) of this section, the high-tax kickout
rules must be applied separately to the subpart F inclusion
attributable to the income earned by QBU Y and the income earned by
QBU Z. After application of the high-tax kickout rules, the $25x of
net passive income attributable to QBU Y will be treated as passive
category income because the foreign taxes paid and deemed paid on
the income do not exceed the highest U.S. tax rate multiplied by the
$25x of net passive income ($5x < $5.25x (21% x $25x)). The $25x of
net passive income attributable to QBU Z will be treated as general
category income because the foreign taxes paid and deemed paid on
the income exceed the highest U.S. tax rate multiplied by the $25x
of net passive income ($10x > $5.25x (21% x $25x)).
(iii) Example 3. Domestic corporation USP operates in branch
form in foreign countries X and Y. The branches are qualified
business units (QBUs), within the meaning of section 989(a). In Year
1, QBU X earns passive royalty income, interest income, and rental
income. All of the QBU X passive income is from Country Z sources.
The royalty income is not subject to a withholding tax, and is not
taxed by Country X, and the interest and the rental income are
subject to a 4% and 10% withholding tax, respectively. QBU Y earns
interest income in Country Y that is not subject to foreign tax. For
purposes of determining whether USP's foreign source passive income
is high-taxed income, the rental income and the interest income
earned in QBU X are treated as one item of income pursuant to
paragraph (c)(3)(ii) of this section. The interest income earned in
QBU Y and the royalty income earned in QBU X are each treated as a
separate item of income under paragraphs (c)(4) and (c)(3)(iii) of
this section. If, after allocation of expenses, QBU X's items of
income composed of rental income and interest income are high-taxed
income, the income may be treated as foreign branch category income.
(iv) Example 4. CFC, a controlled foreign corporation
incorporated in foreign Country R, is a wholly-owned subsidiary of
USP, a domestic corporation. USP and CFC have calendar year taxable
years for both U.S. and Country R tax purposes. The highest tax rate
under section 11 is 34% and 21% in Year 1 and Year 2, respectively.
For Year 1, USP is required under section 951(a)(1) to include in
gross income $80x (not including the section 78 amount) attributable
to the earnings and profits of CFC for such year, all of which is
foreign personal holding company income that is passive rent or
royalty income. CFC does not make any distributions in Year 1.
Foreign income taxes paid by CFC for Year 1 that are deemed paid by
USP for such year under section 960(a) with respect to the section
951(a)(1) inclusion equal $20x. USP properly allocates $30x of
expenses to the section 951(a)(1) inclusion. The foreign income tax
paid with respect to the section 951(a)(1) inclusion does not exceed
the highest U.S. tax rate multiplied by the amount of income after
allocation of USP's expenses ($20x < $23.80x (34% x $70x)). Thus,
USP's section 951(a)(1) inclusion for Year 1 is included in USP's
passive category income and the $20x of taxes attributable to that
inclusion are treated as taxes related to passive category income.
In Year 2, CFC distributes $70x to USP, and under section 959 that
distribution is treated as attributable to the earnings and profits
with respect to the amount included in income by USP in Year 1 and
is excluded from USP's gross income. Foreign Country R imposes a
withholding tax of $14x on the distribution in Year 2. Under
paragraph (c)(6)(i) of this section, the withholding tax in Year 2
does not affect the characterization of the Year 1 inclusion as
passive category income, nor does it affect the characterization of
the $20x of taxes paid in Year 1 as taxes paid with respect to
passive category income. No further expenses of USP are allocable to
the receipt of that distribution. In Year 2, the foreign taxes paid
($14x) exceed the product of the highest U.S. tax rate and the
amount of the inclusion reduced by taxes deemed paid in the year of
inclusion ($14x > $3.80x ((34% x $70x) - $20x)). Thus, under
paragraph (c)(6)(iii) of this section, $3.80x ((34% x $70x) - $20x)
of the $14x withholding tax paid in Year 2 is treated as taxes
related to passive category income and the remaining $10.20x ($14x -
$3.80x) of the withholding tax is treated as related to general
category income.
(v) through (viii) [Reserved]
(ix) Example 9. USP, a domestic corporation, earns $100x of
passive royalty income from sources within the United States. Under
the laws of Country X, however, that royalty is considered to be
from sources within Country X, and Country X imposes a 5%
withholding tax on the payment of the royalty. USP also earns $100x
of foreign source passive dividend income from Country Y subject to
a 10% withholding tax to which $15x of expenses are allocated. In
determining whether USP's passive income is high-taxed, the $5x
withholding tax on USP's royalty income is allocated to passive
income, and to the group of passive income described in paragraph
(c)(3)(ii) of this section (passive income subject to a withholding
tax of less than 15% (but greater than zero)). For purposes of
determining whether the income is high-taxed, however, only the $85x
of foreign source dividend income (and not the $100x of U.S. source
royalty income) is taken into account. The foreign source dividend
income is treated as passive category income because the foreign
taxes paid on the passive income in the group ($15x) do not exceed
the highest U.S. tax rate multiplied by the $85x of net foreign
source income in the group ($15x < $17.85x ($100x - $15x) x 21%).
(x) Example 10. In Year 1, P, a U.S. citizen with a tax home in
Country X, earns the following items of gross income: $400x of
foreign source, passive interest income not subject to foreign
withholding tax but subject to Country X income tax of $100x, $200x
of foreign source, passive royalty income subject to a 5% foreign
withholding tax (foreign tax paid is $10x), $1,300x of foreign
source, passive rental income subject to a 25% foreign withholding
tax (foreign tax paid is $325x), $500x of foreign source, general
category loss, and $2,000x of U.S. source capital gain that is not
subject to any foreign tax. P has a $900x deduction allocable to its
passive rental income. P's only other deduction is a $700x capital
loss on the sale of stock that is allocated to foreign source
passive category income under Sec. 1.865-2(a)(3)(i). The $700x
capital loss is initially allocated to the group of passive income
described in paragraph (c)(3)(iv) of this section (passive income
subject to no withholding tax but subject to foreign tax other than
withholding tax). This group comprises the $400x of interest income
not subject to foreign withholding tax but subject to Country X
income tax. Under paragraph (c)(2)(ii) of this section, the $300x
amount by which the capital loss exceeds the income in the group
must be reallocated to the net income in the other groups described
in paragraph (c)(3) of this section, but the $500x general category
separate limitation loss is not allocated until the high-tax kickout
rules are applied to determine whether the passive income is high-
taxed income. P's $200x of royalty income subject to a 5%
withholding tax is described in paragraph (c)(3)(i) of this section
(passive income that is subject to a withholding tax of less than
15%, but greater than zero). P's $1,300x of rental income subject to
a 25% withholding tax is described in paragraph (c)(3)(ii) of this
section (passive income that is subject to a withholding tax of 15%
or greater). The $1,300x of rental income is reduced by the $900x
deduction allocable to such income. Therefore, the total net income
in the other groups under paragraph (c)(3) is $600x, the $200x of
royalty income and the $400x of rental income. The ($300x) net loss
in the net basis tax group thus reduces the royalty income by $100x
to $100x ($200x - ($300x x (200x/600x))) and the rental income by
$200x to
[[Page 69081]]
$200x ($400x - ($300x x (400x/600x))). The $100x of net royalty
income is not high-taxed and remains passive category income because
the foreign taxes of $10x do not exceed the highest U.S. rate of tax
on that income, which is 37% for individuals ($10x < $37x (37% x
$100x)). Under the high-tax kickout, the $200x of rental income and
the $325x of associated foreign tax are assigned to the general
category.
(xi) Example 11. The facts are the same as in paragraph
(c)(8)(x) of this section (the facts in Example 10), except the
amount of the capital loss that is allocated under Sec. 1.865-
2(a)(3)(i) and paragraph (c)(2) of this section to the group of
foreign source passive income subject to no withholding tax but
subject to foreign tax other than withholding tax is $1,200x. Under
paragraph (c)(2)(ii) of this section, the excess deductions of $800x
must be reallocated to the $200x of net royalty income subject to a
5% withholding tax and the $400x of net rental income subject to a
15% or greater withholding tax. The income in each of these groups
is reduced to zero, and the foreign taxes imposed on the rental and
royalty income are considered related to general category income.
The remaining loss of $200x constitutes a separate limitation loss
with respect to passive category income.
(xii) Example 12. In Year 1, USP, a domestic corporation, earns
a $100x dividend that is foreign source passive income subject to a
30% withholding tax. The dividend is not paid by a specified 10-
percent owned foreign corporation (as defined in section
245A(b)(1)). A foreign tax credit for the withholding tax on the
dividend is disallowed under section 901(k). A deduction for the tax
is allowed, however, under sections 164 and 901(k)(7). In
determining whether USP's passive income is high-taxed, under
paragraph (c)(3) of this section the $100x dividend and the $30x
deduction are allocated to the group of income described in
paragraph (c)(3)(iv) of this section (passive income subject to no
withholding tax or other foreign tax).
(d) General category income. The term general category income means
all income other than passive category income, foreign branch category
income, section 951A category income, and income in a specified
separate category. Any item that is excluded from the passive category
under paragraph (c) or (h) of this section or Sec. 1.904-5(b)(1) is
included in general category income only to the extent that such item
does not meet the definition of another separate category. General
category income also includes income treated as general category income
under the look-through rules referenced in Sec. 1.904-5(a)(2).
(e) * * * (1) In general--(i) Treatment of financial services
income. Passive income that is characterized as financial services
income is not assigned to the passive category but is assigned in
accordance with this paragraph (e)(1)(i). Financial services income
that meets the definition of foreign branch category income (see
paragraph (f)(1) of this section) is treated as income in that
category. Financial services income of a controlled foreign corporation
that is included in gross income of a United States shareholder under
section 951A(a) is treated as section 951A category income in the hands
of the United States shareholder. Financial services income that is
neither treated as foreign branch category income nor treated as
section 951A category income is treated as general category income.
Distributions, interest, rents, or royalties received from a related
person that is a financial services entity that would be assigned to
the passive category under the look-through rules in Sec. 1.904-5, but
for the fact such amounts are paid by a financial services entity (and,
therefore, not attributable to passive category income of the payor),
are assigned to separate categories (other than the passive category)
under the rules in this section.
(ii) Definition of financial services income. The term financial
services income means income derived by a financial services entity, as
defined in paragraph (e)(3) of this section, that is:
(A) Income derived in the active conduct of a banking, insurance,
financing, or similar business (active financing income as defined in
paragraph (e)(2) of this section);
(B) Passive income as defined in section 904(d)(2)(B) and paragraph
(b) of this section as determined before the application of the
exception for high-taxed income but after the application of the
exception for export financing interest; or
(C) Incidental income as defined in paragraph (e)(4) of this
section.
* * * * *
(f) Foreign branch category income--(1) Foreign branch category
income--(i) In general. Except as provided in paragraph (f)(1)(ii) of
this section, the term foreign branch category income means income of a
United States person, other than a pass-through entity, that is--
(A) Income attributable to foreign branches of the United States
person held directly or indirectly through disregarded entities;
(B) A distributive share of partnership income that is attributable
to foreign branches held by the partnership directly or indirectly
through disregarded entities, or held indirectly by the partnership
through another partnership or other pass-through entity that holds the
foreign branch directly or indirectly through disregarded entities; and
(C) Income from other pass-through entities determined under
principles similar to those described in paragraph (f)(1)(i)(B) of this
section.
(ii) Passive category income excluded from foreign branch category
income. Income assigned to the passive category under paragraph (b) of
this section is not foreign branch category income, regardless of
whether the income is described in paragraph (f)(1)(i) of this section.
Income that is treated as passive category income under the look-
through rules in Sec. 1.904-5 is also excluded from foreign branch
category income, regardless of whether the income is attributable to a
foreign branch. However, income that would be passive category income
but for the application of section 904(d)(2)(B)(iii) (export financing
interest and high-taxed income) or 904(d)(2)(C) (financial services
income) and also meets the definition of foreign branch category income
is foreign branch category income.
(2) Gross income attributable to a foreign branch--(i) In general.
Except as provided in this paragraph (f)(2), gross income is
attributable to a foreign branch to the extent the gross income (as
adjusted to conform to Federal income tax principles) is reflected on
the separate set of books and records (as defined in Sec. 1.989(a)-
1(d)(1) and (2)) of the foreign branch. Gross income that is not
attributable to the foreign branch and is therefore attributable to the
foreign branch owner is income in a separate category (other than the
foreign branch category) under the other rules of this section.
(ii) Income attributable to U.S. activities. Except as provided in
paragraph (f)(2)(vi) of this section, gross income attributable to a
foreign branch does not include items arising from activities carried
out in the United States, regardless of whether the items are reflected
on the foreign branch's separate books and records.
(iii) Income arising from stock--(A) In general. Except as provided
in paragraph (f)(2)(iii)(B) of this section, gross income attributable
to a foreign branch does not include items of income arising from stock
of a corporation (whether foreign or domestic), including gain from the
disposition of such stock or any inclusion under sections 951(a),
951A(a), 1248, or 1293(a).
(B) Exception for dealer property. Paragraph (f)(2)(iii)(A) of this
section does not apply to gain recognized from dispositions of stock in
a corporation, if the stock would be dealer property (as defined in
Sec. 1.954-2(a)(4)(v)) if the foreign branch were a controlled foreign
corporation.
[[Page 69082]]
(iv) Disposition of interests in certain entities--(A) In general.
Except as provided in paragraph (f)(2)(iv)(B) of this section, gross
income attributable to a foreign branch does not include gain from the
disposition of an interest in a partnership or other pass-through
entity or an interest in a disregarded entity. See also paragraph
(n)(2) of this section for general rules relating to the sale of a
partnership interest.
(B) Exception for sales by a foreign branch in the ordinary course
of business. The rule in paragraph (f)(2)(iv)(A) of this section does
not apply to gain from the sale or exchange of an interest in a
partnership or other pass-through entity or an interest in a
disregarded entity if the gain is reflected on the books and records of
a foreign branch and the interest is held by the foreign branch in the
ordinary course of its active trade or business. An interest is
considered to be held in the ordinary course of the foreign branch's
active trade or business only if the foreign branch--
(1) Directly engages in the same, or a related, trade or business
as that partnership, other pass-through entity, or disregarded entity;
and
(2) In the case of a partnership or other pass-through entity, the
foreign branch owns 10 percent or more of the capital or profits
interests in the partnership or other pass-through entity.
(v) Adjustments to items of gross income reflected on the books and
records. If a principal purpose of recording or failing to record an
item of gross income on the books and records of a foreign branch, or
of making or not making a disregarded payment described in paragraph
(f)(2)(vi) of this section, is the avoidance of Federal income tax, the
purposes of section 904, or the purposes of section 250 (in connection
with section 250(b)(3)(A)(i)(VI)), the item must be attributed to one
or more foreign branches or the foreign branch owner in a manner that
reflects the substance of the transaction. For purposes of this
paragraph (f)(2)(v), interest received by a foreign branch from a
related person is presumed to be attributable to the foreign branch
owner (and not to the foreign branch) unless the interest income meets
the definition of financial services income under paragraph (e)(1)(ii)
of this section. For purposes of this paragraph (f)(2)(v), a related
person is any person that bears a relationship to the foreign branch
owner described in section 267(b) or 707.
(vi) Attribution of gross income to which disregarded payments are
allocable--(A) In general. If a foreign branch makes a disregarded
payment to its foreign branch owner and the disregarded payment is
allocable to gross income that would be attributable to the foreign
branch under the rules in paragraphs (f)(2)(i) through (v) of this
section, the gross income attributable to the foreign branch is
adjusted downward to reflect the allocable amount of the disregarded
payment, and the gross income attributable to the foreign branch owner
is adjusted upward by the same amount, translated (if necessary) from
the foreign branch's functional currency to U.S. dollars at the spot
rate (as defined in Sec. 1.988-1(d)) on the date of the disregarded
payment. For rules addressing multiple disregarded payments in a
taxable year, see paragraph (f)(2)(vi)(F) of this section. Similarly,
if a foreign branch owner makes a disregarded payment to its foreign
branch and the disregarded payment is allocable to gross income
attributable to the foreign branch owner, the gross income attributable
to the foreign branch owner is adjusted downward to reflect the
allocable amount of the disregarded payment, and the gross income
attributable to the foreign branch is adjusted upward by the same
amount, translated (if necessary) from U.S. dollars to the foreign
branch's functional currency at the spot rate on the date of the
disregarded payment. An adjustment to the attribution of gross income
under this paragraph (f)(2)(vi) does not change the total amount,
character, or source of the United States person's gross income; does
not change the amount of a United States person's income in any
separate category other than the foreign branch and general categories
(or a specified separate category associated with the foreign branch
and general categories); and has no bearing on the analysis of whether
an item of gross income is eligible to be resourced under an income tax
treaty. The principles of the rules in this paragraph (f)(2)(vi)(A)
also apply in the case of disregarded payments between a foreign branch
and another foreign branch with the same foreign branch owner if either
foreign branch makes a disregarded payment to, or receives a
disregarded payment from, the foreign branch owner.
(B) Allocation of disregarded payments--(1) In general. Except as
provided in paragraph (f)(2)(vi)(B)(2) of this section, whether a
disregarded payment is allocable to gross income attributable to a
foreign branch or gross income attributable to its foreign branch
owner, and the source and separate category of the gross income to
which the disregarded payment is allocable, is determined under the
following rules:
(i) Disregarded payments from a foreign branch owner to its foreign
branch are allocable to gross income attributable to the foreign branch
owner to the extent a deduction for that payment or any disregarded
cost recovery deduction relating to that payment, if regarded, would be
allocated and apportioned to gross income attributable to the foreign
branch owner under the principles of Sec. Sec. 1.861-8 through 1.861-
14T and 1.861-17 (without regard to exclusive apportionment) by
treating foreign source gross income and U.S. source gross income in
each separate category (determined prior to the application of this
paragraph (f)(2)(vi) to the disregarded payment at issue) each as a
statutory grouping; and
(ii) Disregarded payments from a foreign branch to its foreign
branch owner are allocable to gross income attributable to the foreign
branch to the extent a deduction for that payment or any disregarded
cost recovery deduction relating to that payment, if regarded, would be
allocated and apportioned to gross income attributable to the foreign
branch under the principles of Sec. Sec. 1.861-8 through 1.861-14T and
1.861-17 (without regard to exclusive apportionment) by treating
foreign source gross income and U.S. source gross income in each
separate category (determined prior to the application of this
paragraph (f)(2)(vi) to the disregarded payment at issue) each as a
statutory grouping.
(2) Special rule for certain disregarded payments. Whether a
disregarded payment made in connection with a sale or exchange of
property is allocable to gross income attributable to a foreign branch
or its foreign branch owner, and the source and separate category of
the gross income to which the disregarded payment is allocable, is
determined under the following rules:
(i) Except as provided in paragraph (f)(2)(vi)(D) of this section,
disregarded payments from a foreign branch owner to its foreign branch
in respect of non-inventory property are allocable to the gross income
attributable to the foreign branch owner, if any, that is recognized
with respect to a regarded sale or exchange of that property (including
gross income arising in a later taxable year) to the extent of the
adjusted disregarded gain with respect to the transferred property, and
in the same proportions as the source and separate category of the gain
recognized on the regarded sale or exchange of the transferred
property;
(ii) Except as provided in paragraph (f)(2)(vi)(D) of this section,
disregarded
[[Page 69083]]
payments from a foreign branch to its foreign branch owner or to
another foreign branch in respect of non-inventory property are
allocable to the gross income attributable to the foreign branch, if
any, that is recognized with respect to a regarded sale or exchange of
that property (including gross income arising in a later taxable year)
to the extent of the adjusted disregarded gain with respect to the
transferred property, and in the same proportions as the source and
separate category of the gain recognized on the regarded sale or
exchange of the transferred property; and
(iii) The principles of paragraphs (f)(2)(vi)(B)(2)(i) and (ii) of
this section apply in the case of disregarded payments in respect of
inventory property between a foreign branch and its foreign branch
owner or between foreign branches to the extent the disregarded
payment, if regarded, would, for purposes of determining gross income,
be subtracted from gross receipts that are regarded for Federal income
tax purposes.
(3) Timing of reattribution--(i) In general. The gross income
attributable to the foreign branch is adjusted under paragraph
(f)(2)(vi)(B)(1) of this section only in the taxable year that a
disregarded payment, if regarded, would be allowed as a deduction
(including by giving rise to disregarded cost recovery deductions), or
otherwise would be taken into account as an increase to cost of goods
sold.
(ii) Disregarded sales of property. The gross income attributable
to a foreign branch is adjusted under paragraph (f)(2)(vi)(B)(2) of
this section only in the taxable year or years in which gain is
recognized by reason of the disposition of property with an adjusted
disregarded basis in a transaction that is regarded for Federal income
tax purposes.
(C) Exclusion of certain disregarded payments. Paragraph
(f)(2)(vi)(A) of this section does not apply to the following payments,
accruals, or other transfers between a foreign branch and its foreign
branch owner, or between foreign branches, that are disregarded for
Federal income tax purposes:
(1) Interest, and interest equivalents that, if regarded, would be
described in Sec. Sec. 1.861-9(b) and 1.861-9T(b);
(2) Remittances from the foreign branch to its foreign branch
owner, except as provided in paragraph (f)(2)(vi)(D) of this section;
(3) Contributions of money, securities, and other property from the
foreign branch owner to its foreign branch, except as provided in
paragraph (f)(2)(vi)(D) of this section; or
(4) Any disregarded payment that, if made to a foreign branch and
regarded for Federal income tax purposes, could not result in the
attribution of gross income to a foreign branch (for example, the sale
of an interest in a partnership by a foreign branch to its foreign
branch owner, unless the sale or exchange occurred in the ordinary
course of business within the meaning of paragraph (f)(2)(iv)(B) of
this section).
(D) Certain transfers of intangible property--(1) In general. For
purposes of applying this paragraph (f)(2)(vi), the amount of gross
income attributable to a foreign branch (and the amount of gross income
attributable to its foreign branch owner) must be adjusted under the
principles of paragraph (f)(2)(vi)(B) of this section to reflect all
transactions that are disregarded for Federal income tax purposes in
which property described in section 367(d)(4) is transferred to or from
a foreign branch or between foreign branches, whether or not a
disregarded payment is made in connection with the transfer. In
determining the amount of gross income that is attributable to a
foreign branch that must be adjusted by reason of this paragraph
(f)(2)(vi)(D), the principles of sections 367(d) and 482 apply. For
example, if a foreign branch owner transfers property described in
section 367(d)(4) to a foreign branch, the principles of section 367(d)
are applied by treating the foreign branch as a separate foreign
corporation to which the property is transferred in exchange for stock
of the corporation in a transaction described in section 351.
Similarly, if a foreign branch remits property described in section
367(d)(4) to its foreign branch owner, the foreign branch is treated as
having sold the transferred property to the foreign branch owner in
exchange for annual payments contingent on the productivity or use of
the property, the amounts of which are determined under the principles
of section 367(d).
(2) Transactions occurring before December 7, 2018. Paragraph
(f)(2)(vi)(D)(1) of this section does not apply to a disregarded
transfer of property that occurred before December 7, 2018.
(3) Transitory ownership--(i) In general. Paragraph
(f)(2)(vi)(D)(1) of this section does not apply to disregarded
transfers of property by a foreign branch or a foreign branch owner
(such foreign branch or foreign branch owner, the limited transferor),
if the conditions in paragraphs (f)(2)(vi)(D)(3)(ii) and (iii) of this
section are met.
(ii) Transitory ownership period. The limited transferor's
ownership of the property is transitory.
(iii) Use of property. The limited transferor does not develop,
exploit, or otherwise employ the property in a trade or business, other
than in the ordinary course of the limited transferor's business during
the period of transitory ownership.
(iv) Predecessors. For purposes of paragraphs (f)(2)(vi)(D)(3)(ii)
and (iii) of this section, a reference to a limited transferor that is
a foreign branch owner includes any predecessor to the foreign branch
owner. No person is a predecessor with respect to a foreign branch
under this paragraph (f)(2)(vi)(D)(3)(iv).
(E) Amount of disregarded payments. The amount of each disregarded
payment used to make an adjustment under this paragraph (f)(2)(vi) (or
the absence of any adjustment) must be determined in a manner that
results in the attribution of the proper amount of gross income to each
of a foreign branch and its foreign branch owner under the principles
of section 482, applied as if the foreign branch were a corporation.
(F) Multiple disregarded payments. In the case of multiple
disregarded payments, this paragraph (f)(2)(vi) is applied with respect
to each disregarded payment, and under the ordering rules specified in
paragraphs (f)(2)(vi)(F)(1) and (2) of this section. For purposes of
this paragraph (f)(2)(vi), paragraph (f)(2)(vi)(F)(1) of this section
applies before paragraph (f)(2)(vi)(F)(2) of this section.
(1) Income initially attributable to a foreign branch. In applying
this paragraph (f)(2)(vi) to gross income that would, but for this
paragraph (f)(2)(vi), be attributable to a foreign branch, adjustments
related to disregarded payments from a foreign branch to another
foreign branch are computed first, followed by adjustments related to
disregarded payments from a foreign branch to its foreign branch owner,
followed by adjustments related to disregarded payments from a foreign
branch owner to its foreign branch.
(2) Income initially attributable to a foreign branch owner. In
applying this paragraph (f)(2)(vi) to gross income that would, but for
this paragraph (f)(2)(vi), be attributable to a foreign branch owner,
adjustments related to disregarded payments from a foreign branch owner
to a foreign branch are computed first, followed by adjustments related
to disregarded payments from a foreign branch to another foreign
branch, followed by adjustments related to disregarded payments from a
foreign branch to its foreign branch owner.
(3) Definitions. The following definitions apply for purposes of
this paragraph (f).
[[Page 69084]]
(i) Adjusted disregarded basis. The term adjusted disregarded basis
means, with respect to property transferred in a transaction that is
disregarded for Federal income tax purposes, the tentative disregarded
basis of the property--
(A) Reduced by any disregarded cost recovery deductions with
respect to the property; and
(B) Increased by any disregarded section 1016(a)(1) expenditures
with respect to the property.
(ii) Adjusted disregarded gain--(A) In general. The term adjusted
disregarded gain means, with respect to property transferred in a
transaction that is disregarded for Federal income tax purposes, the
lesser of--
(1) The adjusted disregarded basis of the property, reduced by the
adjusted basis of the property at the time the property was transferred
in a transaction that is disregarded for Federal income tax purposes;
and
(2) The gain (if any) attributable to a regarded sale or exchange
of the transferred property.
(B) Limitation. Adjusted disregarded gain may not be less than
zero.
(iii) Disregarded cost recovery deduction. For a taxable year, the
term disregarded cost recovery deduction means, with respect to
property transferred in a transaction that is disregarded for Federal
income tax purposes--
(A) The amounts that would be allowed as a deduction, and that
would give rise to an adjustment described in section 1016(a)(2), with
respect to the transferred property if the transfer (and the foreign
branch) were regarded for Federal income tax purposes, to the extent
that, under paragraph (f)(2)(vi)(B)(1) of this section, the deduction
would be allocable to--
(1) Gross income attributable to a foreign branch owner, in the
case of property transferred to a foreign branch owner; or
(2) Gross income attributable to a foreign branch, in the case of
property transferred to a foreign branch; reduced by
(B) The amounts that are allowed as a deduction, and that give rise
to an adjustment described in section 1016(a)(2), with respect to the
transferred property to the extent that, under the principles of
paragraph (f)(2)(vi)(B)(1) of this section, the deduction would be
allocable to--
(1) Gross income attributable to a foreign branch owner, in the
case of property transferred to a foreign branch owner; or
(2) Gross income attributable to a foreign branch, in the case of
property transferred to a foreign branch.
(iv) Disregarded entity. The term disregarded entity means an
entity described in Sec. 301.7701-2(c)(2) of this chapter that is
disregarded as an entity separate from its owner for Federal income tax
purposes.
(v) Disregarded payment. The term disregarded payment means any
amount described in paragraph (f)(3)(v)(A) or (B) of this section.
(A) Transfers to or from a disregarded entity. An amount described
in this paragraph (f)(3)(v)(A) is an amount that is transferred to or
from a disregarded entity in connection with a transaction that is
disregarded for Federal income tax purposes and that is reflected on
the separate set of books and records of a foreign branch.
(B) Other disregarded amounts. An amount described in this
paragraph (f)(3)(v)(B) is any amount reflected on the separate set of
books and records of a foreign branch that would constitute an item of
income, gain, deduction, or loss (other than an amount described in
paragraph (f)(3)(v)(A) of this section), a distribution to or
contribution from the foreign branch owner, or a payment in exchange
for property if the transaction to which the amount is attributable
were regarded for Federal income tax purposes.
(vi) Disregarded section 1016(a)(1) expenditure. The term
disregarded section 1016(a)(1) expenditure means a disregarded payment
that, if regarded for Federal income tax purposes, would be described
in section 1016(a)(1) and that, under the principles of paragraph
(f)(2)(vi)(B)(1) of this section, would be allocable to--
(A) General category gross income, in the case of property held by
a foreign branch owner; or
(B) Foreign branch category income, in the case of property held by
a foreign branch.
(vii) Foreign branch--(A) In general. The term foreign branch means
a qualified business unit (QBU), as defined in Sec. 1.989(a)-
1(b)(2)(ii) and (b)(3), that conducts a trade or business outside the
United States. For an illustration of the principles of this paragraph
(f)(3)(vii), see paragraph (f)(4)(i) of this section (Example 1).
(B) Trade or business outside the United States. Activities carried
out in the United States, whether or not such activities are described
in Sec. 1.989(a)-1(b)(3), do not constitute the conduct of a trade or
business outside the United States. Activities carried out outside the
United States that constitute a permanent establishment under the terms
of an income tax treaty between the United States and the country in
which the activities are treated as carried out pursuant to a trade or
business conducted outside the United States for purposes of this
paragraph (f)(3)(vii)(B). In determining whether activities constitute
a trade or business under Sec. 1.989(a)-1(c), disregarded payments are
taken into account and may give rise to a trade or business, provided
that the activities (together with any other activities of the QBU)
would otherwise satisfy the rule in Sec. 1.989(a)-1(c).
(C) Activities of a partnership, estate, trust, or corporation--(1)
Treatment as a foreign branch. For purposes of this paragraph
(f)(3)(vii), the activities of a partnership, estate, trust, or
corporation that conducts a trade or business that satisfies the
requirements of Sec. 1.989(a)-1(b)(2)(ii)(A) (as modified by paragraph
(f)(3)(vii)(B) of this section) are--
(i) Deemed to satisfy the requirements of Sec. 1.989(a)-
1(b)(2)(ii)(B); and
(ii) Comprise a foreign branch.
(2) Separate set of books and records. A foreign branch described
in this paragraph (f)(3)(vii)(C) is treated as maintaining a separate
set of books and records with respect to the activities described in
paragraph (f)(3)(vii)(C)(1) of this section, and must determine, as the
context requires, the items of gross income, disregarded payments, and
any other items that would be reflected on those books and records in
applying this paragraph (f) with respect to the foreign branch. The
principles of Sec. 1.1503(d)-5(c) apply for purposes of determining
which items would be reflected on such books and records.
(viii) Foreign branch owner. The term foreign branch owner means,
with respect to a foreign branch, the person (including a foreign or
domestic partnership or other pass-through entity) that owns the
foreign branch, either directly or indirectly through one or more
disregarded entities. For purposes of this paragraph (f)(3)(viii), the
foreign branch owner does not include the foreign branch or another
foreign branch of the person that owns the foreign branch.
(ix) Remittance. The term remittance means a transfer of property
(within the meaning of section 317(a)) by a foreign branch that would
be treated as a distribution if the foreign branch were treated as a
separate corporation.
(x) Tentative disregarded basis. The term tentative disregarded
basis means, in connection with the transfer of property in a
transaction that is disregarded for Federal income tax purposes, the
basis that property would have if the disregarded payment made
[[Page 69085]]
in exchange for the transferred property were treated as the cost of
such property under section 1012(a).
(4) Examples. The following examples illustrate the application of
this paragraph (f).
(i) Example 1: Determination of foreign branches and foreign
branch owner--(A) Facts--(1) P, a domestic corporation, is a partner
in PRS, a domestic partnership. All other partners in PRS are
unrelated to P. PRS conducts activities solely in Country A (the
Country A Business), and those activities constitute a trade or
business outside the United States within the meaning of paragraph
(f)(3)(vii)(B) of this section. PRS reflects items of income, gain,
loss, and expense of the Country A Business on the books and records
of PRS's home office. PRS is in the business of manufacturing
bicycles.
(2) PRS owns FDE1, a disregarded entity organized in Country B.
FDE1 conducts activities in Country B (the Country B Business), and
those activities constitute a trade or business outside the United
States within the meaning of paragraph (f)(3)(vii)(B) of this
section. FDE1 maintains a set of books and records that are separate
from those of PRS, and the separate set of books and records
reflects items of income, gain, loss, and expense with respect to
the Country B Business. FDE1 is in the business of selling bicycles
manufactured by PRS.
(3) FDE1 owns FDE2, a disregarded entity organized in Country C.
FDE2 conducts activities in Country C (the Country C Business), and
those activities constitute a trade or business outside the United
States within the meaning of paragraph (f)(3)(vii)(B) of this
section. FDE2 maintains a set of books and records that are separate
from those of PRS and FDE1, and the separate set of books and
records reflects items of income, gain, loss, and expense with
respect to the Country C Business. FDE2's paper business is not
related to FDE1's bicycle sales business, and FDE1 does not hold its
interest in FDE2 in the ordinary course of its trade or business.
(B) Analysis--(1) Country A Business's activities comprise a
trade or business conducted outside the United States within the
meaning of Sec. 1.989(a)-1(b)(2)(ii)(A) and (b)(3) (in each case,
as modified by paragraph (f)(3)(vii) of this section). PRS does not
maintain a separate set of books and records with respect to the
Country A Business. However, under paragraph (f)(3)(vii)(C) of this
section, the Country A Business's activities are deemed to satisfy
the requirement of Sec. 1.989(a)-1(b)(2)(ii)(B) that a QBU maintain
a separate set of books and records with respect to the relevant
activities. Thus, for purposes of this paragraph (f), the activities
of the Country A Business constitute a QBU as defined in Sec.
1.989-1(b)(2)(ii) and (b)(3), as modified by paragraph (f)(3)(vii)
of this section, that conducts a trade or business outside the
United States. Accordingly, the activities of the Country A Business
constitute a foreign branch within the meaning of paragraph
(f)(3)(vii) of this section. PRS, the person that owns the Country A
Business, is the foreign branch owner, within the meaning of
paragraph (f)(3)(viii) of this section, with respect to the Country
A Business.
(2) Country B Business's activities comprise a trade or business
outside the United States within the meaning of Sec. 1.989(a)-
1(b)(2)(ii)(A) and (b)(3) (in each case, as modified by paragraph
(f)(3)(vii) of this section). PRS maintains a separate set of books
and records with respect to the Country B Business, as described in
Sec. 1.989(a)-1(b)(2)(ii)(B). Thus, for purposes of this section,
the activities of the Country B Business constitute a QBU as defined
in Sec. 1.989-1(b)(2)(ii) and (b)(3), as modified by paragraph
(f)(3)(vii) of this section, that conducts a trade or business
outside the United States. Accordingly, the activities of the
Country B Business constitute a foreign branch within the meaning of
paragraph (f)(3)(vii) of this section. Under paragraph (f)(3)(viii)
of this section, PRS, the person that owns the Country B Business
indirectly through FDE1 (a disregarded entity), is the foreign
branch owner with respect to the Country B Business.
(3) The same analysis that applies to the Country B Business
applies to the Country C Business. Accordingly, the activities of
the Country C Business constitute a foreign branch within the
meaning of paragraph (f)(3)(vii) of this section. PRS, the person
that owns the Country C Business indirectly through FDE1 and FDE2
(disregarded entities), is the foreign branch owner with respect to
the Country C Business.
(ii) Example 2: Sale of foreign branch--(A) Facts. The facts are
the same as in paragraph (f)(4)(i)(A) of this section (the facts in
Example 1), except that in Year 1, FDE1 sells FDE2 to an unrelated
person, recording gain from the sale on its books and records. In
Year 2, PRS sells FDE1 to another unrelated person, recording gain
from the sale on its books and records. In each year, PRS allocates
a portion of the gain to P.
(B) Analysis--(1) Sale of FDE2. Under paragraph (f)(1)(i)(B) of
this section, P's distributive share of gain recognized by PRS in
connection with the sales of FDE1 and FDE2 constitutes foreign
branch category income if it is attributable to a foreign branch
held by PRS directly or indirectly through one or more disregarded
entities. PRS's gross income from the Year 1 sale of FDE2 is
reflected on the separate set of books and records maintained with
respect to the Country B Business (a foreign branch) operated by
FDE1. Therefore, absent an exception, under paragraph (f)(2)(i) of
this section PRS's gross income from the sale of FDE2 would be
attributable to the Country B Business, and would constitute foreign
branch category income. However, under paragraph (f)(2)(iv) of this
section, gross income attributable to the Country B Business does
not include gain from the sale or exchange of an interest in FDE2, a
disregarded entity, unless the interest in FDE2 is held by the
Country B Business in the ordinary course of its active trade or
business (within the meaning of paragraph (f)(2)(iv)(B) of this
section). In this case, the Country B Business does not hold FDE2 in
the ordinary course of its active trade or business within the
meaning of paragraph (f)(2)(iv)(B) of this section. As a result, P's
distributive share of gain from the sale of FDE2 is not attributable
to a foreign branch, and is not foreign branch category income.
(2) Sale of FDE1. The analysis of PRS's sale of FDE1 in Year 2
is the same as the analysis for the sale of FDE2, except that PRS,
through its Country A Business, holds FDE1 in the ordinary course of
its active trade or business within the meaning of paragraph
(f)(2)(iv)(B) of this section because the Country A Business engages
in a trade or business that is related to the trade or business of
FDE1. Therefore, P's distributive share of gain from the sale of
FDE1 is attributable to a foreign branch, and is foreign branch
category income.
(iii) Example 3: Disregarded payment for services--(A) Facts. P,
a domestic corporation, owns FDE, a disregarded entity that is a
foreign branch within the meaning of paragraph (f)(3)(vii) of this
section. FDE's functional currency is the U.S. dollar. In Year 1, P
accrues and records on its books and records (and not FDE's books
and records) $1,000x of gross income from the performance of
services to unrelated parties that is not passive category income,
$400x of which is foreign source income in respect of services
performed outside the United States by employees of FDE and $600x of
which is U.S. source income in respect of services performed in the
United States. Absent the application of paragraph (f)(2)(vi) of
this section, the $1,000x of gross income earned by P would be
general category income that would not be attributable to FDE. FDE
provides services in support of P's gross income from services. P
compensates FDE for its services with an arm's length payment of
$400x, which is disregarded for Federal income tax purposes. The
deduction for the payment of $400x from P to FDE would be allocated
to P's $1,000x of general category gross services income and
apportioned entirely to the $400x of foreign source services income
under Sec. Sec. 1.861-8 and 1.861-8T principles (treating foreign
source general category gross income and U.S. source general
category gross income each as a statutory grouping) if the payment
were regarded for Federal income tax purposes.
(B) Analysis. The disregarded payment from P, a United States
person, to FDE, its foreign branch, is not recorded on FDE's
separate books and records (as adjusted to conform to Federal income
tax principles) within the meaning of paragraph (f)(2)(i) of this
section because it is disregarded for Federal income tax purposes.
However, the disregarded payment is allocable to gross income
attributable to P because a deduction for the payment, if it were
regarded, would be allocated and apportioned to the $400x of P's
foreign source services income. Accordingly, under paragraphs
(f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this section, the amount of
gross income attributable to the FDE foreign branch (and the gross
income attributable to P) is adjusted in Year 1 to take the
disregarded payment into account. As such, $400x of P's foreign
source gross income from the performance of services is attributable
to the FDE foreign branch for purposes of this section. Therefore,
$400x of the foreign source gross income that P earned with respect
to its services in Year 1 constitutes gross income that is assigned
to the foreign branch category.
(iv) Example 4: Disregarded payment for non-inventory property--
(A) Facts. P, a
[[Page 69086]]
domestic corporation, owns FDE, a disregarded entity that is a
foreign branch within the meaning of paragraph (f)(3)(vii) of this
section. FDE's functional currency is the U.S. dollar. P holds Asset
A, a non-depreciable asset, with an adjusted basis of $200x. In Year
1, P sells Asset A, which will be used in FDE's manufacturing
business, to FDE for $500x. FDE makes no other disregarded payments
with respect to Asset A. No adjustments described in section 1016(a)
apply with respect to Asset A while FDE holds Asset A. In Year 3,
FDE sells Asset A to a third party for $600x and reflects $400x of
gross income on its separate set of books and records (that is,
$600x amount realized less Asset A's $200x adjusted basis). Under
sections 865(e)(1) and 904(d)(2)(B)(i), the income arising from the
sale of Asset A is foreign source income that is not treated as
passive category income. Asset A is not inventory property. Absent
the application of paragraph (f)(2)(vi) of this section, the entire
$400x of gross income earned by P by reason of FDE's sale of Asset A
would be attributable to FDE and be treated as foreign branch
category income.
(B) Analysis--(1) Disregarded basis determinations. If regarded,
the $500x payment from FDE to P would result in FDE holding Asset A
with a basis of $500x under section 1012. Accordingly, the tentative
disregarded basis (within the meaning of paragraph (f)(3)(x) of this
section) with respect to Asset A is $500x. Because there are no
adjustments described in section 1016 with respect to Asset A
(including any adjustments resulting from any disregarded payments
made with respect to the transferred property), the adjusted
disregarded basis (within the meaning of paragraph (f)(3)(i) of this
section) with respect to Asset A is $500x.
(2) Adjusted disregarded gain. Under paragraph (f)(3)(ii) of
this section, the adjusted disregarded gain with respect to Asset A
is $300x, which is equal to the lesser of $300x (FDE's adjusted
disregarded basis in Asset A ($500x) less the adjusted basis of
Asset A at the time that Asset A was transferred to FDE ($200x)) and
$400x (the gain (if any) attributable to the regarded sale or
exchange of Asset A).
(3) Attribution of gross income. Under paragraph (f)(2)(vi)(A)
of this section, the gross income attributable to FDE ($400x) is
adjusted downward to the extent that the $500x disregarded payment
from FDE to P is allocable to gross income of FDE that is reflected
on FDE's separate set of books and records. Under paragraph
(f)(2)(vi)(B)(2)(ii) of this section, the $500x payment from FDE to
P is allocable to gross income attributable to FDE to the extent of
FDE's adjusted disregarded gain ($300x) with respect to Asset A. The
source and separate category of the gross income of FDE to which the
payment is allocable is proportionate to the source and separate
category of the gain recognized by FDE with respect to Asset A.
Accordingly, $300x of the payment is allocable to foreign source
income that would be foreign branch category income. Thus, under
paragraphs (f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this section,
foreign source gross income attributable to P is adjusted upward by
$300x (increasing foreign source general category income by $300x)
and foreign source gross income attributable to FDE is adjusted
downward by $300x (decreasing foreign source foreign branch category
income by $300x) in Year 3.
(v) Example 5: Disregarded payment for depreciable non-inventory
property--(A) Facts. The facts are the same as in paragraph
(f)(4)(iv)(A) of this section (the facts in Example 4), except as
set forth in this paragraph (f)(4)(v)(A). Asset A is depreciable
property. In Year 2, P is entitled to a $20x depreciation deduction
with respect to Asset A, $18x of which is allocated and apportioned
to non-passive category gross income attributable to FDE under
Sec. Sec. 1.861-8 through 1.861-14T and $2x of which is allocated
and apportioned to passive category gross income under Sec. Sec.
1.861-8 through 1.861-14T. If the transfer of Asset A were regarded
for Federal income tax purposes, FDE would be entitled to a $50x
depreciation deduction, 90% of which would be allocated and
apportioned to non-passive category gross income attributable to FDE
under Sec. Sec. 1.861-8 through 1.861-14T and 10% of which would be
allocated and apportioned to passive category gross income under
Sec. Sec. 1.861-8 through 1.861-14T. In Year 2, FDE earns $315x of
gross income that it reflects on its books and records that, in the
absence of paragraph (f)(2)(vi) of this section, would be foreign
branch category income. FDE also earns $35x of passive category
income in Year 2 from the non-active rental of a portion of Asset A.
In Year 3, FDE reflects $420x of gross income on its separate set of
books and records by reason of the sale of Asset A (that is, $600x
amount realized less Asset A's $180x adjusted basis), $42x of which
is passive category income under paragraph (b) of this section.
(B) Analysis--(1) Attribution of gross income in Year 2. The
disregarded payment from FDE to P in Year 1 is disregarded for
Federal income tax purposes, and does not generate gross income.
However, under paragraph (f)(2)(vi)(B)(1)(ii) of this section, the
disregarded payment is allocable to gross income attributable to FDE
to the extent of any disregarded cost recovery deduction relating to
that payment in Year 2. Under paragraph (f)(3)(iii) of this section,
the disregarded cost recovery deduction with respect to Asset A is
$30x, which is $50x (the amount that would be allowed as a
deduction, and that would give rise to an adjustment described in
section 1016(a)(2), with respect to Asset A if the transfer of Asset
A to FDE were regarded for Federal income tax purposes, to the
extent that the deduction would be allocable to income attributable
to a foreign branch), reduced by $20x (the amount allowed as a
deduction, and that gives rise to an adjustment described in section
1016(a)(2), with respect to Asset A, to the extent allocable to
income attributable to a foreign branch). If regarded, $27x (90% of
$30x) of the disregarded cost recovery deduction would be allocated
and apportioned to non-passive category gross income attributable to
FDE under Sec. Sec. 1.861-8 through 1.861-14T and $3x (10% of $30x)
would be allocated and apportioned to passive category gross income
under Sec. Sec. 1.861-8 through 1.861-14T. Accordingly, under
paragraphs (f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this section, the
$315x of non-passive category gross income that would otherwise be
attributed to FDE is reduced to $288x ($315x less $27x), and the
non-passive category gross income attributable to P is increased by
$27x in Year 2. As a result, in Year 2, P's foreign branch category
gross income is $288x, and its general category gross income is
increased by $27x. P's passive category gross income is $35x. See
paragraphs (f)(1)(ii) and (f)(2)(vi)(A) of this section.
(2) Attribution of gross income in Year 3--(i) Adjusted
disregarded basis. If regarded, the $500x payment from FDE to P
would result in FDE holding Asset A with a basis of $500x under
section 1012. Accordingly, the tentative disregarded basis (within
the meaning of paragraph (f)(3)(x) of this section) with respect to
Asset A is $500x. To determine FDE's adjusted disregarded basis with
respect to Asset A under paragraph (f)(3)(i) of this section, FDE's
tentative disregarded basis is reduced by $30x (the disregarded cost
recovery deduction with respect to Asset A), resulting in an
adjusted disregarded basis of $470x.
(ii) Adjusted disregarded gain. Under paragraph (f)(3)(ii) of
this section, the adjusted disregarded gain with respect to Asset A
is $270x, which is equal to the lesser of $270x (FDE's adjusted
disregarded basis in Asset A ($470x) less the adjusted basis of
Asset A at the time that Asset A was transferred to FDE ($200x)),
and $420x (the gain attributable to the regarded sale or exchange of
Asset A).
(iii) Sale of Asset A. Under paragraph (f)(2)(vi)(A) of this
section, the gross income attributable to FDE ($420x) by reason of
the sale of Asset A is adjusted downward to the extent that the
$500x disregarded payment from FDE to P is allocable to gross income
that would be attributable to FDE under paragraphs (f)(2)(i) through
(v) of this section. Under paragraph (f)(2)(vi)(B)(2)(ii) of this
section, the $500x payment from FDE to P is allocable to gross
income attributable to FDE to the extent of the adjusted disregarded
gain with respect to Asset A, which is $270x. The source and
separate category of the gross income of FDE to which that amount is
allocable is proportionate to the source and separate category of
the $420x of gain recognized on the regarded sale of Asset A ($378x
of foreign source non-passive category income and $42x of foreign
source passive category income). Consequently, under paragraphs
(f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this section, in Year 3, gross
income attributable to P is adjusted upward by $270x (increasing P's
foreign source general category gross income by $243x, which bears
the same proportion to $270x as the foreign source non-passive gain
($378x) bears to P's overall gain with respect to Asset A ($420x)),
and the foreign source gross income attributable to FDE is adjusted
downward by $270x (with foreign source foreign branch category gross
income reduced by $243x). P also has $42x of foreign source passive
category income from the sale of Asset A. See paragraphs (f)(1)(ii)
and (f)(2)(vi)(A) of this section.
[[Page 69087]]
(vi) Example 6: Disregarded payment for non-depreciable non-
inventory property--regarded gain limitation--(A) Facts. The facts
are the same as in paragraph (f)(4)(iv)(A) of this section (the
facts in Example 4), except that in Year 3, FDE sells Asset A to a
third party for $340x and reflects $140x of gross income on its
separate set of books and records (that is, $340x amount realized
less Asset A's $200x adjusted basis), none of which is passive
category income.
(B) Analysis. The analysis is the same as the analysis in
paragraph (f)(4)(iv)(B) of this section (the analysis in Example 4),
except that in Year 3, the adjusted disregarded gain with respect to
Asset A is $140x, which is equal to the lesser of $300x (FDE's
adjusted disregarded basis in Asset A ($500x) less the adjusted
basis of Asset A at the time that Asset A was transferred to FDE
($200x)), and $140x (the gain attributable to the regarded sale or
exchange of Asset A). Accordingly, under paragraphs (f)(2)(vi)(A)
and (f)(2)(vi)(B)(3) of this section, gross income attributable to P
is adjusted upward by $140x (increasing P's foreign source general
category gross income by $140x) and gross income attributable to FDE
is adjusted downward by $140x (decreasing P's foreign source foreign
branch category gross income by $140x) in Year 3.
(vii) Example 7: Disregarded payment for non-depreciable non-
inventory property--loss--(A) Facts. The facts are the same as in
paragraph (f)(4)(iv)(A) of this section (the facts in Example 4),
except that in Year 3, FDE sells Asset A to a third party for $175x
and reflects a $25x loss on its separate set of books and records
(that is, $175x amount realized less Asset A's $200x adjusted
basis).
(B) Analysis. The analysis is the same as the analysis in
paragraph (f)(4)(iv)(B) of this section (the analysis in Example 4),
except that in Year 3, the adjusted disregarded gain with respect to
Asset A is $0x, which is equal to the lesser of $300x (FDE's
adjusted disregarded basis in Asset A ($500x) less the adjusted
basis of Asset A at the time that Asset A was transferred to FDE
($200x)), and $0x (the gain attributable to the regarded sale or
exchange of Asset A). Accordingly, gross income amounts attributable
to P and FDE are not adjusted under paragraph (f)(2)(vi)(A) of this
section by reason of the transfer of Asset A from P to FDE.
(viii) Example 8: Disregarded payment for non-depreciable non-
inventory property--disregarded gain limitation--(A) Facts. The
facts are the same as in paragraph (f)(4)(iv)(A) of this section
(the facts in Example 4), except that in Year 1, P sells Asset A to
FDE for $65x.
(B) Analysis. The analysis is the same as the analysis in
paragraph (f)(4)(iv)(B) of this section (the analysis in Example 4),
except that in Year 3, the tentative disregarded basis and the
adjusted disregarded basis with respect to Asset A are $65x. Under
paragraph (f)(3)(ii)(B) of this section, the adjusted disregarded
gain with respect to Asset A is $0x. Accordingly, under paragraph
(f)(2)(vi)(A) of this section, gross income amounts attributable to
P and FDE are not adjusted under paragraph (f)(2)(vi)(A) of this
section by reason of the transfer of Asset A from P to FDE.
(ix) Example 9: Application of the rules to the sale of
inventory from a foreign branch owner to a foreign branch for
distribution--(A) Facts. P, a domestic corporation, owns FDE, a
disregarded entity that is a foreign branch within the meaning of
paragraph (f)(3)(vii) of this section. FDE's functional currency is
the U.S. dollar. P manufactures portable electronic devices, which
it sells to FDE for $1,500x during a taxable year in a transaction
that is disregarded for Federal income tax purposes. In the same
taxable year, FDE sells the portable electronic devices to its
customers for $1,750x. P uses an overall accrual method of
accounting and has $1,300x of cost of goods sold for the taxable
year, $1,200x of which were incurred prior to the disregarded sale
to FDE and recorded on P's separate set of books and records and
$100x of which were incurred after the disregarded sale and recorded
on the books and records of FDE. P reports $450x of gross income for
the taxable year: $1,750x of gross receipts less cost of goods sold
of $1,300x. The $450x of gross income from the sale of portable
electronic devices is U.S. source income under section 863(b).
(B) Analysis--(1) In general. The gross receipts from the sale
of portable electronic devices ($1,750x), which results in U.S.
source gross income of $450x, is recorded on FDE's separate books
and records (as adjusted to conform to Federal income tax
principles). Therefore, the gross income ($450x) generally would be
foreign branch category income under paragraph (f)(2)(i) of this
section. However, under paragraph (f)(2)(vi)(A) of this section, the
amount of gross income attributable to FDE (and the gross income
attributable to P) is adjusted to take the disregarded payment for
the portable electronic devices from FDE to P into account. If both
FDE and the disregarded payment from FDE to P were recognized for
Federal income tax purposes, the amount of the payment ($1,500x)
would reduce FDE's gross income. Therefore, under paragraph
(f)(2)(vi)(B)(2)(iii) of this section, the principles of paragraph
(f)(2)(vi)(B)(2)(ii) of this section apply for purposes of
determining whether, and to what extent, the disregarded payment is
allocable to non-passive category income attributable to FDE for
purposes of determining the extent of any adjustment.
(2) Applying the principles of the tangible property rules to
sales of inventory. The principles of paragraph (f)(2)(vi)(B)(2)(ii)
of this section are applied by treating the cost of goods sold with
respect to expenses recorded on P's separate set of books and
records ($1,200x) similarly to the adjusted basis at the time of the
disregarded sale; the gross income ($450x) similarly to gain from
the disposition of non-inventory property; and the lesser of the
recognized gross income ($450x) and the disregarded payment less the
cost of goods sold attributable to expenses reflected on P's
separate set of books and records ($1,500x less $1,200x) similarly
to disregarded gain ($300x). Accordingly, under paragraph
(f)(2)(vi)(A) of this section, general category U.S. source gross
income attributable to P is adjusted upward by $300x and the non-
passive category U.S. source gross income attributable to FDE is
adjusted downward by $300x.
(x) Example 10: Gross income initially attributable to a foreign
branch--(A) Facts--(1) Overview. P, a domestic corporation, owns
FDE, which is a disregarded entity that is a foreign branch within
the meaning of paragraph (f)(3)(vii) of this section that has the
U.S. dollar as its functional currency. P, which is a foreign branch
owner with respect to FDE, also conducts a trade or business in the
United States. During a single taxable year, P and FDE engage in the
transactions described in paragraphs (f)(4)(x)(A)(2) and (3) of this
section.
(2) Unrelated party transactions. P, through its U.S. office,
accrues and records on its books and records $5,000x of gross income
from the performance of accounting services for Customer A, an
unrelated party (the Customer A services). The gross income from the
Customer A services performed by P is non-passive category income
and, under section 861(a)(3), is U.S. source income. Absent the
application of paragraph (f)(2)(vi) of this section, the gross
income earned by P through its U.S. office would be general category
income. FDE accrues and records on its books and records $3,400x of
gross income from the performance of web design services for
Customer B, an unrelated party (the Customer B services). The gross
income from the Customer B services performed by FDE is non-passive
category income and, under section 862(a)(3), is foreign source
income. Absent the application of paragraph (f)(2)(vi) of this
section, the $3,400x of gross income earned by FDE would be foreign
branch category income.
(3) Disregarded payments. FDE provides web design services to P.
As compensation for those services, P pays $300x to FDE. The
deduction for P's payment to FDE (if regarded) would be allocable to
the $5,000x of general category U.S. source gross income earned from
P's performance of the Customer A services. P provides accounting
services to FDE from P's U.S. office. As compensation for those
services, FDE pays $300x to P. The deduction for FDE's payment to P
(if regarded) would be allocable to the $3,400x of non-passive
category foreign source gross income earned from FDE's performance
of the Customer B services.
(B) Analysis--(1) Application of multiple disregarded payments
rule. Under paragraph (f)(2)(vi)(F) of this section, paragraph
(f)(2)(vi) of this section applies to determine the effects of the
disregarded payments described in paragraph (f)(4)(x)(A)(3) of this
section on gross income initially attributable to FDE before
paragraph (f)(2)(vi) of this section is applied to gross income
initially attributable to P.
(2) Disregarded payment from FDE to P. The disregarded payment
from FDE to P is disregarded for Federal income tax purposes, and
does not generate gross income. However, the disregarded payment is
allocable to non-passive category gross income attributable to FDE
because a deduction for the payment, if it were regarded, would be
allocated to FDE's $3,400x of non-passive category foreign source
gross services income under Sec. 1.861-8. Under paragraph
(f)(2)(vi)(A) of this section, the amount of non-passive category
foreign source gross income attributable to
[[Page 69088]]
FDE is adjusted downward, and the amount of general category foreign
source gross income attributable to P (in its capacity as a foreign
branch owner) is adjusted upward, to take the disregarded payment
into account. Thus, $300x of FDE's foreign source gross income
relating to the Customer B services is attributable to P for
purposes of this section, and $3,100x of that income is attributable
to FDE.
(3) Disregarded payment from P to FDE. The disregarded payment
from P to FDE is not recorded on FDE's separate books and records
(as adjusted to conform to Federal income tax principles) within the
meaning of paragraph (f)(2)(i) of this section because it is
disregarded for Federal income tax purposes. However, the
disregarded payment is allocable to general category U.S. source
gross income attributable to P because a deduction for the payment,
if it were regarded, would be allocated to P's $5,000x of general
category U.S. source gross services income under Sec. 1.861-8.
Accordingly, under paragraph (f)(2)(vi)(A) of this section, the
amount of general category U.S. source gross income attributable to
P is adjusted downward, and the amount of non-passive category U.S.
source gross income attributable to FDE is adjusted upward, to take
the disregarded payment into account. Thus, $300x of P's U.S. source
gross income from the performance of Customer A services is
attributable to FDE for purposes of this section, and $4,700x of
that income is attributable to P.
(xi) Example 11: Ordering rule--(A) Facts--(1) Overview. P, a
domestic corporation, owns FDE1 and FDE2, each of which is a
disregarded entity that is a foreign branch within the meaning of
paragraph (f)(3)(vii) of this section that has the U.S. dollar as
its functional currency. P, which is a foreign branch owner with
respect to FDE1 and FDE2, also conducts a trade or business in the
United States. During a single taxable year, P, FDE1, and FDE2
engage in the transactions described in paragraphs (f)(4)(xi)(A)(2)
and (3) of this section.
(2) Unrelated party transactions. FDE1 accrues and records on
its books and records $1,000x of gross income from the performance
of services for Customer A, an unrelated party (the Customer A
services). The gross income from the Customer A services performed
by FDE is non-passive category income and, under section 862(a)(3),
is foreign source income. Absent the application of paragraph
(f)(2)(vi) of this section, the $1,000x of non-passive foreign
source gross income earned by FDE1 would be foreign branch category
income. FDE2 accrues and records on its books and records $1,100x of
gross income from royalties received from Customer B, an unrelated
party (the Customer B royalties) on licensed intangible property
developed by FDE2 and used by Customer B in the United States. The
gross income from the Customer B royalties is non-passive category
income and under section 861(a)(4) is U.S. source income. Absent the
application of paragraph (f)(2)(vi) of this section, the $1,100x of
non-passive category U.S. source gross income earned by FDE2 would
be foreign branch category income.
(3) Disregarded payments. FDE2 provides services to FDE1. As
compensation for those services, FDE1 pays $200x to FDE2. The
deduction for FDE1's payment to FDE2 (if regarded) would be
allocable to the $1,000x of non-passive category foreign source
gross income earned from the Customer A services. P provides
services to FDE2 from P's U.S. office. As compensation for those
services, FDE2 pays $50x to P. The deduction for FDE2's payment to P
(if regarded) would be allocable to the non-passive category foreign
source gross income attributable to FDE2 (see paragraph
(f)(4)(xi)(B)(1) of this section) relating to gross income from the
Customer A services.
(B) Analysis--(1) Disregarded payment from FDE1 to FDE2. The
$1,000x of gross income earned by FDE1 from the Customer A services
would, but for paragraph (f)(2)(vi) of this section, be attributable
to FDE1 (a foreign branch). Accordingly, under paragraph
(f)(2)(vi)(F)(1) of this section, adjustments related to disregarded
payments from FDE1 to FDE2 are computed before adjustments related
to disregarded payments from FDE2 to P (in its capacity as a foreign
branch owner). The disregarded payment from FDE1 to FDE2 is not
recorded on FDE2's separate books and records (as adjusted to
conform to Federal income tax principles) within the meaning of
paragraph (f)(2)(i) of this section because it is disregarded for
Federal income tax purposes. However, the disregarded payment is
allocable to gross income attributable to FDE1 because a deduction
for the payment, if it were regarded, would be allocated to FDE1's
$1,000x of non-passive category foreign source gross services income
under Sec. 1.861-8. Accordingly, under paragraph (f)(2)(vi)(A) of
this section, the amount of non-passive category foreign source
gross income attributable to FDE1 is adjusted downward, and the
amount of non-passive category foreign source gross income
attributable to FDE2 is adjusted upward, to take the disregarded
payment into account. Thus, $200x of FDE1's non-passive category
foreign source gross income from the performance of Customer A
services is attributable to FDE2 for purposes of this section, and
$800x of that income is attributable to FDE1.
(2) Disregarded payment from FDE2 to P. The disregarded payment
from FDE2 to P is disregarded for Federal income tax purposes, and
does not generate gross income. However, the disregarded payment is
allocable to gross income attributable to FDE2 because a deduction
for the payment, if it were regarded, would be allocated to FDE2's
$200x of non-passive category foreign source gross services income
under Sec. 1.861-8. Under paragraph (f)(2)(vi)(A) of this section,
the amount of non-passive category foreign source gross income
attributable to FDE2 is adjusted downward, and the amount of general
category foreign source gross income attributable to P is adjusted
upward, to take the $50x disregarded payment into account. Thus,
$50x of non-passive category foreign source gross income relating to
the Customer A services is attributable to P for purposes of this
section, $150x of that income is attributable to FDE2, and $800x of
that income remains attributable to FDE1. FDE2's $1,100x of U.S.
source royalty income is not adjusted under paragraph (f)(2)(vi) of
this section and remains foreign branch category income.
(xii) Example 12: Application of intangible property rules--(A)
Facts. P, a domestic corporation that has a calendar taxable year,
owns FDE, a disregarded entity that is a foreign branch within the
meaning of paragraph (f)(3)(vii) of this section. FDE's functional
currency is the U.S. dollar. Asset A, a patent with a useful life
ending on December 31, Year 2, was obtained with respect to a
discovery that was made by FDE in the course of its trade or
business and was used in that trade or business until December 31,
Year 1. On December 31, Year 1, FDE remits Asset A to P and receives
no consideration. Asset A has an adjusted basis of $0. In Year 2, P
uses Asset A to generate general category gross income. P earns
$1,000x of general category U.S. source gross income in Year 2,
including the income generated by its use of Asset A. If FDE were a
domestic corporation, P were a foreign corporation, and Asset A had
been transferred in exchange for stock in a transaction described in
section 351, such that section 367(d) applied by its terms (but all
other facts remained the same), the payment determined under section
367(d) for Year 2 would be $300x. A disregarded payment for the use
of Asset A, if it were regarded, would be allocated to FDE's $1,000x
of general category U.S. source gross income under Sec. 1.861-8.
(B) Analysis. The remittance of Asset A by FDE to P is a
transfer of intangible property described in section 367(d)(4) from
a foreign branch to its foreign branch owner. The facts in paragraph
(f)(4)(xii)(A) of this section do not implicate an exception in
paragraph (f)(2)(vi)(D)(2) or (3) of this section. Therefore, this
is a transaction to which paragraph (f)(2)(vi)(D)(1) of this section
applies. The foreign branch is treated as having sold the
transferred property to the foreign branch owner in exchange for
annual payments contingent on the productivity or use of the
property, the amount of which for Year 2 is determined under the
principles of section 367(d) to be $300x. Thus, in Year 2, P is
treated as making a $300x disregarded payment to FDE. The payment
would be allocable to general category U.S. source income under
paragraph (f)(2)(vi)(B)(1)(i) of this section. Therefore, $300x of
P's non-passive category U.S. source gross income is attributable to
FDE under paragraphs (f)(2)(vi)(A) and (f)(2)(vi)(B)(3) of this
section. P has $700x of general category U.S. source gross income
and $300x of foreign branch category U.S. source gross income in
Year 2.
(g) Section 951A category income--(1) In general. Except as
provided in paragraph (g)(2) of this section, the term section 951A
category income means amounts included (directly or indirectly through
a pass-through entity) in gross income of a United States person under
section 951A(a).
(2) Exceptions for passive category income. Section 951A category
income does not include any amounts included under section 951A(a) that
are allocable
[[Page 69089]]
to passive category income under Sec. 1.904-5(c)(6).
(h) * * *
(2) Treatment of export financing interest. Except as provided in
paragraph (h)(3) of this section, if a taxpayer (including a financial
services entity) receives or accrues export financing interest from an
unrelated person, then that interest is not treated as passive category
income. Instead, the interest income is treated as foreign branch
category income, section 951A category income, general category income,
or income in a specified separate category under the rules of this
section.
* * * * *
(4) Examples. The following examples illustrate the application of
paragraph (h)(3) of this section.
(i) Example 1. Controlled foreign corporation CFC is a wholly-
owned subsidiary of domestic corporation USP. CFC is not a financial
services entity and has accumulated cash reserves. USP has
uncollected trade and service receivables of foreign obligors. USP
sells the receivables at a discount (``factors'') to CFC. The income
derived by CFC on the receivables is related person factoring
income. The income is also export financing interest. Because the
income is related person factoring income, the income is passive
category income to CFC.
(ii) Example 2. Domestic corporation USS is a wholly-owned
subsidiary of domestic corporation USP. USS is not a financial
services entity, does not have any foreign qualified business
entities, and has accumulated cash reserves. USP has uncollected
trade and service receivables of foreign obligors. USP factors the
receivables to USS. The income derived by USS on the receivables is
related person factoring income. The income is also export financing
interest. The income will be passive category income to USS.
(iii) Example 3. The facts are the same as in paragraph
(h)(4)(ii) of this section (the facts in Example 2), except that
instead of factoring USP's receivables, USS finances the sales of
USP's goods by making loans to the purchasers of USP's goods. The
interest derived by USS on these loans is export financing interest
and is not related person factoring income. The income will be
general category income to USS.
(5) Income eligible for section 864(d)(7) exception (same country
exception) from related person factoring treatment--(i) Income other
than interest. If any foreign person receives or accrues income that is
described in section 864(d)(7) (income on a trade or service receivable
acquired from a related person in the same foreign country as the
recipient) and such income would also meet the definition of export
financing interest if section 864(d)(1) applied to such income (income
on a trade or service receivable acquired from a related person treated
as interest), then the income is considered to be export financing
interest and is not treated as passive category income. The income is
treated as foreign branch category income, section 951A category
income, general category income, or income in a specified separate
category under the rules of this section.
(ii) Interest income. If export financing interest is received or
accrued by any foreign person and that income would otherwise be
treated as related person factoring income of a controlled foreign
corporation under section 864(d)(6) if section 864(d)(7) did not apply,
section 904(d)(2)(B)(iii)(I) applies and the interest is not treated as
passive category income. The income is treated as general category
income in the hands of the controlled foreign corporation.
(iii) Examples. The following examples illustrate the application
of this paragraph (h)(5):
(A) Example 1. CFC1, a controlled foreign corporation, is a
wholly-owned subsidiary of domestic corporation USP. CFC2, a
controlled foreign corporation, is a wholly-owned subsidiary of
CFC1. CFC1 and CFC2 are incorporated in Country M. In Year 1, USP
sells tractors to CFC2, which CFC2 sells to X, an unrelated foreign
corporation organized in Country M. The tractors are to be used in
Country M. CFC2 uses a substantial part of its assets in its trade
or business located in Country M. CFC2 has uncollected trade
receivables from X that it factors to CFC1. The income is not
related person factoring income because it is described in section
864(d)(7) (income eligible for the same country exception) and is
tested income. If section 864(d)(1) applied, the income CFC1 derived
from the receivables would meet the definition of export financing
interest. The income, therefore, is considered to be export
financing interest and is general category income to CFC1 and may be
section 951A category income to USP.
(B) Example 2. CFC1, a controlled foreign corporation, is a
wholly-owned subsidiary of domestic corporation, USP. CFC2, a
controlled foreign corporation, is a wholly-owned subsidiary of
CFC1. CFC1 and CFC2 are incorporated in Country M. In Year 1, USP
sells tractors to CFC2, which CFC2 sells to X, a foreign partnership
that is organized in Country M and is related to CFC1 and CFC2. CFC1
makes a loan to X to finance the tractor sales. The interest earned
by CFC1 from financing the sales is described in section 864(d)(7)
and is export financing interest and is tested income. Therefore,
the income is general category income to CFC1 and may be section
951A category income to USP.
* * * * *
(k) Separate category under section 904(d)(6) or 865(h) for items
resourced under treaties--(1) Section 904(d)(6)--(i) In general. Except
as provided in paragraph (k)(1)(iv)(A) of this section, sections
904(a), (b), (c), (d), (f), and (g) and sections 907 and 960 are
applied separately to any item of income that, without regard to a
treaty obligation of the United States, would be treated as derived
from sources within the United States, but under a treaty obligation of
the United States such item of income would be treated as arising from
sources outside the United States, and the taxpayer chooses the
benefits of such treaty obligation.
(ii) Aggregation of items of income in each other separate
category. For purposes of applying the general rule of paragraph (k)(1)
of this section, items of income in each other separate category of
income that are resourced under each applicable treaty are aggregated
in a single separate category for income in that separate category that
is resourced under that treaty. For example, all items of passive
category income that would otherwise be treated as derived from sources
within the United States but which the taxpayer chooses to treat as
arising from sources outside the United States pursuant to a provision
of a bilateral U.S. income tax treaty are treated as income in a
separate category for passive category income resourced under the
particular treaty, and the high-tax kickout grouping rules of paragraph
(c) of this section are applied separately to the groups of passive
income included in that separate category. Any items of resourced high-
taxed passive income are assigned to a separate category for general
(or other) category income resourced under a tax treaty. Items of
income described in paragraph (k)(1) of this section are not combined
with other income that is foreign source income under the Code, even if
the other income arises from sources within the jurisdiction with which
the United States has a bilateral income tax treaty (``treaty
jurisdiction'') and is included in the same separate category to which
the resourced income would be assigned without regard to section
904(d)(6). Items of income described in paragraph (k)(1) of this
section are also not combined with other items of resourced income that
are subject to a separate limitation by reason of a Code provision
other than section 904(d)(6).
(iii) Related taxes. Foreign taxes, including foreign taxes paid to
a foreign jurisdiction other than the treaty jurisdiction on an item of
resourced income, are allocated to each separate category described in
paragraph (k)(1)(ii) of this section in accordance with Sec. 1.904-6.
(iv) Coordination with certain income tax treaty provisions--(A)
Exception for
[[Page 69090]]
special relief from double taxation for individual residents of treaty
jurisdictions. Section 904(d)(6)(A) and paragraph (k)(1) of this
section do not apply to any item of income deemed to be from foreign
sources by reason of the relief from double taxation rules in any U.S.
income tax treaty that is solely applicable to U.S. citizens who are
residents of the other Contracting State.
(B) U.S. competent authority assistance. For purposes of applying
paragraph (k)(1) of this section, if, under the mutual agreement
procedure provisions of an applicable income tax treaty, the U.S.
competent authority agrees to allow a taxpayer to treat an item of
income as foreign source income, where such item of income would
otherwise be treated as derived from sources within the United States,
then the taxpayer is considered to have chosen the benefits of such
treaty obligation to treat the item as foreign source income.
(v) Coordination with other Code provisions. Section 904(d)(6)(A)
and paragraph (k)(1) of this section do not apply to any item of income
to which any of section 245(a)(10), 865(h), or 904(h)(10) applies. See
also paragraph (l) of this section.
(2) Section 865(h). If any gain, as defined in section
865(h)(2)(A)(i), would be treated as derived from sources within the
United States under section 865, but pursuant to a treaty obligation of
the United States such gain would be treated as arising from sources
outside the United States, and the taxpayer chooses the benefits of
such treaty obligation, then that gain will be treated as foreign
source income. However, sections 904(a), (b), (c), (d), (f), and (g)
and sections 907 and 960 are applied separately to amounts described in
the preceding sentence with respect to each treaty under which the
taxpayer has claimed benefits and, within each treaty, to each separate
category of income. The principles of the rules in paragraphs
(k)(1)(ii) through (iv) of this section apply to gains, and foreign
taxes on gains, that are subject to a separate limitation under section
865(h).
(l) Priority rule. Income that meets the definitions of a specified
separate category and another category of income described in section
904(d)(1) is subject to the separate limitation described in paragraph
(m) of this section and is not treated as general category income,
foreign branch category income, passive category income, or section
951A category income.
(m) Income treated as allocable to a specified separate category.
If section 904(a), (b), and (c) are applied separately to any category
of income under the Internal Revenue Code (for example, under section
245(a)(10), 865(h), 901(j), 904(d)(6), or 904(h)(10)), that category of
income is treated for all purposes of the Internal Revenue Code as if
it were a separate category listed in section 904(d)(1). For purposes
of this section, a separate category that is treated as if it were
listed in section 904(d)(1) by reason of the first sentence in this
paragraph (m) is referred to as a specified separate category.
(n) Income from partnerships and other pass-through entities--(1)
Distributive shares of partnership income--(i) In general. Except as
provided in paragraph (n)(1)(ii) of this section, a partner's
distributive share of partnership income is characterized as passive
category income to the extent that the distributive share is a share of
income earned or accrued by the partnership in the passive category. A
partner's distributive share of partnership income that is not
described in the first sentence of this paragraph (n) is treated as
foreign branch category income, general category income, or income in a
specified separate category under the rules of this section. The
principles of the rules in this paragraph (n)(1)(i) also apply to
characterize a person's share of income from any other pass-through
entity.
(ii) Less than 10 percent partners partnership interests--(A) In
general. Except as provided in paragraph (n)(1)(ii)(B) of this section,
if any limited partner owns less than 10 percent of the value in a
partnership, the partner's distributive share of partnership income
from the partnership is passive income to the partner (subject to the
exception for high-taxed income under section 904(d)(2)(B)(iii)(II) and
paragraph (c) of this section), and the partner's distributive share of
partnership deductions from the partnership is allocated and
apportioned under the principles of Sec. 1.861-8 only to the partner's
passive income from that partnership. See also Sec. 1.861-9(e)(4) for
rules for apportioning partnership interest expense.
(B) Exception for partnership interest held in the ordinary course
of business. If a partnership interest described in paragraph
(n)(1)(ii)(A) of this section is held in the ordinary course of a
partner's active trade or business, the rules of paragraph (n)(1)(i) of
this section apply for purposes of characterizing the partner's
distributive share of the partnership income. A partnership interest is
considered to be held in the ordinary course of a partner's active
trade or business if the partner (or a member of the partner's
affiliated group of corporations (within the meaning of section 1504(a)
and without regard to section 1504(b)(3))) engages (other than through
a less than 10 percent interest in a partnership) in the same or a
related trade or business as the partnership.
(2) Income from the sale of a partnership interest--(i) In general.
To the extent a partner recognizes gain on the sale of a partnership
interest, that income shall be treated as passive income to the
partner, subject to the exception for high-taxed income under section
904(d)(2)(B)(iii)(II) and paragraph (c) of this section.
(ii) Exception for sale by 25-percent owner. Except as provided in
paragraph (f)(2)(iv) of this section, in the case of a sale of an
interest in a partnership by a partner that is a 25-percent owner of
the partnership, determined by applying section 954(c)(4)(B) and
substituting ``partner'' for ``controlled foreign corporation'' every
place it appears, for purposes of determining the separate category to
which the income recognized on the sale of the partnership interest is
assigned such partner is treated as selling the proportionate share of
the assets of the partnership attributable to such interest.
(3) Value of a partnership interest. For purposes of paragraphs
(n)(1) and (2) of this section, a partner will be considered as owning
10 percent of the value of a partnership for a particular year if the
partner, together with any person that bears a relationship to the
partner described in section 267(b) or 707, owns 10 percent of the
capital and profits interest of the partnership. For purposes of this
paragraph (n)(3), value will be determined at the end of the
partnership's taxable year.
(4) Example. The following example illustrates the application of
this paragraph (n).
(i) Facts. PRS is a domestic partnership. PRS has two general
partners, A and B. A and B each have a greater than 10% interest in
PRS. PRS also has two limited partners, C and D. C has a 50%
interest in the partnership and D has a 9% interest. D's partnership
interest is not held in the ordinary course of business. A, B, C and
D are all United States persons. In Year 1, PRS has $100x of general
category non-subpart F income on which it pays no foreign tax.
(ii) Analysis. Under paragraph (n)(1)(i) of this section, A's,
B's, and C's distributive shares of PRS's income are not passive
category income. Under paragraph (n)(1)(ii)(A) of this section,
because D is a limited partner with a less than 10% interest in PRS,
D's distributive share of PRS's income is passive category income.
(o) Separate category of section 78 gross up. The amount included
in income under section 78 by reason of taxes deemed paid under section
960 is
[[Page 69091]]
assigned to the separate category to which the taxes are allocated
under Sec. 1.904-6(b).
(p) Separate category of foreign currency gain or loss. Foreign
currency gain or loss recognized under section 986(c) with respect to a
distribution of previously taxed earnings and profits (as described in
section 959 or 1293(c)) is assigned to the separate category or
categories of the previously taxed earnings and profits from which the
distribution is made. See Sec. 1.987-6(b) for rules on assigning
section 987 gain or loss on a remittance from a section 987 QBU to a
separate category or categories.
(q) Applicability dates. This section applies for taxable years
that both begin after December 31, 2017, and end on or after December
4, 2018.
0
Par. 21. Section 1.904-5 is amended by:
0
1. Revising paragraphs (a), (b), and (c)(1).
0
2. Revising the third and fourth sentences and adding a sentence to the
end of paragraph (c)(2)(i).
0
3. Removing the language ``noncontrolled section 902 corporation'' and
adding the language ``noncontrolled 10-percent owned foreign
corporation'' in its place in the heading and text of paragraph
(c)(2)(iii).
0
4. Revising paragraphs (c)(2)(v) and (c)(3).
0
5. In paragraph (c)(4)(i):
0
i. Revising the first sentence.
0
ii. Removing the language ``paragraph'' and adding the language
``paragraph (c)(4)'' in its place in the second sentence.
0
6. Revising paragraph (c)(4)(iii).
0
7. Removing paragraph (c)(4)(iv).
0
8. Adding paragraphs (c)(5), (6), and (7).
0
9. Revising paragraphs (d)(1), (2), and (3) and (e)(2).
0
10. Removing and reserving paragraph (f)(1).
0
11. Removing paragraph (f)(3).
0
12. In paragraph (g):
0
i. Removing the language ``section 904(d)(3) and this section'' and
adding the language ``paragraph (c) of this section'' in its place in
the first sentence.
0
ii. Removing the language ``United States corporation'' and adding the
language ``domestic corporation'' wherever it appears.
0
iii. Removing the last sentence.
0
13. Revising paragraph (h).
0
14. In paragraph (i)(1):
0
i. Removing the language ``paragraphs (i)(2), (3), and (4)'' and adding
the language ``paragraphs (i)(2) and (3)'' in its place in the first
sentence.
0
ii. In the second sentence:
0
A. Removing the language ``noncontrolled section 902 corporation'' and
adding the language ``noncontrolled 10-percent owned foreign
corporation''.
0
B. Removing the language ``paragraph (i)(4)'' and adding the language
``paragraph (i)(3)'' in its place.
0
iii. Revising the sixth and seventh sentences.
0
15. Revising paragraph (i)(2) and (3).
0
16. Removing and reserving paragraph (i)(4).
0
17. Revising paragraph (i)(5).
0
18. Removing the last sentence of paragraph (j).
0
19. Adding the language ``under Sec. 1.904-4'' after the language
``characterized'' in the first sentence of paragraph (k)(1).
0
20. Revising paragraphs (k)(2)(iii) and (l).
0
21. In paragraph (m)(1):
0
i. Removing the language ``noncontrolled section 902 corporations'' and
adding the language ``noncontrolled 10-percent owned foreign
corporations'' in its place and removing the language ``noncontrolled
section 902 corporation'' and adding the language ``noncontrolled 10-
percent owned foreign corporation'' in its place.
0
ii. Removing the language ``or amount treated as a dividend,
including'' and adding the language ``which, for purposes of this
paragraph (m), includes'' in its place in the third sentence.
0
iii. Removing the language ``951(a)(1)(A),'' and adding the language
``951(a)(1)(A), 951A(a),'' in its place in the fourth sentence.
0
22. Revising paragraphs (m)(2)(ii), (m)(3), and (m)(4)(i).
0
23. Removing paragraph (m)(4)(iii).
0
24. Revising the heading of paragraph (m)(5), the first sentence of
paragraph (m)(5)(i), and paragraph (m)(5)(ii).
0
25. Removing the language ``section 902(a) and section 960(a)(1)'' and
adding the language ``section 960'' in its place in paragraph (m)(6).
0
26. In paragraph (m)(7)(i):
0
i. Removing the language ``904(g)(6)'' and ``904(g)'' from the first
sentence and adding the language ``904(h)(6)'' and ``904(h)'' in its
place, respectively.
0
ii. Removing the language ``(d) and (f)'' from the second sentence and
adding the language ``(d), (f), and (g)'' in its place and removing the
language ``902,''.
0
27. Revising paragraph (m)(7)(ii).
0
28. In paragraph (n):
0
i. Removing the language ``noncontrolled section 902 corporation'' and
adding the language ``noncontrolled 10-percent owned foreign
corporation'' in its place, and by removing the language ``section
904(d)(1)'' and adding ``Sec. 1.904-4'' in its place in the first
sentence.
0
ii. Revising the last sentence.
0
29. Revising paragraph (o).
The additions and revisions read as follows:
Sec. 1.904-5 Look-through rules as applied to controlled foreign
corporations and other entities.
(a) Scope and definitions--(1) Look-through rules under section
904(d)(3) to passive category income. Paragraph (c) of this section
provides rules for determining the extent to which dividends, interest,
rents, and royalties received or accrued by certain eligible persons,
and inclusions under sections 951(a)(1) and 951A(a), are treated as
passive category income. Paragraph (g) of this section provides rules
applying the principles of paragraph (c) of this section to foreign
source interest, rents, and royalties paid by a domestic corporation to
a related corporation. Paragraph (h) of this section provides rules for
assigning a partnership payment to a partner described in section 707
to the passive category. Paragraph (i) of this section provides rules
applying the principles of this section to assign distributions and
payments from certain related entities to the passive category or to
treat the distributions and payments as not in the passive category.
(2) Other look-through rules under section 904(d). Under section
904(d)(4) and paragraph (c)(4)(iii) of this section, certain dividends
from noncontrolled 10-percent owned foreign corporations are treated as
income in a separate category. Under section 904(d)(3)(H) and paragraph
(j) of this section, certain inclusions under section 1293 are treated
as income in a separate category. Paragraph (i) of this section
provides rules applying the principles of this section to assign
distributions from certain related entities to separate categories.
(3) Other rules provided in this section. Paragraph (b) of this
section provides operative rules for this section. Paragraph (d) of
this section provides rules addressing exceptions to passive category
income for certain purposes in the case of controlled foreign
corporations that meet the requirements of section 954(b)(3)(A) (de
minimis rule) or section 954(b)(4) (high-tax exception). Paragraph (e)
of this section provides rules for characterizing a controlled foreign
corporation's foreign base company income and gross insurance income
when section 954(b)(3)(B) (full inclusion rule) applies. Paragraph (f)
of
[[Page 69092]]
this section modifies the look-through rules for certain types of
income. Paragraph (k) of this section provides ordering rules for
applying the look-through rules. Paragraph (l) of this section provides
examples illustrating the application of certain rules in this section.
Paragraphs (m) and (n) of this section provide rules related to the
resourcing rules described in section 904(h).
(4) Definitions. For purposes of this section, the following
definitions apply:
(i) The term controlled foreign corporation has the meaning given
such term by section 957 (taking into account the special rule for
certain captive insurance companies contained in section 953(c)).
(ii) The term look-through rules means the rules described in this
section that assign income to a separate category based on the separate
category of the income to which it is allocable.
(iii) The term noncontrolled 10-percent owned foreign corporation
has the meaning provided in section 904(d)(2)(E)(i).
(iv) The term pass-through entity means a partnership, S
corporation, or any other person (whether domestic or foreign) other
than a corporation to the extent that the income or deductions of the
person are included in the income of one or more direct or indirect
owners or beneficiaries of the person. For example, if a domestic trust
is subject to Federal income tax on a portion of its income and its
owners are subject to tax on the remaining portion, the domestic trust
is treated as a domestic pass-through entity with respect to such
remaining portion.
(v) The term separate category means, as the context requires, any
category of income described in section 904(d)(1)(A), (B), (C), or (D),
any specified separate category of income as defined in Sec. 1.904-
4(m), or any category of earnings and profits to which income described
in such provisions is attributable.
(vi) The term United States shareholder has the meaning given such
term by section 951(b) (taking into account the special rule for
certain captive insurance companies contained in section 953(c)),
except that for purposes of this section, a United States shareholder
includes any member of the controlled group of the United States
shareholder. For purposes of this paragraph (a)(4)(vi), the controlled
group is any member of the affiliated group within the meaning of
section 1504(a)(1) except that ``more than 50 percent'' is substituted
for ``at least 80 percent'' wherever it appears in section 1504(a)(2).
When used in reference to a noncontrolled 10-percent owned foreign
corporation described in section 904(d)(2)(E)(i)(II), the term United
States shareholder also means a taxpayer that meets the stock ownership
requirements described in section 904(d)(2)(E)(i)(II).
(b) Operative rules--(1) Assignment of income not assigned under
the look-through rules. Except as provided by the look-through rules,
dividends, interest, rents, and royalties received or accrued by a
taxpayer from a controlled foreign corporation in which the taxpayer is
a United States shareholder are excluded from passive category income.
Income excluded from the passive category under this paragraph (b)(1)
is assigned to another separate category (other than the passive
category) under the rules in Sec. 1.904-4.
(2) Priority and ordering of look-through rules. Except as provided
in this paragraph (b)(2), to the extent the look-through rules assign
income to a separate category, the income is assigned to that separate
category rather than the separate category to which the income would
have been assigned under Sec. 1.904-4 (not taking into account Sec.
1.904-4(l)). See paragraph (k) of this section for ordering rules for
applying the look-through rules. However, passive income that is
financial services income is assigned to a separate category under the
rules in Sec. 1.904-4(e)(1), (f)(1), and (l), regardless of whether
the look-through rules otherwise would have assigned such income to the
passive category.
(c) * * * (1) Scope. Subject to the exceptions in paragraph (f) of
this section, paragraphs (c)(2) through (6) (other than paragraph
(c)(4)(iii) of this section) of this section provide look-through rules
with respect to interest, rents, royalties, dividends, and inclusions
under sections 951(a)(1) and 951A(a) that are received or accrued from
a controlled foreign corporation in which the taxpayer is a United
States shareholder. Paragraph (c)(4)(iii) of this section provides a
look-through rule for dividends received from a noncontrolled 10-
percent owned foreign corporation by a domestic corporation that is a
United States shareholder in the foreign corporation.
(2) * * * (i) * * * Related person interest is treated as passive
category income to the extent it is allocable to passive category
income of the controlled foreign corporation. If related person
interest is received or accrued from a controlled foreign corporation
by two or more persons, the amount of interest received or accrued by
each person that is allocable to passive category income is determined
by multiplying the amount of related person interest allocable to
passive category income by a fraction. * * * Solely for purposes of
assigning interest income to a separate category under section
904(d)(3) and the look-through rule in this paragraph (c)(2), the rules
in paragraph (c)(2)(ii) of this section for allocating and apportioning
interest expense of a controlled foreign corporation apply for purposes
of characterizing interest income in the hands of the recipient, even
if a deduction for the interest expense is deferred or disallowed to
the controlled foreign corporation.
* * * * *
(v) Examples. The following examples illustrate the application of
this paragraph (c)(2).
(A) Example 1--(1) CFC, a controlled foreign corporation, is a
wholly-owned subsidiary of USP, a domestic corporation. In Year 1,
CFC earns $200x of foreign personal holding company income that is
passive category income. CFC also earns $100x of foreign base
company sales income that is general category income. CFC has
$2,000x of passive category assets and $2,000x of general category
assets. In Year 1, CFC makes a $150x interest payment to USP with
respect to a $1,500x loan from USP. CFC also pays $100x of interest
to an unrelated person on a $1,000x loan from that person. CFC has
no other expenses. CFC uses the asset method to apportion interest
expense.
(2) Under paragraph (c)(2)(ii)(C) of this section, the $150x
related person interest payment is allocable to CFC's passive
category foreign personal holding company income. Therefore, the
$150x interest payment is passive category income to USP. Because
the entire related person interest payment is allocated to passive
category income under paragraph (c)(2)(ii)(C) of this section, none
of the related person interest payment is apportioned to general
category income under paragraph (c)(2)(ii)(D) of this section. Under
paragraph (c)(2)(iv)(B) of this section, the entire amount of the
related person debt is allocable to passive category assets ($1,500x
= $1,500x x $150x/$150x). Under paragraph (c)(2)(ii)(E) of this
section, $20x of the interest expense paid to an unrelated person is
apportioned to passive category income ($20x = $100x x ($2,000x -
$1,500x)/($4,000x - $1,500x)), and $80x of the interest expense paid
to an unrelated person is apportioned to general category income
($80x = $100x x $2,000x/($4,000x - $1,500x)).
(B) Example 2. The facts are the same as in paragraph
(c)(2)(v)(A) of this section (the facts in Example 1), except that
CFC uses the modified gross income method to apportion interest
expense. Under paragraph (c)(2)(ii)(E) of this section, the
unrelated person interest expense is apportioned based on gross
income. Therefore, $33x of interest expense paid to an unrelated
person is apportioned to CFC's passive category income ($33x = $100x
x ($200x - $150x)/($300x - $150x)) and $67x of interest expense paid
to an unrelated person is
[[Page 69093]]
apportioned to CFC's general category income ($67x = $100x x $100x/
($300x - $150x)).
(C) Example 3--(1) The facts are the same as in paragraph
(c)(2)(v)(A) of this section (the facts in Example 1), except that
CFC has an additional $50x of third person interest expense that is
directly allocated to income from a specific property that produces
only passive category income. The principal amount of indebtedness
to which the interest relates is $500x. CFC also has $50x of
additional non-interest expenses that are not definitely related
expenses and that are apportioned on an asset basis.
(2) Under paragraph (c)(2)(ii)(B) of this section, the $50x of
directly allocated third person interest is first allocated to
reduce the passive category income of CFC. Under paragraph
(c)(2)(ii)(C) of this section, the $150x of related person interest
is allocated to the remaining $150x of passive category income.
Under paragraph (c)(2)(iv)(B) of this section, all of the related
person debt is allocated to passive category assets ($1,500x =
$1,500x x $150x/$150x).
(3) Under paragraph (c)(2)(ii)(E) of this section, the non-
interest expenses that are not definitely related are apportioned on
the basis of the asset values reduced by the allocated related
person debt. Therefore, $10x of these expenses are apportioned to
the passive category ($50x x ($2,000x - $1,500x)/($4,000x -
$1,500x)) and $40x are apportioned to the general category ($50x x
$2,000x/($4,000x - $1,500x)).
(4) In order to apportion third person interest (that was not
directly allocated third person interest) between the categories of
assets, the value of assets in a separate category must also be
reduced under the principles of Sec. 1.861-8 by the indebtedness
relating to the specifically allocated interest. Therefore, under
paragraph (c)(2)(iv)(B) of this section, the value of assets in the
passive category for purposes of apportioning the additional third
person interest = 0 ($2,000x minus $500x (the principal amount of
the debt, the interest payment on which is directly allocated to
specific interest-producing properties) minus $1,500x (the related
person debt allocated to passive category assets)). Under paragraph
(c)(2)(ii)(E) of this section, all $100x of the non-definitely
related third person interest expense is apportioned to the general
category ($100x = $100x x $2,000x/($4,000x - $500x - $1,500x)).
(D) Example 4--(1) CFC, a controlled foreign corporation, is a
wholly-owned subsidiary of USP, a domestic corporation. In Year 1,
CFC earns $100x of foreign personal holding company income that is
passive category income. CFC also earns $100x of foreign base
company sales income that is general category income. CFC has
$1,000x of general category assets and $1,000x of passive category
assets. In Year 1, CFC makes a $150x interest payment to USP on a
$1,500x loan from USP and has $20x of general and administrative
expenses (G & A) that under the principles of Sec. Sec. 1.861-8
through 1.861-14T is treated as directly allocable to all of CFC's
gross income. CFC also makes a $25x interest payment to an unrelated
person on a $250x loan from the unrelated person. CFC has no other
expenses. CFC uses the asset method to apportion interest expense.
CFC uses the modified gross income method to apportion G & A.
(2) Under paragraph (c)(2)(iv)(B) of this section, related
person debt allocated to passive category assets equals $1,000x
($1,000x = $1,500x x $100x/$150x).Under paragraph (c)(2)(ii)(C) of
this section, $100x of the interest payment to USP is allocable to
CFC's passive category foreign personal holding company income.
Under paragraph (c)(2)(ii)(D) of this section, the additional $50x
of related person interest expense is apportioned to CFC's general
category income ($50x = $50x x $1,000x/$1,000x).
(3) Under paragraph (c)(2)(ii)(E) of this section, none of the
$25x of interest expense paid to an unrelated person is apportioned
to passive category income ($0 = $25x x ($1,000x - $1,000x)/($2,000x
- $1,000x)). All $25x of the interest expense paid to an unrelated
person is apportioned to general category income ($25x = $25x x
$1,000x/($2,000x - $1,000x)). Under paragraph (c)(2)(ii)(E) of this
section, none of the G & A is allocable to CFC's passive category
foreign personal holding company income ($0 = $20x x ($100x -
$100x)/($200x - $100x)). All $20x of the G & A is apportioned to
CFC's general category income ($20x = $20x x $100x/($200x - $100x)).
(E) Example 5. The facts are the same as in paragraph
(c)(2)(v)(D) of this section (the facts in Example 4), except that
CFC uses the modified gross income method to apportion interest
expense. As in paragraph (c)(2)(v)(D) of this section (Example 4),
$100x of the interest payment to USP is allocated to passive
category income under paragraph (c)(2)(ii)(C) of this section. Under
paragraph (c)(2)(ii)(D) of this section, the additional $50x of
related person interest expense is apportioned to general category
income ($150x--100x x $100x/$100x). Under paragraph (c)(2)(ii)(E) of
this section, none of the unrelated person interest expense and none
of the G & A is apportioned to passive category income, because
after the application of paragraph (c)(2)(ii)(C) of this section, no
income remains in the passive category.
(F) Example 6. CFC2, a controlled foreign corporation, is a
wholly-owned subsidiary of CFC1, a controlled foreign corporation.
CFC1 is a wholly-owned subsidiary of USP, a domestic corporation.
CFC1 and CFC2 are incorporated in the same country. In Year 1, USP
sells tractors to CFC2, which CFC2 sells to X, a foreign corporation
that is related to both CFC1 and CFC2 and is organized in the same
country as CFC1 and CFC2. CFC1 makes a loan to x to finance the
tractor sales. Assume that the interest earned by CFC1 from
financing the sales is export financing interest that is neither
related person factoring income nor foreign personal holding company
income. Under Sec. 1.904-4(h), the export financing interest earned
by CFC1 is, therefore, general category income. CFC1 earns no other
income. CFC1 makes a $100x interest payment to USP. The $100x of
interest paid is not allocable under the look-through rules and
paragraph (c)(2)(ii) of this section to passive category income of
CFC1. The income is general category income to USP.
(3) Rents and royalties. Any rents or royalties received or accrued
from a controlled foreign corporation in which the taxpayer is a United
States shareholder are treated as passive category income to the extent
they are allocable to passive category income of the controlled foreign
corporation under the principles of Sec. Sec. 1.861-8 through 1.861-
14T.
(4) * * * (i) * * * Except as provided in paragraph (d)(2) of this
section, any dividend paid or accrued out of the earnings and profits
of any controlled foreign corporation is treated as passive category
income in proportion to the ratio of the portion of earnings and
profits attributable to passive category income to the total amount of
earnings and profits of the controlled foreign corporation. * * *
* * * * *
(iii) Look-through rule for dividends from noncontrolled 10-percent
owned foreign corporations--(A) In general. Except as provided in
paragraph (c)(4)(iii)(B) of this section, any dividend that is
distributed by a noncontrolled 10-percent owned foreign corporation and
received or accrued by a domestic corporation that is a United States
shareholder of such foreign corporation is treated as income in a
separate category in proportion to the ratio of the portion of earnings
and profits attributable to income in such category to the total amount
of earnings and profits of the noncontrolled 10-percent owned foreign
corporation.
(B) Inadequate substantiation. A dividend distributed by a
noncontrolled 10-percent owned foreign corporation is treated as income
in the separate category described in section 904(d)(4)(C)(ii) if the
Commissioner determines that the look-through characterization of the
dividend cannot reasonably be determined based on the available
information.
(5) Inclusions under section 951(a)(1)(A). Any amount included in
gross income under section 951(a)(1)(A) is treated as passive category
income to the extent the amount included is attributable to income
received or accrued by the controlled foreign corporation that is
passive category income. All other amounts included in gross income
under section 951(a)(1)(A) are treated as general category income or
income in a specified separate category under the rules in Sec. 1.904-
4. For rules concerning a distributive share of partnership income, see
Sec. 1.904-4(n). For rules concerning the gross up under section 78,
see Sec. 1.904-4(o). For rules concerning inclusions under section
[[Page 69094]]
951(a)(1)(B), see paragraph (c)(4)(i) of this section.
(6) Inclusions under section 951A(a). Any amount included in gross
income under section 951A(a) is treated as passive category income to
the extent the amount included is attributable to income received or
accrued by the controlled foreign corporation that is passive category
income. All other amounts included in gross income under section
951A(a) are treated as section 951A category income or income in a
specified separate category under the rules in Sec. 1.904-4. For rules
concerning a distributive share of partnership income, see Sec. 1.904-
4(n). For rules concerning the gross up under section 78, see Sec.
1.904-4(o).
(7) Examples. The following examples illustrate the application of
paragraph (c) of this section.
(i) Example 1--(A) Facts. CFC, a controlled foreign corporation,
is a wholly-owned subsidiary of USP, a domestic corporation. In Year
1, CFC earns $100x of net income, $85x of which is general category
foreign base company sales income and $15x of which is passive
category foreign personal holding company income. No foreign tax is
imposed on the income. CFC's income of $100x is subpart F income
taxed currently to USP under section 951(a)(1)(A).
(B) Analysis. Because $15x of the subpart F inclusion is
attributable to passive category income of CFC, under section
904(d)(3)(B) and paragraph (c)(5) of this section $15x of the
subpart F inclusion is passive category income to USP. The remaining
$85x subpart F inclusion is general category income to USP.
(ii) Example 2--(A) Facts. CFC1, a controlled foreign
corporation, is a wholly-owned subsidiary of USP, a domestic
corporation. CFC2 is a controlled foreign corporation wholly owned
by CFC1 and is incorporated and operates all of its business in the
same country as CFC1. All of CFC2's earnings and profits are
attributable to passive category foreign personal holding company
income. USP elects to exclude CFC2's income from subpart F income
under section 954(b)(4). In Year 1, CFC2 makes a distribution to
CFC1 and CFC1 makes a distribution to USP, all of which is
attributable to Year 1 earnings and profits. CFC1 has no earnings
and profits in Year 1 other than those received from CFC2.
(B) Analysis--(1) With respect to the dividend from CFC2 to
CFC1, such amount is not subpart F income. See section 954(c)(3).
Under section 904(d)(3)(D) and (E) and paragraphs (c)(4) and (d)(2)
of this section the dividend income is not passive category income
and therefore under Sec. 1.904-4 it is general category income to
CFC1. Under section 951A(c)(2)(A)(i)(IV), such dividend income is
not tested income.
(2) With respect to the dividend from CFC1 to USP, under section
904(d)(3)(D) and (E) and paragraphs (c)(4) and (d)(2) of this
section, such dividend income is not passive category income and
therefore under Sec. 1.904-4 is general category income to USP.
(iii) Example 3--(A) Facts. The facts are the same as in
paragraph (c)(7)(ii)(A) of this section (the facts in Example 2),
except that CFC1 receives interest income from CFC2 instead of
dividend income.
(B) Analysis. Under section 904(d)(3)(C) and paragraph (c)(2)(i)
of this section, the interest income is passive category income to
CFC1 because such interest is properly allocable to the passive
category income of CFC2. The interest income from CFC2 is subpart F
income of CFC1 taxable to USP because such income reduces the
subpart F income of CFC2 or such interest is properly allocable to
the subpart F income of CFC2. See section 954(c)(3) and (6). Under
section 904(d)(3)(B) and paragraph (c)(5) of this section, the
subpart F inclusion is passive category income to USP. Under section
959(a), the distribution from CFC1 to USP is excluded from USP's
gross income.
(iv) Example 4--(A) Facts. The facts are the same as in
paragraph (c)(7)(iii)(A) of this section (the facts in Example 3),
except that USP elects to exclude CFC1's interest income from
subpart F income under section 954(b)(4).
(B) Analysis. Under section 904(d)(3)(D) and (E) and paragraphs
(c)(4) and (d)(2) of this section, the distribution from CFC1 to USP
is not a passive category dividend and therefore under Sec. 1.904-4
is general category income to USP.
(v) Example 5--(A) Facts. The facts are the same as in paragraph
(c)(7)(iv)(A) of this section (the facts in Example 4), except that
USP receives interest income from CFC1 instead of dividend income.
(B) Analysis. Under section 904(d)(3)(C) and paragraph (c)(2)(i)
of this section, the interest income is passive category income to
USP because such interest is properly allocable to passive category
income of CFC1.
(d) * * * (1) De minimis amount of subpart F income. If the sum of
a controlled foreign corporation's gross foreign base company income
(determined under section 954(a) without regard to section 954(b)(5))
and gross insurance income (determined under section 953(a)) for the
taxable year is less than the lesser of 5 percent of gross income or
$1,000,000, then none of that income is treated as passive category
income. In addition, if the test in the first sentence of this
paragraph (d)(1) is satisfied, for purposes of paragraphs (c)(2)(ii)(D)
and (E) of this section (apportionment of interest expense to passive
income using the asset method), any passive assets are not treated as
passive category assets but are treated as assets in the general
category or a specified separate category. The determination in the
first sentence of this paragraph (d)(1) is made before the application
of the exception for certain income subject to a high rate of foreign
tax described in paragraph (d)(2) of this section.
(2) Exception for certain income subject to high foreign tax.
Except as provided in Sec. 1.904-4(c)(7)(iii) (relating to reductions
in tax upon distribution), for purposes of the dividend look-through
rule of paragraph (c)(4)(i) of this section, an item of net income that
would otherwise be passive category income (after application of the
priority rules of Sec. 1.904-4(l)) and that is received or accrued by
a controlled foreign corporation is not treated as passive category
income, and the earnings and profits attributable to such income is not
treated as passive category earnings and profits, if the taxpayer
establishes to the satisfaction of the Secretary under section
954(b)(4) that the income was subject to an effective rate of income
tax imposed by a foreign country greater than 90 percent of the maximum
rate of tax specified in section 11 (with reference to section 15, if
applicable). Such income is treated as general category income or
income in a specified separate category under the rules in Sec. 1.904-
4. The first sentence of this paragraph (d)(2) has no effect on amounts
(other than dividends) paid or accrued by a controlled foreign
corporation to a United States shareholder of such controlled foreign
corporation to the extent those amounts are allocable to passive
category income of the controlled foreign corporation.
(3) Example. The following example illustrates the application of
this paragraph (d).
(i) Facts. CFC, a controlled foreign corporation, is a wholly-
owned subsidiary of USP, a domestic corporation. In Year 1, CFC
earns $100x of gross income, $4x of which is interest that is
foreign personal holding company income and $96x of which is gross
manufacturing income that is not subpart F income. CFC has no other
earnings for Year 1. CFC has no expenses and pays no foreign taxes.
(ii) Analysis. Under the de minimis rule of section 954(b)(3)(A)
and Sec. 1.954-1(b)(1)(i), none of CFC's income is treated as
foreign base company income. All of CFC's income, therefore, is
treated as general category income and tested income. In Year 1, USP
has a GILTI inclusion amount with respect to CFC. Such amount is
section 951A category income to USP.
(e) * * *
(2) Example. The following example illustrates the application of
this paragraph (e).
(i) Facts. Controlled foreign corporation CFC is a wholly-owned
subsidiary of USP, a domestic corporation. CFC earns $100x, $75x of
which is foreign personal holding company income and $25x of which
is non-subpart F services income. CFC's gross and net income are
equal.
(ii) Analysis. Under the 70 percent full inclusion rule of
section 954(b)(3)(B), the entire $100x is foreign base company
income currently taxable to USP under section 951. Because $75x of
the $100x section 951 inclusion is attributable to CFC's passive
[[Page 69095]]
category income, $75x of the inclusion is passive category income to
USP. The remaining $25x of the inclusion is treated as general
category income to USP.
* * * * *
(h) Application of look-through rules to payments from a
partnership or other pass-through entity. Payments to a partner
described in section 707 (e.g., payments to a partner not acting in
capacity as a partner) are characterized as passive category income to
the extent that the payment is attributable under the principles of
Sec. 1.861-8 and this section to passive category income of the
partnership, if the payments are interest, rents, or royalties that
would be characterized under the controlled foreign corporation look-
through rules of paragraph (c) of this section if the partnership were
a foreign corporation, and the partner who receives the payment owns 10
percent or more of the value of the partnership (as determined under
Sec. 1.904-4(n)(3)). A payment by a partnership to a member of the
controlled group (as defined in paragraph (a)(4)(vi) of this section)
of the partner is characterized under the look-through rules of this
paragraph (h) if the payment would be a section 707 payment entitled to
look-through treatment if it were made to the partner. The rules in
this paragraph (h) do not apply with respect to interest to the extent
the interest income is assigned to a separate category under the
downstream partnership loan rules described in Sec. 1.861-9(e)(8). The
principles of the rules in this paragraph (h) apply to characterize a
payment from any other pass-through entity.
(i) * * * (1) * * * For purposes of this paragraph (i)(1), indirect
ownership of stock is determined under section 318. In the case of a
partnership or other pass-through entity, indirect ownership and value
is determined under the rules in paragraph (i)(2) of this section.
(2) Indirect ownership and value of a partnership interest. A
person is considered as owning, directly or indirectly, more than 50
percent of the value of a partnership if the person, together with any
other person that bears a relationship to the first person that is
described in section 267(b) or 707, owns more than 50 percent of the
capital and profits interests of the partnership. For purposes of this
paragraph (i)(2), value will be determined at the end of the
partnership's taxable year. The principles of this paragraph (i)(2)
apply with respect to a person that owns a pass-through entity other
than a partnership.
(3) Special rule for dividends between certain foreign
corporations. Solely for purposes of dividend payments between
controlled foreign corporations, noncontrolled 10-percent owned foreign
corporations, or a controlled foreign corporation and a noncontrolled
10-percent owned foreign corporation, the two foreign corporations are
considered related look-through entities if the same person is a United
States shareholder of both foreign corporations.
* * * * *
(5) Examples. The following examples illustrate the application of
this paragraph (i):
(i) Example 1. USP, a domestic corporation, owns all of the
stock of CFC1, a controlled foreign corporation. CFC1 owns 40% of
the stock of CFC2, a Country X corporation that is a controlled
foreign corporation. The remaining 60% of the stock of CFC2 is owned
by V, a domestic corporation, unrelated to USP. The percentages of
value and voting power of CFC2 owned by CFC1 and V correspond to
their percentages of stock ownership. CFC2 owns 40% (by vote and
value) of the stock of CFC3, a Country Z corporation that is a
controlled foreign corporation. The remaining 60% of CFC3 is owned
by unrelated United States persons. CFC3 earns exclusively general
category income that is neither subpart F income nor tested income.
In Year 1, CFC3 makes an interest payment of $100x to CFC2. Look-
through principles do not apply because CFC2 and CFC3 are not
related look-through entities under paragraph (i)(1) of this section
(because CFC2 does not own more than 50% of the voting power or
value of CFC3). The interest is passive category income to CFC2 and
is subpart F income of CFC2 that is taxable to USP and V. Under
paragraph (c)(5) of this section, USP and V's subpart F inclusion
with respect to CFC2 is passive category income.
(ii) Example 2. The facts are the same as in paragraph (i)(5)(i)
of this section (the facts in Example 1), except that instead of a
$100x interest payment, CFC3 pays a $50x dividend to CFC2 in Year 1.
USP and V each own, directly or indirectly, more than 10% of the
voting power of all classes of stock of both CFC2 and CFC3, and,
therefore, CFC2 and CFC3 have the same United States shareholders.
Pursuant to paragraph (i)(3) of this section, because CFC2 and CFC3
have a common United States shareholder, for purposes of applying
this section to the dividend from CFC2 to CFC3, CFC2 and CFC3 are
treated as related look-through entities. Therefore, look-through
principles apply. Because CFC3 has no passive category income or
earnings and profits, the dividend income is characterized as
general category income to CFC2. The dividend is subpart F income of
CFC2 that is taxable to USP and V. Under paragraph (c)(5) of this
section, the subpart F inclusions of USP and V are not passive
category income to USP and V and therefore under Sec. 1.904-4 the
subpart F inclusions are general category income to USP and V.
(iii) Example 3. The facts are the same as in paragraph
(i)(5)(i) of this section (the facts in Example 1), except that CFC3
pays both a $100x interest payment and a $50x dividend to CFC2, and
CFC2 owns 80% (by vote and value) of CFC3. Under paragraph (i)(1) of
this section, CFC2 and CFC3 are related look-through entities,
because CFC2 owns more than 50% (by vote and value) of CFC3.
Therefore, look-through principles apply to both the interest and
dividend income paid or accrued by CFC3 to CFC2, and CFC2 treats
both types of income as general category income because CFC3 does
not have any passive category earnings. Under paragraph (c)(5) of
this section and Sec. 1.904-4, the resulting subpart F inclusions
are general category income to USP and V.
(iv) Example 4. USP, a domestic corporation, owns 50% of the
voting stock of CFC1, a controlled foreign corporation. CFC1 owns
10% of the voting stock of CFC2, a controlled foreign corporation.
The remaining 50% of the stock of CFC1 is owned by X. The remaining
90% of the stock of CFC2 is owned by Y. X and Y are each United
States shareholders of CFC2 but are not related to USP, CFC1, or
each other. In Year 1, CFC2 pays a $100x dividend to CFC1. Under
paragraph (i)(3) of this section because no person is a United
States shareholder of both CFC1 and CFC2 (USP and X each own only 5%
of CFC2), CFC1 and CFC2 are not related look-through entities.
Because CFC2 is not a related person to CFC1 within the meaning of
section 954(d)(3), section 954(c)(3) and (c)(6) are inapplicable,
and the dividend is subpart F income of CFC1 that is taxable to USP
and X. Therefore, under section 904(d)(2)(B)(i) and Sec. 1.904-
4(b)(2)(i)(A), because the dividend income is foreign personal
holding company income, it is passive category income to CFC1.
(v) Example 5. The facts are the same as in paragraph (i)(5)(iv)
of this section (the facts in Example 4), except that X owns 10% of
the voting stock of CFC2 and Y owns only 80% of the voting stock of
CFC2. Because CFC2 is not a related person to CFC1 within the
meaning of section 954(d)(3), the dividend is subpart F income of
CFC1 that is taxable to USP and X. In addition, because X is a
United States shareholder of both CFC1 and CFC2, CFC2 and CFC1 are
related look-through entities under paragraph (i)(3) of this
section, the dividend income is general category income to CFC1 and
the subpart F inclusion is general category income to USP and X.
* * * * *
(k) * * *
(2) * * *
(iii) Inclusions under sections 951(a)(1)(A) and 951A(a) and
distributive shares of partnership income;
* * * * *
(l) Examples. The following examples illustrate the application of
this section.
(1) Example 1--(i) Facts. CFC1 and CFC2, controlled foreign
corporations, are wholly-owned subsidiaries of USP, a domestic
corporation. CFC1 and CFC2 are incorporated in two different foreign
countries and CFC2 is a financial services entity. In Year 1, CFC1
earns $100x of gross income that is passive category foreign
personal holding company
[[Page 69096]]
income. CFC1's only expense is a $50x interest payment to CFC2.
CFC1's $50x of pre-tax income is subject to $20x of foreign income
tax, and USP elects to exclude CFC1's $30x of net income from
subpart F income under section 954(b)(4).
(ii) Analysis. The $50x of interest is foreign personal holding
company income in CFC2's hands because section 954(c)(3)(A)(i) (same
country exception for interest payments) and section 954(c)(6) do
not apply, because the interest payment is allocable to and reduces
CFC1's subpart F income. The $50x of interest income is also passive
category income to CFC2 because CFC1 and CFC2 are related look-
through entities within the meaning of paragraph (i)(1) of this
section and, therefore the look-through rules of paragraph (c)(2)(i)
of this section apply to characterize the interest payment. However,
because CFC2 is a financial services entity, under Sec. 1.904-
4(e)(1) and paragraph (b)(2) of this section, the income is treated
as financial services income and therefore as general category
income in CFC2's hands. Thus, with respect to CFC2, under Sec.
1.904-4(d) and paragraph (c)(5) of this section, USP includes in its
gross income a $50x general category inclusion under section
951(a)(1)(A) attributable to the general category foreign personal
holding company income.
(2) Example 2--(i) Facts. USP, a domestic corporation, owns 75%
of USS, a domestic corporation. USP and USS are not financial
services entities. In Year 1, USS's earnings consist of $100x of
foreign source passive income. USS makes a $100x foreign source
royalty payment to USP.
(ii) Analysis. Under paragraph (g) of this section, the royalty
payment to USP is subject to the look-through rules of paragraph
(c)(3) of this section and is characterized as passive category
income the extent that it is allocable to such income in USS's
hands.
(3) Example 3--(i) Facts. USP, a domestic corporation, owns 100%
of the stock of CFC1, a controlled foreign corporation, and CFC1
owns 100% of the stock of CFC2, a controlled foreign corporation.
CFC1 has $100x of passive foreign personal holding company income
from unrelated persons and $100x of general category income. CFC1
also has $50x of interest income from CFC2. CFC1 pays CFC2 $100x of
interest.
(ii) Analysis. Under paragraph (k)(2) of this section, the $100x
interest payment from CFC1 to CFC2 is reduced for limitation
purposes to the extent of the $50x interest payment from CFC2 to
CFC1 before application of the rules in paragraph (c)(2)(ii) of this
section. Therefore, the interest payment from CFC2 to CFC1 is
disregarded. CFC1 is treated as if it paid $50x of interest to CFC2,
all of which is allocable to CFC1's passive category foreign
personal holding company income under paragraph (c)(2)(ii)(C) of
this section. Therefore, under paragraph (c)(2)(i) of this section,
the $50x interest payment from CFC1 to CFC2 is passive category
income.
(4) Example 4--(i) Facts. USP, a domestic corporation, owns 100%
of the stock of CFC1, a controlled foreign corporation. CFC1 owns
100% of the stock of CFC2, a controlled foreign corporation, and
100% of the stock of CFC3, a controlled foreign corporation. In Year
1, CFC2 pays CFC1 $5x of interest, CFC1 pays CFC3 $10x of interest,
and CFC3 pays CFC2 $20x of interest.
(ii) Analysis. Under paragraph (k)(2) of this section, the
interest payments from CFC1 to CFC3 must be offset by the amount of
interest that CFC1 is considered as receiving indirectly from CFC3
and the interest payment from CFC3 to CFC2 is offset by the amount
of the interest payment that CFC3 is considered as receiving
indirectly from CFC2. The $10x payment by CFC1 to CFC3 is reduced by
$5x, the amount of the interest payment from CFC2 to CFC1 that is
treated as being paid indirectly by CFC3 to CFC1. Similarly, the
$20x interest payment from CFC3 to CFC2 is reduced by $5x, the
amount of the interest payment from CFC1 to CFC3 that is treated as
being paid indirectly by CFC2 to CFC3. Therefore, under paragraph
(k)(2) of this section, CFC2 is treated as having made no interest
payment to CFC1, CFC1 is treated as having paid $5x of interest to
CFC3, and CFC3 is treated as having paid $15x to CFC2.
(5) Example 5--(i) Facts. USP, a domestic corporation, owns 100%
of the stock of CFC1, a controlled foreign corporation, and CFC1
owns 100% of the stock of CFC2, a controlled foreign corporation. In
Year 1, CFC1 earns $100x of passive category foreign personal
holding company income and $100x of general category non-subpart F
sales income from unrelated persons and $100x of general category
non-subpart F interest income from a related person. CFC1 pays $150x
of interest to CFC2. CFC2 earns $200x of general category sales
income from unrelated persons and the $150x interest payment from
CFC1. CFC2 pays CFC1 $100x of interest. USP does not have an
inclusion under section 951A.
(ii) Analysis--(A) Under paragraph (k)(2) of this section, the
$100x interest payment from CFC2 to CFC1 reduces the $150x interest
payment from CFC1 to CFC2. CFC1 is treated as though it paid $50x of
interest to CFC2. CFC2 is treated as though it made no interest
payment to CFC1.
(B) Under paragraph (k)(2)(ii) of this section, the remaining
$50x interest payment from CFC1 to CFC2 is then characterized. The
interest payment is first allocable under the rules of paragraph
(c)(2)(ii)(C) of this section to CFC1's passive category income.
Therefore, under paragraph (c)(2)(i) of this section, the $50x
interest payment to CFC2 is passive category income. The interest
income is foreign personal holding company income in CFC2's hands.
CFC2, therefore, has $50x of passive category subpart F income and
$200x of general category non-subpart F income.
(C) Under paragraph (k)(2)(iii) of this section, inclusions
under section 951(a)(1)(A) are characterized next. USP has an
inclusion under section 951(a)(1)(A) with respect to CFC1 of $50x
that is attributable to passive category income of CFC1 and is
treated as passive category income to USP. USP has an inclusion
under section 951(a)(1)(A) with respect to CFC2 of $50x that is
attributable to passive category income of CFC2 and is treated as
passive category income to USP.
(6) Example 6--(i) Facts. USP, a domestic corporation, owns 100%
of the stock of CFC1, a controlled foreign corporation, and CFC1
owns 100% of the stock of CFC2, a controlled foreign corporation.
USP also owns 100% of the stock of CFC3, a controlled foreign
corporation. CFC1, CFC2, and CFC3 are all incorporated in different
foreign countries. In Year 1, CFC1 earns $100x of passive category
foreign personal holding company income and $200x of general
category non-subpart F income from unrelated persons. CFC1 also
receives a $150x distribution from CFC2. CFC1 pays $100x of interest
to CFC2 and $100x of interest to CFC3. CFC3 earns $300x of general
category non-subpart F income and the $100x of interest received
from CFC1. CFC3 pays a $100x royalty to CFC2. The royalty is
directly allocable to CFC3's general category income and the royalty
is not subpart F income to CFC2. CFC2 earns the $100x interest
payment received from CFC1 and the $100x royalty received from CFC3.
USP does not have an inclusion under section 951A.
(ii) Analysis--(A) Under paragraph (k)(2)(i) of this section,
the royalty paid by CFC3 to CFC2 is characterized first. With
respect to CFC2, the royalty is general category non-subpart F
income.
(B) Under paragraph (k)(2)(ii) of this section, the interest
payments from CFC1 to CFC2 and CFC3 are characterized next. Under
paragraph (c)(2)(ii)(C) of this section, the interest payments are
first allocable to CFC1's passive category income. Therefore, under
paragraph (c)(2)(i) of this section, $50x of the interest payment to
CFC2 is passive category income and $50x of the interest payment to
CFC3 is passive category income. The remaining $50x paid to CFC2 is
general category income and the remaining $50x paid to CFC3 is
general category income. Because $100x of the interest income
received or accrued from CFC1 is properly allocable to income of
CFC1 which is not subpart F income, under section 954(c)(6) the
general category interest income is not treated as foreign personal
holding company income to CFC2 and CFC3. The remaining $100x of
interest income received or accrued from CFC1 is passive category
subpart F foreign personal holding company income to both
recipients. Therefore, CFC3 and CFC2 each have $50x of passive
category subpart F foreign personal holding company income related
to the interest received from CFC1.
(C) Under paragraph (k)(2)(iii) of this section, USP's $50x
inclusion under section 951(a)(1)(A) with respect to CFC2 is
characterized next. Under paragraph (c)(5) of this section, USP's
inclusion under section 951(a)(1)(A) is attributable to the passive
category portion of the interest income received by CFC2 from CFC1
and is passive category income to USP. Under paragraph (k)(2)(iii)
of this section, USP's $50x inclusion under section 951(a)(1)(A)
with respect to CFC3 is also characterized next. Under paragraph
(c)(5) of this section, USP's inclusion under section 951(a)(1)(A)
is attributable to the passive category portion of the interest
income received by CFC3 from CFC2 and is passive category income to
USP.
(D) Under paragraph (k)(2)(iv) of this section, the $150x
distribution from CFC2 to CFC1 is characterized next. The first $50x
of the distribution is out of passive category
[[Page 69097]]
earnings and profits described in section 959(c)(2). The remaining
$100x of the distribution is a dividend that is not attributable to
CFC2's passive category income, so under paragraph (c)(4)(i) of this
section it is general category income to CFC1 in its entirety.
Because $100x of the dividend received or accrued from CFC2 is
attributable to income of CFC2 which is not subpart F income, under
section 954(c)(6) such dividend income is not treated as foreign
personal holding company income of CFC1.
(7) Example 7--(i) Facts. USP, a domestic corporation, owns 100%
of the stock of CFC1, a controlled foreign corporation, and CFC1
owns 100% of the stock of CFC2, a controlled foreign corporation.
USP also owns 100% of the stock of CFC3, a controlled foreign
corporation. CFC1, CFC2, and CFC3 are all incorporated in different
foreign countries. In Year 1, CFC2 earns $100x of general category
income that is not subpart F income and distributes the entire
amount to CFC1 as a dividend. CFC1 earns $100x of passive category
foreign personal holding company income and the $100x dividend from
CFC2. CFC1 pays $100x of interest to CFC3. CFC3 earns $200x of
general category income that is foreign base company income and the
$100x of interest income from CFC1. USP does not have an inclusion
under section 951A.
(ii) Analysis. This transaction does not involve circular
payments and, therefore, the ordering rules of paragraph (k)(2) of
this section do not apply. Instead, pursuant to paragraph (k)(1) of
this section, income received is characterized first. CFC2's
earnings and, thus, the dividend from CFC2 to CFC1 are characterized
first. Under paragraph (c)(4)(i) of this section, CFC1 includes the
$100x dividend from CFC2 in gross income as general category income
because none of CFC2's earnings are passive category income. CFC1
thus has $100x of passive category foreign personal holding company
income and $100x of general category income that is excluded from
subpart F income under section 954(c)(6)(A). The interest payment
from CFC1 to CFC3 is then characterized as $100x passive category
income under paragraph (c)(2)(ii)(C) of this section because it is
allocable to passive foreign personal holding company income of
CFC1. For Year 1, CFC3 thus has $200x of general category income
that is subpart F income, and $100x of passive category foreign
personal holding company income. For Year 1, under Sec. 1.904-4(d)
and paragraph (c)(5) of this section, USP includes in its gross
income an inclusion under section 951(a)(1)(A) with respect to CFC3,
$200x of which is general category income and $100x of which is
passive category income.
(m) * * *
(2) * * *
(ii) Interest payments from noncontrolled 10-percent owned foreign
corporations. If interest is received or accrued by a shareholder from
a noncontrolled 10-percent owned foreign corporation (where the
shareholder is a domestic corporation that is a United States
shareholder of such noncontrolled 10-percent owned foreign
corporation), the rules of paragraph (m)(2)(i) of this section apply in
determining the portion of the interest payment that is from sources
within the United States, except that the related party interest rules
of paragraph (c)(2)(ii)(C) of this section do not apply.
(3) Examples. The following examples illustrate the application of
this paragraph (m).
(i) Example 1--(A) Facts. Controlled foreign corporation CFC is
a wholly-owned subsidiary of USP, a domestic corporation. In Year 1,
CFC pays USP $300x of interest. CFC has no other expenses. In Year
1, CFC has $3,000x of assets that generate $650x of foreign source
general category income and a $1,000x loan to an unrelated foreign
person that generates $20x of foreign source passive category
interest income. CFC also has a $4,000x loan to an unrelated United
States person that generates $70x of U.S. source passive category
interest income and $4,000x of assets that generate $100x of U.S.
source general category income. CFC uses the asset method to
allocate interest expense. The following chart summarizes CFC's
assets and income:
Table 1 to Paragraph (m)(3)(i)(A)
------------------------------------------------------------------------
Foreign U.S. Totals
------------------------------------------------------------------------
Assets:
Passive............................... 1,000x 4,000x 5,000x
General............................... 3,000x 4,000x 7,000x
-----------------------------
Total............................. 4,000x 8,000x 12,000x
Income:
Passive............................... 20x 70x 90x
General............................... 650x 100x 750x
-----------------------------
Total............................. 670x 170x 840x
------------------------------------------------------------------------
(B) Analysis. Under paragraph (c)(2)(ii)(C) of this section,
$90x of the related person interest payment is allocable to CFC's
passive category income. Under paragraph (m)(2) of this section,
$70x of USP's $90x of passive category interest income is from
sources within the United States and $20x is from foreign sources.
Under paragraph (c)(2)(ii)(D) of this section, the remaining $210x
of the related person interest payment is allocated to general
category income. Under paragraph (m)(2) of this section, $120x of
the remaining $210x of USP's interest income is treated as general
category income from sources within the United States ($120x = $210x
x $4,000x/$7,000x) and $90x is treated as general category income
from foreign sources ($90x = $210x x $3,000x/$7,000x).
(ii) Example 2. The facts are the same as in paragraph (m)(3)(i)
of this section (the facts in Example 1), except that CFC uses the
modified gross income method to allocate interest expense. The first
$90x of related person interest expense is allocated to passive
category income in the same manner as in paragraph (m)(3)(i) of this
section (Example 1), $70x to U.S. sources and $20x to foreign
sources. Under paragraph (c)(2)(ii)(D) of this section, the
remaining $210x of the related person interest expense is allocated
to CFC's general category income. Under paragraph (m)(2) of this
section, $28x of the remaining $210x of USP's interest income is
treated as general category income from U.S. sources ($28x = $210x x
$100x/$750x) and $182x is treated as general category income from
foreign sources ($182x = $210x x $650x/$750x).
(4) * * * (i) Rule. Any dividend or distribution treated as a
dividend under this paragraph (m) (including an amount included in
gross income under section 951(a)(1)(B)) that is received or accrued by
a United States shareholder from a controlled foreign corporation, or
any dividend that is received or accrued by a domestic corporation from
a noncontrolled 10-percent owned foreign corporation with respect to
which the shareholder is a United States shareholder, are treated as
income in a separate category derived from sources within the United
States in proportion to the ratio of the portion of the earnings and
profits of the controlled foreign corporation or noncontrolled 10-
percent owned foreign corporation in the corresponding separate
category from U.S. sources to the total amount of earnings and profits
of the controlled foreign corporation or noncontrolled 10-percent owned
foreign corporation in that separate category.
* * * * *
(5) Treatment of inclusions under sections 951(a)(1)(A), 951A and
1293--(i) * * * Any amount included in the gross income of a United
States shareholder of a controlled foreign corporation under section
951(a)(1)(A), 951A, or in the gross income of a domestic corporation
that is a United States shareholder of a noncontrolled 10-percent owned
foreign corporation described in section 904(d)(2)(E)(i)(II) that is a
qualified electing fund under section 1293 is treated as income subject
to a separate category that is derived from sources within the United
States to the extent the amount is attributable to income of the
controlled foreign corporation or qualified electing fund,
respectively, in the corresponding category of income from sources
within the United States. * * *
(ii) Example. The following example illustrates the application of
this paragraph (m)(5).
(A) Facts. Controlled foreign corporation CFC is a wholly-owned
subsidiary of domestic corporation, USP. In Year 1, CFC earns $100x
of subpart F foreign personal holding company income that is passive
category income. Of this amount, $40x is derived from sources within
the United States. CFC also earns $50x of subpart F general category
income. None of this income is from sources within the United
States. Assume that CFC pays no foreign taxes and has no expenses.
(B) Analysis. USP must include $150x in gross income under
section 951(a). Of this
[[Page 69098]]
amount, $60x is foreign source passive category income to USP, $40x
is U.S. source passive category income to USP, and $50x is foreign
source general category income to USP.
* * * * *
(7) * * *
(ii) Example. The following example illustrates the application of
this paragraph (m)(7).
(A) Facts. Controlled foreign corporation CFC is incorporated in
Country A and is a wholly-owned subsidiary of USP, a domestic
corporation. In Year 1, CFC earns $80x of general category foreign
base company sales income in Country A and $40x of passive category
U.S. source interest income. CFC incurs $20x of expenses
attributable to its sales business. CFC pays USP $40x of interest
that is allocated to CFC's U.S. source passive category income under
paragraph (c)(2)(ii)(C) of this section and so is U.S. source
passive category income to USP under paragraphs (c)(2)(i) and (m)(2)
of this section. Assume that earnings and profits equal net income.
All of CFC's net income of $60x is subpart F income includible in
USP's gross income under section 951(a)(1). For Year 1, USP also has
$100x of foreign source passive category income derived from
investments in Country B. Pursuant to section 904(h)(3) and
paragraph (m)(2) of this section, the $40x interest payment from CFC
is U.S. source income to USP because it is attributable to U.S.
source interest income of CFC. The United States-Country A income
tax treaty, however, treats all interest payments by residents of
Country A as Country A sourced and USP elects to apply the treaty.
(B) Analysis. Pursuant to section 904(h)(10) and this paragraph
(m)(7), the entire interest payment will be treated as foreign
source income to USP. USP thus has $60x of foreign source general
category income, $40x of foreign source Country A treaty category
passive income from CFC, and $100x of foreign source passive
category income.
(n) * * * Section 904(d)(3), (d)(4), and (h) and this section are
then applied for purposes of characterizing and sourcing income
received, accrued, or included by a United States shareholder of the
foreign corporation that is attributable or allocable to income or
earnings and profits of the foreign corporation.
(o) Applicability dates. This section is applicable for taxable
years that both begin after December 31, 2017, and end on or after
December 4, 2018.
0
Par. 22. Section 1.904-6 is amended by:
0
1. In paragraph (a)(1)(i):
0
i. Revising the first sentence and adding two sentences after the
fourth sentence.
0
ii. Removing the language ``(unless it is a withholding tax that is not
the final tax payable on the income as described in Sec. 1.904-4(d))''
and adding the language ``(as defined in section 901(k)(1)(B))'' in its
place in the new seventh sentence.
0
3. Revising paragraph (a)(1)(iv).
0
4. Adding paragraphs (a)(2) and (3).
0
5. Revising paragraph (b).
0
6. Removing and reserving paragraph (c).
0
7. Adding paragraph (d).
The revisions and additions read as follows:
Sec. 1.904-6 Allocation and apportionment of taxes.
(a) * * * (1) * * * (i) * * * The amount of foreign taxes paid or
accrued with respect to a separate category (as defined in Sec. 1.904-
5(a)(4)(v)) of income (including U.S. source income within the separate
category) includes only those taxes that are related to income in that
separate category. * * * Income included in the foreign tax base is
calculated under foreign law, but characterized as income in a separate
category under Federal income tax principles. For example, a foreign
tax imposed on an amount realized on the disposition of controlled
foreign corporation stock that is characterized as a capital gain under
foreign law but as a dividend under section 1248 is generally assigned
to the general category, not the passive category. * * *
* * * * *
(iv) Base and timing differences. If, under the law of a foreign
country or possession of the United States, a tax is imposed on a type
of item that does not constitute income under Federal income tax
principles (a base difference), such as gifts or life insurance
proceeds, that tax is treated as imposed with respect to income in the
separate category described in section 904(d)(2)(H)(i). If, under the
law of a foreign country or possession of the United States, a tax is
imposed on an item of income that constitutes income under Federal
income tax principles but is not recognized for Federal income tax
purposes in the current year (a timing difference), that tax is
allocated and apportioned to the appropriate separate category or
categories to which the tax would be allocated and apportioned if the
income were recognized under Federal income tax principles in the year
in which the tax was imposed. If the amount of an item of income as
computed for foreign tax purposes is positive but is greater than the
amount of income that is currently recognized for Federal income tax
purposes, for example, due to a difference in depreciation conventions
or the timing of recognition of gross income, or because of a permanent
difference between U.S. and foreign tax law in the amount of deductions
that are allowed to reduce gross income, the tax is allocated or
apportioned to the separate category to which the income is assigned,
and no portion of the tax is attributable to a base difference. In
addition, a tax imposed on a distribution that is excluded from gross
income under section 959(a) or section 959(b) is treated as
attributable to a timing difference (and not a base difference) and is
treated as tax imposed on the earnings and profits from which the
distribution was paid.
(2) Special rules for foreign branches--(i) In general. Except as
provided in this paragraph (a)(2), any foreign tax reflected on the
books and records of a foreign branch under the principles of Sec.
1.987-2(b) is allocated and apportioned under the rules of paragraph
(a)(1) of this section.
(ii) Disregarded reattribution transactions--(A) Foreign branch to
foreign branch owner. In the case of a disregarded payment from a
foreign branch to a foreign branch owner that is treated as a
disregarded reattribution transaction that results in gross income
being attributed to the foreign branch owner under Sec. 1.904-
4(f)(2)(vi), any foreign tax imposed solely by reason of that
transaction, such as a withholding tax imposed on a disregarded
payment, is allocated and apportioned to the reattributed gross income.
(B) Foreign branch owner to foreign branch. In the case of a
disregarded payment from a foreign branch owner to a foreign branch
that is treated as a disregarded reattribution transaction that results
in gross income being attributed to the foreign branch under Sec.
1.904-4(f)(2)(vi), any foreign tax imposed solely by reason of that
transaction is allocated and apportioned to the reattributed gross
income. In the case of a foreign branch owner that is a partnership, a
foreign tax imposed solely by reason of a disregarded reattribution
transaction that results in general category income being attributed to
a foreign branch is allocated and apportioned to the partnership's
general category income that is attributable to the foreign branch (as
described in paragraph (b)(4)(ii) of this section).
(iii) Other disregarded payments--(A) Foreign branch to foreign
branch owner. In the case of a disregarded payment from a foreign
branch to a foreign branch owner that is not a disregarded
reattribution transaction, foreign tax imposed solely by reason of that
disregarded payment is allocated and apportioned to a separate category
under paragraph (a)(1) of this section based on the nature of the item
(determined under Federal income tax
[[Page 69099]]
principles) that is included in the foreign tax base. For example, if a
remittance of an appreciated asset results in gain recognition under
foreign law, the tax imposed on that gain is treated as attributable to
a timing difference with respect to recognition of the gain, and is
allocated and apportioned to the separate category to which gain on a
sale of that asset would have been assigned if it were recognized for
Federal income tax purposes. However, a gross basis withholding tax on
a remittance is attributable to a timing difference in taxation of the
income out of which the remittance is made, and is allocated and
apportioned to the separate category or categories to which a section
987 gain or loss would be assigned under Sec. 1.987-6(b).
(B) Foreign branch owner to foreign branch. In the case of a
disregarded payment from a foreign branch owner that is a United States
person to a foreign branch that is neither a disregarded reattribution
transaction nor described in Sec. 1.904-4(f)(2)(vi)(C)(4), any foreign
tax imposed solely by reason of the receipt of that disregarded payment
is allocated and apportioned to the foreign branch category. In the
case of a foreign branch owner that is a partnership, a foreign tax
imposed solely by reason of the receipt of a disregarded payment by a
foreign branch is allocated and apportioned to the partnership's
general category income that is attributable to the foreign branch (as
described in paragraph (b)(4)(ii) of this section).
(iv) Definitions. The following definitions apply for purposes of
this paragraph (a)(2):
(A) Disregarded reattribution transaction. The term disregarded
reattribution transaction means a disregarded payment or a transfer
described in Sec. 1.904-4(f)(2)(vi)(D) to the extent that it results
in an adjustment to the gross income attributable to the foreign branch
under Sec. 1.904-4(f)(2)(vi)(A).
(B) The terms disregarded payment, foreign branch, foreign branch
owner, and remittance have the same meaning given to those terms in
Sec. 1.904-4(f)(3).
(3) Taxes imposed on high-taxed income. For rules on the treatment
of taxes imposed on high-taxed income, see Sec. 1.904-4(c).
(b) Allocation and apportionment of deemed paid taxes and certain
creditable foreign tax expenditures--(1) Taxes deemed paid under
section 960(a) or (d). If a domestic corporation that is a United
States shareholder includes any amount in gross income under section
951(a)(1)(A) or 951A(a), any foreign tax deemed paid with respect to
such amount under section 960(a) or (d) is allocated to the separate
category to which the inclusion is assigned.
(2) Taxes deemed paid under section 960(b)(1). If a domestic
corporation that is a United States shareholder receives a distribution
of previously taxed earnings and profits from a first-tier corporation
that is excluded from the domestic corporation's income under section
959(a) and Sec. 1.959-1, any foreign tax deemed paid under section
960(b)(1) with respect to such distribution is allocated to the same
separate category as the annual PTEP account and PTEP group (as defined
in Sec. 1.960-3(c)) from which the distribution is made.
(3) Taxes deemed paid under section 960(b)(2). If a controlled
foreign corporation receives a distribution of previously taxed
earnings and profits from an immediately lower-tier corporation that is
excluded from such controlled foreign corporation's gross income under
section 959(b) and Sec. 1.959-2, any foreign tax deemed paid under
section 960(b)(2) with respect to such distribution is allocated to the
same separate category as the annual PTEP account and PTEP group (as
defined in Sec. 1.960-3(c)) from which the distribution is made. See
also Sec. 1.960-3(c)(2).
(4) Creditable foreign tax expenditures--(i) In general. Except as
provided in paragraph (b)(4)(ii) of this section, creditable foreign
tax expenditures (CFTEs) allocated to a partner under Sec. 1.704-
1(b)(4)(viii)(a) are allocated for purposes of this section to the same
separate category as the separate category to which the taxes were
allocated in the hands of the partnership under the rules of paragraph
(a) of this section.
(ii) Foreign branch category. CFTEs allocated to a partner in a
partnership under Sec. 1.704-1(b)(4)(viii)(a) are allocated and
apportioned to the foreign branch category of the partner to the extent
that:
(A) The CFTEs are allocated and apportioned by the partnership
under the rules of paragraph (a) of this section to the general
category;
(B) In the hands of the partnership, the CFTEs are related to
general category income attributable to a foreign branch (as described
in Sec. 1.904-4(f)(2)) under the principles of paragraph (a) of this
section; and
(C) The partner's distributive share of the income described in
paragraph (b)(4)(ii)(B) of this section is foreign branch category
income of the partner under Sec. 1.904-4(f)(1)(i)(B).
* * * * *
(d) Applicability dates. This section is applicable for taxable
years that both begin after December 31, 2017, and end on or after
December 4, 2018.
0
Par. 23. Section 1.904(b)-3 is added to read as follows:
Sec. 1.904(b)-3 Disregard of certain dividends and deductions under
section 904(b)(4).
(a) Disregard of certain dividends and deductions--(1) In general.
For purposes of section 904(a), in the case of a domestic corporation
which is a United States shareholder with respect to a specified 10-
percent owned foreign corporation (as defined in section 245A(b)), the
domestic corporation's foreign source taxable income in a separate
category and entire taxable income is determined without regard to the
following items:
(i) Any dividend for which a deduction is allowed under section
245A;
(ii) Deductions properly allocable or apportioned to gross income
in the section 245A subgroup as determined under paragraphs (b) and
(c)(1) of this section; and
(iii) Deductions properly allocable or apportioned to stock of
specified 10-percent owned foreign corporations in the section 245A
subgroup as determined under paragraphs (b) and (c) of this section.
(2) Deductions properly allocable or apportioned to the residual
grouping. Deductions that are properly allocable or apportioned to
gross income or stock in the section 245A subgroup of the residual
grouping (consisting of U.S. source income) are disregarded solely for
purposes of determining entire taxable income under section 904(a).
(b) Determining properly allocable or apportioned deductions. The
amount of deductions properly allocable or apportioned to gross income
or stock described in paragraphs (a)(1)(ii) and (iii) of this section
is determined by subdividing the United States shareholder's gross
income and assets in each separate category described in Sec. 1.904-
5(a)(4)(v) into a section 245A subgroup and a non-section 245A
subgroup. Gross income and assets in the residual grouping for U.S.
source income are also subdivided into a section 245A subgroup and a
non-section 245A subgroup. Each section 245A subgroup is treated as a
statutory grouping under Sec. 1.861-8(a)(4). Deductions properly
allocable or apportioned to dividends or stock described in paragraphs
(a)(1)(ii) and (iii) of this section only include those deductions that
are allocated and apportioned under Sec. Sec. 1.861-8 through 1.861-
14T and 1.861-17 to the section
[[Page 69100]]
245A subgroups. The deduction allowed under section 245A(a) for
dividends is allocated and apportioned solely among the section 245A
subgroups on the basis of the relative amounts of gross income from
such dividends in each section 245A subgroup.
(c) Income and assets in the 245A subgroups--(1) In general. For
purposes of applying the allocation and apportionment rules under
Sec. Sec. 1.861-8 through 1.861-14T and 1.861-17 to the deductions of
a United States shareholder, the only gross income included in a
section 245A subgroup is dividend income for which a deduction is
allowed under section 245A. The only asset included in a section 245A
subgroup is the portion of the value of stock of each specified 10-
percent owned foreign corporation that is assigned to the section 245A
subgroup determined under paragraph (c)(2) of this section.
(2) Assigning stock to a subgroup. The value of stock of a
specified 10-percent owned foreign corporation is characterized as an
asset in a separate category described in Sec. 1.904-5(a)(4)(v) or the
residual grouping for U.S. source income under the rules of Sec.
1.861-12(c). If the specified 10-percent owned foreign corporation is
not a controlled foreign corporation, all of the value of its stock
(other than the portion of stock assigned to the statutory groupings
for gross section 245(a)(5) income under Sec. Sec. 1.861-12(c)(4) and
1.861-13) in each separate category and in the residual grouping for
U.S. source income is assigned to the section 245A subgroup in such
separate category or residual grouping. If the specified 10-percent
owned foreign corporation is a controlled foreign corporation, a
portion of the value of stock in each separate category and in the
residual grouping for U.S. source income is subdivided between a
section 245A and non-section 245A subgroup under Sec. 1.861-13(a)(5).
(d) Coordination with OFL and ODL rules--(1) In general. Section
904(b)(4) and this section apply before the operation of the overall
foreign loss rules in section 904(f) and the overall domestic loss
rules in section 904(g). See Sec. 1.904(g)-3(c).
(2) [Reserved]
(e) Example. The following example illustrates the application of
this section.
(1) Facts--(i) Income and assets of USP. USP is a domestic
corporation. USP owns a factory in the United States with a tax book
value of $27,000x. USP also directly owns all of the stock of each
of the following three controlled foreign corporations: CFC1, CFC2,
and CFC3. USP's tax book value in each of CFC1, CFC2, and CFC3 is
$10,000x. USP incurs $1,500x of interest expense and earns $1,600x
of U.S. source gross income. Under section 951A and the section 951A
regulations (as defined in Sec. 1.951A-1(a)(1)), USP's GILTI
inclusion amount is $2,200x. USP's deduction under section 250 is
$1,100x (``section 250 deduction''), all of which is by reason of
section 250(a)(1)(B)(i). No portion of USP's section 250 deduction
is reduced by reason of section 250(a)(2)(B). None of the CFCs makes
any distributions.
(ii) Characterization of CFC stock. After application of Sec.
1.861-13(a), USP determined that $8,000x of the stock of each of
CFC1, CFC2, and CFC3 is assigned to the section 951A category
(``section 951A category stock'') in the non-section 245A subgroup
and the remaining $2,000x of the stock of each of CFC1, CFC2, and
CFC3 is assigned to the general category (``general category
stock'') in the section 245A subgroup. Additionally, under Sec.
1.861-8(d)(2)(ii)(C)(2), $4,000x of the stock of each of CFC1, CFC2,
and CFC3 that is section 951A category stock is an exempt asset.
Accordingly, with respect to the stock of its controlled foreign
corporations in the aggregate, USP has $12,000x of section 951A
category stock in a non-section 245A subgroup; $6,000x of general
category stock in a section 245A subgroup; and $12,000x of stock
that is an exempt asset.
(iii) Apportioning of expenses. Taking into account USP's
factory and its stock in CFC1, CFC2, and CFC3, the tax book value of
USP's assets for purposes of apportioning expenses is $45,000x
(excluding the $12,000x of exempt assets). Under Sec. 1.861-9T(g),
USP's $1,500 of interest expense is apportioned as follows: $400x
($1,500x x $12,000x/$45,000x) to section 951A category income, $200x
($1,500x x $6,000x/$45,000x) to general category income, and the
remaining $900x ($1,500 x $27,000x/$45,000x) to the residual U.S.
source grouping. Under Sec. 1.861-8(e)(14), all of USP's section
250 deduction is allocated and apportioned to section 951A category
income.
(2) Analysis--(i) USP's pre-credit U.S. tax. USP's worldwide
taxable income is $1,200x, which equals its GILTI inclusion amount
of $2,200x plus its U.S. source gross income of $1,600x, less its
deduction under section 250 of $1,100 and its interest expense of
$1,500x. For purposes of applying section 904(a), before taking into
account any foreign tax credit under section 901, USP's Federal
income tax liability is 21% of $1,200x, or $252x.
(ii) Application of section 904(b)(4). Under section 904(d)(1),
USP applies section 904(a) separately to each separate category of
income.
(A) General category income. Before application of section
904(b)(4) and the rules in this section, USP's foreign source
taxable income in the general category is a loss of $200x, which
equals $0 (USP's foreign source general category income) less $200x
(interest expense apportioned to general category income), and USP's
worldwide taxable income is $1,200. Under paragraph (d) of this
section, the rules in section 904(f) and (g) apply after section
904(b)(4) and the rules in this section. Under paragraphs (b) and
(c)(1) of this section, USP has no deductions properly allocable or
apportioned to gross income in the section 245A subgroup because USP
has no dividend income in the general category for which a deduction
is allowed under section 245A. Under paragraphs (b) and (c) of this
section, USP has $200x of deductions for interest expense that are
properly allocable or apportioned to stock of specified 10-percent
owned foreign corporations in the section 245A subgroup because
USP's only general category assets are the general category stock of
CFC1, CFC2, and CFC3, all of which are in the section 245A subgroup.
Therefore, under paragraph (a) of this section, USP's foreign source
taxable income in the general category and its worldwide taxable
income are determined without regard to the $200x of deductions for
interest expense. Accordingly, USP's foreign source taxable income
in the general category is $0 and its worldwide taxable income is
$1,400x, and therefore, there is no separate limitation loss for
purposes of section 904(f). Under section 904(a) and (d)(1) USP's
foreign tax credit limitation for the general category is $0.
(B) Section 951A category income. Before application of section
904(b)(4) and the rules in this section, USP's foreign source
taxable income in the section 951A category is $700x, which equals
$2,200x (USP's GILTI inclusion amount) less $1,100x (USP's section
250 deduction) less $400x (interest apportioned to section 951A
category income). Under paragraphs (b) and (c)(1) of this section,
USP has no deductions properly allocable and apportioned to gross
income in a section 245A subgroup of the section 951A category.
Under paragraphs (b) and (c) of this section, USP has no deductions
properly allocable and apportioned to stock of specified 10-percent
owned foreign corporations in a section 245A subgroup of section
951A category stock because no portion of section 951A category
stock is assigned to a section 245A subgroup. See Sec. 1.861-
13(a)(5)(v). Therefore, under paragraph (a) of this section no
adjustment is made to USP's foreign source taxable income in the
section 951A category. However, the adjustments to USP's worldwide
taxable income described in paragraph (e)(2)(ii)(A) of this section
apply for purposes of calculating USP's foreign tax credit
limitation for the section 951A category. Accordingly, USP's foreign
source taxable income in the section 951A category is $700x and its
worldwide taxable income is $1,400x. Under section 904(a) and
(d)(1), USP's foreign tax credit limitation for the section 951A
category is $126x ($252x x $700x/$1,400x).
(f) Applicability date. This section applies to taxable years that
both begin after December 31, 2017, and end on or after December 4,
2018.
0
Par. 24. Sec. 1.904(f)-12 is amended by adding reserved paragraph (i)
and paragraph (j) to read as follows:
Sec. 1.904(f)-12 Transition rules.
* * * * *
(j) Recapture in years beginning after December 31, 2017, of
separate limitation losses, overall foreign losses, and overall
domestic losses incurred in
[[Page 69101]]
years beginning before January 1, 2018--(1) Definitions--(i) The term
pre-2018 separate categories means the separate categories of income
described in section 904(d) and any specified separate categories of
income, as applicable to taxable years beginning before January 1,
2018.
(ii) The term post-2017 separate categories means the separate
categories of income described in section 904(d) and any specified
separate categories of income, as applicable to taxable years beginning
after December 31, 2017.
(iii) The term specified separate category has the meaning set
forth in Sec. 1.904-4(m)).
(2) Allocation of separate limitation loss or overall foreign loss
account incurred in a pre-2018 separate category--(i) Allocation to the
same category. To the extent that a taxpayer has a balance in any
separate limitation loss or overall foreign loss account in a pre-2018
separate category at the end of the taxpayer's last taxable year
beginning before January 1, 2018, the amount of such balance is
allocated on the first day of the taxpayer's next taxable year to the
same post-2017 separate category as the pre-2018 separate category of
the separate limitation loss or overall foreign loss account.
(ii) Exception for general category separate limitation loss or
overall foreign loss account--(A) In general. To the extent a taxpayer
has a balance in any separate limitation loss or overall foreign loss
account in the pre-2018 separate category for general category income
at the end of the taxpayer's last taxable year beginning before January
1, 2018, a taxpayer may choose to allocate any such balance to the
taxpayer's post-2017 separate category for foreign branch category
income to the extent the balance in the loss account would have been
allocated to the taxpayer's post-2017 separate category for foreign
branch category income if that separate category applied in the year or
years the losses giving rise to the account were incurred. Any
remaining portion of the balance in the separate limitation loss or
overall foreign loss account is allocated to the taxpayer's post-2017
separate category for general category income.
(B) Safe harbor. In lieu of applying paragraph (j)(2)(ii)(A) of
this section, the taxpayer may choose to recapture the balance in any
loss account described in paragraph (j)(2)(ii)(A) of this section from
the first available income in the taxpayer's post-2017 separate
category for general category income or foreign branch category income.
If the sum of taxpayer's general category income and foreign branch
category income for a taxable year subject to recharacterization
exceeds the amount of the loss account described in paragraph
(j)(2)(ii)(A) of this section that is to be recaptured, then the amount
of general category income and foreign branch category income that will
be recharacterized under the relevant recapture provisions is
determined on a proportionate basis. The recapture under this paragraph
(j)(2)(ii)(B) of any loss account described in paragraph (j)(2)(ii)(A)
of this section is made before the recapture of any amount by which the
balance of the loss account is increased after the end of the
taxpayer's last taxable year beginning before January 1, 2018.
(C) Rules regarding the exception. A taxpayer applying the
exception described in paragraph (j)(2)(ii)(A) or (B) of this section
must apply the exception to all balances in any separate limitation
loss or overall foreign loss account in a pre-2018 separate category
for general category income at the end of the taxpayer's last taxable
year beginning before January 1, 2018. A taxpayer may apply the
exception on a timely filed original return (including extensions) or
an amended return. A taxpayer that applies the exception on an amended
return must make appropriate adjustments to eliminate any double
benefit arising from application of the exception to years that are not
open for assessment.
(3) Recapture of separate limitation loss or overall domestic loss
that reduced pre-2018 separate category income--(i) Recapture as income
in the same separate category. To the extent that at the end of the
taxpayer's last taxable year beginning before January 1, 2018, a
taxpayer has a balance in any separate limitation loss or overall
domestic loss account which offset pre-2018 separate category income,
such loss is recaptured in subsequent taxable years as income in the
same post-2017 separate category as the pre-2018 separate category of
income that was offset by the loss.
(ii) Exception for separate limitation loss or overall domestic
loss that reduced general category income--(A) In general. To the
extent that a taxpayer's separate limitation loss or overall domestic
loss account offset pre-2018 separate category income that was general
category income, a taxpayer may choose to recapture the balance in the
loss account at the end of the taxpayer's last taxable year beginning
before January 1, 2018, in subsequent taxable years as income in the
post-2017 separate category for foreign branch category income to the
extent the balance in the loss account would have offset foreign branch
category income had that separate category applied in the year or years
the losses were incurred. Any remaining portion of the balance in the
loss account is recaptured as income in the taxpayer's post-2017
separate category for general category income.
(B) Safe harbor. In lieu of applying paragraph (j)(3)(ii)(A) of
this section, a taxpayer that had unused foreign income taxes in a pre-
2018 taxable year that were allocated to the foreign branch category
under Sec. 1.904-2(j)(1)(iii)(A) or (B) may choose to recapture the
balance in any loss account described in paragraph (j)(3)(ii)(A) of
this section in subsequent taxable years ratably as income in the
taxpayer's post-2017 separate categories for general category and
foreign branch category income, based on the proportion in which any
unused foreign taxes in the pre-2018 separate category for general
category income are allocated under Sec. 1.904-2(j)(1)(iii)(A) or (B).
(C) Rules regarding the exception. A taxpayer applying the
exception described in paragraph (j)(2)(ii)(A) or (B) of this section
must apply the exception to the recapture of all balances at the end of
the taxpayer's last taxable year beginning before January 1, 2018 in
any separate limitation loss or overall domestic loss account which
offset pre-2018 separate category income that was general category
income. A taxpayer may apply the exception on a timely filed original
return (including extensions) or an amended return. A taxpayer that
applies the exception on an amended return must make appropriate
adjustments to eliminate any double benefit arising from application of
the exception to years that are not open for assessment.
(4) Treatment of foreign losses that are part of net operating
losses incurred in pre-2018 taxable years which are carried forward to
post-2017 taxable years--(i) Treatment as a loss in the same separate
category. A foreign loss that is part of a net operating loss incurred
in a taxable year beginning before January 1, 2018, which is carried
forward, pursuant to section 172, to a taxable year beginning after
December 31, 2017, will be carried forward under the rules of Sec.
1.904(g)-3(b)(2). For purposes of applying the rules of Sec. 1.904(g)-
3(b)(2), the portion of a net operating loss carryforward that is
attributable to a foreign loss from a pre-2018 separate category will
be treated as a loss attributable to the same post-2017 separate
category as the pre-2018 separate category.
(ii) Exception for general category foreign losses that are part of
net operating losses--(A) In general. A
[[Page 69102]]
taxpayer may choose to treat the portion of a net operating loss
carryforward that is attributable to a foreign loss from the pre-2018
separate category for general category income as attributable to the
post-2017 separate category for foreign branch category income to the
extent the net operating loss would have been attributable to the
taxpayer's post-2017 separate category for foreign branch category
income had that separate category applied in the year or years the net
operating loss arose. Any remaining portion of the net operating loss
carryforward is treated as attributable to the taxpayer's post-2017
separate category for general category income.
(B) Safe harbor. In lieu of applying paragraph (j)(4)(ii)(A) of
this section, for the post-2017 taxable year in which a net operating
loss carryforward described in paragraph (j)(4)(ii)(A) of this section
is used, the taxpayer may choose to treat the net operating loss
carryforward as attributable to the taxpayer's post-2017 separate
categories for general category income and foreign branch category
income to the extent of any general category income and foreign branch
category income, respectively, that is available in the carryforward
year to be offset by the net operating loss carryforward. To the extent
the net operating loss carryforward offsets any other income in the
carryforward year, it is treated as attributable to the taxpayer's
post-2017 separate category for general category income. If the sum of
taxpayer's general category income and foreign branch income in the
carryforward year exceeds the amount of the net operating loss
carryforward, then the amount of each type of separate income that is
offset by the net operating loss carryforward, and therefore the
separate category treatment of the net operating loss carryforward, is
be determined on a proportionate basis. A general category net
operating loss to which the exception is applied is absorbed before any
general category net operating loss that is incurred after the end of
the taxpayer's last taxable year beginning before January 1, 2018.
(C) Rules regarding the exception. A taxpayer applying the
exception described in paragraph (j)(4)(ii)(A) or (B) of this section
must apply the exception to all of its net operating losses that are
attributable to a foreign loss from the pre-2018 separate category for
general category income. A taxpayer may apply the exception on a timely
filed original return (including extensions) or an amended return. A
taxpayer that applies the exception on an amended return must make
appropriate adjustments to eliminate any double benefit arising from
application of the exception to years that are not open for assessment.
(5) Coordination rule with respect to exceptions. A taxpayer that
applies any exception described in Sec. 1.904-2(j)(1)(iii) or
paragraph (j)(2)(ii), (j)(3)(ii), or (j)(4)(ii) of this section must
apply all such exceptions and cannot apply any of the general rules
described in Sec. 1.904-2(j)(1)(ii) or paragraph (j)(2)(i), (j)(3)(i),
or (j)(4)(i) of this section. However, in applying each such exception,
the taxpayer may choose to apply the safe harbor provision regardless
of whether the safe harbor is applied for purposes of any other
exception.
(6) Applicability date. This paragraph (j) applies to taxable years
beginning after December 31, 2017.
0
Par. 25. Section 1.904(g)-0 is amended by:
0
1. Adding an entry for Sec. 1.904(g)-3(i) and removing and reserving
the entry for Sec. 1.904(g)-3(j).
0
2. Revising the entry for Sec. 1.904(g)-3(k) and adding an entry for
Sec. 1.904(g)-3(l).
The revisions and additions read as follows:
Sec. 1.904(g)-0 Outline of regulation provisions.
* * * * *
Sec. 1.904(g)-3 Ordering rules for the allocation of net operating
losses, net capital losses, U.S. source losses, and separate limitation
losses, and for the recapture of separate limitation losses, overall
foreign losses, and overall domestic losses.
* * * * *
(i) Step Eight: Dispositions under section 904(f)(3) in which gain
would not otherwise be recognized.
(j) [Reserved]
(k) Examples.
(l) Applicability date.
0
Par. 26. Section 1.904(g)-3 is amended by:
0
1. Removing the language ``paragraphs (b) through (i)'' and adding the
language ``paragraphs (b) through (j)'' in its place in paragraph (a).
0
2. Adding a sentence at the end of paragraph (c).
0
3. Revising paragraph (f).
0
4. Adding paragraph (i).
0
5. Removing and reserving paragraph (j) and revising paragraph (k).
0
6. Adding paragraph (l).
The revisions and additions read as follows:
Sec. 1.904(g)-3 Ordering rules for the allocation of net operating
losses, net capital losses, U.S. source losses, and separate limitation
losses, and for the recapture of separate limitation losses, overall
foreign losses, and overall domestic losses.
* * * * *
(c) * * * The taxpayer also takes into account any adjustments
required under section 904(b)(4) and Sec. 1.904(b)-3.
* * * * *
(f) Step Five: Recapture of overall foreign loss accounts. If the
taxpayer's separate limitation income for the taxable year (reduced by
any losses carried over under paragraph (b) of this section) exceeds
the sum of the taxpayer's U.S. source loss and separate limitation
losses for the year, so that the taxpayer has separate limitation
income remaining after the application of paragraphs (d)(1) and (e) of
this section, then the taxpayer recaptures prior year overall foreign
losses, if any, in accordance with Sec. 1.904(f)-2, and reduces
overall foreign loss accounts in accordance with Sec. 1.904(f)-2. The
recapture in this paragraph (f) includes amounts determined under Sec.
1.904(f)-2(c) and (d)(3) but not Sec. 1.904(f)-2(d)(4), which is
covered in paragraph (i) of this section.
* * * * *
(i) Step Eight: Dispositions under section 904(f)(3) in which gain
would not otherwise be recognized. The taxpayer determines the amount
of gain that would otherwise not be recognized but that must be
recognized in accordance with Sec. 1.904(f)-2(d)(4) (not exceeding the
taxpayer's applicable overall foreign loss account) and then applies
Sec. 1.904(f)-2(a) and (b) to recapture and reduce its overall foreign
loss accounts in an amount equal to the gain recognized. To the extent
this recognition of gain in a taxable year reduces the amount of a
current year net operating loss or increases the amount of a net
operating loss carryover to that taxable year, paragraphs (b) through
(e) of this section are applied to determine the allocation of any
additional net operating loss deduction and other deductions or losses
and the applicable increases in the taxpayer's overall foreign loss,
separate limitation loss, and overall domestic loss accounts, but only
after the applicable overall foreign loss account has been recaptured
as provided in this paragraph (i).
* * * * *
(k) Examples. The following examples illustrate the rules of this
section. Unless otherwise noted, all corporations use the calendar year
as the U.S. taxable year.
[[Page 69103]]
(1) Example 1--(i) Facts--(A) USC is a domestic corporation with
foreign branch operations in Country X. For Year 1, USC had the
following taxable income and losses after application of section
904(f) and (g) to income and loss in Year 1:
Table 1 to Paragraph (k)(1)(i)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$400x........................................... $200x $110x
------------------------------------------------------------------------
(B) For Year 2, USC has a net operating loss of ($500x),
determined as follows:
Table 2 to Paragraph (k)(1)(i)(B)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
($300x)......................................... $0 ($200x)
------------------------------------------------------------------------
(ii) Analysis--(A) Net operating loss allocation. Because USC's
taxable income for Year 1 exceeds its total net operating loss for
Year 2, the full net operating loss is carried back. Under paragraph
(b) of this section (Step 1), each component of the net operating
loss is carried back and combined with its same category in Year 1.
See paragraph (b)(2) of this section. After allocation of the net
operating loss, USC has the following taxable income and losses for
Year 1:
Table 3 to Paragraph (k)(1)(ii)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$100x........................................... $200x ($90x)
------------------------------------------------------------------------
(B) Loss allocation. Under paragraph (e) of this section (Step
4), the ($90x) of U.S. loss is allocated proportionately to reduce
the foreign branch category and passive category income.
Accordingly, $30x ($90x x $100x/$300x) of the U.S. loss is allocated
to foreign branch category income and $60x ($90x x $200x/$300x) of
the U.S. loss is allocated to passive category income, with a
corresponding creation or increase to USC's overall domestic loss
accounts.
(2) Example 2--(i) Facts--(A) USC is a domestic corporation with
foreign branch operations in Country X. As of January 1, Year 1, USC
has no loss accounts subject to recapture. For Year 1, USC has a net
operating loss of ($1,400x), determined as follows:
Table 4 to Paragraph (k)(2)(i)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
($400x)......................................... ($200x) ($800x)
------------------------------------------------------------------------
(B) For Year 2, USC has the following taxable income and losses:
Table 5 to Paragraph (k)(2)(i)(B)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$500x........................................... ($100x) $1200x
------------------------------------------------------------------------
(ii) Analysis--(A) Net operating loss allocation. Under
paragraph (b) of this section (Step 1), because USC's total taxable
income for Year 2 of $1600x ($1,200x + $500x - $100x) exceeds the
total Year 1 net operating loss, the full $1,400x net operating loss
is carried forward. Under paragraph (b)(2) of this section, each
component of the net operating loss is carried forward and combined
with its same category in Year 2. After allocation of the net
operating loss, USC has the following taxable income and losses:
Table 6 to Paragraph (k)(2)(ii)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$100x........................................... ($300x) $400x
------------------------------------------------------------------------
(B) Loss allocation. Under paragraph (d) of this section (Step
3), $100x of the passive category loss offsets the $100x of foreign
branch category income, resulting in a passive category separate
limitation loss account with respect to foreign branch category
income, and the other $200x of passive category loss offsets $200x
of the U.S. source taxable income, resulting in the creation of an
overall foreign loss account in the passive category.
(3) Example 3--(i) Facts. Assume the same facts as in paragraph
(k)(2)(i) of this section (the facts in Example 2), except that in
Year 2, USC had the following taxable income and losses:
Table 7 to Paragraph (k)(3)(i)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$200x........................................... ($100x) $1200x
------------------------------------------------------------------------
(ii) Analysis--(A) Net operating loss allocation. Under
paragraph (b) of this section (Step 1), because the total net
operating loss for Year 1 of ($1,400x) exceeds total taxable income
for Year 2 of $1,300x ($1,200x + $200x - $100x), USC has a partial
net operating loss carryover to Year 2 of $1,300x. Under paragraph
(b)(3)(i) of this section, first, the $800x U.S. source component of
the net operating loss is allocated to U.S. income for Year 2. The
tentative foreign branch category carryover under paragraph
(b)(3)(ii) of this section ($200x) does not exceed the remaining net
operating loss carryover amount ($500x). Therefore, $200x of the
foreign branch category component of the net operating loss is next
allocated to the foreign branch category income for Year 2. Under
paragraph (b)(3)(iii) of this section, the remaining $300x of net
operating loss carryover ($1300x - $800x - $200x) is carried over
proportionally from the remaining net operating loss components in
the foreign branch category ($200x, or $400x total foreign branch
category loss - $200x foreign branch category loss already
allocated) and passive category ($200x). Therefore, $150x ($300x x
$200x/$400x) of the remaining net operating loss carryover is
carried over from the foreign branch category for Year 1 and
combined with the foreign branch category income for Year 2, and
$150x ($300x x $200x/$400x) of the remaining net operating loss
carryover is carried over from the passive category for Year 1 and
combined with the passive category loss for Year 2. After allocation
of the net operating loss carryover from Year 1 to the appropriate
categories for Year 2, USC has the following taxable income and
losses:
Table 8 to Paragraph (k)(3)(ii)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
($150x)......................................... ($250x) $400x
------------------------------------------------------------------------
(B) Loss allocation. Under paragraph (d) of this section (Step
3), the losses in the foreign branch and passive categories fully
offset the U.S. source income, resulting in the creation of foreign
branch category and passive category overall foreign loss accounts.
(4) Example 4--(i) Facts. Assume the same facts as in paragraph
(k)(2)(i) of this section (the facts in Example 2), except that in
Year 2, USC has the following taxable income and losses:
Table 9 to Paragraph (k)(4)(i)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$200x........................................... $200x ($200x)
------------------------------------------------------------------------
(ii) Analysis--(A) Net operating loss allocation. Under
paragraph (b) of this section (Step 1), because the total net
operating loss of ($1400x) exceeds total taxable income for Year 2
of $200x ($200x + $200x - $200x), USC has a partial net operating
loss carryover to Year 2 of $200x. Because USC has no U.S. source
income in Year 2, under paragraph (b)(3)(i) of this section no
portion of the U.S. source component of the net operating loss is
initially carried into Year 2. Because the total tentative carryover
under paragraph (b)(3)(ii) of this section of $400x ($200x in each
of the foreign branch and passive categories) exceeds the net
operating loss carryover amount, the tentative carryover from each
separate category is reduced proportionately by $100x ($200x x
$200x/$400x). Accordingly, $100x ($200x - $100x) of the foreign
branch category component of the net operating loss is carried
forward and $100x ($200x - $100x) of the passive category component
of the net operating loss is carried forward and combined with
income in the same respective categories for Year 2. After
allocation of the net operating loss carryover from Year 1, USC has
the following taxable income and losses:
Table 10 to Paragraph (k)(4)(ii)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$100x........................................... $100x ($200x)
------------------------------------------------------------------------
(B) Loss allocation. Under paragraph (e) of this section (Step
4), the $200x U.S. source loss offsets the remaining $100x of
foreign branch category income and $100x of passive category income,
resulting in the creation of overall domestic loss accounts with
respect to the foreign branch and passive categories.
[[Page 69104]]
(5) Example 5--(i) Facts. Assume the same facts as in paragraph
(k)(2)(i) of this section (the facts in Example 2), except that in
Year 2, USC has the following taxable income and losses:
Table 11 to Paragraph (k)(5)(i)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$800x........................................... ($100x) $100x
------------------------------------------------------------------------
(ii) Analysis--(A) Net operating loss allocation. Under
paragraph (b) of this section (Step 1), because USC's total net
operating loss in Year 1 of ($1,400x) exceeds its total taxable
income for Year 2 of $800x ($100x + $800x - $100x), USC has a
partial net operating loss carryover to Year 2 of $800x. Under
paragraph (b)(3)(i) of this section, $100x of the U.S. source
component of the net operating loss is allocated to U.S. income for
Year 2. The tentative foreign branch category carryover under
paragraph (b)(3)(ii) of this section does not exceed the remaining
net operating loss carryover amount. Therefore, $400x of the foreign
branch category component of the net operating loss is allocated to
reduce foreign branch category income in Year 2. Under paragraph
(b)(3)(iii) of this section, of the remaining $300x of net operating
loss carryover ($800x - $100x - $400x), $200x is carried forward
from the passive category component of the net operating loss and
combined with the passive category loss for Year 2. Under paragraph
(b)(3)(iv) of this section, the remaining $100x ($300x - $200x) of
net operating loss carryover is carried forward from the U.S. source
component of the net operating loss and combined with the U.S.
source income (and the previously allocated U.S. source component of
the net operating loss) for Year 2. After allocation of the net
operating loss carryover from Year 1, USC has the following taxable
income and losses:
Table 12 to Paragraph (k)(5)(ii)(A)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$400x........................................... ($300x) ($100x)
------------------------------------------------------------------------
(B) Loss allocation--(1) Under paragraph (d) of this section
(Step 3), the $300x passive category loss offsets the $300x of
income in the foreign branch category, resulting in the creation of
a passive category separate limitation loss account with respect to
the foreign branch category.
(2) Under paragraph (e) of this section (Step 4), the $100x U.S.
source loss offsets the remaining $100x of the foreign branch
category income, resulting in the creation of an overall domestic
loss account with respect to the foreign branch category.
(6) Example 6--(i) Facts--(A) USC is a domestic corporation with
foreign branch operations in Country X. USC has no net operating
losses and does not make an election to recapture more than the
required amount of overall foreign losses. As of January 1, Year 1,
USC has a ($200x) foreign branch category overall foreign loss (OFL)
account and a ($200x) foreign branch category separate limitation
loss (SLL) account with respect to the passive category. For Year 1,
USC has $400x of passive category income that is fully offset by a
($400x) domestic loss in that taxable year, giving rise to the
creation of an overall domestic loss (ODL) account with respect to
the passive category. As of January 1, Year 2, USC has the following
balances in its OFL, SLL, and ODL accounts:
Table 13 to Paragraph (k)(6)(i)(A)
------------------------------------------------------------------------
Foreign branch US
------------------------------------------------------------------------
SLL ODL
OFL (passive) (passive)
------------------------------------------------------------------------
$200x........................................... $200x $400x
------------------------------------------------------------------------
(B) In Year 2, USC has the following taxable income and losses:
Table 14 to Paragraph (k)(6)(i)(B)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$400x........................................... ($100x) $600x
------------------------------------------------------------------------
(ii) Analysis--(A) Loss allocation. Under paragraph (d) of this
section (Step 3), the $100x of passive category loss offsets $100x
of the foreign branch category income, creating a passive category
SLL account of $100x with respect to the foreign branch category.
Because there is an offsetting foreign branch category SLL account
of $200x with respect to the passive category from a prior taxable
year, the two accounts are netted against each other so that all
that remains is a $100x foreign branch category SLL account with
respect to the passive category.
(B) OFL account recapture. Under paragraph (f) of this section
(Step 5), 50% of the remaining $300x, or $150x, of income in the
foreign branch category is subject to recharacterization as U.S.
source income as a recapture of part of the OFL account in the
foreign branch category.
(C) SLL account recapture. Under paragraph (g) of this section
(Step 6), $100x of the remaining $150x of income in the foreign
branch category is recharacterized as passive category income as a
recapture of the foreign branch category SLL account with respect to
the passive category.
(D) ODL account recapture. Under paragraph (h) of this section
(Step 7), 50% of the $600, or $300, of U.S. source income is subject
to recharacterization as foreign source passive category income as a
recapture of a part of the ODL account with respect to the passive
category. None of the $150x of foreign branch category income that
was recharacterized as U.S. source income under paragraph (f) of
this section (Step 5) is included here as income subject to
recharacterization in connection with recapture of the ODL account.
(E) Results--(1) After the allocation of loss and recapture of
loss accounts, USC has the following taxable income and losses for
Year 2:
Table 15 to Paragraph (k)(6)(ii)(E)(1)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
$50x............................................ $400x $450x
------------------------------------------------------------------------
(2) As of January 1, Year 3, USC has the following balances in
its OFL, SLL and ODL accounts:
Table 16 to Paragraph (k)(6)(ii)(E)(2)
------------------------------------------------------------------------
Foreign branch Passive US
------------------------------------------------------------------------
SLL
OFL SLL (foreign ODL
(passive) branch) (passive)
------------------------------------------------------------------------
$50x................................ $0 $0 $100x
------------------------------------------------------------------------
(l) Applicability date. This section applies to taxable years
ending on or after December 16, 2019.
Sec. 1.904(i)-1 [Amended]
0
Par. 27. Section 1.904(i)-1 is amended by removing the language ``Sec.
1.904-5(a)(1)'' and adding in its place the language ``Sec. 1.904-
5(a)(4)(v)'' in the first sentence of paragraph (a)(1)(i).
0
Par. 28. Section 1.905-2 is amended by adding a sentence after the
fourth sentence of paragraph (a)(2) to read as follows:
Sec. 1.905-2 Conditions of allowance of credit.
(a) * * *
(2) * * * If the receipt or the return is in a foreign language, a
certified translation thereof must be furnished by the taxpayer. * * *
* * * * *
0
Par. 29. Section 1.905-3 is added to read as follows:
Sec. 1.905-3 Adjustments to U.S. tax liability as a result of a
foreign tax redetermination.
(a) Foreign tax redetermination. The term foreign tax
redetermination means a change in the liability for a foreign income
tax, as defined in Sec. 1.960-1(b)(5), or certain other changes
described in this paragraph (a) that may affect a taxpayer's foreign
tax credit. In the case of a taxpayer that claims the credit in the
year the taxes are paid, a foreign tax redetermination occurs if any
portion of the tax paid is subsequently refunded. In the case of a
taxpayer that claims the credit in the year the taxes accrue, a foreign
tax redetermination occurs if taxes that when paid or later adjusted
differ from amounts accrued by the taxpayer and claimed as a credit or
added to PTEP group taxes (as defined in Sec. 1.960-3(d)(1)). A
foreign tax redetermination
[[Page 69105]]
includes corrections and other adjustments to accrued amounts to
reflect the final foreign tax liability, including additional payments
of tax that accrue after the close of the taxable year to which the tax
relates and, for foreign income taxes taken into account when accrued
but translated into dollars on the date of payment, a payment of
accrued tax if the value of the foreign currency relative to the dollar
has changed between the date or taxable year of accrual and the date of
payment. A foreign tax redetermination occurs if any tax claimed as a
credit or added to PTEP group taxes is refunded in whole or in part,
regardless of whether such tax was paid within the meaning of Sec.
1.901-2(e) at the time the tax was claimed as a credit or added to PTEP
group taxes. A foreign tax redetermination also includes accrued
foreign income taxes that are not paid on or before the date that is 24
months after the close of the taxable year of the section 901 taxpayer
(as defined in Sec. 1.986(a)-1(a)(1)) to which such taxes relate, as
well as a subsequent payment of any such accrued but unpaid taxes. If
accrued foreign income taxes are not paid on or before the date that is
24 months after the close of the taxable year to which they relate, the
resulting foreign tax redetermination is accounted for as if the unpaid
portion of the foreign income taxes were refunded on such date. Foreign
income taxes that first accrue after the date 24 months after the close
of the taxable year to which such taxes relate may not be claimed as a
credit or added to PTEP group taxes until paid. See section 905(b) and
Sec. 1.461-4(g)(6)(iii)(B), which require the taxpayer to establish
the amount of tax that was properly accrued.
(b) Redetermination of U.S. tax liability--(1) Foreign income taxes
other than taxes deemed paid under section 960--(i) In general. This
paragraph (b)(1) applies to foreign income taxes claimed as a credit
under section 901 other than foreign income taxes deemed paid under
section 960. If a foreign tax redetermination occurs with respect to
foreign income tax claimed as a credit under section 901 (other than a
tax deemed paid under section 960), then a redetermination of U.S. tax
liability is required for the taxable year in which the tax was claimed
as a credit and any year to which unused foreign taxes from such year
were carried under section 904(c). In the case of a taxpayer that
claims the credit in the year the taxes are paid, the redetermination
of U.S. tax liability is made by reducing the tax paid in such year by
the amount refunded. In the case of a taxpayer that claims the credit
in the year the taxes accrue, the redetermination of U.S. tax liability
is made by treating the redetermined amount of foreign tax as the
amount of tax that accrued in the year to which the redetermined tax
relates. However, a redetermination of U.S. tax liability is not
required (and a taxpayer need not notify the IRS) if the foreign income
taxes are taken into account when accrued but translated into dollars
on the date of payment, the difference between the dollar value of the
accrued foreign income tax and the dollar value of the foreign income
tax paid is solely attributable to fluctuations in the value of the
foreign currency relative to the dollar between the date or taxable
year of accrual and the date of payment, and the net dollar amount of
the currency fluctuations attributable to the foreign tax
redeterminations with respect to each and every foreign country is less
than the lesser of $10,000 or two percent of the total dollar amount of
the foreign income tax initially accrued with respect to that foreign
country for the taxable year. In such case, if no redetermination of
U.S. tax liability is made, an appropriate adjustment is made to the
taxpayer's U.S. tax liability in the taxable year during which the
foreign tax redeterminations occur.
(ii) Examples. The following examples illustrate the application of
this paragraph (b)(1) and Sec. 1.986(a)-1. In all examples, assume
that USC is a domestic corporation that uses the calendar year as its
taxable year both for Federal income tax purposes and for foreign tax
purposes and that it is doing business through a foreign branch
operating in Country X, which is a qualified business unit (within the
meaning of section 989 and Sec. 1.989(a)-1) (QBU) the functional
currency of which is the ``u.'' Except as otherwise provided, the ``u''
is not an inflationary currency within the meaning of Sec. 1.986(a)-
1(a)(2)(iii). USC is an accrual basis taxpayer.
(A) Example 1: Contested tax--(1) Facts. In Year 1, USC earned
500u of foreign source foreign branch category income through its
foreign branch in Country X and accrued and paid 50u of Country X
foreign income tax on its earnings. The average exchange rate for
Year 1 used to translate the foreign income taxes into dollars was
$1x:1u. See Sec. 1.986(a)-1(a)(1). On its Year 1 income tax return,
USC claimed a foreign tax credit under section 901 of $50x (50u
translated at the average exchange rate for Year 1, that is,
$1x:1u). In Year 4, Country X assessed an additional 20u of tax with
respect to USC's Year 1 earnings. USC did not pay or accrue the
additional 20u of tax and contested the assessment. After exhausting
all effective and practical remedies to reduce, over time, its
liability for foreign tax, USC settled the contest with Country X in
Year 6, paying 10u of additional tax on September 1, Year 6, when
the spot rate was $1.10x:1u.
(2) Analysis. USC's payment in Year 6 of the 10u of additional
tax accrued with respect to Year 1 is a foreign tax redetermination
under paragraph (a) of this section. Under paragraph (b)(1)(i) of
this section, the additional tax is taken into account in Year 1,
the year to which the redetermined tax relates, irrespective of when
the tax is paid. Under Sec. 1.986(a)-1(a)(2)(i), because the tax
was paid more than 24 months after the close of the year to which
the redetermined tax relates, the 10u of tax is translated into
dollars at the spot rate on the date of payment in Year 6 (10u at
$1.10x:1u = $11x). If USC timely notifies the IRS, it may claim an
increased foreign tax credit for Year 1. USC must also make
corresponding adjustments in determining its taxable income and net
unrecognized section 987 gain or loss in Year 1. See Sec. Sec.
1.987-3(c)(2)(v) and 1.987-4(d)(7).
(B) Example 2: Refund of tax improperly claimed as a credit--(1)
Facts. USC holds a note issued by FC, an unrelated foreign
corporation in Country Y. In Year 1, FC owed USC 500u of interest on
the loan. The statutory rate of withholding on interest paid to a
nonresident of Country Y is 20%. On December 1, Year 1, when the
spot rate was $1x:1u, FC withheld and remitted to Country Y 100u of
tax and paid 400u to USC Effective for Year 1, USC elected under
Sec. 1.986(a)-1(a)(2)(iv) to translate its taxes denominated in
nonfunctional currency into dollars at the spot rate on the date the
taxes are paid. Under the United States--Country Y Income Tax Treaty
(Treaty), USC was entitled to a reduced 15% rate of withholding that
would result in a withholding tax of 75u. However, USC improperly
claimed a foreign tax credit under section 901 for 100u = $100x on
its Year 1 Federal income tax return. (See Sec. 1.901-2(e)(2)(i)
and (e)(5), providing that an amount is not tax paid to the extent
it exceeds the taxpayer's liability for tax or is reasonably certain
to be refunded.) In Year 4, USC filed a refund claim with Country Y
for 25u, the difference between the amount actually withheld at the
20% statutory rate of tax and the amount owed by USC at the 15%
Treaty rate. On March 15, Year 6, when the spot rate was $1.10x:1u,
USC received a refund from Country Y of 25u. USC converted the 25u
into dollars on the same day.
(2) Analysis. Notwithstanding that the 25u of refundable tax did
not constitute an amount of tax paid within the meaning of Sec.
1.901-2(e) at the time USC improperly claimed it as a credit, the
25u refund in Year 6 is a foreign tax redetermination under
paragraph (a) of this section. Under paragraph (b)(1)(i) of this
section, USC must redetermine its U.S. tax liability for Year 1, the
taxable year to which the redetermined tax relates. Under Sec.
1.986(a)-1(c), the refund is translated at the exchange rate that
was used to translate such amount when originally claimed as a
credit. Accordingly, if not previously adjusted by USC or the
Internal Revenue Service, USC must file an
[[Page 69106]]
amended return for Year 1, reducing the amount of foreign tax credit
claimed for Year 1 by $25x (25u translated at the spot rate on
December 1, Year 1; that is, $1x:1u). Under Sec. 1.986(a)-1(e)(1),
USC's basis in the 25u is the same dollar value of the refund as
determined under Sec. 1.986(a)-1(c), or $25x. When USC converted
the 25u to $27.50x (translated at the spot rate on March 15, Year 6,
that is, $1.10x:1u), it realized an exchange gain (within the
meaning of Sec. 1.988-1(e)) equal to $2.50x ($27.50x-$25x basis).
(C) Example 3: Change in functional currency--(1) Facts. In Year
1, USC earned 500u of foreign source foreign branch category income
through its foreign branch in Country X and accrued 100u of Country
X foreign income tax on its earnings. The average exchange rate for
Year 1 used to translate the foreign income taxes into dollars was
$1x:1u. See Sec. 1.986(a)-1(a)(1). On its Federal income tax return
for Year 1, USC claimed a foreign tax credit under section 901 of
$100x (100u translated at the average exchange rate for Year 1, that
is, $1x:1u). As of Year 2, the foreign branch changed its functional
currency from the ``u'' to the dollar, and pursuant to Sec. 1.985-
5(d)(2), USC's foreign branch terminated and USC recognized section
987 gain or loss on December 31, Year 1 (the date of change). The
rate of exchange, as determined under Sec. 1.985-5(c), used to
calculate the U.S. dollar basis in the foreign branch's property on
the date of the change was $1.10x:1u, the spot rate on December 31,
Year 1. On June 15, Year 3, when the spot rate was $1.30x:1u, USC's
foreign branch received a refund from Country X of 10u. The foreign
branch converted the 10u into $13x on the same day.
(2) Analysis. The 10u refund in Year 3 is a foreign tax
redetermination under paragraph (a) of this section. Under paragraph
(b)(1)(i) of this section, USC must redetermine its U.S. tax
liability for Year 1, the taxable year to which the redetermined tax
relates. Under Sec. 1.986(a)-1(c), the refund is translated at the
exchange rate that was used to translate such amount when originally
claimed as a credit. Accordingly, USC must file an amended return,
reducing the amount of foreign tax credit claimed for Year 1 by $10x
(10u translated at the average exchange rate for Year 1, that is
$1x:1u). USC must also make corresponding adjustments in determining
its taxable income and net unrecognized section 987 gain or loss in
Year 1. See Sec. Sec. 1.987-3(c)(2)(v) and 1.987-4(d)(8). Because
the foreign branch changed its functional currency to the dollar in
Year 2, the 10u it receives is a refund of nonfunctional currency
tax that is denominated in a currency that was the functional
currency of the foreign branch at the time USC originally claimed a
credit for that foreign income tax. Under Sec. Sec. 1.985-5(d)(2)
and 1.987-4(d), in Year 1 USC must recognize an additional $1x of
section 987 gain (or $1x less of section 987 loss) by reason of the
10u being treated as an asset of the foreign branch at the time of
the foreign branch's termination. Under Sec. 1.986(a)-1(e)(2),
USC's basis in the 10u refund is $11x, which is determined by using
the exchange rate used under Sec. 1.985-5(c) when the foreign
branch changed its functional currency in Year 2 ($1.10x:1u). When
the foreign branch converted the 10u to $13x (translated at the spot
rate on June 15, Year 3, which is $1.30x:1u), it realized an
exchange gain (within the meaning of Sec. 1.988-1(e)) equal to $2x
($13x-$11x (10u translated at $1.10x:1u)).
(D) Example 4: Inflationary currency--(1) Facts. In Year 1, USC
earned 500u of foreign source foreign branch category income through
its foreign branch in Country X and accrued 100u of Country X
foreign income tax on its earnings. The average exchange rate for
Year 1 used to translate the foreign income taxes into dollars was
$1x:1u. See Sec. 1.986(a)-1(a)(1). On its Federal income tax return
for Year 1, USC claimed a foreign tax credit under section 901 of
$100x (100u translated at the average exchange rate for Year 1, that
is, $1x:1u). USC paid the 100u of tax on April 15, Year 3, when the
spot rate was $1x:2u. In Year 3, but not in Year 1, the u was an
inflationary currency within the meaning of Sec. 1.986(a)-
1(a)(2)(iii).
(2) Analysis. Under Sec. 1.986(a)-1(a)(2)(iii), because the u
was an inflationary currency in the year the taxes were paid, USC
must translate the 100u of Year 1 tax into dollars using the spot
rate on the date of payment of the foreign taxes. Under paragraph
(a) of this section, because the translated value of USC's Year 1
taxes when paid, that is, $50x (100u translated at the spot rate on
April 15, Year 3, that is, $1x:2u), differs from the amount claimed
as credits, that is, $100x (100u translated at the average exchange
rate for Year 1, that is, $1x:1u), a foreign tax redetermination has
occurred. Under paragraph (b)(1)(i) of this section, because the
$50x foreign tax redetermination resulting from the currency
fluctuation exceeds 2% of the $100x initially accrued, USC must
redetermine its U.S. tax liability for Year 1, the taxable year to
which the redetermined tax relates. Accordingly, USC must notify the
IRS, reducing the amount of foreign tax credit claimed for Year 1 by
$50x (the excess of the translated value of the Year 1 taxes when
accrued, that is, $100x, over the translated value of the Year 1
taxes when paid, that is, $50x).
(E) Example 5: Two-year rule--(1) Facts. In Year 1, USC earned
500u of foreign source foreign branch category income through its
foreign branch in Country X and accrued 100u of Country X foreign
income tax on its earnings. The average exchange rate used to
translate the foreign income taxes into dollars for Year 1 was
$1x:1u. See Sec. 1.986(a)-1(a)(1). On its Federal income tax return
for Year 1, USC claimed a foreign tax credit under section 901 of
$100x (100u translated at the average exchange rate for Year 1, that
is, $1x:1u). USC did not pay the Year 1 foreign income taxes until
March 15, Year 6, when the spot rate was $0.8x:1u.
(2) Analysis--(i) Result in Year 3. USC's failure to pay the tax
by the end of Year 3 results in a foreign tax redetermination under
paragraph (a) of this section. Because the taxes were not paid on or
before the date 24 months after the close of the taxable year to
which the tax relates, USC must account for the redetermination as
if the unpaid 100u of accrued taxes were refunded on the last day of
Year 3. Under paragraph (b)(1)(i) of this section, USC must
redetermine its U.S. tax liability for Year 1, the taxable year to
which the redetermined tax relates. Under Sec. 1.986(a)-1(c), the
deemed refund is translated at the exchange rate that was used to
translate such amount when originally claimed as a credit.
Accordingly, USC must notify the IRS, reducing the amount of foreign
tax credit claimed for Year 1 by $100x (100u translated at the
average exchange rate for Year 1, that is, $1x:1u). USC must also
make corresponding adjustments in determining its taxable income and
net unrecognized section 987 gain or loss in Year 1. See Sec. Sec.
1.987-3(c)(2)(v) and 1.987-4(d)(8).
(ii) Result in Year 6. USC's payment of the Year 1 tax liability
of 100u on March 15, Year 6, results in a second foreign tax
redetermination under paragraph (a) of this section. Under paragraph
(b)(1)(i) of this section, the additional tax is taken into account
in Year 1, the year to which the redetermined tax relates,
irrespective of when the tax is paid. Under Sec. 1.986(a)-
1(a)(2)(i), because the tax was paid more than 24 months after the
close of the year to which the tax relates, USC must translate the
100u of tax at the spot rate on the date of payment of the foreign
taxes in Year 6. If USC timely notifies the IRS, it may claim an
increased foreign tax credit for Year 1. USC must also make
corresponding adjustments in determining its taxable income and net
unrecognized section 987 gain or loss in Year 1. See Sec. Sec.
1.987-3(c)(2)(v) and 1.987-4(d)(7).
(F) Example 6: Cash basis taxpayer that pays additional foreign
tax--(1) Facts. Individual A, a U.S. citizen resident in Country X,
is a cash basis taxpayer who has not made an election under section
905(a) to claim the foreign tax credit in the year the taxes accrue.
A uses the calendar year as the taxable year for both U.S. and
Country X tax purposes. In Year 2, A pays 100u of foreign income
taxes to Country X with respect to Year 1. The exchange rate used to
translate the foreign income taxes into dollars was $1x:1u, the spot
rate on the date A paid the taxes in Year 2. See section
986(a)(2)(A) and Sec. 1.986(a)-1(b). On A's Year 2 Federal income
tax return, A claims a foreign tax credit under section 901 of
$100x. In Year 4, Country X assesses an additional 20u of tax with
respect to A's Year 1 income. A does not pay the additional 20u of
tax and contests the assessment. After exhausting all effective and
practical remedies to reduce, over time, A's liability for foreign
tax, A settles the contest with Country X in Year 6, paying 10u of
additional tax on September 1, Year 6, when the spot rate is
$1.10x:1u.
(2) Analysis. Because A is a cash basis taxpayer that claims the
foreign tax credit in the year the taxes are paid, A's payment in
Year 6 of 10u of additional tax owed with respect to Year 1 is not a
foreign tax redetermination requiring a redetermination of U.S. tax
liability under paragraph (b)(1) of this section. Rather, A is
eligible to claim the additional tax as a credit in Year 6, the year
in which the tax is paid. Under Sec. 1.986(a)-1(b), the 10u of tax
is translated into dollars at the spot rate on the date of payment
in Year 6 (10u at $1.10x:1u = $11x).
(G) Example 7: Cash basis taxpayer that receives a refund of
foreign tax--(1) Facts.
[[Page 69107]]
The facts are the same as paragraph (b)(1)(ii)(F) of this section
(the facts in Example 6) except that instead of being assessed
additional tax in Year 4, A receives a refund in Year 4 of 10u with
respect to A's Year 1 tax that was claimed as a credit in Year 2.
(2) Analysis. Under paragraphs (a) and (b)(1) of this section, A
must redetermine its U.S. tax liability for Year 2 and any year to
which unused foreign taxes were carried from Year 2. Under Sec.
1.986(a)-1(c), the amount of A's foreign tax credit for Year 2 is
reduced by $10x, the 10u refund translated at the exchange rate used
to translate the tax when claimed as a credit. Under Sec. 1.986(a)-
1(e)(1), A's basis in the 10u is $10x.
(2) and (3) [Reserved]
(c) Foreign income tax imposed on foreign refund. If a
redetermination of foreign income tax for a taxable year or years
results from a refund to the section 901 taxpayer of foreign income
taxes paid to a foreign country or possession of the United States and
the foreign country or possession imposed foreign income tax on such
refund, then, in accordance with section 905(c)(5), the amount of the
refund is considered to be reduced by the amount of any foreign income
tax described in section 901 imposed by the foreign country or
possession of the United States with respect to such refund. In such
case, no other credit under section 901, and no deduction under section
164, is allowed for any taxable year with respect to such tax imposed
on such refund.
(d) Applicability dates. This section applies to foreign tax
redeterminations occurring in taxable years ending on or after December
16, 2019.
Sec. 1.905-3T [Removed]
0
Par. 30. Section 1.905-3T is removed.
Sec. 1.951A-2 [Amended]
0
Par. 31. Section 1.951A-2 is amended by removing the language ``Sec.
1.904-5(a)'' and adding in its place the language ``Sec. 1.904-
5(a)(4)(v)'' in the first sentence of paragraph (c)(3).
Sec. 1.952-1 [Amended]
0
Par. 32. Section 1.952-1 is amended by removing the language ``Sec.
1.904-5(a)(1)'' and adding in its place the language ``Sec. 1.904-
5(a)(4)(v)'' in paragraph (e)(1)(i), the first sentence of paragraph
(e)(5), and the first sentence of paragraph (f)(2)(ii).
0
Par. 33. Section 1.954-1 is amended by:
0
1. Removing the language ``Sec. 1.904-5(a)(1)'' and adding in its
place the language ``Sec. 1.904-5(a)(4)(v)'' in the introductory text
of paragraph (c)(1)(iii)(A).
0
2. In paragraph (d)(3)(i):
0
i. Removing the language ``section 960'' and adding in its place the
language ``section 960(a) and Sec. 1.960-2(b)(1)'' in the first
sentence.
0
ii. Removing the language ``section 960'' and adding in its place the
language ``section 960(a)'' in the second sentence.
0
iii. Removing the last sentence.
0
3. Removing the language ``section 960'' and adding in its place the
language ``section 960(a) and Sec. 1.960-2(b)(1)'' in paragraph
(d)(3)(ii).
0
4. Adding paragraph (d)(3)(iii).
0
5. Removing paragraph (g)(4).
0
6. Adding paragraph (h).
The additions read as follows:
Sec. 1.954-1 Foreign base company income.
* * * * *
(d) * * *
(3) * * *
(iii) Effect of potential and actual changes in taxes paid or
accrued. Except as otherwise provided in this paragraph (d)(3)(iii),
the amount of foreign income taxes paid or accrued with respect to a
net item of income, determined in the manner provided in this paragraph
(d), does not take into account any potential reduction in foreign
income taxes that may occur by reason of a future distribution to
shareholders of all or part of such income. However, to the extent the
foreign income taxes paid or accrued by the controlled foreign
corporation are reasonably certain to be returned by the foreign
jurisdiction imposing such taxes to a shareholder, directly or
indirectly, through any means (including, but not limited to, a refund,
credit, payment, discharge of an obligation, or any other method) on a
subsequent distribution to such shareholder, the foreign income taxes
are not treated as paid or accrued for purposes of this paragraph
(d)(3).
* * * * *
(h) Applicability dates--(1) Paragraph (d)(3) of this section.
Paragraph (d)(3) of this section applies to taxable years of a
controlled foreign corporation ending on or after December 4, 2018.
(2) Paragraph (g) of this section. Paragraph (g) of this section
applies to taxable years of a controlled foreign corporation beginning
on or after July 23, 2002.
0
Par. 34. Section 1.960-1 is revised to read as follows:
Sec. 1.960-1 Overview, definitions, and computational rules for
determining foreign income taxes deemed paid under section 960(a), (b),
and (d).
(a) Overview--(1) Scope of Sec. Sec. 1.960-1 through 1.960-3. This
section and Sec. Sec. 1.960-2 and 1.960-3 provide rules to associate
foreign income taxes of a controlled foreign corporation with the
income that a domestic corporation that is a United States shareholder
of the controlled foreign corporation takes into account in determining
a subpart F inclusion or GILTI inclusion amount of the domestic
corporation, as well as to associate foreign income taxes of a
controlled foreign corporation with distributions of previously taxed
earnings and profits. This section and Sec. Sec. 1.960-2 and 1.960-3
provide the exclusive rules for determining the foreign income taxes
deemed paid by a domestic corporation under section 960. Therefore,
only foreign income taxes of a controlled foreign corporation that are
associated under these rules with a subpart F inclusion or GILTI
inclusion amount of a domestic corporation that is a United States
shareholder of the controlled foreign corporation, or with previously
taxed earnings and profits, are eligible to be deemed paid. This
section provides definitions and computational rules for determining
foreign income taxes deemed paid under section 960(a), (b), and (d).
Section 1.960-2 provides rules for computing the amount of foreign
income taxes deemed paid by a domestic corporation that is a United
States shareholder of a controlled foreign corporation under section
960(a) and (d). Section 1.960-3 provides rules for computing the amount
of foreign income taxes deemed paid by a domestic corporation that is a
United States shareholder of a controlled foreign corporation, or by a
controlled foreign corporation, under section 960(b). This section and
Sec. Sec. 1.960-2 and 1.960-3 also apply for purposes of any provision
that treats a taxpayer as a domestic corporation that is deemed to pay
foreign income taxes or treats a foreign corporation as a controlled
foreign corporation for purposes of section 960. See, for example,
sections 962(a)(2) and 1293(f).
(2) Scope of this section. Paragraph (b) of this section provides
definitions for purposes of this section and Sec. Sec. 1.960-2 and
1.960-3. Paragraph (c) of this section provides computational rules to
coordinate the various calculations under this section and Sec. Sec.
1.960-2 and 1.960-3. Paragraph (d) of this section provides rules for
computing the income in an income group within a section 904 category,
and for associating foreign income taxes with an income group.
Paragraph (e) of this section provides a rule for the treatment of
taxes associated with the residual income group. Paragraph (f) of this
section provides an example illustrating the application of this
section.
[[Page 69108]]
(b) Definitions. The following definitions apply for purposes of
this section and Sec. Sec. 1.960-2 and 1.960-3.
(1) Annual PTEP account. The term annual PTEP account has the
meaning set forth in Sec. 1.960-3(c)(1).
(2) Controlled foreign corporation. The term controlled foreign
corporation means a foreign corporation described in section 957(a).
(3) Current taxable year. The term current taxable year means the
U.S. taxable year of a controlled foreign corporation that is an
inclusion year, or during which the controlled foreign corporation
receives a section 959(b) distribution or makes a section 959(a)
distribution or a section 959(b) distribution.
(4) Current year tax. The term current year tax means a foreign
income tax paid or accrued by a controlled foreign corporation in a
current taxable year (taking into account any adjustments resulting
from a foreign tax redetermination (as defined in Sec. 1.905-3(a)). A
foreign income tax accrues when all the events have occurred that
establish the fact of the liability and the amount of the liability can
be determined with reasonable accuracy. See Sec. Sec. 1.446-
1(c)(1)(ii)(A) and 1.461-4(g)(6)(iii)(B) (economic performance
exception for certain foreign taxes). Withholding taxes described in
section 901(k)(1)(B) that are withheld from a payment accrue when the
payment is made. A foreign income tax calculated on the basis of net
income (or a base in lieu of net income) for a foreign taxable year
accrues on the last day of the foreign taxable year. Accordingly,
current year taxes include foreign withholding taxes that are withheld
from payments made to the controlled foreign corporation during the
current taxable year, and foreign income taxes that accrue in the
controlled foreign corporation's current taxable year in which or with
which its foreign taxable year ends. Additional payments of foreign
income taxes resulting from a redetermination of foreign tax liability,
including contested taxes that accrue when the contest is resolved,
``relate back'' and are considered to accrue as of the end of the
foreign taxable year to which the taxes relate.
(5) Foreign income tax. The term foreign income tax means each
separate levy (as defined in Sec. 1.901-2(d)) that is an income, war
profits, and excess profits tax as defined in Sec. 1.901-2(a), and tax
included in the term income, war profits, and excess profits tax by
reason of section 903 and Sec. 1.903-1(a), that is imposed by a
foreign country or a possession of the United States, including any
such tax that is deemed paid by a controlled foreign corporation under
section 960(b)(2). Income, war profits, and excess profits taxes do not
include amounts excluded from the definition of those taxes under
section 901. See, for example, section 901(f), (g), and (i). Foreign
income tax also does not include taxes paid by a controlled foreign
corporation for which a credit is disallowed at the level of the
controlled foreign corporation. See, for example, sections 245A(e)(3),
901(k)(1), (l), and (m), 909, and 6038(c)(1)(B). Foreign income tax,
however, includes tax that may be deemed paid but for which a credit is
reduced or disallowed at the level of the United States shareholder.
See, for example, sections 901(e), 901(j), 901(k)(2), 908, 965(g), and
6038(c)(1)(A).
(6) Foreign taxable year. The term foreign taxable year has the
meaning set forth in section 7701(a)(23), applied by substituting
``under foreign law'' for the phrase ``under subtitle A.''
(7) Foreign taxable income. The term foreign taxable income means
the base upon which a current year tax is imposed that comprises the
items included in gross income under foreign law and the deductions
allowed under foreign law. In the case of a current year tax that is
imposed with respect to a taxable period, foreign taxable income
includes all of the items taken into account under foreign law with
respect to that period. See paragraph (d)(3)(ii)(A) of this section for
rules for apportioning current year tax to section 904 categories or
income groups on the basis of foreign taxable income.
(8) GILTI inclusion amount. The term GILTI inclusion amount has the
meaning set forth in Sec. 1.951A-1(c)(1) (or, in the case of a member
of a consolidated group, Sec. 1.1502-51(b)).
(9) Gross tested income. The term gross tested income has the
meaning set forth in Sec. 1.951A-2(c)(1).
(10) Inclusion percentage. The term inclusion percentage has the
meaning set forth in Sec. 1.960-2(c)(2).
(11) Inclusion year. The term inclusion year means the U.S. taxable
year of a controlled foreign corporation which ends during or with the
taxable year of a United States shareholder of the controlled foreign
corporation in which the United States shareholder includes an amount
in income under section 951(a)(1) or 951A(a) with respect to the
controlled foreign corporation.
(12) Income group. The term income group means a group of income
described in paragraph (d)(2)(ii) of this section.
(13) Partnership CFC. The term partnership CFC means, with respect
to a U.S. shareholder partnership, a controlled foreign corporation
stock of which is owned (within the meaning of section 958(a)) by the
U.S. shareholder partnership.
(14) Passive category. The term passive category means the separate
category of income described in section 904(d)(1)(C) and Sec. 1.904-
4(b).
(15) Previously taxed earnings and profits. The term previously
taxed earnings and profits means earnings and profits described in
section 959(c)(1) or (2), including earnings and profits described in
section 959(c)(2) by reason of section 951A(f)(1) and Sec. 1.951A-
5(b)(1).
(16) PTEP group. The term PTEP group has the meaning set forth in
Sec. 1.960-3(c)(2).
(17) PTEP group taxes. The term PTEP group taxes has the meaning
set forth in Sec. 1.960-3(d)(1).
(18) Recipient controlled foreign corporation. The term recipient
controlled foreign corporation has the meaning set forth in Sec.
1.960-3(b)(2).
(19) Reclassified previously taxed earnings and profits. The term
reclassified previously taxed earnings and profits has the meaning set
forth in Sec. 1.960-3(c)(4).
(20) Reclassified PTEP group. The term reclassified PTEP group has
the meaning set forth in Sec. 1.960-3(c)(4).
(21) Residual income group. The term residual income group has the
meaning set forth in paragraph (d)(2)(ii)(D) of this section.
(22) Section 904 category. The term section 904 category means a
separate category of income described in Sec. 1.904-5(a)(4)(v).
(23) Section 951A category. The term section 951A category means
the separate category of income described in section 904(d)(1)(A) and
Sec. 1.904-4(g).
(24) Section 959 distribution. The term section 959 distribution
means a section 959(a) distribution or a section 959(b) distribution.
(25) Section 959(a) distribution. The term section 959(a)
distribution means a distribution excluded from the gross income of a
United States shareholder under section 959(a).
(26) Section 959(b) distribution. The term section 959(b)
distribution means a distribution excluded from the gross income of a
controlled foreign corporation for purposes of section 951(a) under
section 959(b).
(27) Section 959(c)(2) PTEP group. The term section 959(c)(2) PTEP
group has the meaning set forth in Sec. 1.960-3(c)(4).
(28) Subpart F inclusion. The term subpart F inclusion has the
meaning set forth in Sec. 1.960-2(b)(1).
(29) Subpart F income. The term subpart F income has the meaning
set forth in section 952 and Sec. 1.952-1(a).
[[Page 69109]]
(30) Subpart F income group. The term subpart F income group has
the meaning set forth in paragraph (d)(2)(ii)(B)(1) of this section.
(31) Tested foreign income taxes. The term tested foreign income
taxes has the meaning set forth in Sec. 1.960-2(c)(3).
(32) Tested income. The term tested income means the amount with
respect to a controlled foreign corporation that is described in
section 951A(c)(2)(A) and Sec. 1.951A-2(b)(1).
(33) Tested income group. The term tested income group has the
meaning set forth in paragraph (d)(2)(ii)(C) of this section.
(34) United States shareholder. The term United States shareholder
has the meaning set forth in section 951(b).
(35) U.S. shareholder partner. The term U.S. shareholder partner
means, with respect to a U.S. shareholder partnership and a partnership
CFC of the U.S. shareholder partnership, a United States person that is
a partner in the U.S. shareholder partnership and that is also a United
States shareholder (as defined in section 951(b)) of the partnership
CFC.
(36) U.S. shareholder partnership. The term U.S. shareholder
partnership means a domestic partnership (within the meaning of section
7701(a)(4)) that is a United States shareholder of one or more
controlled foreign corporations.
(37) U.S. taxable year. The term U.S. taxable year has the same
meaning as that of the term taxable year set forth in section
7701(a)(23).
(c) Computational rules--(1) In general. For purposes of computing
foreign income taxes deemed paid by either a domestic corporation that
is a United States shareholder with respect to a controlled foreign
corporation under Sec. 1.960-2 or Sec. 1.960-3 or by a controlled
foreign corporation under Sec. 1.960-3 for the current taxable year,
the following rules apply in the following order, beginning with the
lowest-tier controlled foreign corporation in a chain with respect to
which the domestic corporation is a United States shareholder:
(i) First, items of gross income of the controlled foreign
corporation for the current taxable year other than a section 959(b)
distribution are assigned to section 904 categories and included in
income groups within those section 904 categories under the rules in
paragraph (d)(2) of this section. The receipt of a section 959(b)
distribution by the controlled foreign corporation is accounted for
under Sec. 1.960-3(c)(3).
(ii) Second, deductions (other than for current year taxes) of the
controlled foreign corporation for the current taxable year are
allocated and apportioned to reduce gross income in the section 904
categories and the income groups within a section 904 category. See
paragraph (d)(3)(i) of this section. Additionally, the functional
currency amounts of current year taxes of the controlled foreign
corporation for the current taxable year are allocated and apportioned
to reduce gross income in the section 904 categories and the income
groups within a section 904 category, and to reduce earnings and
profits in any PTEP groups that were increased as provided in paragraph
(c)(1)(i) of this section. See paragraph (d)(3)(ii) of this section.
For purposes of computing foreign taxes deemed paid, current year taxes
allocated and apportioned to income groups and PTEP groups in the
section 904 categories are translated into U.S. dollars in accordance
with section 986(a). See paragraph (c)(3) of this section.
(iii) Third, current year taxes deemed paid under section 960(a)
and (d) by the domestic corporation with respect to income of the
controlled foreign corporation are computed under the rules of Sec.
1.960-2. In addition, foreign income taxes deemed paid under section
960(b)(2) with respect to the receipt of a section 959(b) distribution
by the controlled foreign corporation are computed under the rules of
Sec. 1.960-3(b).
(iv) Fourth, any previously taxed earnings and profits of the
controlled foreign corporation resulting from subpart F inclusions and
GILTI inclusion amounts with respect to the controlled foreign
corporation's current taxable year are separated from other earnings
and profits of the controlled foreign corporation and added to an
annual PTEP account, and a PTEP group within the PTEP account, under
the rules of Sec. 1.960-3(c).
(v) Fifth, paragraphs (c)(1)(i) through (iv) of this section are
repeated for each next higher-tier controlled foreign corporation in
the chain.
(vi) Sixth, with respect to the highest-tier controlled foreign
corporation in a chain that is owned directly (or indirectly through a
partnership) by the domestic corporation, foreign income taxes that are
deemed paid under section 960(b)(1) in connection with the receipt of a
section 959(a) distribution by the domestic corporation are computed
under the rules of Sec. 1.960-3(b).
(2) Inclusion of current year items. For a current taxable year,
the items of income and deductions (including for taxes), and the U.S.
dollar amounts of current year taxes, that are included in the
computations described in this section and assigned to income groups
and PTEP groups for the taxable year are the items that the controlled
foreign corporation accrues and takes into account during the current
taxable year.
(3) Functional currency and translation. The computations described
in this paragraph (c) that relate to income and earnings and profits
are made in the functional currency of the controlled foreign
corporation (as determined under section 985), and references to taxes
deemed paid are to U.S. dollar amounts (translated in accordance with
section 986(a)).
(d) Computing income in a section 904 category and an income group
within a section 904 category--(1) Scope. This paragraph (d) provides
rules for assigning gross income (including gains) of a controlled
foreign corporation for the current taxable year to a section 904
category and income group within a section 904 category, and for
allocating and apportioning deductions (including losses and current
year taxes) and the U.S. dollar amount of current year taxes of the
controlled foreign corporation for the current taxable year among the
section 904 categories, income groups within a section 904 category,
and PTEP groups. For rules regarding maintenance of previously taxed
earnings and profits in an annual PTEP account, and assignment of those
previously taxed earnings and profits to PTEP groups, see Sec. 1.960-
3.
(2) Assignment of gross income to section 904 categories and income
groups within a category--(i) Assigning items of gross income to
section 904 categories. Items of gross income of the controlled foreign
corporation for the current taxable year are first assigned to a
section 904 category of the controlled foreign corporation under
Sec. Sec. 1.904-4 and 1.904-5, and under Sec. 1.960-3(c)(1) in the
case of gross income relating to a section 959(b) distribution received
by the controlled foreign corporation. Income of a controlled foreign
corporation, other than gross income relating to a section 959(b)
distribution, cannot be assigned to the section 951A category. See
Sec. 1.904-4(g).
(ii) Grouping gross income within a section 904 category--(A) In
general. Gross income within a section 904 category is assigned to an
income group under the rules of this paragraph (d)(2)(ii), or to a PTEP
group under the rules of Sec. 1.960-3(c)(3). Gross income other than a
section 959(b) distribution is assigned to a subpart F income group,
tested income group, or residual income group.
(B) Subpart F income groups--(1) In general. The term subpart F
income group means an income group within a
[[Page 69110]]
section 904 category that consists of income that is described in
paragraph (d)(2)(ii)(B)(2) of this section. Gross income that is
treated as a single item of income under Sec. 1.954-1(c)(1)(iii) is in
a separate subpart F income group under paragraph (d)(2)(ii)(B)(2)(i)
of this section. Items of gross income that give rise to income
described in paragraph (d)(2)(ii)(B)(2)(ii) of this section are
aggregated and treated as gross income in a separate subpart F income
group. Similarly, items of gross income that give rise to income
described in each one of paragraphs (d)(2)(ii)(B)(2)(iii) through (v)
of this section are aggregated and treated as gross income in a
separate subpart F income group.
(2) Income in subpart F income groups. The income included in
subpart F income groups is:
(i) Items of foreign base company income treated as a single item
of income under Sec. 1.954-1(c)(1)(iii);
(ii) Insurance income described in section 952(a)(1);
(iii) Income subject to the international boycott factor described
in section 952(a)(3);
(iv) Income from certain bribes, kickbacks and other payments
described in section 952(a)(4); and
(v) Income subject to section 901(j) described in section
952(a)(5).
(C) Tested income groups. The term tested income group means an
income group that consists of tested income within a section 904
category. Items of gross tested income in each section 904 category are
aggregated and treated as gross income in a separate tested income
group.
(D) Residual income group. The term residual income group means the
income group within a section 904 category that consists of income that
is not in a subpart F income group, tested income group, or PTEP group.
(E) Examples. The following examples illustrate the application of
this paragraph (d)(2)(ii).
(1) Example 1: Subpart F income groups--(i) Facts. CFC, a
controlled foreign corporation, is incorporated in Country X. CFC
uses the ``u'' as its functional currency. At all relevant times, 1u
= $1x. CFC earns from sources outside of Country X portfolio
dividend income of 100,000u, portfolio interest income of
1,500,000u, and 70,000u of royalty income that is not derived from
the active conduct of a trade or business. CFC also earns 50,000u
from the sale of personal property to a related person for use
outside of Country X that gives rise to foreign base company sales
income under section 954(d). Finally, CFC earns 45,000u for
performing consulting services outside of Country X for related
persons that gives rise to foreign base company services income
under section 954(e). None of the income is taxed by Country X. The
dividend income is subject to a 15 percent third-country withholding
tax after application of the applicable income tax treaty. The
interest income and the royalty income are subject to no third-
country withholding tax. CFC incurs no expenses.
(ii) Analysis. Under paragraph (d)(2)(i) of this section and
Sec. 1.904-4, the interest income, dividend income, and royalty
income are passive category income and the sales and consulting
income are general category income. Under paragraph (d)(2)(ii)(B) of
this section, CFC has a separate subpart F income group within the
passive category with respect to the 100,000u of dividend income,
which is foreign personal holding company income described in Sec.
1.954-1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties
and annuities) that falls within a single group of income under
Sec. 1.904-4(c)(3)(i) for passive income that is subject to
withholding tax of fifteen percent or greater. CFC also has a
separate subpart F income group within the passive category with
respect to the 1,500,000u of interest income and the 70,000u of
royalty income (in total 1,570,000u) which together are foreign
personal holding company income described in Sec. 1.954-
1(c)(1)(iii)(A)(1)(i) (dividends, interest, rents, royalties and
annuities) that falls within a single group of income under Sec.
1.904-4(c)(3)(iii) for passive income that is subject to no
withholding tax or other foreign tax. With respect to its 50,000u of
sales income, CFC has a separate subpart F income group with respect
to foreign base company sales income described in Sec. 1.954-
1(c)(1)(iii)(A)(2)(i) within the general category. With respect to
its 45,000u of services income, CFC has a separate subpart F income
group with respect to foreign base company services income described
in Sec. 1.954-1(c)(1)(iii)(A)(2)(ii) within the general category.
(2) Example 2: Tested income groups--(i) Facts. CFC, a
controlled foreign corporation, is incorporated in Country X. CFC
uses the ``u'' as its functional currency. At all relevant times, 1u
= $1x. CFC earns 500u from the sale of goods to unrelated parties.
CFC also earns 75u for performing consulting services for unrelated
parties. All of its income is gross tested income. CFC incurs no
deductions.
(ii) Analysis. Under paragraph (d)(2)(i) of this section and
section 904 and Sec. 1.904-4, the sales income and services income
are both general category income. Under paragraph (d)(2)(ii)(C) of
this section, with respect to the 500u of sales income and 75u
services income (in total 575u), CFC has one tested income group
within the general category.
(3) Allocation and apportionment of deductions among section 904
categories, income groups within a section 904 category, and certain
PTEP groups--(i) In general. Gross income of the controlled foreign
corporation in each income group within each section 904 category is
reduced by deductions (including losses) of the controlled foreign
corporation for the current taxable year under the rules in this
paragraph (d)(3)(i). No deductions of the controlled foreign
corporation for the current taxable year other than a deduction for
current year taxes imposed solely by reason of the receipt of a section
959(b) distribution are allocated or apportioned to reduce earnings and
profits in a PTEP group.
(A) First, the rules of sections 861 through 865 and 904(d) (taking
into account the rules of section 954(b)(5) and Sec. 1.954-1(c), and
section 951A(c)(2)(A)(ii) and Sec. 1.951A-2(c)(3), as appropriate)
apply to allocate and apportion to reduce gross income (or create a
loss) in each section 904 category and income group within a section
904 category any deductions of the controlled foreign corporation that
are definitely related to less than all of the controlled foreign
corporation's gross income as a class. See paragraph (d)(3)(ii) of this
section for special rules for allocating and apportioning current year
taxes to section 904 categories, income groups, and PTEP groups.
(B) Second, related person interest expense is allocated to and
apportioned among the subpart F income groups within the passive
category under the principles of Sec. Sec. 1.904-5(c)(2) and 1.954-
1(c)(1)(i).
(C) Third, any remaining deductions are allocated and apportioned
to reduce gross income (or create a loss) in the section 904 categories
and income groups within each section 904 category under the rules
referenced in paragraph (d)(3)(i)(A) of this section.
(ii) Allocation and apportionment of a current year tax--(A) In
general. A current year tax is allocated and apportioned among the
section 904 categories under the rules of Sec. 1.904-6(a)(1) based on
the portion of the foreign taxable income (as characterized under
Federal income tax principles) that is assigned to a particular section
904 category. An amount of the current year tax that is allocated and
apportioned to a section 904 category is then allocated and apportioned
among the income groups within the section 904 category under the
principles of Sec. 1.904-6(a)(1) based on the portion of the foreign
taxable income (as characterized under Federal income tax principles)
that is assigned to a particular income group. Therefore, the portion
of a current year tax that is attributable to a timing difference
described in Sec. 1.904-6(a)(1)(iv) is treated as related to the
section 904 category and income group within a section 904 category to
which the tax would be assigned if the foreign taxable income on which
the tax is imposed was recognized under Federal income tax principles
in the year in which the tax is paid or accrued. For purposes of
[[Page 69111]]
determining foreign income taxes deemed paid under the rules in
Sec. Sec. 1.960-2 and 1.960-3, the U.S. dollar amount of a current
year tax is assigned to the section 904 categories, income groups, and
PTEP groups (to the extent provided in paragraph (d)(3)(ii)(C) of this
section) to which the current year tax is allocated and apportioned.
(B) Foreign taxable income that includes a base difference. For
purposes of allocating and apportioning a current year tax among the
income groups within a section 904 category under the rules of this
paragraph (d)(3)(ii), the portion of the foreign taxable income that
constitutes a base difference described in Sec. 1.904-6(a)(1)(iv) is
assigned to a residual income group. An amount of current year tax that
is imposed on such portion of the foreign taxable income is therefore
allocated and apportioned to the residual income group within a section
904 category.
(C) Foreign taxable income that includes previously taxed earnings
and profits. For purposes of allocating and apportioning a current year
tax under this paragraph (d)(3)(ii), a PTEP group that is increased
under Sec. 1.960-3(c)(3) as a result of the receipt of a section
959(b) distribution in the current taxable year of the controlled
foreign corporation is treated as an income group within the section
904 category. In such case, under the principles of Sec. 1.904-
6(a)(1), the portion of the foreign taxable income that is
characterized under Federal income tax principles as a distribution of
previously taxed earnings and profits that results in the increase in
the PTEP group in the current taxable year is assigned to that PTEP
group. If a PTEP group is not treated as an income group under the
first sentence of this paragraph (d)(3)(ii)(C), and the principles of
Sec. 1.904-6(a)(1) would otherwise apply to assign foreign taxable
income to a PTEP group, that foreign taxable income is instead assigned
to the income group to which the income that gave rise to the
previously taxed earnings and profits would be assigned if the income
were recognized by the recipient controlled foreign corporation under
Federal income tax principles in the current taxable year. For example,
a net basis tax imposed on a controlled foreign corporation's receipt
of a section 959(b) distribution by the corporation's country of
residence is allocated or apportioned to a PTEP group. Similarly, a
withholding tax imposed with respect to a controlled foreign
corporation's receipt of a section 959(b) distribution is allocated and
apportioned to a PTEP group. In contrast, a withholding tax imposed on
a disregarded payment from a disregarded entity to its controlled
foreign corporation owner is never treated as related to a PTEP group,
even if all of the controlled foreign corporation's earnings are
previously taxed earnings and profits, because the payment that gives
rise to the foreign taxable income from which the tax was withheld does
not constitute a section 959(b) distribution in the current taxable
year. That foreign taxable income, however, may be assigned to a
subpart F income group or tested income group under paragraph
(d)(3)(ii)(A) of this section (applying the principles of Sec. 1.904-
6(a)(1)(iv)).
(e) No deemed paid credit for current year taxes related to
residual income group. Current year taxes paid or accrued by a
controlled foreign corporation that are allocated and apportioned under
paragraph (d)(3)(ii) of this section to a residual income group cannot
be deemed paid under section 960 for any taxable year.
(f) Example. The following example illustrates the application of
this section and Sec. 1.960-3.
(1) Facts--(i) Income of CFC1 and CFC2. CFC1, a controlled
foreign corporation, conducts business in Country X. CFC1 uses the
``u'' as its functional currency. At all relevant times, 1u=$1x.
CFC1 owns all of the stock of CFC2, a controlled foreign
corporation. CFC1 and CFC2 both use the calendar year as their U.S.
and foreign taxable years. In 2019, CFC1 earns 2,000,000u of gross
income that is foreign oil and gas extraction income, within the
meaning of section 907(c)(1), and 2,000,000u of interest income from
unrelated persons, for both U.S. and Country X tax law purposes.
Country X exempts interest income from tax. In 2019, CFC1 also
receives a section 959(b) distribution from CFC2 of 4,000,000u of
previously taxed earnings and profits attributable to an inclusion
under section 965(a) for CFC2's 2017 U.S. taxable year. The
inclusion under section 965(a) was income in the general category.
There are no PTEP group taxes associated with the previously taxed
earnings and profits distributed by CFC2 at the level of CFC2. The
section 959(b) distribution is treated as a dividend taxable to CFC1
under Country X law. In 2019, CFC2 earns no gross income and
receives no distributions.
(ii) Pre-tax deductions of CFC1 and CFC2. For both U.S. and
Country X tax purposes, in 2019, CFC1 incurs 1,500,000u of
deductible expenses other than current year taxes that are allocable
to all gross income. For U.S. tax purposes, under Sec. Sec. 1.861-8
through 1.861-14T, 750,000u of such deductions are apportioned to
each of CFC1's foreign oil and gas extraction income and interest
income. Under Country X law, 1,000,000u of deductions are allocated
and apportioned to the 4,000,000u treated as a dividend, and
500,000u of deductions are allocated and apportioned to the
2,000,000u of foreign oil and gas extraction income. Under Country X
law, no deductions are allocable to the interest income. Country X
imposes tax of 900,000u on a base of 4,500,000u (6,000,000u gross
income-1,500,000u deductions) consisting of 3,000,000u (4,000,000u-
1,000,000u) attributable to CFC1's section 959(b) distribution and
1,500,000u (2,000,000u-500,000u) attributable to CFC1's foreign oil
and gas extraction income. In 2019, CFC2 has no expenses (including
current year taxes).
(iii) United States shareholders of CFC1. All of the stock of
CFC1 is owned (within the meaning of section 958(a)) by corporate
United States shareholders that use the calendar year as their U.S.
taxable year. In 2019, the United States shareholders of CFC1
include in gross income subpart F inclusions in the passive category
totaling $1,250,000x with respect to 1,250,000u of subpart F income
of CFC1.
(2) Analysis--(i) CFC2. Under paragraph (c)(1) of this section,
the computational rules of paragraph (c)(1) of this section are
applied beginning with CFC2. However, CFC2 has no gross income or
expenses in 2019 (the ``current taxable year''). Accordingly, the
computational rules described in paragraphs (c)(1)(i) through (iv)
of this section are not relevant with respect to CFC2. Under
paragraph (c)(1)(v) of this section, the rules in paragraph
(c)(1)(i) through (iv) of this section are then applied to CFC1.
(ii) CFC1--(A) Step 1. Under paragraph (c)(1)(i) of this
section, CFC1's items of gross income for the current taxable year
are assigned to section 904 categories and included in income groups
within those section 904 categories. In addition, CFC1's receipt of
a section 959(b) distribution is assigned to a PTEP group. Under
paragraph (d)(2)(i) of this section and Sec. 1.904-4, the interest
income is passive category income and the foreign oil and gas
extraction income is general category income. Under paragraph
(d)(2)(ii) of this section, the 2,000,000u of interest income is
assigned to a subpart F income group (the ``subpart F income
group'') within the passive category because it is foreign personal
holding company income described in Sec. 1.954-
1(c)(1)(iii)(A)(1)(i) that falls within a single group of income
under Sec. 1.904-4(c)(3)(iii) for passive income that is subject to
no withholding tax or other foreign tax. The 2,000,000u of foreign
oil and gas extraction income is assigned to the residual income
group within the general category. Under Sec. 1.960-3(c), the
4,000,000u section 959(b) distribution is assigned to the PTEP group
described in Sec. 1.960-3(c)(2)(vii) within the 2017 annual PTEP
account (the ``PTEP group'') within the general category.
(B) Step 2--(1) Allocation and apportionment of deductions for
expenses other than taxes. Under paragraph (c)(1)(ii) of this
section, CFC1's deductions for the current taxable year are
allocated and apportioned among the section 904 categories, income
groups within a section 904 category, and any PTEP groups that were
increased as provided in paragraph (c)(1)(i) of this section. Under
paragraph (d)(3)(i) of this section and Sec. Sec. 1.861-8 through
1.861-14T, 750,000u of deductions are allocated and
[[Page 69112]]
apportioned to the residual income group within the general
category, and 750,000u of deductions are allocated and apportioned
to the subpart F income group within the passive category.
Therefore, CFC1 has 1,250,000u (2,000,000u-750,000u) of pre-tax
income attributable to the residual income group within the general
category and 1,250,000u (2,000,000u-750,000u) of pre-tax income
attributable to the subpart F income group within the passive
category. For U.S. tax purposes, no deductions other than current
year taxes are allocated and apportioned to the 4,000,000u in CFC1's
PTEP group.
(2) Allocation and apportionment of current year taxes. Under
paragraph (c)(1)(ii) of this section, CFC1's current year taxes are
allocated and apportioned among the section 904 categories, income
groups within a section 904 category, and any PTEP groups that were
increased as provided in paragraph (c)(1)(i) of this section. Under
paragraphs (d)(3)(i) and (ii) of this section, for purposes of
allocating and apportioning taxes to reduce the income in a section
904 category, an income group, or PTEP group, Sec. 1.904-6(a)(1)
and (ii) are applied to determine the amount of foreign taxable
income, computed under Country X law but characterized under Federal
income tax law, in each section 904 category, income group, and PTEP
group that is included in the Country X tax base. For Country X
purposes, 1,000,000u of deductions are apportioned to CFC1's PTEP
group within the general category, 500,000u of deductions are
apportioned to the residual income group within the general
category, and no deductions are apportioned to the subpart F income
group in the passive category. Therefore, for Country X purposes,
CFC1 has 3,000,000u of foreign taxable income attributable to the
PTEP group within the general category, 1,500,000u of foreign
taxable income attributable to the residual income group within the
general category, and no income attributable to the subpart F income
group within the passive category. Under paragraph (d)(3)(ii) of
this section, 600,000u (3,000,000u/4,500,000u x 900,000u) of the
900,000u current year taxes paid by CFC1 are related to the PTEP
group within the general category, and 300,000u (1,500,000u/
4,500,000u x 900,000u) are related to the residual income group
within the general category. No current year taxes are allocated or
apportioned to the subpart F income group within the passive
category because the interest expense is exempt from Country X tax.
Thus, for U.S. tax purposes, CFC1 has 3,400,000u of previously taxed
earnings and profits (4,000,000u-600,000u) in the PTEP group within
the general category, 1,250,000u of income in the subpart F income
group within the passive category, and 950,000u of income
(1,250,000u-300,000u) in the residual income group within the
general category. For purposes of determining foreign taxes deemed
paid under section 960, CFC1 has $600,000x of foreign income taxes
in the PTEP group within the general category and $300,000x of
current year taxes in the residual income group within the general
category. Under paragraph (e) of this section, the United States
shareholders of CFC1 cannot claim a credit with respect to the
$300,000x of taxes on CFC1's income in the residual income group.
(C) Step 3. Under paragraph (c)(1)(iii) of this section, the
United States shareholders of CFC1 compute current year taxes deemed
paid under section 960(a) and (d) and the rules of Sec. 1.960-2.
None of the Country X tax is allocated to CFC1's subpart F income
group. Therefore, there are no current year taxes deemed paid by
CFC1's United States shareholders with respect to their passive
category subpart F inclusions. See Sec. 1.960-2(b)(5) and (c)(7)
for examples of the application of section 960(a) and (d) and the
rules in Sec. 1.960-2. Additionally, under paragraph (c)(1)(iii) of
this section, foreign income taxes deemed paid under section
960(b)(2) by CFC1 are determined with respect to the section 959(b)
distribution from CFC2 under the rules of Sec. 1.960-3. There are
no PTEP group taxes associated with the previously taxed earnings
and profits distributed by CFC2 in the hands of CFC2. Therefore,
there are no foreign income taxes deemed paid by CFC1 under section
960(b)(2) with respect to the section 959(b) distribution from CFC2.
See Sec. 1.960-3(e) for examples of the application of section
960(b) and the rules in Sec. 1.960-3.
(D) Step 4. Under paragraph (c)(1)(iv) of this section,
previously taxed earnings and profits resulting from subpart F
inclusions and GILTI inclusion amounts with respect to CFC1's
current taxable year are separated from CFC1's other earnings and
profits and added to an annual PTEP account and PTEP group within
the PTEP account, under the rules of Sec. 1.960-3(c). The United
States shareholders of CFC1 include in gross income subpart F
inclusions totaling $1,250,000x with respect to 1,250,000u of
subpart F income of CFC1, and the subpart F inclusions are passive
category income. Therefore, under Sec. 1.960-3(c)(2), 1,250,000u of
previously taxed earnings and profits resulting from the subpart F
inclusions is added to CFC1's section 951(a)(1)(A) PTEP within the
2019 annual PTEP account within the passive category.
(E) Step 5. Paragraph (c)(1)(v) of this section does not apply
because CFC1 is the highest-tier controlled foreign corporation in
the chain.
(F) Step 6. Paragraph (c)(1)(vi) of this section does not apply
because CFC1 did not make a section 959(a) distribution.
0
Par. 35. Section 1.960-2 is revised to read as follows:
Sec. 1.960-2 Foreign income taxes deemed paid under sections 960(a)
and (d).
(a) Scope. Paragraph (b) of this section provides rules for
computing the amount of foreign income taxes deemed paid by a domestic
corporation that is a United States shareholder of a controlled foreign
corporation under section 960(a). Paragraph (c) of this section
provides rules for computing the amount of foreign income taxes deemed
paid by a domestic corporation that is a United States shareholder of a
controlled foreign corporation under section 960(d).
(b) Foreign income taxes deemed paid under section 960(a)--(1) In
general. If a domestic corporation that is a United States shareholder
of a controlled foreign corporation includes in gross income under
section 951(a)(1)(A) its pro rata share of the subpart F income of the
controlled foreign corporation (a subpart F inclusion), the domestic
corporation is deemed to have paid the amount of the controlled foreign
corporation's foreign income taxes that are properly attributable to
the items of income in a subpart F income group of the controlled
foreign corporation that give rise to the subpart F inclusion of the
domestic corporation that is attributable to the subpart F income
group. For each section 904 category, the domestic corporation is
deemed to have paid foreign income taxes equal to the sum of the
controlled foreign corporation's foreign income taxes that are properly
attributable to the items of income in the subpart F income groups to
which the subpart F inclusion is attributable. See Sec. 1.904-6(b)(1)
for rules on assigning the foreign income tax to a section 904
category. No foreign income taxes are deemed paid under section 960(a)
with respect to an inclusion under section 951(a)(1)(B).
(2) Properly attributable. The amount of the controlled foreign
corporation's foreign income taxes that are properly attributable to
the items of income in the subpart F income group of the controlled
foreign corporation to which a subpart F inclusion is attributable
equals the domestic corporation's proportionate share of the current
year taxes of the controlled foreign corporation that are allocated and
apportioned under Sec. 1.960-1(d)(3)(ii) to the subpart F income
group. No other foreign income taxes are considered properly
attributable to an item of income of the controlled foreign
corporation.
(3) Proportionate share--(i) In general. A domestic corporation's
proportionate share of the current year taxes of a controlled foreign
corporation that are allocated and apportioned under Sec. 1.960-
1(d)(3)(ii) to a subpart F income group within a section 904 category
of the controlled foreign corporation is equal to the total U.S. dollar
amount of current year taxes that are allocated and apportioned under
Sec. 1.960-1(d)(3)(ii) to the subpart F income group multiplied by a
fraction (not to exceed one), the numerator of which is the portion of
the domestic corporation's subpart F inclusion that is attributable to
the subpart F income group and the denominator of which is the total
net income in the subpart F income group, both determined in the
[[Page 69113]]
functional currency of the controlled foreign corporation. If the
numerator or denominator of the fraction is zero or less than zero,
then the proportionate share of the current year taxes that are
allocated and apportioned under Sec. 1.960-1(d)(3)(ii) to the subpart
F income group is zero.
(ii) Effect of qualified deficits. Neither an accumulated deficit
nor any prior year deficit in the earnings and profits of a controlled
foreign corporation reduces its net income in a subpart F income group.
Accordingly, any such deficit does not affect the denominator of the
fraction described in paragraph (b)(3)(i) of this section. However, the
first sentence of this paragraph (b)(3)(ii) does not affect the
application of section 952(c)(1)(B) for purposes of determining the
domestic corporation's subpart F inclusion. Any reduction to the
domestic corporation's subpart F inclusion under section 952(c)(1)(B)
is reflected in the numerator of the fraction described in paragraph
(b)(3)(i) of this section.
(iii) Effect of current year E&P limitation or chain deficit. To
the extent that an amount of income in a subpart F income group is
excluded from the subpart F income of the controlled foreign
corporation under section 952(c)(1)(A) or (C), the net income in the
subpart F income group that is the denominator of the fraction
described in paragraph (b)(3)(i) of this section is reduced (but not
below zero) by the amount excluded. The domestic corporation's subpart
F inclusion that is the numerator of the fraction described in
paragraph (b)(3)(i) of this section is based on the controlled foreign
corporation's subpart F income computed with the application of section
952(c)(1)(A) and (C).
(4) Domestic partnerships. For purposes of applying this paragraph
(b), in the case of a domestic partnership that is a U.S. shareholder
partnership with respect to a partnership CFC, the distributive share
of a U.S. shareholder partner of the U.S. shareholder partnership's
subpart F inclusion with respect to the partnership CFC is treated as a
subpart F inclusion of the U.S. shareholder partner with respect to the
partnership CFC.
(5) Example. The following example illustrates the application of
this paragraph (b).
(i) Facts. USP, a domestic corporation, owns 80% of the stock of
CFC, a controlled foreign corporation. The remaining portion of the
stock of CFC is owned by an unrelated person. USP and CFC both use
the calendar year as their U.S. taxable year, and CFC also uses the
calendar year as its foreign taxable year. CFC uses the ``u'' as its
functional currency. At all relevant times, 1u=$1x. For its U.S.
taxable year ending December 31, 2018, after the application of the
rules in Sec. 1.960-1(d) the income of CFC after foreign taxes is
assigned to the following income groups: 1,000,000u of dividend
income in a subpart F income group within the passive category
(``subpart F income group 1''); 2,400,000u of gain from commodities
transactions in a subpart F income group within the passive category
(``subpart F income group 2''); and 1,800,000u of foreign base
company services income in a subpart F income group within the
general category (``subpart F income group 3''). CFC has current
year taxes, translated into U.S. dollars, of $740,000x that are
allocated and apportioned as follows: $50,000x to subpart F income
group 1; $240,000x to subpart F income group 2; and $450,000x to
subpart F income group 3. USP has a subpart F inclusion with respect
to CFC of 4,160,000u = $4,160,000x, of which 800,000u is
attributable to subpart F income group 1, 1,920,000u to subpart F
income group 2, and 1,440,000u to subpart F income group 3.
(ii) Analysis--(A) Passive category. Under paragraphs (b)(2) and
(3) of this section, the amount of CFC's current year taxes that are
properly attributable to items of income in subpart F income group 1
to which a subpart F inclusion is attributable equals USP's
proportionate share of the current year taxes that are allocated and
apportioned under Sec. 1.960-1(d)(3)(ii) to subpart F income group
1, which is $40,000x ($50,000x x 800,000u/1,000,000u). Under
paragraphs (b)(2) and (3) of this section, the amount of CFC's
current year taxes that are properly attributable to items of income
in subpart F income group 2 to which a subpart F inclusion is
attributable equals USP's proportionate share of the current year
taxes that are allocated and apportioned under Sec. 1.960-
1(d)(3)(ii) to subpart F income group 2, which is $192,000x
($240,000x x 1,920,000u/2,400,000u). Accordingly, under paragraph
(b)(1) of this section, USP is deemed to have paid $232,000x
($40,000x + $192,000x) of passive category foreign income taxes of
CFC with respect to its $2,720,000x subpart F inclusion in the
passive category.
(B) General category. Under paragraphs (b)(2) and (3) of this
section, the amount of CFC's current year taxes that are properly
attributable items of income in subpart F income group 3 to which a
subpart F inclusion is attributable equals USP's proportionate share
of the foreign income taxes that are allocated and apportioned under
Sec. 1.960-1(d)(3)(ii) to subpart F income group 3, which is
$360,000x ($450,000x x 1,440,000u/1,800,000u). CFC has no other
subpart F income groups within the general category. Accordingly,
under paragraph (b)(1) of this section, USP is deemed to have paid
$360,000x of general category foreign income taxes of CFC with
respect to its $1,440,000x subpart F inclusion in the general
category.
(c) Foreign income taxes deemed paid under section 960(d)--(1) In
general. If a domestic corporation that is a United States shareholder
of one or more controlled foreign corporations includes an amount in
gross income under section 951A(a) and Sec. 1.951A-1(b), the domestic
corporation is deemed to have paid an amount of foreign income taxes
equal to 80 percent of the product of its inclusion percentage
multiplied by the sum of all tested foreign income taxes in the tested
income group within each section 904 category of the controlled foreign
corporation or corporations.
(2) Inclusion percentage. The term inclusion percentage means, with
respect to a domestic corporation that is a United States shareholder
of one or more controlled foreign corporations, the domestic
corporation's GILTI inclusion amount divided by the aggregate amount
described in section 951A(c)(1)(A) and Sec. 1.951A-1(c)(2)(i) with
respect to the United States shareholder.
(3) Tested foreign income taxes. The term tested foreign income
taxes means, with respect to a domestic corporation that is a United
States shareholder of a controlled foreign corporation, the amount of
the controlled foreign corporation's foreign income taxes that are
properly attributable to tested income taken into account by the
domestic corporation under section 951A and Sec. 1.951A-1.
(4) Properly attributable. The amount of the controlled foreign
corporation's foreign income taxes that are properly attributable to
tested income taken into account by the domestic corporation under
section 951A(a) and Sec. 1.951A-1(b) equals the domestic corporation's
proportionate share of the current year taxes of the controlled foreign
corporation that are allocated and apportioned under Sec. 1.960-
1(d)(3)(ii) to the tested income group within each section 904 category
of the controlled foreign corporation. No other foreign income taxes
are considered properly attributable to tested income.
(5) Proportionate share. A domestic corporation's proportionate
share of current year taxes of a controlled foreign corporation that
are allocated and apportioned under Sec. 1.960-1(d)(3)(ii) to a tested
income group within a section 904 category of the controlled foreign
corporation is the U.S. dollar amount of current year taxes that are
allocated and apportioned under Sec. 1.960-1(d)(3)(ii) to a tested
income group within a section 904 category of the controlled foreign
corporation multiplied by a fraction (not to exceed one), the numerator
of which is the portion of the tested income of the controlled foreign
corporation in the tested income group within the section 904 category
that is included in computing the domestic corporation's aggregate
amount described in section 951A(c)(1)(A) and Sec. 1.951A-1(c)(2)(i),
and the denominator of which is the
[[Page 69114]]
income in the tested income group within the section 904 category, both
determined in the functional currency of the controlled foreign
corporation. If the numerator or denominator of the fraction is zero or
less than zero, the domestic corporation's proportionate share of the
current year taxes allocated and apportioned under Sec. 1.960-
1(d)(3)(ii) to the tested income group is zero.
(6) Domestic partnerships. See Sec. 1.951A-1(e) for rules
regarding the determination of the GILTI inclusion amount of a U.S.
shareholder partner.
(7) Examples. The following examples illustrate the application of
this paragraph (c).
(i) Example 1: Directly owned controlled foreign corporation--
(A) Facts. USP, a domestic corporation, owns 100% of the stock of a
number of controlled foreign corporations, including CFC1. USP and
CFC1 each use the calendar year as their U.S. taxable year. CFC1
uses the ``u'' as its functional currency. At all relevant times,
1u=$1x. For its U.S. taxable year ending December 31, 2018, after
application of the rules in Sec. 1.960-1(d), the income of CFC1 is
assigned to a single income group: 2,000u of income from the sale of
goods in a tested income group within the general category (``tested
income group''). CFC1 has current year taxes, translated into U.S.
dollars, of $400x that are all allocated and apportioned to the
tested income group. For its U.S. taxable year ending December 31,
2018, USP has a GILTI inclusion amount determined by reference to
all of its controlled foreign corporations, including CFC1, of
$6,000x, and an aggregate amount described in section 951A(c)(1)(A)
and Sec. 1.951A-1(c)(2)(i) of $10,000x. All of the income in CFC1's
tested income group is included in computing USP's aggregate amount
described in section 951A(c)(1)(A) and Sec. 1.951A-1(c)(2)(i).
(B) Analysis. Under paragraph (c)(5) of this section, USP's
proportionate share of the current year taxes that are allocated and
apportioned under Sec. 1.960-1(d)(3)(ii) to CFC1's tested income
group is $400x ($400x x 2,000u/2,000u). Therefore, under paragraph
(c)(4) of this section, the amount of current year taxes properly
attributable to tested income taken into account by USP under
section 951A(a) and Sec. 1.951A-1(b) is $400x. Under paragraph
(c)(3) of this section, USP's tested foreign income taxes with
respect to CFC1 are $400x. Under paragraph (c)(2) of this section,
USP's inclusion percentage is 60% ($6,000x/$10,000x). Accordingly,
under paragraph (c)(1) of this section, USP is deemed to have paid
$192 of the foreign income taxes of CFC1 (80% x 60% x $400x).
(ii) Example 2: Controlled foreign corporation owned through
domestic partnership--(A) Facts--(1) US1, a domestic corporation,
owns 95% of PRS, a domestic partnership. The remaining 5% of PRS is
owned by US2, a domestic corporation that is unrelated to US1. PRS
owns all of the stock of CFC1, a controlled foreign corporation. In
addition, US1 owns all of the stock of CFC2, a controlled foreign
corporation. US1, US2, PRS, CFC1, and CFC2 all use the calendar year
as their taxable year. CFC1 and CFC2 both use the ``u'' as their
functional currency. At all relevant times, 1u=$1x. For its U.S.
taxable year ending December 31, 2018, after application of the
rules in Sec. 1.960-1(d), the income of CFC1 is assigned to a
single income group: 300u of income from the sale of goods in a
tested income group within the general category (``CFC1's tested
income group''). CFC1 has current year taxes, translated into U.S.
dollars, of $100x that are all allocated and apportioned to CFC1's
tested income group. The income of CFC2 is also assigned to a single
income group: 200u of income from the sale of goods in a tested
income group within the general category (``CFC2's tested income
group''). CFC2 has current year taxes, translated into U.S. dollars,
of $20x that are allocated and apportioned to CFC2's tested income
group.
(2) Under Sec. 1.951A-1(e)(1), for purposes of determining the
GILTI inclusion amount of US1 and US2, PRS is not treated as owning
(within the meaning of section 958(a)) the stock of CFC1; instead,
PRS is treated in the same manner as a foreign partnership for
purposes of determining the stock of CFC1 owned by US1 and US2 under
section 958(a)(2). Therefore, only US1 is a United States
shareholder of CFC1. Taking into account both CFC1 and CFC2, US1 has
a GILTI inclusion amount in the general category of $485x, and an
aggregate amount described in section 951A(c)(1)(A) and Sec.
1.951A-1(c)(2)(i) within the general category of $485x. 285u (95% x
300u) of the income in CFC1's tested income group and 200u of the
income in CFC2's tested income group is included in computing US1's
aggregate amount described in section 951A(c)(1)(A) and Sec.
1.951A-1(c)(2)(i) within the general category. Because US2 is not a
U.S. shareholder with respect to CFC1, US2 does not take into
account CFC1's tested income in determining its GILTI inclusion
amount.
(B) Analysis--(1) US1--(i) CFC1. Under paragraphs (c)(5) and (6)
of this section, US1's proportionate share of the current year taxes
that are allocated and apportioned under Sec. 1.960-1(d)(3)(ii) to
CFC1's tested income group is $95x ($100x x 285u/300u). Therefore,
under paragraph (c)(4) of this section, the amount of the current
year taxes properly attributable to tested income taken into account
by US1 under section 951A(a) and Sec. 1.951A-1(b) is $95x. Under
paragraph (c)(3) of this section, US1's tested foreign income taxes
with respect to CFC1 are $95x. Under paragraph (c)(2) of this
section, US1's inclusion percentage is 100% ($485x/$485x).
Accordingly, under paragraph (c)(1) of this section, US1 is deemed
to have paid $76x of the foreign income taxes of CFC1 (80% x 100% x
$95x).
(ii) CFC2. Under paragraph (c)(5) of this section, US1's
proportionate share of the foreign income taxes that are allocated
and apportioned under Sec. 1.960-1(d)(3)(ii) to CFC2's tested
income group is $20x ($20x x 200u/200u). Therefore, under paragraph
(c)(4) of this section, the amount of foreign income taxes properly
attributable to tested income taken into account by US1 under
section 951A(a) and Sec. 1.951A-1(b) is $20x. Under paragraph
(c)(3) of this section, US1's tested foreign income taxes with
respect to CFC2 are $20. Under paragraph (c)(2) of this section,
US1's inclusion percentage is 100% ($485x/$485x). Accordingly, under
paragraph (c)(1) of this section, US1 is deemed to have paid $16 of
the foreign income taxes of CFC2 (80% x 100% x $20x).
(2) US2. US2 is not a United States shareholder of CFC1 or CFC2.
Accordingly, under paragraph (c)(1) of this section, US2 is not
deemed to have paid any of the foreign income taxes of CFC1 or CFC2.
0
Par. 36. Section 1.960-3 is revised to read as follows:
Sec. 1.960-3 Foreign income taxes deemed paid under section 960(b).
(a) Scope. Paragraph (b) of this section provides rules for
computing the amount of foreign income taxes deemed paid by a domestic
corporation that is a United States shareholder of a controlled foreign
corporation, or by a controlled foreign corporation, under section
960(b). Paragraph (c) of this section provides rules for the
establishment and maintenance of PTEP groups within an annual PTEP
account. Paragraph (d) of this section defines the term PTEP group
taxes. Paragraph (e) of this section provides examples illustrating the
application of this section.
(b) Foreign income taxes deemed paid under section 960(b)--(1)
Foreign income taxes deemed paid by a domestic corporation with respect
to a section 959(a) distribution. If a controlled foreign corporation
makes a distribution to a domestic corporation that is a United States
shareholder with respect to the controlled foreign corporation and that
distribution is, in whole or in part, a section 959(a) distribution
with respect to a PTEP group within a section 904 category, the
domestic corporation is deemed to have paid the amount of the foreign
corporation's foreign income taxes that are properly attributable to
the section 959(a) distribution with respect to the PTEP group and that
have not been deemed to have been paid by a domestic corporation under
section 960 for the current taxable year or any prior taxable year. See
Sec. 1.965-5(c)(1)(iii) for rules disallowing credits in relation to a
distribution of certain previously taxed earnings and profits resulting
from the application of section 965. For each section 904 category, the
domestic corporation is deemed to have paid foreign income taxes equal
to the sum of the controlled foreign corporation's foreign income taxes
that are properly attributable to section 959(a) distributions with
respect to all PTEP groups within the section 904 category. See Sec.
1.904-6(b)(2) for rules on
[[Page 69115]]
assigning the foreign income tax to a section 904 category.
(2) Foreign income taxes deemed paid by a controlled foreign
corporation with respect to a section 959(b) distribution. If a
controlled foreign corporation (distributing controlled foreign
corporation) makes a distribution to another controlled foreign
corporation (recipient controlled foreign corporation) and the
distribution is, in whole or in part, a section 959(b) distribution
from a PTEP group within a section 904 category, the recipient
controlled foreign corporation is deemed to have paid the amount of the
distributing controlled foreign corporation's foreign income taxes that
are properly attributable to the section 959(b) distribution from the
PTEP group and that have not been deemed to have been paid by a
domestic corporation under section 960 for the current taxable year or
any prior taxable year. See Sec. 1.904-6(b)(3) for rules on assigning
the foreign income tax to a section 904 category.
(3) Properly attributable. The amount of foreign income taxes that
are properly attributable to a section 959 distribution from a PTEP
group within a section 904 category equals the domestic corporation's
or recipient controlled foreign corporation's proportionate share of
the PTEP group taxes with respect to the PTEP group within the section
904 category. No other foreign income taxes are considered properly
attributable to a section 959 distribution.
(4) Proportionate share. A domestic corporation's or recipient
controlled foreign corporation's proportionate share of the PTEP group
taxes with respect to a PTEP group within a section 904 category is
equal to the total amount of the PTEP group taxes with respect to the
PTEP group multiplied by a fraction (not to exceed one), the numerator
of which is the amount of the section 959 distribution from the PTEP
group, and the denominator of which is the total amount of previously
taxed earnings and profits in the PTEP group, both determined in the
functional currency of the controlled foreign corporation. If the
numerator or denominator of the fraction is zero or less than zero,
then the proportionate share of the PTEP group taxes with respect to
the PTEP group is zero.
(5) Domestic partnerships. For purposes of applying this paragraph
(b), in the case of a domestic partnership that is a U.S. shareholder
partnership with respect to a partnership CFC, the distributive share
of a U.S. shareholder partner of a U.S. shareholder partnership's
section 959(a) distribution from the partnership CFC is treated as a
section 959(a) distribution received by the U.S. shareholder partner
from the partnership CFC.
(c) Accounting for previously taxed earnings and profits--(1)
Establishment of annual PTEP account. A separate, annual account
(annual PTEP account) must be established for the previously taxed
earnings and profits of the controlled foreign corporation to which
inclusions under section 951(a) and GILTI inclusion amounts of United
States shareholders of the CFC are attributable. Each account must
correspond to the inclusion year of the previously taxed earnings and
profits and to the section 904 category to which the inclusions under
section 951(a) or GILTI inclusion amounts were assigned at the level of
the United States shareholders. Accordingly, a controlled foreign
corporation may have an annual PTEP account in the section 951A
category or a treaty category (as defined in Sec. 1.861-13(b)(6)),
even though income of the controlled foreign corporation that gave rise
to the previously taxed earnings and profits cannot initially be
assigned to the section 951A category or a treaty category.
(2) PTEP groups within an annual PTEP account. The amount in an
annual PTEP account is further assigned to one or more of the following
groups of previously taxed earnings and profits (each, a PTEP group)
within the account:
(i) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
965(a) (``reclassified section 965(a) PTEP'');
(ii) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
965(b)(4)(A) (``reclassified section 965(b) PTEP'');
(iii) Earnings and profits described in paragraphs (c)(2)(iii)(A)
through (C) of this section (which are aggregated into a single PTEP
group, ``general section 959(c)(1) PTEP''):
(A) Earnings and profits described in section 959(c)(1)(A) by
reason of section 951(a)(1)(B) and not by reason of section 959(a)(2);
(B) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
951(a)(1)(A) (other than earnings that were initially described in
paragraphs (c)(2)(vi) through (ix) of this section); and
(C) Earnings and profits described in section 959(c)(1)(B),
including by reason of section 959(a)(3) (before its repeal);
(iv) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
951A(f)(2) (``reclassified section 951A PTEP'');
(v) Earnings and profits described in paragraphs (c)(2)(v)(A)
through (C) of this section (which are aggregated into a single PTEP
group, ``reclassified section 245A(d) PTEP''):
(A) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
245A(e)(2);
(B) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
959(e); and
(C) Earnings and profits described in section 959(c)(1)(A) that
were initially described in section 959(c)(2) by reason of section
964(e)(4);
(vi) Earnings and profits described in section 959(c)(2) by reason
of section 965(a) (``section 965(a) PTEP'');
(vii) Earnings and profits described in section 959(c)(2) by reason
of section 965(b)(4)(A) (``section 965(b) PTEP'');
(viii) Earnings and profits described in section 959(c)(2) by
reason of section 951A(f)(2) (``section 951A PTEP'');
(ix) Earnings and profits described in paragraphs (c)(2)(ix)(A)
through (C) of this section (which are aggregated into a single PTEP
group, ``section 245A(d) PTEP''):
(A) Earnings and profits described in section 959(c)(2) by reason
of section 245A(e)(2);
(B) Earnings and profits described in section 959(c)(2) by reason
of section 959(e); and
(C) Earnings and profits described in section 959(c)(2) by reason
of section 964(e)(4); and
(x) Earnings and profits described in section 959(c)(2) by reason
of section 951(a)(1)(A) not otherwise described in paragraph (c)(2)(vi)
through (ix) of this section (``section 951(a)(1)(A) PTEP'').
(3) Accounting for distributions of previously taxed earnings and
profits. With respect to a recipient controlled foreign corporation
that receives a section 959(b) distribution, such distribution amount
is added to the annual PTEP account, and PTEP group within the annual
PTEP account, that corresponds to the inclusion year and section 904
category of the annual PTEP account, and PTEP group within the annual
PTEP account, from which the distributing controlled foreign
corporation is treated as making the distribution under section 959.
Similarly, with respect to a controlled foreign corporation that makes
a section 959 distribution, such distribution amount reduces the annual
PTEP
[[Page 69116]]
account, and PTEP group within the annual PTEP account, that
corresponds to the inclusion year and section 904 category of the
annual PTEP account, and PTEP group within the annual PTEP account,
from which the controlled foreign corporation is treated as making the
distribution under section 959. Earnings and profits in a PTEP group
are reduced by the amount of current year taxes that are allocated and
apportioned to the PTEP group under Sec. 1.960-1(d)(3)(ii), and the
U.S. dollar amount of the taxes are added to an account of PTEP group
taxes under the rules in paragraph (d)(1) of this section.
(4) Accounting for reclassifications of earnings and profits
described in section 959(c)(2) to earnings and profits described in
section 959(c)(1). If an amount of previously taxed earnings and
profits that is in a PTEP group described in paragraphs (c)(2)(vi)
through (x) of this section (each, a section 959(c)(2) PTEP group) is
reclassified as previously taxed earnings and profits described in
section 959(c)(1) (reclassified previously taxed earnings and profits),
the section 959(c)(2) PTEP group is reduced by the functional currency
amount of the reclassified previously taxed earnings and profits. This
amount is added to the corresponding PTEP group described in paragraph
(c)(2)(i), (ii), (iii) (by reason of paragraph (c)(2)(iii)(B) of this
section), (iv) or (v) of this section (each, a reclassified PTEP group)
in the same section 904 category and same annual PTEP account as the
reduced section 959(c)(2) PTEP group.
(d) PTEP group taxes--(1) In general. The term PTEP group taxes
means the U.S. dollar amount of foreign income taxes (translated in
accordance with section 986(a)) that are paid, accrued, or deemed paid
with respect to an amount in each PTEP group within an annual PTEP
account. The foreign income taxes that are paid, accrued, or deemed
paid with respect to a PTEP group within an annual PTEP account of a
controlled foreign corporation are--
(i) The sum of--
(A) The current year taxes paid or accrued by the controlled
foreign corporation that are allocated and apportioned to the PTEP
group under Sec. 1.960-1(d)(3)(ii);
(B) Foreign income taxes that are deemed paid under section
960(b)(2) and paragraph (b)(2) of this section by the controlled
foreign corporation with respect to a section 959(b) distribution
received by the controlled foreign corporation, the amount of which is
added to the PTEP group under paragraph (c)(3) of this section; and
(C) In the case of a reclassified PTEP group of the controlled
foreign corporation, reclassified PTEP group taxes that are
attributable to the section 959(c)(2) PTEP group that corresponds to
the reclassified PTEP group.
(ii) Reduced by--
(A) Foreign income taxes that were deemed paid under section
960(b)(2) and paragraph (b)(2) of this section by another controlled
foreign corporation that received a section 959(b) distribution from
the controlled foreign corporation, the amount of which is subtracted
from the controlled foreign corporation's PTEP group under paragraph
(c)(3) of this section;
(B) Foreign income taxes that were deemed paid under section
960(b)(1) and paragraph (b)(1) of this section by a domestic
corporation that is a United States shareholder of the controlled
foreign corporation that received a section 959(a) distribution from
the controlled foreign corporation, the amount of which is subtracted
from the controlled foreign corporation's PTEP group under paragraph
(c)(3) of this section; and
(C) In the case of a section 959(c)(2) PTEP group of the controlled
foreign corporation, reclassified PTEP group taxes.
(2) Reclassified PTEP group taxes. Reclassified PTEP group taxes
are foreign income taxes that are initially included in PTEP group
taxes with respect to a section 959(c)(2) PTEP group under paragraph
(d)(1)(i)(A) or (B) of this section multiplied by a fraction, the
numerator of which is the portion of the previously taxed earnings and
profits in the section 959(c)(2) PTEP group that become reclassified
previously taxed earnings and profits, and the denominator of which is
the total previously taxed earnings and profits in the section
959(c)(2) PTEP group.
(3) Foreign income taxes deemed paid with respect to PTEP groups
established for pre-2018 inclusion years. In the case of foreign income
taxes paid or accrued in a taxable year of the controlled foreign
corporation that began before January 1, 2018, with respect to an
annual PTEP account, and a PTEP group within such account, that was
established for an inclusion year that begins before January 1, 2018,
the foreign income taxes are treated as PTEP group taxes of a
controlled foreign corporation for purposes of this section only if
those foreign income taxes were--
(i) Not included in a controlled foreign corporation's post-1986
foreign income taxes (as defined in section 902(c)(2) as in effect on
December 21, 2017) used to compute foreign taxes deemed paid under
section 902 (as in effect on December 21, 2017) in any taxable year
that began before January 1, 2018; and
(ii) Not treated as deemed paid under section 960(a)(3) (as in
effect on December 21, 2017) by a domestic corporation that was a
United States shareholder of the controlled foreign corporation.
(e) Examples. The following examples illustrate the application of
this section.
(1) Example 1: Establishment of PTEP groups and PTEP accounts--
(i) Facts. USP, a domestic corporation, owns all of the stock of
CFC1, a controlled foreign corporation. CFC1 owns all of the stock
of CFC2, a controlled foreign corporation. USP, CFC1, and CFC2 each
use the calendar year as their U.S. taxable year. CFC1 and CFC2 use
the ``u'' as their functional currency. At all relevant times, 1u =
$1x. With respect to CFC2, USP includes in gross income a subpart F
inclusion of 1,000,000u = $1,000,000x for the taxable year ending
December 31, 2018. The inclusion is with respect to passive category
income. In its U.S. taxable year ending December 31, 2019, CFC2
distributes 1,000,000u to CFC1. CFC2 has no earnings and profits
except for the 1,000,000u of previously taxed earnings and profits
resulting from USP's 2018 taxable year subpart F inclusion. CFC2's
country of organization, Country X, imposes a withholding tax on
CFC1 of 300,000u on CFC2's distribution to CFC1. Under Sec. 1.960-
1(d)(3)(ii), CFC1's 300,000u of current year taxes are allocated and
apportioned to the PTEP group within the annual PTEP account within
the section 904 category to which the 1,000,000u of previously taxed
earnings and profits are assigned.
(ii) Analysis--(A) Under paragraph (c)(1) of this section, a
separate annual PTEP account in the passive category for the 2018
taxable year is established for CFC2 as a result of USP's subpart F
inclusion. Under paragraph (c)(2) of this section, this account
contains one PTEP group, section 951(a)(1)(A) PTEP.
(B) Under paragraph (c)(3) of this section, in the 2019 taxable
year, the 1,000,000u related to the section 959(b) distribution from
CFC2 is added to CFC1's annual PTEP account for the 2018 taxable
year in the passive category and to the section 951(a)(1)(A) PTEP
within such account. Similarly, CFC2's 2018 taxable year annual PTEP
account within the passive category, and the section 951(a)(1)(A)
PTEP within such account, is reduced by the amount of the 1,000,000u
section 959(b) distribution to CFC1. Additionally, CFC1's annual
PTEP account for the 2018 taxable year in the passive category, and
the section 951(a)(1)(A) PTEP within such account, is reduced by the
300,000u of withholding tax imposed on CFC1 by Country X. Therefore,
CFC1's annual PTEP account for the 2018 taxable year within the
passive category and the section 951(a)(1)(A) PTEP within such
account is 700,000u.
(C) Under paragraph (d)(1) of this section, the 300,000u of
withholding tax is translated
[[Page 69117]]
into U.S. dollars and $300,000x is added to the PTEP group taxes
with respect to CFC1's section 951(a)(1)(A) PTEP within the annual
PTEP account for the 2018 taxable year within the passive category.
(2) Example 2: Foreign income taxes deemed paid under section
960(b)--(i) Facts. USP, a domestic corporation, owns 100% of the
stock of CFC1, which in turn owns 60% of the stock of CFC2, which in
turn owns 100% of the stock of CFC3. USP, CFC1, CFC2, and CFC3 all
use the calendar year as their U.S. taxable year. CFC1, CFC2, and
CFC3 all use the ``u'' as their functional currency. At all relevant
times, 1u = $1x. On July 1, 2020, CFC2 distributes 600u to CFC1 and
the entire distribution is a section 959(b) distribution
(``distribution 1''). On October 1, 2020, CFC1 distributes 800u to
USP and the entire distribution is a section 959(a) distribution
(``distribution 2''). CFC1 and CFC2 make no other distributions in
the year ending December 31, 2020, earn no other income, and incur
no taxes on distribution 1 or distribution 2. Before taking into
account distribution 1, CFC2 has 1,000u of section 951(a)(1)(A) PTEP
within an annual PTEP account for the 2016 taxable year within the
general category. The previously taxed earnings and profits in
CFC2's PTEP group relate to subpart F income of CFC3 that was
included by USP in 2016. CFC3 distributed the earnings and profits
to CFC2 before the 2020 taxable year and, solely as a result of the
distribution of the previously taxed earnings and profits, CFC2
incurred withholding and net basis tax, resulting in $150 of PTEP
group taxes with respect to section 951(a)(1)(A) PTEP. Before taking
into account distribution 1 and distribution 2, CFC1 has 200u in
section 951A PTEP within an annual PTEP account for the 2018 taxable
year within the section 951A category. The previously taxed earnings
and profits in CFC1's PTEP group relate to the portion of a GILTI
inclusion amount that was included by USP in 2018 and allocated to
CFC2 under section 951A(f)(2) and Sec. 1.951A-6(b)(2). CFC2
distributed the earnings and profits to CFC1 before the 2020 taxable
year and, solely as a result of the distribution of the previously
taxed earnings and profits, CFC1 incurred withholding and net basis
tax, resulting in $25x of PTEP group taxes with respect to section
951A PTEP.
(ii) Analysis--(A) Foreign income taxes deemed paid by CFC1.
With respect to distribution 1 from CFC2 to CFC1, under paragraph
(b)(4) of this section CFC1's proportionate share of PTEP group
taxes with respect to CFC2's section 951(a)(1)(A) PTEP within an
annual PTEP account for the 2016 taxable year within the general
category is $90x ($150x x 600u/1,000u). Under paragraph (b)(3) of
this section, the amount of foreign income taxes that are properly
attributable to distribution 1 is $90x. Accordingly, under paragraph
(b)(2) of this section, CFC1 is deemed to have paid $90x of general
category foreign income taxes of CFC2 with respect to its 600u
section 959(b) distribution in the general category.
(B) Adjustments to PTEP accounts of CFC1 and CFC2. Under
paragraph (c)(3) of this section, the 600u related to distribution 1
is added to CFC1's section 951(a)(1)(A) PTEP within an annual PTEP
account for the 2016 taxable year within the general category.
Similarly, CFC2's section 951(a)(1)(A) PTEP within an annual PTEP
account for the 2016 taxable year within the general category is
reduced by 600u, the amount of the section 959(b) distribution to
CFC1. Additionally, under paragraph (d) of this section, CFC1's PTEP
group taxes with respect to its section 951(a)(1)(A) PTEP within an
annual PTEP account for the 2016 taxable year within the general
category are increased by $90 and CFC2's PTEP group taxes with
respect to section 951(a)(1)(A) PTEP within an annual PTEP account
for the 2016 taxable year within the general category are reduced by
$90x.
(C) Foreign income taxes deemed paid by USP. With respect to
distribution 2 from CFC1 to USP, because CFC1 has PTEP groups in
more than one section 904 category, this section is applied
separately to each section 904 category (that is, distribution 2 of
800u is applied separately to the 200u of CFC1's section 951A PTEP
and 600u of CFC1's section 951(a)(1)(A) PTEP).
(1) Section 951A category. Under paragraph (b)(4) of this
section, USP's proportionate share of PTEP group taxes with respect
to CFC1's section 951A PTEP within an annual PTEP account for the
2018 taxable year within the section 951A category is $25x ($25x x
200u/200u). Under paragraph (b)(3) of this section, the amount of
foreign income taxes within the section 951A category that are
properly attributable to distribution 2 is $25x. Accordingly, under
paragraph (b)(1) of this section USP is deemed to have paid $25x of
section 951A category foreign income taxes of CFC1 with respect to
its 200u section 959(a) distribution in the section 951A category.
(2) General category. Under paragraph (b)(4) of this section,
USP's proportionate share of PTEP group taxes with respect to CFC1's
section 951(a)(1)(A) PTEP within an annual PTEP account for the 2016
taxable year within the general category is $90x ($90x x 600u/600u).
Under paragraph (b)(3) of this section, the amount of foreign income
taxes that are properly attributable to distribution 2 is $90x.
Accordingly, under paragraph (b)(1), USP is deemed to have paid $90x
of general category foreign income taxes of CFC1 with respect to its
600u section 959(a) distribution in the general category.
0
Par. 37. Section 1.960-4 is amended by:
0
1. Removing the language ``960(b)(1)'' and adding the language
``960(c)(1)'' in its place wherever it appears.
0
2. In paragraph (a)(1):
0
i. Removing the language ``he'' and adding the language ``the
taxpayer'' in its place.
0
ii. Removing the language ``subparagraph (2) of this paragraph'' and
adding the language ``paragraph (a)(2) of this section'' in its place.
0
iii. Adding two sentences at the end.
0
3. Revising the last sentence of paragraph (d).
0
4. Revising paragraph (f).
The addition and revisions read as follows:
Sec. 1.960-4 Additional foreign tax credit in year of receipt of
previously taxed earnings and profits.
(a) * * * (1) * * * For purposes of this section, an amount
included in gross income under section 951A(a) is treated as an amount
included in gross income under section 951(a). The amount of the
increase in the foreign tax credit limitation allowed by this section
is determined with regard to each separate category of income described
in Sec. 1.904-5(a)(4)(v).
* * * * *
(d) * * * For purposes of this paragraph (d), the term ``foreign
income taxes'' includes foreign income taxes paid or accrued, foreign
income taxes deemed paid or accrued under section 904(c), and foreign
income taxes deemed paid under section 960 (or section 902 with respect
to taxable years of foreign corporations beginning before January 1,
2018), for the taxable year of inclusion.
* * * * *
(f) Examples. The application of this section may be illustrated by
the following examples:
(1) Example 1. USP, a domestic corporation, owns all of the one
class of stock of CFC, a controlled foreign corporation that uses
the U.S. dollar as its functional currency. CFC, after paying
foreign income taxes of $10x, has earnings and profits for Year 1 of
$90x, all of which are attributable to an amount required under
section 951(a) to be included in USP's gross income for Year 1
because the income is general category foreign base company services
income of CFC. Both corporations use the calendar year as the
taxable year. For Year 2 and Year 3, CFC has no earnings and profits
attributable to an amount required to be included in USP's gross
income under section 951(a); for each such year it makes a
distribution of $45x (from its section 951(a)(1)(A) PTEP within the
annual PTEP account for Year 1) from which a foreign income tax of
$6x is withheld. For each of Year 1, Year 2, and Year 3, USP derives
taxable income of $50x from sources within the United States and
claims a foreign tax credit under section 901, subject to the
limitation under section 904. The U.S. tax payable by USP is
determined as follows, assuming a corporate tax rate of 21%:
[[Page 69118]]
Table 1 to Paragraph (f)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 1
------------------------------------------------------------------------
Taxable income of USP:
U.S. sources........................ .............. $50.00x
Sources without the U.S.:
Amount required to be included $90.00x ..............
in USP's gross income under
section 951(a).................
Foreign income taxes deemed paid 10.00x 100.00x
by USP under section 960(a) and
included in USP's gross income
under section 78 ($10x x $90x/
$90x)..........................
-------------------------------
Total taxable income........ .............. 150.00x
U.S. tax payable for Year 1:
U.S. tax before credit ($150x x 21%) .............. 31.50x
Credit: Foreign income taxes of .............. 10.00x
$10x, but not to exceed the
limitation of $21x for Year 1
($100x/$150x x $31.50x)............
U.S. tax payable.................... .............. 21.50x
------------------------------------------------------------------------
Table 2 to Paragraph (f)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 2
------------------------------------------------------------------------
Taxable income of USP, consisting of .............. $50.00x
income from U.S. sources...............
U.S. tax before credit ($50x x 21%)..... .............. 10.50x
Section 904 limitation for Year 2:
Limitation for Year 2 before .............. 10
increase under section 960(c)(1)
($10.50x x $0/$50x)................
Plus: Increase in limitation for
Year 2 under sec. 960(c)(1):
Amount by which Year 1 21.00x ..............
limitation was increased by
reason of inclusion in USP's
gross income under section
951(a) for Year 1 ($21x-[($50x
x 21%) x $0/$50x]).............
Less: Foreign income taxes 10.00x ..............
allowed as a credit for Year 1
which were allowable solely by
reason of such section 951(a)
inclusion ($10x-$0)............
-------------------------------
Balance..................... 11.00x ..............
But: Such balance not to exceed 6.00x 6.00x
foreign income taxes paid by
USP for Year 2 with respect to
$45x distribution excluded
under section 959(a)(1) ($6x
tax withheld)..................
Limitation for Year 2............... .............. 6.00x
U.S. tax payable for Year 2:
U.S. tax before credit ($50x x 21%). .............. 10.50x
Credit: Foreign income taxes of $6x, .............. 6.00x
but not to exceed limitation of $6x
for Year 2.........................
U.S. tax payable.................... .............. 4.50x
------------------------------------------------------------------------
Table 3 to Paragraph (f)(1)
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 3
------------------------------------------------------------------------
Taxable income of USP, consisting of .............. $50.00x
income from U.S. sources...............
U.S. tax before credit ($50x x 21%)..... .............. 10.50x
Section 904 limitation for Year 3:
Limitation for Year 3 before .............. 0
increase under section 960(c)(1)
($10.50x x $0/$50x)................
Plus: Increase in limitation for
Year 3 under section 960(c)(1):
Amount by which Year 1 $21.00x ..............
limitation was increased by
reason of inclusion in USP's
gross income under section
951(a) for Year 1 ($21x-[ ($50
x 21%) x $0/$50x] )............
Less: Foreign income taxes 10.00x ..............
allowed as a credit for Year 1
which were allowable solely by
reason of such section 951(a)
inclusion ($10x-$0)............
Tentative balance............... 11.00x ..............
Less: Increase in limitation 6.00x ..............
under section 960(c)(1) for
Year 2 by reason of such sec.
951(a) inclusion...............
-------------------------------
Balance..................... 5.00x ..............
But: Such balance not to exceed 6.00x 5.00x
foreign income taxes paid by USP
for Year 3 with respect to $45x
distribution excluded under section
959(a)(1) ($6x tax withheld).......
Limitation for Year 3............... .............. 5.00x
U.S. tax payable for Year 3:
U.S. tax before credit ($50x x 21%). .............. 10.50x
Credit: Foreign income taxes of $6, .............. 5.00x
but not to exceed section 904(a)
limitation of $5x..................
U.S. tax payable.................... .............. 5.50x
------------------------------------------------------------------------
(2) Example 2. The facts for Year 1 and Year 2 are the same as
in paragraph (f)(1) of this section (the facts in Example 1), except
that in Year 0, in which USP also claimed a foreign tax credit under
section 901, USP pays $11x of foreign income taxes in excess of the
general category limitation and such excess is not absorbed as a
carryback to the prior year under section 904(c). Therefore, there
is no increase under section 960(c)(1) in the limitation for Year 2
since the amount ($21x) by which the Year 1 limitation was increased
by reason of the inclusion in USP's gross income for Year 1 under
section 951(a), less the foreign income taxes ($21x) allowed as a
credit which were allowable solely by reason of such inclusion, is
zero. The foreign income taxes so allowed as a credit for Year
[[Page 69119]]
1 which were allowable solely by reason of such section 951(a)
inclusion consist of the $10 of foreign income taxes deemed paid for
Year 1 under section 960(a) and the $11x of foreign income taxes for
Year 0 carried over and deemed paid for Year 1 under section 904(c).
0
Par. 38. Section 1.960-5 is amended by:
0
1. In paragraph (a)(1):
0
i. Removing the language ``951(a)'' and adding the language ``951(a) or
951A(a)'' in its place.
0
ii. Removing the comma and adding a semicolon in its place.
0
2. Revising paragraph (b).
The revision reads as follows:
Sec. 1.960-5 Credit for taxable year of inclusion binding for
taxable year of exclusion.
* * * * *
(b) Example. The application of this section may be illustrated by
the following example:
(1) Facts. USP, a domestic corporation, owns all the one class
of stock of CFC, a controlled foreign corporation. Both corporations
use the calendar year as the taxable year and the functional
currency of CFC is the U.S. dollar. All of CFC's earnings and
profits of $80x for Year 1 (after payment of foreign income taxes of
$20x on its total income of $100x for such year) are attributable to
amounts required under section 951(a) to be included in USP's gross
income for Year 1 because such income is general category foreign
base company services income of CFC. For Year 1, USP chooses to
claim a foreign tax credit for the $20x of foreign income taxes
which for such year are paid by CFC and deemed paid by USP under
section 960(a) and Sec. 1.960-2(b). In Year 2, CFC distributes the
entire $80x of Year 1 previously taxed earnings and profits, from
which a foreign income tax of $8x is withheld. Also in Year 2, CFC
pays $40x of interest to USP, from which a foreign income tax of $4x
is withheld. For Year 2, USP chooses to claim deductions for its
creditable foreign income taxes under section 164 rather than a
foreign tax credit under section 901.
(2) Analysis. Although USP does not choose to claim a foreign
tax credit for Year 2, under section 960(c)(4) and paragraph (a) of
this section it may not deduct the $8x of foreign income taxes under
section 164. USP may, however, deduct under such section the foreign
income tax of $4x which is withheld from the interest paid by CFC in
Year 2.
0
Par. 39. Section 1.960-6 is amended by removing the language
``960(b)(1)'' and adding the language ``960(c)(1)'' in its place in
paragraph (a) and revising paragraph (b) to read as follows:
Sec. 1.960-6 Overpayments resulting from increase in limitation for
taxable year of exclusion.
* * * * *
(b) Example. The application of this section may be illustrated by
the following example:
(1) Facts. USP, a domestic corporation, owns all of the one
class of stock of CFC, a controlled foreign corporation. Both
corporations use the calendar year as the taxable year, and the
functional currency of CFC is the U.S. dollar. For Year 1, CFC has
total income of $100,000x on which it pays foreign income taxes of
$20,000x. All of CFC's earnings and profits for Year 1 of $80,000x
are attributable to an amount which is required under section 951(a)
to be included in USP's gross income for Year 1 because such income
is general category foreign base company services income of CFC. By
reason of such income inclusion USP is deemed for Year 1 to have
paid under section 960(a), and is required under section 78 to
include in gross income for such year, the $20,000x ($20,000x x
$80,000x/$80,000x) of foreign income taxes paid by CFC for such
year. USP also derives $100,000x of taxable income from sources
within the United States for Year 1. For Year 2, USP has $4,000x of
taxable income, all of which is derived from sources within the
United States. No part of CFC's earnings and profits for Year 2 is
attributable to an amount required under section 951(a) or section
951A(a) to be included in USP's gross income. During Year 2, CFC
makes one distribution consisting of its $80,000x earnings and
profits for Year 1, all of which is excluded under section 959(a)(1)
from USP's gross income for Year 2, and from which distribution
foreign income taxes of $1,000x are withheld. For Year 1 and Year 2,
USP claims the foreign tax credit under section 901, subject to the
limitation of section 904.
(2) Analysis. The U.S. tax liability of USP is determined as
follows for such years, assuming a corporate tax rate of 21%:
Table 1 to Paragraph (b)(2)
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 1
------------------------------------------------------------------------
Taxable income of USP:
U.S. sources........................ .............. $100,000.00x
Sources without the U.S.: ..............
Amount required to be included $80,000.00x ..............
in USP's gross income under
section 951(a).................
Foreign income taxes deemed paid 20,000.00x 100,000.00x
by USP under section 960(a) and
included in USP's gross income
under section 78 ($20,000x x
$80,000x/$80,000x).............
-------------------------------
Total taxable income........ .............. 200,000.00x
U.S. tax payable for Year 1:
U.S. tax before credit ( [$200,000x .............. 42,000.00x
x 21%] )...........................
Credit: Foreign income taxes of .............. 20,000.00x
$20,000x, but not to exceed
limitation of $21,000x ($42,000x x
$100,000x/$200,000x)...............
-------------------------------
U.S. tax payable................ .............. 22,000.00x
------------------------------------------------------------------------
Table 2 to Paragraph (b)(2)
------------------------------------------------------------------------
------------------------------------------------------------------------
Year 2
------------------------------------------------------------------------
Taxable income of USP, consisting of .............. $4,000x
income from U.S. sources...............
U.S. tax before credit ($4,000x x 21%).. .............. 840x
Section 904 limitation for Year 2:
Limitation for Year 2 before .............. 0
increase under section 960(c)(1)
($840x x $0/$4,000x)...............
Plus: Increase in section 904
limitation for Year 2 under section
960(c)(1):
Amount by which Year 1 $21,000x ..............
limitation was increased by
reason of inclusion in USP's
gross income under section
951(a) for Year 1 ($21,000x-
[$21,000x x $0/$100,000x]).....
Less: Foreign income taxes 20,000x ..............
allowed as a credit for Year 1
which were allowable solely by
reason of such section 951(a)
inclusion ($20,000x-$0)........
-------------------------------
Balance..................... 1,000x ..............
[[Page 69120]]
But: Such balance not to exceed 1,000x 1,000x
foreign income taxes paid by
USP for Year 2 with respect to
$80,000x distribution excluded
under section 959(a)(1)
($1,000x tax withheld).........
Limitation for Year 2............... .............. 1,000x
U.S. tax payable for Year 2:
U.S. tax before credit ($4,000x x .............. 840x
21%)...............................
Credit: Foreign income taxes of .............. 1,000x
$1,000x, but not to exceed
limitation of $1,000x for Year 2...
U.S. tax payable.................... .............. None
Overpayment of tax for Year 2:
Increase in limitation under section .............. 1,000x
960(c)(1) for Year 2...............
Less: Tax imposed for Year 2 under .............. 840x
chapter 1 of the Code..............
Excess treated as overpayment....... .............. 160x
------------------------------------------------------------------------
0
Par. 40. Section 1.960-7 is revised to read as follows:
Sec. 1.960-7 Applicability dates.
Sections 1.960-1 through 1.960-6 apply to each taxable year of a
foreign corporation that both begin after December 31, 2017, and ends
on or after December 4, 2018, and to each taxable year of a domestic
corporation that is a United States shareholder of the foreign
corporation in which or with which such taxable year of such foreign
corporation ends.
0
Par. 41. Section 1.965-5 is amended by adding paragraph (c)(1)(iii) to
read as follows:
Sec. 1.965-5 Allowance of a credit or deduction for foreign income
taxes.
* * * * *
(c) * * *
(1) * * *
(iii) Foreign income taxes deemed paid under section 960(b) (as
applicable to taxable years of controlled foreign corporations
beginning after December 31, 2017, and to taxable years of United
States persons in which or with which such taxable years of foreign
corporations end). Paragraph (c)(1)(i) of this section applies to
foreign income taxes deemed paid under section 960(b) (as in effect for
a taxable year of a controlled foreign corporation beginning after
December 31, 2017, and a taxable year of a United States person in
which or with which such controlled foreign corporation's taxable year
ends) only if such taxes are deemed paid under Sec. 1.960-3(b)(1) with
respect to distributions to a domestic corporation of section 965(a)
previously taxed earnings and profits or section 965(b) previously
taxed earnings and profits. See also Sec. 1.960-3(c)(2)(i), (ii),
(vi), or (vii). Foreign income taxes that would have been deemed paid
under section 960(a)(1) (as in effect on December 21, 2017) with
respect to the portion of a section 965(a) earnings amount that was
reduced under Sec. 1.965-1(b)(2) or Sec. 1.965-8(b) are not eligible
to be deemed paid under section 960(b) and Sec. 1.960-3(b) or any
other section of the Code.
* * * * *
Sec. 1.965-7 [Amended]
0
Par. 42. Section 1.965-7 is amended by removing the language ``Sec.
1.904-5(a)'' and adding in its place the language ``Sec. 1.904-
5(a)(4)(v)'' in the last sentence of paragraph (e)(1)(i).
0
Par. 43. Section 1.965-9 is amended by:
0
1. Removing the language ``Sections 1.965-1 through 1.965-8 apply'' and
adding in its place the language ``Except as otherwise provided in this
section, Sec. Sec. 1.965-1 through 1.965-8 apply'' in paragraph (a).
0
2. Adding paragraph (c).
The addition reads as follows:
Sec. 1.965-9 Applicability dates.
* * * * *
(c) Applicability date for certain portions of Sec. 1.965-5.
Paragraph (c)(1)(iii) of Sec. 1.965-5 applies to taxable years of
foreign corporations that both begin after December 31, 2017, and end
on or after December 4, 2018, and with respect to a United States
person, to the taxable years in which or with which such taxable years
of the foreign corporations end.
Sec. 1.985-3 [Amended]
0
Par. 44. Section 1.985-3 is amended by removing the language ``Sec.
1.904-5(a)(1)'' and adding in its place the language ``Sec. 1.904-
5(a)(4)(v)'' in the second sentence of paragraph (e)(2)(iv).
0
Par. 45. Section 1.986(a)-1 is added to read as follows:
Sec. 1.986(a)-1 Translation of foreign income taxes for purposes of
the foreign tax credit.
(a) Translation of foreign income taxes taken into account when
accrued--(1) In general. For purposes of this section, the term section
901 taxpayer means the ``taxpayer'' described in Sec. 1.901-2(f)(1)
and so includes a partnership or a specified 10-percent owned foreign
corporation (as defined in section 245A(b)) that has legal liability
under foreign law for foreign income tax. Except as provided in
paragraph (a)(2) of this section, in the case of a section 901 taxpayer
that takes foreign income taxes (as defined in section 986(a)(4)
(including taxes described in section 903)) into account when accrued,
the amount of any foreign income taxes denominated in foreign currency
that has been paid or accrued, including additional tax liability
denominated in foreign currency, foreign income taxes withheld in
foreign currency, or estimated foreign income taxes paid in foreign
currency, are translated into dollars using the weighted average
exchange rate (as defined in Sec. 1.989(b)-1) (the ``average exchange
rate'') for the section 901 taxpayer's U.S. taxable year (as defined in
Sec. 1.960-1(b)(37)) to which such foreign income taxes relate. See
section 986(a)(1)(A). See section 988 and Sec. Sec. 1.988-1(a)(2)(ii)
and 1.988-2(c) for rules for determining whether and the extent to
which there is a foreign currency gain or loss when an accrued
functional currency amount of foreign income tax denominated in
nonfunctional currency differs from the functional currency amount
paid.
(2) Exceptions--(i) Foreign income taxes not paid within 24 months.
Any foreign income taxes denominated in foreign currency that are paid
more than 24 months after the close of the section 901 taxpayer's U.S.
taxable year to which they relate are translated into dollars using the
spot rate on the date of payment of the foreign income taxes. See
section 986(a)(1)(B)(i) and (a)(2)(A). For purposes of this section and
Sec. 1.905-3, the term spot rate has the meaning provided in Sec.
1.988-1(d). To the extent any accrued foreign income taxes denominated
in foreign currency remain unpaid more than 24 months after the close
of the taxable year to which they relate, see Sec. 1.905-3 and
paragraph (c) of this section for the required adjustments.
(ii) Foreign income taxes paid before taxable year begins. Any
foreign income taxes denominated in foreign currency that are paid
before the beginning of the
[[Page 69121]]
section 901 taxpayer's U.S. taxable year to which such taxes relate are
translated into dollars using the spot rate on the date of payment of
the foreign income taxes. See section 986(a)(1)(B)(ii) and (a)(2)(A).
(iii) Inflationary currency. Any foreign income taxes denominated
in a foreign currency that is an inflationary currency in the section
901 taxpayer's U.S. taxable year to which the foreign income taxes
relate, or in any subsequent taxable year up to and including the
taxable year in which the taxes are paid, are translated into dollars
using the spot rate on the date of payment of such taxes. For purposes
of section 986(a)(1)(C) and this paragraph (a)(2)(iii), the term
inflationary currency means the currency of a country in which there is
cumulative inflation during the base period of at least 30 percent, as
determined under the principles of Sec. 1.985-1(b)(2)(ii)(D), where
the base period, with respect to any taxable year, is the 36 months
ending on the last day of such taxable year (in lieu of the base period
described in Sec. 1.985-1(b)(2)(ii)(D), which ends on the last day of
the preceding calendar year). Accrued but unpaid foreign income taxes
denominated in a foreign currency that is an inflationary currency in
the taxable year accrued are translated into dollars at the spot rate
on the last day of the section 901 taxpayer's U.S. taxable year to
which such taxes relate (provisional year-end rate). However, a U.S.
taxpayer that claims a foreign tax credit under section 901 may choose
to translate accrued but unpaid foreign income taxes (including foreign
income taxes deemed paid under section 960) denominated in a foreign
currency that is an inflationary currency into dollars at the spot rate
on the date of payment, in lieu of the provisional year-end rate, if
such taxes are paid prior to the due date (with extensions) of the
original Federal income tax return for the taxable year for which the
credit is claimed and such return is timely filed. In all other cases,
see Sec. 1.905-3 and paragraph (c) of this section for required
adjustments upon payment of accrued foreign income taxes denominated in
an inflationary currency.
(iv) Election to translate foreign income taxes using the spot rate
as of date of payment--(A) Eligibility to make election. An individual
or corporate taxpayer (including a specified 10-percent owned foreign
corporation) that is otherwise required to translate foreign income
taxes that are denominated in foreign currency using the average
exchange rate may elect to translate foreign income taxes described in
this paragraph (a)(2)(iv) into dollars using the spot rate on the date
of payment of the foreign income taxes, provided that the liability for
such taxes is denominated in nonfunctional currency. For purposes of
section 986(a)(1)(D) and this paragraph (a)(2)(iv), whether the
currency in which a tax liability attributable to a qualified business
unit (within the meaning of section 989(a)) (QBU) is denominated is a
nonfunctional currency is determined by reference to the functional
currency of the individual or corporate taxpayer and not that of the
QBU of the taxpayer. Accrued but unpaid foreign income taxes subject to
the election under this paragraph (a)(2)(iv) are translated at the
provisional year-end rate. However, a taxpayer that claims a foreign
tax credit under section 901 may choose to translate accrued but unpaid
foreign income taxes (including foreign taxes deemed paid under section
960 with respect to a specified 10-percent owned foreign corporation
that has made an election under this paragraph (a)(2)(iv)) into dollars
at the spot rate on the date of payment, in lieu of the provisional
year-end rate, if such taxes are paid prior to the due date (with
extensions) of the original return for the taxable year for which the
credit is claimed and such return is timely filed. In all other cases,
see Sec. 1.905-3 and paragraph (c) of this section for required
adjustments upon payment of accrued foreign income taxes that are
translated into dollars at the spot rate on the date of payment.
(B) Scope of election. In general, an individual taxpayer may make
an election under this paragraph (a)(2)(iv) for all foreign income
taxes denominated in nonfunctional currency, or only for those foreign
income taxes that are denominated in nonfunctional currency and that
are attributable to the individual's non-QBU activities and all QBUs
with dollar functional currencies. A corporate taxpayer may make an
election under this paragraph (a)(2)(iv) for all foreign income taxes
that are denominated in nonfunctional currency, or only for those
foreign income taxes that are denominated in nonfunctional currency and
that are attributable to all QBUs (including the corporate taxpayer)
with dollar functional currencies. Therefore, an election under this
paragraph (a)(2)(iv) may not be made for foreign income taxes that are
denominated in a nonfunctional currency of the taxpayer and
attributable to QBUs with non-dollar functional currencies, except as
part of an election to translate all taxes denominated in nonfunctional
currency at the spot rate on the date of payment. For purposes of this
paragraph (a)(2)(iv)(B), foreign income tax is attributable to a QBU if
the tax is properly recorded on the books and records of the QBU in
accordance with sections 985 through 989. An election under this
paragraph (a)(2)(iv) by a domestic corporation (or an individual that
has made an election under section 962) does not apply to any taxes
paid or accrued by foreign corporations with respect to which the
individual or corporation is a United States shareholder. However, an
election may be made on behalf of a foreign corporation to translate
either all of the foreign corporation's foreign income taxes
denominated in nonfunctional currency, or only the foreign income taxes
denominated in nonfunctional currency that are attributable to the
foreign corporation's QBUs with dollar functional currencies, using the
spot rate on the date of payment. Such an election is made using the
procedures under Sec. 1.964-1(c)(3) that apply to permit controlling
domestic shareholders to make or change a tax accounting election on
behalf of a foreign corporation.
(C) Time and manner of election. The election under this paragraph
(a)(2)(iv) must be made by attaching a statement to the taxpayer's
timely filed Federal income tax or information return (including
extensions) for the first taxable year to which the election applies.
The statement must identify whether the election under this paragraph
(a)(2)(iv) is made for all foreign income taxes denominated in
nonfunctional currency or only for those foreign income taxes that are
denominated in nonfunctional currency and that are either attributable
to the taxpayer's QBUs with dollar functional currencies or, in the
case of an individual, attributable to non-QBU activities. Once made,
the election under this paragraph (a)(2)(iv) applies for the taxable
year for which made and all subsequent taxable years unless revoked
with the consent of the Commissioner.
(D) Example--(1) Facts. USP, a domestic corporation that uses
the calendar year as its taxable year, owns a partnership interest
in PS, a non-hybrid partnership organized in Country X. USP also
owns an equity interest in HPS, a Country X corporation that has
filed an entity classification election under Sec. 301.7701-3 of
this chapter to be treated as a partnership for Federal income tax
purposes. USP also owns 100% of CFC, a Country Y controlled foreign
corporation that uses the U.S. dollar as its functional currency. PS
and HPS each use a fiscal year ending November 30 as its taxable
year both for Federal income tax purposes and for Country X tax
purposes, and their functional
[[Page 69122]]
currency is the Euro. HPS is the section 901 taxpayer of foreign
income taxes denominated in Euros that it pays to Country X and
properly records on its books and records. USP takes its
distributive share of the HPS taxes into account under sections
702(a)(6) and 901(b)(5) and Sec. Sec. 1.702-1(a)(6) and 1.704-
1(b)(4)(viii) in computing its foreign tax credit. USP is the
section 901 taxpayer of Euro-denominated foreign income taxes it
pays to Country X with respect to its distributive share of the
income of PS, and also pays Country X taxes withheld in Euros from
distributions from HPS to USP and properly records these taxes on
its books and records. Pursuant to Sec. 1.985-1(b)(1)(iii), USP's
functional currency is the dollar. USP timely elects under Sec.
1.986(a)-1(a)(2)(iv) to use the spot rate on the date of payment to
translate into dollars its foreign income taxes denominated in
nonfunctional currency that are attributable to all QBUs with dollar
functional currencies.
(2) Result. The Euro taxes paid by USP with respect to its
distributive share of income from PS and the Euro taxes withheld
from distributions from HPS are nonfunctional currency taxes
attributable to USP, a QBU with a dollar functional currency.
Accordingly, these taxes are translated into dollars at the spot
rate on the date the taxes are paid. USP's distributive share of the
Euro taxes paid by HPS are attributable to HPS, a Euro functional
currency QBU of USP. Because these taxes are not attributable to a
dollar QBU of USP, they are not covered by USP's election and so are
translated into dollars at the average exchange rate for HPS's U.S.
taxable year ending on November 30. See Sec. 1.986(a)-1(a)(1).
Foreign income taxes paid by CFC are not covered by USP's election;
however, if USP so chooses it may make a separate election on behalf
of CFC to use the spot rate on the date of payment to translate
either all of CFC's nonfunctional currency taxes, or only those
taxes that are attributable to CFC's dollar QBUs (which includes
CFC). If instead USP had elected to use the spot rate on the date of
payment to translate all of its foreign income taxes denominated in
nonfunctional currency, rather than only those taxes attributable to
QBUs with dollar functional currencies, then the spot rate on the
date of payment would apply to translate all of the Euro taxes paid
or accrued by USP, including its distributive share of taxes paid by
HPS. However, this election would still not apply to taxes paid or
accrued by CFC. See Sec. 1.986(a)-1(a)(2)(iv)(B).
(v) Regulated investment companies. In the case of a regulated
investment company (as defined in section 851) which takes into account
income on an accrual basis, foreign income taxes paid or accrued with
respect to such income are translated into dollars using the spot rate
on the date the income accrues. See section 986(a)(1)(E).
(b) Translation of foreign income taxes taken into account when
paid. In the case of a section 901 taxpayer that takes foreign income
taxes into account when paid, the amount of any foreign income tax
liability denominated in foreign currency, including additional income
tax liability denominated in foreign currency or estimated foreign
income taxes paid in foreign currency, are translated into dollars
using the spot rate on the date of payment of such taxes. See section
986(a)(2)(A). Foreign income taxes withheld in foreign currency are
translated into dollars using the spot rate on the date on which such
taxes were withheld.
(c) Refunds or other reductions of foreign income tax liability. In
the case of a section 901 taxpayer that takes foreign income taxes into
account when accrued, a reduction in the amount of previously-accrued
foreign income taxes that is attributable to a refund of foreign income
taxes, a credit allowed in lieu of a refund, or a reduction in or other
downward adjustment to an accrued amount, including an adjustment on
account of accrued foreign income taxes that were not paid by the date
24 months after the close of the U.S. taxable year to which such taxes
relate, is translated into dollars using the exchange rate that was
used to translate such amount when claimed as a credit or added to PTEP
group taxes (as defined in Sec. 1.960-3(d)(1)). In the case of foreign
income taxes taken into account when accrued but translated into
dollars on the date of payment, see Sec. 1.905-3(b) for required
adjustments to reflect a foreign tax redetermination (as defined in
Sec. 1.905-3(a)) attributable to a reduction in the amount of
previously-accrued foreign income taxes that is attributable to a
difference in exchange rates between the date or taxable year of
accrual and the date of payment. In the case of a section 901 taxpayer
that takes foreign income taxes into account when paid, a refund or
other reduction in or downward adjustment to the amount of foreign
income taxes is translated into dollars using the exchange rate that
was used to translate such amount when claimed as a credit. If a refund
or other reduction of foreign income taxes relates to foreign income
taxes paid or accrued on more than one date, then the refund or other
reduction is deemed to be derived from, and reduces, the payments of
foreign income taxes in order, starting with the most recent payment of
foreign income taxes first, to the extent thereof.
(d) Allocation of refunds of foreign income taxes. Refunds of
foreign income taxes are allocated to the same separate category as the
foreign income taxes to which the refunded taxes relate. Refunds are
related to foreign income taxes in a separate category if the foreign
income tax that was refunded was imposed with respect to that separate
category. See Sec. 1.904-6 concerning the allocation of foreign income
taxes to separate categories of income.
(e) Basis of foreign currency refunded--(1) Nonfunctional currency
tax liability and dollar functional currency. If the functional
currency of the QBU that paid the tax and received the refund is the
dollar or the person receiving the refund is not a QBU, then the
recipient's basis in the foreign currency refunded is the dollar value
of the refund determined under paragraph (c) of this section by using
the exchange rate that was used to translate such amount into dollars
when claimed as a credit or added to PTEP group taxes.
(2) Nonfunctional currency tax liability and non-dollar functional
currency. If the functional currency of the QBU receiving the refund is
not the dollar and is different from the currency in which the foreign
income taxes were paid, then the recipient's basis in the refunded
foreign currency is equal to the functional currency value of the
nonfunctional currency refund, translated into functional currency at
the appropriate exchange rate between the functional currency and the
nonfunctional currency. Such exchange rate is determined under the
principles of paragraph (c) of this section, substituting the words
``functional currency'' for the word ``dollar'' and using the exchange
rate that was used to translate such amount into the QBU's functional
currency when claimed as a credit or added to PTEP group taxes (as
defined in Sec. 1.960-3(d)(1)). If a QBU receives a refund of
nonfunctional currency tax that is denominated in a currency that was
the functional currency of the QBU when the refunded tax was claimed as
a credit or added to PTEP group taxes, the QBU's basis in the
nonfunctional currency received in the refund is determined by using
the exchange rate used under Sec. 1.985-5(c) when the QBU's functional
currency changed. See Sec. 1.905-3(b)(1)(ii)(C) (Example 3).
(3) Functional currency tax liabilities. If the functional currency
of the QBU receiving the refund is the currency in which the refund was
made, then the recipient's basis in the currency received is the amount
of the functional currency received. If the QBU receives a refund of
functional currency tax that was denominated in a nonfunctional
currency of the QBU when the tax was claimed as a credit or added to
PTEP group taxes, the QBU will recognize the section 988 gain or loss
that would have been recognized under Sec. 1.985-5(b) if the refund
had been received
[[Page 69123]]
immediately before the QBU's functional currency changed.
(4) Foreign currency gain or loss. For rules for determining
subsequent foreign currency gain or loss on the disposition of
nonfunctional currency, the basis of which is determined under this
paragraph (e), see section 988(c)(1)(C).
(f) Applicability dates. This section applies to taxable years
ending on or after December 16, 2019, and to taxable years of foreign
corporations which end with or within a taxable year of a United States
shareholder ending on or after December 16, 2019.
0
Par. 46. Section 1.988-2 is amended by:
0
1. Removing the language ``paragraph (a)(2)(iii)(B)'' and adding the
language ``paragraphs (a)(2)(iii)(B) and (C)'' in its place in
paragraph (a)(2)(iii)(A).
0
2. Adding paragraph (a)(2)(iii)(C).
The additions read as follows:
Sec. 1.988-2 Recognition and computation of exchange gain or loss.
(a) * * *
(2) * * *
(iii) * * *
(C) Basis in refunded foreign income tax. See Sec. 1.986(a)-1(e)
for rules relating to the determination of basis in refunded foreign
income tax denominated in nonfunctional currency.
* * * * *
Sunita Lough,
Deputy Commissioner for Services and Enforcement.
Approved: October 30, 2019.
David J. Kautter,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2019-24848 Filed 12-16-19; 8:45 am]
BILLING CODE 4830-01-P